Question

Suppose the current spot rate for the Norwegian krone is NKr5.5923 while the expected inflation rate in Norway is 2.2 percent compared to 1.8 percent in the U.S. A risk-free asset in the U.S. is yielding 3.4 percent. What approximate real rate of return should you expect on a risk-free Norwegian security?

Answer 1

Answer:

The Risk-free asset in the Norwegian is 3.8%

Explanation:

The computation of the real rate of return of Norwegian security is shown below:

The calculation is done by comparing the two countries risk-free asset and the inflation rate.

Risk-free asset in the U.S - expected inflation rate in the U.S = Risk-free asset in the Norwegian - expected inflation rate in the Norwegian

3.4% - 1.8% = Risk free asset in the Norwegian - 2.2%

1.6% + 2.2% =  Risk free asset in the Norwegian

The inflation rate should be deducted from the countries risk-free asset because it gives the fair value of the return.

So, the Risk-free asset in the Norwegian is 3.8%