Fannie Mae 2009 Annual Report Download - page 183

Debt Instruments
Historically, the primary tool we have used to fund the purchase of mortgage assets and manage the interest
rate risk implicit in our mortgage assets is the variety of debt instruments we issue. The debt we issue is a mix
that typically consists of short- and long-term, non-callable debt and callable debt. The varied maturities and
flexibility of these debt combinations help us in reducing the mismatch of cash flows between assets and
liabilities in order to manage the duration risk associated with an investment in long-term fixed-rate assets.
Callable debt helps us manage the prepayment risk associated with fixed-rate mortgage assets because the
duration of callable debt changes when interest rates change in a manner similar to changes in the duration of
mortgage assets. See “Liquidity and Capital Management—Liquidity Management—Debt Funding” for
additional information on our debt activity.
Derivative Instruments
Derivative instruments also are an integral part of our strategy in managing interest rate risk. Derivative
instruments may be privately negotiated contracts, which are often referred to as over-the-counter derivatives,
or they may be listed and traded on an exchange. When deciding whether to use derivatives, we consider a
number of factors, such as cost, efficiency, the effect on our liquidity, results of operations, and our overall
interest rate risk management strategy.
The derivatives we use for interest rate risk management purposes consist primarily of over-the-counter
contracts that fall into three broad categories:
•Interest rate swap contracts. An interest rate swap is a transaction between two parties in which each
agrees to exchange, or swap, interest payments. The interest payment amounts are tied to different interest
rates or indices for a specified period of time and are generally based on a notional amount of principal.
The types of interest rate swaps we use include pay-fixed swaps, receive-fixed swaps and basis swaps.
•Interest rate option contracts. These contracts primarily include pay-fixed swaptions, receive-fixed
swaptions, cancelable swaps and interest rate caps. A swaption is an option contract that allows us to
enter into a pay-fixed or receive-fixed swap at some point in the future.
•Foreign currency swaps. These swaps have the effect of converting debt that we issue in foreign-
denominated currencies into U.S. dollars. We enter into foreign currency swaps only to the extent that we
issue foreign currency debt.
We use interest rate swaps and interest rate options, in combination with our issuance of debt securities, to
better match the prepayment risk and duration of our assets with the duration of our liabilities. We are
generally an end user of derivatives; our principal purpose in using derivatives is to manage our aggregate
interest rate risk profile within prescribed risk parameters. We generally only use derivatives that are relatively
liquid and straightforward to value. We use derivatives for four primary purposes:
(1) As a substitute for notes and bonds that we issue in the debt markets;
(2) To achieve risk management objectives not obtainable with debt market securities;
(3) To quickly and efficiently rebalance our portfolio;
(4) To hedge foreign currency exposure;
Decisions regarding the repositioning of our derivatives portfolio are based upon current assessments of our
interest rate risk profile and economic conditions, including the composition of our consolidated balance
sheets and relative mix of our debt and derivative positions, the interest rate environment and expected trends.
Table 53 presents, by derivative instrument type, our risk management derivative activity for the years ended
December 31, 2009 and 2008, along with the stated maturities of derivatives outstanding as of December 31,
2009.
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