Freddie Mac 2015 Annual Report Download - page 147

Management's Discussion and Analysis Risk Management | Interest Rate Risk and Other Market Risks
Freddie Mac 2015 Form 10-K 145
down rate shocks is the PMVS. In cases where both the up rate and down rate shocks result in a
positive effect, the PMVS is zero. Because this process uses a parallel, or level, shock to interest
rates, we refer to this measure as PMVS-L.
• To estimate sensitivity related to the shape of the yield curve, a yield curve steepening and
flattening of 25 basis points is applied using the duration of all interest-rate sensitive instruments.
The resulting change in market value for the aggregate portfolio is computed for both the
steepening and flattening yield curve scenarios. The more adverse yield curve scenario is then
used to determine the PMVS. Because this process uses a non-parallel shock to interest rates,
we refer to this measure as PMVS-YC.
We estimate the sensitivity to changes in interest rates of the fair value of all financial assets and
liabilities, including derivatives, on a pre-tax basis. In making these calculations, we do not consider the
sensitivity to interest-rate changes of the following assets and liabilities:
• Credit guarantee activities - We do not consider the sensitivity of the fair value of credit guarantee
activities to changes in interest rates except for the guarantee-related items mentioned above
because we do not actively manage the change in the fair value of our guarantee business that is
attributable to changes in interest rates. We do not believe that periodic changes in fair value due to
movements in interest rates are the best indication of the long-term value of our guarantee business
because these changes do not take into account the potential for future guarantee business activity.
• Other assets with minimal interest-rate sensitivity - We do not include other assets, primarily non-
financial instruments such as fixed assets and REO, because we estimate their impact on PMVS and
duration gap to be minimal.
Limitations of Market Risk Measures
Our PMVS and duration gap estimates are determined using models that involve our judgment of interest-
rate and prepayment assumptions. While we believe that PMVS and duration gap are useful risk
management tools, they should be understood as estimates rather than as precise measurements. There
could be times when we hedge differently than our model estimates during the period, such as when we
are making changes or market updates to these models. While PMVS and duration gap estimate our
exposure to changes in interest rates, they do not capture the potential effect of certain other market
risks, such as changes in volatility and spread risk. The effect of these other market risks can be
significant.
There are inherent limitations in any methodology used to estimate exposure to changes in market
interest rates. Our sensitivity analyses for PMVS and duration gap contemplate only certain movements
in interest rates and are performed at a particular point in time based on the estimated fair value of our
existing portfolio. These sensitivity analyses do not consider other factors that may have a significant
effect on our financial instruments, most notably business activities and strategic actions that
management may take in the future to manage interest-rate risk. These analyses are not intended to
provide precise forecasts of the effect a change in market interest rates would have on the estimated fair
value of our net assets.
In addition, it has been more difficult in recent years to measure and manage the interest-rate risk related
to mortgage assets as risk for prepayment model error remains high due to the low interest rate
environment and uncertainty regarding default rates, unemployment, government policy changes and