Investment Banking

Interview Course
Technical & Fit Questions
 Course Roadmap
1. Course Introduction & Overview 4

2a. Accounting – Concepts 9

2b. Accounting – Practice Questions 39

3a. Valuation – Concepts 47

3b. Valuation – Practice Questions 79

4a. DCF – Concepts 88

4b. DCF – Practice Questions 125

5a. LBO – Concepts 134

5b. LBO – Practice Questions 169

6a. Mergers & Acquisitions – Concepts 178

6b. Mergers & Acquisitions – Practice Questions 205

7a. Other Common Technical Questions - Stocks 214

7b. Other Common Technical Questions - Bonds, Loans And Interest Rates 227
 Course Roadmap (Cont.)
7c. Other Common Technical Questions - Currencies 247

7d. Other Common Technical Questions - Options and Derivatives 252

8a. Behavioral Interview - Concepts 261

8b. Behavioral Interview – Guaranteed Questions 271

8c. Behavioral Interview – Industry Questions 274

8d. Behavioral Interview – Personal Questions 285

8e. Behavioral Interview – Situational Questions 309

8f. Behavioral Interview – Tricky Questions 325

8g. Behavioral Interview – Other Questions 332

8h. Behavioral Interview – Your Questions 338

9a. Bonus Module - Investment Banking or S&T 343

9b. Bonus Module - International Student Recruiting Strategies 348

9c. Bonus Module - Essential Interviewing & Networking Strategies 353

9d. Investment Banking Internship Survival 357

Course Introduction & Overview
 Course Introduction

Steven Tessler Course Background

Chief Instructor
• Taught and vetted by actual industry professionals
• Leverages the largest interview database in the
• Investor at MidOcean Partners
industry, with over 30,000 submissions from members
• Investment Banking at Credit Suisse of the WSO community
• Each course is beta-tested
• Course content is continuously reviewed and updated

Patrick Curtis Course Objectives

CEO & Founder – WSO
• Learn the concepts behind commonly asked Investment
Banking interview technical questions
• Founder & CEO of Wall Street Oasis (aka Chief
Monkey) • Apply this knowledge by reviewing the sample practice
questions in this course as well as WSO’s extensive
• Past:
bank of interview questions
• Investor at Tailwind Capital
• Investment Banking at Rothschild
• MBA: The Wharton School; BA: Williams College

Course Introduction & Overview 5

 How Is This Course Structured?

• Core Concepts – The course is broken down into 6 Core Concepts: Accounting, Valuation, DCF, LBO,
M&A, and Behavioral. For the 5 technical Core Concepts (Accounting, Valuation, DCF, M&A, LBO),
each section includes an overview of the theory and mechanics behind the concept (understanding the
“why” behind the interview questions)

• For further learning and/or practice on the theoretical concepts, consider taking advantage of the
additional courses referenced on the following slide

• Practice Questions – Each of the 6 Core Concepts includes a sample set of practice questions to test
your knowledge of the concepts and better prepare for interview scenarios

• Flashcard Module – This course has a flashcard module to help users drill the concepts fast. This
module is constantly evolving and adds/filters new interview questions as they are submitted by
members of the WSO community

Course Introduction & Overview 6

 Additional Courses to Consider

Elite Modeling Package Foundations Package

Course Introduction & Overview 7

 How To Use This Course Based On Timelines

Less than 24 hours:

• Familiar with Core Concepts: Review sample Practice Questions and Flashcard Module, focusing
on concepts you feel weakest in

• Unfamiliar with Core Concepts: Review Concepts and Basic Practice Questions for each Concept

1-2 Weeks:

• Spend 1-2 days on each Core Concept (depending on the level of comfort), starting with the
conceptual teaching before moving to Practice Questions (both Basic and
Intermediate/Advanced) and the Flashcard Module

• Prior to the interview, quickly review all concepts and brush up on any weak points

>1 Month:

• Plan to spend 1 or more weeks with each concept, starting with the conceptual teaching

• Review all Practice Questions and the Flashcard Module; try to get comfortable with the
Intermediate/Advanced level questions

• Leverage additional WSO courses for further conceptual learning

Course Introduction & Overview 8

Accounting – Concepts
 What is Accounting and Why Does it Matter?

• Language of business and finance and a set of rules/standards for tracking a firm’s financial
performance

• Who uses accounting information?

Equity Investors
Firms Employees
(Current and Potential)

Credit Investors
Government and Regulators Other Stakeholders
(Current and Potential)

Accounting - Concepts 10
 Understanding The Fundamental Accounting Equation and Debits and Credits

• Assets = Liabilities + Shareholder’s Equity is the fundamental accounting equation & always holds true

Assets = Liabilities + Equity

Assets Liabilities + Equity

Debits Debits

Credits Credits

Accounting - Concepts 11
 Understanding The Fundamental Accounting Equation and Debits and Credits

• Ex. 1 – Purchase Equipment for $50 in Cash • Ex. 2 – Borrow $100 in the form of a Bank Loan
and Receive $100 in Cash

Assets Liabilities + Equity Assets Liabilities + Equity

Equipment $50 (Debit) Cash $100 (Debit) Bank Loan $100 (Credit)

Cash $50 (Credit)

Accounting - Concepts 12
 Understanding The Fundamental Accounting Equation and Debits and Credits

• The Income Statement can be thought of as part of the Shareholder’s Equity

• Shareholder’s Equity is simplistically composed of Common Stock and Retained Earnings
• Common stock and other equity instruments are essentially the amounts that the owners have invested into the
business

• Retained earnings = sum of all prior net incomes of the business - sum of all prior dividends

Shareholder’s Equity

Retained Earnings

Net Income Dividends

Credits (Revenues, Gains, etc.)

Debits (Expenses, Losses, etc.)

Accounting - Concepts 13
 Summary of Debits and Credits

Item ↑ Increases ↓ Decreases

Assets Debits Credits

Liabilities Credits Debits

Equity Credits Debits

Revenue Credits Debits

Expenses Debits Credits

Accounting - Concepts 14
 What is the Income Statement?

• The income statement is a financial report

that depicts the operating performance of
a company (i.e., revenues less expenses
generated – i.e., profitability) over a
specific period of time (typically a quarter
or year)

• The income statement facilitates the

analysis of a company’s growth prospects,
cost structure, and profitability

• Analysts can use the income statement to

identify the components and sources of
net earnings

Accounting - Concepts 15
 What are the Income Statement Operating Items?

Item Description
Total value of goods and services that are credited to an income statement over a particular time
Revenue
period.
The cost of Goods sold represents a company's direct cost to manufacture (for manufacturers) or
Cost of Goods Sold (COGS)
procurement (for merchandisers) of a good or service that the company sells to generate revenue.
Gross Profit Revenue – Cost of Goods Sold
Selling, General & Operating costs not directly associated with the production or procurement of the product or
Administrative Expenses service that the company sells to generate revenue. Payroll, wages, commissions, meal and travel
(SG&A) expenses, stationary, advertising, and marketing expenses fall under this line item.
Research & Development
A company's activities that are directed at developing new products or procedures.
(R&D)
Other Operating Expenses /
Any operating expenses not allocated to COGS, SG&A, R&D, D&A.
Income
Earnings before interest, taxes, depreciation & amortization: Gross Profit – SG&A – R&D – Other
EBITDA
Operating Expenses. EBITDA is a popular measure of a company's financial performance.
Depreciation & Amortization The allocation of cost over a fixed asset's useful life in order to match the timing of the cost of the
(D&A) asset with when it is expected to generate revenue benefits.
EBIT Earnings before interest & taxes: EBITDA – D&A.

Accounting - Concepts 16
 What are the Income Statement Non-Operating Items?

Item Description
EBIT Earnings before interest & taxes: EBITDA – D&A
Interest expense is the amount the company has to pay on debt owed. This could be to bondholders
Interest Expense
or to banks.
Interest Income A company’s income from its cash holdings and investments (stocks, bonds, and savings accounts).
Items peripheral to core operations. Includes gains / losses on investments and revaluation of certain
Non-operating items
financial assets and debt obligations.
EBT Earnings before taxes: EBIT – Net Interest Expense – Other Non operating items
Income Tax Expense The tax liability a company reports on the income statement.
Net Income EBT – Taxes
Basic earnings per share (EPS) Net income / Basic Weighted Average Shares Outstanding
Diluted EPS Net income / Diluted Weighted Average Shares Outstanding

Accounting - Concepts 17
 Income Statement Operations Summary and Rules of Thumb

• The income statement is a summary of a company’s profitability over a certain period of time
• Items that appear on the income statement must correspond to the period shown on the income statement only and
must affect the company’s taxes (e.g., paying salaries reduces a company’s taxable income, but money spent on capital
expenditures does NOT reduce taxable income)

• Revenues are recognized when an economic exchange occurs (risks and rewards are transferred), and expenses
associated with a product are matched during the same period as revenue generated from that product (matching
principle)

• Costs are bucketed into whether they are directly tied to the production/offering of a good/service or general business
expenses

• Profitability is the difference between revenues and expenses generated by a company’s activities
• Special attention must be paid to distinguish operating expenses (stemming from core activities) from non-operating
costs (arising from peripheral transactions) in arriving at a company’s operating income

• Both Operating Income and Net income are important indicators of a company’s financial performance
• Analysts focus on EPS, EBIT, and EBITDA as measures of a company’s profitability

Accounting - Concepts 18
 Coffee Shop Example

Toffee Coffee records the following transactions for the month of November. Build the Income Statement up to
Operating Income.

1. TC sells $1,000 worth of coffee in November, receiving half Income Statement

of it in cash
2. TC sells $2,000 worth of toffee in November, receiving 75% Revenue $3,000)
of it in cash
3. TC collected $1,000 of A/R in November
(-) Cost of Goods Sold ($750)
4. The raw ingredients to produce the coffee sold costs $500 = Gross Profit $2,250)
5. TC purchased raw ingredients to produce toffee for $500,
with half being used to sell toffee in November and the (-) SG&A ($850)
remainder being held for December
6. TC paid its cashiers $500 for November's work (-) Research & Development Expense ($250)
7. TC spent $250 researching and developing a new premium
blend of coffee that has yet to go into production = Operating Income $1,150)
8. TC spent $100 on Facebook advertising during November
9. TC prepurchased $250 worth of ingredients for its
December coffee production run
10. TC paid $250 for November's rent expense

Accounting - Concepts 19
 Fiona’s Foliage Example

Fiona's Foliage records the following transactions for the fiscal year 2022. Build the Income Statement down to Net
Income and EPS. Separately calculate the company's EBITDA.

1. On January 1, 2022, Fiona incorporates her new plant and flower shop business, Fiona's Foliage. The business is funded with
$10,000 of her own cash by issuing herself 10,000 shares and a two-year $5,000 bank loan which carries a 5% interest rate.
2. Fiona purchases $3,000 worth of plants, pots, and wrapping paper, enough to produce 300 products for sale.
3. Fiona signs a rental agreement that costs $200 per month. Approximately 25% of the store will be used to produce the finished
potted plants, whereas the remainder will be the storefront for sales and operating the business.
4. Fiona buys a potting machine that costs $2,000 and is expected to last 2 years, with no residual value.
5. Fiona buys a cash register that costs $150 and is expected to last 5 years, with no residual value.
6. Fiona operates the business for the first year and sells all 300 plants at an average price of $50. All were cash sales except for 100 of
these plants, which were sold to wholesalers who pay half in cash and the remaining on February 1, 2023.
7. Fiona hires her brother, Jon, to operate the potting machine and create the finished products for sale. She paid him $5,000 for the
year.
8. Fiona hires a part-time student, Michael, to support the storefront, operating the cash register and answering customer questions.
She paid him $2,500 for the year.
9. Fiona purchases 50 rare flowers for $5,000 and runs a promotion, Fiona's Flower Frenzy, to sell them. The marketing promotion
costs $1,000. The inventory sold out within minutes at an average sales price of $250 per flower.
10. Fiona wins a legal dispute with a competing flower shop venue for trademark infringement. Fiona's Foliage is awarded $2,000.
11. The company pays a corporate tax rate of 30%.

Accounting - Concepts 20
 Fiona’s Foliage Example (Cont’d)

Fiona's Foliage records the following transactions for the fiscal year 2022. Build the Income Statement down to Net
Income and EPS. Separately calculate the company's EBITDA.

Income Statement EPS

Revenue $27,500) Net Income $6,524

(-) Cost of Goods Sold ($14,600) Weighted Average Shares Outstanding 10,000

= Gross Profit $12,900) Earnings Per Share $0.65

(-) SG&A ($5,330)

(-) Other Operating Expenses $2,000) EBITDA

= Operating Income (EBIT) $9,570) Operating Income (EBIT) $9,570

(-) Interest Expense ($250) (+) Depreciation Expense $1,030

= Profit Before Tax $9,320) EBITDA $10,600

(-) Tax Expense ($2,796)

= Net Income $6,524)

Accounting - Concepts 21
 Introduction to the Balance Sheet

Assets = Liabilities + Equity

• The balance sheet reports the company’s

resources (assets) and how those resources
were funded (liabilities and shareholders’
equity) on a particular date (end of the
quarter, end of the year).

• This is in contrast with the income statement,

which reports a company’s revenues,
expenses, and profitability over a specified
period of time.

• Most balance sheet items are reported at

their historical cost; the balance sheet does
not report the true market value of a
company – only its resources and funding at
their historical cost

Accounting - Concepts 22
 Introduction to Assets

Assets represent the company’s resources. To qualify as an asset, the following requirements must be met:

• A company must own/control the resource

• The resource must be of value / economic benefit

• The resource must have a quantifiable, measurable cost

Asset Description
Cash Monies held by the company in its bank account or petty cash
Marketable Securities / Short-Term
Debt or equity securities held by the company
Investments
Payment owed to a business by its customers for products and services already delivered
Accounts Receivable (A/R)
to them
Any unfinished or finished goods that are waiting to be sold, and the direct costs
Inventories
associated with the production of these goods
When a company prepays for things like utilities, insurance and rents, the right to the
Prepaid Expenses
future services become assets
Land, buildings, machinery, equipment used to manufacture the company’s services and
Property Plant and Equipment (PP&E)
products
Non-physical assets such as patents, trademarks, and goodwill acquired by the company
Intangible Assets & Goodwill
that have value based on the rights belonging to that company

Accounting - Concepts 23
 Introduction to Liabilities

Liabilities represent the claims against the company’s resources. To qualify as a liability, the following
requirements must be met:

• It is the result of a past transaction / probable that the present obligation will need to be settled

• Resource of value / economic benefit will flow out of the entity

• The resource must have a quantifiable, measurable cost

Liability Description
Obligations to pay suppliers for services and products already purchased from them, but
Accounts Payable which have not been paid. In other words, accounts payable represent the company’s
unpaid bills to its suppliers for services obtained on credit from them
Expenses like employee compensation that the company has incurred, but for which it
Accrued Expenses
has not yet paid
Cash collected in advance from customers for products/services yet to be delivered,
Deferred Revenue
which will be recognized as real revenue over time
The company has paid lower taxes than what it really owes, which will need to be made
Deferred Tax Liability
up for by paying additional taxes in the future
Short term Debt Debt due within 12 months
Long-Term Debt Debt whose maturity exceeds 12 months

Accounting - Concepts 24
 Introduction to Equity

Equity represents sources of funds through equity investments and retained earnings (what the company
has earned via its operations since inception).

Equity Description
Preferred Stock Stock that has special rights and takes priority over common stock.
Common Stock Represents capital received by a company when it issues shares.
Treasury Stock Common stock that had been issued but then reacquired (repurchased) by a company.
Retained Earnings Total company earnings / losses since its inception less all dividends.

Net Income

Retained Earnings

Dividends

Accounting - Concepts 25
 What is a Liability or Equity?

Classify each of the below as a Liability, Equity or Neither. Also, provide the subcategory classification (e.g., ST debt).

An employee bonus, earned but not paid by IBM

Microsoft’s 10-year bond

A building owned by GE

Preferred shares issued by Verizon

Employees of a McDonald’s

A truck owned by Pfizer

Retained earnings of AT&T

A utility bill that has been prepaid in advance by J.P.Morgan

A 6-month loan taken out by Google to pay rent

Amazon stock issued but then repurchased by the company

Toyota’s management team

Accounting - Concepts 26
 What is a Liability or Equity?

Classify each of the below as a Liability, Equity or Neither. Also, provide the subcategory classification (e.g., ST debt).

An employee bonus, earned but not paid by IBM Liability – Accrued Expenses

Microsoft’s 10-year bond Liability – LT Debt

A building owned by GE Neither

Preferred shares issued by Verizon Equity – Preferred Stock

Employees of a McDonald’s Neither

A truck owned by Pfizer Neither

Retained earnings of AT&T Equity – Retained Earnings

A utility bill that has been prepaid in advance by J.P.Morgan Neither

A 6-month loan taken out by Google to pay rent Liability – ST Debt

Amazon stock issued but then repurchased by the company Equity – Treasury Stock

Toyota’s management team Neither

Accounting - Concepts 27
 Current vs. Long-Term Presentation

The distinction between current and long term is important for financial reporting and analysis, as it reflects the
liquidity and solvency of a business.

• Current assets: Assets that can be converted into cash or used up within one year.
• Current liabilities: Liabilities that must be paid within one year.
• Long term assets: Assets that have a useful life of more than one year.
• Long term liabilities: Liabilities that are due after one year.

Classify each of the below as a Current Asset, LT Asset, Current Liability or LT Liability.
Prepaid Expenses
Accrued Expenses
Cash
Accounts Payable
Newly issued 10-year zero coupon bond
Income Tax Payable
Land
Accounts Receivable
15-year bond with 6 months to maturity
Building
Goodwill

Accounting - Concepts 28
 Current vs. Long-Term Presentation

Classify each of the below as a Current Asset, LT Asset, Current Liability or LT Liability.

Prepaid Expenses Current asset

Accrued Expenses Current liability

Cash Current asset

Accounts Payable Current liability

Newly issued 10-year zero coupon bond Long-term liability

Income Tax Payable Current liability*

Land Long-term asset

Accounts Receivable Current asset

15-year bond with 6 months to maturity Current liability

Building Long-term asset

Goodwill Long-term asset

Accounting - Concepts 29
 Betty’s Bath Shop Example

Betty's Bathshop records the following transactions for the fiscal month of December 2022. Calculate the closing balances
of cash, accounts receivable, inventory, prepaid expenses, and accrued expenses as of December 31, 2022.

1. On December 1, 2022, Betty has the following balances for her accounts: Cash: $10,000, Accounts Receivable: $2,000, Inventory:
$20,000, Prepaid Expenses: $400, Accrued Expenses, $0.
2. Betty's rent expense, which she prepays at the beginning of each year, is $400 per month. She prepays for 2023 in December 2022.
3. Betty sells through all her inventory for $85,000, receiving half in cash.
4. With the Christmas rush over, Betty decides only to restock $10,000 of inventory for January, which is typically a slower month. She
covers the cost immediately with her cash balance.
5. Betty is thrilled with the results for December and sends an email on Christmas morning to her two staff members saying they will
each be getting a $2,000 bonus in January.
6. On December 31, Betty collected $1,500 from accounts receivable.

