Freddie Mac 2004 Annual Report Download - page 116

‚ master netting agreements and collateral agreements; and
‚ stress-testing to evaluate potential exposure under possible adverse market scenarios.
On an ongoing basis, we review the credit fundamentals of all of our derivative counterparties to conÑrm
that they continue to meet internal standards. Internal ratings, credit, capital and trading limits are assigned to
each counterparty based on quantitative and qualitative analysis, which we update and monitor on a regular
basis. Additional reviews are completed when market conditions dictate or events aÅecting an individual
counterparty occur.
Derivative Counterparties. Our standards for entering into OTC interest-rate swaps, option-based
derivatives and foreign-currency swaps include rigorous internal credit and legal reviews. Our derivative
counterparties carry external credit ratings among the highest available from major rating agencies. All of
these counterparties are major Ñnancial institutions and are experienced participants in the OTC derivatives
market.
Master Netting and Collateral Agreements. We use master netting and collateral agreements to reduce
our credit risk exposure to our active OTC derivative counterparties for interest-rate swaps, option-based
derivatives and foreign-currency swaps. Master netting agreements provide for the netting of amounts
receivable and payable from an individual counterparty, which reduces our exposure to a single counterparty in
the event of default. For example, if we have a gain position on one derivative and a loss position on another
derivative with the same counterparty, then the gain can be netted with the loss to determine the amount of
our net exposure to the counterparty. On a daily basis, the market value of each counterparty's derivatives
outstanding is calculated to determine the amount of our net credit exposure, which is equal to derivatives in a
net gain position by counterparty after giving consideration to collateral posted. Our collateral agreements
require most counterparties to post collateral for the amount of our net exposure to them above the applicable
threshold. Collateral posting thresholds are generally tied to a counterparty's credit rating. Derivative
exposures and collateral amounts are monitored on a daily basis using both internal pricing models and dealer
price quotes. Our derivative counterparties typically transfer collateral within one to three business days based
on the values of the related derivatives. As described further below, this time lag in posting collateral can
aÅect our net uncollateralized exposure to derivative counterparties.
The collateral posted by counterparties serves to protect us against the risk of counterparty credit losses.
Collateral posted by a derivative counterparty is typically in the form of cash, U.S. Treasury securities, agency
securities or other mortgage-related securities. In the event a counterparty defaults on its obligations under the
derivatives agreement and the default is not remedied in the manner prescribed in the agreement, we have the
right under the agreement to direct the custodian bank to transfer the collateral to us or, in the case of non-
cash collateral, to sell the collateral and transfer the proceeds to us.
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