Freddie Mac 2008 Annual Report Download - page 80

includes the accrual of periodic settlements for derivatives that are not in hedge accounting relationships. Although
derivatives are an important aspect of our management of interest-rate risk, they generally increase the volatility of reported
net income (loss), particularly when they are not accounted for in hedge accounting relationships.
Table 17 — Derivatives Not in Hedge Accounting Relationships
Notional or
Contractual
Amount
Derivative
Gains
(Losses)
Notional or
Contractual
Amount
Derivative
Gains
(Losses)
Notional or
Contractual
Amount
Derivative
Gains
(Losses)
2008 2007 2006
Year Ended December 31,
(in millions)
Call swaptions
Purchased ..................................... $ 177,922 $ 17,242 $ 259,272 $ 2,472 $194,200 $(1,128)
Written ....................................... — 14 1,900 (121) — —
Put swaptions
Purchased ..................................... 41,550 (1,095) 18,725 (4) 29,725 (100)
Written ....................................... 6,000 156 2,650 (72) — —
Receive-fixed swaps
Foreign-currency denominated . . . .................... 12,924 489 18,321 (335) 26,804 (254)
U.S. dollar denominated . .......................... 266,685 29,732 283,328 4,240 195,827 (36)
Total receive-fixed swaps ......................... 279,609 30,221 301,649 3,905 222,631 (290)
Pay-fixed swaps . . ................................. 404,359 (58,295) 409,682 (11,362) 217,565 649
Futures . . ....................................... 128,698 (2,074) 196,270 142 22,400 (248)
Foreign-currency swaps
(1)
............................ 12,924 (584) 20,118 2,341 29,234 (92)
Forward purchase and sale commitments .................. 108,273 (112) 72,662 445 9,942 (95)
Other
(2)
........................................ 167,685 868 39,953 18 32,342 39
Subtotal ...................................... 1,327,020 (13,659) 1,322,881 (2,236) 758,039 (1,265)
Accrual of periodic settlements:
Receive-fixed swaps
(3)
........................... 1,928 (327) (418)
Pay-fixed swaps ............................... (3,482) 703 541
Foreign-currency swaps .......................... 319 (48) (34)
Other....................................... (60) 4 3
Total accrual of periodic settlements . .................... (1,295) 332 92
Total . . ....................................... $1,327,020 $(14,954) $1,322,881 $ (1,904) $758,039 $(1,173)
(1) Foreign-currency swaps are defined as swaps in which the net settlement is based on one leg calculated in a foreign-currency and the other leg
calculated in U.S. dollars.
(2) Consists of basis swaps, certain option-based contracts (including written options), interest-rate caps, swap guarantee derivatives and credit derivatives.
Includes $27 million loss related to the Lehman bankruptcy for the year ended December 31, 2008. For additional information, see “CREDIT RISKS —
Institutional Credit Risk — Derivative Counterparty Credit Risk.”
(3) Includes imputed interest on zero-coupon swaps.
We use receive- and pay-fixed swaps to adjust the interest rate characteristics of our debt funding in order to more
closely match changes in the interest-rate characteristics of our mortgage assets. A receive-fixed swap results in our receipt
of a fixed interest-rate payment from our counterparty in exchange for a variable-rate payment to our counterparty.
Conversely, a pay-fixed swap requires us to make a fixed interest-rate payment to our counterparty in exchange for a
variable-rate payment from our counterparty. Receive-fixed swaps increase in value and pay-fixed swaps decrease in value
when interest rates decrease (with the opposite being true when interest rates increase).
We use swaptions and other option-based derivatives to adjust the characteristics of our debt in response to changes in
the expected lives of mortgage-related assets in our mortgage-related investments portfolio. Purchased call and put swaptions,
where we make premium payments, are options for us to enter into receive- and pay-fixed swaps, respectively. Conversely,
written call and put swaptions, where we receive premium payments, are options for our counterparty to enter into receive-
and pay-fixed swaps, respectively. The fair values of both purchased and written call and put swaptions are sensitive to
changes in interest rates and are also driven by the market’s expectation of potential changes in future interest rates (referred
to as “implied volatility”). Purchased swaptions generally become more valuable as implied volatility increases and less
valuable as implied volatility decreases. Recognized losses on purchased options in any given period are limited to the
premium paid to purchase the option plus any unrealized gains previously recorded. Potential losses on written options are
unlimited.
We also use derivatives to synthetically create the substantive economic equivalent of various debt funding structures.
For example, the combination of a series of short-term debt issuances over a defined period and a pay-fixed swap with the
same maturity as the last debt issuance is the substantive economic equivalent of a long-term fixed-rate debt instrument of
comparable maturity. Similarly, the combination of non-callable debt and a call swaption with the same maturity as the non-
callable debt, is the substantive economic equivalent of callable debt. However, the use of these derivatives exposes us to
additional counterparty credit risk.
During 2008, we recognized a significantly larger derivative loss than we recognized for 2007 primarily because swap
interest rates declined significantly in 2008 resulting in a loss of $58.3 billion on our pay-fixed swap positions, partially
77 Freddie Mac