30 Investment Banking Interview Questions You'll Be Asked
What is the formula for enterprise value and how to calculate it?
The formula for enterprise value (EV) is:
EV = market capitalization + debt - cash and cash equivalents
To calculate EV, you would add the current market capitalization of a company (the current stock price multiplied by the number of shares outstanding) to the total debt of the company, and then subtract any cash and cash equivalents that the company has on hand.
For example, if a company has a market capitalization of $100 million, $50 million in debt, and $10 million in cash and cash equivalents, the EV would be:
EV = $100 million + $50 million - $10 million = $140 million
It's worth noting that EV is a more comprehensive measure of a company's value than market capitalization alone, as it takes into account both the equity and debt value of a company.
What is minority interest and why do we add in the enterprise value formula?
Minority interest is the portion of a subsidiary company that is not owned by the parent company. It is included in the enterprise value formula because it represents a financial interest in the subsidiary company that the parent company does not fully control. The inclusion of minority interest in the enterprise value formula is important because it gives a more accurate picture of the total value of the subsidiary company and the parent company's interest in it.
Which will place a higher value on the company, equity comparables (trading comparables) or M&A comparables (transaction comparables ) and why?
The value placed on a company by equity comparables (also known as trading comparables) and M&A comparables (also known as transaction comparables) can vary depending on the specific circumstances of each comparison.
Equity comparables involve comparing a company's valuation to that of similar publicly traded companies. This method of valuation is typically based on financial metrics such as price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, or enterprise value-to-EBITDA (EV/EBITDA) ratio. This method is useful for valuing companies that have similar financial characteristics and operate in the same industry, and it's relatively easy to obtain data on public companies.
M&A comparables, on the other hand, involve comparing a company's valuation to that of other companies that have been involved in a merger or acquisition. This method of valuation is typically based on the price paid for the company in the transaction. This method can be more useful for valuing companies that are not publicly traded, and it takes into account the premium paid for the company in the transaction.
In general, M&A comparables can place a higher value on a company as the transaction comparables take into account strategic value, market conditions, and other non-financial factors that may not be reflected in the trading comparables. However, it's also worth noting that the M&A comparables are based on past transactions and may not be reflective of the current market conditions.
In conclusion, the method of valuation that places a higher value on a company depends on the specific circumstances of the comparison, and both methods have their advantages and disadvantages. It's important to consider both methods when valuing a company.
Suppose a company makes a $10,000 cash purchase of equipment on Dec 31 How does this impact the three statements?
The purchase of equipment for $10,000 cash will impact the three financial statements in the following ways:
Balance Sheet: The cash balance will decrease by $10,000 and the equipment account will increase by $10,000. This results in a decrease in the company's current assets and an increase in its non-current assets.
Income Statement: The purchase will not have any direct impact on the income statement, as it is a non-operating expense. However, if the equipment is expected to generate revenue, this will be reflected in future income statements.
Cash Flow Statement: The purchase will decrease the company's cash balance by $10,000 and this decrease will be reflected in the company's cash flow from investing activities section.
It's important to note that the impact on the financial statements will change depending on the accounting method used for the purchase, for example if it is capitalized and depreciated over time, it will be different.
Explain to me how you would value a company and Which are the most used financial tools in this area?
Valuing a company is the process of determining the current worth of a business. There are several methods that can be used to value a company, and the most appropriate method will depend on the specific circumstances of the company being valued and the purpose of the valuation.
The most commonly used financial tools for valuing a company are:
Discounted Cash Flow (DCF) analysis: This method involves forecasting the future cash flows of a company and discounting them back to their present value. This method is considered to be one of the most accurate ways to value a company, but it also requires a significant amount of forecasting and estimation.
Price-to-Earnings (P/E) ratio: This method compares the current market price of a stock to the company's earnings per share (EPS). This method is widely used and is considered to be a simple and straightforward way to value a company.
Price-to-Book (P/B) ratio: This method compares the current market price of a stock to the company's book value. This method is widely used and is considered to be a simple and straightforward way to value a company.
