Q&A_ 300+ Finance Interview Questions « Leverage Academy Forum

7/23/2019 Q&A_ 300+ Finance Interview Questions Leverage Academy Forum

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Q&A: 300+ Finance Interview Questions

PLEASE USE THESE QUESTIONS TO PREPARE FOR INTERVIEWS IN INVESTMENT BANKING, INVESTMENT MANAGEMENT,PRIVATE EQUITY, COMMERCIAL BANKING, LEVERAGED FINANCE, RESTRUCTURING, AND OTHER FINANCE RELATED JOBS.THANK YOU JASMINE FOR YOUR HARD WORK AND DEDICATION.

Finance Interview Questions

Background Questions1. Walk me through your resume. Tell me about yourself.2. What was the most important thing that you got out of your last or current job?3. Tell me about your previous work experience and walk me through a sample project from your work.4. What is the number one thing I should know about you that I cannot learn from your resume?5. Coming out of this interview, what are three things about you I should take away?6. How would your friends describe you? How would your professors describe you?7. Why did you choose to pursue your degree (MBA)?8. Why are you working in your current industry? Why did you choose the firm you are at now? Why did you choose your college? Do you regretchoosing the school or job you chose?9. Tell me about your college experience.10. What was your favorite andleast favorite course in school? Why? What were your grades in each?11. Have you had a performancereview?Whatdid it say?a. What would your last or current boss say about you?12. What types of activities did you pursue in college?

13. What do you do in your free time? Tell me something interesting about you.14. What serves as your biggest motivation?15. What is the most recent book youve read?16. What separates you from other candidates? Why should we hire you?17. What are some of your strengths?18. Why this firm? Be specific.19. What do you think is the most important characteristic for this job?20. What qualities do you feel that you have that are transferrable to this position?21. What are the qualities of a successful leader?a. Trustworthy, enthusiastic, confident, organized, tolerant, calm, focused, committed, and a great communicator. A good leader empowers others, allowsgroup members to make decisions rather than micromanaging, and expresses appreciation for good work.22. Why do you think you will be good in this job?23. Why are you interested in finance, and do you have any experience in the field?a. Why hedge funds or private equity?24. What is a hedge fund?a. A hedge fund is a private investment partnership, which uses aggressive strategies unavailable to other types of funds. It is a loosely regulated

investment pool that are open only to high net worth individuals since they are limited by law to 100 investors and thus typically require a minimuminvestment of $1 million. They liberally use financial techniques to hedge against risk with the goal of making a profit in any market environment, such asshort-selling, swaps, risk arbitrage, and derivatives. Often these funds take on high risk and are highly leveraged to give their clients the potential for higherreturns. They have much more latitude in the types of securities they can invest in because they are typically not restricted by most of regulations that othermutual funds must follow.25. Why are you applying here? What do you hope to gain from this job? What in particular is attractive about this firm?26. What do you know about our firm?27. What is the strategy of our fund?28. What three things would you change about this company? What direction would you take the firm if you were running it?29. If you had only three questions to ask senior management of a company, what would they be and why?30. What is your ideal work environment? What qualities would your ideal job have?31. Can ethical requirements in a firm be too high?32. If there were no such businesses as hedge funds/private equity, what would you do?33. What would you do for a living if you did not have to worry about money?34. Are you willing to travel or relocate for this position?35. What other types of jobs are you looking at? Only in hedge funds? Private Equity?36. Who else are you interviewing with and where are you in the process with other firms?37. What do you plan on doing in the next 10 years?38. Do you plan on going to business school? Why or why not?39. What aspect of finance do you find most interesting?40. If you have taken a finance course, present the most interesting topic you covered, and explain why you find that topic the most interesting.41. Provide a few different examples of careers in finance, and what exactly do they do? (i.e. investment bankers or investment managers)a. Investment bankers raise capital through debt or equity offerings for companies in the public or private marketplace. They also provide advice for

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companies on mergers and acquisitions and financial restructurings. They often do valuation work and pitch their banks expertise to potential clientcompanies. At higher levels, investment bankers focus more on the clients and building relationships that can generate deal flow. At middle levels, bankersare more focused on executing the given service at a high quality to keep clients.

b. Investment managers manage money for individuals and institutions.42. What is an institutional investor?

a. An organization that pools together large sums of money and puts that money to use in other investments. Some examples are investment banks,insurance companies, retirement funds, pensions funds, hedge funds, and mutual funds. They act as specialized investors who invest on behalf of theirclients.

43. What are some recent trends in investment banking?a. Consolidation: banks being acquired by other banks. JPMorgan buying Bear Stearns, Barclays buying part of Lehman Brothers.

b. Capital Infusions: Buffett investing in Goldman Sachs, Mitsubishi in Morgan Stanley, TARPc. Global Expansions: firms looking to expand into other, fast growing nations

d. Technology: high technology is being used to execute trades and distribute information more quickly.44. What do you think you will be doing on a daily basis as an analyst?a. An analyst is responsible for financial modeling in Excel, comparable company analysis, precedent transaction analysis, preparing pitch books and

PowerPoint presentations for clients, industry research, gathering of financial information. Long hours, and hopefully a chance for more responsibility if mywork is good.

45. Can you handle the grunt work?46. Imagine that you are hired, but a few months into the job you are fired. Provide three reasons why this may happen, and what you can do to prevent

this.a. What are your weaknesses?

47. What is your favorite web site?48. What recent article in the Wall Street Journal stands out to you most, and why?

49. Do you read WSJ every day? Whats on todays front page?50. What would you like for me to tell you? Do you have any questions for me?

a. Financial:i. What is your opinion of where the economy is going in the next year?

ii. Have you seen a change in deal flow due to the economic downturn?

iii. In your opinion, what desks/product groups have the best reputation and/or the most promising future at this firm?iv. Do you think more investment banks will go under in the coming years?

v. What do you see as the future of investment banking?b. Lifestyle

i. How did you get into banking or this position?ii. Have you enjoyed your experience?

iii. Have you worked at other firms, and how do your former experiences compare to this one?iv. What do you think separates this bank from similar banks?

v. Culture-wise, what do you think is the biggest positive with this bank? The biggest negative?vi. What advice would give me going forward?

c. Otheri. What are the next steps in this process? When should I expect to hear from you?

Personal Examples and Behavior Questions1. How do you manage stress in your life?2. How do you arrange your priorities when time constrained? What would you place as most and least important?

3. Provide an example of when you have had to pick between two priorities, and how you chose between the two? (i.e. attending a last minute meetingover attending an event you previously committed too)

4. Provide an example of a time where you had to handle many things at once or multitask.5. Provide an example of a time you had to make a split second decision.

6. Provide an example of a time where you anticipated potential problems and took measures to prevent them.7. Provide an example of a time where you learned something new in a short amount of time.

8. Describe a situation when you or your group was at risk of missing a deadline, what did you do?9. Provide an example of a time where you set a goal and were able to meet or achieve it.

10. What is the biggest risk you have taken in your life?11. What is the biggest obstacle or challenge you have faced and overcome in your life?

12. Provide an example of a time where you failed and turned it into a learning experience.13. What is the biggest mistake you have made in your professional life?

14. What do you consider to be your greatest failure?15. What is the toughest decision you have ever had to make?

16. What is the most difficult experience you have had? Why? How did you approach it and how would you have done things differently?17. Provide an example of your greatest accomplishment or an accomplishment you are proud of.

18. What role do you like to take in a team situation?19. Do you feel more comfortable working in a group or individually?20. Provide an example of a situation where you worked with a team. Provide an example of a time you took a leadership role in a team situation.

21. Provide an example of a time you had to deal with conflict in a team situation.22. Provide an example when you had to deal with an upset teammate or co-worker?

23. Provide an example when you were in a group where someone was not contributing as they should have been. What did you do?24. Provide an example of a project you have completed that you particularly enjoyed.

25. How do you manage dealing with a difficult boss, co-worker, or teammate?26. Provide an example of a time where you successfully persuaded others to do something or see your point of view.

27. Provide an example of a time you had to motivate others.28. Provide an example of a time you went above and beyond expectations.

29. Provide an example of a time when you were required to pay close attention to detail.30. Provide an example of a situation where that involved heavy analytical or quantitative thinking.

31. How have you modeled with equations in the past?32. Provide an example of an experience of failure or when you failed to meet expectations.

