Consultation on Potential
Enhancements to the MSCIHedged Indices
January 2009

Overview
 MSCI is consulting with investors to better understand the need for potential
enhancements to the MSCI Hedged Indices methodology
 The main proposed enhancements to the MSCI Hedged Indices include thefollowing: Adopt a revised rebalancing and announcement schedule for the notional amountof FX forwards to be sold for hedging
 Determine the notional amount of FX forwards from the aggregate free float market
capitalization of the countries in the underlying MSCI equity index rather than fromthe currencies
 Adopt a revised methodology for mark to market valuation of odd-day forwards fordaily valuation of index using shorter term forwards

 Further, MSCI would also like to understand investors’ desire for more
flexibility in terms of customized hedging/rebalancing cycles, such as weeklyor quarterly rebalancing, in addition to the standard monthly cycle
 Please note, this consultation may or may not lead to the adoption, in whole
or in part, of the enhancements described herein and may not lead to any
change to the current MSCI Hedged Indices methodology© 2009. All rights reserved.

2

Background: Understanding Currency Hedging
Investment Process
 How do you employ currency hedging in your international investments?
 Is the currency hedging done by the equity manager or by a separate overlaymanager?
 What is periodicity of hedging – weekly, monthly or quarterly?
 Do you hedge all currencies and what is your typical hedge ratio – static ordynamic?

 Do you currently use hedged equity indices?
 If yes, do you use a daily or monthly version?
 Why do you use the hedged index? To enhance return or to lower risk?
 Is the strategic allocation benchmark a hedged or not?
 Is the performance benchmark/mandate a hedged or not?

© 2009. All rights reserved.

3

MSCI Hedged Indices MSCI calculates currency hedged indices for Developed and Emerging
Market countries which provide a close estimation of local equity returns
after hedging the currency exposures
 Each foreign currency in the index is hedged back to the base currency of theindex by selling the foreign currency at the one-month Forward rate The amount of Forwards sold represents the value (or the marketcapitalization) of foreign currencies of securities included in the index as of theclose of the last trading day of the month i.e. reflecting changes in thecomposition of the index implemented as of the close of that day In the daily mark to market valuation of the daily Hedged Indices, MSCI uses alinear interpolation based solely on the spot and 1-month Forwards
premium(discount) to estimate the value of odd-days Forwards every day
during the month© 2009. All rights reserved.

4Proposed Enhancements© 2009. All rights reserved.

5

Proposal: Determining the Notional Amount of FX
Forwards for Hedging
 In the current MSCI Hedged Indices each foreign currency in the Index ishedged back to the base currency of the index
 By selling each foreign currency at the one-month Forward rate and The amount of Forwards sold represents the value (or the marketcapitalization) of currencies of securities included in the index as of the closeof the last trading day of the month i.e. reflecting changes in the compositionof the index implemented as of the close of that day

 MSCI proposes to announce the notional amount of FX forwards to besold for hedging
 Two business days before the end of the calendar month, but taking into
account any month end changes in the index constituents due to rebalancing
and corporate actions

 This proposal is intended to facilitate the replicability of the index andprovide sufficient time in the implementation of hedges
 Will it be useful to announce the notional value of FX forwards to be sold2 business days before the end of the calendar month?
© 2009. All rights reserved.

6

Proposal: Determining the Notional Amount of FX
Forwards for Hedging (continued)
 MSCI currently determines the notional amount of FX forwards to be sold by
aggregating the free float market capitalization using the currency of securities
included in the index (currency weights). MSCI now proposes to determine thenotional amount of FX forwards to be sold by aggregating the free float market
capitalization using the country classification of the securities included inthe underlying MSCI equity index (country weights)
This is relevant only for a few countries like China, Russia, Israel and Peru where theMSCI equity indices includes stocks that trade in a currency different from the currency ofthe country
Stock Prices
Price (previousMonth end)
Russian Stock A 1 (Traded locally in Rubles)
Russian Stock A 1 (Traded as ADR in USD)

100
100

Currency Rate and Return2
Previous Month End (USD/Ruble)
Current Month End (USD/Ruble)
One Month Forward as Previous Month End (USD/Ruble)
Return of USD/Rouble for the month

10.5
1-50%

Price (currentMonth end)
10050BeginningPortfolio
Weight50.0%
50.0%

ReturnStock A

Stock B

Portfolio-25%
Return ("Local currency")
0%-50%
Return (unhedged in USD)
-50%
-50%
-50%
Hedged Return (current methodology using currency exposures)
0%
-50%
-25%
Hedge Return (if using country exposures)
0%
0%
0%
1
For illustration we have included the two line of shares of the same company which trade in the local and foreign markets.
2Currency rates and returns are only for illustration.

