Freddie Mac 2010 Annual Report Download - page 156

Given the substantial senior preferred stock dividend obligation to Treasury, which will increase with additional draws,
senior preferred stock dividend payments will contribute to our future draw requests under the Purchase Agreement with
Treasury.
For more information on the Purchase Agreement, its effect on our business and capital management activities, and the
potential impact of making additional draws, see “Liquidity — Dividend Obligation on the Senior Preferred Stock,”
“BUSINESS — Executive Summary — Long-Term Financial Sustainability and Future Status” and “RISK FACTORS.”
FAIR VALUE MEASUREMENTS AND ANALYSIS
Fair Value Measurements
Fair value represents the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. The accounting standards for fair value measurements and
disclosures establish a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value based
on the inputs a market participant would use at the measurement date. Observable inputs reflect market data obtained from
independent sources. Unobservable inputs reflect assumptions based on the best information available under the
circumstances. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available, or in
situations where there is little, if any, market activity for an asset or liability at the measurement date. We use valuation
techniques that maximize the use of observable inputs, where available, and minimize the use of unobservable inputs.
The three levels of the fair value hierarchy under the accounting standards for fair value measurements and disclosures
are described below:
• Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical assets
or liabilities;
• Level 2: Quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets
and liabilities in markets that are not active; inputs other than quoted market prices that are observable for
the asset or liability; and inputs that are derived principally from or corroborated by observable market data
for substantially the full term of the assets or liabilities; and
• Level 3: Unobservable inputs for the asset or liability that are supported by little or no market activity and that are
significant to the fair values.
We categorize assets and liabilities measured and reported at fair value in our consolidated balance sheets within the fair
value hierarchy based on the valuation process used to derive their fair values and our judgment regarding the observability
of the related inputs. Those judgments are based on our knowledge and observations of the markets relevant to the individual
assets and liabilities and may vary based on current market conditions. In applying our judgments, we review ranges of third
party prices and transaction volumes, and hold discussions with dealers and pricing service vendors to understand and assess
the extent of market benchmarks available and the judgments or modeling required in their processes. Based on these factors,
we determine whether the inputs are observable and whether the principal markets are active or inactive.
Our Level 1 financial instruments consist of exchange-traded derivatives, Treasury bills, and Treasury notes, where
quoted prices exist for the exact instrument in an active market.
Our Level 2 instruments generally consist of high credit quality agency securities, CMBS, non-mortgage-related asset-
backed securities, FDIC guaranteed corporate medium-term notes, interest-rate swaps, option-based derivatives, and foreign-
currency denominated debt. These instruments are generally valued through one of the following methods: (a) dealer or
pricing service inputs with the value derived by comparison to recent transactions involving similar securities and adjusting
for differences in prepayment or liquidity characteristics; or (b) modeled through an industry standard modeling technique
that relies upon observable inputs such as discount rates and prepayment assumptions.
Our Level 3 assets primarily consist of non-agency mortgage-related securities. The non-agency mortgage-related
securities market continued to be illiquid during 2010, with low transaction volumes, wide credit spreads, and limited
transparency. We value the non-agency mortgage-related securities we hold based primarily on prices received from pricing
services and dealers. The techniques used by these pricing services and dealers to develop the prices generally are either:
(a) a comparison to transactions involving instruments with similar collateral and risk profiles; or (b) industry standard
modeling, such as a discounted cash flow model. For a large majority of the securities we value using dealers and pricing
services, we obtain at least three independent prices, which are non-binding both to us and our counterparties. When multiple
prices are received, we use the median of the prices. The models and related assumptions used by the dealers and pricing
services are owned and managed by them. However, we have an understanding of their processes used to develop the prices
provided to us based on our ongoing due diligence. We periodically have discussions with our dealers and pricing service
vendors to maintain a current understanding of the processes and inputs they use to develop prices. We make no adjustments
to the individual prices we receive from third party pricing services or dealers for non-agency mortgage-related securities
153 Freddie Mac