Definition of hard loan
What is a hard loan?
A hard loan is a foreign loan that must be repaid in strong currency, which is the currency of a nation that has political stability and a reputation for economic strength. For example, a country classified as a developing country can borrow through a hard loan named in US dollars.
Key points to remember
- An outright loan occurs when a foreign borrower takes out a loan denominated in a hard currency, such as a reserve currency like the US dollar.
- Outright loans are often taken by borrowers in developing countries, as loans denominated in less stable currencies can be risky for lenders.
- Currency volatility can be detrimental to borrowers on outright loans, as a devalued currency will make it more expensive to repay the loan.
How a hard loan works
An outright loan is a type of loan between a lender and a borrower occurring in two different counties, and that is denominated in hard currency. Hard currency refers to a monetary system or reserve currency widely accepted around the world as a form of payment for goods and services. It usually comes from a country that has a strong economic and political position, and it may not be the currency of the borrower or lender. An outright loan significantly reduces the risk that would exist if the loan was denominated in less stable currencies.
There are some risks, however. If the borrower’s national currency drops significantly against the hard currency, he or she may have great difficulty repaying the loan. For example, if a Brazilian manufacturer takes out a firm loan denominated in euros and the euro strengthens by 20% against the real over the life of the loan, it will effectively increase the loan interest rate by 20%, as well as the principal amount.
Forex Considerations On Hard Loans
What qualifies a currency as hard? It is expected to remain relatively stable over a short period and to be very liquid in foreign currencies – or forex (FX): market on which currencies are traded. The forex market is the largest and most liquid market in the world, with average values traded in the trillions of dollars per day.It includes all the currencies of the world.
Forex transactions take place on a cash or forward basis and are executed over the counter and 24 hours a day. There is no centralized market for foreign exchange transactions. The largest foreign exchange markets are located in major financial centers, such as London, New York, Singapore, Tokyo, Frankfurt, Hong Kong and Sydney.??
The hard currency must have a stable value. The value of a currency is primarily based on economic fundamentals such as gross domestic product (GDP) and employment. The international strength of the US dollar reflects the US GDP, which at the end of 2019 was the world’s largest at $ 21.43 trillion. China and India held the second and fifth largest GDPs in the world, respectively, but neither the Chinese yuan nor the Indian rupee is considered a hard currency.This helps explain how central bank policies and the stability of a country’s money supply are also factored into exchange rates. The US dollar is considered the world’s reserve currency, which is why it is used in 88% of international business transactions.
Example of a firm loan
An example of a hard loan would be a loan agreement between a Brazilian company and an Argentinian bank in which the debt must be paid in US dollars is a type of hard loan because US dollars are considered a strong currency and more stable than the real. brazilian (BRL) or the Argentine peso (ARP).