Thank you Mariano for reminding us on the uni/puny-code things.
Yes, fred(client) can create_domain 
xn--mund-4na.fo and more or less anything else, given 'allow_idn = true' in /etc/fred/server.conf, all over EPP, and it goes into the zone file without problems.  Even '
ámund.fo' works as expected in both whois interfaces. This is great news around here. :-)
  Our expectation was that it would be possible to create domain  '
ámund.fo', but this just returns a 'bad format of fqdn domain'. I guess we will have to adjust our expectations, and just live with the xn-*.fo domains in lists and such.