33. You do not seem very driven. How will you be able to handle this position?

34. How did you go about preparing for this interview?Knowledge and Technical Questions

1. Explain what happened with the mortgage crisis?a. Mortgage market in America created a financial crisis. Interest rates were very low, and lenders allowing people to borrow large amounts with low credit

ratings. Loans were granted with teaser rates, no down payments, and no review of a borrowers income history. Many mortgages were adjustable ratemortgages that begin with affordable payment but increase the rate later on. Borrowers with less than stellar credit ratings, called subprime borrowers, weretaking out loans that they really could not afford. Due to these loans, demand for houses increased and home value increased creating a housing bubble from


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2000 to 2005. In 2006, the bubble burst and total home equity dropped from $13 trillion to $8.8 trillion. By January 2009, 20% of US homes wereunderwater since the owner owed more on their mortgage then their home was worth. When more homeowners found themselves underwater, they had noincentive to continue paying mortgages so walked away from home. When homeowner foreclosed upon or walks way, stop paying mortgage payments,decreasing the value of MBS that were on the balance sheets as assets of many banks and had to be written down due to the declining value causing banks toincur loss. As capital and asset base declines, they restricted lending to meet reserve requirements and preserve liquidity.

b. Increasing the severity of the problem, banks making these loans were selling off the future mortgage payments to other banks. They repackaged themand sold them as Mortgage Based Securities.

c. Combination of these features led to a cycle which is largely the catalyst of the recession were currently in. (housing prices declinenegativeequityhomeowners walk awayincreased supply of houses) (when homeowners walk awaymortgage payments declinevalue of mortgage backedsecurities declinesbanks incur lossesbank capital declinesbanks restrict lendingeconomic activity slows and unemployment increases) Because supplyof houses increased, housing prices declined further, and cycle started over.

2. What is a mortgage backed security?

a. A class of asset-backed security that pays its holder periodic payments based on cash flows from underlying mortgages that fund the security. MBSmarket allowed investors to lend money to homeowners with banks as middlemen with investor purchasing MBS and paid back over time by payments fromhomeowners.

b. Many MBS rated AAA because considered highly diversified and not though that housing market would collapse across the board. Now we knowhousing values highly correlated and AAA rating too optimistic.

3. What is collateralized debt obligation?a. Broad asset class in which a number of interest paying assets are packaged together, securitized, and sold in the form of bonds

b. A type of security that pools together a number of interest paying assets, and pays coupon payments based on those assets future cash flows.c. Investor pays market value for CDO and then has right to interest payments in form of coupon payments over time.

4. What is a credit default swap?a. Insurance on a companys debt and is a way to insure that an investor will not be hurt in the event of a default. Sold over the counter in an unregulated

market. The credit default swap market is estimated at $62 trillion. If you own the bond of a company and purchase a CDS of that bond, and the companydefaults, then the party that sold you the CDS is responsible for paying you a certain amount of what you lost because of the default.

b. CDS buyer promised to pay seller annual payments, receive large payout if underlying company defaults, swap will become more valuable if underlyingcompany becomes financially distressed

c. CDS seller promises to pay swap buyer certain a mount if underlying company defaults, receives annual payments in exchange for the insurance; sellers

include investment banks, hedge funds, insurance companies, etc.d. Can be used for hedging (as an insurance policy against bond defaulting) or speculating (purchase the swap with the thought that the bond will become

distressed, and more investors will desire the insurance, raising the value of the swap which can be sold).5. What is securitization?

a. When an issuer bundles together a group of assets and creates a new financial instrument by combining those assets and reselling them in different tierscalled tranches. One of the reasons for the recession has been the mortgage backed securities market, which is made up of a securitized pool of mortgagesbanks issued and then sell off the future cash flows, mortgage payments, from those mortgages to another investor.

6. What are the three main financial statements?a. The Income Statement, Balance Sheet, and Statement of Cash Flows.

7. What is the difference between the Income Statement and Cash Flow Statement?a. The Income Statement records revenues and expenses, while the cash flow statement has the following categories: operating cash flows, investing cash

flows, and finance cash flows. It records what cash is actually being used and where it is being spent by the company during that time period. A companycan be profitable as seen by the Income Statement, but still go bankrupt if it doesnt have enough cash flow to make interest payments.

8. Walk me through the lines on the Cash Flow Statement? Income Statement?a. Beginning cash balance, then cash from operations, then cash from investing activities, then cash from financing activities, and the ending cash balance.

b. Revenues-COGS=Gross Margin-Operating Expenses=Operating Income-Other Expenses-Income Taxes=Net Income9. What are the components of each of the items on the Cash Flows Statement?

a. Operations is cash generated from the normal operations of the company. Investing is change in cash from activities outside normal scope of thebusiness, including purchases of property and equipment, and other investments not reflected on the income statement. Financing is cash from changes inliabilities and stockholders equity including any dividends paid out, issuance of any debt or equity, or the repurchase of debt or equity.

10. How are the three financial statements connected?a. Income Statement: Net income minus dividends is added to Retained Earnings under shareholders equity on the Balance Sheet. Net income is added to

cash flows from operations on CF statement after making adjustments for non-cash items.b. Balance Sheet: Interest expense is calculated from the long term debt under liabilities. Depreciation expense on Income Statement and Cash Flow

Statement is calculated based on property and equipment.c. CF Statement: starts with beginning cash balance from Balance sheet. After making adjustments to Net income, the cash flow form operations,

investing, and financing, calculate the ending cash balance, which become current periods balance sheet cash. Cash from operations is derived fromchanged in Balance sheet accounts, and is impacted by the change in net working capital (CA-CL). Any change in property due to purchase or sale of thatequipment affects cash from investing.

11. From the three financial statements, if you had to choose two, which would you and why? If you had to choose one, which would it be?a. The Balance Sheet and Income Statement can be used to make the St of Cash Flows.

b. Not IS, because full of non-cash items. CFS because cash is king in determining a companys health. Or BS because you can back out the maincomponents of the cash flow statement (capex via PP&E and depreciation, net income via retained earnings, etc). The BS is helpful in distressed situations todetermine the companys liquidation values.

12. What happens to each of the three primary financial statements when you change a) gross margin, b) capital expenditures, c) depreciation expense?a. Gross margin is gross profit/sales= total sales- cost of goods sold. If it decreases, then gross profit decreases relative to sales. Less income tax and lower

net income if nothing else changed on the Income Statement. On the Statement of Cash Flows, have less cash. On Balance Sheet, less cash and thus lessshareholders equity.

b. Capital expenditures decrease. On CF St, Capital expenditures would decrease and thus increase cash, increasing cash on Balance Sheet but decreasinglevel of Property and Equipment so total assets remain constant. On the income statement, depreciation expense would be lower, so net income would behigher, which would increase income tax, cash, and shareholders equity in the future.

c. Increase in Depreciation. Lower operating profit and thus pay less taxes and decrease net income. On Cash Flows St: Reduction of net income reducescash from operations, but increases cash from operations since depreciation is non-cash expense thus increasing ending cash. Balance sheet: cash increases,PP&E decrease, overall assets fall, retained earnings fall due to drop in net income.

13. If you sold an asset and received $200 million in cash. How would it affect your three main financial statements?a. Ask for book value of the asset. If book asset is $100 mil, then $100 gain on sale of asset is recorded, so net income increases by $60 mil if assume 40%

tax rate. On CFS, assets are recorded at book value when sold, so have $100 mil under cash from investing activities. Net cash flow is $160 mil. On the BS,

cash increases by $160, and property decreases by $100 mil. Balance by increasing shareholders equity by $60 mil.14. An item cost $10 to buy, and has a life of ten years. How would you put it on the balance sheet?

a. On the left side, $10 as an asset. Assuming straight line depreciation for book and no salvage value at the end of its useful life, it would be worth $9 atthe end of the first year. Net income will be lowered every year by the tax-affected depreciation, so shareholders equity will be reduced by 60 centsassuming a 40% tax rate.

15. If you later discover the item is a valuable collectors item, how much would it be on the balance sheet now?a. Still $8, since you continue to depreciate it and assets are recorded at historical values. Some traded financial instruments qualify for mark to market


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accounting, so these assets are valued at market.16. If after the second year, the pen runs out of ink and is thrown away, how much is it on the balance sheet?

a. Write down the value of the equipment to $0. Due to the write down, net income declines by $4.8 based on 40% tax rate, which flows to shareholdersequity. On the CFS, it is added to the $4.8 decline in net income since the $8 write-down is non-cash, resulting in a net cash flow of $3.2. Combined with thewrite-down in property, net change in assets is a decrease of $4.8, which balances the decrease in shareholders equity.

