Freddie Mac 2005 Annual Report Download - page 96

veriÑcation of Ñnancial instrument pricing with third-party broker/dealers or pricing services. Furthermore, our estimates of
fair value are likely to change in future periods to reÖect changes in market factors such as interest rates and related
volatility, credit performance, expectations about prepayment behavior and other factors. Our estimates of fair value for
individual instruments may change by material amounts, depending on market developments. See ""RISK MANAGE-
MENT Ì Interest-Rate Risk and Other Market Risks'' for discussion of market risks and our interest-rate sensitivity
measures, PMVS and duration gap.
Issuances and Transfers of PCs and Structured Securities
As is further discussed in ""BUSINESS,'' we issue PCs and Structured Securities to third parties in several diÅerent
ways. In general, we account for such transfers as sales of Ñnancial assets or as Ñnancial guarantee transactions.
We evaluate whether transfers of PCs or Structured Securities qualify as sales based upon the requirements of
SFAS No. 140, ""Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities'' and, prior
to April 1, 2001, SFAS No. 125, ""Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities,'' which we collectively refer to as SFAS 125/140. In this regard, we account for a transfer as a sale to the extent
we conclude that (i) assets that underlie the transferred PCs or Structured Securities are legally beyond our reach and the
reach of our creditors even in the event that we were to become Ñnancially insolvent, (ii) a third-party buyer can freely
pledge or exchange the PCs or Structured Securities that were transferred to it and (iii) we did not maintain eÅective
control over transferred PCs or Structured Securities through either (a) an arrangement that both entitles and obligates us
to repurchase or redeem transferred PCs or Structured Securities before their maturity or (b) the ability to unilaterally
cause the holder of a transferred PC or Structured Security to return speciÑc assets (i.e., other than through a clean up call).
If a transfer of PCs or Structured Securities qualiÑes as a sale, we recognize a gain or loss on the sale immediately in
earnings based upon the diÅerence in value between cash received, the recognized carrying value of interests sold and the
fair value of liabilities incurred upon sale. In this case, our guarantee of the payment of principal and interest on PCs and
Structured Securities results in the recognition of a Guarantee asset and Guarantee obligation on our consolidated balance
sheets.
If we determine that a transfer of PCs or Structured Securities does not qualify as a sale, we account for such transfer as
a secured borrowing or as a Ñnancial guarantee transaction pursuant to the provisions of FASB Interpretation No. 45,
""Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others'', or FIN 45. Many of the transfers of PCs and Structured Securities that are made to third parties do not qualify as
sales or secured borrowings, but are accounted for as Ñnancial guarantee transactions pursuant to the provisions of FIN 45.
For such transactions, at the inception of an executed guarantee, we recognize a Guarantee obligation that is initially
measured to be the greater of (a) fair value or (b) the contingent liability amount required to be recognized at inception of
the guarantee by SFAS No. 5, ""Accounting For Contingencies,'' or SFAS 5. We also recognize the fair value of any
consideration received on such transactions. Positive diÅerences between the fair value of consideration expected and
received, and Guarantee obligations incurred, are deferred as a component of recognized Guarantee obligations, while
negative diÅerences between such amounts are recognized immediately in earnings as a component of Other expense.
With respect to all transfers of PCs and Structured Securities to third parties, the measurement of the Guarantee asset,
Guarantee obligation and credit enhancement-related assets involves our best estimate with respect to key assumptions,
including expected credit losses and the exposure to credit losses that could be greater than expected credit losses,
prepayment rates, forward yield curves and discount rates. We believe that the assumptions we made in this regard are
comparable to those used by other market participants. The use of diÅerent pricing models and assumptions could produce
materially diÅerent results. See ""NOTE 2: TRANSFERS OF SECURITIZED INTERESTS IN MORTGAGE-
RELATED ASSETS'' to our consolidated Ñnancial statements for further discussion of the approach we use to determine
the fair values of the Guarantee asset and Guarantee obligation.
Derivative Instruments and Hedging Activities
The determination of whether a derivative qualiÑes for hedge accounting requires signiÑcant judgment and has a
signiÑcant impact on how such instruments are accounted for in our consolidated Ñnancial statements. As described more
fully in ""CONSOLIDATED RESULTS OF OPERATIONS Ì Derivative Gains (Losses),'' we discontinued substan-
tially all of our cash Öow hedge accounting relationships eÅective as of April 2, 2004, because they no longer met the hedge
eÅectiveness requirements of SFAS 133, as amended by SFAS No. 138, ""Accounting for Certain Derivative Instruments
and Certain Hedging Activities'' and SFAS No. 149, ""Amendment of Statement 133 on Derivative Instruments and
Hedging Activities,'' which we collectively refer to as SFAS 133. In addition, we voluntarily discontinued a signiÑcant
portion of our fair value hedging relationships eÅective November 1, 2004. Accordingly, the portion of our derivatives
portfolio that was designated in hedge accounting relationships was signiÑcantly reduced by the end of 2004. EÅective at the
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