Fannie Mae 2006 Annual Report Download - page 281

10. Derivative Instruments
We use derivative instruments, in combination with our debt issuances, to reduce the duration and prepayment
risk relating to the mortgage assets we own. We also enter into commitments to purchase and sell mortgage-
related securities and commitments to purchase mortgage loans. We account for some of these commitments
as derivatives. Typically, we settle the notional amount of our mortgage commitments; however, we do not
settle the notional amount of our derivative instruments. Notional amounts, therefore, simply provide the basis
for calculating actual payments or settlement amounts.
Although derivative instruments are critical to our interest rate risk management strategy, we did not apply
hedge accounting to instruments entered into during the three-year period ended December 31, 2006. As such,
all fair value changes and gains and losses on these derivatives, including accrued interest, were recognized as
“Derivatives fair value losses, net” in the consolidated statements of income.
Prior to our adoption of SFAS 133, certain of our derivative instruments met the criteria for hedge accounting
under the accounting standards at that time. Accordingly, effective with our adoption of SFAS 133, we
deferred gains of approximately $230 million from fair value-type hedges as basis adjustments to the related
debt and $75 million for cash flow-type hedges in AOCI. We recorded amortization related to the fair value-
type hedges of $18 million, $22 million and $31 million for the years ended December 31, 2006, 2005 and
2004, respectively, in the consolidated statements of income as a reduction of “Interest expense” or “Debt
extinguishment losses, net” if the related debt is extinguished. We recorded amortization related to the cash
flow-type hedges of $7 million for each of the years ended December 31, 2006, 2005 and 2004, as a reduction
of “Interest expense” in the consolidated statements of income.
Risk Management Derivatives
We issue various types of debt to finance the acquisition of mortgages and mortgage-related securities. We use
interest rate swaps and interest rate options, in combination with our debt issuances, to better match both the
duration and prepayment risk of our mortgages and mortgage-related securities, which we would not be able
to accomplish solely through the issuance of debt. These instruments primarily include interest rate swaps,
swaptions and caps. Interest rate swaps provide for the exchange of fixed and variable interest payments based
on contractual notional principal amounts. These may include callable swaps, which give counterparties or us
the right to terminate interest rate swaps before their stated maturities. Swaptions provide us with an option to
enter into interest rate swaps at a future date. Caps provide ceilings on the interest rates of our variable-rate
debt. We also use basis swaps, which provide for the exchange of variable payments based on different
interest rate indices, such as the Treasury Bill rate, the Prime rate, or the London Inter-Bank Offered Rate.
Although our foreign-denominated debt represents approximately 1% of total debt outstanding as of both
December 31, 2006 and 2005, we enter into foreign currency swaps to effectively convert our foreign-
denominated debt into U.S. dollars.
F-50
FANNIE MAE
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)