17. What is a 10-K?a. A report similar to the annual report, except it contains more detailed information about the companys business, finances, and management. It also

includes the bylaws of the company, other legal documents and information about any lawsuits in which the company is involved. All publicly tradedcompanies are required to file an annual 10-K to the SEC.

18. What is Sarbanes-Oxley and what are the implications?a. A bill passed by Congress in 2002 in response to accounting scandals. To reduce the likelihood of accounting scandals, the law established new

standards for publicly held companies. Those in favor of this law believe it will restore investor confidence by increasing corporate accounting controls.

Those opposed to this law believe it will hinder organizations that do not have a surplus of funds to spend on adhering to the new accounting policies.19. What should a company do with excess cash on the balance sheet?a. There is an opportunity cost to holding too much cash by giving up potential earnings from investing that cash elsewhere. A company should have

enough cash to protect itself from bankruptcy, but above that level cash should be either: reinvested into the firm, paid out in the form of dividend to equityholders, or used to pay off debt, repurchase equity, expand to new markets or buy out a competitor, supplier, or distributor. Growing companies tend toreinvest rather than pay dividends.

20. If a company has seasonal working capital, is that a deal killer?a. Working capital= current assets-current liabilities. Seasonal working capital applies to firms whose business is tied to certain time periods. When current

assets are higher than current liabilities, more cash is being tied up instead of being borrowed. In a season when demand is higher, the firm must build upinventories to meet this demand at this time, increasing current assets which increases liquidity risk, so if the product is not purchased the company is stuckholding the inventory. Also, if the company cant collect owed cash from AR in time to pay creditors, it runs risk of bankruptcy. This is an issue, but not adeal killer if the company has an adequate revolver and can predict the seasonal WC requirements with some clarity. Generally, any recurring event is fine aslong as it continues to perform as planned. A massive surprise event is what kills an investment.

21. A products life cycle is now mature. What happens to the working capital?a. The net working capital needs should decrease as the business matures, which increases cash flows. As the business develops, it becomes more efficient

and invest requirements are lower.

22. What is goodwill and how does it affect net income?a. Goodwill is an intangible asset on the balance sheet that includes brand name, good customer relations, and intellectual property. It is often created in an

acquisition, which represents the value between price paid and the companys book value acquired. If an event occurs that diminishes the value of goodwill(patent running out, or event hurting brand name), it is written down and is then subtracted as a non-cash expense thus reducing net income.

23. Is goodwill depreciated?a. Not anymore. Accounting rules now state that goodwill must be tested once per year for impairment. Otherwise, it remains on the BS at its historical

value.24. What is PIK?

a. PIK stands for paid in kind, an important non-cash item that refers to interest or dividends paid by issuing more of the security instead of cash. It can betoggled on at a particular time, often times at the option of the issuer. It becomes popular with PE firms, who could pay more aggressive prices by assumingmore debt. Flipping on PIK may be an indicator that the company is nearing default on interest payments due to lack of cash because of a deterioratingbusiness. PIK can dramatically increase the debt burden on the company at a time when it is already showing signs of difficulty with the existing levels.

25. If a company issues a PIK security, what impact will that have on the three financial statements?a. This can mean compounding profits for the lenders and flexibility for the borrower. If a mezzanine bond of $100 mil and 10% PIK interest is issued, it is

added to the BS as $100 mil of debt and cash. On the CFS, cash flow from financing increases by $100 mil. When PIK is triggered, interest on the IS isincreased by $10 mil, which reduced net income. This carries over onto CFS due to the net lower net income, but PIK interest is added back since it is non-cash, thus resulting in a positive cash flow which thus increases cash on the BS and debt increases, causing shareholders equity to decrease.

26. What is a PIPE?a. With the cost of credit rising, private investments in public equity are more popular through providing an alternative way for companies to raise

capital. They are made by qualified investors (HF, PE, mutual funds) who purchase stock in a company at a discount to the current market value. Thefinancing structure become prevalent due to the relative cheapness and efficiency in time versus a traditional secondary offering. There are less regulatoryrequirements. The most visible PIPE transaction of 2008: Bank of Americas $2 billion investment in convertible preferreds of mortgage lender CountrywideFinancial.

27. If you put $100 in the bank and got back $2 every year for 5 years and then in the 6th year, received $102, what is your IRR?a. 2%. The duration of the investment doesnt matter.

28. What is the difference between IRR, NPV, and payback?a. IRR measures the return per year on a given project and is the discount rate that makes NPV=0. NPV measures whether or not a project can add

additional or equal value to the firm based on its associated costs. Payback measures the amount of time it takes for a firm to recoup the initial costs of aproject without taking into account the time value of money.

29. What is a coverage ratio? What is a leverage ratio?a. Coverage ratios determine how much cash a company has to pay its existing interest payments. The formula: EBITDA/interest.

b. Leverage rations are used to determine the leverage, or the relation of a firms debt to its cash flow generation. There are many forms: debt/EBITDA ordebt/Equity which measures the relation of debt to equity that a company is using to finance its operations.30. If I increase AR by $5 million, what effect does that have on cash?

a. No immediate effect on cash. AR means that cash will be received for the product or service at a later point in time. There will be an increase in cash of$10 mil when the company collects on the AR.

31. Give examples of ways companies can manipulate earnings.a. Switching from LIFO to FIFO. In a rising cost environment, FIFO will show lower earnings, higher costs, and lower taxes.

b. Switching from fair value to cash flow hedges. Changes in fair value hedges are in earnings, changes in cash flow hedges are in other comprehensiveincome. Having negative fair value hedges and then shifting them to cash flow hedges will increase earnings.

c. Taking write-downs to inventory will decrease earnings.d. Changing depreciation methods

e. Having a more aggressive revenue recognition policy. Accounts receivable will increase rapidly because theyre extending easier credit.f. Capitalizing interest that shouldnt be capitalized, so you decrease interest expense on the income statement

g. Manipulating pre-tax or after-tax gainsh. Mark-to-market/mark-to-model

32. What is enterprise value?

a. The value of an entire firm to both debt and equity holders.b. Enterprise value= market value of equity (market cap) + debt + value of outstanding preferred stock + value of minority interest the company has cash

the company currently holds.33. If enterprise value is 150, and equity value is 100, what is net debt?

a. Net debt is 50.34. Why do you subtract cash from enterprise value?

a. Cash is already accounted for within the market value of equity. Also, subtract cash because can either use that cash to pay off some of the debt, or pay


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yourself a dividend, effectively reducing the purchase price of the company.35. What is EBITDA?

a. Earnings before interest, taxes, depreciation, and amortization. A proxy for cash flow, metric to evaluate a companys profitability and financialperformance. Good way of comparing the performance of different companies because it removes the effects of financing and accounting decisions likeinterest and depreciation, and is also considered a rough estimate of free cash flow.

b. EBITDA= Revenues-Expenses (excluding T,D,A)36. You have a company with $50 million in sales. Which makes the biggest impact? Volume increases by 20%, price increases by 20%, expenses

decrease by $15 million?a. Price by 20% if you consider how EBITDA is affected. Price has a bigger cost impact than expenses. Volume will increase revenue but variable costs

will increase proportionally.37. If a companys revenue grows by 15%, would its EBITDA grow by more than, less than, or the same percent?

a. Unless there are no fixed costs, EBITDA will grow more, because fixed costs stay the same so total costs will not increase as much as revenue.

38. Given that there is no multiple expansion and flat EBITDA, how can you still generate a return?a. Reduce interest expense, improve tax rate, depreciation tax shield, the simple act of leverage, pay down debt, pay a dividend, reduce capes, reduceworking capital requirements and reduce change in other.

39. What are different multiples that can be used to value a company?a. Price to Earnings multiple (P/E Ratio), EBITDA, EV/EBIT, EV/Sales and book value or Price/Book. Different multiples may be more or less

appropriate for specific industry. The relevant multiple depends on the industry. Internet companies are valued with revenue multiples, which is whycompanies with low profits have high market caps. Companies in the metal and mining industry are valued using EBITDA.

