Freddie Mac 2012 Annual Report Download - page 306

observability of the related inputs. The following is a description of the valuation techniques we use for fair value
measurement and disclosure; the significant inputs used in those techniques (if applicable); our basis for classifying the
measurements as Level 1, Level 2, or Level 3 of the fair value hierarchy; and, for those measurements classified as Level 3 of
the hierarchy, a narrative description of the sensitivity of the fair value measurement to changes in significant unobservable
inputs and a description of any interrelationships between those unobservable inputs. Although the sensitivities of the
unobservable inputs are generally discussed below in isolation, interrelationships exist among the inputs such that a change
in one unobservable input typically results in a change to one or more of the other inputs. For example, the most common
interrelationship that impacts the majority of our fair value measurements is between future interest rates, prepayment
speeds, and probabilities of default. Generally, a change in the assumption used for future interest rates results in a
directionally opposite change in the assumption used for prepayment speeds and a directionally similar change in the
assumption used for probabilities of default.
Each technique discussed below may not be used in a given reporting period, depending on the composition of our
assets and liabilities measured at fair value and relevant market activity during that period.
Investments in Securities
Mortgage-Related Securities
Agency Securities
Agency securities, both trading and available-for-sale, consist of mortgage-related securities issued and guaranteed by
Freddie Mac, Fannie Mae, and Ginnie Mae. The valuation techniques for agency securities vary depending on the type of
security.
Fixed-rate single-class securities are valued using observable prices for similar securities in the TBA market. The
observable TBA prices vary based on agency, term, coupon, and settlement date. In addition, we may adjust the TBA price
accordingly based on matrices we receive from external dealers for securities with specific collateral characteristics if we
observe those collateral characteristics to be trading at a premium or discount to the TBA price. Significant inputs used in
this technique are the TBA prices and the security characteristics mentioned above. These securities have observable market
pricing and are classified as Level 2.
Adjustable-rate single-class securities and the majority of multiclass securities are valued using the median of external
sources. For certain multiclass securities, we are able to receive prices from only a single external source. Adjustable-rate
single-class securities and the multiclass securities valued using these techniques generally have observable market prices
and are classified as Level 2. However, certain multiclass securities valued using these techniques are classified as Level 3
when there is a low volume or level of activity in the market for those securities.
Certain multiclass securities for which we are not able to obtain external prices due to limited relevant market activity
are valued using a discounted cash flow technique. Under this technique, securities are valued by starting with a third-party
market price for a similar security within our portfolio. We then use our proprietary prepayment and interest rate models to
calculate an OAS for the similar security, which is used to determine the net present value of the projected cash flows for the
security to be valued. The significant unobservable input used in the fair value measurement of these securities is the OAS.
Significant increases (decreases) in the OAS in isolation would result in a significantly lower (higher) fair value
measurement. These securities are classified as Level 3 as significant inputs used in the fair value measurement are
unobservable.
Certain complex multiclass securities for which current cash flow information is not readily available are valued using a
risk-metric pricing technique. Under this technique, securities are valued by starting with a prior period price and adjusting
that price for market changes in certain key risk metrics such as key rate durations. If necessary, our judgment is applied to
adjust the price based on specific security characteristics. The significant unobservable inputs used in the fair value
measurement of these securities are the key risk metrics. Significant increases (decreases) in key rate durations in isolation
would result in a significantly lower (higher) fair value measurement. These securities are classified as Level 3 as significant
inputs used in the fair value measurement are unobservable.
Commercial Mortgage-Backed Securities
The majority of our CMBS are valued using the median of external sources. For a small number of CMBS, we are able
to receive prices from only a single external source. CMBS valued using these techniques generally have observable market
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