When you make a layer dynamic, numerous things occur:
The layer's data source is imported as a new feature class into the personal geodatabase for the current analysis (cvanalysis.mdb). The original data source is not modified or deleted.
The new feature class is assigned the same spatial reference and projection as was specified for the original layer.
A default spatial index grid size will be calculated for the new feature class. This will be optimized for the spatial reference, average feature size, and number of features in the input shapefile or coverage.
If the original layer is not a geodatabase layer (e.g. shapefile, coverage), an appropriate extent for the new feature class will be determined. The extent will be created by unioning the visible extent and the map's full extent - this equals the full extent if the user is zoomed in or the full visible (zoomed out) extent if the user has zoomed out beyond the full extent. Note: having reference layers with a very large extent loaded while creating a dynamic layer, will result in lower precision for spatial measurements and calculations for the dynamic layer.
Some field names from the original data source may be invalid for a geodatabase feature class. Field names will be modified if necessary. A message will be displayed to inform you of any modifications.
See also Map units and coordinate systems