Freddie Mac 2004 Annual Report Download - page 172

Subject to certain qualifying conditions, Freddie Mac may designate a derivative as either a hedge of the
cash Öows of a variable-rate instrument or forecasted transaction (""cash Öow hedge''), a hedge of the fair
value of a Ñxed-rate instrument (""fair value hedge'') or a foreign-currency fair value or cash Öow hedge
(""foreign currency hedge''). In order to be designated as an accounting hedge, the derivative must initially be
expected to be highly eÅective in oÅsetting the changes in cash Öows or fair value of the hedged item resulting
from the hedged risk. In addition, the documentation of the hedging designation must include identiÑcation of
the hedged item, the hedging instrument, the risk exposure and corresponding risk management objective,
how eÅectiveness will be assessed and how ineÅectiveness will be measured.
For a derivative qualifying as a cash Öow hedge, Freddie Mac reports changes in the fair value of these
instruments in AOCI to the extent the hedge is eÅective. The remaining ineÅective portion, calculated using
the hypothetical derivative method, is reported as Hedge accounting gains (losses). This method requires the
company to develop a hypothetical derivative whose terms match those of the hedged item and compare
estimated changes in the fair value of the hypothetical derivative to changes in the fair value of the hedging
derivative. In general, Freddie Mac recognizes the associated amounts reported in AOCI as Income
(expense) related to derivatives during the period or periods in which the hedged item aÅects earnings. If the
hedged item relates to a forecasted issuance of debt, Freddie Mac reclassiÑes the associated amount reported
in AOCI into earnings as Net interest income over the periods when the debt is issued and aÅects earnings.
Amounts reported in AOCI related to changes in the fair value of commitments to purchase or sell securities
that are designated as cash Öow hedges are recognized as interest income for assets held and Gains (losses) on
investment activity for assets sold.
If the hedged item in a cash Öow hedge is the forecasted issuance of debt, and the occurrence of the
forecasted transaction becomes probable of not occurring, the amount in AOCI is reclassiÑed to earnings
immediately. If Freddie Mac expects at any time that continued reporting of a net loss in AOCI would lead to
recognizing a net loss on the combination of a hedging instrument and the hedged transaction (and related
asset acquired or liability incurred) in one or more future periods, the loss is reclassiÑed immediately into
earnings for the amount that is not expected to be recovered.
For a derivative qualifying as a fair value hedge, Freddie Mac reports changes in the fair value of the
derivative as Hedge accounting gains (losses) along with the changes in the fair value of the hedged item
attributable to the risk being hedged. When the hedge is terminated or redesignated, the fair value adjustment
to the carrying amount of the hedged asset or liability is amortized to earnings as a component of the hedged
item's interest income or expense over the remaining life of the hedged item using the eÅective yield method.
If a derivative no longer qualiÑes as a cash Öow or fair value hedge, the company discontinues hedge
accounting prospectively. Freddie Mac continues to carry the derivative on the consolidated balance sheets at
fair value and records further fair value gains and losses in the consolidated statements of income as Derivative
gains (losses) until the derivative is terminated or redesignated.
The periodic interest cash Öows related to derivative contracts currently accrued, which are derived
primarily from interest-rate swap contracts, are classiÑed as Income (expense) related to derivatives for
derivatives in hedge relationships and as Derivative gains (losses) for derivatives not in hedge accounting
relationships.
Inception gains or losses associated with commitments to purchase mortgage loans are deferred. With
respect to those purchase commitments that have been designated as cash Öow hedges, inception gains or
losses are considered together with that portion of the cumulative change in fair value of such derivative
instruments that are recognized in AOCI for the purpose of determining whether a net deferred loss exists
that, as described above, should be reclassiÑed to earnings. Additionally, and similar to derivative-related gains
that are recognized as a component of AOCI, deferred inception-based gains on mortgage purchase
commitments will be reclassiÑed into earnings in the same period or periods during which acquired mortgage
loans aÅect earnings. SpeciÑcally, inception gains or losses are:
‚ Recognized as a component of the gain or loss on sale of corresponding mortgage loans (either in
whole loan or securitized form); or
‚ Recognized as interest income over the life of the corresponding mortgage loans at the point that,
where applicable, such mortgage loans are reclassiÑed as held-for-investment.
Freddie Mac
160