Fannie Mae 2006 Annual Report Download - page 100

Outstanding
Weighted
Average
Interest Rate
(1)
Outstanding
(2)
Weighted
Average
Interest Rate
(1)
Maximum
Outstanding
(3)
As of December 31, Average During the Year
2004
(Dollars in millions)
Federal funds purchased and securities
sold under agreements to
repurchase . . . . . . . . . . . . . . . . . . . $ 2,400 1.90% $ 2,704 0.80% $ 10,455
Fixed-rate short-term debt:
Discount notes . . . . . . . . . . . . . . . . $299,728 2.14% $306,539 1.42% $323,289
Foreign exchange discount notes . . . 6,591 0.84 3,064 1.10 7,089
Other fixed-rate short-term debt . . . . 3,724 1.59 3,236 1.43 3,779
Floating-rate short-term debt . . . . . . . . 6,250 2.19 7,548 1.41 9,135
Debt from consolidations . . . . . . . . . . 3,987 2.20 2,989 1.54 3,987
Total short-term debt . . . . . . . . . . $320,280 2.11%
(1)
Includes unamortized discounts, premiums and other cost basis adjustments.
(2)
Average amount outstanding during the year has been calculated using month-end balances.
(3)
Maximum outstanding represents the highest month-end outstanding balance during the year.
Derivative Instruments
While we use debt instruments as the primary means to fund our mortgage investments and manage our
interest rate risk exposure, we supplement our issuance of debt with interest rate-related derivatives to manage
the prepayment and duration risk inherent in our mortgage investments. As an example, by combining a pay-
fixed swap with short-term variable-rate debt, we can achieve the economic effect of converting short-term
variable-rate debt into long-term fixed-rate debt. By combining a pay-fixed swaption with short-term variable-
rate debt, we can achieve the economic effect of converting short-term variable-rate debt into long-term
callable debt. The cost of derivatives used in our management of interest rate risk is an inherent part of the
cost of funding and hedging our mortgage investments and is economically similar to the interest expense that
we recognize on the debt we issue to fund our mortgage investments. However, because we do not apply
hedge accounting to our derivatives, the fair value gains or losses on our derivatives, including the periodic net
contractual interest expense accruals on our swaps, are reported as “Derivatives fair value losses, net” in our
consolidated statements of income rather than as interest expense.
Our derivatives consist primarily of OTC contracts and commitments to purchase and sell mortgage assets that
are valued using a variety of valuation models. The primary factors affecting changes in the fair value of our
derivatives include the following:
•Changes in the level of interest rates: Because our derivatives portfolio as of December 31, 2006, 2005
and 2004 predominately consisted of pay-fixed swaps, we typically reported declines in fair value as
interest rates decreased and increases in fair value as interest rates increased. As part of our economic
hedging strategy, these derivatives, in combination with our debt issuances, are intended to offset changes
in the fair value of our mortgage assets, which tend to increase in value when interest rates decrease and,
conversely, decrease in value when interest rates rise.
•Implied interest rate volatility: We purchase option-based derivatives to economically hedge the
embedded prepayment option in our mortgage investments. A key variable in estimating the fair value of
option-based derivatives is implied volatility, which reflects the market’s expectation about the future
volatility of interest rates. Assuming all other factors are held equal, including interest rates, a decrease in
implied volatility would reduce the fair value of our derivatives and an increase in implied volatility
would increase the fair value.
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