Accounts Prepaid Accrued

Item Cash Receivable Inventory Expenses Expenses
Opening Balance $10,000) $2,000) $20,000) $400) $0)
Transaction 2 ($4,800) $4,400)
Transaction 3 $42,500) $42,500) ($20,000)
Transaction 4 ($10,000) $10,000)
Transaction 5 ) $4,000)
Transaction 6 $1,500) ($1,500)
Closing Balance $39,200) $43,000) $20,000) $4,000)

Accounting - Concepts 30
 Introduction to the Cash Flow Statement

• The cash flow statement is a financial

statement that provides insight into how
much cash a company generates and from
what activities

• The cash flow statement reconciles net

income to a company’s actual change in cash
balance over a period of time

• The cash flow statement is typically broken

out into 3 buckets: cash from operations,
cash from (or used for) investing, and cash
from (or used for) financing

Accounting - Concepts 31
 Cash Flow Statement Components

Companies have two methods for reporting cash flows:

• Direct Method: listing cash receipts

• Indirect Method: reconciling net income with cash flows

Cash from Operations (CFO) Cash from Investing (CFI) Cash from Financing (CFF)

• Net income as a starting • Capital expenditures / • New borrowing / pay-

point asset sales and purchases down of debt / new
issuance of stock / share
• Converts accrual-based • Acquisitions
repurchases
net income into cash flow
from operations via a • Issuance of dividends
series of adjustments (i.e.,
non-cash and accrual)

Accounting - Concepts 32
 Cash from Operations Summary

Cash from Operations

Starting point of cash flow statement using the indirect

Net Income
method

+ Depreciation and Amortization + Noncash D&A expense

- Increases in A/R, inventory, prepaid expenses, other - Increases in WC asset balances = cash outflows
current assets (working capital assets) - Decreases in WC asset balances = cash inflows
+ Increases in A/P, accrued expenses, taxes payable, and - Increases in WC liability balances = cash inflows
other current liabilities (working capital liabilities) - Decreases in WC liability balances = cash outflows
+ Impairments
- Gains on sale of assets
+/- Other Items + Stock-based compensation
- Increases in deferred tax assets
+ Increases in deferred tax liabilities

Accounting - Concepts 33
 Cash from Investing Summary

Cash from Investing tracks the additions and disposals to fixed assets and investments during the year

Accounting - Concepts 34
 Cash from Financing Summary

Cash from Financing tracks changes in the sources of a company’s capital and associated payments

In practice, this means new borrowings, debt repayments, stock issuances, stock buybacks, and dividends

Accounting - Concepts 35
 How to Link the 3 Statements

While there are many exceptions in the real world, you can follow the below steps to link the three
financial statements for most interview scenarios:

1) Calculate net income (or net loss) from the income statement by subtracting total expenses from total
revenue – this becomes the top line of the cash flow statement

2) Add back any non-cash expenses (such as depreciation and amortization) and subtract any non-cash
revenue (such as gains on the sale of assets)

3) Record changes in working capital (i.e., changes in operational balance sheet line items). Remember
that if an asset goes up, cash flow goes down (and vice versa); if a liability goes up, cash flow goes up
(and vice versa). This, combined with step 2, will get you Cash From Operations

4) Record the cash flows from investing (additions and disposals of fixed assets) and financing
(borrowings, debt repayments, equity issuances, etc.) to arrive at your ending cash balance

5) Reconcile the changes in balance sheet line items from the cash flow statement to update the balance
sheet

6) Bring Net Income from IS into retained earnings for balance sheet

Accounting - Concepts 36
 Putting it All Together: The Depreciation Interview Question

Alex' Apartments has a $10,000 depreciation expense for the year. Calculate and walk through the impact on each of the
three main financial statements. Assume a 30% tax rate.

Income Statement Cash Flow Statement Balance Sheet

Revenue -) Net Income ($7,000) Cash $3,000)

(-) Cost of Goods ($10,000) Depreciation $10,000) A/R -)

Sold
Cash from $3,000) Inventory -)
= Gross Profit ($10,000)
Operations
PP&E ($10,000)
(-) SG&A -)
Cash from -) Total Assets ($7,000)
(-) Other Operating -)
Investing
Expenses
= Operating Income ($10,000)
Cash from Financing -) Bank Loan -)
(-) Interest Expense -)
Common Stock -)
= Profit Before Tax ($10,000)
Opening Cash -)
Retained Earnings ($7,000)
(-) Tax Expense $3,000)
Change in Cash $3,000)
Total Liabilities & ($7,000)
= Net Income ($7,000) Equity
Ending Cash $3,000)

Accounting - Concepts 37
 To Access 800+ Accounting Questions

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38
Accounting – Practice Questions
 Accounting Practice Questions – Basic

WHAT ARE THE THREE MAIN FINANCIAL STATEMENTS? IF YOU COULD USE ONLY ONE FINANCIAL STATEMENT TO
EVALUATE THE FINANCIAL STATE OF A COMPANY, WHICH
• Income Statement WOULD YOU CHOOSE?

• Revenues – Cost of Goods Sold – Expenses = Net Income • SAMPLE ANSWER: I would want to see the Cash Flow Statement so I
could see the actual liquidity position of the business and how much cash
• Balance Sheet it is using and generating.

• Assets = Liabilities + Shareholder’s Equity • The Income Statement can be misleading due to any non-cash expenses
that may not truly affect the overall business.
• Statement of Cash Flows
• And the Balance Sheet alone just shows a snapshot of the Company at one
• Beginning Cash + CF from Operations + CF from Investing + CF point in time without showing how operations are actually performing.
from Financing = Ending Cash
• But whether a company has a healthy cash balance and generates
• The three main financial statements are the Income Statement, the significant cash flow indicates it is probably financially stable, which is
Balance Sheet, and the Statement of Cash Flows. what the CF Statement would show.

• The Income Statement shows a company’s revenues, costs, and

expenses, which together yield net income.

• The Balance Sheet shows a company’s assets, liabilities, and equity.

• The Cash Flow Statement starts with net income from the Income
Statement; then, it shows adjustments for non-cash expenses, non-
expense purchases such as capital expenditures, changes in working
capital, or debt repayment and issuance to calculate the company’s
ending cash balance.

Accounting – Practice Questions 40

 Accounting Practice Questions – Basic

WHEN SHOULD AN EXPENSE APPEAR ON THE INCOME WALK ME THROUGH THE MAJOR LINE ITEMS OF AN INCOME
STATEMENT? STATEMENT

• Expenses that end up on the income statement are things like

marketing expenses, employee salaries, etc. YEAR 1 ($) YEAR 2 ($)
Revenue 1,000 1,200
• In order to be on the income statement, the expense must be tax
deductible and must have been incurred during the period of the Cost of Goods Sold 100 120
income statement. GROSS PROFIT 900 1,080

Operating Expenses 150 170

OPERATING INCOME 750 910

Net Interest Expenses 90 90

Other Expenses 10 10
PRE-TAX INCOME 650 810

Income Tax Provision 25 40

NET INCOME 625 770

• The first line of the Income Statement represents revenues or sales.

From that, you subtract the cost of goods sold, which leaves gross
profit. Subtracting operating expenses from gross profit gives you
operating income.

• From operating income, you subtract interest expense and any other
expenses (or add other income) to get pre-tax income. Then subtract
tax payments, and what’s left is net income.

Accounting – Practice Questions 41

 Accounting Practice Questions – Basic

WHAT ARE THE THREE COMPONENTS OF THE STATEMENT OF WHAT IS THE LINK BETWEEN THE BALANCE SHEET AND THE
CASH FLOWS? INCOME STATEMENT?

• The Statement of Cash Flows is one of the three financial reports that • The profits generated on the Income Statement after any payment of
all public companies are required by the SEC to produce on a quarterly dividends are added to the shareholder’s equity on the Balance Sheet
basis. (Most non-public companies also produce Cash Flow (CF) under retained earnings.
Statements.) The CF Statement comprises the three main components
described below, showing all the company’s sources and uses of cash. • Debt on the Balance Sheet is used to calculate interest expense on the
Income Statement.
• Since companies tend to use accrual accounting, a company’s net
income may not (and most of the time does not) portray how much • Property, plant, and equipment on the Balance Sheet is used to
cash is actually flowing in or out due to non-cash expenses, investing calculate depreciation expense on the Income Statement.
activities, financing activities, changes in working capital, etc.
• There are many other links, but the above are some of the main
• Because of this, even profitable companies may have trouble connections.
managing their cash flows, and non-profitable companies may be able
to survive without raising outside capital. • SAMPLE ANSWER: There are many links between the Balance Sheet
and the Income Statement. The major link is that any net income from the
• CASH FROM OPERATIONS: Cash generated or lost through normal Income Statement, after the payment of any dividends, is added to
operations, sales, and changes in working capital (more detail on retained earnings.
working capital below).
• In addition, debt on the Balance Sheet is used to calculate the interest
• CASH FROM INVESTING: Cash generated or spent on investing expense on the Income Statement, and property plant and equipment will
activities; may include, for example, capital expenditures (use of cash) be used to calculate any depreciation expense.
or asset sales (source of cash). This section will also show any
investments in the financial markets and operating subsidiaries. NOTE:
This section can explain a large negative cash flow during the
reporting period, which isn’t necessarily a bad thing if it is due to a
large capital expenditure in preparation for future growth.

• CASH FROM FINANCING: Cash generated or spent on financing the

business; may include proceeds from debt or equity issuance (source
of cash) or cost of debt or equity repurchase (use of cash).

Accounting – Practice Questions 42

 Accounting Practice Questions – Intermediate/Advanced

FROM THE THREE MAIN FINANCIAL STATEMENTS, IF YOU HAD WHY ARE INCREASES IN ACCOUNTS RECEIVABLE A CASH
TO CHOOSE TWO TO ANALYZE A COMPANY, WHICH WOULD REDUCTION ON THE CASH FLOW STATEMENT?
YOU CHOOSE AND WHY?
• Since the cash flow statement starts with net income, an increase in
• The key to this question is understanding that if you have the accounts receivable is an adjustment to net income to reflect the
beginning and ending Balance Sheets for the period, along with the fact that the company never actually received those funds.
ending Income Statement, you can generate a Cash Flow Statement
for yourself.
• Accounts receivable is cash that the company has earned but has
not yet collected. If accounts receivable go up, the company has not
• So, the answer to this question is easy: you want the beginning and actually collected the cash for the income it has earned, and this is a
ending Balance Sheets and the Income Statement for the same negative adjustment on the cash flow statement in cash flow from
period. operations.
• SAMPLE ANSWER: If I had to choose two financial statements, I • Accounts payable is the opposite of the above and is, therefore, a
would choose the Balance Sheet and the Income Statement. As long as I positive adjustment on the cash flow statement in cash flow from
had the Balance Sheets from the beginning and end of the period, as operations.
well as the end of period Income Statement, I would be able to generate
a Cash Flow Statement.

Accounting – Practice Questions 43

 Accounting Practice Questions – Intermediate/Advanced

HOW WOULD A $10 INCREASE IN DEPRECIATION EXPENSE AFFECT EACH OF THE THREE FINANCIAL STATEMENTS?

NOTE: There are many forms of this question. An interviewer could ask how the statements are affected by a $20 decrease in inventory or a $50 million
capital expenditure project. Since you will not be able to memorize each and every possible question, you must know how the changes in line items flow
through the financial statements. Use the WSO model provided in this guide to help you master that.
Break this question down into pieces.
• Start with the Income Statement.
• The $10 increase in depreciation is an expense, which therefore lowers operating profit by $10 and reduces taxes.
• Taxes decrease by $10 x Tax Rate and net income decreases by $10 x (1–Tax Rate).
• Assuming a 40% tax rate, the drop in net income will be $6 [$10 x (1–0.40)].
• Next, move to the Statement of Cash Flows.
• The $6 reduction in net income reduces cash from operations by $6.
• However, depreciation is a non-cash item, so it will increase cash from operations by $10 because you add back depreciation.
• Ending cash is therefore increased by $4.
• Now to the Balance Sheet.
• Cash increases by $4.
• PP&E decreases by $10 because of depreciation.
• Overall assets fall by $6.
• This needs to balance with the other side of the Balance Sheet; therefore, retained earnings will fall by $6 due to the drop in net income.
SAMPLE ANSWER: Let’s start with the Income Statement. The $10 increase in depreciation will be an expense and will reduce net income by $10 times (1–
the tax rate). Assuming a 40% tax rate, this will mean a reduction in net income of 60% or $6. So $6 flows to cash from operations, where net income will be
reduced by $6, but depreciation will increase by $10, resulting in an increase of ending cash by $4. Cash then flows onto the Balance Sheet, where it increases
by $4, PP&E decreases by $10, and retained earnings decrease by $6, keeping everything in balance.

Accounting – Practice Questions 44

 Accounting Practice Questions – Intermediate/Advanced

WHAT’S THE DIFFERENCE BETWEEN CASH-BASED ACCOUNTING WHY DO CAPITAL EXPENDITURES INCREASE ASSETS (PP&E),
AND ACCRUAL ACCOUNTING? WHILE OTHER CASH OUTFLOWS, LIKE PAYING SALARY, TAXES,
ETC., DO NOT CREATE ANY ASSET AND INSTEAD INSTANTLY
CREATE AN EXPENSE ON THE INCOME STATEMENT THAT
• CASH-BASED ACCOUNTING: This form of accounting recognizes
REDUCES EQUITY VIA RETAINED EARNINGS?
revenues and expenses as of the time cash is actually collected or
disbursed. For example, if a company receives a payment on a credit
card, it wouldn’t be recorded as revenue until the credit card • Capital expenditures are capitalized on the balance sheet because it
company actually deposits the money into the company’s bank is expected that their benefits will be realized over a long period of
account. time, likely a number of years. If a company purchases a truck, the
Company will see the benefit of that truck over the course of its
• ACCRUAL ACCOUNTING: With accrual accounting, as soon as the
useful life and, therefore, will expense the truck over the course of
company makes a payment or sale and believes it will pay for or be
that life in the form of depreciation on the income statement.
paid for a good or service, it will recognize the expense or revenue.
Using the prior example, if the company is using accrual accounting, • This is in contrast to a salary or wage expense, which is realized
they will book the revenue as soon as they are paid, and it will show immediately because the Company is seeing the benefit of the work
up as an accounts receivable on the Balance Sheet until the money that the employee is being paid for just in that short period of time.
is actually deposited into their account at which time the accounts
receivable balance will go down, and the cash balance will go up.
• SAMPLE ANSWER: With cash-based accounting, a company won’t
recognize expenses or revenues until the cash is actually disbursed or
collected.
• With accrual accounting, a company will recognize expenses and
revenues when it has entered into a transaction or agreement that will
require it to pay or be paid, even if cash won’t change hands until
sometime in the future.
• Most companies use accrual accounting since credit cards are so
prevalent.

Accounting – Practice Questions 45

 To Access 800+ Accounting Questions

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46
Valuation – Concepts
 Valuation Roadmap

Valuation will be fundamental to nearly every type of corporate finance-related

project or strategic transaction you may work on

In addition to trading comparables, precedent transactions, and the DCF,

you may receive exposure to additional valuation methodologies

• Leveraged Buyout valuation

• Sum of the Parts valuation (or “Breakup” valuation)
• Gordon Growth
• Other industry-specific methodologies

Different methodologies will inherently lead to an implied valuation range

A critical part of any finance professional’s role is to intuitively understand

the different approaches (i.e., why they may lead to different results)

There is no one right way to value a company, and there are various ways to
define value! Valuation is an art, not an exact science

Valuation - Concepts 48
 Conceptual Framework for Company Value

Two key company valuation metrics are Enterprise and Equity Value. While different, both
inherently derive value from a company’s projected future cash flows

How do you measure

“Company Value”? • Does it refer to what the market
believes a company is worth? Or does
it refer to our opinion of what the
company is worth?
• Does value include all the company’s
The two main ways to measure
assets or just those related to its core
“Company Value” are Equity Value and
business?
Enterprise Value. This is difficult in
practice because companies are worth • Does value refer to certain investors,
different amounts to investors! or all investors?

Company Value = Cash Flow / (Discount Rate – Cash Flow Growth Rate)

Valuation - Concepts 49
 Introduction to Equity Value

Equity Value represents the value of a company's common shares, either in aggregate or on a per
Definition share basis

Deep Dive

How its Calculated Also Known As… What It’s Not

• Price per share x common shares • Often referred to as “Market Cap” • Does NOT represent the value of the
outstanding Firm and its core operations, which
• Can be thought of as the market also includes the value of other
• Shares calculated on a “fully diluted” value of the shareholders’ total investor capital (i.e., from debt
basis (in-the-money options, invested capital investors, etc.)
warrants, converts, etc., convert to
common)

• Net of outstanding debt or other

obligations

Equity Value (aka. “Market Cap”) = Price per Share * Fully Diluted Shares Outstanding(1)

1. Fully Diluted Shares Outstanding = Basic Shares Outstanding + Shares from In-the-Money Stock Options & Warrants + Shares from
other In-the-Money Convertible or Dilutive Securities (i.e., Restricted Stock, etc.)

Valuation - Concepts 50
 Example: Simple Equity Value Calculation

Can you guess which company has the largest market cap as of April 14th, 2023?

Price Per Share Shares Outstanding Market Cap

$165.21 X 15.82 Billion = $2.614 Trillion !!

Where to Source
• 3rd party market data services • Basic shares outstanding: page 1 of most • Also available via 3rd party
provider (i.e., Bloomberg, recent quarterly/annual 10K/Q filing market data services
FactSet) • Securities that may dilute basic shares providers
outstanding (for example, options, etc.) will be
detailed in the footnotes to the financial
statements

Valuation - Concepts 51
 Introduction to Enterprise Value

Enterprise Value reflects the value of a company’s core assets funded by (and attributable to)
Definition both the company's debt and equity investors

Deep Dive

How its Calculated Also Known As… What It’s Not

• Value of all ownership interests and • Can be thought of as the value of the • EXCLUDES non-core assets, for
claims on core business assets (from company’s operational assets, in example, excess cash (or cash not
both debt and equity investors) addition to its future growth required for operational needs)
opportunities

Enterprise Value (“EV”) = Equity Value + Total Debt + Value of Preferred Stock(1) + Value of Non-Controlling
Interests(1) - Excess Cash and Non-core Assets(1)

1. If applicable, most companies have some combination of debt and common equity funding, but not necessarily. Preferred stock and
non-controlling interests are less frequently seen in public company capital structures but are still prevalent.

Valuation - Concepts 52
 Example: Moving from Equity Value to Enterprise Value

To move from a company’s Equity Value to its Enterprise Value, subtract non-core assets and add Debt & Equity items that
represent other investor groups

1. Equity Value = value of core business assets + value of non-core business assets
2. Enterprise Value = value of core business assets (usually all those except cash/short-term investments)
3. Equity Value = value to common equity investors (net of debt obligations)
4. Enterprise Value = value to equity investors + value to debt investors + value to preferred stock/other investors

Equity Value Enterprise Value

Metric Amount Metric Amount

Equity Value $100 million
Price per Share $10
(+) Assumed Total Debt $50 million

(*) Assumed FDSO (Fully

(+) Assumed Pref. Stock --
Diluted Shares Outstanding) 10 million
(+) Assumed NCI --
(-) Excess Cash ($2 million)
Equity Value $100 million
(=) Enterprise Value $148 million

Valuation - Concepts 53
 Example: What Affects Enterprise Value?

Only changes to a company’s core business affect Enterprise Value. Changes to a company’s capital structure will NOT
affect Enterprise Value.

Example Impact on Enterprise Value

Enterprise Value Original Pro Forma

A monthly rent-a-Peloton startup Adjustment
Build Amount Amount
called “Max’s Bikes” has:
Equity Value $100mm $100mm
• $100mm Market Cap (+) Total Debt $50mm $75mm $125mm
• $50mm of Total Debt (+) Pref. Stock $25mm $25mm
Enterprise Value remains
• $25mm of Preferred Stock (+) NCI the same
-- because the --
• $10mm of Cash increase in Cash offsets the
(-) Excess Cash ($10mm) ($75mm) ($85mm)
incremental debt raised
Max’s Bikes decides to raise $75 million of (=) Enterprise
incremental debt that is held on the Balance $165mm $165 mm
Value
Sheet as Cash. How does this affect its
Enterprise Value?

