Final answer:
The portfolio balance (Asset mark) approach to exchange rate determination involves linking portfolio investment to expectations about how exchange rates will shift. Investors analyze future exchange rate expectations to make decisions about buying or selling assets in different currencies. If exchange rates move as predicted, investors can make profits from their portfolio investments.
Step-by-step explanation:
The portfolio balance (Asset mark) approach to exchange rate determination involves linking portfolio investment to expectations about how exchange rates will shift.
It considers the impact of exchange rate changes on the value of a portfolio investment.
For example, a U.S. financial investor considering purchasing U.K. issued bonds will analyze the expected future exchange rate between the U.S. dollar and the British pound to determine potential profits or losses.
If the investor believes that the British pound will increase in value against the U.S. dollar, they may decide to convert their U.S. dollars to British pounds and invest in U.K. bonds.
If the pound indeed appreciates as predicted, the investor can sell the bonds and convert the British pounds back to U.S. dollars at a higher exchange rate, resulting in a profit.
On the other hand, if the investor believes that the British pound will decrease in value against the U.S. dollar, they may choose to sell their U.K. bonds and convert the British pounds to U.S. dollars.
If the pound depreciates as predicted, the investor can then convert the U.S. dollars back to British pounds at a lower exchange rate, again making a profit.