Freddie Mac 2015 Annual Report Download - page 305

Financial Statements Notes to the Consolidated Financial Statements | Note 14
Freddie Mac 2015 Form 10-K 303
ongoing due diligence, which includes discussions with our vendors at least annually and often more
frequently. We believe that the procedures executed by the pricing services and dealers, combined with
our internal verification and analytical procedures, provide assurance that the prices used in our financial
statements comply with the accounting guidance for fair value measurements and disclosures and reflect
the assumptions that a market participant would use in pricing our assets and liabilities. The price quotes
we receive are non-binding both to us and to our counterparties.
In many cases, we receive quotes from third-party pricing services or dealers and use those prices
without adjustment. For a large majority of the assets and liabilities we value using pricing services and
dealers, we obtain quotes from multiple external sources and use the median of the prices to measure fair
value. This technique is referred to below as “median of external sources.” The significant inputs used in
the fair value measurement of assets and liabilities that are valued using the median of external sources
pricing technique are the third-party quotes. Significant increases (decreases) in any of the third-party
quotes in isolation may result in a significantly higher (lower) fair value measurement. In limited
circumstances, we may be able to receive pricing information from only a single external source. This
technique is referred to below as “single external source.”
VALUATION TECHNIQUES
The following table contains a description of the valuation techniques we use for fair value measurement
and disclosure; the significant inputs used in those techniques (if applicable); the classification within the
fair value hierarchy; and, for those measurements that we report on our consolidated balance sheets and
are classified as Level 3 of the hierarchy, a narrative description of the sensitivity of the fair value
measurement to changes in significant unobservable inputs. Although the sensitivities of the
unobservable inputs are discussed below in isolation, interrelationships exist among the inputs such that
a change in one unobservable input can result in a change to one or more of the other inputs. For
example, the most common interrelationship that impacts the majority of our fair value measurements is
between future interest rates, prepayment speeds, and probabilities of default. Generally, a change in the
assumption used for future interest rates results in a directionally opposite change in the assumption used
for prepayment speeds and a directionally similar change in the assumption used for probabilities of
default.
Each technique discussed below may not be used in a given reporting period, depending on the
composition of our assets and liabilities measured at fair value and relevant market activity during that
period.
Instrument Valuation Technique
Classification in
the Fair Value
Hierarchy
Securities
U.S. Treasury
Securities
Valuations are based on quoted prices in active markets. Level 1
Agency mortgage-
related securities
Valuations are based on:
Fixed-rate single-class: Observable prices for similar TBA securities
adjusted for specific collateral characteristics
Level 2