Valuation - Concepts 54
 Enterprise Value’s Relationship with Capital Structure

Capital structure independence is one of the key advantages of comparing Enterprise Value multiples of peer companies

Since financial / non-core

activities do not impact EV,
✓ Allows us to analyze the peer companies should have
value of the Enterprise (both relatively consistent EV
in $ and as a multiple of multiples What kinds of
revenue, operating profit,
business activities
etc.)
actually impact
✓ Provides a better view on a Certain profit metrics (Net EV?
company’s core assets and Income, EPS) ARE influenced
business operations by non-core activities or
capital structure; these
cannot be compared to EV

Valuation - Concepts 55
 Enterprise & Equity Value Practice Examples

Example Situation Change to EV? Explanation

EV increases by $200 as PP&E is
• Enterprise Value
expected to generate additional cash flow
Max’s Bikes issues $200 increases
from the core business
of common shares to
1. PP&E acquire a new Peloton
Investment (PP&E) • Equity Value The equity issuance used to fund the
increases PP&E causes Equity Value to increase by
$200

Max’s Bikes issues $200 • Enterprise Value Jen’s Mopeds is a core-business asset,
of common shares and so EV increases by $100
2. M&A increases
acquires Jen’s Mopeds
Activity
for $100, leaving $100 Equity Value increases by $200 since
in cash on the BS • Equity Value the deal was funded through an
increases equity issuance

Enterprise Value changes when there is a change to core business assets (like PP&E) or activities
(like an acquisition) that is considered core to business operations

Valuation - Concepts 56
 Enterprise & Equity Value Practice Examples (Cont’d)

Does the core business change as a result of these transactions?

Example Situation Change to EV? Explanation

• Enterprise Value Enterprise Value doesn’t change

does not change because the core assets of the
Max’s Bikes issues $500 business have not changed
3. Dividend
in dividends to equity
Issuance investors • Equity Value
decreases The company uses cash to issue
dividends, reducing Equity Value

Initial debt issuance increases cash

Max’s Bikes raises • Enterprise Value and debt by $1,000. New debt and
4. Debt
$1,000 of debt, leaving does not change cash offset each other
Issuance &
$500 on the Balance
Stock Sheet using $500 to • Equity Value Equity Value then decreases by $500
Repurchase repurchase shares decreases when a company uses cash to
repurchase shares(1)

1. While less cash combined with additional debt results in a decrease in Equity Value assuming a constant price per share,
this example should not be confused with a stock repurchase funded by a company’s excess cash. Companies may repurchase
shares with excess cash because the market price per share may actually increase, offsetting fewer shares outstanding
(neutral to Equity Value). The increase in share price reflects the belief that a company’s fundamental market value should not
change simply due to a reduction in shares outstanding (all else equal)

Valuation - Concepts 57
 Other Activities Impacting Enterprise Value

Each of the following changes might affect a company’s current Market-Implied and Intrinsic (DCF-based) Enterprise Value

Winding down an ➢ Each example changes

unprofitable projected free cash flows
division, improving
profit margins and ➢ Only changes to core business
expected future affect Enterprise Value, but
cash flows both financial and operational
Winning a contract Negotiating better
changes affect Equity Value
with a new terms on contracts
customer, with suppliers,
increasing improving margins
forecasted revenue and cash flows

Valuation - Concepts 58
 Intro to Enterprise & Equity Value Multiples

To account for differences in EV and Equity Value in absolute $, we compare them in the form of multiples of performance
metrics that are standardized across peer companies

Other non-core differences that could

be considered:
✓ Capital structure differences

✓ Differences in accounting policies of

comparable companies

One of the most challenging aspects of ✓ Non-recurring items (restructuring

Relative Valuation is identifying truly expenses, litigation costs, etc.)
comparable companies or transactions
✓ Business life cycle differences
Operationally similar companies often
still need to be adjusted for other
differences, notably SIZE

Valuation - Concepts 59
 Common Metrics That Pair With Enterprise & Equity Value

Metrics that represent value to all investors are compared to Enterprise Value, whereas metrics that are only available to
Equity investors are compared to Equity Value

Enterprise Value Equity Value

The most commonly-used metrics that pair with Some of the most common multiples measuring
Enterprise Value: relative Equity Value are:

✓ Revenue ✓ P/E

✓ Operating Income or EBIT (Earnings Before ✓ PEG

Interest and Taxes)
✓ P/B
✓ EBITDA (Earnings Before Interest, Taxes,
Depreciation, and Amortization) ✓ If a profit metric reflects Interest Expense and/or
Preferred Dividends, pair it with Equity Value

Residual profit, after paying interest, taxes, and dividends, is available ONLY to the equity investors. This is why
Net Income is compared to Equity Value!

Valuation - Concepts 60
 Introduction to Trading Comps

Comparable Companies Analysis (aka “Trading Comps”) – similar companies provide a key
Concept reference point for valuing one given company.

Deep Dive

Why Trading Comps? Purpose of Analysis How to Do It

• Peer companies share similar • Calculating a potential valuation • Select peer companies to benchmark
business models, financial profiles, range for a target based on trading against one another
performance drivers, and risks values of publicly-traded peers
• Calculate valuation multiples for peers
based on public market trading levels

• Apply your company’s financial

metrics to the range implied by peers
to derive a valuation

By comparing a company’s relative position within its industry, we can establish a framework for its valuation

Valuation - Concepts 61
 Review of Multiples

Multiples – use a value metric in the numerator and a financial or operational metric in the
Definition denominator. Reflects current valuation per unit based on market conditions

Enterprise Value Multiples Equity Value Multiples

EV / Revenue P/E
Equity Value divided by Net Income, OR
Enterprise Value divided by Revenue (Price per Share divided by EPS)

EV / EBITDA PEG
P / E ratio divided by Projected Long-term EPS
Enterprise Value divided by EBITDA Growth Rate

EV / EBIT P/B

Enterprise Value divided by EBIT Equity Value divided by Book Value of Equity

Valuation - Concepts 62
 Commonly Used Enterprise Value Multiples

In Valuation

Multiple Description

• Measures valuation as a multiple of Revenue

EV / Revenue • Employed for high-growth (typically early-stage)
• EV multiples are used in
companies with little to no profitability
corporate finance/banking
because they are
independent of capital
• Measures valuation as a multiple of EBITDA structure and other items
unrelated to core business
EV / EBITDA • Most popular EV multiple across industries
activities
• P&L-based proxy for Cash Flow from Ops.
• They allow companies to
adjust historical financial
performance for non-
• Measures valuation as a multiple of EBIT
recurring items easily
EV / EBIT • Reflects core operations without the impact of
capital structure and other non-core activities

These are the most frequently-used Enterprise Value multiples in practice. EV multiples compare the value of the
company to all investors relative to a revenue or profit metric

Valuation - Concepts 63
 Considerations of Enterprise Value Multiples

Financial analysts use multiples to fit a specific use case, such as valuing an early-stage venture
Concept versus an established, mature, and profitable Fortune 500 company

Multiple Denominator Benefits Drawbacks

• Assumes peer companies have
• Used to value companies
comparable cost structures
based on future prospects
EV / Revenue Total Revenue • Revenue potential is not a direct link
• High growth or early-stage
or guarantee for profit or cash flow
companies
generation

• Most popular EV multiple used

EBITDA (Revenue – across industries • Less useful when comps have
COGS – Operating • Independent of capital different levels of capital intensity
EV / EBITDA
Expenses + D&A +/- structure because the need to exclude the
Non-recurring Items) • P&L-based proxy for cash flow impact of D&A expense is less critical
from ops. as it excludes D&A
• Reflects core operations
without impact of financing and • Used less than EV / EBITDA because
EBIT (Revenue – COGS non-recurring items differences in D&A accounting
EV / EBIT – OpEx +/- Non-
• Useful when capital intensity is policies and CapEx timing can cause
recurring Items) not comparable or when D&A skews in data
is not available

Valuation - Concepts 64
 Commonly Used Equity Value Multiples

In Valuation
Multiple Description

• Price per Share / Earnings per Share, OR Market

Price / Earnings Cap / Net Income to Common
• Equity Value multiples
• Net Income and EPS measure net profit are popular because
they are easy to
calculate based on
• Price per Share / Book Value of Equity per Share,
OR Market Cap / Book Value of Equity readily available
Price / Book • Differences in Book Value of Equity vs. Market
information
Cap is goodwill driving higher market valuation • NOT independent of
capital structure, taxes,
• P/E ratio / Long-term EPS growth rate and other non-core
PEG • Standardizes P/E ratios against projected long- activities
term EPS growth

Equity Value multiples compare the market value of a company’s equity relative to Net Income to
common shareholders

Valuation - Concepts 65
 Considerations of Equity Value Multiples

Financial analysts use multiples to fit a specific use case, such as valuing an early-stage venture
Concept versus an established, mature and profitable Fortune 500 company

Multiple Denominator Benefits Drawbacks

• Net Income and EPS are GAAP
• Most widely-recognized figures which can mask core business
P/E OR Price Per Net Income or trading multiple performance
Share / EPS OR
Earnings per Share • Useful when companies have • Less useful for earlier-stage high
Equity Value / NI growth companies with no profit
consistently grown EPS
• Not independent of capital structure

• Most relevant for financial • Less relevant for companies outside

institutions and insurance the financial institutions industry
Book Value of
Price / Book • Highlights companies whose • Book Value is based on historical
Shareholder’s Equity
market cap is driven by trends and could be conservative
intangible assets • Not meaningful if BV is negative

• Compares peers at different

stages of maturity but with
• Not useful for companies whose EPS
positive earnings
PEG EPS Growth Rate is heading downward, even if positive
• Helps identify companies who
• Also influenced by capital structure
may be overvalued (higher PEG
ratios)

Valuation - Concepts 66
 Sample Trading Comps Analysis Output

The output from a trading comps analysis is known as the “Football Field” and can be presented in
Concept either a horizontal or vertical format

Football Field output can

Football Field output can also help identify methods
help identify methods that that produce wide
produce a “tighter” valuation ranges (potential
valuation range outliers)

This Football Field shows a company’s implied share price (on the Y-axis) based on different trading valuation
multiples (noted on the X-axis)

Valuation - Concepts 67
 Trading Comps FAQ’s

1
What are the key risks to using trading comps as a
main valuation methodology?

2
Are LTM multiples or forward multiples more
important to the analysis?

3
If markets are efficient, why do we need a trading
comps analysis to value public companies?

4
Should the company being evaluated as part of your
valuation be included in the universe of peer comps?

5
Should the median or mean be used when calculating
a valuation range based on trading comps?

Valuation - Concepts 68
 Sector-Specific Enterprise Value Multiples

Certain sectors may have valuation multiples that are more applicable to the nature of the
Concept industries or stage of life for the companies in the sector

Relevant Multiple Applicable Sector(s) Commentary

• Retail • Rent is one of the most significant expenses in these sectors, and accounting
EBITDAR
• Restaurants treatments for leases can lead to large differences in terms of rent expense
(Earnings Before Interest,
Taxes, D&A and Rent • Airlines • Owning real estate vs. renting may also cause differences that can be standardized
Expense)
• Casinos • EBITDAR standardizes by removing rent expenses

EBITDAX • Similar to the rent example above, Exploration activities are the largest investments
(Earnings Before Interest, • Oil & Gas for O&G companies; however, different accounting treatments for Exploration can
Taxes, D&A, Depletion, & create misleading views of one comp’s profitability vs. another’s
• Natural Resources
Exploration) • EBITDAX standardizes by removing D&A and exploration expenses
Production / Capacity • Oil & Gas
(in units) • High risk / high reward NatRes projects can be valued as multiples of operating
• Natural Resources
metrics if the asset(s) is either idle or in development
Reserves • Metals & Mining

• Software & Tech • Early-stage tech. companies with little to no revenue and negative profitability can
be valued through operating metrics, such as subscribers, monthly active users, etc.
Subscribers / Users • Media
• Be careful – assumes monthly users and subscribers will lead to revenues and
• Telecommunications profits (and at consistent rates across peer companies)

Square Footage & • Real Estate

• Key operating metrics driving current top line and future growth potential
Same Store Sales • Retail

Fiber Miles • Telecommunications • One of the highest value assets in telecomm are owned fiber miles

Valuation - Concepts 69
 Introduction to Precedent Transactions

Precedent Transactions (aka “Transaction Comps”) values companies on a relative basis compared
Concept to peer companies that have been sold in recent M&A transactions

Deep Dive

Why Transaction Comps? Purpose of Analysis How to Do It

• Buyers and sellers need to know the • By benchmarking a company’s • Select precedent transactions to
industry's recent M&A in terms of relative position within its benchmark against one another
multiples and premiums paid to share competitive landscape, we can create
prices a view on its valuation • Calculate multiples for comps / deals
based on transaction or offer values

• Apply your company’s financial

metrics to the range implied by
precedent transactions to derive a
valuation

Precedent transactions analyses often require some of the greatest amount of judgment on behalf of the financial
professional. This is part of the “art” of valuation

Valuation - Concepts 70
 Precedent Transactions Valuation Terminology

• Transaction Value (equal to Enterprise Value, but in the context of an M&A transaction)
represents the consideration paid by buyers to acquire comparable companies in the past

• General rule: most recent transactions (last 3 years) are most relevant – likely took place under
similar market conditions

• Transaction Value differs from Offer Value, which represents the value of the offer made to
equity holders for their shares in the company

• Offer Value is equal to a company’s Equity Value but in the context of an M&A transaction

• Consistent with trading comps, we standardize for transaction size by using valuation multiples

• Consider deals involving companies in different but somewhat related sectors if they share
similar end markets, distribution channels, or financial profiles

Valuation - Concepts 71
 Common Precedent Transaction Valuation Multiples

Multiple Valuation Metric Considerations

Transaction Value / Revenue Enterprise Value • Assumes peer companies have comparable cost structures

• Less useful when comparing companies with different levels of

Transaction Value / EBITDA Enterprise Value capital intensity because the need to remove the impact of D&A
is less critical

• Less commonly used than Transaction Value / EBITDA due to

Transaction Value / EBIT Enterprise Value potential skew in data as a result of disparities in D&A
accounting policies

Offer Value / • Influenced by capital structure, taxes and non-core aspects of

Equity Value
Net Income (P/E) the business

Offer Value per Share / EPS • Influenced by capital structure, taxes and non-core aspects of
Equity Value
(P/E) the business

Valuation - Concepts 72
 Intro to the Control Premium

Precedent transactions generally imply a higher valuation multiple range than that of trading
Concept comps. One of the primary drivers is the “control premium”

Control Premium

Definition: • Control Premium arises from the purchase of majority control (> 50%) of a business

• Control gives the buyer the right to make decisions regarding a company’s operations or business
model, impacting its cash flow profile
Key Themes:
• Transaction multiples and premiums paid represent what acquirers can expect to pay to gain
control based on comparable transactions from the (hopefully recent) past

Premiums paid for public companies are often > 25% above their current market values

Valuation - Concepts 73
 Intro to Synergies

Concept Strategic acquirers can also absorb the cost of the control premium by realizing synergies

Synergies

• Synergies are potential cost savings, growth opportunities, lower costs of capital, or other benefits
Definition: resulting from the combination of two companies, such as expected incremental cash flow and
earnings in the future (beyond what the buyer could generate on its own)

• Prices (and valuation multiples) can be impacted by the buyer’s opinion of the probability of
achieving potential synergies (timing, size, etc.)
Key Themes:
• Most relevant for strategic buyers (less for financial buyers)

• Sometimes (not always) disclosed, either in absolute $ or % of the target’s revenue

Premiums paid for public companies are often > 25% above their current market values

Valuation - Concepts 74
 Precedent Transactions: Benefits & Considerations

Precedent transactions compare prices and multiples paid for comparable peers and value
Concept companies based on the multiples implied by those precedent deals

Benefits Considerations

• Market-based – valuations at the time of the

• Market-based – precedent-based; actual acquisition
transaction can be skewed depending on the general
multiples and premiums paid for peers
macroeconomic environment

• Potentially No Relevant Comps or Limited

• Relativity – easy to measure and benchmark against
Information – it may be difficult to identify “pure play”
peer companies and sectors
comparable companies or recent transactions

• Simplicity – key multiples for a few selected • Timing of the Transaction – Even if within 3 years,
transactions representing core pure play comps can precedent transactions may not reflect current market
provide the foundation for a valuation basis sentiment / conditions

• Transaction Dynamics – multiple paid by a buyer may

• Not Subject to Assumptions – mitigates risk of
be based on a different multiple than one can
erroneous future cash flow assumptions
calculate with publicly available information

Valuation - Concepts 75
 Precedent Transactions – Football Field

Multiples from precedent M&A may imply a range that is not meaningful as recent deals may not
Concept be truly comparable to the target company

Significant difference when

comparing implied share
prices based on valuation
multiples vs. premiums paid
to public share prices

In this scenario, focusing on premiums to publicly traded share prices, rather than on implied share prices based on
multiples, we can derive valuations that may actually be accepted by the target’s shareholders

Valuation - Concepts 76
 Putting It All Together: Sample Football Field Across Valuation Methodologies

To be covered in subsequent
sections

Valuation - Concepts 77
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78
Valuation – Practice Questions
 Valuation Practice Questions – Basic

WHAT IS ENTERPRISE VALUE? WHAT IS NET DEBT?

• Enterprise Value is the value of an entire firm, both debt and equity, • SAMPLE ANSWER: Net debt is a company’s total debt minus the cash it
according to the equation below. This is the price that would be paid has on the balance sheet. Net debt assumes that a company pays off any
for a company in the event of an acquisition. Enterprise Value = debt it can with excess cash on the balance sheet. One can simplify the
Market Value of Equity + Debt + Preferred Stock + Minority Interest – Enterprise Value formula above by replacing “Debt” with “Net Debt” and
Cash removing the subtraction of Cash since that is already built into Net Debt.

• SAMPLE ANSWER: Enterprise Value is the value of a firm as a whole, to

both debt and equity holders. To calculate Enterprise Value in its simplest
form, you take the market value of equity (aka the company’s market cap),
add the debt and the value of the outstanding preferred stock, add the
value of any minority interests the company owns, and then subtract the
cash the company currently holds.

NOTE: This is a highly simplified Enterprise Value formula. When

bankers working on a deal are calculating the true Enterprise Value in
an acquisition, they must take into account numerous other factors
such as leases, pension obligations, and NOLs.

Valuation – Practice Questions 80

 Valuation Practice Questions – Basic

IF ENTERPRISE VALUE IS $150MM, AND EQUITY VALUE IS WHY DO YOU SUBTRACT CASH FROM ENTERPRISE VALUE?
$100MM, WHAT IS NET DEBT?
• SAMPLE ANSWER: One good reason is that cash has already been
• SAMPLE ANSWER: Since Enterprise Value = Equity Value + Net Debt + accounted for within the market value of equity. You also subtract cash
Preferred Stock + Minority Interest, if we assume there is no minority because it can be used either to pay a dividend or to reduce debt,
interest or preferred stock, then Net Debt will be $150mm –$100mm, or effectively reducing the purchase price of the company.
$50mm.

Valuation – Practice Questions 81

 Valuation Practice Questions – Basic

WHAT IS THE DIFFERENCE BETWEEN ENTERPRISE VALUE AND WHAT IS VALUATION, AND WHAT IS IT USED FOR?
EQUITY VALUE?
• Valuation is the procedure of calculating the worth of an asset,
• SAMPLE ANSWER: Equity Value represents residual value for common security, company, etc. This is one of the primary tasks that
shareholders after the company satisfies its outstanding obligations (net investment bankers do for their clients.
debt, preferred stock, which is senior to common equity).
• Investment bankers are hired to value a company, often in the context
of purchasing another company, selling itself or divesting a division, or
raising capital.

• Investment bankers use valuation analyses in pitch books and other

presentations to guide clients toward what they should expect in
terms of investor interest.
EQUITY VALUE
• Private equity firms, hedge funds, asset managers, and others engage
in valuation techniques to determine which assets are undervalued,
Net Debt how much to pay for an asset, etc.

