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International Business Theory Final Exam 1.What are the various types of capital market loans? Capital market loans to corporations are either equity loans or debt loans. An equity loan is made when a corporation sells stock to investors. The money the corporation receives in return for its stock can be used to purchase plants and equipment, fund R&D projects, pay wages, and so on. A debt loan requires the corporation to repay a predetermined portion of the loan amount at regular intervals regardless of how much profit it is making. Management has no discretion as to the amount it will pay investors. Debt loans include cash loans from banks and funds raised from the sale of corporate bonds to investors. 2. How can a borrower hedge against unpredictable movements in exchange rates? The borrower can hedge against unpredictable movements in exchange rates by entering a forward contract to purchase the required amount of the currency being borrowed at a predetermined exchange rate when the loan comes due. Although this will raise the borrower's cost of capital, the added insurance limits the risk involved in such a transaction. When a firm borrows funds from the global capital market, it must weigh the benefits of a lower interest rate against the risks of an increase in the real cost of capital due to adverse exchange rate movements. Although using forward exchange markets may lower foreign exchange risk with short-term borrowings, it cannot remove the risk. Most importantly, the forward exchange market does not provide adequate coverage for long-term.
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