Enterprise Value-to-EBITDA (EV/EBITDA) ratio: This method compares the enterprise value of a company to its earnings before interest, taxes, depreciation, and amortization (EBITDA). This method is widely used and is considered to be a simple and straightforward way to value a company.
Comparable Transactions Analysis (M&A Comparables): This method involves comparing the company's valuation to that of other companies that have been involved in a merger or acquisition.
Comparable Company Analysis (Equity Comparables): This method involves comparing a company's valuation to that of similar publicly traded companies.
Tell me why cannot we use EV/Earnings or Price/EBITDA as valuation metrics?
EV/Earnings and Price/EBITDA are not considered to be reliable valuation metrics on their own for several reasons:
EV/Earnings does not take into account the level of debt or other liabilities a company has, so it may not accurately reflect the company's true value.
Earnings can be affected by one-time events or accounting adjustments, which can skew the results.
Price/EBITDA also does not take into account a company's debt or other liabilities, and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) can be adjusted or manipulated by management to make the company appear more profitable than it actually is.
Both metrics are based on accounting figures and not on cash flow, which could be a better indicator of the company's ability to generate returns.
It is important to consider these metrics as part of a larger analysis, along with other valuation methods, such as discounted cash flow analysis, comparable company analysis, and precedent transaction analysis, to get a more accurate picture of a company's true value.
Tell me what factors can lead to the dilution of EPS in an acquisition?
Dilution of earnings per share (EPS) can occur when a company acquires another company, and the acquisition results in the issuance of new shares of stock. This can happen in a variety of ways, such as:
Stock-for-stock exchange: In a stock-for-stock exchange, the acquiring company issues new shares of stock to the shareholders of the acquired company. This results in an increase in the number of outstanding shares, which can lead to dilution of EPS.
Cash-and-stock exchange: In a cash-and-stock exchange, the acquiring company issues new shares of stock and also pays cash to the shareholders of the acquired company. This can also result in dilution of EPS.
Financing the acquisition with stock: If the acquiring company uses its own stock to finance the acquisition, the result is an increase in the number of outstanding shares, which can lead to dilution of EPS.
Debt-to-equity conversion: If the acquired company has a significant amount of debt, the acquiring company may convert some of the debt into equity in order to reduce the acquired company's debt load. This can also result in dilution of EPS.
Stock options, warrants, convertible debt: These financial instruments can be issued as a part of the acquisition deal, resulting in dilution of EPS as well.
It's important to note that dilution of EPS is not necessarily a bad thing, as it can be outweighed by other benefits of the acquisition, such as increased revenue, cost savings, and strategic positioning. However, it's important for investors to be aware of the potential dilution of EPS in an acquisition, as it can have an impact on the value of their investment.
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Tell me why we are subtracting cash in the enterprise value formula?
In the enterprise value formula, cash is subtracted from the total value of a company because it represents the amount of money that the company has on hand that can be used to pay off its debts or make acquisitions. In other words, cash is considered to be a "non-operating asset" that is not directly related to the company's core operations.
When valuing a company, it is important to take into account both its operating assets (such as its inventory, equipment, and real estate) as well as its non-operating assets (such as cash and cash equivalents, investments, and other securities). By subtracting cash from the total value of the company, we are able to get a more accurate picture of the company's true operating value.
Another reason why we are subtracting cash in the enterprise value formula is because it represents the company's liquidity. The company can use cash and cash equivalents to pay off any debt it has, so it is a valuable asset that can mitigate the risk of default.
Also, it is important to note that enterprise value is a measure of a company's overall value and it's used to compare companies of different sizes and in different industries. Subtracting cash from the total value of a company allows us to compare companies on a more equal footing, since cash is not necessarily a core part of a company's operations.
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Where do you see yourself after 5 years?
In five years, I hope to have become a successful investment banker. I want to have acquired a deep understanding of the markets and financial instruments, as well as the ability to assess the risk and opportunities of any given situation. I am highly motivated and driven to learn and grow in this sector and I am confident that I can become a trusted adviser and trusted partner to clients. My aim is to build a successful career in investment banking and to help create value for clients and organizations.
Tell me if you have had to make a tough decision. How did you deal with this?