40. Why do P/E and EBITDA multiples yield different valuation results?a. EBITDA multiples represent the value to all stakeholders (debt and equity), while the P/E ratios only represent the value to all equity holders. EBITDA

multiples are often used to value firms that have negative income, but positive EBITDA. They do not factor in the effect of interest and thus allow forcomparability across firms regardless of capital structure. You will never see EV/Earnings or Price/EBITDA ratios, since the numerator and denominatormust correspond to the same set of stakeholders.

41. Which industries interest you? What are the P/E multiples for these industries?42. Is 15 a high P/E ratio?

a. It depends. P/E ratios represent how many dollars an investor is willing to pay for one dollar of earnings. It is a relative measurement and to determine ifit is high you need to know the general P/E ratio of comparable companies. High growth firms usually have higher P/E ratios, since they have high

anticipated growth in earnings and thus their earnings are low relative to price with the assumption that the earnings will eventually grow more rapidly thanthe stocks price. Thus, if 15 in high growth tech industry, then relatively low.

43. Why are the P/E multiples for an international company, say in Europe, different than a United States company?a. The P/E multiples can be different even if all other factors are constant because of the difference in the way earnings are recorded. Market valuations in

American markets tend to be higher than in the UK.44. What does spreading comps mean?

a. Task of collecting and calculating relevant multiples for comparable companies and summarizing them for easy analysis or comparison.45. What is valuation?

a. Procedure of calculating the worth of an asset, security, company, etc.b. One of the primary tasks investment bankers do for clients. Value their company or value a company they are thinking about purchasing or divesting.

46. Given a companys income, how would you find its free cash flow?a. Net Income + Depreciation and Amortization Capital Expenditures (how much cash company invests in plant and equipment each year) change in

net working capital = Free Cash Flow (FCF)47. How do you calculate free cash flow to equity?

a. To equity (levered cash flow): Same as firm FCF and then subtract interest and any required debt amortization.48. What is net working capital?

a. Net working capital=current assets- current liabilitiesb. It is a measure of how able a company is to pay off its short term liabilities with its short term assets. If the number is negative, the company may runinto trouble paying off creditors which could result in bankruptcy if cash reserves are low enough.

49. What happens to free cash flow if net working capital increases?a. Net working capital is the net dollars tied up to run the business. As more cash is tied up, there is less cash flow generated. Since subtract change in net

working capital in calculation of free cash flow, if net working capital increases then free cash flow decreases.50. What are the basic ways to value a company?

a. Comparable Companies (to calculate either enterprise value or equity value), how other similar companies were valued recently as multiplei. Average multiple from comparable companies multiplied by the operating metric of the company valuing

ii. Most common multiple is enterprise value/EBITDAiii. Ex: if comparable company trading at EV/EBITDA multiple of 6.0x, and the company you are valuing has EBITDA of $100 mil, EV would be $600

mil based on this valuation methodb. Market Valuation/Market Capitalization

i. Market value of equity is only for publicly traded companies.ii. Market cap= number of shares outstanding x current share price

iii. Market cap of company+ net debt on its books to get total enterprise valuec. Precedent Transactionsi. Find historical transactions similar to this transaction. Once identified comparable transactions, look at how those companies were valued. What were the

EV/EBITDA and EV/Sales multiples paid? Calculate variation multiple based on the sale prices in those transactions and apply the multiple to theappropriate metric of the company being valued. This will often result in highest valuation due to inclusion of control premium that a company will pay forassumed synergies that they hope will occur after purchase.

d. Discounted Cash Flow Analysisi. Project free cash flows for a period of time (5 years). Next, predict the free cash flows for the years beyond 5 years though using a terminal value

multiple or using the perpetuity method. To calculate perpetuity, establish a terminal growth rate which is usually around the rate of inflation or GDPgrowth. Then multiply the final, or year 5, cash flow by 1 plus the growth rate and divide it by your discount rate minus the growth rate. To do this, you mustestablish a discount rate using WACC (Question 46), and discount all your cash flows back to year 0 using that discount rate. The sum of the present valuesof all those cash flows is the value of the firm.

e. LBO Valuationi. Leveraged buyout is when a firm uses a higher than normal amount of debt to fianc the purchase of a company, then uses the cash flows from the

company to pay off the debt over time. Often use the assets of the company being acquired as collateral for the loan. When sell company, ideally the debt hasbeen partially or fully paid off, and they can collect most of the profits from the sale as the sole equity owners of the company. Since a smaller equity check

was needed up front due to higher level of debt used to purchase the company, this can result in higher returns to the original investors than if had paid forcompany with all own equity.

51. Why do you project out free cash flows for the DCF model?a. Because FCF is the amount of actual cash that could hypothetically be paid out to lenders and investors from the earnings of a company.

52. How would an increase in depreciation in year 4 affect the DCF valuation of a company?a. Decreases net income, but add back depreciation in calculation of free cash flow, so FCF increases and valuation increase and valuation will increase by

the present value of that increase.


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b. PV of increase in yr 4= increase amount/ (1+WACC)^453. Why might there be multiple valuations of a single company?

a. Since there are several different methods of valuation, each yields a different valuation due to different assumption, different multiples, or differentcomparable companies or transactions. The two main methods, WACC and APV, make different assumptions about interest tax shields which leads todifferent valuations.

54. Of the valuation methodologies, which are likely to have a higher/lower value?a. Of the four main valuation techniques (market value, market comps, precedent transactions and DCF), the highest valuation will normally come form

the Precedent Transactions technique because a company will pay a premium for the synergies coming from the merger. DCF will usually give next highestbecause those building DCF tend to be optimistic in assumptions and projections going into their model. Market comps and market values will give lowestvaluation. Market comps is based on other similar companies and how they are trading in the market, so no control premium or synergies. Market valuationis based on how the target is being valued by the market, and is just equity value no premiums or synergies. LBO is lower than DCF, as its discounted at ahigher cost of equity.

55. What is the risk free rate?a. The risk-free rate is the current yield on the government Treasury bond for the period for which the projections are being considered. The ten yeartreasury is often used. It is considered risk-free since the US government is considered to be a risk-free borrower.

56. What is beta?a. A measure of relative volatility or risk of a given investment with respect to the market. If Beta is 1, the returns on the investment vary identically with

the markets returns. B


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a. Stock price= value/shares so 5/1, which is a stock at $5 per share72. What if the company wins $5 million in the lottery?

a. The company doubled in cash and thus its value, so now $10 per share.73. How do you think about the credit metric: (IBITDA- Capex)/Interest expense?

a. How many times a company can cover its interest burden while still being able to reinvest into the company.74. Of the four debt covenants (minimum EBITDA, maximum capex, minimum interest coverage, maximum leverage), which one is the most important?

a. Minimum EBITDA because EBITDA is the basis of valuation, and if the company cant make its EBITDA covenant, its a signal that there might besomething operationally wrong with the company. A company can sell assets to pay down debt and reduce interest expense, but that will not solveunderlying business problems.

75. What is the difference between bank loan and high-yield debt covenants?a. Bank loans are stricter in terms of maintenance covenants. For looser covenants, high-yield debt is rewarded with higher interest rates. Covenants can

restrict economic activities, finance activities, or accounting measurements. Economic activities restricted would include the sale of assets, capex, changes in

corporate structure. Finance activities restricted could include issuance of additional debt and payment of cash dividends. Covenants often track accountingmeasurements, such as interest coverage, current ratios, minimum EBITDA.

76. What determined your split between bonds and bank in the deal? If there is a higher growth capex proportion of total capex, would you still want to usesame split?

a. Usually prefer bank debt because its cheaper than bonds. However, this depends on bank willingness to grant loan. The sponsor and debt holders haveto negotiate agreements/covenants that they can live with. The more senior the debt, like the bank debt, the more restrictive it tends to be. Bank debt usuallyrequires collateral to be pledge. The timeline of debt payback needs to be evaluated; bank debt usually has a shorter maturity, so the bank needs to ensurethat the company will be able to face its liabilities when due or else face bankruptcy. Growth capes is more favorable than maintenance capex. Its flexible;maintenance capex needs to be paid every year just to keep the company running, whereas growth capex can be stalled in times of downturn. Growth capeximplies investments, which yield higher cash flows in the future, than can be used to support more debt.

