Technical Knowledge – Investment Banking

1. What are the three main accounting statements and how are they connected?

The three main accounting statements are:

(1) The Income Statement, which shows the manufacturing and selling actions of the enterprise that results in profit or loss. Net income, the bottom line, flows from the Income Statement to Retained Earnings on the Balance Sheet. It also becomes the first line of Cash from Operations on the Cash Flow Statement. Income Statement is like a cumulative record over a period of time.

(2) The Balance Sheet records what the company owns and what it owes, including the owner’s stake. Each statement views the enterprise’s financial health from a different and necessary perspective. Like its name suggests, the Balance Sheet always balances. This financial statement acts as a record for a firm's assets and all the claims against those assets. The remaining value is called Stockholder's Equity. The Cash Balance, which is the first line item under Current Assets at the top of the Balance Sheet, is taken from the Ending Cash on the Cash Flow Statement. The Balance Sheet, unlike the Income Statement, is not a cumulative record over time; it is a snapshot of one moment in time.

(3) The Cash Flow Statement, which details the movements of cash into and out of the coffers of the enterprise. The Cash Flow Statement connects the three financial statements together. The statement begins with Net Income from the Income Statement and the Ending Cash balance at the bottom Cash Flow Statement flows to Cash and Cash Equivalents at the top of the Balance Sheet.

2. What are the three ways to value a company (and explain when to use them)?

There are three basic techniques to value a company, which include: discounted cash flow (DCF), relative valuation (multiples approach) and comparable transactions.

Intrinsic value (DCF) is considered the more academically respected approach. The DCF says that the value of a productive asset equals the present value of its cash flows. The answer should run along the line of “project free cash flows for 5-20 years, depending on the availability and reliability of information, and then calculate a terminal value.  Discount both the free cash flow projections and terminal value by an appropriate cost of capital (weighted average cost of capital (WACC) for unlevered DCF and cost of equity for levered DCF).  In an unlevered DCF (the more common approach) this will yield the company’s enterprise value (firm and transaction value), from which we need to subtract net debt to arrive at equity value.  Divide equity value by diluted shares outstanding to arrive at equity value per share.

Relative valuation (Multiples): The second approach involves determining a comparable peer group – companies that are in the same industry with similar operational, growth, risk, and return on capital characteristics.  Truly identical companies of course do not exist, but you should attempt to find as close to comparable companies as possible. Calculate appropriate industry multiples. Apply the median of these multiples on the relevant operating metric of the target company to arrive at a valuation.  Common multiples are EV/Rev, EV/EBITDA, and P/E.

Lastly, the last valuation method is the comparable transactions, which is the main approach of the method and is used to look at similar transactions where the acquisition target has a similar business model and similar client base to the company being evaluated. This approach is fundamentally different from that of DCF valuation method, which calculates intrinsic value.

3. Walk me through a discounted cash flow (DCF).

A DCF involves first forecasting the free cash flows of the business for a certain period of time, for example five years. After this period of time, we must calculate a terminal value. This represents our estimate of the value at year five of all future cash flows of the business. Finally, we need to turn all these future cash flows into a “present value”. To do this we discount all cash flows at the weighted average cost of capital.

There are 3 essential parts to a DCF:

(1) Company’s Free Cash Flow (FCF)(2) Terminal Value of a Company(3) The Weighted Average Cost of Capital (WACC)

Free Cash Flow = Operating Cash Flow – Capital Expenditures – Change in Net Working CapitalTerminal Value of the Company – two methods: EBITDA Multiple or Perpetuity GrowthWACC – two components: Cost of Equity (CAPM) and the after tax cost of debt

4. Why would a company issue stock vs. debt?

A company issues stock because companies need to raise money. To do this, companies can either borrow it from somebody or raise it by selling part of the company, which is known as issuing stock. A company can borrow by taking a loan from a bank or by issuing bonds. Both methods fit under the process of debt financing.

On the other hand, issuing stock is called equity financing. Issuing stock is advantageous for the company because it does not require the company to pay back the money or make interest payments along the way. All that the shareholders get in return for their money is the hope that the shares will someday be worth more than what they paid for them. The first sale of a stock, which is issued by the private company itself, is called the initial public offering (IPO).

5. Tell me about a merger or acquisition that has recently occurred. What are some possible synergies between the two companies?

Recently, it was announced that Heinz Inc. and Kraft Foods Group would merge. The merger will create the 3rd largest food and beverage company in North America and the 5th largest food and beverage company in the world.

The significant synergy potential in this particular merger includes an estimated $1.5 billion in annual cost savings implemented by the end of 2017. With stock and cash transaction, Kraft shareholders will receive a special cash dividend of $16.50 per share upon closing and stock in the combined company representing a 49% stake in the new company. Berkshire Hathaway and 3G Capital will invest an additional $10 billion in The Kraft Heinz Company; existing Heinz shareholders will collectively own 51% of the new company. Significant synergy opportunities with strong platform for organic growth in North America, as well as global expansion, by combining Kraft’s brands with Heinz’s international platform.