Recently, I had to make a difficult decision in my job. I had to choose between two potential strategies to invest in a certain sector. On the one hand, I could invest in a market with a higher return but also a higher risk. On the other hand, I could focus on a more secure, lower return market. After a lot of deep consideration and analysis, I chose the latter option as it provided a more stable investment. I was comfortable with this decision as I knew it would provide the best returns for my clients in the long run. It was a tough decision to make, but I'm satisfied with the outcome.
Name a time you have been entrepreneurial. What did you learn from this?
Entrepreneurial spirit is the drive to create and build something new, either to solve a problem or to make an impact. I have been inspired by this spirit and I have learned to be creative, driven and resourceful. I have learned that the most successful entrepreneurs are willing to take risks, be flexible and adapt to changes in the market. They are able to think outside the box, be open to new opportunities and develop innovative solutions. This has taught me the importance of being creative and open to new ideas, even if they may be outside of my comfort zone.
Tell me what is a common ratio used in project finance and how do you calculate it?
The common ratio, also known as the coverage ratio, is a financial metric used in project finance to measure a project's ability to meet its debt service obligations. It is calculated by dividing the cash flow available for debt service by the total debt service.
A higher common ratio indicates a stronger ability to meet debt service obligations and is considered more favorable. A ratio of 1.0 or higher is generally considered acceptable for project finance.
The formula for calculating the common ratio is:
Common ratio = (Cash flow available for debt service) / (Total debt service)
The cash flow available for debt service is the cash flow generated by the project after operating expenses, taxes, and other non-debt-service related payments have been made. The total debt service is the total amount of debt payments, including interest and principal, that must be made during the period being considered.
The common ratio is an important metric used by lenders and investors to assess the creditworthiness of a project and the likelihood that the project will be able to generate enough cash flow to meet its debt service obligations.
It's important to note that the common ratio is one of many factors that lenders and investors consider when evaluating a project's creditworthiness. Other factors include the project's revenue and cost structure, the creditworthiness of the project sponsors, and the overall market conditions.
Why is the DSCR (debt-service coverage ratio) used and what range do you expect it to be in?
The DSCR (debt-service coverage ratio) is used to measure a company's ability to generate enough cash flow to cover its debt payments. It is calculated by dividing the company's net operating income by its total debt payments. The DSCR is used by lenders and investors as a measure of a company's creditworthiness and ability to meet its debt obligations.
A DSCR of 1.0 or higher is generally considered to be healthy, as it indicates that the company's cash flow is sufficient to cover its debt payments. A DSCR below 1.0 indicates that the company's cash flow is not sufficient to cover its debt payments, which is a sign of financial distress. However, Lenders may require a higher DSCR for a company as collateral for the loan or to have a better creditworthiness.
A DSCR range of 1.1 to 1.5 is typically considered to be a healthy range for most companies. This means that the company has a margin of safety and is able to generate enough cash flow to cover its debt payments, as well as have some extra cash to cover unexpected events.
It's important to keep in mind that the DSCR is a historical ratio, meaning that it reflects the company's past performance and it is not a guarantee of future performance. Other factors such as interest rates, the company's ability to generate cash flow and its industry should also be taken into account when evaluating a company's creditworthiness.
What is the credit rating for a high-yield bond?
A high-yield bond, also known as a "junk bond," is a type of bond that is issued by companies or entities that have a lower credit rating than investment-grade companies. The credit rating for a high-yield bond is typically below "BBB-" by the major credit rating agencies such as Standard & Poor's, Fitch Ratings and Moody's. These agencies assign credit ratings to bonds based on the issuer's ability to repay the bond's principal and interest. A lower credit rating indicates that the issuer is considered to be a higher credit risk, and therefore the bond pays a higher yield to compensate investors for the added risk.
It's important to note that credit ratings are not guarantees of a bond's performance and can change over time as the issuer's creditworthiness changes. High-yield bonds carry a higher level of risk than investment-grade bonds and are considered to be speculative investments. As a result, they are typically considered to be more suitable for investors who are willing to accept a higher level of risk in exchange for the potential for higher returns.
Why do we use a project finance structure as opposed to corporate finance?
