Understanding Financial Operations, Financing, and Capitalization

TMA 1 - Financial Operations

Financial operations consist of investing or lending a capital, resulting in interest generated over the duration of the loan or investment. This process is called capitalization. By contrast, the operation of returning a borrowed capital, along with its corresponding interest, is called depreciation.

1.1. Financing

Funding: Economic resources set and used by an enterprise or family. There are 2 types:

• Internal financing or self-financing: Generated by the entity's own economic possibilities.
• External financing: Obtaining capital from outside the entity's own economic resources, usually through capital contributions or third-party loans, which must be returned with interest over a given time.

Families, enterprises, and public administrations have financing as primary sources of income. In some cases, these are sufficient to cover their costs, resulting in what we call budgetary equilibrium:

• Income > Expenditure (Surplus), which generates savings.
• Expenses > Income (Deficit).

1.2. Concept of a Financial Operation

Financial operation: Any action intended to replace, at a determined reference point, one or more capitals by applying a specific financial law.

For a financial operation to be financially equivalent, the following conditions must be met:

• The exchange is not simultaneous.
• A specific financial law is applied to the operation.
• The counterpart and the performance are financially equivalent.

A financial law applied to a financial operation uses either simple capitalization or compound capitalization. To apply these laws, it is necessary to have a series of preliminary calculation data.

The value of capital at a present moment is called the current value, while its value at a postponed maturity is called the final value. At the moment of valuation, the initial capital is also known as the initial capital, and the capital valued at its final maturity is called the final amount capital.

In summary, a financial operation can be defined as a mercantile exchange operation, not simultaneous, between two people or enterprises.

1.3. Classification of Financial Operations

A. Depending on the Amount and Maturity Certainty

• Certain financial operations: Those in which both the amount and maturity are determined from the beginning.
• Aleatory financial operations: Those in which neither the amount nor the maturity are determined beforehand.

B. Depending on the Duration of the Operation

• Short-term financial operations: Operations lasting less than a financial year.
• Long-term financial operations: Operations lasting longer than a financial year.

C. Depending on the Distribution of Components

• Simple operations: Those in which a single capital intervenes for both performance and counterpart.
• Compound operations: Operations where the financial performance and/or counterpart involve several capitals with different maturities.

D. Depending on the Implementation of the Financial Law

There are 3 types of application for the financial law:

• Capitalization: Characterized by an equivalence moment (P) that is posterior to the last capital's maturity.
• Update or discount: Operations where the equivalence moment is prior to the first capital's maturity.
• Mixed: When the equivalence moment (P) is between the first and last maturity of the capitals.

1.4. Regimes of Capitalization

Every financial operation, whether capitalization or update (discount), is subject to a determined financial law known as a capitalization regime.

• Simple: The interest (i) generated in each period is not accumulated into the capital. Consequently, the interest corresponding to subsequent periods is always calculated on the initial capital ($C_0$).
• Compound: The interest generated in each period is accumulated into the capital of the previous calculation to determine the interest for subsequent periods.