Freddie Mac 2004 Annual Report Download - page 212

assessment as required by SFAS 133. Consequently, Freddie Mac discontinued hedge accounting treatment
for these relationships for Ñnancial reporting purposes eÅective as of the beginning of the second quarter of
2004, resulting in pay-Ñxed swaps with a notional balance of approximately $108 billion being moved from the
cash Öow hedge designation to no hedge designation.
Freddie Mac voluntarily discontinued hedge accounting treatment for a signiÑcant amount of its receive-
Ñxed interest-rate swaps eÅective November 1, 2004, resulting in receive-Ñxed interest-rate swaps with a
notional balance of approximately $50 billion being moved from a fair value hedge designation to no hedge
designation.
Fair value hedges
Fair value hedges represent hedges of exposure to foreign currency Öuctuations and changes in the fair
value of a recognized liability. Freddie Mac uses interest-rate swaps, futures and foreign-currency swaps to
hedge against the changes in fair value of Ñxed rate debt due to changes in benchmark interest rates, either the
rate on U.S. Treasury obligations or LIBOR, or foreign currency Öuctuations, or a combination of both. These
derivatives may be executed to manage interest-rate risk at an aggregate portfolio level or at an individual debt
instrument level. For accounting purposes, Freddie Mac ultimately links these derivatives to speciÑc debt
positions. Where derivatives were executed to manage interest-rate risk at an aggregate portfolio level, Freddie
Mac frequently reset the amount of Ñxed-rate debt being hedged in order to maintain highly eÅective
accounting hedges in this strategy. To accomplish this, the accounting hedges were typically terminated at the
time of reset and the derivatives were contemporaneously redesignated in new hedge accounting relationships
of Ñxed-rate debt. These derivatives were moved to no hedge designation eÅective November 1, 2004 as part
of the voluntary discontinuance of hedge accounting treatment, as discussed above. Alternatively, when
derivatives are executed for speciÑc debt instruments, redesignation is typically not necessary to maintain
highly eÅective accounting hedges. For 2004 and 2003, no amounts have been excluded from the assessment
of eÅectiveness for derivatives designated as fair value hedges. For 2002, pre-tax losses of $103 million were
excluded from the assessment of eÅectiveness for derivatives designated as fair value hedges. The excluded
component represents the change in fair value related to the diÅerence between the spot price and the forward
price on certain sale commitments used as hedges of existing mortgage-related securities.
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) on the consolidated statements of income along with the
changes in the fair value of the hedged item attributable to the risk being hedged. Hedge ineÅectiveness arises
when the fair value change of a derivative is not equal to the fair value change of the hedged item. For 2004,
2003 and 2002, hedge ineÅectiveness related to fair value hedges was a net $742 million gain, $697 million
gain and $241 million gain, respectively, on a pre-tax basis, and was reported in Hedge accounting gains
(losses). Hedge accounting gains (losses) will vary from period to period based on the notional amount of
derivatives accounted for in hedge accounting relationships and the extent to which diÅerences in the
characteristics or terms of the derivative and the hedged item result in fair value changes that are not exactly
oÅset. For example, a portion of derivatives in Freddie Mac's fair value hedges are forward starting and valued
using forward rates while the hedged debt is valued using spot rates. Therefore, the diÅerence between the spot
rate and the forward rate generally produces ineÅectiveness in these fair value hedges.
Cash Öow hedges
Cash Öow hedges represent hedges of exposure to the variability in the cash Öows of a forecasted
transaction. Freddie Mac uses interest-rate swaps, futures, foreign-currency swaps and forward purchase and
sale commitments to hedge the changes in cash Öows associated with the forecasted issuances of debt,
forecasted purchase or sale of mortgage-related assets, and foreign currency Öuctuations.
For a derivative qualifying as a cash Öow hedge, changes in fair value are generally reported in AOCI, net
of taxes, on the consolidated balance sheets to the extent the hedge is eÅective. The remaining ineÅective
portion is reported as Hedge accounting gains (losses) on the consolidated statements of income. For 2004,
2003 and 2002, hedge ineÅectiveness related to cash Öow hedges was a net $1 million gain, $53 million loss
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