Bank of Montreal 2008 Annual Report Download - page 128

Foreign Currency Risk
We manage foreign currency risk through cross-currency swaps. Cross-
currency swaps are marked to market, with realized and unrealized gains
and losses recorded in non-interest revenue, consistent with the account-
ing treatment for gains and losses on the economically hedged item.
We also periodically hedge U.S. dollar earnings through forward
foreign exchange contracts to minimize fluctuations in our Canadian
dollar earnings due to the translation of our U.S. dollar earnings. These
contracts are marked to fair value, with gains and losses recorded as
non-interest revenue in foreign exchange, other than trading.
Embedded Derivatives
From time to time, we purchase or issue financial instruments
containing embedded derivatives. The embedded derivative is sepa-
rated from the host contract and carried at fair value if the economic
characteristics of the derivative are not closely related to those of
the host contract, the terms of the embedded derivative are the same
as those of a stand-alone derivative, and the combined contract is
not held for trading or designated at fair value. To the extent that
we cannot reliably identify and measure the embedded derivative,
the entire contract is carried at fair value, with changes in fair value
reflected in earnings. Embedded derivatives in our equity linked notes
are accounted for separately from the host instrument.
Fair Value
Fair value represents point-in-time estimates that may change in
subsequent reporting periods due to market conditions or other factors.
Fair value for exchange-traded derivatives is considered to be the price
quoted on derivatives exchanges. Fair value for over-the-counter
derivatives is determined using multi-contributor prices or zero coupon
valuation techniques further adjusted for credit, model and liquidity
risks, as well as administration costs. Zero coupon curves are created
using generally accepted valuation techniques from underlying instru-
ments such as cash, bonds and futures observable in the market.
Option implied volatilities, an input into the valuation model, are either
obtained directly from market sources or calculated from market prices.
Notes
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
124 | BMO Financial Group 191st Annual Report 2008
Fair values of our derivative instruments are as follows:
(Canadian $ in millions) 2008 2007
Gross assets Gross liabilities Net Gross assets Gross liabilities Net
Trading
Interest Rate Contracts
Swaps $ 25,925 $(26,243) $ (318) $ 7,273 $ (7,697) $ (424)
Forward rate agreements 165 (166) (1) 13 (8) 5
Futures 19 (12) 7 33 (10) 23
Purchased options 1,804 – 1,804 1,084 (1) 1,083
Written options – (1,643) (1,643) – (988) (988)
Foreign Exchange Contracts
Cross-currency swaps 1,212 (1,346) (134) 1,997 (1,239) 758
Cross-currency interest rate swaps 7,867 (7,259) 608 7,203 (7,562) (359)
Forward foreign exchange contracts 8,383 (7,913) 470 4,842 (5,246) (404)
Purchased options 566 – 566 262 – 262
Written options – (774) (774) – (158) (158)
Commodity Contracts
Swaps 2,336 (3,102) (766) 2,220 (1,988) 232
Purchased options 3,953 – 3,953 5,628 – 5,628
Written options – (3,497) (3,497) – (5,374) (5,374)
Equity Contracts 5,606 (2,019) 3,587 1,318 (2,458) (1,140)
Credit Default Swaps
Purchased 6,435 – 6,435 642 – 642
Written – (5,828) (5,828) – (570) (570)
Total fair value –trading derivatives $ 64,271 $(59,802) $ 4,469 $ 32,515 $(33,299) $ (784)
Average fair value (1) $ 43,917 $(40,456) $ 3,461 $ 33,817 $(34,629) $ (812)
Hedging
Interest Rate Contracts
Cash flow hedges –swaps $ 752 $ (187) $ 565 $ 60 $ (176) $ (116)
Fair value hedges –swaps 563 (59) 504 10 (109) (99)
Total swaps $ 1,315 $ (246) $ 1,069 $ 70 $ (285) $ (215)
Total fair value –hedging derivatives (2) $ 1,315 $ (246) $ 1,069 $ 70 $ (285) $ (215)
Average fair value (1) $ 540 $ (257) $ 283 $ 69 $ (266) $ (197)
Total fair value –trading and hedging derivatives $ 65,586 $(60,048) $ 5,538 $ 32,585 $(33,584) $ (999)
Less: Impact of master netting agreements $(41,748) $ 41,748 $ – $(16,403) $ 16,403 $ –
Total $ 23,838 $(18,300) $ 5,538 $ 16,182 $(17,181) $ (999)
(1) Average fair value amounts are calculated using a five-quarter rolling average.
(2) The fair values of hedging derivatives wholly or partially offset the changes in fair values of
the related on-balance sheet financial instruments or future cash flows.
Assets are shown net of liabilities to customers where we have an enforceable right to offset
amounts and we intend to settle contracts on a net basis.
Included in foreign exchange contracts is $nil as at October 31, 2008 ($nil in 2007) related
to gold contracts.
Certain comparative figures have been reclassified to conform with the current year’s presentation.
Derivative instruments recorded in our Consolidated Balance Sheet are as follows:
(Canadian $ in millions) Assets Liabilities
2008 2007 2008 2007
Fair value of trading derivatives $ 64,271 $ 32,515 $ 59,802 $ 33,299
Fair value of hedging derivatives 1,315 70 246 285
Total $ 65,586 $ 32,585 $ 60,048 $ 33,584