Bank of America 2005 Annual Report Download - page 102

instruments allow us to seek to mitigate risks by reducing the effect of movements in the level of interest rates, changes
in the shape of the yield curve as well as changes in interest rate volatility. Hedging instruments used to mitigate these
risks include related derivatives such as options, futures, forwards and swaps.
Foreign Exchange Risk
Foreign exchange risk represents exposures we have to changes in the values of current holdings and future cash
flows denominated in other currencies. The types of instruments exposed to this risk include investments in foreign
subsidiaries, foreign currency-denominated loans, foreign currency-denominated securities, future cash flows in foreign
currencies arising from foreign exchange transactions, and various foreign exchange derivative instruments whose
values fluctuate with changes in currency exchange rates or foreign interest rates. Instruments used to mitigate this
risk are foreign exchange options, currency swaps, futures, forwards and deposits. These instruments help insulate us
against losses that may arise due to volatile movements in foreign exchange rates or interest rates.
Mortgage Risk
Our exposure to mortgage risk takes several forms. First, we trade and engage in market-making activities in a
variety of mortgage securities, including whole loans, pass-through certificates, commercial mortgages, and
collateralized mortgage obligations. Second, we originate a variety of asset-backed securities, which involves the
accumulation of mortgage-related loans in anticipation of eventual securitization. Third, we may hold positions in
mortgage securities and residential mortgage loans as part of the ALM portfolio. Fourth, we create MSRs as part of our
mortgage activities. See Notes 1 and 9 of the Consolidated Financial Statements for additional information on MSRs.
These activities generate market risk since these instruments are sensitive to changes in the level of market interest
rates, changes in mortgage prepayments and interest rate volatility. Options, futures, forwards, swaps, swaptions and
mortgage-backed securities are used to hedge mortgage risk by seeking to mitigate the effects of changes in interest
rates.
Equity Market Risk
Equity market risk arises from exposure to securities that represent an ownership interest in a corporation in the
form of common stock or other equity-linked instruments. The instruments held that would lead to this exposure
include, but are not limited to, the following: common stock, listed equity options (puts and calls), over-the-counter
equity options, equity total return swaps, equity index futures and convertible bonds. We seek to mitigate the risk
associated with these securities via hedging on a portfolio or name basis that focuses on reducing volatility from changes
in stock prices. Instruments used for risk mitigation include options, futures, swaps, convertible bonds and cash
positions.
Commodity Risk
Commodity risk represents exposures we have to products traded in the petroleum, natural gas, metals and power
markets. Our principal exposure to these markets emanates from customer-driven transactions. These transactions
consist primarily of futures, forwards, swaps and options. We seek to mitigate exposure to the commodity markets with
instruments including, but not limited to, options, futures and swaps in the same or similar commodity product, as well
as cash positions.
Issuer Credit Risk
Our portfolio is exposed to issuer credit risk where the value of an asset may be adversely impacted for various
reasons directly related to the issuer, such as management performance, financial leverage or reduced demand for the
issuer’s goods or services. Perceived changes in the creditworthiness of a particular debtor or sector can have significant
effects on the replacement costs of cash and derivative positions. We seek to mitigate the impact of credit spreads, credit
migration and default risks on the market value of the trading portfolio with the use of CDS, and credit fixed income and
similar securities.
Trading Risk Management
Trading-related revenues represent the amount earned from our trading positions, which include trading account
assets and liabilities, as well as derivative positions and, prior to the conversion of the Certificates into MSRs, market
value adjustments to the Certificates and the MSRs. Trading positions are taken in a diverse range of financial
instruments and markets. Trading account assets and liabilities, and derivative positions are reported at fair value.
MSRs are reported at the lower of cost or market. For more information on fair value, see Complex Accounting
Estimates beginning on page 74. For additional information on MSRs, see Notes 1 and 9 of the Consolidated Financial
Statements. Trading Account Profits represent the net amount earned from our trading positions and, as reported in the
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