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Loans

Loans

Businesses are financed either by equity or debt, usually by both. Equity, of course, is the capital paid into the business by its owner and other investors who buy shares. This money can be recovered only by selling the shares or by selling the company, and investors are at risk for the total of their investment. Debt is based on contractual arrangements under which both repayment of the principal and payment of interest are specified, although certain forms of debt bear no interest: an example is trade credit under which a buyer may have up to 90 days to satisfy a bill. All forms of credit, in effect, represent loans from one party to another. Thus leasing of rental space or of equipment may be viewed as loans of real estate or of equipment, with rents and lease payments representing interest. All such transactions are recorded on a company's books as liabilities. A company's debt-equity ratio (liabilities divided by equity) represents the degree to which it is said to be "leveraged." The ratio is one of the measures lenders use to make judgments on whether to lend or not or, alternatively, on how much to lend. The old-fashioned, traditional view is that debt should be avoided; progressive thought holds that a good balance between debt and equity gives a company optimum flexibility for growth; speculative views favor maximum leverage in order to achieve the highest possible return for stockholders.

CHARACTERISTICS OF LOAN TRANSACTIONS

Lending and borrowing transactions are characterized by time factors, costs, and risk considerations; all three are closely related.

Time Factors. Term loans are classified by the length of time for which money is lent. Loans come in short-term, intermediate-, and long-term forms. Revolving credit and perpetual debt, however, have no fixed retirement dates. Revolving credit, better known as a "line of credit," provides a sum of money which the borrower draws down and then pays back, borrowing again when funds are needed again. Interest is paid only when funds are being used. Brokerage houses that extend margin credit for customers on certain securities work the same way. The holder of a perpetual loan, usually issued through a registered offering, only pays interest on the money and decides in his or her own time when to retire the principal.

Repayment Schedules match the type of loan obtained and also affect the costs of the borrowing. Payment terms available either call for combined payments of principal and interest at regular intervals or require interest payments only with the principal repaid as a single sum at the end of the contract. In the first case interest is charged only on the remaining balance of principal so that the interest portion declines over time. Under some types of leases, the lessor gradually acquires the real estate or the equipment being leased. In these cases the lease payment remains the same but the lessor's costs decline because he or she is able to claim a portion of the property as depreciation against taxes.

Cost. The cost of a loan is the interest charged. Interest may be fixed for the term of the loan or may be variable. If the rates are variable, they may be adjusted daily, annually, or at intervals of years (3, 5, and 10). Such rates (called floating rates) are tied to some index such as the prime federal lending rate. As a general rule interest costs are based on the current cost of money and the relative risk of the loan, so that collateralized debt costs less than unsecured debt.

Security. Assets pledged as security against the loss of the loan are known as collateral. Credit backed by collateral is secured. In many cases, the asset purchased by the loan often serves as the only collateral, but in other cases the borrower puts other assets, including cash, aside as collateral. Real estate or land collateralize mortgages. Unsecured debt relies on the earning power of the borrower.

COMMON TYPES OF LOANS

Consumers and small businesses obtain loans with varying maturities in order to fund purchases of real estate, transportation and production equipment, raw materials, parts, and other needs. The source of such funding may be friends and relatives, banks, credit unions, finance companies, insurance companies, leasing companies, and trade credit. State and federal governments sponsor a number of loan programs to support small businesses.

Short-Term Loans

A special commitment loan is a single-purpose loan with a maturity of less than one year. Its purpose is to cover cash shortages resulting from a onetime increase in current assets, such as a special inventory purchase, an unexpected increase in accounts payable, or a need for interim financing. Trade credit is also a kind of short-term loan extended to the business by a vendor who allows the purchaser up to three months to settle a bill. In the past it was common practice for vendors to discount trade bills by one or two percentage points as an incentive for quick payment.

A seasonal line of credit of less than one year may be used to finance inventory purchases or production. The successful sale of inventory repays the line of credit. A permanent working capital loan provides a business with financing from one to five years during times when cash flow from earnings does not coincide with the timing or volume of expenditures. Such loans are common in seasonal businesses where, for instance, goods are manufactured in summer for winter sale or vice versa. In all such cases, creditors expect future earnings to be sufficient to retire the loan.