Project finance is a structure that is used to finance large, capital-intensive projects, such as infrastructure, power plants, and mining operations. It is used as an alternative to traditional corporate finance because it offers several advantages:
Asset-based financing: Project finance is based on the assets of the project, rather than the creditworthiness of the company. This allows companies with limited credit history or high levels of debt to access financing for their projects.
Limited recourse: Project finance typically involves limited recourse or non-recourse debt. This means that the lender's claims are limited to the assets of the project, and not the assets of the parent company. This reduces the risk for the lender and makes it more willing to provide financing.
Separation of risks: Project finance allows the project sponsors to separate the risks associated with the project from the risks associated with the company. This allows the project sponsors to manage and mitigate the risks more effectively.
Tax benefits: Project finance structures can offer tax benefits to the project sponsors, such as accelerated depreciation, which can help to improve the project's cash flow.
Specialized nature of the projects: Project finance structure is used for the financing of specialized projects that are not part of the company's core business operations, and therefore it is more suitable for them.
Overall, project finance structure allows companies to access financing for large, capital-intensive projects in a way that is more flexible and less risky than traditional corporate finance.
What is the delta of an option when it is at the money?
The delta of an option is a measure of how much the price of the option will change in relation to a change in the price of the underlying asset. It is typically expressed as a decimal value between 0 and 1 for call options and -1 and 0 for put options.
When an option is "at the money," it means that the current price of the underlying asset is equal to the strike price of the option. At this point, the option has a delta of approximately 0.5 for call options and -0.5 for put options. This is because the option has no intrinsic value, so the delta is equal to the probability that the option will be in the money at expiration.
It's important to note that delta is not a constant value and it can change as the underlying asset price and the time to expiration change. As the underlying asset price moves further away from the strike price, the delta will move closer to 1 for call options and -1 for put options. As the expiration date approaches, the delta will decrease.
It's also worth mentioning that the delta of an option is also known as the option's sensitivity to the underlying asset price changes, and it is used to measure the risk of an option position. Knowing the delta of an option can help traders and investors to adjust their positions and plan their risk management strategy.
Explain to me what will happen to the price of the option if there is an increase in interest rates?
An increase in interest rates can have an impact on the price of options, depending on the type of option and the underlying asset. In general, an increase in interest rates will tend to decrease the value of options.
For call options, an increase in interest rates will decrease the value of the option because it will decrease the present value of the underlying asset. Higher interest rates increase the cost of borrowing and reduce the present value of future cash flows, making the underlying asset less valuable. This decrease in value will lead to a decrease in the price of the call option.
For put options, an increase in interest rates will also decrease the value of the option because it will decrease the present value of the underlying asset. Higher interest rates increase the returns on bonds and other fixed-income investments, making the underlying asset less attractive to investors. This decrease in demand will lead to a decrease in the price of the put option.
For options on bonds, interest rate increase will lead to decrease in bond price, thus decreasing the option price as well.
For options on stocks, the relationship is more complex because stocks also pay dividends and have different volatility. However, generally speaking, an increase in interest rates will decrease the price of options on stocks, due to the decrease in the present value of the underlying asset.
It is important to note that the above explanation is a general one and the impact on the option price can vary depending on various factors such as volatility, strike price, expiration date, etc. It is also important to note that the interest rate increase could lead to decrease in the volatility of the underlying asset which could also impact the option price.
What is the price of an option if the volatility tends towards infinity And what if the expiry date tends towards infinity?
The price of an option is determined by several factors, including the price of the underlying asset, the strike price of the option, the time to expiration, the risk-free interest rate, and the volatility of the underlying asset.
If the volatility tends towards infinity, the price of the option will also tend towards infinity. This is because volatility is a measure of the amount of uncertainty surrounding the price of the underlying asset, and as volatility increases, the potential range of prices for the underlying asset also increases. This creates more uncertainty and risk, which results in higher option prices.
If the expiry date tends towards infinity, the price of the option will tend towards the intrinsic value of the option. Intrinsic value is the difference between the underlying asset's current price and the strike price of the option, for in-the-money options. It will tend towards zero for at-the-money options and out-of-the-money options. As expiration date goes to infinity, the time value component of the option price, which is the difference between the intrinsic value and the option price, will decrease and eventually reach zero.
