Freddie Mac 2008 Annual Report Download - page 181

Adjust Funding Mix
We generally use interest-rate swaps to mitigate contractual funding mismatches between our assets and liabilities. We
also use swaptions and other option-based derivatives to adjust the contractual funding of our debt in response to changes in
the expected lives of mortgage-related assets in our mortgage-related investments portfolio. As market conditions dictate, we
take rebalancing actions to keep our interest-rate risk exposure within management-set limits. In a declining interest-rate
environment, we typically enter into receive-fixed swaps or purchase Treasury-based derivatives to shorten the duration of
our funding to offset the declining duration of our mortgage assets. In a rising interest-rate environment, we typically enter
into pay-fixed swaps or sell Treasury-based derivatives in order to lengthen the duration of our funding to offset the
increasing duration of our mortgage assets.
Types of Derivatives
The derivatives we use to hedge interest-rate and foreign-currency risk are common in the financial markets. We
principally use the following types of derivatives:
• LIBOR- and the Euro Interbank Offered Rate, or Euribor-, based interest-rate swaps;
• LIBOR- and Treasury-based options (including swaptions);
• LIBOR- and Treasury-based exchange-traded futures; and
• Foreign-currency swaps.
In addition to swaps, futures and purchased options, our derivative positions include the following:
Written Options and Swaptions
Written call and put swaptions are sold to counterparties allowing them the option to enter into receive- and pay-fixed
swaps, respectively. Written call and put options on mortgage-related securities give the counterparty the right to execute a
contract under specified terms, which generally occurs when we are in a liability position. We use these written options and
swaptions to manage convexity risk over a wide range of interest rates. Written options lower our overall hedging costs,
allow us to hedge the same economic risk we assume when selling guaranteed final maturity REMICs with a more liquid
instrument and allow us to rebalance the options in our callable debt and REMIC portfolios. We may, from time to time,
write other derivative contracts such as caps, floors, interest-rate futures and options on buy-up and buy-down commitments.
Forward Purchase and Sale Commitments
We routinely enter into forward purchase and sale commitments for mortgage loans and mortgage-related securities.
Most of these commitments are derivatives subject to the requirements of SFAS 133.
Swap Guarantee Derivatives
We issue swap guarantee derivatives that guarantee the payments on (a) multifamily mortgage loans that are originated
and held by state and municipal housing finance agencies to support tax-exempt multifamily housing revenue bonds and
(b) Freddie Mac pass-through certificates which are backed by tax-exempt multifamily housing revenue bonds and related
taxable bonds and/or loans. In connection with some of these guarantees, we may also guarantee the sponsor’s or the
borrower’s performance as a counterparty on any related interest-rate swaps used to mitigate interest-rate risk.
Credit Derivatives
We have entered into credit derivatives, including risk-sharing agreements. Under these risk-sharing agreements, default
losses on specific mortgage loans delivered by sellers are compared to default losses on reference pools of mortgage loans
with similar characteristics. Based upon the results of that comparison, we remit or receive payments based upon the default
performance of the referenced pools of mortgage loans. In addition, we have entered into agreements whereby we assume
credit risk for mortgage loans held by third parties in exchange for a monthly fee. We are obligated to purchase any of the
mortgage loans that become 120 days delinquent.
In addition, we have purchased mortgage loans containing debt cancellation contracts, which provide for mortgage debt
or payment cancellation for borrowers who experience unanticipated losses of income dependent on a covered event. The
rights and obligations under these agreements have been assigned to the servicers. However, in the event the servicer does
not perform as required by contract, under our guarantee, we would be obligated to make the required contractual payments.
Derivative-Related Risks
Our use of derivatives exposes us to derivative market liquidity risk. See “MD&A — CREDIT RISKS — Derivative
Counterparty Credit Risk” for information on derivative counterparty credit risk.
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