Freddie Mac 2010 Annual Report Download - page 277

Interest-Rate Swaps and Option-Based Derivatives
The fair values of interest-rate swaps are determined by using the appropriate yield curves to discount the expected cash
flows of both the fixed and variable rate components of the swap contracts. In doing so, we first observe publicly available
market spot interest rates, such as money market rates, Eurodollar futures contracts and LIBOR swap rates. The spot curves
are translated to forward curves using internal models. From the forward curves, the periodic cash flows are calculated on
the pay and receive side of the swap and discounted back at the relevant forward rates to arrive at the fair value of the swap.
Since the fair values of the swaps are determined by using observable inputs from active markets, these are generally
classified as Level 2 under the fair value hierarchy.
Option-based derivatives include call and put swaptions and other option-based derivatives, the majority of which are
European options. The fair values of the European call and put swaptions are calculated by using market observable interest
rates and dealer-supplied interest rate volatility grids as inputs to our option-pricing models. Within each grid, prices are
determined based on the option term of the underlying swap and the strike rate of the swap. Derivatives with embedded
American options are valued using dealer-provided pricing grids. The grids contain prices corresponding to specified option
terms of the underlying swaps and the strike rate of the swaps. Interpolation is used to calculate prices for positions for
which specific grid points are not provided. Derivatives with embedded Bermudan options are valued based on prices
provided directly by counterparties. Swaptions are classified as Level 2 under the fair value hierarchy. Other option-based
derivatives include exchange-traded options that are valued by exchange-published daily closing prices. Therefore, exchange-
traded options are classified as Level 1 under the fair value hierarchy. Other option-based derivatives also include purchased
interest-rate cap and floor contracts that are valued by using observable market interest rates and cap and floor rate volatility
grids obtained from dealers, and cancellable interest rate swaps that are valued by using dealer prices. Cap and floor
contracts are classified as Level 2 and cancellable interest rate swaps with fair values using significant unobservable inputs
are classified as Level 3 under the fair value hierarchy.
As of December 31, 2010, the fair value of our interest-rate swaps, before counterparty and cash collateral netting
adjustments, was $(17.5) billion. The fair value of option-based derivatives, before counterparty and cash collateral netting
adjustments, was $11.0 billion on December 31, 2010, with a remaining weighted-average life of 4.46 years. Table 20.5
below shows the fair value, prior to counterparty and cash collateral netting adjustments, for our interest-rate swaps and
option-based derivatives and the maturity profile of our derivative positions. It also provides the weighted-average fixed rates
of our pay-fixed and receive-fixed swaps.
Table 20.5 — Fair Values and Maturities for Interest-Rate Swaps and Option-Based Derivatives
Notional or
Contractual Amount
Total Fair
Value
(2)
Less than
1 Year
1to3
Years
Greater than 3
and up to 5 Years
In Excess
of 5 Years
Fair Value
(1)
December 31, 2010
(dollars in millions)
Interest-rate swaps:
Receive-fixed:
Swaps ................................. $302,178 $ 3,314 $ 137 $ 534 $ 1,269 $ 1,374
Weighted average fixed rate
(3)
............... 1.54% 1.12% 2.39% 3.66%
Forward-starting swaps
(4)
.................... 22,412 371 — 123 (9) 257
Weighted average fixed rate
(3)
............... — 3.47% 1.88% 4.19%
Basis (floating to floating) . .................... 2,375 4 — — 4 —
Pay-fixed:
Swaps ................................. 338,035 (17,189) (273) (1,275) (3,297) (12,344)
Weighted-average fixed rate
(3)
............... 3.11% 2.21% 3.04% 4.02%
Forward-starting swaps
(4)
.................... 56,259 (4,009) — — — (4,009)
Weighted-average fixed rate
(3)
............... — — — 4.54%
Total interest-rate swaps . .................... $721,259 $(17,509) $ (136) $ (618) $(2,033) $(14,722)
Option-based derivatives:
Call swaptions . . . .......................... $125,885 $ 8,147 $2,754 $ 2,661 $ 1,246 $ 1,486
Put swaptions . . . .......................... 65,975 1,396 136 451 226 583
Other option-based derivatives
(5)
................. 47,234 1,450 (8) — (1) 1,459
Total option-based ......................... $239,094 $ 10,993 $2,882 $ 3,112 $ 1,471 $ 3,528
(1) Fair value is categorized based on the period from December 31, 2010 until the contractual maturity of the derivatives.
(2) Represents fair value for each product type, prior to counterparty netting, cash collateral netting, net trade/settle or payable, and net derivative interest
receivable or payable adjustments.
(3) Represents the notional weighted average rate for the fixed leg of the swaps.
(4) Represents interest-rate swap agreements that are scheduled to begin on future dates ranging from less than one year to fifteen years.
(5) Primarily includes purchased interest rate caps and floors.
274 Freddie Mac