Assume the expected inflation rate in Switzerland is 2.2 percent while it is 1.6 percent in the U.S.Also assume a risk-free asset in the U.S.is yielding 3.7 percent.What real rate of return should you expect on a risk-free Swiss security?

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Quizplus · Accepted Answer

The real rate of return can be approximated using the Fisher equation, which is $1 + nominal rate = (1 + real rate) \times (1 + inflation rate)$. Given the U.S. nominal rate is 3.7% and its inflation rate is 1.6%, we can solve for the U.S. real rate: $1.037 = (1 + real rate) \times 1.016$. Solving for the real rate gives approximately 2.1%. Since the question implies looking for a comparable rate in Switzerland and does not provide a Swiss nominal rate, we assume the real rates should be similar due to arbitrage opportunities in an efficient market, thus the expected real rate of return on a risk-free Swiss security would also be around 2.1%.

Assume the Expected Inflation Rate in Switzerland Is 2