2. Updated WSO Technical Guide

2. Updated WSO Technical Guide - Buyer Gena...

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Unformatted text preview: Buyer: Gena Jiang ([email protected]) Transaction ID: 83G76986JA281445G Technical Interview Guide Preparation for Finance Interviews Second Edition Copyright 2009 by WallStreetOasis.com. All rights reserved. All information in this guide is subject to change without notice. WallStreetOasis.com makes no claims as to the accuracy and reliability of this guide and the information contained within. No part of this guide may be reproduced or transmitted in any form or by any means, electronic or mechanical, for any purpose, without the express written permission of WallStreetOasis.com Page 1 Buyer: Gena Jiang ([email protected]) Transaction ID: 83G76986JA281445G Contents Technical Questions: Introduction ..................................................................................................................................................... 3 General Topics of Study ..................................................................................................................................................................... 5 Keeping Current is Key! ................................................................................................................................................................. 5 Financial Report Basics .................................................................................................................................................................. 6 Current Event Related ........................................................................................................................................................................ 7 Accounting, Finance and Valuation .................................................................................................................................................. 10 Basic ............................................................................................................................................................................................ 10 Intermediate ................................................................................................................................................................................. 23 Advanced ..................................................................................................................................................................................... 30 Stocks .............................................................................................................................................................................................. 31 Basic ............................................................................................................................................................................................ 31 Intermediate ................................................................................................................................................................................. 34 Advanced......................................................................................................................................................................................... 39 Bonds and Interest Rates .................................................................................................................................................................. 40 Basic ............................................................................................................................................................................................ 40 Intermediate ................................................................................................................................................................................. 46 Advanced......................................................................................................................................................................................... 51 Currencies........................................................................................................................................................................................ 53 Basic ............................................................................................................................................................................................ 53 Intermediate ................................................................................................................................................................................. 54 Advanced ..................................................................................................................................................................................... 55 Options and Derivatives ................................................................................................................................................................... 56 Basic ............................................................................................................................................................................................ 56 Intermediate ................................................................................................................................................................................. 59 Advanced ..................................................................................................................................................................................... 61 Mergers and Acquisitions ................................................................................................................................................................. 63 Basic ............................................................................................................................................................................................ 63 Intermediate ................................................................................................................................................................................. 65 Advanced ..................................................................................................................................................................................... 67 Other ............................................................................................................................................................................................... 