The current spot rate for the Norwegian krone is $1 = NKr6.83.The expected inﬂation rate in Norway is 2 percent and in the U.S.4 percent.A risk-free asset in the U.S.is yielding 5 percent. What risk-free rate of return should you expect on a Norwegian security?

Question

Quizplus · Accepted Answer

The formula for calculating the risk-free rate in a foreign currency is as follows: 
Risk-free rate in foreign currency = (1 + risk-free rate in domestic currency) x [(1 + expected foreign currency inflation rate) / (1 + expected domestic currency inflation rate)] - 1

Plugging in the numbers for this problem, we get: 
Risk-free rate in Norwegian krone = (1 + 0.05) x [(1 + 0.02) / (1 + 0.04)] - 1 
= 1.03 x 0.98/1.04 - 1 
= 0.03076 or 3.076%

Therefore, choice B is the correct answer.

The Current Spot Rate for the Norwegian Krone Is $1