ENTERPRISE VALUE • SAMPLE ANSWER: Valuation is the procedure of calculating the worth
of an asset, security, company, etc.
Preferred Stock

Minority Interest

Valuation – Practice Questions 82

 Valuation Practice Questions – Basic

WOULD YOU BE CALCULATING ENTERPRISE VALUE OR EQUITY WHAT DOES SPREADING COMPS MEAN?
VALUE WHEN USING A MULTIPLE BASED ON FREE CASH FLOW
OR EBITDA? • “Spreading comps” is the task of collecting and calculating relevant
multiples for comparable companies. Sometimes an analyst can pull
• SAMPLE ANSWER: EBITDA and free cash flow represent cash flows the relevant multiples from a resource like CapitalIQ.
available to repay holders of a company’s debt and equity, so a multiple
based on one of those two metrics would describe the firm's value to all • However, sometimes you have to research a company’s data and
investors. financial information in their 10-K/10-Q to make sure they have
adjusted for non-recurring charges or irregular accounting across an
• A multiple such as the P/E ratio, based on earnings alone, represents the industry that can skew multiples across comparable companies.
amount available to common shareholders after all expenses are paid, so if
you used this multiple, you would be calculating the value of the firm’s • These charges can include one-time legal expenses, restructuring fees,
equity. asset write-downs, etc. These adjustments will be detailed in the
footnotes section of the financial statements.

• SAMPLE ANSWER: Spreading comps means calculating relevant

multiples from comparable companies and summarizing them for easy
analysis and comparison. It can be challenging when a company’s data and
financial information must be scoured to conduct the necessary research.

Valuation – Practice Questions 83

 Valuation Practice Questions – Basic

WHY MIGHT THERE BE MULTIPLE VALUATIONS OF A SINGLE HOW DO YOU DETERMINE WHICH VALUATION METHODOLOGY
COMPANY? TO USE?

• SAMPLE ANSWER: Each method of valuation will generate a different • SAMPLE ANSWER: Because each method has a unique ability to
value because it is based on different assumptions, different multiples, provide useful information, you don’t choose just one.
or different comparable companies and/or transactions.
• The best way to determine the value of a company is to use a
• Generally, the precedent transaction methodology and discounted cash combination of valuation techniques.
flow method lead to higher valuations than comparable companies
analysis or market valuation does.
• For example, if you have a precedent transaction valuation that you feel
is extremely accurate, you may give that result more weight. Or if you
• The precedent transaction result may be higher because the approach are extremely confident in your DCF analysis, you will place more
usually will include a “control premium” above the company’s market emphasis on its outcome. Valuing a company is as much an art as it is a
value to entice shareholders to sell and will account for the “synergies” science.
that are expected from the merger.
• The DCF approach normally produces higher valuations because
analysts’ projections and assumptions are usually somewhat optimistic.

Valuation – Practice Questions 84

 Valuation Practice Questions – Intermediate/Advanced

HOW MUCH WOULD YOU PAY FOR A COMPANY WITH $50 HOW WOULD YOU VALUE A COMPANY WITH NO REVENUE?
MILLION IN REVENUE AND $5 MILLION IN PROFIT?
• SAMPLE ANSWER: In order to value a company with no revenue,
• If this was the only information you were given, you could use such as a start up, you must project the company’s cash flows for future
multiples or a precedent transactions analysis. years and then construct a discounted cash flow model of those cash
flows using an appropriate discount rate.
• SAMPLE ANSWER: Since you have no information about historical or
projected performance, and no details about the firm’s capital structure, • Alternatively, you could use other operating metrics to value the
it would be impossible to do a DCF analysis. company as well. If you took a start-up website with 50,000
subscribers, but no revenue, you could look at a similar website’s value
• Assuming you know the firm’s industry, you could identify a group of
per subscriber and apply that multiple to the website you are valuing.
comparable companies and do a multiples analysis using the ratios from
those most relevant to the company being valued.

Valuation – Practice Questions 85

 Valuation Practice Questions – Intermediate/Advanced

IF YOU HAVE TWO COMPANIES THAT ARE EXACTLY THE SAME

IN REVENUE, GROWTH, RISK, ETC. BUT ONE IS PRIVATE AND ONE
IS PUBLIC, WHICH COMPANY’S SHARES WOULD BE HIGHER
PRICED?

• The public company most likely will be priced higher due to the
liquidity premium one would pay to be able to buy and sell the
shares quickly and easily in the public capital markets.
• Another reason the public shares should be priced higher would be
the transparency required for the firm to be listed on a public
exchange. Publicly traded companies are required to file audited
financial statements, allowing investors to view them.
• SAMPLE ANSWER: The public company is likely to be priced higher for
a couple of reasons. The main reason is the liquidity premium investors
will pay for the ability to trade their stock quickly and easily on public
exchanges.
• A second reason is a sort of “transparency premium” that derives from
the public company’s requirement to make their audited financial
documents public.

Valuation – Practice Questions 86

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87
DCF – Concepts
 What Is A Discounted Cash Flow Analysis (DCF)?

The DCF analysis values a company based on the present value (“NPV”) of the sum of its
Definition projected future free cash flows

Comparison

DCF Trading Comps Transaction Comps

• Used to value companies based on • Compares the value of similar • Compares the value of similar
future prospects companies that have the same companies that have the same
fundamental business model fundamental business model
• Generally considered to be a
fundamental valuation approach • Takes on a relative valuation • Takes on a relative valuation approach
approach
• All valuation methods generally rely • Shows what previous investors have
on the DCF in one way or another • Reflects the “market value” of a actually paid to acquire a target
company
• Reflects the “intrinsic value” of a • More relevant in M&A
company • Often more realistic since it shows
what current investors are currently • Less reflective of the current market
• Often unrealistic/optimistic because paying for a company environment since precedent
very dependent on assumptions transactions have occurred in the past
• Relies on the assumption that
companies with the same
fundamental operations should trade
at the same multiple

DCF - Concepts 89
 DCF vs. Relative Valuation Techniques

While the DCF is a highly analytical tool for determining a company’s Intrinsic Value, in practice, it may be less relevant than
the company’s Relative Valuation (implied by comps)

• Relative Valuation uses comparable

• DCF discounts a company’s future cash company multiples (i.e., multiples of
flows at WACC to derive the present Revenue, EBITDA, etc.) to derive a
value (its Intrinsic Value) company's Market Value

• Challenges with DCF Analysis: • Multiples allow us to compare comps

of different sizes, capital structures,
- Sensitivity to key assumptions, such as and other characteristics
Cost of Capital, Terminal Value, etc.
• In theory, Market Value and Intrinsic
- Performing a comprehensive analysis Value should equal one another in a
may require detailed company info perfect market
- Garbage data or assumptions will result
in a meaningless DCF-implied valuation

DCF - Concepts 90
 The DCF Process

Determine Terminal
Project FCF Calculate WACC Arrive At Valuation
Value

• Free Cash Flow represents • WACC is the weighted • Projecting FCF more • The summation of a
the cash generated by a average cost of capital than a few years (or in company’s present value
company that is available • Rate used discount future perpetuity) is hard, so of all future free cash
to all its financiers FCF to its value today we calculate a TV to flows would indicate its
• Focus on historical and (Present Value, or PV) reflect value in a steady intrinsic value
projected drivers of FCF – state from beyond • Consider variability of
• Dependent on whether projection
growth, profit, CapEx, the company is financed key inputs and
working capital needs, etc. by equity or debt • TV may comprise a large assumptions with
portion of DCF sensitivity analyses
valuation

• Perpetuity Growth or
Exit Multiple?

𝟎
𝑪𝑭𝟏 𝑪𝑭𝟐 𝐂𝐅 𝐧
Formula 𝑵𝑷𝑽 = 𝑪𝑭 + + + ⋯+ 𝒏
𝟏 + 𝑾𝑨𝑪𝑪 ൫𝟏 + 𝑾𝑨𝑪𝑪ሻ𝟐 𝟏 + 𝑾𝑨𝑪𝑪

DCF - Concepts 91
 Simplified DCF Example 1: Value Of An Annuity

Given Info
• You are considering selling your home and received a $1 million cash offer with no closing risks

• Alternatively, that same potential buyer offers to rent the home from you (rather than purchase it from you) for
$150,000 per year for 10 years. You can assume would not be obligated to fund any repairs or ongoing
maintenance costs

• Your discount rate is 3% per year

• Dec. 2019 if closing on sale; or the first year’s rent payment occurs in Dec. 2020

• Which proposal offers a higher value in today’s dollars?

Solution

Income
Stream:

$𝟏𝟓𝟎𝑲
$𝟏𝟓𝟎𝑲
= $𝟏𝟒𝟔𝑲
$𝟏𝟓𝟎𝑲
= $𝟏𝟒𝟏𝑲
$𝟏𝟓𝟎𝑲
= $𝟏𝟑𝟕𝑲 ....................................... = $𝟏𝟏𝟐𝑲
𝟏. 𝟎𝟑 𝟏. 𝟎𝟑𝟐 𝟏. 𝟎𝟑𝟐 𝟏. 𝟎𝟑𝟏𝟎

NPV = ~$1.28mm

DCF - Concepts 92
 Simplified DCF Example 2: Value Of A Perpetuity

Given Info
• A university alumnus wants to endow a professorship to fund emerging virus vaccine research

• However, the alumnus does not know how to determine the appropriate donation to fund it. The alumnus can
reliably assume the following:

1. Donation must fund the professor’s salary, agreed upon at $150K/year with a 5% annual increase

2. 10% discount rate

Solution

Value of Donation = Cash Flow to Fund Professor / (Discount Rate – Cash Flow Growth Rate)

Value of Donation = $150K / (.10 – .05) Value of Donation =

$3mm
Value of Donation = $150K / (.05)

DCF - Concepts 93
 The DCF Process: Projecting FCF

Determine Terminal
Project FCF Calculate WACC Arrive At Valuation
Value

• Free Cash Flow represents

the cash generated by a
company that is available
to all its financiers
• It can be Unlevered or
Levered depending if the
cash is available to all
investors or simply
shareholders
• Focus on historical and
projected drivers of FCF –
growth, profit, CapEx,
working capital needs, etc.

𝟎
𝑪𝑭𝟏 𝑪𝑭𝟐 𝐂𝐅 𝐧
Formula 𝑵𝑷𝑽 = 𝑪𝑭 + + + ⋯+ 𝒏
𝟏 + 𝑾𝑨𝑪𝑪 ൫𝟏 + 𝑾𝑨𝑪𝑪ሻ𝟐 𝟏 + 𝑾𝑨𝑪𝑪

DCF - Concepts 94
 Sector-Specific Enterprise Value Multiples

Concept There are 2 FCF metrics used in a DCF: (1) unlevered free cash flow and (2) levered free cash flow

Unlevered Free Cash Flow (UFCF) Levered Free Cash Flow (LFCF)

• Cash flows from core business operations

• Cash flows distributable to equity investors
distributable to debt and equity investors
Definition • In addition to costs from operating expenses, cash
• Haven’t been used to “service” debt (make
flows have been used to service debt and/or to
interest/principal payments) or for other capital
satisfy other senior obligations
structure items, like dividends or share repurchases

• UFCF = EBIT * (1 - MTR %) + D&A (and other non- • LFCF = Cash Flow from Operating Activities – CapEx
Formula
cash items) - CapEx +/(-) Decrease/(Increase) in NWC - Debt Principal Repayment

• Value of core business operations to all

investors/sources of capital • Value of the business to equity investors (after
What is being Valued?
satisfying senior obligations)
• Enterprise Value

• Weighted Average Cost of Capital (WACC) – • Cost of Equity – reflects cost and expected returns of
Relevant Discount Rate
blended cost of all sources of capital JUST equity capital

DCF - Concepts 95
 Locating Relevant Information To Project Free Cash Flow

Sources of information to project free cash flow can vary in terms of the detail they provide and
Concept the creativity they require from the finance professional

Comparison

Management Guidance Research Reports Other Sources

• Ideal source for any company • Consensus estimates for Revenue, • With no management guidance or
projection, especially for privately- EBITDA, EBIT, etc., often form the equity research reports, use publicly
held businesses basis of public company projections available historical financial data,
current sector trend info., and
• However, in practice, you will not • Equity research reports may provide consensus estimates for public comps
always have access to management 2-3 years of high-level projections (or
guidance or projections even sometimes a full 3-statement • Get creative and use sources that you
mode) believe are relevant to your target

DCF - Concepts 96
 Calculating UFCF (Illustrative)

Hypothetical situation: Coca-Cola is considering a spin-out and IPO of its energy drink segment. Potential investors would
like to evaluate the business’ cash flows

Calculate the energy drink segment’s annual UFCF based

Solution:
on the below assumptions:

• It is currently 6/30/19. The spin-out will close on

12/31/19. Future cash flows assumed to occur on
each future 12/31
• Spin out requires a $50mm cash investment at close to
fund equipment replacements and maintenance;
estimated 5 yr. useful life and no salvage value
(straight-line depreciation)
• Sales projections:
▪ 2020: 50K units @ $1.60 / unit
▪ 2021: 70K units @ $1.60 / unit
▪ 2022: 100K units @ $1.75 / unit
▪ 2023: 80K units @ $1.75 / unit
▪ 2024: 40K units @ $1.75 / unit
• COGS: 75% of Revenue
• SG&A / Other OpEx: 6% of Revenue
Annual UFCF is forecasted to be ~$18mm in
2020, growing to a peak of ~$32mm in 2022
• Tax Rate: 21%
based on Revenue of $80-$175mm
• Working capital as % of Sales: 5%; Existing Working
Cap: $250k

DCF - Concepts 97
 Calculating UFCF (Illustrative)

Hypothetical situation: Coca-Cola is considering a spin-out and IPO of its energy drink segment. Potential investors would
like to evaluate the business’ cash flows

Solution:
Given Assumptions

• It is currently 6/30/23. The spin out will close on Units Sold

12/31/23. Future cash flows assumed to occur on (x) Average Price Per Unit
each future 12/31
= Total Revenue
• Spin out requires a $50mm cash investment at close to
(-) COGS (Excl. Depreciation)
fund equipment replacements and maintenance;
estimated 5 yr. useful life and no salvage value = Gross Profit
(straight-line depreciation)
(-) SG&A(Excl. Depreciation)
• Sales projections: = EBITDA
▪ 2024: 50K units @ $1.60 / unit (-) D&A

▪ 2025: 70K units @ $1.60 / unit = EBIT

▪ 2026: 100K units @ $1.75 / unit (-) Taxes

▪ 2027: 80K units @ $1.75 / unit (-) Change in NWC

▪ 2028: 40K units @ $1.75 / unit (+) D&A

(-) CapEx
• COGS: 75% of Revenue
= Unlevered Free Cash Flow
• SG&A / Other OpEx: 6% of Revenue
• Tax Rate: 21%
• Working capital as % of Sales: 5%; Existing Working
Cap: $250k

DCF - Concepts 98
 Calculating UFCF (Illustrative)

Solution

('000) 2023 2024 2025 2026 2027 2028

Unit Sold 50,000 70,000 100,000 80,000 40,000
Avg. Price Per Unit $ 1.60 $ 1.60 $ 1.75 $ 1.75 $ 1.75

Total Revenue $ 80,000 $ 112,000 $ 175,000 $ 140,000 $ 70,000

(-) COGS (excl. Depreciation) 60,000 84,000 131,250 105,000 52,500

Gross Profit $ 20,000 $ 28,000 $ 43,750 $ 35,000 $ 17,500

Gross Margin (%) 25% 25% 25% 25% 25%
(-) SG&A (excl. Depreciation) 4,800 6,720 10,500 8,400 4,200

EBITDA $ 15,200 $ 21,280 $ 33,250 $ 26,600 $ 13,300

(-) D&A 10,000 10,000 10,000 10,000 10,000

EBIT $ 5,200 $ 11,280 $ 23,250 $ 16,600 $ 3,300

(-) Taxes
(1,092) (2,369) (4,883) (3,486) (693)
(-) Changes in NWC 3,750 1,600 3,150 (3,500)
(1,750)
(+) D&A 10,000 10,000 10,000 10,000 10,000
(-) CapEx 50,000 - - - - -

Unlevered Free Cash Flow $ (50,000) $ 17,858 $ 20,511 $ 31,518 $ 21,364 $ 9,107
Annual UFCF forecasted to be ~$10mm in 2024, growing to a peak of ~$25mm in 2026 based on Revenue of $80-$175mm

DCF - Concepts 99
 Calculating Net Working Capital

Net Working Capital (NWC) = Value of all non-cash current assets – Value of non-interest-bearing liabilities

• Increases in current assets mean use of cash flow, and increases in current liabilities mean sources of cash flow – WHY?
• Increases in A/R are uses of cash – funds that the company hasn’t yet collected from its sales
• Increases in A/P are sources of cash – funds the company hasn’t paid for its obligations (thus, cash remains in the bank)

Example 1: Calculating Net Working Capital Example 2: Calculating Net Working Capital

Assets Liabilities Assets Liabilities

▪ Cash: $100 ▪ A/P: $175 ▪ Cash: $100 ▪ A/P: $375
▪ A/R: $250 ▪ Accrued Liabilities: $100 ▪ A/R: $450 ▪ Accrued Liabilities: $150
▪ Inventory: ▪ Other Current Liabilities: $5 ▪ Inventory: $80 ▪ Other Current Liabilities: $75
$200
▪ Current Portion of LT Debt: $10 ▪ Prepaids: $20 ▪ Current Portion of LT Debt: $10
▪ Prepaids: $50

NWC = $220 NWC = -$50

Note: A positive NWC signals that current assets are sufficient to meet
its current liabilities, and vice versa

DCF - Concepts 100

 Calculating Changes in Net Working Capital

Changes in Net Working Capital (∆NWC) = NWC this year– NWC last year

Example 1: Annual Changes in Net Working Capital Alternative Presentation of Annual Change in NWC
Calculate the annual change in NWC for Company A Calculate the annual change in NWC for Company A
based on the below current assets and liabilities: based on the below current assets and liabilities:

An increase in NWC represents a decrease in cash, whereas a decrease in NWC represents an increase in cash

DCF - Concepts 101

 Estimating Net Working Capital

There are techniques beyond growing revenue, increasing margins and managing CapEx we need
Concept to understand before forecasting and driving UFCF calculations

Unlevered Free Cash Flow (UFCF)

• Projecting the individual components of NWC (current assets and liabilities) for each year based on historical ratios from the
prior 1-3 years (also taking into account expected future trends / developments based on guidance or management outlook)
Detailed Balance • Preferred method for projecting NWC since it allows us to “toggle” individual variables that may be key drivers of NWC and,
Sheet Approach ultimately, UFCF generation
• For example, for companies with a significant % of A/R due from government entities/contracts (which are notoriously slow
to pay), we would ideally like to understand the sensitivity of UFCF to the speed of collecting that A/R

“Quick & Dirty”

• UFCF = EBIT * (1 - MTR %) + D&A (and other non-cash items) - CapEx +/(-) Decrease/(Increase) in NWC
Approach

DCF - Concepts 102

 Calculating Net Working Capital

Concept A company’s historical ratios can be used to estimate its balance sheet items

Item Applicable Ratio(s) Formula(s) Description & Application

𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 • Measures # of days it takes to collect payments from

Days Sales Outstanding ∗ 365
Accounts Receivable 𝑆𝑎𝑙𝑒𝑠 customers after selling a good or service
(DSO)
• Lower number of days reflects a faster cash collection

• DIH: # of days it takes a company to sell its inventory –

Days Inventory Held (DIH) • Inventory / COGS * 365 lower # reflects faster sales cycle
Inventory
/ Inventory Turns • COGS / Inventory • Turns: # of times a company “turns over” its inventory in
a given year

Prepaid Expenses / • Prepaid Expenses / Sales • Both prepaids and other current assets are typically
% of Sales
Other Current Assets • Other Current Assets / Sales projected based on an assumed % of sales

