Freddie Mac 2010 Annual Report Download - page 235

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 interest rate 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 interest rate swaps or sell Treasury-based derivatives in order to lengthen the duration of our
funding to offset the increasing duration of our mortgage assets.
Foreign-Currency Exposure
We use foreign-currency swaps to eliminate virtually all of our exposure to fluctuations in exchange rates related to our
foreign-currency denominated debt by entering into swap transactions that effectively convert foreign-currency denominated
obligations into U.S. dollar-denominated obligations.
Types of Derivatives
We principally use the following types of derivatives:
• LIBOR- and 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
interest rate 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 REMICs 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.
Commitments
We routinely enter into commitments that include: (a) our commitments to purchase and sell investments in securities;
and (b) our commitments to purchase and extinguish or issue debt securities of our consolidated trusts. Most of these
commitments are derivatives subject to the requirements of derivatives and hedging accounting.
Swap Guarantee Derivatives
In connection with some of the guarantee arrangements pertaining to multifamily housing revenue bonds and
multifamily pass-through certificates, we may also guarantee the sponsor’s or the borrower’s obligations as a counterparty on
any related interest-rate swaps used to mitigate interest-rate risk, which are accounted for as swap guarantee derivatives.
Credit Derivatives
We 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 four monthly payments past due.
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.
For a discussion of our significant accounting policies related to derivatives, please see “NOTE 1: SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES — Derivatives.”
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