Freddie Mac 2009 Annual Report Download - page 276

swap with the same maturity as the last debt issuance is the substantive economic equivalent of a long-term fixed-rate debt
instrument of comparable maturity. Similarly, the combination of non-callable debt and a call swaption, or option to enter
into a receive-fixed interest rate swap, with the same maturity as the non-callable debt, is the substantive economic
equivalent of callable debt. These derivatives strategies increase our funding flexibility and allow us to better match asset
and liability cash flows, often reducing overall funding costs.
Adjust Funding Mix
We generally use interest-rate swaps to mitigate contractual funding mismatches between our assets and liabilities. We
also use swaptions and other option-based derivatives to adjust the contractual terms of our debt funding in response to
changes in the expected lives of our investments in mortgage-related assets. As market conditions dictate, we take
rebalancing actions to keep our interest-rate risk exposure within management-set limits. In a declining interest-rate
environment, we typically enter into receive-fixed interest rate swaps or purchase Treasury-based derivatives to shorten the
duration of our funding to offset the declining duration of our mortgage assets. In a rising interest-rate environment, we
typically enter into pay-fixed interest rate swaps or sell Treasury-based derivatives in order to lengthen the duration of our
funding to offset the increasing duration of our mortgage assets.
Foreign-Currency Exposure
We use foreign-currency swaps to eliminate virtually all of our exposure to fluctuations in exchange rates related to our
foreign-currency denominated debt by entering into swap transactions that effectively convert foreign-currency denominated
obligations into U.S. dollar-denominated obligations.
Types of Derivatives
We principally use the following types of derivatives:
• LIBOR- and Euribor-based interest-rate swaps;
• LIBOR- and Treasury-based options (including swaptions);
• LIBOR- and Treasury-based exchange-traded futures; and
• Foreign-currency swaps.
In addition to swaps, futures and purchased options, our derivative positions include the following:
Written Options and Swaptions
Written call and put swaptions are sold to counterparties allowing them the option to enter into receive- and pay-fixed
interest rate swaps, respectively. Written call and put options on mortgage-related securities give the counterparty the right to
execute a contract under specified terms, which generally occurs when we are in a liability position. We use these written
options and swaptions to manage convexity risk over a wide range of interest rates. Written options lower our overall
hedging costs, allow us to hedge the same economic risk we assume when selling guaranteed final maturity REMICs with a
more liquid instrument and allow us to rebalance the options in our callable debt and REMIC portfolios. We may, from time
to time, write other derivative contracts such as caps, floors, interest-rate futures and options on buy-up and buy-down
commitments.
Forward Purchase and Sale Commitments
We routinely enter into forward purchase and sale commitments for mortgage loans and mortgage-related securities.
Most of these commitments are derivatives subject to the requirements of derivatives and hedge accounting.
Swap Guarantee Derivatives
We issue swap guarantee derivatives that guarantee the payments on (a) multifamily mortgage loans that are originated
and held by state and municipal housing finance agencies to support tax-exempt multifamily housing revenue bonds and
(b) Freddie Mac pass-through certificates which are backed by tax-exempt multifamily housing revenue bonds and related
taxable bonds and/or loans. In connection with some of these guarantees, we may also guarantee the sponsor’s or the
borrower’s performance as a counterparty on any related interest-rate swaps used to mitigate interest-rate risk.
Credit Derivatives
We have entered into credit derivatives, including risk-sharing agreements. Under these risk-sharing agreements, default
losses on specific mortgage loans delivered by sellers are compared to default losses on reference pools of mortgage loans
with similar characteristics. Based upon the results of that comparison, we remit or receive payments based upon the default
performance of the referenced pools of mortgage loans. In addition, we have entered into agreements whereby we assume
credit risk for mortgage loans held by third parties in exchange for a monthly fee, where we are obligated to purchase
delinquent mortgage loans in certain circumstances.
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