• Measures # of days it takes to make payments to

Days Payable Outstanding 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 vendors after buying an input/service
Accounts Payable ∗ 365
(DPO) 𝐶𝑂𝐺𝑆 • Higher number of days reflects more favorable vendor
terms

Accrued Expenses / • Accrued Expenses / Sales • Accrued expenses and other current liabilities are
Other Current % of Sales
• Other Current Liabilities / Sales typically projected based on an assumed % of sales
Liabilities

DCF - Concepts 103

 Calculating WACC

Determine Terminal
Project FCF Calculate WACC Arrive At Valuation
Value

• WACC is the weighted

average cost of capital
• Rate used discount future
FCF to its value today
(Present Value, or PV)
• Dependent on whether
the company is financed
by equity or debt

𝟎
𝑪𝑭𝟏 𝑪𝑭𝟐 𝐂𝐅 𝐧
Formula 𝑵𝑷𝑽 = 𝑪𝑭 + + + ⋯+ 𝒏
𝟏 + 𝑾𝑨𝑪𝑪 ൫𝟏 + 𝑾𝑨𝑪𝑪ሻ𝟐 𝟏 + 𝑾𝑨𝑪𝑪

DCF - Concepts 104

 WACC Overview

Definition
• WACC represents a given company’s weighted average return on invested capital based on that company’s underlying capital
structure

• Debt and equity components have different “expected” returns and tax implications and thus need to be analyzed
independently before combining

• Companies with similar WACC are deemed equally as risky and demand the same return (hence the similar cost of capital)

Formula

Debt Equity Where:

• rd = Cost of Debt
• re = Cost of Equity
(After-tax Cost of Debt * % of (Cost of Equity * % of Equity in
• T = Marginal Tax Rate
Debt in Capital Structure) Capital Structure)
• D = Market Value of Debt
• E = Market Value of Equity
𝐷 𝐸
(𝑟𝑑 ∗ (1 − 𝑡ሻሻ ∗ 𝑟𝑒 ∗ • V = Total Value (D + E)
𝑉 𝑉

WACC is critical to a DCF analysis, as it represents the annual rate that free cash flows in the future are discounted by, so it is
critical to understand its composition intuitively

DCF - Concepts 105

 Formula For Weighted Average Cost Of Capital

WACC represents a firm’s weighted average return on invested capital based on its underlying capital structure. It is also
the discount rate applied to future UFCF to derive DCF-based EV

Term Equation

Weighted Average 𝑫 𝑬
Cost of Capital
𝐖𝐀𝐂𝐂 = 𝑹 𝐱 1 − 𝐓𝑐 + 𝑹
(WACC)
𝑽 d 𝑽 e

Equation Name Where to Find It

• Book value of debt can usually serve as a proxy as long as the debt does not
𝑫 Market Value of Debt /
trade at meaningful discounts or premiums to par; otherwise use market value
𝑽 Total Firm Value (E + D)
• Capital structure should be representative of company’s long-term target

• Blended current yield on debt outstanding (Bloomberg for public debt)

𝑹𝒅 Cost of Debt
• Yields of debt with similar credit ratings for a private company (Moody’s / S&P)

𝑹𝒆 Cost of Equity • Can be derived from the CAPM equation

𝐓𝐜 Corporate Tax Rate • Marginal tax rate; often assumed to equal US corp. tax rate (currently 21%)

𝑬 Market Value of Equity / • Can be found by calculating or researching a company’s Market Cap
𝑽 Total Firm Value (E + D) • Capital structure should be representative of company’s long-term target

DCF - Concepts 106

 Capital Asset Pricing Model

CAPM calculates the cost (expected return) of equity capital based on expected stock market performance and risks and
the company’s share price sensitivity to movements in the overall market (beta)

Term Equation

Capital Asset Pricing

Model (CAPM) 𝐂𝐀𝐏𝐌: 𝑹e = 𝑹f + 𝜷 (𝑹m − 𝑹f ሻ

Equation Name Where to Find It

𝑹𝒆 Re (cost of equity) • Derived from CAPM

• Current yield on US 10-year bond is preferred 𝑹𝒇 proxy in US

𝑹𝒇 Risk-free Rate • Reflects YTM of “riskless” government bonds of equivalent maturity to the duration of
each cash flows being discounted
Market Risk • Excess expected market return (typically the S&P 500) over that of the risk-free rate;
𝑹𝐦 − 𝑹𝒇
Premium assumptions vary but generally 5-8%
Asset Beta
𝜷 • Can be derived from the Asset Beta equation (following page)
(Unlevered Beta)

DCF - Concepts 107

 Unlevering Beta Calculation

Unlevered Beta (aka Asset Beta) is a metric that reflects the sensitivity of a company’s share price to movements in the
overall market (i.e., S&P 500)

Term Equation
𝛃𝐞
TermBeta
Unlevered 𝛃𝐚 = 𝑬 𝑫
Calculation 𝑫 𝐎𝐑 𝛃𝐚 = 𝜷 + 𝜷
1 + 1 − 𝐓𝐜
𝑬 𝑽 𝐞 𝑽 𝐝

Equation Name Where to Find It

𝑹𝒆 Re (cost of equity) • Derived from CAPM

• Current yield on US 10-year bond is preferred 𝑹𝒇 proxy in US

𝑹𝒇 Risk-free Rate • Reflects YTM of “riskless” government bonds of equivalent maturity to the duration of
each cash flows being discounted
Market Risk • Excess expected market return (typically the S&P 500) over that of the risk-free rate;
𝑹𝐦 − 𝑹𝒇
Premium assumptions vary but generally 5-8%
Asset Beta
𝜷 • Can be derived from the Asset Beta equation (following page)
(Unlevered Beta)

DCF - Concepts 108

 Interpreting Beta

Can you guess which of these two companies has a greater Beta?

Key Themes
• Tech & media industry • Gaming / leisure industry
• Core business of ad-sales is somewhat cyclical but less • Highly cyclical business Beta = 2.23!
relative to other industries
• Extremely competitive market
• Business units in other industries help provide
diversification
Beta = 1.16

Interpretation: Meta’s share price is only 16% more volatile than the S&P, but MGM’s share price is 123% more
volatile than the S&P

DCF - Concepts 109

 Example: Calculating Cost Of Equity

Question
Max’s Bikes is financed by a combination of both debt and equity. Max gave us the following information they have
on hand and asked for our help to find the following numbers:

Given Information
𝑹𝒆 ? 𝑹𝒅 5% 𝐖𝐀𝐂𝐂 ?
𝜷 1.3 𝑻𝑪 .21 𝑹𝒎 9%
𝑬 𝑫
𝑹𝒇 2% .7 .3
𝑽 𝑽

Solution

To find 𝑹𝒆 , we want to use the CAPM equation

𝑹𝒆 = 𝟏𝟏. 𝟏%
𝐂𝐀𝐏𝐌: 𝑹𝒆 = 𝑹𝒇 + 𝜷 (𝑹𝒎 − 𝑹𝒇 ሻ

DCF - Concepts 110

 Example: Calculating WACC

Question
Max’s Bikes is financed by a combination of both debt and equity. Max gave us the following information they have
on hand and asked for our help to find the following numbers:

Information on Cost of Capital

𝑹𝒆 ? 𝑹𝒅 5% 𝐖𝐀𝐂𝐂 ?
𝜷 1.3 𝑻𝑪 .21 𝑹𝒎 9%
𝑬 𝑫
𝑹𝒇 2% .7 .3
𝑽 𝑽

Solution

We then use the WACC equation

𝑫 𝑬 𝑾𝑨𝑪𝑪 = 𝟗. 𝟎%
𝐖𝐀𝐂𝐂 = 𝐑 𝐝 × (𝟏 − 𝑻𝑪 ሻ + 𝑹
𝑽 𝑽 𝒆

DCF - Concepts 111

 How Does WACC Fit Into Valuation?

You would use WACC to discount unlevered free cash flows, and CAPM to discount levered free
Concept cash flows

Unlevered Free Cash Flow (UFCF)

𝑪𝑭1 𝑪𝑭2
Net Present 𝐍𝐏𝐕 = 𝑪𝑭0 + + + ⋯,
Value (NPV) 1 + 𝑾𝑨𝑪𝑪 ൫1 + 𝑾𝑨𝑪𝑪ሻ2

Weighted 𝑫 𝑬
Average Cost of 𝐖𝐀𝐂𝐂 = 𝑹𝒅 𝐱 1 − 𝐓𝐜 + 𝑹𝒆
𝑽 𝑽
Capital (WACC)

Capital Asset
Pricing Model 𝐂𝐀𝐏𝐌 = 𝑹𝒊 = 𝑹𝒇 + 𝜷 (𝑹𝒎 − 𝑹𝒇ሻ
(CAPM)

𝛃𝐞 𝑬 𝑫
Unlevered Beta 𝛃𝐚 = 𝑫 𝛃𝐚 = 𝜷𝐞 + 𝜷𝐝
1+ 1−𝐓𝐜 𝑽 𝑽
𝑬

DCF - Concepts 112

 Projecting Terminal Value

Determine Terminal
Project FCF Calculate WACC Arrive At Valuation
Value

• Projecting FCF for more

than a few years (or in
perpetuity) is hard, so
we calculate a TV to
reflect value in a steady
state from beyond
projection

• TV may comprise a large

portion of DCF
valuation

• Perpetuity Growth or
Exit Multiple?

𝟎
𝑪𝑭𝟏 𝑪𝑭𝟐 𝐂𝐅 𝐧
Formula 𝑵𝑷𝑽 = 𝑪𝑭 + + + ⋯+ 𝒏
𝟏 + 𝑾𝑨𝑪𝑪 ൫𝟏 + 𝑾𝑨𝑪𝑪ሻ𝟐 𝟏 + 𝑾𝑨𝑪𝑪

DCF - Concepts 113

 Projecting Terminal Value

The DCF analysis includes the concept of a Terminal Value, which represents the Present Value of
Concept all the free cash flows generated after the projection period (in perpetuity)

Final year of projection period Known as the “Present

must represent “steady state” Value of the Terminal
performance (not the peak or Value” (PV of TV)
trough of an industry cycle)

TV Formula derives
TV assumes FCF An alternative
the PV at end of the
approach is known
grows at a constant projection period; it
as the “Exit Multiple
rate in perpetuity needs to be
Method”
discounted to T0

DCF - Concepts 114

 Terminal Value – Perpetuity Growth Method

Perpetuity Growth Method

• Uses UFCF from the final year of projection as a base for annual FCF in perpetuity, along with an assumed FCF perpetual
growth rate to calculate the Terminal Free Cash Flow

• TV first needs to be discounted to the end of the projection period (using the formula below) and then discounted further to
the present day

• Perpetual growth rate should be a sustainable FCF growth rate in the long-term (often industry specific but usually in the 2-
4% range, in line with GDP)

• Highly impacts the DCF-based valuation, so sensitizing and using a range is recommended

Formula
𝟐 𝟑
𝐓𝐕 𝐅𝐂𝐅 𝐅𝐂𝐅(𝟏 + 𝐠ሻ 𝐅𝐂𝐅 𝟏 + 𝐠 𝐅𝐂𝐅 𝟏 + 𝐠

⋯⋯⋯∞

0 1 2 3 4

where,
𝐅𝐂𝐅
𝐓𝐞𝐫𝐦𝐢𝐧𝐚𝐥 𝐕𝐚𝐥𝐮𝐞(𝐓𝐕ሻ = • r = relevant discount rate
𝒓−𝒈
• g = perpetual growth rate

There are two methods commonly used to derive a company’s Terminal Value – (1) Perpetuity Growth Method and
(2) Exit Multiple Method

DCF - Concepts 115

 Terminal Value – Exit Multiple Method

Exit Multiple Method

• Calculates TV on the basis of a multiple of Terminal Year EBITDA

• Multiple usually based on most recent LTM valuation multiples based on trading comps (assuming normalized)

• Highly impacts the DCF-based valuation, so sensitizing and using a range is recommended

• Frequently used in practice as it depends less on assumptions for perpetual cash flows and growth

Formula

𝐓𝐞𝐫𝐦𝐢𝐧𝐚𝐥 𝐕𝐚𝐥𝐮𝐞 𝐓𝐕 = 𝐓𝐞𝐫𝐦𝐢𝐧𝐚𝐥 𝐄𝐁𝐈𝐓𝐃𝐀 × 𝐄𝐱𝐢𝐭 𝐌𝐮𝐥𝐢𝐭𝐩𝐥𝐞

There are two methods commonly used to derive a company’s Terminal Value – (1) Perpetuity Growth Method and
(2) Exit Multiple Method

DCF - Concepts 116

 Which Method Is Better?

Neither, both methods for calculating Terminal Value are often used in tandem and are cross-referenced as a sanity check

Implied Perpetual Growth Rate (Based on Exit Multiple)

= ((Terminal Value using Exit Multiple * WACC) – FCF in final year of projection period)
(Terminal Value using Exit Multiple + FCF in final year of projection period)

• An implied perpetual growth rate that is too high or too low may indicate your exit multiple assumptions are
unrealistic

Implied Exit Multiple (Based on Perpetual Growth Rate)

= Terminal Value using Perpetual Growth

EBITDA in final year of projection period

• An implied exit multiple that is not in line with the trading multiples of its peers (or even the company’s own
historical trading levels) may indicate unrealistic perpetual growth assumptions

DCF - Concepts 117

 Example: Calculating Terminal Value

As a reminder, Coca-Cola is hypothetically considering a spin-out of its energy drink segment. Investors evaluated its
potential cash flows and now need to derive its TV

Use the annual UFCF projections and assumptions below Solution Using Perpetual Growth
to calculate the Terminal Value under both methods:
• It is currently 6/30/23. The spin-out will close on 𝑻𝑽 × (𝟏 + 𝒈ሻ
=
12/31/23. Future cash flows assumed to occur on each 𝒓 −𝒈
future 12/31
• PGM: WACC of 7%; Perpetual growth rate of 3% $𝟏𝟔, 𝟏𝟎𝟕𝑲 ∗ (𝟏 + 𝟎. 𝟎𝟑ሻ = $414
• EMM: Exit multiple of 10x EBITDA =
million
𝟎. 𝟎𝟕 − 𝟎. 𝟎𝟑

Unlevered Free Cash Flows

BONUS QUESTION! What is the implied exit multiple?

𝑻𝑽 $𝟒𝟏𝟒
= = = 𝟑𝟏. 𝟏𝟖x
𝑻𝒆𝒓𝒎𝒊𝒏𝒂𝒍 𝑬𝑩𝑰𝑻𝑫𝑨 $𝟏𝟑. 𝟑

Solution Using Exit Multiple

= 𝑻𝒆𝒓𝒎𝒊𝒏𝒂𝒍 𝑬𝑩𝑰𝑻𝑫𝑨 × 𝑬𝑩𝑰𝑻𝑫𝑨 𝑴𝒖𝒍𝒕𝒊𝒑𝒍𝒆

= 13,300 * 10 = $133 million

DCF - Concepts 118

 Arriving At A Valuation

Determine Terminal
Project FCF Calculate WACC Arrive At Valuation
Value

• The summation of a
company’s present value
of all future free cash
flows would indicate its
intrinsic value
• Consider variability of
key inputs and
assumptions with
sensitivity analyses

𝟎
𝑪𝑭𝟏 𝑪𝑭𝟐 𝐂𝐅 𝐧
Formula 𝑵𝑷𝑽 = 𝑪𝑭 + + + ⋯+ 𝒏
𝟏 + 𝑾𝑨𝑪𝑪 ൫𝟏 + 𝑾𝑨𝑪𝑪ሻ𝟐 𝟏 + 𝑾𝑨𝑪𝑪

DCF - Concepts 119

 Moving From Enterprise Value to Equity Value

After discounting both UFCF and the Terminal Value to PV to derive a DCF-based Enterprise Value, we bridge to Equity
Value (to calculate an implied share price) with “Net Debt”

$7,000
Technically, the correct calculation of Net
Debt is Total Debt minus Cash / Cash
$6,000 Equivalents
$1,000
$5,000 $250
$350

$4,000

$3,000 $5,952 However, some industry professionals use the

shorthand “Net Debt” to refer to all of the items
$5,052
included above
$2,000

$1,000

$0
Enterprise Value Total Debt Non-Controlling Interest Cash Equity Value

DCF - Concepts 120

 Additional Consideration On Fully Diluted Shares Outstanding

Ensure your calculation of Market Cap is based on Fully Diluted Shares Outstanding (as opposed
Concept to Basic Shares). Otherwise, the Market Cap will be understated

FDSO = Basic Shares Outstanding + Shares from Dilutive Securities

• Information on a company’s dilutive securities is included in a company’s most recent 10-K

• Search for options “exercisable”, “options outstanding”, or “granted”

• Trading comps analyses make adjustments to the basic share count and add dilutive securities (i.e. options, warrants,
convertible debt, etc.) that are currently “in-the-money”

“In-the-money” dilutive securities are those with a strike price < current price per share

DCF - Concepts 121

 Additional Detail: Fully Dilutive Shares Outstanding

Descriptions of Potentially Dilutive Securities

Stock Options Warrants Convertible Debt Other (Convert Prf., RSUs)

• Issued to motivate and • Similar to options – allows • Bonds issued by a • Convertible preferred
compensate employees (in holder to purchase company that can convert stock is similar in nature
a non-cash form) common shares at a into common shares at a and treatment to
certain price certain strike price convertible bonds
• Employee may be able to
• If warrants are exercised, • The ability to convert • RSUs are similar to Stock
purchase common stock at
the holder must pay the provides flexibility to the Options – non-cash
a given price (strike price)
company a certain amount company because it can compensation used to
in the future up until a
of cash to acquire the raise capital at a entice employees
defined expiration date
shares compelling cost with
• RSUs are issued to
• Options are “in-the- limited incremental risk
• Occasionally issued as part employees over a longer
money” if strike price < of debt capital raises time period (vesting
current share price period) to entice that
• In these situations, the
employee to stay
• Options are “out-of-the- debt continues as an
money” if strike price > outstanding liability even • Once vested, RSUs
current share price if warrants are exercised convert to common shares

DCF - Concepts 122

 Basic FDSO Exercises

Exercise One Exercise Two Exercise Three

Assumptions: Assumptions: Assumptions:

• A public company has equity value • In-the-money options are • Company issued 10mm shares of
of $250mm and 50mm shares exercised by employees, resulting convert. pref. stock, which are
outstanding in 12.5mm additional shares now in-the-money

• Assume a $0 strike price • Each pref. share converts to 2

common

Question:
Question: Question:
• What do you expect the new share
• What do you expect the price per • What do you expect the new share price to be?
share to be? price to be?

