In this article I will explain you the balance Balance of payments model and Asset market model.

Balance of Payments Model 

This model holds that a foreign exchange rate must be at its equilibrium level.It is the rate by which a stable current account balance is produced. A nation that is facing a trade deficit will experience reduction in its foreign exchange reserves and due to this the value of its currency will  ultimately lowers (depreciates). The nation’s goods (exports) become more affordable in the global market place due to the cheaper currency while it makes imports more expensive. After that an intermediate period is reached then the imports are forced down and exports rise, thus it stabilizes the trade balance and push the currency towards equilibrium.

Just like PPP, the main focus of balance of payments model is on tradable goods and services and it ignores the increasing role of global capital flows. Explaining this in other words, money is not only chasing goods and services, but to a greater  extent the financial assets such as stocks and bonds are also chased by money. Their flows go into the capital account item of the balance of payments, thus it balances the deficit that is present in the current account. The rise in capital flows has given rise to the asset market model.

Asset Market Model 

The explosion in trading of financial assets (stocks and bonds) has provided a new shape to the  way the analysts and traders look at currencies. Now Economic variables such as economic growth, inflation and productivity are no longer the only drivers of currency movements. The extent of currency transactions generated from trading in goods and services have been dwarfed by the proportion of foreign exchange transactions that has been originated from cross border-trading of financial assets.

currencies are viewed by the asset market approach as asset prices traded in an efficient financial market. As a result of this, currencies are increasingly showing a strong correlation with other markets, particularly equities.

Like in the stock exchange, investors and speculators  can make or loose money on the foreign exchange market by buying and selling at the right times. The traders can trade currencies at spot and foreign exchange options markets. current exchange rates are represented by the spot market, whereas options are derivatives of exchange rates.

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