By Jonathan Stempel

NEW YORK, Feb 29 (Reuters) - Warren Buffett's Berkshire Hathaway Inc (BRKa.N: Quote, Profile, Research) (BRKb.N: Quote, Profile, Research) ended 2007 with $40 billion of exposure to derivative contracts designed to make money if junk bonds stay out of default and stock indexes rise.

Berkshire's maximum exposure under derivative contracts rose from about $24 billion a year earlier, according to the company's annual report released on Friday. In his shareholder letter accompanying the report, Buffett said the exposure was tied to 94 derivative contracts, up from 62 a year earlier.

The exposure may seem curious given Buffett's proclamation in his shareholder letter five years ago that "derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."

Berkshire also spent about five years extricating its General Re Corp reinsurance unit from its derivatives business -- one Buffett knew about when he bought that company.

But Glenn Tongue, an investor at T2 Partners LLC in New York, said the risk of Berkshire's derivative contracts is low, in contrast to risks posed from other complex instruments.

He pointed to MBIA Inc (MBI.N: Quote, Profile, Research) and Ambac Financial Group Inc (ABK.N: Quote, Profile, Research), bond insurers that found trouble after guaranteeing debt, including some tied to subprime mortgages, that now suffers from deteriorating credit quality, falling prices, and illiquidity.

"Berkshire has derivative contracts where it has been paid, and there is no counterparty risk," he said. "In the case of MBIA and Ambac, there is both counterparty risk with their reinsurance contracts, and their exposure to structured products. Berkshire doesn't have that."

Buffett said Berkshire has written 54 derivative contracts requiring payouts if some high-yield bonds default between now and 2013. He said Berkshire has received $3.2 billion of premiums and paid out $472 million, a number he said is certain to rise. The maximum further loss is $4.7 billion, he said.