Freddie Mac 2011 Annual Report Download - page 187

“RISK FACTORS — Conservatorship and Related Matters — We expect to make additional draws under the Purchase
Agreement in future periods, which will adversely affect our future results of operations and financial condition.”
For more information on the Purchase Agreement, its effect on our business and capital management activities,
factors that could adversely affect the size and timing of further draws, and the potential impact of making additional
draws, see “Liquidity — Dividend Obligation on the Senior Preferred Stock,” “BUSINESS — Executive Summary —
Government Support for Our Business” and “RISK FACTORS.”
FAIR VALUE MEASUREMENTS AND ANALYSIS
Fair Value Measurements
Fair value represents the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. The accounting guidance for fair value measurements
and disclosures establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair
value based on the inputs a market participant would use at the measurement date. Observable inputs reflect market data
obtained from independent sources. Unobservable inputs reflect assumptions based on the best information available under
the circumstances. Unobservable inputs are used to measure fair value to the extent that observable inputs are not
available, or in situations where there is little, if any, market activity for an asset or liability at the measurement date. We
use valuation techniques that seek to maximize the use of observable inputs, where available, and minimize the use of
unobservable inputs.
The three levels of the fair value hierarchy under the accounting guidance for fair value measurements and
disclosures are described below:
• Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical
assets or liabilities;
• Level 2: Quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar
assets and liabilities in markets that are not active; inputs other than quoted market prices that are observable for
the asset or liability; and inputs that are derived principally from or corroborated by observable market data for
substantially the full term of the assets or liabilities; and
• Level 3: Unobservable inputs for the asset or liability that are supported by little or no market activity and that are
significant to the fair values.
We categorize assets and liabilities measured and reported at fair value in our consolidated balance sheets within the
fair value hierarchy based on the valuation process used to derive their fair values and our judgment regarding the
observability of the related inputs. Those judgments are based on our knowledge and observations of the markets relevant
to the individual assets and liabilities and may vary based on current market conditions. In applying our judgments, we
review ranges of third party prices and transaction volumes, and hold discussions with dealers and pricing service vendors
to understand and assess the extent of market benchmarks available and the judgments or modeling required in their
processes. Based on these factors, we determine whether the inputs are observable and whether the principal markets are
active or inactive.
Our Level 1 financial instruments consist of exchange-traded derivatives, Treasury bills, and Treasury notes, where
quoted prices exist for the exact instrument in an active market.
Our Level 2 instruments generally consist of high credit quality agency securities, CMBS, non-mortgage-related
asset-backed securities, FDIC-guaranteed corporate medium-term notes, interest-rate swaps, option-based derivatives, and
foreign-currency denominated debt. These instruments are generally valued through one of the following methods:
(a) dealer or pricing service inputs with the value derived by comparison to recent transactions involving similar securities
and adjusting for differences in prepayment or liquidity characteristics; or (b) modeled through an industry standard
modeling technique that relies upon observable inputs such as discount rates and prepayment assumptions.
Our Level 3 assets primarily consist of non-agency mortgage-related securities. The non-agency mortgage-related
securities market continued to be illiquid during 2011, with low transaction volumes, wide credit spreads, and limited
transparency. We value the non-agency mortgage-related securities we hold based primarily on prices received from
pricing services and dealers. The techniques used by these pricing services and dealers to develop the prices generally are
either: (a) a comparison to transactions involving instruments with similar collateral and risk profiles; or (b) industry
standard modeling, such as a discounted cash flow model. For a large majority of the securities we value using dealers
and pricing services, we obtain multiple independent prices, which are non-binding both to us and our counterparties.
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