Freddie Mac 2006 Annual Report Download - page 158

Mortgage-related securities, excluding PC residuals
Mortgage-related securities represent pass-throughs and other mortgage-related securities classiÑed as available-for-sale
and trading, which are already reÖected at fair value on our GAAP consolidated balance sheets. Mortgage-related securities
consist of securities issued by us, Fannie Mae and Ginnie Mae, as well as non-agency mortgage-related securities.
The fair value of securities with readily available third-party market prices is generally based on market prices obtained
from broker/dealers or reliable third-party pricing service providers. Fair value may be estimated by using third-party quotes
for similar instruments, adjusted for diÅerences in contractual terms. For other securities, a market option-adjusted spread
approach based on observable market parameters is used to estimate fair value. Option-adjusted spreads for certain securities
are estimated by deriving the option-adjusted spread for the most closely comparable security with an available market
price, using proprietary interest-rate and prepayment models. If necessary, our judgment is applied to estimate the impact of
diÅerences in prepayment uncertainty or other unique cash Öow characteristics related to that particular security. Fair values
for these securities are then estimated by using the estimated option-adjusted spread as an input to the interest-rate and
prepayment models, and estimating the net present value of the projected cash Öows. The remaining instruments are priced
using other modeling techniques or by using other securities as proxies.
PC residuals
PC residuals are reported at fair value on our GAAP consolidated balance sheets. Fair value for PC residuals is
estimated in the same manner as described for the Guarantee asset and the Guarantee obligation for PCs below.
Cash and cash equivalents
Cash and cash equivalents largely consist of highly liquid investment securities with an original maturity of three
months or less used for cash management purposes, as well as cash collateral posted by our derivative counterparties. Given
that these assets are short-term in nature with limited market value volatility, the carrying amount on our GAAP
consolidated balance sheets is deemed to be a reasonable approximation of fair value.
Investments
At December 31, 2006 and 2005, Investments consists solely of non-mortgage-related securities, which are reported at
fair value on our GAAP consolidated balance sheets. The fair values of Investments were estimated using the methods
described above in ""Mortgage-related securities, excluding PC residuals.''
Securities purchased under agreements to resell and Federal funds sold
Securities purchased under agreements to resell and Federal funds sold principally consists of short-term contractual
agreements such as reverse repurchase agreements involving Treasury and agency securities, Federal funds sold and
Eurodollar time deposits. Given that these assets are short-term in nature, the carrying amount on our GAAP consolidated
balance sheets is deemed to be a reasonable approximation of fair value.
Derivative assets
Derivative assets, at fair value largely consists of interest-rate swaps, option-based derivatives, futures, and forward
purchase and sale commitments that we account for as derivatives, which are reÖected at fair value on our GAAP
consolidated balance sheets. The fair values of interest-rate swaps are determined by using the appropriate yield curves to
calculate and discount the expected cash Öows for both the Ñxed-rate and variable-rate components of the swap contracts.
Option-based derivatives, which principally include call and put swaptions, are valued using an option-pricing model. This
model uses market interest rates and market-implied option volatilities, where available, to calculate the option's fair value.
Market-implied option volatilities are based on information obtained from broker/dealers. The fair value of exchange-
traded futures is based on end-of-day closing prices obtained from third-party pricing services. Derivative forward purchase
and sale commitments are valued using the methods described for mortgage-related securities valuation above.
The fair value of derivative assets considers the impact of institutional credit risk in the event that the counterparty does
not honor its payment obligation. Our fair value of derivatives is not adjusted for expected credit losses because we obtain
collateral from most counterparties typically within one business day of the daily market value calculation and substantially
all of our credit risk arises from counterparties with investment-grade credit ratings of A¿ or above.
Guarantee asset
At December 31, 2006 and 2005, we had a Guarantee asset on our GAAP consolidated balance sheets for
approximately 95 percent and 93 percent, respectively, of PCs and Structured Securities held by third parties. For more
information regarding the accounting for the Guarantee asset related to PCs and Structured Securities, see ""NOTE 1:
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.''
146 Freddie Mac