73 Brainteasers ..................................................................................................................................................................................... 75 Income Statement Basics.................................................................................................................................................................. 78 Balance Sheet Basics........................................................................................................................................................................ 79 Cash Flow Basics ............................................................................................................................................................................. 80 Link Between Financial Statements .................................................................................................................................................. 81 Page 2 Buyer: Gena Jiang ([email protected]) Transaction ID: 83G76986JA281445G Technical Questions: Introduction Technical questions are part of almost every finance interview. While the level of difficulty of these questions vary from firm to firm, and will change based on a candidates background, all interviewees will undoubtedly be quizzed on technical questions in at least one round. This guide is a fairly exhaustive compilation of the most common technical questions in finance interviews. Obviously, you will not encounter every question, however, the interview may also contain variations or new questions altogether. The more detailed and accurate responses you give, the more likely you will impress your interviewer. The questions in this guide are broken down into the following categories: Current Events, Accounting / Finance / Valuation, Stocks, Bonds / Interest Rates, Currencies, Options / Derivatives, and Mergers & Acquisitions. These categories are then divided into basic, intermediate and advanced concepts. The questions you are most likely to be asked are in bold. Obviously, you should focus your studies on the relevant industry you are trying to enter. If you are preparing for a Sales and Trading interview, you should focus on stocks, bonds/interest rates, currencies, and options/derivatives. For Investment Banking positions you should have a general background in all of those categories, but you are more likely to encounter questions from the Accounting/Finance/Valuation and the Mergers and Acquisitions section. The final category is the brainteasers section. Getting brainteasers can definitely rattle you in an interview. In some cases, an interviewer will give a brain teaser to see how you react under pressure. What is more important than actually getting the answer to the teaser correct is the way you think through the problems -- they want to observe your analytical ability. See the examples for more information. You will soon find out that interviews are a game. Your interviewer will likely push you to see how far you can go until you don’t know an answer -- and that’s a good thing. You can have a 4.0 with a double major in finance and econ from Wharton, but you still know little compared to the person on the other side of the table. Remember when studying these questions, you cannot prepare for everything that interviewers may ask. They will always be coming up with new questions and new twists on older concepts so it is important that you try and understand the concepts behind the answers, rather than just memorizing them. If you come to a question you do not understand, try to do some research and develop a deeper understanding. The explanations in this guide are intentionally kept brief. Your answers to most of these questions should not take more than 30 seconds to a minute. Answer the question and move on. Do not try and guess your way through technical questions. If you do not know the answer, do not waste your interviewer’s time and just say that you don’t know -- but also do not apologize. Ask them if they can explain it to you. Be confident in what you know and don’t know. What is most important is that you prove you have the ability to learn on the job. If you get into questions from the advanced section of this guide, chances are that your interviewer is trying to push you to see how you respond to pressure. The key is to remain calm, cool and collected. Finally, in most cases you cannot eliminate yourself from contention by failing to answer a technical question. However, you can definitely hurt your chances by answering a fit or behavioral question in an Page 3 Buyer: Gena Jiang ([email protected]) Transaction ID: 83G76986JA281445G undesirable manner. Most of the time truly connecting with your interviewer on a personal level and showing you have the drive, passion and ability to learn in this crazy business can outweigh a misstep on a technical question (just don't stumble too much!) Note: The first few bullets of each question include any pertinent definitions and information about the question. The bullet in italics is a sample response and common follow-up questions are also included in subsequent bullets. Page 4 Buyer: Gena Jiang ([email protected]) Transaction ID: 83G76986JA281445G General Topics of Study Keeping Current is Key! In the technical portion of an interview, you may encounter questions about current events and the markets in addition to the more standard questions that are listed below. Answering these types of questions to demonstrate your interest in current events and the industry is a key to your success in an interview. While perfecting the answers to the standard technical questions may show your interviewer that you have done your homework, your responses to the current event questions can often shed more light on your ability to think on your feet and express a coherent opinion. Answering these types of questions without some sort of background on the topic is almost impossible. Your interviewer will likely have a thorough understanding of the topic they are asking you about, and will immediately be able to tell if you try to answer off the cuff. The only way to succeed is to actually know what is going on. Your interviewer isn’t going to grill you on some obscure article from the 18th page of the Financial Times from three weeks ago, but you very well may be asked about yesterday’s lead story in the Wall Street Journal, especially if it is in any way related to the firm you are interviewing with. So to prepare, read the headlines of the Wall Street Journal, Financial Times and glance at the online version of The Economist every week. You should give yourself about 30 minutes to an hour of time to prepare every day if you really want to absorb the latest financial news. Holding an intelligent conversation about the latest current events is a fairly easy way to demonstrate your passion for the industry and impress your interviewer. Page 5 Buyer: Gena Jiang ([email protected]) Transaction ID: 83G76986JA281445G Financial Reporting Reporting Basics Throughout this guide, we refer to 10-K’s and 10-Q’s… but what are they? These are financial statements required to be filed with the Securities and Exchange Commission for any publicly traded company in the United States. These documents must follow specific standards and are available for any person to see at any time. The most common documents are 10-Ks (annual reports) and 10-Qs (quarterly reports), but documentation is required essentially any time a public company has a significant financial event. 