Assume the current spot rate for the Norwegian krone is $1 = NKr7.0305.The expected inflation rate in Norway is 2.6 percent,and in the United States its 1.3 percent.A risk-free asset in the U.S.is yielding 2.2 percent.What risk-free rate of return should you expect on a Norwegian security?

Question

Quizplus · Accepted Answer

According to the Fisher effect, the expected rate of return on a foreign security can be calculated as follows:
Expected return = nominal risk-free rate + expected inflation rate + risk premium
Here, the nominal risk-free rate in the US is 2.2%, and the inflation rates in Norway and the US are 2.6% and 1.3%, respectively. Hence, the risk premium required on a Norwegian security is:
Risk premium = nominal risk-free rate - expected inflation rate in US = 2.2% - 1.3% = 0.9%
Therefore, the expected rate of return on a Norwegian security is 2.6% + 0.9% = 3.5%. Hence, the correct answer is option C).

Assume the Current Spot Rate for the Norwegian Krone Is