Synergies will come from the increased scale of the new organization, the sharing of best practices and cost reductions. The combination of these iconic food companies joins together two portfolios of beloved brands, including Heinz, Kraft, Oscar Mayer, Ore-Ida and Philadelphia. Together the new company will have eight $1+ billion brands and five brands between $500 million and $1 billion. The complementary nature of the two brand portfolios presents substantial opportunity for synergies, which will result in increased investments in marketing and innovation.

Technical Knowledge – Sales & Trading

6. What information is important when reading stock price quotes on Google Finance or Yahoo Finance? What are some of the metrics you want to pay attention to? Describe what they mean in relations to the company’s stock.

Information that is crucial when looking and reading into a stock price quotes on Google Finance or Yahoo Finance are:

P/E Ratio – The price to earnings ratio reflects the relationship between the price per share and the income earned per share by the company in which the shares are held. A higher P/E points to a more expensive stock, relatively speaking, because an investor pays more per unit of income.

Market Capitalization – Market capitalization estimates the total dollar value of the company who’s stock is being traded. It’s determined by multiplying the total number of shares by the last trade.

52-week range – The 52-week range is practically the same as the day’s range: it’s just the range of prices a stock has sold for over the course of the last year. In a volatile market like we’re in now, the day’s range can actually offer better information than the 52 week range because drops and rallies can make it harder to tell what a realistic range for a given stock looks like.

Volume - A stock’s volume reflects the total number of shares of that stock that have been traded throughout a single day. If a stock is particularly active, it’s worth checking into why: bad news could have lead investors to unload a particular stock, while good news could send every investor looking for a few shares.

Average volume – The average volume over the past three months of a stock is often fairly similar to the stock’s volume over the past day. Knowing the average volume can help you decide when the daily volume is active enough to warrant notice.

Earnings per share (EPS) - Earnings per share is the amount of money that you would have earned if you purchased a share of this stock last quarter and sold it today. Right now, many stocks’ EPS are looking grim: it’s a useful indicator of how a stock will do if you plan to sell it in the short term, but if you’re planning to hold it long-term, the EPS is less of a concern.

Dividend & Yield - If you’re looking to turn a profit on stocks, the dividend and yield are probably the first places you look. The dividend is the payment the company pays to shareholders based on its profits. The yield is the dividend expressed as a percentage of the price per share. And while a high dividend is good, an extremely high yield definitely isn’t: extremely high yields can point to a company in some financial trouble.

7. Pitch me a stock

I recommend Microsoft (MSFT) as the company announced that it was realigning its divisions to focus on services and devices. Microsoft has been shifting its business away from only personal computers to creating a Microsoft eco-system, a computing platform where various devices will access data through the Internet. Microsoft is focused on creating a seamless experience across all end user devices.

Currently Microsoft is trading at $40.29 and is a very solid value stock with a fortress balance sheet and priced accordingly. The stock is on the cusp of a major paradigm shift toward growth. All bets are off in regards to what happens next for the company. I believe Microsoft has substantial upside from here.

Microsoft is outperforming the industry and its peers with regard to profitability. With gross margins slightly better than its peers and on par with the industry average Microsoft is performing well. Moreover, when it comes to net profit margins Microsoft is doing considerably better than its peers and the industry average. This tells me Microsoft is doing a good job of managing overhead and fixed cost.

Microsoft has an enormous amount of firepower. It can move into a new industry and start making profits in short order by acquisition and expansion. Microsoft's strong financial position allows the company to make moves which lead to opportunity for greater profits.

The fact that Microsoft is so formidable regarding to size and strength is both good and bad. With a company of this size, the constant redeployment of personnel and assets can become a money drain if not managed closely. Microsoft will need to stay on track regarding the realignment of operations to be successful.

8. What is high-frequency trading?

High-frequency trading (HFT) is a primary form of algorithmic trading in finance that uses powerful computers to transact a large number of orders at very fast speeds. High-frequency trading uses complex algorithms to analyze multiple markets and execute orders based on market conditions.

Specifically, it is the use of sophisticated technological tools and computer algorithms to rapidly trade securities. As of 2009, HFT accounted for 60-73% of all US equity trading volume, with that number falling to approximately 50% in 2012. High-frequency traders move in and out of short-term positions at high volumes aiming to capture sometimes a fraction of a cent in profit on every trade. High-frequency traders typically compete against other HFTs, rather than long-term investors. HFT firms make up the low margins with incredibly high volumes of trades, frequently numbering in the millions.

