Fannie Mae 2009 Annual Report Download - page 185

The decline of our outstanding notional balance of our risk management derivatives during 2009 resulted from
our normal portfolio rebalancing activities, which included the termination of a significant portion of offsetting
pay-fixed and receive-fixed swap positions that we determined are no longer providing an economic hedging
benefit. The increase of our outstanding notional balance of our risk management derivatives during 2008
reflected both rebalancing activities we undertook, which included increasing our pay-fixed and receive-fixed
interest rate swaps in response to the interest rate volatility during the period, and the increased reliance
during the second half of 2008 on short-term debt and derivatives to hedge incremental fixed-rate mortgage
asset purchases.
Monitoring and Active Portfolio Rebalancing
By investing in mortgage assets, we assume prepayment risk. As described above, we attempt to offset this
prepayment risk either by issuing callable debt that we can redeem at our option or by purchasing option-
based derivatives that we can exercise at our option. We also manage the prepayment risk of our assets
relative to our funding through active portfolio rebalancing. We implement rebalancing strategies based on a
number of factors, including an assessment of current market conditions and various measurements of interest
rate risk. In 2009, we formed a cross-functional risk committee that meets on a weekly basis to assess our
current market risk and provide appropriate portfolio rebalancing guidance.
Measurement of Interest Rate Risk
Our interest rate risk measurement framework is based on the fair value of our assets, liabilities and derivative
instruments and the sensitivity of these values to changes in market factors. Estimating the impact of
prepayment risk is critical in managing interest rate risk. We use prepayment models to determine the
estimated duration and convexity of our mortgage assets and various quantitative methods for measuring our
interest rate exposure. Because no single method can reflect all aspects of the interest rate risk inherent in our
mortgage portfolio, we utilize various risk measurements that together provide a more complete assessment of
our aggregate interest rate risk profile.
We measure and monitor the fair value sensitivity to both small and large changes in the level of interest rates,
changes in the shape of the yield curve, and changes in interest rate volatility. In addition, we perform a range
of stress test analyses that measure the sensitivity of the portfolio to severe hypothetical changes in market
conditions.
Below we present two quantitative metrics that provide useful estimates of our interest rate exposure: (1) fair
value sensitivity of net portfolio to changes in interest rate levels and slope of yield curve and (2) duration
gap. We also provide additional information that may be useful in evaluating our interest rate exposure. Our
overall interest rate exposure, as reflected in the fair value sensitivity to changes in interest rate levels and the
slope of the yield curve and duration gap, was within acceptable, pre-defined corporate limits as of
December 31, 2009.
Our fair value sensitivity and duration gap metric, which are based on our net portfolio defined above, are
calculated using internal models that require standard assumptions regarding interest rates and future
prepayments of principal over the remaining life of our securities. These assumptions are derived based on the
characteristics of the underlying structure of the securities and historical prepayment rates experienced at
specified interest rate levels, taking into account current market conditions, the current mortgage rates of our
existing outstanding loans, loan age and other factors. The reliability of our interest rate risk analysis depends
on the availability and quality of historical data for each of the types of securities in our net portfolio.
Fair Value Sensitivity to Changes in Interest Rate Level and Slope of Yield Curve
As part of our disclosure commitments with FHFA, we disclose on a monthly basis the estimated adverse
impact on the fair value of our net portfolio that would result from the following hypothetical situations:
• A 50 basis point shift in interest rates.
• A 25 basis point change in the slope of the yield curve.
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