Freddie Mac 2010 Annual Report Download - page 77

Gains (Losses) on Debt Recorded at Fair Value
Gains (losses) on debt recorded at fair value primarily relates to changes in the fair value of our foreign-currency
denominated debt. During 2010, we recognized gains on debt recorded at fair value of $580 million primarily due to the U.S.
dollar strengthening relative to the Euro. During 2009 and 2008, we recognized gains (losses) on debt recorded at fair value
of $(404) million and $406 million, respectively, primarily due to fluctuations in exchange rates of the U.S. dollar relative to
the Euro. We mitigate changes in the fair value of our foreign-currency denominated debt by using foreign currency swaps
and foreign-currency denominated interest-rate swaps.
Derivative Gains (Losses)
Table 12 presents derivative gains (losses) reported in our consolidated statements of operations. See “NOTE 12:
DERIVATIVES — Table 12.2 — Gains and Losses on Derivatives” for information about gains and losses related to specific
categories of derivatives. Changes in fair value and interest accruals on derivatives not in hedge accounting relationships are
recorded as derivative gains (losses) in our consolidated statements of operations. At December 31, 2010 and 2009, we did
not have any derivatives in hedge accounting relationships; however, there are amounts recorded in AOCI related to
discontinued cash flow hedges. Amounts deferred in AOCI associated with these closed cash flow hedges are reclassified to
earnings when the forecasted transactions affect earnings. While derivatives are an important aspect of our management of
interest-rate risk, they generally increase the volatility of reported net income (loss), because, while fair value changes in
derivatives affect net income, fair value changes in several of the types of assets and liabilities being hedged do not affect net
income.
Table 12 — Derivative Gains (Losses)
Derivatives not designated as hedging instruments under
the accounting standards for derivatives and hedging 2010 2009 2008
Year Ended December 31,
Derivative Gains (Losses)
(in millions)
Interest-rate swaps . . . ............................................................. $(7,679) $ 13,611 $(27,965)
Option-based derivatives
(1)
.......................................................... 4,843 (10,686) 17,080
Other derivatives
(2)
............................................................... (755) (882) (2,774)
Accrual of periodic settlements
(3)
...................................................... (4,494) (3,943) (1,295)
Total . . . .................................................................... $(8,085) $ (1,900) $(14,954)
(1) Primarily includes purchased call and put swaptions and purchased interest rate caps and floors.
(2) Includes futures, foreign currency swaps, commitments, swap guarantee derivatives, and credit derivatives. Foreign-currency swaps are defined as swaps
in which net settlement is based on one leg calculated in a foreign-currency and the other leg calculated in U.S. dollars. Commitments include: (a) our
commitments to purchase and sell investments in securities; and (b) our commitments to purchase and extinguish or issue debt securities of our
consolidated trusts.
(3) Includes imputed interest on zero-coupon swaps.
Gains (losses) on derivatives not accounted for in hedge accounting relationships are principally driven by changes in:
(a) swap and forward interest rates and implied volatility; and (b) the mix and volume of derivatives in our derivatives
portfolio.
Our mix and volume of derivatives change period to period as we respond to changing interest rate environments. We
use receive- and pay-fixed interest rate swaps to adjust the interest-rate characteristics of our debt funding in order to more
closely match changes in the interest-rate characteristics of our mortgage-related assets. A receive-fixed swap results in our
receipt of a fixed interest-rate payment from our counterparty in exchange for a variable-rate payment. Conversely, a pay-
fixed swap requires us to make a fixed interest-rate payment to our counterparty in exchange for a variable-rate payment.
Receive-fixed swaps increase in value and pay-fixed swaps decrease in value when interest rates decrease (with the opposite
being true when interest rates increase).
We use swaptions and other option-based derivatives to adjust the interest-rate characteristics of our debt in response to
changes in the expected lives of our investments in mortgage-related assets. Purchased call and put swaptions, where we
make premium payments, are options for us to enter into receive- and pay-fixed swaps, respectively. Conversely, written call
and put swaptions, where we receive premium payments, are options for our counterparty to enter into receive and pay-fixed
swaps, respectively. The fair values of both purchased and written call and put swaptions are sensitive to changes in interest
rates and are also driven by the market’s expectation of potential changes in future interest rates (referred to as “implied
volatility”). Purchased swaptions generally become more valuable as implied volatility increases and less valuable as implied
volatility decreases. Recognized losses on purchased options in any given period are limited to the premium paid to purchase
the option plus any unrealized gains previously recorded. Potential losses on written options are unlimited.
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
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