Freddie Mac 2009 Annual Report Download - page 85

We also use derivatives to synthetically create the substantive economic equivalent of various debt funding structures.
For example, the combination of a series of short-term debt issuances over a defined period and a pay-fixed interest rate
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 with the same
maturity as the noncallable debt, is the substantive economic equivalent of callable debt. However, the use of these
derivatives may expose us to additional counterparty credit risk. Due to limits on our ability to issue long-term and callable
debt in the second half of 2008 and the first few months of 2009, we pursued these strategies during those periods. For a
discussion regarding our ability to issue debt, see “LIQUIDITY AND CAPITAL RESOURCES — Liquidity — Debt
Securities.”
During 2009, the mix and volume of our derivative portfolio were impacted by fluctuations in swap interest rates,
resulting in a loss on derivatives of $1.9 billion. Longer-term swap interest rates and implied volatility both increased during
2009. As a result of these factors, we recorded gains on our pay-fixed swap positions, partially offset by losses on our
receive-fixed swaps. We also recorded losses on our purchased call swaptions, as the impact of the increasing forward swap
interest rates more than offset the impact of higher implied volatility.
During 2008, we recognized a significantly larger derivative loss than we recognized for 2007 primarily because swap
interest rates declined significantly in 2008 resulting in a loss of $58.3 billion on our pay-fixed swap positions, partially
offset by gains of $30.2 billion on our receive-fixed swaps. Additionally, the decrease in forward swap interest rates during
2008, combined with an increase in implied volatility, resulted in a gain of $17.2 billion related to our purchased call
swaptions.
During 2007, overall decreases in interest rates across the swap yield curve resulted in fair value losses on our interest
rate swap derivative portfolio that were partially offset by fair value gains on our option-based derivative portfolio. Gains on
our option-based derivative portfolio resulted from an overall increase in implied volatility and decreasing interest rates. The
overall decline in interest rates resulted in a loss of $11.4 billion on our pay-fixed swaps that was only partially offset by a
$3.9 billion gain on our receive-fixed swap position. Gains on option-based derivatives, particularly purchased call swaptions,
increased in 2007 to $2.3 billion.
Derivative Instruments Related to Foreign-Currency Denominated Debt
As a result of our election of the fair value option for our foreign-currency denominated debt, foreign-currency
translation gains and losses and fair value adjustments related to our foreign-currency denominated debt are recognized on
our consolidated statements of operations as gains (losses) on debt recorded at fair value. Due to this election, we can better
reflect in earnings the economic offset that exists between certain derivative instruments and our foreign-currency
denominated debt. We use a combination of foreign-currency swaps and foreign-currency denominated receive-fixed interest
rate swaps to manage the risks of changes in fair value of our foreign-currency denominated debt related to fluctuations in
exchange rates and interest rates, respectively. This economic offset is reflected in our results as follows:
• fair value gains (losses) related to translation, which is a component of gains (losses) on debt recorded at fair value,
was partially offset by derivative gains (losses) on foreign-currency swaps; and
• gains (losses) relating to interest rate and instrument-specific credit risk adjustments, which is also a component of
gains (losses) on debt recorded at fair value, was partially offset by derivative gains (losses) on foreign-currency
denominated receive-fixed interest rate swaps.
During 2009, we recognized fair value gains (losses) of $(405) million on our foreign-currency denominated debt. This
amount included:
• fair value gains (losses) related to translation of $(209) million, which was partially offset by derivative gains (losses)
on foreign-currency swaps of $138 million; and
• fair value gains (losses) relating to interest rate and instrument-specific credit risk adjustments of $(196) million,
which was partially offset by derivative gains (losses) on foreign-currency denominated receive-fixed interest rate
swaps of $64 million.
During 2008, we recognized fair value gains (losses) of $406 million on our foreign-currency denominated debt. This
amount included:
• fair value gains (losses) related to translation of $710 million, which was partially offset by derivative gains (losses)
on foreign-currency swaps of $(584) million; and
• fair value gains (losses) relating to interest rate and instrument-specific credit risk adjustments of $(304) million,
which was partially offset by derivative gains (losses) on foreign-currency denominated receive-fixed interest rate
swaps of $489 million.
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