eTrade 2009 Annual Report Download - page 96

Derivative Instruments
We use derivative instruments to help manage our interest rate risk. Interest rate swaps involve the exchange
of fixed-rate and variable-rate interest payments between two parties based on a contractual underlying notional
amount, but do not involve the exchange of the underlying notional amounts. Option products are utilized
primarily to decrease the market value changes resulting from the prepayment dynamics of the mortgage
portfolio, as well as to protect against increases in funding costs. The types of options employed include Cap
Options (“Caps”) and Floor Options (“Floors”). Caps mitigate the market risk associated with increases in
interest rates while Floors mitigate the risk associated with decreases in market interest rates. See derivative
instruments discussion at Note 8—Accounting for Derivative Instruments and Hedging Activities of Item 8.
Financial Statements and Supplementary Data.
Scenario Analysis
Scenario analysis is an advanced approach to estimating interest rate risk exposure. Under the NPVE
approach, the present value of all existing assets, liabilities, derivatives and forward commitments are estimated
and then combined to produce a NPVE figure. The sensitivity of this value to changes in interest rates is then
determined by applying alternative interest rate scenarios, which include, but are not limited to, instantaneous
parallel shifts up 100, 200 and 300 basis points and down 100 basis points. The NPVE method is used at the
E*TRADE Bank level and not for the Company. E*TRADE Bank has 97% and 98% of our enterprise interest-
earning assets at December 31, 2009 and 2008, respectively, and holds 97% and 98% of our enterprise interest-
bearing liabilities at December 31, 2009 and 2008, respectively. The sensitivity of NPVE at December 31, 2009
and 2008 and the limits established by E*TRADE Bank’s Board of Directors are listed below (dollars in
millions):
Change in NPVE
December 31, 2009(1) December 31, 2008
Parallel Change in Interest Rates (basis points)(2) Amount Percentage Amount Percentage Board Limit
+300 $(453.6) (14)% $ (65.6) (3)% (55)%
+200 $(276.6) (9)% $ 68.9 3% (30)%
+100 $ (89.2) (3)% $ 119.4 5% (20)%
-100 $(110.5) (3)% $(334.1) (14)% (20)%
(1) Amounts and percentages include E*TRADE Securities LLC.
(2) On December 31, 2009 and 2008, the yield on the three-month Treasury bill was 0.06% and 0.11%, respectively. As a result, the OTS
temporarily modified the requirements of the NPV Model, resulting in removal of the minus 200 and 300 basis points scenarios for the
periods ended December 31, 2009 and 2008.
Under criteria published by the OTS, E*TRADE Bank’s overall interest rate risk exposure at December 31,
2009 was characterized as “minimum.” We actively manage our interest rate risk positions. As interest rates
change, we will re-adjust our strategy and mix of assets, liabilities and derivatives to optimize our position. For
example, a 100 basis points increase in rates may not result in a change in value as indicated above. The ALCO
monitors E*TRADE Bank’s interest rate risk position.
Other Market Risk
Equity Security Risk
Equity securities risk is the risk of potential loss from investing in public and private equity securities. We
hold equity securities for corporate investment and market-making purposes. For corporate investment purposes,
we currently hold publicly traded equity securities with a fair value of $0.8 million as of December 31, 2009. For
market-making purposes, we currently hold equity securities with a fair value of $67.2 million as of
December 31, 2009.
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