77. Given negative news about a company, what happens to the pricing of the equity versus the senior debt?a. Since equity is riskier and there is more uncertainty associated with it, the equity will be more volatile and decline in price by a greater percentage than

the debt.78. What is a stock purchase and what is an asset purchase?

a. A stock purchase refers to the purchase of an entire company so that all the outstanding stock is transferred to the buyer. Effectively, the buyer takes thesellers lace as the owner of the business and will assume all assets and liabilities. In an asset deal, the seller retains ownership of the stock while the buyer

uses a new or different entity to assume ownership over specified assets.79. Which structure does the seller prefer and why? What about the buyer?

a. A stock deal generally favors the seller because of the tax advantage. An asset deal for a corporation causes the seller to be double-taxed; at thecorporate level when the assets are sold and at the individual level when proceeds are distributed to the shareholders. In contrast, a stock deal avoids thesecond tax because proceeds transfer directly to the seller. In non-C corporations like LLCs and partnerships, a stock purchase can help the seller paytransaction taxes at a lower capital gains rate. Since a stock purchase transfers the entire entity, it allows the seller to completely extract itself from thebusiness.

b. A buyer prefers an asset deal, because it can pick and choose which assets and liabilities to assume, decreasing the amount of due diligence needed.Second, the buyer can write up the value of the assets purchased- a step-up in basis to fair market value over the historical carrying cost, which can create anadditional depreciation write-off, becoming a tax benefit.

80. Why should the fair market value of a company be the higher of its liquidation value and its going-concern value?a. Liquidation value is the amount of money that could quickly be sold immediately, usually at a discount. The fair market value, the rightful value at

which the assets should be sold, is higher. A liquidation value implies the buyer of the assets has more negotiating power than the seller, while fair marketvalues assumes a compromise. The going-concern value is the firms value as an operating business to a potential buyer, so the excess of going-concernvalue over liquidation value is booked as goodwill in acquisition accounting. If positive goodwill exists, the company has intangible benefits that allow it toearn better profits than another company with the same assets; the going-concern value should be higher than the fair market value.

81. How will a decrease in financial leverage affect a companys cost of equity capital?a. A decrease in financial leverage lowers the beta which lowers the cost of equity capital. With less debt, the firm is at a reduced risk of defaulting, and

causes equity investors to expect a lower premium for their investments and therefore reduce the cost of equity.82. Would you rather have an extra dollar of debt pay-down or an extra dollar of EBITDA?

a. An extra dollar of EBITDA because of the multiplier effect. At exit, the EV is dependant on the EBITDA times the exit multiple. An extra dollar of debtpay-down increases your equity value by only $1; an extra dollar of EBITDA is multiplied by the exit multiple, which results in a greater value creation.

83. Given $75 million initial equity investment, 5 years, IRR of 25%, whats exit EBITDA if sold at 10x multiple.a. Knowing an IRR of 25% over 5 year is approximately 3.0x equity return (no mathematic way of knowing this, so ask interviewer if dont know). The

ending equity value is thus 3x*75 million=$225 million, so the exit EBITDA must be $225/10x=$22.5 million.84. Describe a typical companys capital structure?

i. Capital structure is the structure of capital that makes up the firm, or its levels of debt and equity. Debt can be broken down into senior, mezzanine, andsubordinate with senior paid off first then mezzanine then subordinate. Since senior is paid off first it has a lower interest rate. Equity is broken down intopreferred and common stock. Preferred stock is a combination of debt and equity in that it has the opportunity for some appreciation in stock but pays aconstant dividend that is not tied to the market price of the stock. Common stock is traded on the exchanged. In event of bankruptcy, debt has first priority,while common stockholders have the last right to assets in the event of liquidation and thus bear the highest level of risk and the highest return on their

investment.85. What are you assuming when you short the junior piece of a capital structure and long the senior piece?a. You are assuming your return will make up the negative carry you will have to pay due to the higher interest rate on the junior piece of debt.

86. Why is bank debt maturity shorter than subordinated debt maturity?a. Bank debt will usually be cheaper (lower interest rate) because of its seniority, since it is less risky and needs to be paid back before debt tranches below

it. To make it less risky to lenders, a shorter maturity helps, usually less than 10 years. Bank deposits tend to have shorter maturities, so this aligns the cashflows of the bank business.

87. What is your investing strategy?88. What are your long and short ideas?

89. Where do you think the stock market will be in 6 months?90. What happened in the markets during the past three months?

91. What stocks do you own? What three stocks would you invest in?92. What did the S&P 500 close at yesterday?

93. Where do you think the Dow Jones Industrial Average will be in 6 months?94. Talk about the stock price of a company in either your prior line of work or one that interests you.

95. Describe the stock of a company you have been watching? Why did the stock price decrease when it did and increases when it did?

96. Tell me about your portfolio. How has it performed in the last three years?97. Give a bull and bear case on X energy commodity.

i. Commodities are a strict result of supply and demand. What is todays demand and what is expected in the future? Energy needs are rising, but theres ahuge push to remove reliance on fossil fuels and more to renewable sources like solar and wind. Conversely, there is a constant discussion concerningsupply: oil and gas are supposed to dwindle. This point to bull cases for certain energy commodities, but crude oil has fallen dramatically from mid-2008 to2009 because of the slowing global economy and rising inventories.

98. You have three companies in three different industries: retail, tech, and pharmaceuticals. What would you look for in their 10-Ks beyond financials?


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i. In retail, look for strategy of product differentiation and sustainability of that strategy (zero in on competitors). For tech, what is the growth of itsindustry or market year (zero in on longevity of product life)? For pharmaceuticals, measure the current patents in terms of years to expiration, and note thelevel of development of drugs in its pipeline.

99. What is the difference between technical analysis and fundamental analysis?i. Technical analysis is the process of picking stocks based on historical trends and stock movements mainly based on charts. Fundamental analysis is

examining a companys fundaments, financial statements, industry, etc. and picking stocks that are undervalued.100. What are the drivers of growth?

i. Growth can be operationally organic (from inside), acquisition based, or financial (recapitalizing).101. Would I be able to purchase a company at its current stock price?

i. Due to the fact that purchasing a stake in a company will require paying a control premium, most of the time a buyer would not be able to simplypurchase a company at its current stock price. The current shareholders require a premium to be convinced to tender their shares. Premiums usually rangefrom 10-30%.

102. What is correlation?i. Correlation is the way two stocks, or investments, move in relation to each other. If two stocks have a strong positive correlation, when one moves up theother would move up as well. Correlation ranges between -1 and 1.

103. What is diversification?i. Process of creating a portfolio made up of a wide variety of investments with the goal being a higher return and lower risk than putting all capital into

only a few investments. It means investing in stocks, bonds, alternative investments, etc. it also means investing across different industries, pickinginvestments that have a low correlation so they balance each other out during economic conditions. Systematic risk is the risk that affects the entire market,while unsystematic risk affects only specific industries. If properly diversified, an investor can eliminate unsystematic risk from their portfolio, so they limitthe risk associated with one individual stock and their portfolio will only be affected by factors affecting the entire market.

104. If you add a risky stock into a risky portfolio, how is the overall risk of the portfolio affected?a. It depends on the stock relative to that of the portfolio, or the correlation of the new investment to the portfolio. A portfolios overall risk is determined

not just by the riskiness of its individual positions, but by how these positions are correlated with each other. The risk effect of adding a new stock to anexisting portfolio depends on how that stock correlates with the other stocks in the portfolio. Thus, it could potentially lower the overall risk of the portfolio.

105. Put the following portfolios consisting of 2 stocks in order from the least risky to the most risky and explain why.a. A Portfolio of a shoe store stock and an oil company stock?

b. A portfolio of a SUV car company stock and an oil company stock?

c. A portfolio of a shoe store stock and a high-end clothing store stock?i. The least risky is B, then a, then c. The least risky is the one where the two securities have a strong negative correlation, since stocks with a negative

correlation tend to move in the opposite direction under the same circumstances. The value of the portfolio will remain relatively stable over time, making itless risky. High oil prices is bad for an SUV car company, since less people will want to purchase gas-guzzlers, but is good for oil companies. C is mostrisky because shoes and clothing are both apparel companies and have a strong positive correlation, so they tend to move together under the samecircumstances, and are the most risky. A is the middle because shoes and oil have a weak correlation around 0, so the securities generally dont move in thesame direction under the same circumstances.