Intermediate-Term Loans

Term loans finance the purchase of furniture, fixtures, vehicles, and plant and office equipment. Maturity generally runs more than one year but less than five. Consumer loans for autos, boats, and home repairs and remodeling are analogous intermediate loans.

Long-Term Loans

Mortgage loans are used to purchase real estate and are secured by the asset itself. Mortgages generally run between ten and forty years. A bond is a contract held in trust with the obligation of repayment. An indenture is a legal document specifying the terms of a bond issue, including the principal, maturity date, interest rates, any qualifications and duties of the trustees, and the rights and obligations of the issuers and holders. Corporations and government entities issue bonds in a form attractive to both public and private investors. A debenture bond is unsecured, while a mortgage bond holds specific property in lien. A bond may contain safety measures to provide for repayment.

MIXED MOTIVES

In virtually all lending/borrowing situations the motives of the parties involved are in some conflict, at least on the margins. The business borrower's primary motive is to obtain the necessary financing to run the business at the least possible cost. His or her ideal source of funding is paid-in capital, but such equity is put at risk, and the owner feels this risk particularly if it is his or her own money. At the same time, if the money comes from investors, they will own shares of the company, and the more is owned by outsiders the less control the owner has. Even the most persuasive owner, able to get equity funding from others easily, will be constrained at some pointlest he or she lose control of the business. In this balancing act debt becomes an attractive alternative source of money. The owner's motive will be to get as much unsecured financing of this type as necessary at the lowest possible rates of interest and to obtain secured loans only if there is no other way. The owner will try to avoid debt because servicing it costs moneyand it has to happen from cash flow. The less debt the business has to carry, the more rapidly his or her own equity will grow.

Independent investors in the business (if any) have yet another set of motives: they want to pay as little as possible for each share and see the value of that share grow. Investors like to "leverage" their investment by seeing it matched by borrowing. Since the borrowed money is used on their behalf, the more borrowing they can leverage the better. But, here too, constraints set it. Under current law the creditors of a business are first in line when the business fails. If the company is highly leveraged, investors are likely to lose their entire investment. Thus leverage is goodbut it must be kept in line.

The lender, finally, is moved by a desire to earn money by lending it safely. Sources of large amounts of cash (banks, credit unions, insurance companies) are typically restrained by law and prudence from speculative investment of the money they hold in trust for others. They are conservative by their very structure and aim at predictable earnings by the safest possible means. Lenders ideally want secured loans at high interest rates, the latter kept low by competitive forces. They prefer to lend to the financially strongest possible borrowers; if competitive pressures force them to lend to weaker customers, they hedge the risks by charging more. From the lender's point of view, a financially strong borrower is one who has invested much and therefore has a great stake in the business's success; the business will also have a long, successful, and steady history of operations, and will offer ample collateral.

A small start-up with a brief history of mild success is thus in a relatively weak bargaining position and must make a very strong case before a favorable action by a potential lender is assured.

QUALIFYING FOR A LOAN

The three main factors that will help the small business qualify for a loanaside from a successful track recordare good cash flow, a favorable debt-equity ratio, and carefully prepared documentation.

Net Cash Flow to Debt

The lender first looks at a loan-applicant's cash flow because it is the source of loan repayment. Cash flow is often different from the profitability or assets of a business because sales booked appear on the books immediately but may show up as cash only later (when payment is received) and purchases made are immediately shown as costs but may only require cash later (when payments are actually made). The lender will initially calculate the amount of cash available to service the current portions of any new debt. If this amount is minimally 1.25 times the debt service required, the business is at least in the ballpark to receive a loan. A company with a net cash flow of $5,000 a month and a future debt with a $1,750 monthly payment, has a ratio of cash to debt of 2.86plenty, in other words. To be sure, the lender will look for a history of such cash flows: a two-month history will not be enough. The higher this ratio and the longer the history, the more inclined the lender will be to lend. If the cash flow is lower, the battle is almost certainly lostfor now.