$𝟐𝟓𝟎𝒎 $𝟐𝟓𝟎𝒎 $𝟐𝟓𝟎𝒎

𝟓𝟎𝒎 𝒔𝒉𝒂𝒓𝒆𝒔 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 𝟔𝟐. 𝟓𝒎 𝒔𝒉𝒂𝒓𝒆𝒔 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 𝟖𝟐. 𝟓𝒎 𝒔𝒉𝒂𝒓𝒆𝒔 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈
= $𝟓 𝑷𝒆𝒓 𝒔𝒉𝒂𝒓𝒆 = $𝟒 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆 = $𝟑 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆

10mm preferred shares * 2:1 conversion ratio =

20mm incremental common shares

DCF - Concepts 123

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124
DCF – Practice Questions
 DCF Practice Questions – Basic

WHAT CAN A COMPANY USE FREE CASH FLOW FOR? WALK ME THROUGH A DCF

• Free cash flow is the cash that is available to its financiers. Unlevered • Start with projecting a company’s free cash flow for the next ~5 years
free cash flow is cash that is available to both debt & equity holders.
Levered free cash flow is cash that is available to equity holders after • Determine the company’s discount rate using WACC
all debt service obligations are met
• Estimate the company’s terminal value under the assumption that it
• There are many ways a company can use free cash flow. A Company will operate forever (as a going concern)
can use free cash flow to pay back its financiers through tenders of
outstanding debt (debt holders), dividends (equity holders), or share • Discount the company’s free cash flow and terminal value using its
buybacks (equity holders). WACC to find its present value

• However, free cash flow can also be used for other purposes, such as • The sum of the present value of all cash flows will lead to the
growth or maintenance capex, other investments, M&A, or to build company’s enterprise value
cash balances on a balance sheet.
• Subtract a company’s net debt and cash flow to all non-equity
shareholders to reach a market value

• Divide the remaining free cash flow by its fully diluted shares
outstanding to reach an intrinsic share price

DCF – Practice Questions 126

 DCF Practice Questions – Basic

WHAT HAPPENS TO FREE CASH FLOW IF NET WORKING CAPITAL WHAT WOULD BE THE EFFECT OF USING LEVERED FREE CASH
INCREASES? FLOW RATHER THAN UNLEVERED FREE CASH FLOW IN YOUR
DCF MODEL?
• Intuitively, you can think of working capital as the net dollars tied up
to run the business. As more cash is tied up (in accounts receivable, • SAMPLE ANSWER: If you were to use the levered free cash flow in your
inventory, etc.), free cash flow will be reduced. DCF, you would end up with the Equity Value of the company rather than
the Enterprise Value since the cash flows you are finding the present value
• If an asset goes up, this is a use of cash; if a liability goes up; it is a for are after the debt investors had been repaid, therefore indicating how
source of cash. You subtract the change in Net Working Capital when much cash would be available to equity investors, not to all investors.
you calculate Free Cash Flow, so if Net Working Capital increases,
your Free Cash Flow decreases and vice versa.

• Free Cash Flow = EBIT (1 – tax rate) + D&A – change in net working
capital - capex

DCF – Practice Questions 127

 DCF Practice Questions – Basic

WHAT IS THE DIFFERENCE BETWEEN A DCF AND A HOW DO YOU CALCULATE A FIRM’S TERMINAL VALUE?
COMPARABLE COMPANY ANALYSIS? WHICH ONE GIVES A
HIGHER VALUATION, AND WHICH ONE IS PREFERRED? • SAMPLE ANSWER: There are two ways to calculate terminal value. The
first is the terminal multiple method.
• A DCF sums the present value of all free cash flow and terminal value
to estimate the intrinsic value of a company best • To use this method, you choose an operation metric (most commonly
EBITDA) and apply a comparable company’s multiple to that number from
• A comparable company analysis compares the relevant valuation the final year of projections.
multiples of similar companies that exist in the market (e.g. Pepsi &
Coca-Cola) to measure the relative value of a company against its • The second method is the perpetuity growth method, where you choose a
peers modest growth rate, usually just a bit higher than the inflation rate or GDP
growth rate and assume that the company can grow at this rate infinitely.
• The value implied by a DCF tends to be more variable than other
methodologies, as the implied value can vary widely based on the • You then multiply the FCF from the final year by 1 plus the growth rate
assumptions. While a DCF can often produce a higher valuation, it can and divide that number by the discount rate (WACC) minus the assumed
just as easily produce a lower valuation depending on the assumptions. growth rate.
Neither valuation method is preferred, as each method has its own
unique trade-offs. When valuing a company, it is best to use both
methods for both comparison’s sake and as a sanity check

DCF – Practice Questions 128

 DCF Practice Questions – Basic

WHAT IS WACC, AND HOW DO YOU CALCULATE IT? ALL ELSE EQUAL, SHOULD THE WACC BE HIGHER FOR A
COMPANY WITH $100 MILLION OF MARKET CAP OR A
• It reflects the overall cost of a company raising new capital, which is COMPANY WITH $100 BILLION OF MARKET CAP?
also a representation of the riskiness of investment in the company.
• Normally the larger company will be considered “safer” and, therefore
• WACC represents the blended cost (or return on the invested capital) will have a lower WACC. However, depending upon their respective
to both debt holders and equity holders based on the cost of debt and capital structures, the larger company could have a higher WACC.
the cost of equity for that specific firm.
• SAMPLE ANSWER: Without knowing more information about the
𝑫 𝑬 companies, it is impossible to say. If the capital structures are the same,
𝐖𝐀𝐂𝐂 = 𝑹 𝐱 1 − 𝐓𝑐 + 𝑹 then the larger company should be less risky and therefore have a lower
𝑽 d 𝑽 e
WACC. However, if the larger company has a lot of high-interest debt, it
• SAMPLE ANSWER: WACC is the acronym for Weighted Average Cost of could have a higher WACC.
Capital. It is used as the discount rate in a discounted cash flow analysis to
calculate the present value of a company’s cash flows and terminal value.

• It reflects the overall cost of a company’s raising new capital, which is also
a representation of the riskiness of investing in the company.

• Mathematically, WACC is the percentage of equity in the capital structure

times the cost of equity (calculated by the Capital Assets Pricing Model)
plus percentage of debt in the capital structure times one minus the
corporate tax rate times the cost of debt—current yield on outstanding
debt

DCF – Practice Questions 129

 DCF Practice Questions – Basic

WHAT IS THE CAPITAL ASSETS PRICING MODEL? WHERE DO YOU FIND THE RISK-FREE RATE?

• Used to calculate the required/expected return on equity (ROE), or the • The risk-free rate is usually the current yield on the 10-year
cost of equity of a company government treasury, which can be found on the front page of The
Wall Street Journal, on Yahoo! Finance, etc.
𝑅𝑒 = 𝑅𝑓 + 𝛽 𝑅𝑚 − 𝑅𝑓
• This is considered “risk-free” because the U.S. government is
• SAMPLE ANSWER: The Capital Assets Pricing Model, referred to as considered to be a risk-free borrower, meaning the government is
CAPM, is used to calculate the required return on equity or the cost of expected never to default on its debt.
equity. The return on equity is equal to the risk free rate (usually the yield
on a 10-year U.S. government bond) plus the company’s beta (a measure
of the stock’s volatility in relation to the stock market) times the market
risk premium.

DCF – Practice Questions 130

 DCF Practice Questions – Intermediate/Advanced

WHAT’S THE DIFFERENCE BETWEEN LEVERED AND UNLEVERED HOW WOULD YOU CALCULATE THE WACC OF A PRIVATE
BETA? WALK ME THROUGH THE PROCESS OF FINDING BOTH. COMPANY?

• Levered Beta is the normal, unadjusted Beta for a company that you • SAMPLE ANSWER: Since a private company has no market capitalization
can find on Bloomberg or Yahoo Finance. Levered Beta includes the and no beta, you would most likely use the WACC for a comparable public
effects of an individual company’s capital structure and debt load. company.

• Unlevered Beta removes the financial effects of debt in the capital

structure to allow for better comparisons.

• Comparing unlevered betas allows investors to see how much risk

they will be taking by investing in a company’s equity (i.e., buying stock
in the public market).

• When you have a company that doesn’t have a beta, Company A, you
can find comparable Company B, take its levered beta, unlever it, and
then re-lever it using Company A’s capital structure to come up with
their beta.

DCF – Practice Questions 131

 DCF Practice Questions – Intermediate/Advanced

HOW WOULD A $10 INCREASE IN DEPRECIATION IN YEAR 4 WHAT WOULD BE THE EFFECT OF USING LEVERED FREE CASH
AFFECT THE DCF VALUATION OF A COMPANY? FLOW RATHER THAN UNLEVERED FREE CASH FLOW IN YOUR
DCF MODEL?
• SAMPLE ANSWER: A $10 increase in depreciation decreases EBIT by
$10, therefore reducing EBIT (1-T) by$10(1-T). • SAMPLE ANSWER: If you were to use the levered free cash flow in your
DCF, you would end up with the Equity Value of the company rather than
• Assuming a 40% tax rate, it drops EBIT (1-T) by $6, but you must add back the Enterprise Value since the cash flows you are finding the present value
the $10 depreciation in the calculation of Free Cash Flow. for are after the debt investors had been repaid, therefore indicating how
much cash would be available to equity investors, not to all investors.
• Therefore, your FCF increases by $4, and your valuation will increase by
the present value of that $4 (the equation for PV is below).

$4
𝑃𝑉 𝑜𝑓 𝑡ℎ𝑒 $4 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑦𝑒𝑎𝑟 4 = 4
1 + 𝑊𝐴𝐶𝐶

DCF – Practice Questions 132

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133
LBO – Concepts
 Key Terms & Definition

LBO Terminology

LBO Leveraged Buy Out

Sponsor Private Equity (PE) Fund

Leverage Debt

Equity Sponsor Cash “Down Payment” (non-debt source of cash to finance the deal)

Portfolio Company (“Portco”) A company that a PE firm owns

IRR Internal Rate of Return

Cash on Cash or 𝐶𝑎𝑠ℎ 𝑅𝑒𝑐𝑒𝑖𝑣𝑒𝑑 𝐴𝑡 𝐸𝑥𝑖𝑡

Multiple of invested capital ( )
Multiple of Money 𝐶𝑎𝑠ℎ 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑

LBO - Concepts 135

 How Leverage Magnifies Returns

How Leverage Magnifies Return

Analogy: Buying a home with a mortgage that increases in value

% Return on
T=0 T=1
Equity

Home Value = $200k Home Value = $250k

Equity = $200k Equity = $250k

Debt = $0 Debt = $0 +25%
Home Purchase
(All Equity) $𝟐𝟓𝟎𝒌 − $𝟐𝟎𝟎𝒌
$𝟐𝟎𝟎𝒌

Home Value = $200k Home Value = $250k

Equity = $100k Equity = $150k

Debt = $100k Debt = $100k +50%
Home Purchase
with 50%
$𝟏𝟓𝟎𝒌 − $𝟏𝟎𝟎𝒌
Mortgage
$𝟏𝟎𝟎𝒌

Leverage can magnify returns and reduce the required quantum of upfront equity

LBO - Concepts 136

 How Leverage Magnifies Returns

How Leverage Magnifies Return

Analogy: Buying a home with a mortgage that decreases in value

% Return on
T=0 T=1
Equity

Home Value = $200k Home Value = $250k

Equity = $200k Equity = $150k

Debt = $0 Debt = $0 -25%
Home Purchase
(All Equity) $𝟐𝟓𝟎𝒌 − $𝟐𝟎𝟎𝒌
$𝟐𝟎𝟎𝒌

Home Value = $200k Home Value = $250k

Equity = $100k Equity = $50k

Debt = $100k Debt = $100k -50%
Home Purchase
with 50%
$𝟓𝟎𝒌 − $𝟏𝟎𝟎𝒌
Mortgage
$𝟏𝟎𝟎𝒌

Leverage can magnify returns and reduce the required quantum of upfront equity

LBO - Concepts 137

 How Leverage Magnifies Returns/ Losses

Home Purchase (Varying Debt Levels)

150%

100%

50%
Return

0%
100 125 150 175 200 225 250 275 300
-50% Home Value At Exit

-100%

-150%

100% Equity 50% Equity

While leverage magnifies returns, it also magnifies losses

LBO - Concepts 138

 Debt Paydown And Returns

Analogy: Buying a rental home that generates rental income to pay down your mortgage

% Return on
T=0 T=1
Equity

Home Value = $200k Home Value = 250k

Equity = $100k Equity = $200k

Debt = $100k Debt = $50k

+100%
$𝟐𝟎𝟎𝒌 −$𝟏𝟎𝟎𝒌
$𝟏𝟎𝟎𝒌

Rental
Income
$50k

Cash flows generated can further magnify returns by either accruing cash or paying down debt

LBO - Concepts 139

 What Is A Leveraged Buyout?

A Leveraged Buyout (LBO) refers to the purchase of a company while using mainly debt to
Definition finance the transaction

High Level Overview

• Sponsor acquires a company using a large amount of debt
• Pays down debt with company-generated cash flows
• Exits the business in 3-5 years
• A financial buyer will view the opportunity more as an investment and financial engineering opportunity
• This contrasts with a strategic buyer that may be more interested in synergies or IP acquisition

Previous Example

Buying A House LBO Transaction

House Target Company

Mortgage LBO Debt

Down Payment Sponsor Equity Investment

Rental Income Target Company’s Cash Flows

LBO - Concepts 140

 Commentary On Leverage

A Leveraged Buyout (LBO) refers to the purchase of a company while using mainly debt to
Definition finance the transaction

Advantages of Leverage Disadvantages of Leverage

• Magnifies losses: while leverage increases returns, it

• Magnifies returns
also increases risk

• Can target larger companies with less cash • Creates debt service burdens that strain cash flows

• Sharpens management to operate more frugally and

cut non-essential costs

• Debt is cheaper than equity

• Interest on debt is tax deductible

LBO - Concepts 141

 What Is The Internal Rate Of Return?

Definition The Internal Rate Of Return is a rate that discounts all cash flows to a net present value of zero

Overview
• Time – weighted metric that describes the compounded rate of return for a given amount of money invested over a
certain period
• A higher IRR represents a greater return
• All else equal, shorter time horizons increase IRR
• Doesn’t take into account the magnitude of money invested
• Captures return, but not risk (Two projects with 20% IRR may have very different risk profiles)

Example IRR Vs Multiple Of Money

150 Year 0: Invest $100 Year 3 Year 4 Year 5
Year 5: Receive $300 2x 26% 19% 15%

$100 $300 3x 44% 32% 25%

100 𝑁𝑃𝑉 = 0
+
1+𝑟 1+𝑟 5 4x 59% 41% 32%
NPV

5x 71% 50% 38%

50 IRR: 0 = σ𝑛𝑡=0
𝐶𝑎𝑠ℎ𝑓𝑙𝑜𝑤𝑡
IRR ~ 25%
1+𝑟 𝑡

X = multiple of money
0
5% 10% 15% 20% 25% 30% 35% t = years
Discount Rate
LBO - Concepts 142
 IRR Versus WACC

Question

• Suppose that you have the opportunity to invest in a project that has cash flows outlined below

• Should you invest in the project if it has a WACC of 15%? What if it has a WACC of 25%?

Solution

Scenario 1: IRR > WACC Year 0 Year 1 Year 2 Year 3

IRR 20% ($100) $20 $20 $120 NPV
WACC 15% ($100) $17 $15 $79 $11

Scenario 1: IRR < WACC Year 0 Year 1 Year 2 Year 3

IRR 20% ($100) $20 $20 $120 NPV
WACC 25% ($100) $16 $13 $61 ($10)

You would not consider investing in projects where IRR < WACC because they are value destructive with negative NPVs

LBO - Concepts 143

 Key Drivers Of Return

Definition An LBO transaction typically makes money from a few different methods

T = 0 (Entry) T = 1 (Exit) Return

• EBITDA = $100 • EBITDA = $100

Buy/ Sell At An Attractive
• Multiple = 10x • Multiple = 15x
Multiple
• Value = $1,000 • Value = $1,500

• EBITDA = $100 • EBITDA = $150

Operational Improvements • Multiple = 10x • Multiple = 10x 50%
• Value = $1,000 • Value = $1,500

• Value = $1,000 • Value = $1,500

Leverage • (-) Debt = $500 • (-) Debt = $500
• Equity = $500 • Equity = $1,000

Exit Timing The sooner the better

LBO - Concepts 144

 Good LBO Targets

Definition Any firm would be a good LBO target if its price was low enough

Good LBO Targets

Undervalued Target Predictable FCF Fragmented Space

• Strong management team • Needs to be able to sustain debt • Being a larger player with minimal
payments since LBOs are highly competition creates a “moat”
• Has an attractive entry & exit leveraged
multiple • Roll – up opportunities by “buying
• Recurring revenue preferred – down” your multiple
• Has significant growth
opportunity that the market • Stable growing industry with
doesn’t realize minimal technological disruption
Acquisition Add – Pro
On Forma
• Trading at a lower price due to • Competitive advantage to prevent
current market conditions margin erosion EBITDA $200 $100 $300

Multiple 9x 6x 8x
• Minimal Capex
Value $1,800 $600 $2,400

LBO - Concepts 145

 Simple LBO Example (Paper LBO)

The purpose of most LBO case studies is to estimate the returns/loss of investing in a target,
Objective often reaching an IRR/ MoM based on information given

Question
Wall Street Oasis Private Equity Partners are considering the acquisition of a target with the information provided
below. What is the estimated IRR & MoM if they invest?

• LTM EBITDA: $100 • Interest Rate: 7% • Capex = D&A

• EBITDA Purchase Multiple: 7x • Tax Rate: 25% • Holding period: 5 years
• Leverage: 4x EBITDA • D&A: $10 • Exit Multiple: 7x
• EBITDA growth: 5% • Change in NWC: ($5)

Solution

Calculate FCF
Determine Entry Determine debt Determine Exit Calculate IRR/
through holding
Equity schedule equity MoM
period

LBO - Concepts 146

 Simple LBO Example (Paper LBO)

Solution

Valuation Entry Equity Explanations

LTM EBITDA $100 Enterprise Value $700 1. Determine Entry Equity
EBITDA Multiple 7x Debt $400
• Target acquired at 7x EBITDA
Enterprise Value $700 Equity $300 Multiple
• Debt used is 4x EBITDA
Time 1 2 3 4 5 • Entry Equity is $300
EBITDA $105 $110 $116 $122 $128
(-) D&A ($10) ($10) ($10) ($10) ($10) 2. Determine Debt Schedule
(-) Interest ($28) ($28) ($28) ($28) ($28) • Pay a yearly interest of 7% on
EBT $67 $72 $78 $84 $90 debt
• Paydown debt when exiting
business
(-) Taxes ($17) ($18) ($19) ($21) ($22)
Net Income $50 $54 $58 $63 $67
3. Estimate Free Cash Flow
(+) D&A $10 $10 $10 $10 $10 • Follow formula for FCF
• All FCF will be used to pay down
(-) Change in NWC ($5) ($5) ($5) ($5) ($5)
debt
(-) Capex ($10) ($10) ($10) ($10) ($10)
Free Cash Flow $45 $49 $53 $58 $62

LBO - Concepts 147

 Simple LBO Example (Paper LBO)

Solution

Ending Debt Multiple of Money Explanations

Beginning Debt $400 4. Determine Exit Equity
$811
(-) Total Free Cash Flow $318
𝑀𝑜𝑀 = 2.7x • All FCF was used to pay down
Debt At Exit $82 $300 debt
• Exiting debt at $82
Exit Equity • Exit enterprise value at 7x EBITDA
Exit EBITDA $128 Internal Rate Of Return • Subtract enterprise value by debt
to reach equity value of $811
Exit Multiple 7x
Enterprise Value $893
($300ሻ $811
𝐼𝑅𝑅 = + 5. Calculate IRR & MoM
1+𝑟 0 1+𝑟 5
(-) Debt At Exit $82 • Year 0 equity = $300
Equity Value $811
𝒓~𝟐𝟐% • Year 5 equity = $811
• IRR ~ 22% & MoM = 2.7x

LBO - Concepts 148

 Cash In A Leveraged Buyout

Definition Cash management is very important since PE firms typically use high levels of leverage

Main Uses Of Cash

Transaction Fees Purchase Equity Financing Fees

• Legal Fees • Acquisitions have a minimum equity • Underwriting Fees
investment from sponsors
• Accounting Fees • Original Issue Discount (“OID”)
• Sponsors may also refinance debt if
• Other Third Party Consultants they can negotiate better terms • Financing fees are amortized over debt

• M&A Fees

Main Sources

Excess Cash Equity Debt

• Cash on B/S – minimum cash • Sponsor Equity • To be discussed
• Minimum cash tends to be ~2 • Management Rollover
months SG&A expense or 4% • Minimum of 30% through growth
revenue in deals multiples has pushed
actuals higher over the years

