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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Notes
132 BMO Financial Group 193rd Annual Report 2010
Fair Value Hedging Relationships
The following table presents the impact of fair value hedges on our financial results.
(Canadian $ in millions) Pre-tax gains (losses) recorded in income
Hedge ineffectiveness
Amount of gain (loss) Quasi fair value recorded in non-interest
Contract type on hedging derivative (1) adjustment (2) revenue – other
Interest rate contracts – 2010 31 (33) (2)
2009 (100) 90 (10)
2008 747 (736) 11
Embedded Derivatives
From time to time, we purchase or issue financial instruments contain-
ing embedded derivatives. The embedded derivative is separated 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 certain of our equity linked notes are accounted for
separately from the host instrument.
Contingent Features
Certain over-the-counter derivative instruments contain provisions
that link how much collateral we are required to post or payment
requirements to our credit ratings (as determined by the major credit
rating agencies). If our credit ratings were to be downgraded, certain
counterparties to the derivative instruments could demand immediate
and ongoing collateralization overnight on derivative liability positions
or request immediate payment. The aggregate fair value of all
derivative instruments with collateral posting requirements that are in
a liability position on October 31, 2010 is $7.3 billion, for which we have
posted collateral of $6.5 billion. If our credit rating had been downgraded
to A– on October 31, 2010 (per Standard & Poor’s Rating Services), we
would have been required to post collateral or meet payment demands
of an additional $1,082 million.
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 instruments 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.
(1) Unrealized gains (losses) on hedging derivatives are recorded in Other Assets – Derivative
instruments or Other Liabilities – Derivative instruments in the Consolidated Balance Sheet.
(2) Unrealized gains (losses) on hedged items are recorded in Securities – Available for sale,
Subordinated Debt, and Deposits.
Cash Flow Hedging Relationships
The following table presents the impact of cash flow hedges on our financial results.
(Canadian $ in millions) Pre-tax gains (losses) recorded in income
Reclassification of gains Amortization of
(losses) on hedges from spot/forward differential on
Fair value change recorded in Fair value change recorded in other comprehensive income foreign exchange contracts
Contract type other comprehensive income non-interest revenue – other to net interest income to interest expense
2010
Interest rate 303 (2) 237 –
Foreign exchange (80) – – (83)
Total 223 (2) 237 (83)
2009
Interest rate 143 (10) 178 –
Foreign exchange (360) – – (43)
Total (217) (10) 178 (43)
2008
Interest rate 536 16 (92) –
Foreign exchange – – – –
Total 536 16 (92) –
Certain comparative figures have been reclassified to conform with the current year’s presentation.