Debt-Equity Ratio

This ratio is calculated by taking a company's liabilities and dividing them by the company's equity. A ratio of 1 means that for every dollar in equity the company has 1 dollar of debt. A company with no debt at all will have a debt-equity ratio of 0. Using data provided by MSN Money, in 2006 the combined debt-equity ratios of all companies part of the S&P 500 Stock Index was 1.04, suggesting that debt was just a hair greater than equity in these leading companies. But this ratio varies industry to industry. In capital-intensive industries the ratio will be significantly higher; in others much lower. In 2006 Microsoft's ratio was 4 cents to each dollar of investment; General Motors, struggling to stay solvent, had a ratio of nearly $20 in debt for each $1 of equity; General Electric's ratio was $1.94 to $1.

The ratio will tell the lender the commitment investors have made in the company, and the higher this commitment is in relation to borrowing, the more confidence the lender will have in being repaid.

Documentation

In addition to favorable financial ratios, the lender will be looking at the company's performance over time. The borrower should anticipate providing the lender a loan proposal justifying the loan. Parts of that proposal will be a business plan, financial statements, and details on other debts and liabilities. Sometimes unfavorable ratios can be overcome by a consistent history of profitable performance and high growthand even innovative plans with high potential for success will carry weight. But the wise business owner will not bet on that.

The New Automation

In the modern lending environment, computers and the Internet have amplified (and sometimes even usurped) the role of lending officers at financial institutions. One such development is loan origination software (LOS) offered by a number of companies over the Internet to banks, credit unions, and other financing agencies. These packages automate judgment on loan applications by calculating ratios, using averages for industrial categories, weighting experience factors, and even obtaining credit ratings automatically. One such package is LiquidCredit Bank2Business offered by Fair Isaac Corporation, a leading company in the fieldbut there are a number of others. These packages "score" loan applications and thus give loan officers confirmation for their own judgmentor give them pause. Downsizing in the banking sector, as reported by Mike Byfield in Alberta Report has caused an increase in caseloads and thus reliance on such services. So much for the bad news. The good news is that capital markets in the mid-2000s were flush with money. Conditions continuously change and cycle, to be sure, but the well-prepared business owner with good justification can still prevail and get his or her loan. That, of course, is just the beginning of getting on with the program.

BIBLIOGRAPHY

Anderson, Tom. "Choosing a Corporate Bank for Business Loan, Partnership." Memphis Business Journal. 3 November 2000.

Booth, James R. and Lena Chua Booth. "Loan Collateral Decisions and Corporate Borrowing Costs." Journal of Money, Credit & Banking. February 2006.

Byfield, Mike. "Small Business Borrowing Gets Trickier." Alberta Report. 3 January 2000.

Green, Charles. The SBA Loan Book. Adams Media Corporation, July 2005.

Jepsom, Kevin. "Solution To Scoring Biz Loans." Credit Union Journal. 27 February 2006.

"LiquidCredit Bank2Business." Fair Isaac Corporation. Available from http://www.fairisaac.com/fairisaac/. Retrieved on 7 April 2006.

"Make Preparations Before Approaching Bank for Your Loan." Memphis Business Journal. 3 November 2000.

MSN Money. Available from http://moneycentral.msn.com/home.asp. Retrieved on 6 April 2006.

Zhai, David. "Comment: Lenders, Beware Pitfalls In Loan Scoring Systems." American Banker. 30 May 2000.

                              Hillstrom, Northern Lights

                                updated by Magee, ECDI

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Loans

Loans

BIBLIOGRAPHY

A loan is a type of debt. In general, a loan refers to anything given on the condition of its return or the repayment of its equivalent. All material things can be lent, but the most common type of loan is the monetary loan. Like all debt instruments, a loan implies the redistribution of financial assets over time between the lender and the borrower.

In a monetary loan, the borrower initially receives an amount of money from the lender, which he pays back, usually in regular installments. This service is generally provided at a cost, referred to as interest on the debt. The provision of loans is one of the principal tasks of financial institutions. A loan also may be acknowledged by a bond, a promissory note, or a mere oral promise to repay.

The concept of loans dates back to the very old ages of the agricultural era, when people had started living in organized societies. However, it developed and became widespread with the use of money. Because of biblical injunctions against usury, the early Christian church forbade the taking of interest. In feudal European society, loans were little needed by the great mass of relatively self-sufficient and noncommercial farmers and serfs, but kings, nobles, and members of the church community borrowed heavily for personal expenditures. The role of the moneylender was undertaken back then by merchants and other townsmen, especially the Jews, while various devices were found for circumventing the prohibition of usury.

