Editing Exchange rate (section)

==Economic models==
===Uncovered interest rate parity model===
{{See also|Interest rate parity#Uncovered interest rate parity}}
[[Interest rate parity#Uncovered interest rate parity|Uncovered interest rate parity]] (UIRP) states that an appreciation or depreciation of one currency against another currency might be neutralized by a change in the interest rate differential. If US interest rates increase while Japanese interest rates remain unchanged then the US dollar should depreciate against the Japanese yen by an amount that prevents [[arbitrage]] (in reality the opposite, appreciation, quite frequently happens in the short-term, as explained below). The future exchange rate is reflected into the forward exchange rate stated today. In our example, the [[forward exchange rate]] of the dollar is said to be at a discount because it buys fewer Japanese yen in the forward rate than it does in the [[spot price|spot rate]]. The yen is said to be at a premium.

UIRP showed no proof of working after the 1990s. Contrary to the theory, currencies with high interest rates characteristically appreciated rather than depreciated on the reward of the containment of [[inflation]] and a higher-yielding currency.

===Balance of payments model===
The balance of payments model holds that foreign exchange rates are at an equilibrium level if they produce a stable Current account (balance of payments)current account balance. A nation with a trade deficit will experience a reduction in its foreign exchange reserves, which ultimately lowers (depreciates) the value of its currency. A cheaper (undervalued) currency renders the nation's goods (exports) more affordable in the global market while making imports more expensive. After an intermediate period, imports will be forced down and exports to rise, thus stabilizing the trade balance and bring the currency towards equilibrium.

Like purchasing power parity, the balance of payments model focuses largely on tradeable goods and services, ignoring the increasing role of global capital flows. In other words, money is not only chasing goods and services, but to a larger extent, financial assets such as [[stock]]s and [[Bond (finance)|bonds]]. Their flows go into the [[capital account]] item of the balance of payments, thus balancing the deficit in the current account. The increase in capital flows has given rise to the asset market model effectively.

===Asset market model===
{{See also|Capital asset pricing model|Net capital outflow}}

The increasing volume of trading of financial assets (stocks and bonds) has required a rethink of its impact on exchange rates. Economic variables such as [[economic growth]], [[inflation]] and [[productivity]] are no longer the only drivers of currency movements. The proportion of foreign exchange transactions stemming from cross border-trading of financial assets has dwarfed the extent of currency transactions generated from trading in goods and services.<ref>[http://faculty.haas.berkeley.edu/lyons/docs/bookch1.pdf The Microstructure Approach to Exchange Rates, Richard Lyons, MIT Press] (pdf chapter 1)</ref>

The asset market approach views currencies as asset prices traded in an efficient financial market. Consequently, currencies are increasingly demonstrating a strong [[correlation]] with other markets, particularly [[Stock|equities]].

Like the [[stock exchange]], money can be made (or lost) on trading by investors and speculators in the [[foreign exchange market]]. Currencies can be traded at spot and [[foreign exchange option]]s markets. The [[wiktionary:spot market|spot market]] represents current exchange rates, whereas options are [[derivative (finance)|derivatives]] of exchange rates.