Freddie Mac 2015 Annual Report Download - page 144

Management's Discussion and Analysis Risk Management | Interest Rate Risk and Other Market Risks
Freddie Mac 2015 Form 10-K 142
To maintain our interest-rate risk exposure within our risk limits across a range of interest-rate scenarios,
we analyze the interest-rate sensitivity of financial assets and liabilities at the instrument level on a daily
basis across a variety of interest-rate scenarios. For risk management purposes, the interest-rate risk
characteristics are determined daily based on market prices and models. The fair values of our assets
and liabilities, including derivatives, are primarily based on either third-party prices or observable market-
based inputs.
The Risk Committee of our Board of Directors establishes certain Board limits for interest-rate risk
measures, and if we exceed these limits we are required to notify the Risk Committee and address the
limit breach. These limits encompass a range of interest-rate risks that include duration risk, convexity
risk, volatility risk, and yield curve risk associated with our use of various financial instruments, including
derivatives. Also, our ERM division establishes management limits. The management limits are set at
values below those set at the Board level, which is intended to allow us to follow a series of
predetermined actions in the event of a breach of the management limits and helps ensure proper
oversight to reduce the possibility of exceeding the Board limits. Our ERC is responsible for reviewing
performance as compared to the Board and management limits.
We generally do not hedge changes in fair value of our credit guarantees except for interest-rate
exposure related to buy-ups and float. Float, which arises from timing differences between the borrower's
principal payments on the loan and the reduction of the PC balance, can lead to significant interest
expense if the interest rate paid to a PC investor is higher than the reinvestment rate earned by the
securitization trusts on payments received from borrowers and paid to us as trust management income.
Changes in prepayments, defaults, or spreads can adversely affect our economic cash flows, earnings,
and net worth.
We use derivatives as an important part of our strategy to manage interest-rate risk. When deciding to
use derivatives to mitigate our exposures, we consider a number of factors, including cost, exposure to
counterparty risks, and our overall risk management strategy. See “Credit Risk - Institutional Credit Risk”
and “Risk Factors” for more discussion of our market risk exposures, including those related to
derivatives, institutional counterparties, and other market risks.
Measurement of Interest-Rate Risk
The principal types of interest-rate and other market risks to which we are exposed are described below.