The development of money lending among the Jews as their almost exclusive occupation began in the twelfth century, and it was probably the consequence of the persecutions during the First Crusade; Jews at this time could not own land or vineyards, so money lending was one of the few occupations open to the Jews as a means of livelihood. In addition, the Catholic Churchs prohibition against money lending for Christians provided Jews with a unique opportunity to step into this void in establishing themselves as bankers. The laws regarding pawn-broking also became increasingly more detailed. During the Middle Ages, local rulers prohibited Jews from occupying most professions, so they were pushed into marginal occupations that were considered socially inferior, such as money lending.

Historically, attacks on usury have often been connected with anti-Semitism. Moreover, Judaism has been a more lenient religion with respect to lending than other religions. The Torah and later sections of the Hebrew Bible criticize the taking of interest, but interpretations of the biblical prohibition vary. One common interpretation is that Jews are forbidden to charge interest upon loans made to other Jews but allowed to charge interest on transactions with non-Jews. However, the Hebrew Bible itself gives numerous examples where this prohibition was evaded. Moreover, legislation concerning the Jews recognized the rabbinical law. According to the latter, for instance, a Jew who had advanced money on a stolen article was entitled to recover the amount he had loaned for it, including interest, if he could swear that he did not know it had been stolen.

By contrast, many religions prohibit the charge of interest. The most prominent example is that of Islam. Sharia, the Islamic law, does not allow the collection and payment of interest (riba ). However, as Maxime Robinson demonstrates in his book Islam and Capitalism (1974), even the Islamic prohibition of usury and other kinds of transactions was no barrier to the continuation and elaboration of pre-Islamic capitalistic practices. The Koranic revelation, therefore, did not bring into being an exemplary moral economic system that was fundamentally different from any other existing economic system. Thus, Islamic prohibitions on usury were circumvented with the establishment of Islamic banks. Islamic banks have the same purpose as conventional banks but are believed to obey the rules of Sharia. Islamic banking is based on the sharing of profit and loss and the prohibition of interest. According to a common practice used to lend money for a purchase, a bank might buy the item itself from the seller and resell it to the buyer at a profit while allowing the buyer to pay for it in installments. To protect themselves against default, Islamic banks retain ownership of the item until the loan is paid.

The United States has an old tradition of lending. Americans have long relied on credit, which, for day-to- day matters, typically took the form of charge accounts with local retailers. In the early years of the United States, when it was primarily an agrarian society, income for many people rested upon when the crops were harvested and sold. Credit and charge accounts, rather than the more structured repayment of an installment purchase, were more individual in nature, relying heavily on the personal relationship between the consumer and the retailer. Credit cards and other more modern and impersonal means of credit and charge-account purchasing became a fixture in the consumer-retailer relationship in the 1950s. However, even today the traditional, more personal and informal types of charge accounts do exist. Without extending some sort of credit to customers, many businesses in the past simply would not have been able to operate. Todays modern means, the credit card, has greatly reduced the degree to which individual retailers personally extend credit to consumers. However, credit itself remains as essential to the retail economy as it has ever been.

The history of formal lending in the United States is also deeply related to the rise of homeownership in the lower socioeconomic classes. Formal lending, in terms of institutional lending, has long been the means by which many have been able to buy their own home. Before institutionalized lending that was accessible to those who were not wealthy, people relied on private loans or small, regional networks serving a particular ethnic or professional group. These types of lending situations, however, did not nurture and support homeownership in the same ways, or for as great a percentage of people, as does formal or institutional lending today.

The early types of formal mortgages were extended by insurance companies. The terms of these mortgages, however, were often quite risky for the borrower, with the balance of power distinctly tipped toward the lender in ways that would be deemed unfair and even predatory by todays standards. Savings and loan associations also evolved, although they remained separate from traditional banks, which could offer checking accounts and other services, until the 1970s, when banking regulations changed. Once those regulations changed, savings and loan associations became almost indistinguishable from the typical bank of today, but their loan practices became the universal standard among many of todays financial institutions. The practices have been revised continuously through the years by regulations meant to ensure that minorities and women were able to have equal access to fair lending.

