Using state of the art spin-polarized density functional theory it is found that a chemically inert (BN)(36) cluster can be activated by incorporating magnetic nanoparticles inside it. To illustrate this aspect we have calculated the geometries and electronic structure of Fe(BN)(36) and Fe(4)(BN)(36) clusters, which showed the appearance of gap states localized on the impurity atoms. The reaction of O(2) molecules with these clusters results in weak interaction and an elongation of the O-O bond. Further interaction of this complex species with an incoming CO molecule leads to the formation of CO(2). The reaction mechanism has been investigated via Langmuir-Hinshelwood and Elay-Rideal routes, and the minimum energy path calculations are performed using the elastic band method. These results have implications in designing novel materials based on metal nanoparticles for potential applications as industrial catalyst.