It's important to note that these scenarios are theoretical, as in the real world, volatility and expiry date are finite. The value of an option will be influenced by the factors mentioned before, and the actual prices can be estimated using option pricing models such as Black-Scholes or Binomial option pricing model.
How would you value a company?
Valuing a company can be a complex process, as it involves estimating the company's future cash flows and discounting them to their present value. There are several methods that can be used to value a company, including:
Discounted Cash Flow (DCF) analysis: This is a widely used method that involves estimating the company's future cash flows and discounting them to their present value using a discount rate. This method allows for the estimation of the intrinsic value of the company.
Comparable company analysis: This method involves comparing the company being valued to similar publicly traded companies, and using their financial metrics (such as P/E ratio, EV/EBITDA, etc.) to estimate the value of the company being valued.
Precedent transaction analysis: This method involves looking at the prices at which similar companies have been sold in the past, and using that information to estimate the value of the company being valued.
Dividend Discount Model: This method is used to value the company by estimating the future dividends to be received by the shareholders and discounting them to their present value.
Book Value: This method is based on the company's assets and liabilities, and it calculates the value of the company as the difference between its assets and liabilities.
P/E Ratio: This method is based on the company's earnings and compares it to the current market price of the stock.
Ultimately, the choice of method will depend on the specific circumstances of the company being valued, and it's important to take into account the advantages and disadvantages of each method when deciding which one to use. Additionally, the choice of the method should be supported by the data available and the purpose of the valuation.
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How far do you see yourself going in the investment bank?
I see myself growing within the investment bank and having the opportunity to work on larger and more complex projects. My goal is to become a leader in the field and help to shape the future of the investment banking industry. As I progress, I intend to build a robust network of contacts and use my knowledge and experience to make a meaningful impact on the industry. I am also committed to staying abreast of the latest developments in the investment banking industry and using my expertise to add value to the organization.
What are the price options?
The price of an option is the amount that an investor must pay to purchase the option contract. It is also known as the option premium. The price of an option is determined by a number of factors, including the price of the underlying asset, the strike price of the option, the time to expiration, the risk-free interest rate, and the volatility of the underlying asset.
There are two types of options: call options and put options. A call option gives the holder the right, but not the obligation, to buy an underlying asset at a specified price (strike price) on or before a specified date (expiration date). A put option gives the holder the right, but not the obligation, to sell an underlying asset at a specified price on or before a specified date.
Options are typically priced using option pricing models such as Black-Scholes or Binomial option pricing models. These models take into account the factors that affect the price of an option and estimate the price of the option based on the current market conditions. It's important to note that the price of options is not fixed and can change as the underlying asset's price and the time to expiration changes.
Options trading can be used for various investment strategies like hedging, speculation, or income generation. Understanding the pricing of options is important for any investor or trader who wants to use options in their investment strategy.
If our client wants to invest $100 Million, how will you invest and what will your strategy be ?
If a client has a $100 million to invest, my strategy would be to first understand their investment objectives and risk profile. Based on this data, I would recommend an investment portfolio composed of a variety of asset classes, such as stocks, bonds, mutual funds, and alternative investments. I would also recommend diversifying the portfolio geographically to reduce risk while still allowing the client to capitalize on potential returns. In terms of a more specific investment strategy, I would recommend an active strategy, where I would actively monitor the markets, adjust the portfolio as needed, and take advantage of short-term opportunities. Additionally, I would recommend regular rebalancing to ensure that the portfolio remains in line with the client's risk profile and investment objectives.
What are your current views on the Indian economy for investing?
The Indian economy is currently in a period of growth and development, with a growing population and expanding middle class. It is expected that India's GDP will grow by 8.7% in 2021, making it one of the fastest growing economies in the world. The government has also introduced a number of reforms to improve the ease of doing business and attract more foreign investment. This has resulted in strong foreign direct investment inflows, which have contributed to the growth of the Indian economy. Additionally, the Indian rupee has remained relatively stable despite a global slowdown, making it an attractive investment destination for foreign investors. Furthermore, the Indian stock market is well regulated and highly transparent, making it an ideal choice for long-term investing.