Today, banks and finance companies usually extend loans against collateral, such as stocks, personal effects, and mortgages on land and other property. Credit activity is considered to be strongly correlated with consumption, and it is expanding due to the gradually decreasing savings rates of typical households. Financial institutions are the ones responsible for extending loans, and they make a large share of their profits out of this activity. The low penetration of loans to an economy, as is the case in the developing countries of central and southeastern Europe, attracts many foreign direct investments in those countries.

Bank loans and credit are considered to be one way to increase the money supply. Policymakers, such as many central bankers, take into account credit growth developments in their decisions about interest-rate movements. Another aspect of the internationalization of loans is the ability of the participants of economic activitygovernments, companies, and householdsto borrow from abroad under better terms and conditions.

Apart from those who have access to financial markets, the establishment of organizations such as the International Monetary Fund and the World Bank allow the provision of loans to countries experiencing economic problems. This financial assistance enables countries to encounter economic difficulties, reconstruct, and restore conditions for economic growth. Moreover, Muhammad Yunus of Bangladesh, who was awarded the Nobel Peace Prize for providing, through his Grameen Bank, small loans known as micro-credit to poor people without any collateral showed that loans can be accessible and provide support even to those who have no financial security.

SEE ALSO Banking; Banking Industry; Discounted Present Value; Equity Markets; Financial Instability Hypothesis; Financial Markets; Hedging; Leverage; Liquidity Premium; Microfinance; National Debt; ROSCAs

BIBLIOGRAPHY

International Monetary Fund. 2006. IMF Lending. International Monetary Fund, September. http://www.imf.org/external/np/exr/facts/howlend.htm.

Robinson, Maxime. 1974. Islam and Capitalism. Trans. Brian Pearce. New York: Pantheon Books.

Secor, Sharon. 20042006a. A Brief History of Formal Lending in the United States. Direct Lending Solutions. http://www.directlendingsolutions.com/history_of_lending.htm.

Secor, Sharon. 20042006b. Credit History: Before There Was Plastic The Earliest Charge Accounts. Direct Lending Solutions. http://www.directlendingsolutions.com/history_of_credit.htm.

Tran, Mark. 2006. Pioneering Economist Wins Nobel Prize. Guardian Unlimited, October 13. http://business.guardian.co.uk/story/0,,1921726,00.html.

Eleni Simintzi

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loan

loan, in business, sum of money borrowed at a particular interest rate. More generally, it refers to anything given on condition of its return or repayment of its equivalent. A loan may be acknowledged by a bond, a promissory note, or a mere oral promise to repay. Because of biblical injunctions against usury, the early Christian church forbade the taking of interest. In feudal European society, loans were little needed by the great mass of relatively self-sufficient and noncommercial peasants and serfs, but kings, nobles, and ecclesiastics were heavy borrowers for personal expenditures. Merchants and other townsmen, especially the Jews, were the moneylenders, and various devices were found for circumventing the prohibition of usury. With the rise of a commercial society, restrictions on the taking of interest were gradually relaxed. Today, banks and finance companies make most loans, usually on collateral, such as stocks, personal effects, and mortgages on land and other property, or on assignments of wages. Credit unions have attained some importance in making personal loans at relatively low interest rates, and microcredit programs and organizations, which offer small-scale loans, have proved useful, particularly in developing countries, in helping individuals to establish small businesses. The 21st cent. has seen the rise of so-called peer-to-peer lending, in which companies use the Internet to match lenders with borrowers. Focusing on smaller personal and business loans, peer-to-peer lending has developed in part because investors faced lower interest rates on bonds and money-market funds in the aftermath of the recession of 2007–9. A pawnbroker lends money on the security of articles left in his shop.

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loan

loan / lōn/ • n. a thing that is borrowed, esp. a sum of money that is expected to be paid back with interest: borrowers can take out a loan for $84,000. ∎  an act of lending something to someone: she offered to buy him dinner in return for the loan of the car. ∎ short for loanword. • v. [tr.] (often be loaned) borrow (a sum of money or item of property): the word processor was loaned to us by the theater| he knew Rob would not loan him money. PHRASES: on loan (of a thing) being borrowed: the painting is at present on loan to the gallery. ∎  (of a worker or sports player) released to another organization or team, typically for an agreed fixed period. DERIVATIVES: loan·a·ble adj. loan·ee / ˌlōˈnē/ n. loan·er n.

