AIG 2005 Annual Report Download - page 179

AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES
meet the needs of counterparties who may be seeking to hedge
19. Variable Interest Entities
certain aspects of such counterparties’ operations or obtain a
Continued
desired financial exposure. AIGFP also enters into derivative
AIGFP has significant variable interests in various transac- transactions to hedge the financial exposures arising from its
tions where AIGFP is not the primary beneficiary. These counterparty transactions. Such derivative transactions include
transactions consist principally of structured financings, in interest rate, currency, commodity, credit and equity swaps,
which AIGFP owns an investment interest or is a lender, swaptions, and forward commitments. Interest rate swap
financial derivatives or credit support provider. At Decem- transactions generally involve the exchange of fixed and
ber 31, 2005 and 2004, the total assets of these entities were floating rate interest payment obligations without the exchange
$29.9 billion and $18.1 billion, respectively. AIGFP’s maxi- of the underlying principal amounts. AIGFP typically becomes
mum exposure to loss in these transactions, at December 31, a principal in the exchange of interest payments between the
2005, was $15.1 billion in the aggregate. parties and, therefore, is exposed to counterparty credit risk
and may be exposed to loss, if counterparties default. Currency,
20. Derivatives commodity, and equity swaps are similar to interest rate swaps,
but involve the exchange of specific currencies or cashflows
Derivatives are financial arrangements among two or more
based on the underlying commodity, equity securities or
parties with returns linked to or ‘‘derived’’ from some
indices. Also, they may involve the exchange of principal
underlying equity, debt, commodity or other asset, liability, or
amounts at the beginning and end of the transaction.
index. Derivative payments may be based on interest rates and
Swaptions are options where the holder has the right but not
exchange rates and/or prices of certain securities, commodities,
the obligation to enter into a swap transaction or cancel an
or financial or commodity indices or other variables. These
existing swap transaction. At December 31, 2005, the aggre-
instruments are carried at fair value in the consolidated
gate notional principal amount of AIGFP’s outstanding swap
balance sheet. Collateral is required, at the discretion of AIG,
transactions approximated $1,224 billion, primarily related to
on certain transactions based on the creditworthiness of the
interest rate swaps of approximately $837.4 billion.
counterparty.
Notional amount represents a standard of measurement of
The overwhelming majority of AIG’s derivatives activities
the volume of swaps business of Capital Markets operations.
are conducted by the Capital Markets operations. AIGFP
Notional amount is not a quantification of market risk or
becomes a party to derivative financial instruments in the
credit risk and is not recorded on the consolidated balance
normal course of business and to reduce currency, interest rate,
sheet. Notional amounts generally represent those amounts
commodity, and equity exposures. Interest rate, currency,
used to calculate contractual cash flows to be exchanged and
commodity, and equity risks related to such instruments are
are not paid or received, except for certain contracts such as
reflected in the consolidated financial statements and are
currency swaps.
carried at a market or a fair value, whichever is appropriate.
The timing and the amount of cash flows relating to
The recorded estimated fair values of such instruments may be
Capital Markets foreign exchange forwards and exchange
different from the values that might be realized if AIGFP was
traded futures and options contracts are determined by each of
required to sell or close out the transactions prior to maturity.
the respective contractual agreements.
AIGFP, in the ordinary course of operations and as
principal, structures and enters into derivative transactions to
The following table presents the contractual and notional amounts by maturity and type of derivative of Capital Markets
derivatives portfolio at December 31, 2005 and 2004:
Remaining Life of Notional Amount*
One Two Through Six Through After Ten Total Total
(in millions) Year Five Years Ten Years Years 2005 2004
Capital Markets interest rate, currency and
equity swaps and swaptions:
Notional amount:
Interest rate swaps $235,255 $440,686 $141,482 $19,966 $ 837,389 $ 858,733
Currency swaps 57,555 103,483 35,886 14,595 211,519 275,466
Swaptions, equity and commodity swaps 84,960 52,566 22,148 15,423 175,097 151,789
Total $377,770 $596,735 $199,516 $49,984 $1,224,005 $1,285,988
* Notional amount is not representative of either market risk or credit risk and is not recorded on the consolidated balance sheet.
Futures and forward contracts are contracts that obligate the ment, at a specified price or yield. Options are contracts that
holder to sell or purchase foreign currencies, commodities or allow the holder of the option to purchase or sell the
financial indices in which the seller/purchaser agrees to make/ underlying commodity, currency or index at a specified price
take delivery at a specified future date of a specified instru- and within, or at, a specified period of time. As a writer of
AIG m Form 10-K 127