Freddie Mac 2006 Annual Report Download - page 74

‚ PMVS-YC shows the estimated loss in pre-tax portfolio market value, expressed as a percentage of our after-tax fair
value of net assets attributable to common stockholders, from an immediate adverse 25 basis point change in the
slope (up and down) of the LIBOR yield curve. The 25 basis point change in slope for the PMVS-YC measure is
obtained by shifting the two-year and ten-year LIBOR rates by an equal amount (12.5 basis points), but in opposite
directions. LIBOR rate shifts between the two-year and ten-year points are interpolated.
‚ Duration gap estimates the net sensitivity of the fair value of our Ñnancial instruments to movements in interest rates.
Duration gap is presented in units expressed as months. A duration gap of zero implies that the change in value of
assets from an instantaneous rate move will be accompanied by an equal and oÅsetting move in the value of debt
and derivatives thus leaving the net fair value of equity unchanged. However, because duration does not capture
convexity exposure (the amount by which duration itself changes as rates move), actual changes in fair value from
interest-rate changes may diÅer from those implied by duration gap alone. For that reason, we believe duration gap is
most useful when used in conjunction with PMVS.
The 50 basis point shift and 25 basis point change in slope of the LIBOR yield curve used for our PMVS measures
represent events that are expected to have an approximately 5 percent probability of occurring over a one-month time
horizon. We believe that our PMVS measures represent conservative measures of interest-rate risk because these assumed
scenarios are unlikely, and because the scenarios assume instantaneous shocks, therefore these PMVS measures do not
consider the eÅects on fair value of any rebalancing actions that we would typically take to reduce our risk exposure.
The expected loss in portfolio market value, which is the numerator in the fraction used to calculate the PMVS
percentages, is an estimate of the sensitivity to changes in interest rates of the fair value of all interest-earning assets and
interest-bearing liabilities and derivatives on a pre-tax basis. When we calculate the expected loss in portfolio market value
and duration gap, we also take into account the cash Öows related to certain credit guarantee-related items, including net
buy-ups and expected gains or losses due to net interest from Öoat. In making these calculations, we do not consider the
sensitivity to interest-rate changes of the following assets and liabilities:
‚Credit guarantee portfolio. We do not consider the sensitivity of the fair value of the credit guarantee portfolio to
changes in interest rates except for the guarantee-related items mentioned above (i.e., net buy-ups and Öoat),
because we believe the expected beneÑts from replacement business provide an adequate hedge against interest-rate
changes.
‚Other assets with minimal interest-rate sensitivity. We do not include other assets, primarily non-Ñnancial
instruments such as Ñxed assets and REO, because of the minimal impact they would have on both PMVS and
duration gap.
These two categories of assets and liabilities are included in our estimate of the after-tax fair value of net assets
attributable to common stockholders, which is the denominator of the fraction used to calculate the PMVS-L and
PMVS-YC percentages.
PMVS Results. Table 34 provides estimated point-in-time PMVS-L and PMVS-YC results at December 31, 2006
and 2005. Table 34 also provides PMVS-L estimates assuming an immediate 100 basis point shift in the LIBOR yield curve.
Because we do not hedge all prepayment option risk, the duration of our mortgage assets changes more rapidly as changes
in interest rates increase. Accordingly, as shown in Table 34, the PMVS-L results based on a 100 basis point shift in the
LIBOR curve are disproportionately higher than the PMVS-L results based on a 50 basis point shift in the LIBOR curve.
Table 34 Ì Portfolio Market Value Sensitivity Assuming Shifts of the LIBOR Yield Curve
Potential Pre-Tax Loss in
Portfolio Market Value Sensitivity Portfolio Market Value (in millions)
PMVS-YC PMVS-L PMVS-YC PMVS-L
25 bps 50 bps 100 bps 25 bps 50 bps 100 bps
At:
December 31, 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì% 1% 2% $27 $146 $560
December 31, 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì% 1% 3% $26 $236 $798
Derivatives have enabled us to keep our interest-rate risk exposure at consistently low levels in a wide range of interest-
rate environments. By keeping PMVS-L and PMVS-YC low, we have been able to reduce the exposure of the fair value of
our stockholders' equity to adverse changes in interest rates.
Table 35 shows that the low PMVS-L risk levels for the periods presented would generally have been higher if we had
not used derivatives to manage our interest-rate risk exposure.
62 Freddie Mac