Recently, an unusual intermixing-driven scenario for the growth of atomic Pd chains on a Pd(110) surface during deposition of 3d metal atoms has been predicted (Stepanyuk 2009 Phys. Rev. B 79 155410) and confirmed by STM and STS experiments (Wie et al 2009 Phys. Rev. Lett. 103 225504). Performing ab initio calculations we demonstrate that Pd atomic chains grown above embedded Fe atoms exhibit magnetic properties which depend on the substrate mediated exchange interaction between the Fe atoms.