Freddie Mac 2006 Annual Report Download - page 76

the borrower's performance as a counterparty on any related interest-rate swaps used to mitigate interest-rate risk.
Guarantees of these interest-rate swaps entered into after June 30, 2003 are treated as derivatives and are reported as swap
guarantee derivatives.
Credit Derivatives. See ""Credit Risks Ì Mortgage Credit Risk Ì Mortgage Credit Risk Management Strategies'' for
more information.
Derivative-Related Risks
Our use of derivatives exposes us to derivative market liquidity risk and counterparty credit risk.
Derivative Market Liquidity Risk. Derivative market liquidity risk is the risk that we may not be able to enter into or
exit out of derivative transactions at a reasonable cost. A lack of suÇcient capacity or liquidity in the derivatives market
could limit our risk management activities, increasing our exposure to interest-rate risk. To help maintain continuous access
to derivative markets, we use a variety of products and transact with many diÅerent derivative counterparties. In addition to
over-the-counter, or OTC, derivatives, we also use exchange-traded derivatives, asset securitization activities, callable debt
and short-term debt to rebalance our portfolio.
We limit our duration and convexity exposure to each counterparty. At December 31, 2006, the largest single
uncollateralized exposure of our 27 approved OTC counterparties listed in ""Table 36 Ì Derivative Counterparty Credit
Exposure'' was related to a AAA-rated counterparty, constituting $403 million, or 60 percent, of the total uncollateralized
exposure of our OTC interest-rate swaps, option-based derivatives and foreign-currency swaps.
Derivative Counterparty Credit Risk. Counterparty credit risk arises from the possibility that the derivative
counterparty will not be able to meet its contractual obligations. Exchange-traded derivatives, such as futures contracts, do
not measurably increase our counterparty credit risk because changes in the value of open exchange-traded contracts are
settled daily through a Ñnancial clearinghouse established by each exchange. OTC derivatives, however, expose us to
counterparty credit risk because transactions are executed and settled between us and the counterparty. When an OTC
derivative has a market value above zero at a given date (i.e., it is an asset reported as Derivative assets, at fair value on our
consolidated balance sheets), then the counterparty could potentially be obligated to deliver cash, securities or a
combination of both having that market value to satisfy its obligation to us under the derivative.
We actively manage our exposure to counterparty credit risk using several tools, including:
‚ review of external rating analyses;
‚ strict standards for approving new derivative counterparties;
‚ ongoing monitoring of our positions with each counterparty;
‚ master netting agreements and collateral agreements; and
‚ stress-testing to evaluate potential exposure under possible adverse market scenarios.
On an ongoing basis, we review the credit fundamentals of all of our derivative counterparties to conÑrm that they
continue to meet our internal standards. We assign internal ratings, credit capital and exposure limits to each counterparty
based on quantitative and qualitative analysis, which we update and monitor on a regular basis. We conduct additional
reviews when market conditions dictate or events aÅecting an individual counterparty occur.
Derivative Counterparties. Our use of OTC interest-rate swaps, option-based derivatives and foreign-currency swaps is
subject to rigorous internal credit and legal reviews. Our derivative counterparties carry external credit ratings among the
highest available from major rating agencies. All of these counterparties are major Ñnancial institutions and are experienced
participants in the OTC derivatives market.
Master Netting and Collateral Agreements. We use master netting and collateral agreements to reduce our credit risk
exposure to our active OTC derivative counterparties for interest-rate swaps, option-based derivatives and foreign-currency
swaps. See ""NOTE 17: CONCENTRATION OF CREDIT AND OTHER RISKS'' to our consolidated Ñnancial
statements for additional information.
Table 36 summarizes our exposure to counterparty credit risk in our derivatives, which represents the net positive fair
value of derivative contracts and related accrued interest after netting by counterparty as applicable (i.e., net amounts due to
us under derivative contracts). This table is useful in understanding the counterparty credit risk related to our derivative
portfolio.
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