9. What is your opinion on Europe’s economy? Do you think there are any solutions to their economic problems?

The European Central Bank's (ECB) quantitative easing (QE) program have created a state of euphoria among global investors, but it will do very little to fix Europe's economic problems. QE is not the way out for Europe's economic woes. The ECB's plan to purchase public-sector bonds in an attempt to bring inflation up to a target and boost Europe's economy is completely misguided. All that it may accomplish is create asset bubbles and new distortions in the real economy.

The euro crisis has had a devastating impact especially on the Eurozone countries which include Greece, Portugal, Ireland, Spain, Italy and Cyprus, producing massive unemployment and increasing substantially the debt-to-GDP ratio, mainly due to the policies that were implemented in the midst of an economic recession as part of the bailout plans.

GDP in Spain, Portugal, Ireland, and Italy is on the average 7 percent below the pre-crisis levels; Greece's GDP is nearly 25 percent below its pre-crisis peak. The official unemployment rates in the peripheral countries are extremely high, indicating that there is no recovery. In Greece, the official unemployment rate is 26 percent while in Spain it is close to 24 percent. In Portugal it is 13.3 percent, in Italy 12.6 percent, and in Ireland (the country with the highest net migration level in Europe) at over 10 percent.

The public debt ratio has also exploded for all of these countries, leaving them in a state of debt bondage and permanent austerity from which they are unlikely to escape any time in the foreseeable future. What Europe's economies need are fiscal policies that can stimulate real growth and generate jobs. Large-scale direct stimulus spending by governments will boost the real economy by increasing aggregate demand and will help to cause wages to rise.

10. What is your opinion on China’s slowing economy? How do you think this would affect China and the United States? Do you think China should take any actions to boost economic activity?

The slowdown of China’s economy is far from over. In the next two to three years, China’s growth performance is almost certain to deteriorate because of the overhang of its real estate bubble and the massive manufacturing overcapacity. The challenge for Beijing is that these problems are all connected with each other and piecemeal solutions no longer work.

China’s real estate bubble is one primary reason. Even with last year’s 4.5% drop in housing prices, the first in two decades, the unraveling of the overbuilt real estate sector has hardly begun. More than 60 million empty apartments await buyers, and the residential housing market is essentially comatose. Meanwhile, the real estate sector accounts for between 25% and 30% of China’s GDP (if upstream and downstream industries such as steel, cement, glass, furniture, and appliances are included), so it is impossible for the Chinese economy to regain momentum without reviving this vital industry.

The only way to breathe life into the real estate sector is to liquidate excess inventory. Housing prices need to fall further to entice buyers. Unfortunately, plunging housing prices will not only hurt affluent Chinese who have poured their fortunes into investment properties, but it will also trigger defaults by overleveraged real estate developers who can no longer service or repay their bank loans. Although a

financial sector meltdown is unlikely because the Chinese state will support the banking system, restructuring of the real estate sector will unavoidably depress short-term growth.

I personally believe that the Chinese economy will not be able to return to a sustainable growth path unless the government aggressively tackles the interconnected mess of a real estate bubble, excess industrial capacity, and financial deleveraging (debt-to-GDP now stands around 250%, the highest rate of any emerging market economy).

Unfortunately, this is not going to happen. These measures, however crucial to long-term growth, will likely cause an outright recession. For a leadership team that is up for reappointment in 2017, China’s government will do just about anything to avoid this.

Extra Technical Questions

11. Talk to me about the U.S. dollar and its recent position in the economy. How does it affect you as a student in New York City throughout everyday life?

The dollar's rise is a direct result of America's strong economy while other parts of the world struggle. The surging value of the U.S. dollar promises new bargains for American consumers and travelers but also presents big threats to the U.S. economy — in a trend that is shaping up to be one of the most unexpected and significant factors driving the global economy this year. Europe is enacting a new stimulus program to revive its economy, and Japan is also in stimulus mode.

Personally, for someone who loves to travel all over the world, the strong surge of the U.S. dollar would greatly benefit me because I can buy more goods internationally because the U.S. dollar is much stronger right now compared to other international currencies. Travelers are familiar with exchange rates and how they can impact the cost of goods. But the strong dollar's impact goes well beyond travel. It affects everything from gas prices at the pump to the profits of America's big businesses that sell things overseas.

12. Give me your outlook on oil.

I predict that the benchmark price for crude oil, which fell from $98 per barrel in December 2013 to $59 in December 2014, will average $61 per barrel at the end of the year and $69 per barrel in December 2016. Just three months ago, the group forecast that oil would spike to $85 per barrel by December 2015.

Traders, investors and companies that consume a lot of energy — think airlines, shipping companies and manufacturers — have to make some assumption about future prices, as do consumers planning to purchase a car that might average 20 miles per gallon, or 30. The safest assumption, however, may be that nobody really knows where oil prices are headed. We may not know what oil will cost in a year, but we don’t have to be surprised by big moves in either direction.