eTrade 2002 Annual Report Download - page 85

Table of Contents
Index to Financial Statements
To mitigate the short-term effect of changes in currency exchange rates on our non-U.S. dollar-based revenues and operating expenses, we
evaluate the costs and benefits to hedging our material net non-U.S. dollar-based exposures by entering into foreign exchange forward
contracts. Currently, hedges of transactions do not extend beyond twelve months and are immaterial. Given the short-term nature of our foreign
exchange forward contracts, our exposure to risk associated with currency market movement on the instruments is not material.
Financial Instruments
For our working capital and reserves, which are required to be segregated under Federal or other regulations, we primarily invest in money
market funds, resale agreements, certificates of deposit, and commercial paper. Money market funds do not have maturity dates and do not
present a material market risk. The other financial instruments are fixed rate investments with short maturities and do not present a material
interest rate risk.
BANKING OPERATIONS
Our banking operations acquire and manage interest-bearing assets and liabilities in the normal course of business. Interest-bearing instruments
include investment securities, loans, deposits, borrowings and derivative financial instruments. These instruments are subject to changes in
market value as interest rates change. Market risk is the potential for adverse decline in market values. The market values of bank instruments
have a direct or indirect impact on Bank earnings, equity and various regulatory constraints.
Interest Rate Risk
The acquisition, maintenance, and disposition of assets and liabilities are critical elements of the Bank’ s operations. Throughout the process
these instruments are subject to market risk, which is the potential for adverse declines in market values. There are numerous factors that may
influence the speed and direction of changes in market value including, but not limited to, liquidity, the absolute level of interest rates, the shape
of the yield curve, and the implied volatility of future interest rate movements. The net market values of bank instruments may directly or
indirectly impact the Bank’ s current or future earnings and is also subject to certain regulatory constraints.
Day-to-day management of market risk is the responsibility of the Bank’ s Asset Liability Management Committee (“ALCO”). The ALCO is
responsible for measuring, managing and reporting the Bank’ s aggregate market risk within established policy guidelines and limits, which are
reviewed periodically. The Bank maintains a Risk Management Group, which is independent of the Bank’ s portfolio management functions to
assist the ALCO in its responsibilities of measuring and managing market risk.
The market risk profile of the Bank is a net result of the combination of all interest-sensitive assets, liabilities and derivatives. At December 31,
2002, approximately 63% of the market value of the Bank’ s total assets was comprised of residential mortgages and mortgage-backed
securities. The values of these assets are sensitive to changes in interest rates as well as expected prepayment levels. The Bank’ s liability
structure consists primarily of transactional deposit relationships such as money market accounts, shorter-term certificates of deposit, and
wholesale collateralized borrowings from the FHLB and other entities. The derivative portfolio of the Bank is positioned to decrease the overall
market risk resulting from the combination of assets and liabilities. The Bank’ s market risk is discussed and quantified in more detail in the
Scenario Analysis section below.
Most of the Bank’ s assets are generally classified as non-trading portfolios and, as such, are not marked-to-market through earnings for
accounting purposes. The Bank did maintain a trading portfolio of investment-grade securities throughout 2002. The market value of the trading
portfolio at December 31, 2002 was $392 million.
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