Fannie Mae 2006 Annual Report Download - page 107

between our mortgage assets and debt, and changes in implied volatility. Following is a discussion of the
effects these market conditions generally have on the fair value of our net assets and the factors we consider
to be the principal drivers of changes in the estimated fair value of our net assets. We also disclose the
sensitivity of the estimated fair value of our net assets to changes in interest rates in “Risk Management—
Interest Rate Risk Management and Other Market Risks.”
•Capital Transactions, Net. Capital transactions include our issuances of common and preferred stock,
our repurchases of stock and our payment of dividends. Cash we receive from the issuance of preferred
and common stock results in an increase in the fair value of our net assets, while repurchases of stock and
dividends we pay on our stock reduce the fair value of our net assets.
•Estimated Net Interest Income from OAS. OAS income represents the estimated net interest income
generated during the current period that is attributable to the market spread between the yields on our
mortgage-related assets and the yields on our debt during the period, calculated on an option-adjusted
basis.
•Guaranty Fees, Net. Guaranty fees, net, represent the net cash receipts during the reported period related
to our guaranty business, and are generally calculated as the difference between the contractual guaranty
fees we receive during the period and the expenses we incur during the period that are associated with our
guaranty business. Changes in guaranty fees, net, result from changes in portfolio size and composition,
changes in home price appreciation and changes in the market spreads for similar instruments.
•Fee and Other Income and Other Expenses, Net. Fee and other income includes miscellaneous fees,
such as resecuritization transaction fees and technology-related fees. Other expenses primarily include
costs incurred during the period that are associated with the Capital Markets group.
•Return on Risk Positions. Our investment activities expose us to market risks, including duration and
convexity risks, yield curve risk, OAS risk and volatility risk. The return on risk positions represents the
estimated net increase or decrease in the fair value of our net assets resulting from net exposures related
to the market risks we actively manage. We actively manage, or hedge, interest rate risk related to our
mortgage investments in order to maintain our interest rate risk exposure within prescribed limits.
However, we do not actively manage certain other market risks. Specifically, we do not attempt to
actively manage or hedge changes in mortgage-to-debt OAS after we purchase mortgage assets or the
interest rate risk related to our guaranty business. Additional information about credit, market and
operational risks and our strategies for managing these types of risks is included in “Risk Management.”
•Mortgage-to-debt OAS. Funding mortgage investments with debt exposes us to mortgage-to-debt OAS
risk, which represents basis risk. Basis risk is the risk that interest rates in different market sectors will
not move in the same direction or amount at the same time. We generally hold our mortgage investments
to generate a spread over our debt on a long-term basis. The fair value of our assets and liabilities can be
significantly affected by periodic changes in the net OAS between the mortgage and agency debt sectors.
The fair value impact of changes in mortgage-to-debt OAS for a given period represents an estimate of
the net unrealized increase or decrease in the fair value of our net assets resulting from fluctuations
during the reported period in the net OAS between our mortgage assets and our outstanding debt
securities. When the mortgage-to-debt OAS on a given mortgage asset increases, or widens, the fair value
of the asset will typically decline relative to the debt. The level of OAS and changes in OAS are model-
dependent and differ among market participants depending on the prepayment and interest rate models
used to measure OAS.
We work to manage the OAS risk that exists at the time we purchase mortgage assets through our asset
selection process. We use our proprietary models to evaluate mortgage assets on the basis of yield-to-
maturity, option-adjusted yield spread, historical valuations and embedded options. Our models also take
into account risk factors such as credit quality, price volatility and prepayment experience. We purchase
mortgage assets that appear economically attractive to us in the context of current market conditions and
that fall within our OAS targets. Although a widening of mortgage-to-debt OAS during a period generally
results in lower fair values of the mortgage assets relative to the debt during that period, it can provide us
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