106. What kind of stocks would you issue for a startup? For a well-established firm?i. A startup has more risk than a well-established firm. The kind of stocks to issue for a startup would be those that protect the downside of equity holders

while giving them upside, so the stock issued may be a combination of common stock, preferred stock, and debt notes with warrants (options to buy stock).107. When should a company buy back stock? What signals does this send to the market?

i. When its stock is undervalued, has extra cash, believes it can make money by investing in itself, or when it wants to increase stock price by increasingEPS due to reduction in shares outstanding or send a positive signal to the market. Example: if a company has suffered decreased earnings because of aninherently cyclical industry and believes its stock price is too low, it will buy back, or if investors are driving down the price precipitously.

108. What does it mean to short a stock?i. It is the opposite of going long. When an investor buys a stock, they believe they can sell the stock for a higher price in the future. When short selling,

the investor sells a stock they dont actually own under the belief they will be able to purchase it for a lower price in the future. Normally, the short sellerwill borrow the stock form another investor and then sell it. Naked short selling occurs when an investor sells the stock without having any of the stockactually borrowed.

109. What is liquidity?i. How easily an asset or security can be bought and sold on the open markets. Money market accounts and publicly traded large cap stocks are very liquid,

while micro-cap stocks could be relatively low liquid due to the limited market demand for them.ii. How quickly an asset can be converted into cash. Cash is the most liquid asset.

iii. A more liquid investment is relatively safer since the investor can sell it at any time.110. When should a company issue stock rather than debt to fund its operations?

i. If it believes its stock price is inflated, it can raise money on good terms by receiving a high price for shares. If it wants to adjust the debt to equity ratio,which in part determines bond rating? Bond ratings determine the pricing of its capital structure. If bond rating is poor because struggling with large debts,the company may issue equity to pay down debt. If projects for which money is being raised may not generate predictable cash flows in immediate future,company may not be able to pay consistent coupon payments required by debt so issue stock to raise money. Example: startup company- issue stock becauseventure will probably not generate predictable cash flows needed to make regular debt payments and so the risk of venture is diffused among shareholders.

111. When should a company issue debt instead of issuing equity?

i. A company needs a steady cash flow before issuing debt, or else it will fall behind interest payments and get its asset seized. Once a company can issuedebt, it should prefer issuing debt since it is cheaper than equity. Interest payments are tax deductible and therefore provide interest tax shields. It may alsotry to raise debt if it feels its stick is undervalued and would not raise the capital needed from an equity offering. Issuing debt sends a quieter signal to themarket regarding its current cash situation.

ii. If the expected return on equity is higher than the expected return on debt, a company will generally issue debt. Example: a company believes thatprojects completed with $1 mil raised will increase its market value from $4 mil to $10 mil. If raised by issuing equity, it will sell 20% (1 mil/5 mil) of thecompany after the capital infusion. This would then grow to 20% of 10 million (2 million), so it will cost the company $1 million (2-1). If raised by issuing a$1 mil bond that requires $300,000 in interest payments over its life, and thus will only cost $300,000. Thus, it will choose debt, since it is cheaper thanequity.

112. Is the dividend paid on common stock taxable to shareholders? Preferred stock?i. Dividend paid on common stock is taxed at the firm level, since the dividend comes out from the net income after taxes, and the shareholders are taxed

for the dividend as ordinary income on personal income tax. Preferred stock dividend is treated as interest expense and is tax-free at corporate level.113. When would an investor buy preferred stock?

i. Wants the upside potential of equity and wants to minimize risk through receiving steady interest-like dividend payments that are more assured than thedividends on common stock. Get superior right to companys assets in event of bankruptcy.

ii. Corporation would invest in preferred stock because dividends on preferred are taxed at a lower rate than interest rates on bonds.

114. Why would a company distribute earnings through dividends to common stockholders?i. Regular dividend payments signal that the company is healthy and profitable, which attracts more investors or shareholders, potentially increasing stock

price. Also, if it lacks profitable investment opportunities.115. Why would the stock price of a company decrease when it announced increased quarterly earnings?

i. The entire market was down (or the sector of the company), which had more impact than the companys positive earnings, or the Street was expectingearnings to increase more than they did

116. How can a company raise its stock price?


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i. Any type of positive news about the company, such as announcing an accretive merger or acquisition that will increase EPS, announcing a change toorganization structure through cost-cutting or consolidation, could raise its stock price. If it repurchases stock, it lowers the shares outstanding, raising EPSwhich will raise stock price, and also sends a positive signal to the market. It can also produce higher earnings, raising EPS higher than anticipated.

117. If a companys stock has gone up 20% in the last 12 months, is the companys stock actually doing well?i. It depends on the Beta and the performance of the market. If Beta is 1 and the market went up 30%, the company did not do well compared to the

broader market.118. What is an Initial Public Offering?

i. An IPO is the first sale of stock in a previously private company to the public markets, known as going public. Many Companies will go public to raisecapital in order to grow business, to allow original owners and investors to cash out some of their investment, and employee compensation. Some negativesfor going public include sharing future profits with public investors, los of confidentiality and control, IPO expenses to investment banks, legal liabilities,etc.

119. Talk about a recent IPO that you have followed? Why did you choose it?

120. Why do some stocks rise so much on the first day of trading their IPO and others dont? How is that money left on the table?i. Money left on the table means the company could have completed the offering at a higher price (could have sold the same stock in its IPO at a higherprice), and that difference in valuation goes to initial investors in the stock rather than the company raising the money. If the stock rises a lot the first day, itis good publicity for the firm.

ii. Bankers must honestly value a company and its stock over the long term rather than guessing what the market will do. Even if a stock trades upsignificantly initially, a banker looking at the long term would expect the stock to come down, as long as the market eventually correctly values it.

121. What is insider trading and why is it illegal?i. The illegal activity of buying or selling stock based on information that is not public information. The law against insider trading exists to prevent those

with privileged information from using this information to make a tremendous amount of money unfairly.122. If you have two companies that are exactly the same in terms of revenue, growth, risk, etc. but one is private and one is public, which companys

shares would be higher priced?i. Public will be priced higher due to the liquidity premium an investor willingly pays for the ability to quickly and easily trade the stock on public

exchanges ad also for the transparency premium an investor pays since the public company is required to file their financial documents publicly.123. Which has a higher growth potential: a stock currently trading at $5 or a stock at $50?

i. It depends. Growth potential has less to do with stock price than operations and revenue prospects. However, the stock with higher growth potential ismost likely the stock with lower market cap. Thus, if the $5 stock has 1 billion shares outstanding and the $50 stock has 10,000 shares outstanding, the $50

stock has a smaller market cap and would most likely have higher growth potential.124. If you bought a stock a year ago for $20, sold it today for $25, and received $5 in dividends over the year, what would your overall return be?

i. Return on Stock= Sales Price + Dividends-Purch Price/ Purchase Priceii. 25+5-20/20=10/20=50%. Made 50% return on investment.

125. What is the primary market and what is a secondary market?i. The primary market is the market that an investment bank, or firm, sells new securities, a new stock or bond issuance to the first time it comes to market

and thus before they go to market. With an IPO or Bond issuance, the majority of these buyers are institutional investors who purchase large amounts of thesecurity.

ii. The second market is the market that the security, stock or bond, will trade on after the initial offering (NYSE, Nasdaq).126. What are some reasons why a company might tap the high-yield market?

i. Companies with low credit ratings are unable to access investment grade investors and would have to borrow at higher rates in the high yield markets.Other companies must have specific riskier investments that they must pay a higher cost of capital for.

127. If you read that a certain mutual fund achieved 50% returns last year, would you invest in it?i. Past performance is not necessarily an indicator of future results. A mutual fund full of Mortgage Backed Securities could have been up and then been

down 90% last year due to the MBS market collapsing. To make an investment decision, need to research more in depth the firms holdings. How has theoverall market done? How did it do in the years before? Why did it give 50% returns last year? Can that strategy be expected to work continuously over thenext five to ten years?

128. How do you calculate a companys Days Sales Outstanding?i. Average Accounts Receivable/Sales x 365 Days

ii. Average Accounts receivable= (Ending AR + Beginning AR)/2129. If the days sales outstanding of company increased from 53 to 71 days, would you be more or less likely to issue a Buy rating on the stock and why?

i. Less likely, since when the says sales outstanding increases the company is collecting money from customers slower, since customers went from takingan average of 53 days to pay bills to 71 days. Having faster paying customers when sales grow or stay the same is a good thing, so when it takes longer it is abad thing.

