This document discusses dynamic currency hedging (DCH) as a strategy to protect overseas assets from currency risk. It notes that accurately forecasting currency movements is very difficult, with experts often missing the mark. DCH aims to hedge currency risk while allowing upside participation by adjusting hedge levels in response to currency fluctuations using forward contracts. This results in an option-like profile that limits losses when the home currency falls while capturing gains when it rises. The document provides examples showing how DCH outperformed static hedging and unhedged approaches during a period of large Australian dollar depreciation by quickly lowering hedge levels.

1. Macquarie FICCAM – Dynamic Currency Hedging
March 2010

2. 2
Accurate forecasting is near impossible
> Forecasting the future direction
and magnitude of currency
moves is very difficult.
> 8 out of 14 years, expert
forecasts miss the actual rate
by more than 10%.
> In many years experts get the
direction of the currency move
completely wrong (like in 2008)
Source: Macquarie
A professional currency manager
will provide full hedging services
to protect your overseas assets.
-30
-20
-10
0
10
20
30
1996 1998 2000 2002 2004 2006 2008
0.4
0.5
0.6
0.7
0.8
0.9
1
% missed in forecast (LHS) AUD/USD (RHS)
% $

3. 3
The high cost of wrong direction
> During the second half of 2008, the cost of having
the wrong strategy (hedged) versus those with the
right strategy (unhedged) was 34%.
> A wrong hedging strategy may bring a top
performing company to the bottom of the peer
group.
> There is a high correlation between periods of AUD
depreciation and fall in asset value which makes a
wrong decision very costly and unmanageable.
- What happens if your assets are illiquid?
- How do you finance the drawdowns?
34%
Can you leave a 34% fall
unmanaged?
Source: Bloomberg. The results are calculated based on a MSCI currency basket from July 2008 to October 2008
Hedge your overseas assets and choose the
appropriate hedging solution

4. 4
Static hedge
Profit
Loss
AUD/Basket
Down
AUD/Basket
Up
If you fully hedge, the P/L effect due to currency is neutralised.
HEDGE
GAIN
HEDGE
LOSS

5. 5
The perfect hedge
Profit
Loss
> If you do not hedge, the P/L effect due to currency is maximised.
HEDGE
GAIN
NO
HEDGE
AUD/Basket
Down
AUD/Basket
Up
> Ideally you want to fully hedge when the base currency goes up and have
no hedge when the base currency goes down.

6. 6
Dynamic Currency Hedging, the
ultimate hedge
Profit
Loss
A similar profile to the perfect hedge.
HIGH
HEDGE
LOW
HEDGE
AUD/Basket
Down
AUD/Basket
Up

7. 7
What is Dynamic Currency Hedging (DCH)?
> DCH is a systematic trend following strategy with limited
amount of manager discretion.
> DCH is a hedging strategy designed to minimise down side
currency risk while allowing to participate in the upside gain.
> The level of currency hedge changes as exchange rate levels
fluctuate.
> Aims to achieve an option-like pay off over
a 12 month period.
> Primarily use currency forward contracts.
DCH, the ultimate hedge

8. 8
How does Dynamic Currency Hedging work?
AUD/Basket
50 %
25 %
0 %
100 %
75 %
IftheAUDappreciates,DCH
moves
towardsa hedgelevelof100%
Hedge Ratio
IftheAUDdepreciates,DCH
moves
towardsa 0%hedgelevel
A DCH’s return profile shows gains as the AUD rallies but limits downside
losses when the AUD falls
Initial hedge

9. 9
Big hedging losses & illiquid assets
Profit
Loss
When the base currency falls
and your forward contracts
mature you need cash to pay
the loss.
> If your assets are illiquid,
this might be difficult to sell
> If your assets have
depreciated, it could be the
wrong time to sell
HEDGE
LOSS
Unrealised
Gain
Realised
Loss
AUD/Basket
Down

10. The AUD as a proxy for world growth
10
0.4
0.5
0.6
0.7
0.8
0.9
1
1.1
400
500
600
700
800
900
1000
1100
1200
1300
Dec-05
Mar-06
Jun-06
Sep-06
Dec-06
Mar-07
Jun-07
Sep-07
Dec-07
Mar-08
Jun-08
Sep-08
Dec-08
Mar-09
Jun-09
Sep-09
Dec-09
AUD/USD
MSCI World
(Local Currency)
Source: Bloomberg, Morgan Stanley.

11. How DCH performed through the
largest AUD fall
> The DCH program quickly
lowered the hedge level in line
with the 40% fall in AUD late
last year.
> Our disciplined approach
means we were on the trend
as currency moved.
> Drawdowns were minimized
11
0.60
0.65
0.70
0.75
0.80
0.85
0.90
0.95
1.00
Jun-2008
Jul-2008
Aug-2008
Sep-2008
Oct-2008
Nov-2008
Dec-2008
Jan-2009
0%
10%
20%
30%
40%
50%
60%
AUD-USD (LHS)
Hedge Level on Client Account (RHS)

12. 12
Statistics 50% hedged DCH Unhedged Fully hedged
Total currency return* 17.0% 22.7% 30.4% 3.8%
Drawdown (realised loss) -13.5% -7.8% 0.0% -26.6%
Drawdown on $100m
portfolio
-$13.5m -$7.8m $0 -$26.6m
Cash management when the AUD falls
*Equal to ‘realised return (from hedge) + unrealised (from assets)’
Source: Data taken from the track record of our longest running DCH client (since 1992), AUD versus currency basket.
30 Jun 2008 – 30 Dec 2008 (Period including the largest historical fall in the AUD)
> The wrong hedging strategy may bring a top performing company to the
bottom of the peer group.
> Funding the recent fall in the AUD using a static hedging strategy was very
expensive.
> DCH significantly reduced the losses on the hedge and hence the need to
crystallise asset losses at a time of poor liquidity.

13. 13
Dynamic Currency Hedging - Summary
Dynamic Currency Hedging, the ultimate currency hedge
No need to forecast the currency direction 
Limits losses on hedging as the local currency depreciates 
Protects the foreign portfolio as the local currency appreciates 
The hedging strategy with the best long term performance 
Manageable cashflows with one settlement per year 
Tailored programs 