LBO - Concepts 149

 Debt Terminology

Debt Terminology
• Lien refers to the seniority of the debt holder and the priority of payment within the capital structure
• The highest seniority, 1st lien, is fully secured by the company’s assets and has the 1st claim to collateral in
Lien liquidation
• 2nd lien loans sit below 1st lien leveraged loans and are compensated in bankruptcy only to the extent that
there is collateral value remaining after 1st lien lenders are repaid in full

Secured vs. • If a debt instrument is secured, it is backed by collateral – meaning, the assets of the borrowing company
Unsecured • In the case of bankruptcy, the lenders have a legal claim to the assets that were pledged as collateral
• Mandatory Amortization means the minimum amount of principal the borrower must repay each year
Mandatory
• Straight-line amortization is when principal payments must be repaid in equal installments
Amortization
(Pay Down) • Minimum amortization entails lesser amounts of annual payments; thus, the entire principal will not have
been paid off at maturity
• Prepayment Optionality allows the borrower to repay some of the principal ahead of schedule without
incurring any financial penalties
• Many investors prefer the optionality to disallow prepayment, as it means they receive more interest
Prepayment payments in the future
Optionality
• Call protection prohibits borrowers from paying off debt until a specified duration has passed. If the
borrower does pay off debt early, it usually comes with a steep penalty
• “Bullet payment” refers to when the entire loan payment is due at the end of the loan’s lifespan

Tenor • Tenor / Maturity is the lifespan of the loan (i.e., the number of years the obligation is outstanding until full
(Maturity) principal repayment is due)

LBO - Concepts 150

 Debt Terminology

Debt Terminology
• A fixed interest rate means the interest rate is the same each year, regardless of changes to the lending
environment
Fixed • A floating interest rate is typically tied to SOFR plus a specified spread (e.g., SOFR + 400 bps)
vs.
• “bps” = basis points; 400 bps = 4%
Floating Interest
Rate • With floating rate interest, typically a floor of 1% is set
• If interest rates are expected to fall, investors prefer fixed rates. If they are expected to increase, investors
prefer floating rates
• “SOFR” stands for the Secured Overnight Financing Rate, which is a broad measure of the cost of borrowing
SOFR
cash overnight collateralized by Treasury securities

Cash Interest • Cash interest means the interest expense is paid out in the period due with cash
vs. • Payment-in-kind (PIK) accrues the interest to the principal amount, so there is no cash outflow in the period
PIK Accrual due. This additional principal must be paid off at the maturity of the loan
• Covenants are contractual agreements between lenders and borrowers meant to protect the lending party
• Debt holders desire to ensure they receive their payments with high certainty and thereby restrict the
Covenants borrower from making risky capital allocation decisions while maintaining healthy credit statistics
• Failure to comply with these covenants can cause the borrower to be placed into technical default, and
lenders could seize its assets

LBO - Concepts 151

 Debt Covenants

Debt Covenants are restrictions that lenders (investors) impose on borrowers to prevent them
Definition from taking actions that might harm their ability to pay back debt

Type Of Covenants

Maintenance Covenant Incurrence Covenant

• Ensure that borrower maintains sufficient profitability • Prevent the borrower from taking specific actions that
and cash flow to service debt payments and not default could put the lenders’ payback at risk
• Subject to periodic tests (typically each quarter) to
• Will only be tested if the borrower takes a certain
ensure that they are met action (e.g. borrow debt) rather than being tested on a
• The borrower must routinely prove its compliance with regular basis
its maintenance covenants to avoid falling into default

Common Examples
Maintenance Incurrence
• Total Debt/ LTM EBITDA must be below 5.0x • Cannot issue debt more senior in the capital structure
than the current covenant holder
• Debt/ Equity must be below 2.0x
• Cannot issue dividends without approval
• Interest Coverage Ratio must be above 3.0x
• Cannot spend cash on large investment capital

LBO - Concepts 152

 How Do Sponsors Use Leverage?

Sponsors frequently face limits to the amount of leverage per transaction, typically measured by
Definition Debt to EBITDA or Net Debt to EBITDA

Details
Typically limited to a max of 6-7x but will vary depending on market conditions, and company specific factors
• Stability of cash flows is a key consideration
• Lenders want to see sufficient paydown over the hold period (ideally 40-60%)
• Recall that the minimum required equity is usually 30% of the deal value

Other metrics can also be used:

• Interest Coverage
• EBITDA – Capex Interest Coverage
• Fixed Charge Coverage

Types Of Debt

Term Senior Subordinated Mezzanine Preferred

Revolver
Loans Notes Notes Financing Stock

Most Least
Senior Senior

LBO - Concepts 153

 Revolver

A revolver is usually a line of credit offered by a bank that allows a company to draw down, repay,
Definition and reborrow on an as-needed basis (like a credit card)

Details
Typically used by companies to meet short-term working capital obligations & are drawn when available free cash flow is
insufficient to fund daily operations

• Tenor: Typically 3 - 5 years

• Security: Secured 1st or 2nd Lien

• Covenants: Maintenance + Incurrence

• Coupon: Floating Rate (typically SOFR + 600-700 bps)

• Borrower is charged an annual fee on the unused amount (called an “undrawn commitment fee”)
Revolvers come in two forms - Asset Based Loan (ABL) or Cash Flow Revolver:
• ABL - Maximum amount that can be drawn is based on the value of the company’s liquid assets (e.g. A/R & Inventory)
• Cash Flow Revolver - Maximum amount that can be drawn is tied to the target’s historical cash flows

Types of Debt

Term Senior Subordinated Mezzanine Preferred

Revolver
Loans Notes Notes Financing Stock

LBO - Concepts 154

 Term Loans

Term Loan A (TLA) Term Loans B, C, & D

• TLA refer to secured loans syndicated to banks and are • An institutional term loan (“B”, “C,” or “D”) is a loan
normally packaged alongside a revolving credit facility facility for institutional, non-bank investors*
Characteristic
• Tend to have shorter terms and higher amortization • Differs from TLAs in having longer terms while
levels than other term loans requiring minimal or no principal amortization prior to
maturity
Tenor ~5 - 8 years
▪ Typically, straight-line amortized evenly over its tenor ▪ Typically, mandatory amortization will be a
so that full principal is repaid by maturity percentage of the loan that is in aggregate less than
Amortization the total principal (e.g., 5% per year on a 7-year loan)
▪ In some cases, may require no mandatory
amortization
▪ Principal can generally be repaid early by the ▪ Prepayment is generally allowed with institutional
Prepayment borrower with no prepayment penalties via the term loans, however, doing so may come with
absence of call protection clauses prepayment fees depending on the credit terms
Floating
Interest Rate SOFR + 600-700 bps + 1% Floor
Since TLAs have less risk, the interest rate tends to be lower than TLB, C, & D
Security Secured 1st or 2nd Lien
Leverage Typically, maximum of 4x
Covenants Maintenance + Incurrence

Term Senior Subordinated Mezzanine Preferred

Revolver
Loans Notes Notes Financing Stock

LBO - Concepts 155

 Senior Notes

While considered to be safer than subordinated notes and speculative debt, senior notes are still
Definition junior to leveraged loans

Details

Can be viewed as the “middle ground” between term loans and riskier debt instruments

• Tenor: ~7 - 10 years

• Security: Secured or Unsecured

• Leverage: Typically maximum of 2x; plugs the gap between Term Loans and maximum leverage

• Covenants: Incurrence

• Coupon: Fixed; typically 6 - 10%

• No prepayment allowed

Types of Debt

Term Senior Subordinated Mezzanine Preferred

Revolver
Loans Notes Notes Financing Stock

LBO - Concepts 156

 Subordinated Notes

Subordinated Notes are a layer of debt that enables the borrower to increase leverage beyond
Definition what risk-averse banks are willing to provide

Details

Can be raised either in the public bond market or the private institutional market and carries a longer maturity than senior
debt

• Tenor: ~7 - 10 years

• Security: Unsecured

• Leverage: Typically maximum of 2x; plugs the gap between Term Loans + Senior Notes (if any) and maximum leverage

• Covenants: Incurrence

• Coupon: Fixed; typically 8 - 12%, may be a combination of Cash Interest and PIK

• No prepayment allowed

• Sub notes are a riskier layer of credit; oftentimes bonds that carry a credit rating of BBB or worse

Types of Debt

Term Senior Subordinated Mezzanine Preferred

Revolver
Loans Notes Notes Financing Stock

LBO - Concepts 157

 Mezzanine Financing

Mezzanine Financing includes convertible debt, bonds coupled with warrants, and preferred
Definition equity and lies between traditional debt and equity

Details

Often comes with conversion provisions that provide the investor with the optionality to partake in the upside potential of
the equity

• Tenor: ~7 - 10+ years (more variable and tailored)

• Security: Unsecured

• Covenants: None

• Coupon: Fixed; typically 12 - 20% Blended Rate with an Equity Kicker

• Common to see PIK structures

• No prepayment allowed

Types of Debt

Term Senior Subordinated Mezzanine Preferred

Revolver
Loans Notes Notes Financing Stock

LBO - Concepts 158

 Preferred Stock

Definition Preferred Stock is a form of mezzanine financing

Details
Payments made to preferred stock holders are in the form of dividends and therefore not tax deductible

Dividends can be cumulative or non – cumulative, where companies accumulate missed dividends and pay them out at a later
date. Non – cumulative dividends would not have this trait

Participating Preferred

• Participating preferred stockholders are entitled to receive a portion of the remaining liquidation proceeds on an as-
converted to common stock basis, after being paid back their liquidation preference (like “double-dipping” into the
proceeds pool)

Non participating preferred

• Non-participating preferred stockholders have the option to either exercise their liquidation preference or convert their
preferred shares into common shares, and be paid a proportion of the proceeds based on their equity ownership

Types of Debt

Term Senior Subordinated Mezzanine Preferred

Revolver
Loans Notes Notes Financing Stock

LBO - Concepts 159

 Debt Tranche Recap

Term Loans Subordinated Mezzanine

Revolver Term Loan A Senior Note
B, C, & D Note Financing

Lender Banks Institutional, Non-Bank Investors

Lien
(Priority in Highest Lowest
Bankruptcy)

Floating Fixed Fixed Fixed

SOFR + 600-700 bps (floor of 1%) 6 - 10% 8 - 12% 12 - 20%
Coupon Cash Interest Cash Interest Cash, PIK, or Both Cash, PIK, or Both
(Interest Rate)
+ Equity Kicker
Lowest Highest

Leverage Usually limited to

2 - 4x LTM EBITDA 1 - 2x LTM EBITDA
Limit Inventory + AR
Secured or
Security Secured 1st or 2nd Lien Unsecured
Unsecured

Tenor 3 - 5 years 5 - 8 years 7 - 10 years

Mandatory
None Straight-Line Partial None
Amortization
Prepayment
Yes No
Optionality

Covenants Maintenance + Incurrence Incurrence None

LBO - Concepts 160

 What Is A Debt Schedule?

A debt schedule is a table that includes information about a company's outstanding debts. It
Definition usually accounts for all loans that the company has taken out

Details

• The debt schedule shows the balance of each loan at the beginning of the year, the end of the year, as well as how much
is paid in interest and principal during the year

• Arguably the most important part of an LBO

• In an LBO, mandatory amortization requirements are first serviced, and then any remaining cash flow is used to pay down
remaining outstanding balances (assuming prepayment is allowed)

Example

T=0 T=1 Explanation

Home Value = $200k Home Value = 250k • In this case, the rental income of $50k would be used
Equity = $100k Equity = $200k to pay down (amortize) debt
Debt = $100k Debt = $50k
• Assumption: 0% interest rate
Rental
Income
$50k

LBO - Concepts 161

 What Is A Debt Schedule?

The debt schedule is the core part that differentiates an LBO from a typical three-statement
Concept model

Income Statement Balance Sheet Cash Flow Statement

Core Changes: Core Changes: Core Changes:

• Revenue through EBIT is all the • Liabilities portion of B/S will be • Cash flow from financing activities
same as in the three-statement affected will depend on the debt load
model
• Face value of long-term debt • New line for amortized financing
• Net Interest Expense will change depends on how it is amortized fees
with a debt load
• A new line for the original issue • New line for PIK interest
• Taxes and net income will change discount if the face value is greater
with this than the capital raised from the
issue

• A new line for financing fees

LBO - Concepts 162

 Debt Schedule Example

Question
Wall Street Oasis Private Equity Partners are considering a Term A loan with certain details below. Create a debt schedule
for the next 5 years.

Time Forward SOFR

• Principal: $100,000 • 1% financing fees
1 2.30%
• Interest rate: 3mo SOFR + 650 bps • 1% original issue discount 2 2.20%

• Mandatory amortization: 20% • 5 years tenor 3 2.25%

4 2.15%
• No option for prepayment
5 2.33%

Solution

Debt Amortization Interest Expense

• Yearly amortization is 10% of principal ($10,000 per • Interest expense will be based on average of
year) beginning & ending balance multiplied by prevalent
interest rate
• While principal decreases year after year, amount of
debt paydown remains the same and will be 10% of
beginning balance

LBO - Concepts 163

 Debt Schedule Example

Solution

Debt Schedule 0 1 2 3 4 5
Beginning Balance $100,000 $80,000 $60,000 $40,000 $20,000
Mandatory Amortization 20% $20,000 $20,000 $20,000 $20,000 $20,000
Optional Paydown No - - - - -
Ending Balance $100,000 $80,000 $60,000 $40,000 $20,000 -

Explanations
• Mandatory amortization is 20% • The ending balance of principal • Note: There was no optional
of beginning balance when it each year would be listed on the paydown in this example, but PE
was issued, therefore it is fixed balance sheet firms typically use FCF to pay
at $20k down additional principal

LBO - Concepts 164

 What Is A Debt Schedule?

Solution

Financing Fees & OID 1 … 5

Principal $100,000 Financing Fees & OID $400 $400 $400
Financing Fees 1%
• Financing Fees & OID are evenly split over its entire life (5 years)
OID 1%
• They are also considered an interest expense
Total Fees $2,000

Interest Expense 0 1 2 3 4 5
3 Month SOFR 2.30% 2.20% 2.25% 2.15% 2.33%
Beginning Balance - $100,000 $80,000 $60,000 $40,000 $20,000
Ending Balance - $80,000 $60,000 $40,000 $20,000 -
TLA Interest Expense - $6,120 $4,690 $3,375 $1,995 $683

Financing Fees & OID - $400 $400 $400 $400 $400

Net Interest Expense - $6,520 $5,090 $3,775 $2,395 $1,083

Explanations

• The interest rate is the SOFR • Apply the interest rate on the • The Net interest expense would
rate plus 6.5% average of the beginning and go on the income statement and
ending balance to reach interest lower net income by (1 – Tax
• The SOFR rate is typically found expense Rate)
from the forward SOFR curve

LBO - Concepts 165

 LBO Exit

Concept The last part of the LBO model is to exit and determine its IRR

Initial Public Offering (IPO) Trade Sales Other Strategies

• Sell equity to the public by selling • Exit the entire portfolio company Secondary Sale
shares to institutional & retail by selling to a suitable business in • Sell to another PE firm
investors an M&A exit
Management Buyout (MBO)
Example Example • Sell to the portfolio company’s
management team
Blackstone acquired Hilton in 2007 Blackstone acquired a majority stake
for ~$26 bn ($20.5bn debt & $5.6bn in Refinitiv in 2018 for ~$17bn Recapitalization
equity) • Restructure capital structure and
They subsequently sold Refinitiv to buy equity using debt
They sold Hilton via IPO in 2013 and the London Stock Exchange Group
realized about ~$14 billion (about 3x (LSEG) in 2021 for ~$27bn in Liquidate
MoM) enterprise value • Not all LBOs succeed and some
default

LBO - Concepts 166

 Calculating Exit Equity Value

Concept The last part of the LBO model is to exit and determine its IRR

Details
• Arrive at an enterprise value through the LBO model
• Cross check with precedent transactions/ comparable company analyses
• Subtract net debt (and cash or cash equivalents) to bridge to equity value
• Determine IRR based on initial equity in acquisition

Additional Considerations

Sensitivity Analysis
EBITDA Growth Entry Multiple

Operating Assumptions Exit Multiple

Leverage

LBO - Concepts 167

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168
LBO – Practice Questions
 LBO Practice Questions – Basic

WHY DOES PE GENERATE HIGHER RETURNS THAN PUBLIC WHY DOES LBO USE LEVERAGE? OR HOW DOES LEVERAGE
MARKETS? INCREASE RETURNS?

• SAMPLE ANSWER: PE LPs demand higher returns than public market • SAMPLE ANSWER: PE returns are calculated based on the return on
investors, which causes PE investors to price their deals to an IRR of their invested equity. Using leverage to do deals allows you to use less
20% or higher. equity, which means the ultimate returns are larger than the amount
initially invested.
• PE LPs demand these high returns because LBOs are highly levered
and thus riskier than public stocks, and PE investments are much less • Another way to look at it is that the cost of leverage is lower than the
liquid than public stocks cost of equity because equity is priced to an IRR of 20%+, whereas the
annual interest expense on debt is usually below 10%.

• Yet another way to look at it is that using a lot of debt makes the
return on equity much more volatile and much riskier. The high returns
on PE equity may be seen as the fair return associated with the extra
risk associated with high leverage.

LBO – Practice Questions 170

 LBO Practice Questions – Basic

WALK ME THROUGH AN LBO MODEL AT A HIGH LEVEL WOULD YOU RATHER ACHIEVE A HIGH IRR OR A HIGH MOM ON
A DEAL? WHAT ARE THE TRADE-OFFS? WHAT FACTORS MIGHT
• Calculate the total acquisition price, including acquisition of the INFLUENCE YOUR ANSWER?
target’s equity, repayment of any outstanding debt, and any
transaction fees • PE firms try to achieve high IRRs and high MoMs on deals, but
sometimes trade-off choices between these two common returns
• Determine how that total price will be paid, including equity from the metrics do arise.
PE sponsor, roll-over equity from existing owners or managers, debt,
seller financing, etc. Why IRR?

• Project the target’s operating performance over ~5 years and • LPs judge the performance of PE funds by their IRR
determine how much of the debt principal used to acquire the target
can be paid down using the target’s FCF over that time. • PE funds with higher IRR have less problem fundraising

• Project how much the target could be sold for after ~5 years in light of • Most PE funds don’t get carried interest unless IRR exceeds a certain
its projected operating performance; Subtract any remaining net debt hurdle rate
from this total to determine projected returns for equity holders.
• If a fund’s IRR is below or near the hurdle rate, then they would prefer
• Calculate the projected IRR and MoM return on equity based on the IRR
amount of equity originally used to acquire the target and the
projected equity returns upon exit Why MoM?

• Carried interest paid out to GPs is based on MoM

• There will be more transaction costs if PE firms exit their portfolio

company too soon to juice IRR.

• As a general rule, PE firms prefer to hold on to portfolio companies

and grow MoM as long as the annual rate of return is acceptable

LBO – Practice Questions 171

 LBO Practice Questions – Basic

WHAT ARE SOME COMMON WAYS PE FIRMS INCREASE WHAT ARE SOME DIFFERENT TYPES OF DEBT COVENANTS, AND
PORTFOLIO COMPANY VALUE? WHAT ARE THEY USED FOR?

• Recruit better management and board members • Debt covenants are contractual agreements between lenders and
borrowers
• Provide more aligned management incentives
• Maintenance covenants require the borrower to maintain a certain
• Identify and finance new organic growth opportunities equity cushion or debt service coverage cushion to maintain their
ability to repay their debt.
• Find, finance, and execute add-on acquisitions
• Incurrence covenants prevent the borrower from taking certain
• Foster stronger relationships with key customers, suppliers, and Wall actions which could be detrimental to existing lenders
Street

• Support investment in better IT systems, financial reporting, and

control, research & development, etc.

LBO – Practice Questions 172

 LBO Practice Questions – Basic

IN A LEVERAGED BUYOUT, WHAT WOULD BE THE IDEAL WHAT MAKES A COMPANY AN ATTRACTIVE TARGET FOR A
AMOUNT OF LEVERAGE TO PUT ON A COMPANY? LEVERAGED BUYOUT?