130. How do you calculate a companys Current Ratio?i. Current assets/Current liabilities. A high current ratio indicates that a company has enough cash or assets that can quickly turn into cash to cover its

immediate payment requirements on liabilities.131. If the Current Ratio of a company went down from 2.1 to 1.6, would you be more or less likely to buy the stock and why?

i. Less likely, since the company is less able to cover its immediate liabilities with cash and other current assets than it was last quarter.132. If a Company A has assets of $100 million versus another company B with assets of $20 million, but both have the same dollar earnings, which

company would you invest in?

i. Company B has a higher ROA, since it is able to generate the same earnings with less assets and is thus more efficient. From an ROE and ROIperspective, company A might be a better company but it would be riskier from a bankruptcy perspective.133. What is the market risk premium?

i. The required return that investors require for investing in stocks over investing in risk-free securities. Calculated as the average return on the market-riskfree rate

134. What is default risk?i. Risk of a given company going bankrupt

135. What is default premium?i. Difference between the yield on a corporate bond and the yield on a government bond with the same time to maturity to compensate the investor for the

default risk of the corporation, compared with the risk-free comparable government security.136. What is face value?

i. Par value of a bond is the amount the bond issuer must pay back at time of maturity. Bonds are usually issued with $1,000 face value.137. What is the coupon payment?

i. The amount that a company will pay to a bondholder normally on an annual or semi-annual basis. It is the coupon rate x the face value of the bond.138. What determines the premium you place on growth stocks relative to their peers?

i. All the criteria that goes towards a good investment determines the premium you place on a growth stock. P/E versus PEG ratio: P/E/EPS growth. The

PEG ratio is a trading valuation metric for evaluating the relationship between the price of a stock, EPS and the companys expected growth. In general, aP/E ratio is higher for companies with higher growth rates, so dividing P/E by the expected growth rate is a convenient metric to compare companies withdifferent growth rate. A fairly valued company should theoretically have a PEG ratio of 1. By setting PEG to 1 and solving for growth rate, you can gather asense of what premium the market is putting on the particular stock.

139. What is the difference between an investment grade bond and a junk bond?i. An investment grade bond is a bond issued by a company that has a relatively low risk of bankruptcy, a good credit rating, and thus pays a low interest

rate. A junk bond is a bond issued by a company that has a high risk of bankruptcy, has poor credit rating, and thus pays a high interest rate.


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140. What is the difference between a bond and a loan?i. The market that it is traded on. A bond issuance is usually for a larger amount of capital, is sold in the public market and can be traded. A loan is issued

by a bank, and is not traded on a public market.141. How do you determine the discount rate on a bond?

i. Determined by the companys default risk. Factors influencing the discount rate include a companys credit rating, the volatility of their cash flows, theinterest rate on comparable US bonds, and the amount of current debt outstanding.

142. How do you price a bond?i. The net present value of all future cash flows (coupon payments and par value) expected from the bond using the current interest rate.

143. If the price of a bond goes up, what happens to yield?i. The price and yield of a bond move inversely to one another. When the price of a bond goes up, yield goes down.

144. Define the difference between the yield and the rate of return on a bondi. The yield is the return you earn if you hold the bond to maturity versus the rate of return is the actual realized return to the bond holder. If the bond is

sold before maturity, the rate of return can be higher or lower than the yield. A bond may have a promised yield of 5%, but the economic crisis hit andinterest rates have fallen. This increases your rate of return if you sell now; if you hold to maturity then yield and return will be the expected 5%.

145. If you believe interest rates will fall, and want to make money due to the capital appreciation on bonds, would you buy them or short sell them?i. Since prices move inversely to interest rates, if you believe interest rates will fall, bond prices will rise and therefore you should buy bonds.

146. Who is a more senior creditor, a bondholder or stockholder?i. A bondholder is more senior. Stockholders must wait until bondholders are paid during a bankruptcy before claiming company assets. Interest payments

are paid to bondholders before equity holders receive any dividends.147. What is the relationship between a bonds price and its yield?i. They are inversely related. If a bonds price rises, its yield falls. Current yield= interest paid annually/market price * 100%

148. You have an 8% note maturing in 5 years trading at 80. What is the current yield?i. 20/80=25%/5-5%+8/80=15% minus compounding = 14% approx

149. How are bonds priced?i. Bonds are priced based on the net present value of all future cash flows expected from the bond.

150. If I have a bond with a 5% coupon. What happens to the market price when the interest rates rise to 10%? How are the coupons affected?i. When the interest rates rise, the market price of the coupon bond decreases because the investor can obtain a higher interest rate on the market than what

the bond is currently yielding. To make the bond appealing to potential investors, the market price decreases which causes the bonds return to increase at

maturity as means of compensating for the decreased value of coupon payments. The coupons remain constant; the new market price instead balances theyield to keep it neutral with the current market.

151. What are the factors that affect option pricing?i. An option conveys the right, not obligation, to engage in a future transaction on some underlying security. Several factors influence an options

premium, which is intrinsic value + time value. A change in the price of the underlying security either increases or decreases the value of an option, and theprice changes have an opposite effect on calls and puts. The strike price determines whether the option has intrinsic value and it generally increases as theoption becomes further in the money. Time influences option pricing because as expiration approaches, the time value of the option decreases. A securitysvolatility impacts the time value of a premium, and higher volatility estimates generally result in higher option premiums for both puts and calls. Dividendsand the current risk-free interest rate have a small effect known as the cost of carry of shares in an underlying security.152. Explain put-call parity.

i. The relationship between the price of a call option and put option with an identical strike price and expiration date. It is derived using arbitragearguments, and shows that a portfolio of call options and x amount of cash equal to the PV of the options strike price has the same expiration value as aportfolio compromising the corresponding put options and the underlying option. The parity shows that the implied volatility of calls and puts are identical.Also, in a delta-neutral portfolio, a call and a put can be used interchangeably.

153. What is meant by the term securities lending?i. The loan of a security from one broker/dealer to another, who must eventually return the same security as repayment. The loan is often collateralized.

Securities lending allows a broker/dealer in possession of a particular security to earn enhanced returns on the security through finance charges.154. What is arbitrage?

i. Occurs when an investor buys and sells an asset or related assets at the same time in order to capture a guaranteed profit from the trade by takingadvantage of the temporary price differences that occur when two assets are inaccurately priced by the markets. Because of the technology now employed inthe markets today, the only people who can truly take advantage of arbitrage opportunities are traders with sophisticated software since the priceinefficiencies often close in a matter of seconds.

155. What is convertible arbitrage?i. An investment strategy that seeks to exploit pricing inefficiencies between a convertible bond and the underlying stock. Managers will typically long the

convertible bond and short the underlying stock.156. If you buy a normal bond at par and you get the face amount at maturity. Is that most similar to buying a put, selling a put, buying a call, or selling a

call?i. Selling a put because if the stock decreases in value, you lose money, like a bond defaulting. But if its neutral, youre neutral in both cases.

157. Why could two bonds with the same maturity, same coupon, from the same issue be trading at different prices?i. One of the bonds could be callable, put-able, or convertible. A bond that is put-able or convertible demands a premium, and a callable bond trades at a

discount.

158. What are bond ratings?i. A grade given to a bond based on its risk of defaulting that are issued by independent firms (Standard and Poors, Moodys and Fitch) and are updatedover the life of the bond. The lower the grade, the more speculative the stock, and all else equal, the higher the yield. They range from AAA, which arehighly rated investment grade bonds with low default risk, to C, which are junk bonds, or D, which means that the bond is in default and not makingpayments.

159. Which corporate bond would have a higher coupon, AAA or BBB? What are the annual payments received by the owner of a 5 year zero couponbonds?

i. The BBB bond would have a higher coupon because it is perceived to have a higher risk of defaulting. To compensate investors for this higher risk,lower rated bonds offer higher yields. The owner of the zero coupon bond receives no annual payments, instead the owner pays a discount upfront and thenreceives the face value at the time of maturity.

160. What major factors affect the yield on a corporate bond?i. Interest rates on comparable U.S. Treasury bonds, and the companys credit risk.

ii. Corporate bond yields trade at a premium, or spread, over the interest rate on comparable US treasury bonds (a 5 yr corporate bond trading at a premiumof .5% or 50 bases points over the 5 yr Treasury note is priced at 50 over). The size of this spread depends on the companys credit risk: riskier=higherinterest rate the company must pay to convince investors to lend it money and thus the wider the spread over US Treasuries.

