eTrade 2011 Annual Report Download - page 94

Derivative Instruments
We use derivative instruments to help manage 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”), Floor Options (“Floors”), “Payor Swaptions” and “Receiver Swaptions”. Caps mitigate the
market risk associated with increases in interest rates while Floors mitigate the risk associated with decreases in
market interest rates. Similarly, Payor and Receiver Swaptions mitigate the market risk associated with the
respective increases and decreases in interest rates. See derivative instruments discussion at Note 7—Accounting
for Derivative Instruments and Hedging Activities in 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 had 99% of enterprise interest-earning assets
at both December 31, 2011 and 2010 and held 98% of enterprise interest-bearing liabilities at both December 31,
2011 and 2010. The sensitivity of NPVE at December 31, 2011 and 2010 and the limits established by
E*TRADE Bank’s Board of Directors are listed below (dollars in millions):
Parallel Change in Interest Rates (basis points)(1)
Change in NPVE
December 31, 2011 December 31, 2010
Amount Percentage Amount Percentage Board Limit
+300 $ (18.7) (0.5)% $ (88.5) (2.7)% (25)%
+200 $ 120.2 3.4% $ (37.0) (1.1)% (15)%
+100 $ 153.6 4.4% $ 8.0 0.2% (10)%
-100 $(324.0) (9.2)% $(147.5) (4.4)% (10)%
(1) On December 31, 2011 and 2010, the yield for the three-month treasury bill was 0.02% and 0.12%, respectively. As a
result, the requirements of the NPV Model were temporarily modified, resulting in the removal of the minus 200 and 300 basis points
scenarios for the periods ended December 30, 2011 and 2010.
Under criteria published by its regulator, E*TRADE Bank’s overall interest rate risk exposure at
December 31, 2011 was characterized as “minimum.” We actively manage 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. Our
market maker facilitates customer orders and carries equity security positions on a daily basis. From time to time,
we may carry large positions in securities of a single issuer or issuers engaged in a specific industry. As of
December 31, 2011, we held securities with a fair value of $53.6 million in long positions and $48.3 million in
short positions, for a net exposure of $5.3 million.
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