Question

Assume the current spot rate for the Norwegian krone is $1 = NKr7.0323, the expected inflation rate in Norway is 2.1 percent and 1.2 percent in the U.S. A risk-free asset in the U.S. is yielding 3.7 percent. What nominal risk-free rate of return should you expect on a Norwegian security?

4.2%

2.9%

4.6%

3.8%

3.1%

Answer 1

In order to solve this problem, we shall be using the below equation:

Expected inflation rate in Norway - Expected inflation rate in U.S. = Risk free rate of return in Norwegian security - Risk free rate of return in U.S.

Expected inflation rate in Norway = 2.1% or 0.021

Expected inflation rate in U.S. = 1.2% or 0.012

Risk free rate of return in U.S. = 3.7% or 0.037

By plugging these figures in the above mentioned formula we shall get:

= 0.021 - 0.012 = Risk free rate of return in Norwegian security - 0.037

= 0.046 or 4.6% = Risk free rate of return in Norwegian security

So, the risk free rate of return that we expect on a Norwegian security is 4.6%

So the correct answer is option c