Please someone, elaborate on one complicated issue:
The reading on currency management, 6.3.1 Over-/Under-Hedging Using forward contracts
The section says: ” a variant of this approach would be to adjust the hedge ratio based on exchange rate movements: to increase the hedge ratio if the base currency depreciated, but decrease the hedge ratio if the base currency appreciated. Essentially, this approach a form of delta heding, that tries to mimic the payoff function of a put option on the base currency……Doing so adds ” convexity” to the portfolio.”
I understand why do we need to under-hedge if we expect the base currency to appreciate, and vice versa. But I don’t understand the reason to decrease the hedge ratio if the base currency already have appreciated. Also, why the hedge’s payoff function will be a convex curve type?