This approach is based on the relative price of assets, specifically with the relationship between the relative price of domestic and foreign bonds and the exchange rate, where it is assumed that it ‘s supply and demand is affected by changes in monetary and/or fiscal conditions.

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Changes in national income affect both current and capital account, thus causing predictable reactions in the exchange rate in order to restore balance of payments equilibrium. Here’s a simple equation to show what I’m trying to explain here and is used in economics to show how economies adjust to changes in economic dynamics:

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We can determine or predict exchange rates by analyzing interest rate differentials via a few principles. Assuming that the expected returns of a currency should be equalized through speculation in another country once converted back to the first currency, the theory of interest rate parity holds, where:

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