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"loan." The Oxford Pocket Dictionary of Current English. 2009. Encyclopedia.com. 29 Sep. 2016 <http://www.encyclopedia.com>.

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LOAN

LOAN. An item of language given, as if by a lender, from one language to another, used both on its own and in such combinations as LOANWORD, LOAN TRANSLATION, LOAN BLEND, and loanshift. The commonest loans are single words: pizza (from Italian to English), babysitter (from English to French, German, and other languages). Once adopted, loans usually show some adaptation: in sound, French garage, variously pronounced in English; in form, English night taken into Italian as a CLIPPING of nightclub; in grammar, English nouns borrowed into French and provided with a gender, la babysitter (feminine), le golf (masculine). Verbs adapt to the morphology of the borrowing language: in German, babysitten to babysit, past tense babysittete, past participle gebabysittet. See ASSIMILATION, BORROWING, CALQUE, CODE-MIXING AND CODE-SWITCHING, FOREIGNISM.

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TOM McARTHUR. "LOAN." Concise Oxford Companion to the English Language. 1998. Encyclopedia.com. 29 Sep. 2016 <http://www.encyclopedia.com>.

TOM McARTHUR. "LOAN." Concise Oxford Companion to the English Language. 1998. Encyclopedia.com. (September 29, 2016). http://www.encyclopedia.com/doc/1O29-LOAN.html

TOM McARTHUR. "LOAN." Concise Oxford Companion to the English Language. 1998. Retrieved September 29, 2016 from Encyclopedia.com: http://www.encyclopedia.com/doc/1O29-LOAN.html

loan

loan †gift, grant OE.; thing lent, act of lending XIII. — ON. lán, corr. to OE. lǣn (see LEND), MDu. lēne (Du. leen), OHG. lēhan (G. lehen) :- Gmc. *laiχwniz, -az- :- IE. *loiqnes-, -os- (cf. Skr. rékna- inheritance, wealth), f. *loiq- *leiq- *līq-, repr. also by Gr. leipein leave, L. linquere, Goth. leihwan, OHG. līhan (G. leihen), OE. lēon lend.
Hence vb. XVI (latterly esp. U.S.), comp. loanword XIX. after G. lehnwort.

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T. F. HOAD. "loan." The Concise Oxford Dictionary of English Etymology. 1996. Encyclopedia.com. 29 Sep. 2016 <http://www.encyclopedia.com>.

T. F. HOAD. "loan." The Concise Oxford Dictionary of English Etymology. 1996. Encyclopedia.com. (September 29, 2016). http://www.encyclopedia.com/doc/1O27-loan.html

T. F. HOAD. "loan." The Concise Oxford Dictionary of English Etymology. 1996. Retrieved September 29, 2016 from Encyclopedia.com: http://www.encyclopedia.com/doc/1O27-loan.html

loan

loanalone, atone, Beaune, bemoan, blown, bone, Capone, clone, Cohn, Cologne, condone, cone, co-own, crone, drone, enthrone, flown, foreknown, foreshown, groan, grown, half-tone, home-grown, hone, Joan, known, leone, loan, lone, moan, Mon, mown, ochone, outflown, outgrown, own, phone, pone, prone, Rhône, roan, rone, sewn, shown, Simone, Sloane, Soane, sone, sown, stone, strown, throne, thrown, tone, trombone, Tyrone, unbeknown, undersown, zone •Dione • backbone • hambone •breastbone • aitchbone •tail bone, whalebone •cheekbone • shin bone • hip bone •wishbone • splint bone • herringbone •thigh bone • jawbone • marrowbone •knuckle bone • collarbone •methadone • headphone • cellphone •heckelphone • payphone • Freefone •radio-telephone, telephone •videophone • francophone •megaphone • speakerphone •allophone • Anglophone • xylophone •gramophone • homophone •vibraphone • microphone •saxophone • answerphone •dictaphone •sarrusophone, sousaphone •silicone • pine cone • snow cone •flyblown • cyclone • violone •hormone • pheromone • Oenone •chaperone • progesterone •testosterone

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"loan." Oxford Dictionary of Rhymes. 2007. Encyclopedia.com. 29 Sep. 2016 <http://www.encyclopedia.com>.

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