Freddie Mac 2004 Annual Report Download - page 69

in hedge accounting relationships increased signiÑcantly during the second quarter of 2004, and the notional
balance of our receive-Ñxed swaps not in hedge accounting relationships increased signiÑcantly during the
fourth quarter of 2004.
Changes in the fair value of our pay-Ñxed and receive-Ñxed interest-rate swaps are primarily driven by
changes in interest rates. Generally, the fair value of our interest-rate swaps is aÅected by changes in long-
term spot swap rates or, if our interest-rate swaps are forward-starting, long-term forward swap rates. Forward-
starting swaps represent interest-rate swap agreements scheduled to begin on a future date. During 2004,
signiÑcant portions of our swaps not in hedge accounting relationships were forward-starting.
Both spot and forward swap rates were volatile during the year causing signiÑcant changes in the fair
values of our interest rate swaps. Generally, these rates moved in tandem, however, in the fourth quarter of
2004 forward rates declined, ending the year lower than the prior year end, whereas spot rates increased,
ending the year at roughly the same level as the prior year end.
During 2004, net losses on our pay-Ñxed swap portfolio were driven by the overall decline in forward rates.
As shown in Table 27, our pay-Ñxed swap positions experienced net gains of $5.7 billion during the second
quarter of 2004 as spot rates increased from the prior quarter end. However, our pay-Ñxed swap positions
experienced losses of ($5.0) billion in the third quarter of 2004 as spot rates decreased from the prior quarter
end. In the fourth quarter of 2004, we experienced net losses on our forward starting pay-Ñxed swaps as
forward rates declined, partially oÅset by the eÅect of an increase in spot rates which aÅect our current starting
swaps. Our receive-Ñxed swap positions, which generally lose value with increases in interest rates,
experienced net losses during 2004 related primarily to increases in spot rates during the last two months of the
fourth quarter.
In addition, during 2004, there were net losses on our call and put swaption positions as the fair values of
these positions were driven by changes in swap rates and the decline in implied volatilities of interest rates
during the year. Our net swaption position resulted in net gains during the Ñrst and third quarters of 2004
driven by gains in call swaptions due to the decline in swap rates from the prior quarter ends. Our net swaption
position resulted in net losses of ($4.0) billion during the second quarter of 2004 driven by losses in call
swaptions as swap rates increased from the prior quarter end and implied volatilities of interest rates declined.
In the fourth quarter of 2004, our net swaption position resulted in net losses as implied volatilities of interest
rates declined.
The movement of the pay-Ñxed and receive-Ñxed swaps to no hedge designation during 2004 was the
primary driver of the increase in the accrual of periodic settlements (presented in Table 27 above) recorded in
derivative gains (losses) as compared to 2003. Had these pay-Ñxed and receive-Ñxed swaps remained in hedge
accounting relationships, the related accrual of periodic settlements would have been reported as a component
of Net interest income (loss). The increase in the notional balance of our pay-Ñxed swaps not in hedge
accounting relationships contributed to the $0.4 billion increase in the net expense associated with the accrual
of periodic settlements in the second quarter of 2004 as compared to the Ñrst quarter of 2004. This expense
continued to be high in the third and fourth quarters of 2004, but began to be partially oÅset by the accrual of
periodic settlements related to the receive-Ñxed swaps, which were moved to no hedge designation during the
fourth quarter of 2004.
Derivative gains (losses) Öuctuated signiÑcantly during 2003 due to the decrease in interest rates during
the Ñrst half of 2003 versus an increase in interest rates during the third quarter of 2003. During the second
quarter of 2003, derivative gains of $3.5 billion were primarily driven by a $3.1 billion gain in the value of call
swaptions, which was due to interest rate declines during the quarter. As interest rates increased during the
third quarter of 2003, our call swaptions declined in value by ($3.1) billion and we incurred ($1.4) billion of
losses on commitments to purchase or sell mortgages and mortgage-related securities. These losses were
partially oÅset by $2.1 billion in gains on pay-Ñxed swaps.
During 2002, derivative gains (losses) were largest in the third quarter when the gains totaled $6.3 billion.
This third quarter gain in 2002 was driven by a $4.8 billion gain on call swaptions, net of losses on put
swaptions and a $1.3 billion gain on receive-Ñxed swaps, net of losses on pay-Ñxed swaps. The decrease in
interest rates in the third quarter of 2002 increased the fair value of the interest-rate swaps underlying the call
Freddie Mac
57