Freddie Mac 2010 Annual Report Download - page 159

Where applicable, prices are back-tested by comparing the settlement prices to our fair value measurements. Analytical
procedures include automated checks of prices for reasonableness based on variations from prices in previous periods,
comparisons of prices to internally calculated expected prices, based on market moves, and relative value and yield
comparisons based on specific characteristics of securities. To the extent that we determine that a price is outside of
established parameters, we will further examine the price, including follow up discussions with the specific pricing service or
dealer and ultimately not use that price if we are not able to determine that the price is valid. The prices provided to us
consider the existence of credit enhancements, including monoline insurance coverage and the current lack of liquidity in the
marketplace. These processes are executed prior to the use of the prices in the financial statements.
Where models are employed to assist in the measurement of fair value, all changes made to those models during the
periods presented are put through the corporate model change governance process and material changes are reviewed by the
Valuation Committee. Inputs used by those models are regularly updated for changes in the underlying data, assumptions,
valuation inputs, or market conditions.
Consolidated Fair Value Balance Sheets Analysis
Our consolidated fair value balance sheets present our estimates of the fair value of our financial assets and liabilities.
See “NOTE 20: FAIR VALUE DISCLOSURES — Table 20.6 — Consolidated Fair Value Balance Sheets” for our fair value
balance sheets. In conjunction with the preparation of our consolidated fair value balance sheets, we use a number of
financial models. See “RISK FACTORS,” “RISK MANAGEMENT — Operational Risks” and “QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK — Interest-Rate Risk and Other Market Risks” for information
concerning the risks associated with these models.
During 2010 and 2009, our fair value results were impacted by several improvements in our approach for estimating the
fair value of certain financial instruments. See “CRITICAL ACCOUNTING POLICIES AND ESTIMATES,” “NOTE 1:
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,” and “NOTE 20: FAIR VALUE DISCLOSURES” for more
information on fair values.
Key Components of Changes in Fair Value of Net Assets
Our attribution of changes in the fair value of net assets relies on models, assumptions, and other measurement
techniques that evolve over time. The following are the key components of the attribution analysis:
Core Spread Income
Core spread income on our investments in mortgage loans and mortgage-related securities is a fair value estimate of the
net current period accrual of income from the spread between our mortgage-related investments and our debt, calculated on
an option-adjusted basis. OAS is an estimate of the yield spread between a given financial instrument and a benchmark
(LIBOR, agency or Treasury) yield curve, after consideration of potential variability in the instrument’s cash flows resulting
from any options embedded in the instrument, such as prepayment options.
Changes in Mortgage-To-Debt OAS
The fair value of our net assets can be significantly affected from period to period by changes in the net OAS between
the mortgage and agency debt sectors. The fair value impact of changes in OAS for a given period represents an estimate of
the net unrealized increase or decrease in fair value of net assets arising from net fluctuations in OAS during that period. We
do not attempt to hedge or actively manage the basis risk represented by the impact of changes in mortgage-to-debt OAS
because we generally hold a substantial portion of our mortgage assets for the long-term and we do not believe that periodic
increases or decreases in the fair value of net assets arising from fluctuations in OAS will significantly affect the long-term
value of our investments in mortgage loans and mortgage-related securities.
Asset-Liability Management Return
Asset-liability management return represents the estimated net increase or decrease in the fair value of net assets
resulting from net exposures related to the market risks we actively manage. We do not hedge all of the interest-rate risk that
exists at the time a mortgage is purchased or that arises over its life. The market risks to which we are exposed as a result of
our investment activities that we actively manage include duration and convexity risks, yield curve risk and volatility risk.
We seek to manage these risk exposures within prescribed limits as part of our overall investment strategy. Taking these
risk positions and managing them within prudent limits is an integral part of our investment activity. We expect that the net
exposures related to market risks we actively manage will generate fair value returns, although those positions may result in
a net increase or decrease in fair value for a given period. See “QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK — Interest-Rate Risk and Other Market Risks” for more information.
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