10-K: The 10-K includes a written synopsis of the company’s strategy and results for a given fiscal year. It includes a letter to shareholders, management information and compensation, management discussions and an auditor’s statement. It also includes detailed financial statements for the fiscal year, including a Balance Sheet, Income Statement and Cash Flow Statement*. The 10-K also includes a notes section that explains to investors any adjustments made to financial statements in previous reports. It will also include a financial highlights section that is a rather simplified and unregulated summary of the firm’s financial performance. 10-Q: The 10-Q is a boiled down 10-K and must be filed by public companies for each fiscal quarter. The 10-Q is focused mainly on financial statements and includes very little narrative information. Proxy Statement: A proxy statement is a document that a company is required to file when soliciting shareholder votes. These statements are filed with the SEC. A proxy includes information on voting procedures, background information about the company’s nominated board of directors, the company’s board of directors’ and executive compensation, and a breakdown of all fees paid to the auditor. These reports can be found in numerous locations including sec.gov, the firm’s own website, Yahoo! Finance, or a database like CapitalIQ.. * For more information on the three main financial statements, see the “Statement Basics” section at the end of this guide. Page 6 Buyer: Gena Jiang ([email protected]) Transaction ID: 83G76986JA281445G Current Event Related Can you explain what happened with the mortgage crisis? Over the past few years, the mortgage market in America has created a financial crisis the likes of which we have not seen since the great depression. This is a brief overview of how the crisis occurred. Interest rates were very low, and lenders were allowing people to borrow large amounts of money with relatively low credit ratings by historic standards. These borrowers who had less than stellar credit ratings are often referred to as “subprime” borrowers, and these individuals were taking out loans that they really could not afford. Loans were granted with “teaser rates”, no down payment, and no review of a borrower’s income history. Many of these mortgages were adjustable rate mortgages, which meant they would begin with an affordable payment, but down the line, the rate would increase. Because of these loans, the demand for houses increased dramatically and home values skyrocketed from 2000 to 2005, creating a massive housing bubble. In 2006, that bubble burst, and total home equity dropped from $13 trillion to $8.8 trillion. By January 2009, 20% of the homes in the United States were “underwater” meaning the owner owed more on their mortgage than their home was worth. Compounding the problem was the fact that banks making these loans would simply sell off the future mortgage payments to other banks. These other banks would often repackage them and sell them as Mortgage Backed Securities. A mortgage backed security is explained in more depth in the “what is a mortgage backed security question” below. The combination of these factors led to a vicious cycle which was largely the catalyst of the recession we are in today. Below is a chart showing the cycle, with a short description below it. Page 7 Buyer: Gena Jiang ([email protected]) Transaction ID: 83G76986JA281445G As housing prices declined, due to the bursting of the bubble and lower demand, more and more homeowners found themselves “underwater” with negative equity in their homes. They owed more money on their mortgage than their home was actually worth. Because of this, homeowners did not have an incentive to continue paying their mortgages, so many simply walked away from their homes. When a homeowner is foreclosed upon or decides to walk away they stop paying their mortgage payments. Since the mortgages were packaged into mortgage-backed securities, the value of these MBS securities declined precipitously. Banks had many of these MBS on their balance sheets as assets, and when they declined in value they had to be written down, causing the bank to take a loss. As the bank’s capital and asset base declined, they were required to restrict lending in order to meet reserve requirements and preserve liquidity. As the banks restricted lending, economic activity slowed, unemployment increased and the demand for houses continued to wane. Because the supply of houses increased, housing prices continued their decline further, and the cycle started all over again. What is a Mortgage Backed Security? A mortgage-backed security is a class of asset-backed security whose cash flows are secured by a package of mortgages. They will pay periodic payments that are very similar to coupon payments from bonds. The MBS market essentially allowed the investment community to lend money to homeowners, with banks acting as the middlemen. An investor pays to purchase an MBS, and is paid back over time with the mortgage payments from the homeowners. Many MBS were rated AAA because they were considered highly diversified, and it was thought that the housing market would not collapse across the board. Unfortunately, we now know that housing values were highly correlated and the AAA rating has proven to be optimistic at best. A mortgage-backed security is a security that pays its holder a periodic payment based on the cash flows from the underlying mortgages that fund the security. What is a Collateralized Debt Obligation (CDO)? A CDO is the broad asset class in which a number of interest paying assets are packaged together (securitized) and sold in the form of bonds. An investor pays the market value for the CDO, and then has the rights to the interest payments in the form of coupon payments over time. A Collat...
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