I found this elsewhere, hope it helps:
Digital-audio output settings consist of:
* Digital Stereo: select this option to fold any Dolby Digital multichannel audio program down to two channels (left/right) for a direct digital connection to an audio receiver. The console will not collapse multichannel DTS (Digital Theater Systems) output to 2-channel DTS.
* Dolby Digital 5.1: select this option to pass multichannel surround soundeither Dolby Digital 5.1 or DTS 5.1to a compatible audio surround receiver and multichannel speaker system. Most, but not all, games and DVD movies offer 5.1-channel surround sound.
* Dolby Digital with WMA Pro: inactive at this time, this setting will allow a connected Microsoft Windows Media Center PC running Media Center Extender to pass audio from WMA Pro-encoded media through the Xbox 360 console and on to a WMA Pro-compatible audio surround receiver. Selecting Dolby Digital with WMA Pro will keep the WMA Pro audio signal in its pure digital form all the way from your PC to your audio receiver for the best possible sound.