Freddie Mac 2005 Annual Report Download - page 122

we may not recover the unrealized loss. When evaluating these factors, we consider our intent and ability to hold the
investment until a point in time at which recovery of the unrealized loss can be reasonably expected to occur. Impairment
losses on manufactured housing securities exclude the eÅects of separate Ñnancial guarantee contracts that are not
embedded in the securities since the beneÑts of such contracts are not recognized until claims become probable of recovery
under the contracts. When a security is deemed to be impaired, the cost basis of the security is written down to fair value,
with the loss recorded to Gains (losses) on investment activity. Based on the new cost basis, the adjusted deferred amounts
related to the impaired security are amortized over the security's remaining life in a prospective manner consistent with the
amount and timing of the future estimated cash Öows. The security cost basis is not changed for subsequent recoveries in
fair value. For certain securities meeting the criteria of (a) and (b) in the preceding paragraph, other-than-temporary
impairment is deÑned as occurring whenever there is an adverse change in estimated cash Öows coupled with a decline in fair
value below the amortized cost basis.
Gains and losses on the sale of securities are included in Gains (losses) on investment activity, including those gains
(losses) reclassiÑed into earnings from AOCI. We use the speciÑc identiÑcation method for determining the cost of a
security in computing the gain or loss.
Repurchase and Resale Agreements
We enter into repurchase and resale agreements primarily as an investor or to Ñnance our security positions. Such
transactions are accounted for as purchases and sales when the transferor relinquishes control over transferred securities and
as secured Ñnancings when the transferor does not relinquish control. Our policy is to take possession of securities purchased
under agreements to resell and reverse dollar roll transactions.
Debt Securities Issued
Debt securities that we issue are classiÑed as either Due within one year or Due after one year based on their remaining
contractual maturity. The classiÑcation of interest expense on debt securities as either short-term or long-term is based on
the original contractual maturity of the debt security. Deferred items, including premiums, discounts, issuance costs and
hedging-related basis adjustments, are amortized and reported through interest expense using the eÅective interest method
over the contractual life of the related indebtedness. The balance of deferred items remaining when debt is extinguished
prior to its contractual maturity is reÖected in earnings in the period of extinguishment as a component of Gains (losses) on
debt retirement. Prior to 2005, for callable debt, deferred items were amortized over the period during which the related
indebtedness was expected to be outstanding and changes in the expected life were reÖected prospectively as an adjustment
to the eÅective yield on the debt. Amortization of hedging-related basis adjustments is initiated upon the termination of the
related hedge relationship. Amortization of premiums, discounts and issuance costs begins at the time of debt issuance.
Premiums, discounts and hedging-related basis adjustments are reported as a component of Debt securities, net. Issuance
costs are reported as a component of Other assets. Debt securities denominated in a foreign currency are translated into U.S.
dollars using foreign exchange spot rates at the balance sheet dates and any translation gains or losses are reported in Non-
interest income (loss) Ì Other income.
Contemporaneous transfers of cash between us and a creditor in connection with the issuance of a new debt obligation
and satisfaction of an existing debt obligation are accounted for as extinguishments, with recognition of any gains or losses in
earnings if the debt instruments have substantially diÅerent terms. If the debt instruments do not have substantially
diÅerent terms, the transaction is accounted for as an exchange rather than an extinguishment.
Derivatives
Generally, derivatives are Ñnancial instruments with little or no initial net investment in comparison to their notional
amount and whose value is based upon an underlying asset, index, reference rate or other variable. They may be privately
negotiated contractual agreements that can be customized to meet speciÑc needs, including certain commitments to
purchase and sell mortgage loans, mortgage-related securities or debt securities, or they may be standardized contracts
executed through organized exchanges. All derivatives are reported at their fair value on the consolidated balance sheets.
The fair value of derivatives is generally reported net by counterparty, provided that a legally enforceable master netting
agreement exists. Derivatives in a net unrealized gain position are reported as Derivative assets, at fair value. Similarly,
derivatives in a net unrealized loss position are reported as Derivative liabilities, at fair value.
Currently, the majority of our derivatives are not designated in hedge accounting relationships. For those derivatives not
designated as an accounting hedge, fair value gains and losses are reported as Derivative gains (losses) in the consolidated
statements of income. For purchase and sale commitments of securities classiÑed as trading, fair value gains and losses are
reported as Gains (losses) on investment activity in the consolidated statements of income.
Subject to certain qualifying conditions, we may designate a derivative as either a hedge of the cash Öows of a variable-
rate instrument or forecasted transaction, referred to as a cash Öow hedge; a hedge of the fair value of a Ñxed-rate
106 Freddie Mac