The expected inﬂation rate in Finland is one percent while it is three percent in the U.S. A risk-free asset in the U.S. is yielding 6.25 percent. What approximate real rate of return should you expect on
A risk-free Norwegian security?

Question

Quizplus · Accepted Answer

The real rate of return is the nominal rate minus the inflation rate. Therefore, the nominal rate for a risk-free Norwegian security should be: 
Nominal rate = Real rate + Inflation rate in Norway
To calculate the real rate of return, we need to use the difference in inflation rates between the U.S. and Norway: 
Real rate = Nominal rate - Inflation rate in Norway
The inflation rate in Norway is not given, but we can assume it is similar to the rate in Finland (1%). 
So, the nominal rate for a risk-free Norwegian security is: 
Nominal rate = Real rate + 1%
We can use the U.S. risk-free rate (6.25%) to estimate the nominal rate for Norway, using the difference in inflation rates: 
6.25% = Real rate + 3% - 1%
Real rate = 6.25% - 2% = 4.25%
Therefore, the approximate real rate of return for a risk-free Norwegian security is 4.25%. The best choice is B, as it is the closest option.

The Expected Inﬂation Rate in Finland Is One Percent While