 Is the determination of notional amount for FX forwards using the country weights
more appropriate than using the currency weights of the index?
© 2009. All rights reserved.

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Proposal - Mark to Market of the Forwards

 Currently, in the daily mark to market valuation of the current MSCI daily
Hedged Indices, MSCI uses a linear interpolation based solely on thespot and 1-month Forwards premium(discount) to estimate the value of
odd-days Forwards every day during the whole month In the daily mark to market valuation of the MSCI daily Hedged Indices,
MSCI proposes to use a linear interpolation based on the on the spot,
1-week and1-month Forwards premium(discount) to estimate the value ofodd-days Forwards every day during the whole month This will improve the current linear interpolation methodology and take into
account any change in swap point differential at the beginning and end ofmonth Would the use of linear Interpolation of the forward based on spot,
1-week, and 1-month swap points be preferable?

© 2009. All rights reserved.

8

Other Proposals
 MSCI proposes to provide the flexibility to have customized
hedging/rebalancing cycles apart from the standard monthly cycle, forexample, weekly or quarterly rebalancing
 Would customized rebalancing solution that allow currency hedging in weekly,
quarterly or other periods be useful?

© 2009. All rights reserved.

9Appendix© 2009. All rights reserved.

10Current Methodology: Linear Interpolation ofForwards
 Current Linear Interpolation methodology
Current MSCI Methodology

Forward1monthInterpolated Forwardlast business day

SpottSpot

Last
Businessday

Forward 1month expiration

t1

Number of calendar
days till the lastbusiness day ofmontht2
Number of calendar days in the current month© 2009. All rights reserved.

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Proposed Methodology: Linear Interpolation ofForwards
 Proposed Linear Interpolation methodology
Marked to Market of FX Forwards
𝒋Proposed Linear Interpolation Methodology

𝒋+𝟏

𝑭𝒊 (𝒕) = 𝑭𝒊 (𝒕) + 𝑭𝒊

𝒋𝒕 − 𝑭𝒊 (𝒕) ×𝒅(𝒋, 𝒓 + 𝟏)
𝒅(𝒋, 𝒋 + 𝟏)

Forward 1 week or Forward1 month

For r ≤ t ≤ r+1 (where r and r+1 are the roll dates):

Interpolated Forwardlast business day𝑭𝒊 (𝒕) = 1 week market FX forward rate on date t, if 1w < r+1≤ 1month𝒋

Spot or Forward 1 week

Market FX Spot on date t, if 0 < r+1≤ 1w

The closest available FX forward/Spot rate shorter than next roll dates to index calculation day t incurrency i per USD on day. The possible chosen rates are FX Spot, and FX 1 week forward rates.
𝒋+𝟏

𝑭𝒊
Spot or Forward1 week
expiration

LastBusinessdayd (j,r+1)
d (j,j+1)

Forward1 week
expiration orForward 1month
expiration

𝒕 =1 month market FX forward rate on date t, if 1w < r+1≤ 1m



1 week market FX forward rate on date t, if 0 < r+1≤ 1w
𝒋+𝟏

The next available FX forward rate after 𝑭𝒊𝒕 on index calculation day t in currency per USD
on day t. The possible chosen rates are FX 1week forward, and FX 1 month forward rates.
𝒅(𝒋, 𝒓 + 𝟏) = Number of calendar days between the expiry date of the first chosen FX forward rate𝒋𝑭𝒊 (𝒕) and the roll date (last day of business)𝒅(𝒋, 𝒋 + 𝟏) = Number of calendar days between the expiry date of the first chosen FX
𝒋forward/Spot rate 𝑭𝒊 (𝒕) and the expiry date of the second chosen FX forward
𝒋+𝟏𝑺𝒊 (𝒕)rate 𝑭𝒊𝒕= Total number of calendar days during the current month – 7 days (if the FX 1week
forward and FX 1month forwards are used) or 7 days (if Spot and FX 1 week
forwards are used)= Spot mid FX rate, in currency per USD observed on day t

On Roll date period 𝑭𝒊 𝒕 = 𝑺𝒊 (𝒕)© 2009. All rights reserved.

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© 2009. All rights reserved.

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