The current spot rate for the Norwegian krone is $1 = NKr6.0888. The expected inflation rate in Norway is six % and in the U.S. five %. A risk-free asset in the U.S. is yielding 7.5 %. What approximate real rate of return should you expect on a risk-free Norwegian security?

Question

Quizplus · Accepted Answer

The real rate of return can be approximated using the Fisher equation, which states that the nominal interest rate is approximately equal to the real interest rate plus the inflation rate. Given that the U.S. risk-free rate is 7.5% and the U.S. inflation rate is 5%, the real rate of return in the U.S. is approximately 2.5%. Since no arbitrage opportunities should exist in efficient markets, the real rate of return in Norway should be expected to be similar, hence 2.5%.

The Current Spot Rate for the Norwegian Krone Is $1