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Innovative Ideas in Currency Management October 2005 Innovative Ideas in Currency Management October 2005

Evolution of Currency Management • Currency mandates – Hedging (late 1980 s; mid 1990 Evolution of Currency Management • Currency mandates – Hedging (late 1980 s; mid 1990 s); Pure alpha (late 1990 s; current) – Absolute return (early 2000 s) – Cash play – use innovative FX programs to fill cash flow gap • Currency managers – Single style using only forwards in EAFE markets (to late 1990 s) – Multi-style using forwards, options, developed and emerging • Currency clients – Passive benchmark to managing their own strategic currency risk 2

Philosophy: An Untapped Alpha Opportunity! Central Banks (Increase employment, lower inflation) Corporate Treasurers (Insure Philosophy: An Untapped Alpha Opportunity! Central Banks (Increase employment, lower inflation) Corporate Treasurers (Insure foreign profits) Currency Market Individuals (Tourism) International Bond and Equity Managers (Need to buy currency to buy foreign assets) Many participants have non-profit motives 3

Impact of Diversification – Opportunities and Markets Developed Markets Add Options (Developed) Add Emerging Impact of Diversification – Opportunities and Markets Developed Markets Add Options (Developed) Add Emerging Markets All Three Number of Transactions Maximum 10 Additional 20 Currencies Average 40 Net Return (for 12% volatility) 7% 10% 17% Return/Risk Ratio 0. 5 – 0. 8 – 1. 0 – 1. 5 Cannot use overlay models/approach in this absolute return paradigm 4

Market Inefficiency = Simple Rules Make Money • Three simple rules make money in Market Inefficiency = Simple Rules Make Money • Three simple rules make money in currencies. 1. Currency markets trend. Ø Buy the currency that went up last month. 2. Currencies with high interest rates will appreciate vs. currencies with low interest rates. Ø Buy high interest rate currencies. 3. Options tend to be overpriced. Ø Sell options. 5

Performance of JPY Rules/Strategies • Rules Evaluated: (a) yield curve; (b) carry; (c) moving Performance of JPY Rules/Strategies • Rules Evaluated: (a) yield curve; (b) carry; (c) moving average • USD/JPY Strategy = 40% Yield curve and Carry, 20% MA • Diversification improves information ratio, skill, & drawdown Strategy/ Rules USD/JPY Strategy USD/JPY Yield Curve USD/JPY Carry USD/JPY MA 20 -65 Annualized Std Information Cumulative Confidence Success Ratio Good Max Return Deviation Ratio Return in Skill Ratio /Bad Risk Drawdown 4. 59% 8. 56% 0. 5365 57. 45% 94. 17% 52. 86% 0. 9103 -20. 45% 4. 54% 11. 59% 0. 3919 56. 68% 85. 59% 53. 43% 0. 8564 -26. 21% 4. 33% 11. 59% 0. 3741 53. 57% 84. 26% 52. 37% 0. 8613 -26. 21% 3. 62% 11. 59% 0. 3121 43. 22% 79. 05% 51. 12% 1. 06 -20. 51% Source: Alpha. Engine. TM, Mcube Investment Technologies, LLC www. mcubeit. com (purely hypothetical example for educational purpose only) 6

Performance of EUR Rules/Strategies • Rules Evaluated: (a) yield curve; (b) carry; (c) moving Performance of EUR Rules/Strategies • Rules Evaluated: (a) yield curve; (b) carry; (c) moving average • USD/EUR Strategy = 40% Yield curve and Carry, 20% MA • Trend model losses are meaningful; but moderate lower drawdown and worst single performance of the strategy Strategy/ Rules USD/EUR Strategy USD/EUR Yield Curve USD/EUR Carry USD/EUR MA 20 -65 Annualized Std Information Cumulative Confidence Success Ratio Good Max Return Deviation Ratio Return in Skill Ratio /Bad Risk Drawdown 3. 79% 5. 09% 0. 7444 45. 69% 98. 89% 55. 21% 0. 9793 -7. 78% 5. 20% 6. 26% 0. 8301 40. 10% 98. 42% 82. 95% 0. 8599 -8. 08% 8. 48% 9. 71% 0. 8729 127. 66% 99. 56% 55. 21% 0. 8997 -13. 07% -5. 22% 9. 72% -0. 5372 -41. 86% 3. 13% 46. 68% 1. 1392 -49. 12% Source: Alpha. Engine. TM, Mcube Investment Technologies, LLC www. mcubeit. com (purely hypothetical example for educational purpose only) 7

% of Exposure Hedged Partially Hedge Do Nothing Growth of a dollar from hedges % of Exposure Hedged Partially Hedge Do Nothing Growth of a dollar from hedges Return calculated versus a 0% hedged position Fully Hedge 8

Innovative Approaches for Clients • Can generate meaningful cash, without funding, and with a Innovative Approaches for Clients • Can generate meaningful cash, without funding, and with a specific dollar loss limit (easiest constraint to monitor) • Can be delivered through a managed account or even total return swap • Clients can also manage their own strategic decisions – biggest impact on performance • Trend to move away from traditional approaches and markets 9