Freddie Mac 2015 Annual Report Download - page 145

Management's Discussion and Analysis Risk Management | Interest Rate Risk and Other Market Risks
Freddie Mac 2015 Form 10-K 143
Risk Description Risk Exposure
Yield Curve
Risk Yield curve risk is the risk that changes in the level and shape of the yield curve, such as a
level change, or a flattening or steepening, will
adversely affect our economic value. Our yield
curve risk under a specified yield curve scenario
is reflected in our PMVS-YC disclosure.
• A change in the level of interest rates
(represented by a parallel shift of the yield
curve, all else constant) exposes our assets and
liabilities to risk, potentially affecting future
expected cash flows and their present values.
• Similarly, changes in the shape or slope of the
yield curve (often reflecting changes in the
market’s expectation of future interest rates)
exposes our assets and liabilities to risk,
potentially affecting expected future cash flows
and their present values.
Volatility
Risk Volatility risk is the risk that changes in the market’s expectation of the magnitude of future
variations in interest rates will adversely affect
our economic value.
• We are exposed to volatility risk in both our
mortgage-related assets and liabilities,
especially in instruments with embedded
options.
Spread Risk Spread risk is the risk that yields in different
asset classes may not move together and may
adversely affect our economic value.
• This risk arises principally because interest
rates on our mortgage-related investments may
not move in tandem with interest rates on our
financial liabilities and derivatives, potentially
affecting the effectiveness of our hedges.
• We are continually exposed to significant spread
risk, also referred to as mortgage-to-debt OAS
risk, arising from funding mortgage-related
investments with debt securities.
• We also incur spread risk when we use LIBOR-
or Treasury-based instruments in our risk
management activities.
• We are exposed to spread risk arising from the
difference in time between when we commit to
purchase a multifamily mortgage loan and when
we securitize the loan. During this time, spreads
can widen, causing losses due to changes in
fair value. We also have spread risk on the K
Certificates we hold in our mortgage-related
investments portfolio.
Our primary interest-rate risk measures are duration gap and PMVS.
• Duration gap - Measures the difference in price sensitivity to interest rate changes between our
financial assets and liabilities, and is expressed in months relative to the market value of assets. For
example, assets with a six month duration and liabilities with a five month duration would result in a
positive duration gap of one month. A duration gap of zero implies that the duration of our assets
equals the duration of our liabilities. As a result, the change in the value of assets from an
instantaneous move in interest rates, either up or down, would be expected to be accompanied by an
equal and offsetting change in the value of liabilities, thus leaving the economic value unchanged. A
positive duration gap indicates that the duration of our assets exceeds the duration of our liabilities
which, from a net perspective, implies that the economic value will increase in value when interest
rates fall and decrease in value when interest rates rise. A negative duration gap indicates that the
duration of our liabilities exceeds the duration of our assets which, from a net perspective, implies that
the economic value will increase in value when interest rates rise and decrease in value when interest
rates fall.