The following example supports which extension to the Monetary Approach to Exchange rates: Due to changes in the pricing of risk premiums,investors adjust holdings of foreign assets causing an appreciation of domestic currency.
A) Portfolio balance approach
B) Trade balance approach
C) Overshooting approach
D) Currency substitution approach

Question

Quizplus · Accepted Answer

The given example supports the Portfolio balance approach, which is an extension to the Monetary Approach to exchange rates. According to this approach, changes in risk premiums affect the demand for domestic and foreign assets. If the risk premium on domestic assets increases relative to that on foreign assets, investors adjust their portfolios by selling domestic assets and buying foreign assets. This increases the demand for foreign currency, causing an appreciation of the domestic currency. Hence, the given example supports the Portfolio balance approach.

The Following Example Supports Which Extension to the Monetary Approach