161. If interest rates are falling, would you buy a 10 year coupon bond or 10 year zero coupon bond?

i. The 10 year zero coupon bond, because it is more sensitive to changes in interest rates than an equivalent coupon bond, so its price will increase morethan the price of the coupon bond if interest rates fall.

162. Which is riskier: a 30-year coupon bond or a 30-year zero coupon bond?i. Zero coupon bond is riskier since its price is more sensitive to changes in interest rates, and will yield $0 until its date of maturity since it pays no interest

but instead one lump sum upon maturity. A coupon bond pays regular interest payments than pays the principal when the bond matures, so it is less riskysince you receive some money back before over time. Even if the company defaults on its debt prior to maturity, you will have received some payments withthe coupon bond, while the zero coupon bond you have to wait to receive any money back.


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163. What is the Long Bond? What is it trading at?i. The U.S. Treasurys 30-year bond.

164. What is the current yield on the 10-year Treasury note?165. If the price of 10 yr Treasury note rises, what happens to the notes yield?

i. Since price and yield are inversely related, when the price of the note rises, its yield falls.166. What would cause the price of a treasure note to rise?

i. If the stock market is extremely volatile and investors are fearful of losing money, they will desire risk free securities, which are government bonds. Theincrease in demand for these securities will drive the price up, and thus the yield will fall.

167. If you believe interest rates will fall, should you buy bonds or sell bonds?i. Since bond prices rise when interest rates fall, buy bonds.

168. If a company has $300 million of senior debt and $300 million of junior debt. The senior debt has an interest rate of L+300 and, in default, wouldrecover 50%; the junior debt would recover 20% in default. What should the interest rate be on the junior debt?

i. Loss on default*probability of default=incremental interest that needs to be paid. 80% loss*5% probability (assumption you have to make)=400 basispoints over the senior debt or L+700.

169. What if this was an LBO scenario and you had a sponsor putting in 500 million of equity?i. The company would be less risky because it has more liquidity now.

170. What are the three ways to create equity value?i. EBITDA/earnings growth, FCF generation/debt pay-down, multiple expansion

171. You have a company with 2x senior leverage and 5x junior leverage. What happens when you sell the business for 8x EBITDA? What about for 7xEBITDA?

i. Its a de-leveraging transaction because pro-forma the company will have lower total debt to EBITDA ratioii. On a firm basis, it has a neutral impact, but it is de-leveraging on a senior debt basis

172. How many basis points equal 1.5 percent?i. Bond yields are measured in basis points, which are 1/100 of 1%. So 1.5%= 1.5100=150 basis points.

173. Does inflation hurt or help creditors? Why?i. Hurts. Creditors assign interest rates based on the risk of default as well as the expected inflation rate. When creditors lend out money at a fixed rate, the

inflations cuts into the real percentage return they make. So if lent out at 5% a year, and inflation is expected to be 2%, they expect to make a 3% real gain.However, if it increases to 4%, they only make 1% on the loan.

174. If the president is impeached, how would interest rates be affected?i. Any negative news about the country often leads to fears that the economy will decline, so the Fed would balance those fears by lowering interest rates to

stimulate economic expansion.175. How does the government react to fear of hyperinflation?

i. It uses fiscal (taxation, government spending to regulate aggregate level of economic activity) and monetary (Feds use of interest rates, reserverequirements, etc) policies to slow the economy and defuse hyperinflation.

ii. Ex: Increasing taxes and decreasing spending slows down growth in the economy and fights inflation. Raising key interest rates will slow the economy,reduce the money supply, and slow inflation.

176. What is your outlook on the economy? (stock market, consumer spending, unemployment- way interest rats, inflation, and bonds interact)177. If the stock market falls, what would happen to bond prices and interest rates?

i. Expect bond prices to increase and interest rates to fall. When the stock market falls, investors flee to safer securities, like bonds, which causes demandto rise and thus prices. Since prices and yield move inversely, if bond prices rise, yield falls. The government may lower interest rates in an attempt tostimulate the economy.

178. When unemployment decreases, what happens to inflation, interest rates, and bond prices?i. Inflation up, interest rates up, bond prices down.

179. If inflation last month was very low, but bond prices closed lower, why would this happen?i. Bond prices are based on expectations of future inflation, so if traders expect future inflation to be higher regardless of last months inflation figures they

will bid bond prices down today since the demand for bonds today will be lower, increasing the yields to match the increased inflation expectations.ii. A report showing last month inflation was benign would benefit bond prices to the extent that traders believed it was an indication of low future

inflation as well.180. What is a bonds Yield to Maturity?

i. The rate of return, expressed as an annual rate, on a bond if it is purchased today for its current price and held through its maturity date. Calculation isbased on current market price, coupon payments, face value, and time to maturity. If the coupon yield of a bond (coupon/face) is higher than its current yield(coupon/price), it is selling at a premium. If the yield is lower than the current yield, it is selling at a discount.

181. What will happen to the price of a bond if the fed raises interest rates?i. If interest rates rise, newly issued bonds offer higher yields to keep pace. Therefore, existing bonds with lower coupon payments are less attractive, and

the price must fall to raise the yield to match the new bonds.182. What is a Eurodollar bond?

i. A bond issued by a foreign company, but issued in US dollars rather than their home currency.183. What is a callable bond?

i. A bond that allows the issuer of the bond to redeem the bond prior to its maturity date, thus ending their coupon payments. However, a premium is

usually paid by the issuer to redeem the bond early.184. What is a put bond?i. The opposite of a callable bond. Gives the owner of bond the right to force the issuer to buy back the security from them at face value, prior to the

maturity date.185. What is a convertible bond?

i. Can be converted into equity over the course of the life of the bond. A bondholder can decide that equity in the company is worth more than the bondand the company can essentially buy back their debt by issuing new equity.

186. What is a perpetual bond?i. A bond that pays coupon payments every period indefinitely (or the company goes into default) with no repayment of the principal amount (par value).

187. How would you value a zero coupon perpetual bond?i. Zero. A zero coupon doesnt pay any coupons, and a perpetual bond has no maturity date or par value- it pays only coupon payments. Thus if the coupon

is zero and if that continues perpetually, you will never get paid so worth nothing.188. How would you value a perpetual bond that pays you $1,000 a year in coupon?

i. Divide the coupon by the current interest rate. A corporate bond with an interest rate of 10% that pays $1,000 a year in coupons forever would be worth$10,000.ii. Value of perpetual bond= coupon payment/current interest rate on comparable bonds

189. What is duration?i. A measure of the sensitivity of the price of a bond to changes in interest rates, expressed as a number of years. When interest rates rise, the Present Value

of the future cash flows go down more than those earlier in the bonds life cycle. Formally, it is the weighted average maturity of cash flows. If your cashflow occurs faster or sooner your duration is lower and vice versa. A 4 year bond with semi-annual coupons will have a lower duration than a 10 year zero-year coupon bond. The larger the duration number, the greater the impact of interest rate fluctuations on bond prices.

190. What does the term delta mean?i. The change in price of an option for every one point move in the price of the underlying security (a first derivative)


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191. What is meant by gamma?i. A measurement of how fast delta changes, given a unit change in the underlying price (a second derivative)

192. What does the term vega mean?i. The change in the price of an option that results from a 1% change in volatility.

193. What is meant by rho?i. The dollar change in a given options price that results from a 1% change in interest rates

194. What the term theta mean?i. The ratio of the change in an options price to the decrease in its time to expiration, also called time decay

195. What is convexity?i. As duration is the measure of sensitivity of a bonds price to changes in interest rates, convexity is the measure of sensitivity of a bonds duration to

changes in interest rates. In essence, duration could be considered the first derivative of a bonds interest rate sensitivity and convexity the second.196. What is the order of creditor preference in the event of a companys bankruptcy?

i. The first creditors to be paid would be the senior debt holders, usually banks or senior bondholders who usually have some of the firms assets ascollateral. Then those holding subordinated debt, then preferred stockholders, then common stockholders.

197. What are some ways to determine if a company poses a credit risk?i. Look at their credit rating, which is provided by Standard & Poors and Moodys. Can look at long term measures like the long term debt ratio,

debt/equity, and interest coverage ratio (EBIT/Interest Expense), which shows the companys ability to pay its interest expense with its earnings and againcompare these to industry averages. Can also compare the companys Current Ratio and Quick Ratio to other similar companies in their industry.

198. Why is a firms credit rating important?i. The lower a firms credit rating, the higher its risk of bankruptcy and therefore the higher the cost of bo

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