The current spot rate for the Norwegian krone is $1 = NKr6.83. The expected inflation rate in Norway is 3 percent and in the U.S. 2 percent. A risk-free asset in the U.S. is yielding 4.5 percent. What real rate of return should you expect on a risk-free Norwegian security?

Question

Quizplus · Accepted Answer

The real rate of return on a risk-free security can be calculated using the Fisher equation as follows:

Real rate = Nominal rate - Inflation rate

In Norway, the nominal risk-free rate can be calculated using the U.S. risk-free rate and the expected inflation differential:

Nominal rate = U.S. risk-free rate + expected inflation differential
Nominal rate = 4.5% + (3% - 2%) = 5.5%

Therefore, the real rate of return on a risk-free Norwegian security would be:

Real rate = 5.5% - 3% = 2.5%

The best choice is C, as it gives the correct real rate of return that can be expected on a risk-free Norwegian security.

The Current Spot Rate for the Norwegian Krone Is $1