• In order to maximize returns, you would like to finance the deal with • Most importantly, an LBO needs a steady stream of cash flows so it
the least amount of equity possible. can pay down the debt used to purchase the business. This means the
company should be at the lower end of the risk spectrum, should have
• However, there is a fine line to walk between maximizing returns and limited need for additional capital expenditures, and preferably should
putting the company into financial distress with too much debt in the be in a relatively stable industry.
capital structure.
• A good candidate should also have a strong management team (unless
• Typically, an analyst will look at the amount of leverage on similar the private equity firm intends to replace them), the ability to reduce
businesses in the past. The most common ratio an analyst looks at is its cost structure, and a solid asset base that can be used as collateral.
Debt/EBITDA, or leverage. A company with less leverage may demand
a lower interest rate and vice versa. • SAMPLE ANSWER: The most important characteristic of a good LBO
candidate is steady cash flows. The firm ideally could pay off a significant
• SAMPLE ANSWER: In order to maximize returns in a leveraged buyout, portion or all the debt raised in the acquisition over the life of the
the acquiring firm wants to finance the deal with the least amount of investment horizon, with minimal bankruptcy risk.
equity possible. However, they need to be careful not to put the company
into financial distress by overburdening the acquired company with debt. • Some other attractive characteristics include strong or replaceable
management, cost-cutting opportunities, and a non-cyclical industry.

LBO – Practice Questions 173

 LBO Practice Questions – Basic

WHICH VALUATION TECHNIQUES USUALLY PRODUCE THE HOW WOULD YOU ESTIMATE ROUGHLY HOW MUCH DEBT
HIGHEST VS. LOWEST VALUES? WHY? CAPACITY IS AVAILABLE FOR AN LBO?

• There is great variability among the outcomes of different valuation • Debt capacity for an LBO is typically constrained by three primary
techniques for different industries and companies. Some banker ratios: total leverage ratio, interest coverage ratio, and minimum equity
interview guides state that there is a commonly accepted order of ratio.
valuations with precedent transactions at the top and market valuation
at the bottom. • Any one of these ratios could be the governing constraint for a
particular deal. To estimate the debt capacity for an LBO
• PE equity has one of the highest costs of capital, hence PE backed
LBOs will have lower valuations • You calculate all three of these ratios and pick the lowest.

• Precedent transactions are generally higher due to control premiums &

synergy premiums
Debt Ratio

• DCFs are within the middle on average but vary widely due to input
assumptions Total Leverage Ratio 𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
5.0 ×=
Assuming 5.0x leverage ratio 𝐿𝑇𝑀 𝐸𝐵𝐼𝑇𝐷𝐴

Interest Coverage Ratio 𝐿𝑇𝑀 𝐸𝐵𝐼𝑇

An acceptable floor for this ratio is 1.5 ×=
𝐴𝑛𝑛𝑢𝑎𝑙 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
usually 1.5x

Minimum Equity Ratio

Lenders expect firms to put in at
0.75 𝑇𝑜𝑡𝑎𝑙 𝐴𝑐𝑞𝑢𝑖𝑠𝑖𝑡𝑖𝑜𝑛 𝑃𝑟𝑖𝑐𝑒 = 𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝐷𝑒𝑏𝑡
least 20 – 30% equity. Assuming
25% equity

LBO – Practice Questions 174

 LBO Practice Questions – Intermediate/Advanced

HOW DO YOU PICK PURCHASE MULTIPLES AND EXIT HOW DOES AN ACQUIRER DETERMINE THE MIX OF CASH, DEBT,
MULTIPLES FOR AN LBO? AND STOCK TO USE FOR AN ACQUISITION?

• When a private equity firm is evaluating an investment, it is looking to • SAMPLE ANSWER: Since Cash is the cheapest for most acquirers, they’ll
acquire the company for the lowest multiple possible (all else equal), use all the Cash they can before moving to the other funding sources.
then improve the business through operational changes, and
ultimately sell it for a higher multiple off of increased earnings. • So, you might assume that the Cash Available equals the Acquirer’s current
Cash balance minus its Minimum Cash balance. After that, Debt tends to
• These multiples are determined as in any other M&A transaction. The be the next cheapest option.
analysts working on the transaction will look at M&A comparable
transactions and public company comparables. • The acquirer might be able to raise Debt up to the level where its Debt /
EBITDA and EBITDA / Interest ratios stay in line with those of peer
• SAMPLE ANSWER: Purchase and exit multiples for an LBO transaction companies. So, if it’s levered at 2x EBITDA now and similar companies
are determined using many of the same techniques used in general have up to 4-5x Debt / EBITDA, it might be able to raise Debt up to that
valuations for an M&A transaction, such as precedent transactions level.
analysis or public company comparables analysis.
• Finally, there’s no strict limit on the Stock an Acquirer might issue, but very
few companies would issue enough to give up control of the company, and
some Acquirers will issue Stock only up to the point at which the deal turns
dilutive.

LBO – Practice Questions 175

 LBO Practice Questions – Intermediate/Advanced

WHAT IS A DIVIDEND RECAPITALIZATION? WHICH WILL NORMALLY PAY A HIGHER PRICE FOR A
COMPANY, A STRATEGIC BUYER OR A FINANCIAL BUYER?
• In an LBO transaction, a PE firm will put a large amount of debt on the
company it is acquiring and will pay off that debt with free cash flow • STRATEGIC BUYER: A corporation that wants to acquire another
generated by the business over the life of the investment. This company for strategic business reasons such as synergies, growth
paydown of debt will lower the leverage ratios and, therefore, the risk. potential, etc. An example of this would be an automobile maker
purchasing an auto parts supplier in order to gain more control of their
• Eventually, the PE firm will look to exit its investment through a sale or COGS and keep costs down.
IPO fully, but in the interim, the PE firm (along with the other owners
of the company) may want to take earnings out of the business rather • FINANCIAL BUYER: A group looking to acquire another company
than just further paying down debt. purely as a financial investment. An example is a private equity fund
doing a leveraged buyout of the company.
Example
• SAMPLE ANSWER: A strategic buyer will normally pay a higher price due
• PE firm has acquired a portfolio company using large amounts of debt. to their willingness to pay a premium for the synergies of lowering costs,
Three years into the investment, the business has grown, and the improving the existing business, and/or revenue synergies.
company has paid down a significant portion of it.
• The financial buyer typically looks at the company purely in terms of
• Leverage is now low compared to other similar companies; the owners returns on a standalone basis unless they have other companies in their
may decide to do a dividend recap to realize part of their investment portfolio that could significantly improve the operations of the target.
returns.

• The company goes back to the market and recapitalizes by reissuing

debt. They use the proceeds from the debt to pay themselves a
dividend.

• SAMPLE ANSWER: A dividend recap typically occurs in the middle of a

PE firm’s investment in a company when that company has been
performing and paying down debt, reducing leverage. The owners of the
business (normally the PE firm) will go back to market looking to issue new
debt both to repay the existing debt and to fund a distribution to
shareholders.

LBO – Practice Questions 176

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177
Mergers & Acquisitions – Concepts
 M&A: The Big Picture

Investment Banking has various divisions that all do different things but has the main purpose of
Definition advising clients on financial transactions

Details

• IBs are financial services companies advising companies on financial transactions

• IBs exist in all shapes and sizes and range from single-office, single-product boutiques to international, full-service bulge
bracket banks offering the full suite of products

Key Front Office Divisions

Investment Banking Capital Markets Sales & Trading

• Advises on strategic transactions, • These professionals are experts in • This group helps various asset
including M&A activity, debt and accessing the “capital markets” to managers execute financial trades in
equity raises, and other strategic raise debt or equity financing for public/private markets
alternatives operations
• Responsible for maintaining an active,
• Most bankers have industry expertise; • Bankers may be industry-agnostic but informed network of Buyer/Sellers to
smaller shops can be “generalists” have strong knowledge of their match trades effectively
products

M&A – Concepts 179

 M&A: The Big Picture

Concept There are many stakeholders involved in an M&A process

Who? When?
• Buyers are traditionally considered “strategic” (corporations • Whenever your client asks! M&A advisory is a year-round job
like NIKE) or “financial” (such as private equity firms, venture and can be unpredictable
capitalists, SPACs, etc.)
• Private company M&A traditionally takes 6-9 months
• Sellers can be publicly traded or privately held, large or small
• Public-to-public M&A can move much quicker due to
confidentiality

How? Why?
• Stay tuned! • The Buyer usually has strategic or financial reasons to want to
buy the Seller

• Horizontal (acquire competitors) vs. vertical (in the supply

chain) integration

• Gain access to new markets, products, brands, customers,

management, etc.

• Realize revenue and/or cost synergies post-acquisition

• The Seller may want to cash out their investment, focus on

other activities/investments, or fall subject to a “hostile
takeover”

M&A – Concepts 180

 Participants Of M&A

Concept There are many stakeholders involved in an M&A process

Core Players

Corporate Development Division Board Of Directors Shareholders

• Company employees focused leading • Company leaders who make the • Company owners whose approval is
strategic organic and non-organic ultimate choice around whether to required to complete the transaction
growth activities and other pursue a transaction
transformative initiatives

Supporting Players

Regulators Investment Bankers Other Advisors

• Government representatives whose • Advisors helping each transaction • Accounting, tax, legal, consultants
approval is required to complete larger party navigate the M&A process
transactions • Third-party advisors helping clients
navigate their area of expertise
through diligence, structuring,
integration, and growth planning

M&A – Concepts 181

 What Are Synergies?

Definition Added value or benefits from the combination of two or more companies in an M&A process

Details
• Revenue synergies = combined company is able to generate more sales than the two companies individually
• Cost synergies = combined company is able to reduce costs below what the two companies would have individually
• In general, cost synergies are easier to identify and realize than revenue synergies
• A key part of the diligence process is identifying synergy opportunities by function and building those savings into the
financial forecast model
• Bankers can assist their clients in analyzing the financial impact of potential synergy using the merger models

Examples

Revenue Synergies Cost Synergies

• Cross selling new products to existing customers • Consolidate operating footprint
• Sell existing products into new channels, customers, • Eliminate redundant positions
geographies
• Increase machinery utilization
• Increase prices by eliminating competition
• Improve purchasing terms with greater volumes
• Realize operating leverage

M&A – Concepts 182

 Types Of M&A Engagement

Concept Investment banks are traditionally engaged on 3 types of M&A-related engagements.

Buy – Side Engagement Sell – Side Engagement Fairness Opinions

• An investment bank is responsible • An investment bank is responsible • Before certain transactions are
for helping their client for helping their client sell to a completed, the Buyer and/or Seller
analyze/acquire an acquisition new Buyer may require a fairness opinion
target from a “qualified advisor “(i.e.,
• The early-stage work involves investment bank)
• Advisory scope ranges from broad selecting and contacting the
“search-and-screen” to a targeted universe of potential Buyers, • This involves completing a detailed
“rifle shot” approach preparing detailed company valuation analysis to validate that
marketing materials (“CIM”) the transaction valuation is “fair”
• The work involves detailed outlining the investment and is used as a defense against
diligence on the target company, opportunity and key investment shareholder lawsuits
analyzing the strategic acquisition highlights
fit, determining appropriate • These reports are subject to legal
valuation, and analyzing the • The late-stage work involves scrutiny, so they need to be
accretive/dilutive impact (for negotiating with Buyers, and carefully prepared and adequately
public-company clients) structuring sourced

• After the potential Buyers bid, the • Can be stand-alone or

bank will advise the Seller on how complimentary engagements
to proceed

M&A – Concepts 183

 Types Of M&A Engagement

Concept Investment banks are traditionally engaged in 3 types of M&A-related engagements.

Details
• Bankers become trusted advisors by maintaining strong knowledge of their industry and relationships with key industry
players which allows them to source opportunities and suggest strategic transactions
• In other cases, transactions are planned/initiated by the company, who often engage their trusted bankers to assist in
analyzing and completing the transaction

Examples

Origination Timing Origination Process

• Bankers may propose transaction ideas for years • Before bankers are hired to advise on an engagement,
before a company decides to act they traditionally are required to participate in a
“bake-off”, where several banks “pitch” their services
• Significant events within companies, government
in front of the client’s key decision makers and
regulation, industries, or the broader economy can be
compete to win the mandate
the impetus for M&A activity
• These presentations are usually scheduled on short
• Usually, dialogue is friendly between two companies
notice and can be extremely demanding on junior
wishing to explore a transaction, but in certain public-
bankers who rush to prepare the meeting materials (in
company transactions, negotiations can be “hostile” –
comparison, transaction processes can be relatively
a Buyer makes a public offering to acquire the
“slow and steady”)
company without Management’s consent

M&A – Concepts 184

 Common M&A Documents

Confidential
Information Non-Disclosure
Pitchbook Teaser
Memorandum Agreement (NDA)
(CIM)

Indication Of Letter Of Intent

Interest (IOI) (LOI)

M&A – Concepts 185

 What Is A Pitchbook?

Investment banks use pitchbooks to articulate their expertise, industry knowledge, and other key
Concept information to prove they are best suited to advise on the transaction

Details
• Before bankers are hired to advise on an engagement, they traditionally are required to participate in a “bake off”, where several banks
“pitch” their services in front of the client’s key decision makers and compete to win the mandate

• These presentations are usually scheduled on short notice and can be extremely demanding on junior bankers who rush to prepare the
meeting materials (in comparison, transaction processes can be relatively “slow and steady”)

• The supporting document for the bake off is the “pitchbook” and they are prepared using bankers’ industry knowledge and publicly-
available information on the target/Buyers/relevant valuation indicator

• Pitchbooks are easier to create for public companies – for private companies, there will be much less information available, and insight
will be dependent on the banker’s knowledge

What Information Is Included?

Information On Target Deal Dynamics Financial Information Why Our Investment Bank

Key facts Rationale of deal DCF valuation Historical deals

Business plans Key risks Comps analysis Team background

Product range Business plans Synergies Industry specialty

Unique characteristics Post merger integration Scenario analysis

M&A – Concepts 186

 What Is A Teaser?

A teaser is designed by investment banks to show potential buyers details about a company/
Concept asset that is looking to be sold.

Details
• When a Seller is looking to sell a company, the investment bank will help reach out to all potential buyers that might be interested in
the transaction

• Investment banks would then provide potential buyers with a teaser so that they could get a high-level understanding of the business
that is for sale

• The teaser would often be 1 – 2 pages long that highlight the company’s business, financials, projected growth, etc.

• Many potential buyers would actually not be interested in the company; therefore, teasers often redact sensitive information and keep
the company’s name private to protect the company’s competitive advantage

• Only serious buyers who are interested in the deal would find out more information about the seller at a later stage through other
documents such as CIMs

What Information Is Included?

Company Overview Note: The information that goes into a teaser can really be anything
useful that makes the selling company more attractive. They only have
Business Operations to redact sensitive information that is important to the company’s
competitive advantage
Historical Financials

M&A – Concepts 187

 What Is A Confidential Information Memorandum?

A confidential information memorandum (CIM) will contain all the necessary information on the
Concept company that is being sold

Details
• Potential buyers that are more serious about the target will also receive a confidential information memorandum (CIM)

• The CIM can be rather lengthy (around 50 – 150 pages long) because potential buyers will refer to the CIM to know everything
they need to know about the transaction

• Potential buyers have to sign a non-disclosure agreement (NDA) because the CIM will contain sensitive information about the
business

• The CIM will not contain information about valuation. This stage is about sourcing potential buyers rather than deciding the
price of the target

What Information Is Included?

Executive Summary Investment Highlights Operations Overview Industry Overview

Company Overview Customer relationships Hiring/ training process Current market trends

High level financials Proprietary technology Contract process Market size

Company history Pricing power Organizational chart Key competitors

Growth opportunities Company leadership

M&A – Concepts 188

 Remaining Documents

Non-Disclosure Agreement (NDA) Indication Of Interest (IOI) Letter Of Intent (LOI)

• A non-disclosure agreement ensures • An indication of interest is an official • A letter of intent is the buyer’s official
that potential buyers who will receive notification that a potential buyer is notice to the seller that they are
confidential information will not interested in the target that is for sale serious about the transaction
disclose/ use that information for their
own benefit • This document is non–binding, • While the document is generally non–
meaning that sellers cannot force the binding, it is more definitive than the
• Potential buyers have to sign an NDA potential buyer to buy the company IOI
before they receive the CIM
• If the seller agrees to the terms, the
deal should close as long as due
diligence goes smoothly

Contents Contents Contents

1. Restrictions in use of confidential 1. An approximate acquisition price 1. Acquisition price
information (dollar value or expressed as multiple)
2. Deal structure
2. Obligations of the recipient 2. Source of funds
3. Final due diligence items
3. Permitted disclosures 3. Management retention plan
4. Closing conditions
4. Term agreements 4. Due diligence items
5. Proposed deal structure (cash, stock)

M&A – Concepts 189

 M&A Buyside Process

Concept In a buyside process, your client is the Buyer looking to acquire the target company

Action
More
Common
Buyer Initiates Outreach Buyer Responds To Seller
• This is the more complicated and time-intensive approach, as • A seller has contacted the potential Buyer to alert them that
you need to survey the potential acquisition landscape and they are entertaining acquisition offers. Additionally, you know
determine who could make sense to buy and run illustrative that the Seller is interested in a transaction
analysis on that combination
• The flip side is that in these situations there is usually heavy
• Then, you need approach the target and see if they’re competition between other potential Buyers the Seller is likely
interested in a M&A discussion – oftentimes they will not to have reached out to
engage, so you’ll need to progress onto other targets
• Main risk to banker: your client may not be selected as the
• Main risk to banker: significant work with no guarantee of a ultimate acquirer
willing Seller

The timelines for a buy-side process can vary greatly – normally, the full process can take 4 to 8 months; this can vary greatly
based on various factors including competing Bidders, the complexity of diligence, and the state of the financing markets

M&A – Concepts 190

 M&A Buyside Process

While the exact timeline and sequencing of events can vary significantly by transaction, it is
Concept helpful to think about buyside processes in 3 stages

Agreement on Pricing/
Initial Contact &
Detailed Due Diligence Structure, Approval/
Transaction Assessment
(1 – 3 Months) Closing
(2 – 3 Months)
(1 – 2 Months)

1st Stage 2nd Stage 3rd Stage

M&A – Concepts 191

 M&A Buyside Process

Concept The 1st stage is where either buyer or seller makes contact and assesses the transaction

Activity Description Key Participants

• Senior bankers: Suggest companies that make strong
• Analyze the competitive landscape
acquisition candidates; manage expectations with client
Identifying • Leverage banker’s industry knowledge and existing
• Junior bankers: Compile industry research and target
potential targets company relationships to determine potential targets
company information the potential target list
• Think through potential transaction timeline
• Company: Compliment bankers’ efforts
Preliminary • Run initial, high-level valuation analysis on targets to • Senior bankers: Oversee valuation and forecasting work
valuation and determine the financial viability of the acquisition • Junior bankers: Run high-level valuation, “ability-to-pay”,
“ability-to-pay” • Part of this analysis is an “ability-to-pay” and synergy analysis
analysis • Initial synergy assessment • Company: Support bankers’ efforts on synergy estimate
• Determine target outreach list and approach targets • Senior bankers: Finalize target list and use industry
Contact • Sign NDAs relationships to conduct outreach; broker initial
candidates, sign • Initial request for key information to refine valuation conversations and information sharing to aid in the
NDAs, submit assessment (e.g., financials, projections, etc) preliminary target analysis; prepare IOI
IOI • Submit Indication of Interest (IOI) with high-level • Lawyers: Draft NDA and negotiate required NDA edits
non-binding transaction proposal details • Company: sign off on IOI

Initial Contact & Transaction Agreement on Pricing/ Structure,

Detailed Due Diligence
Assessment Approval/ Closing

M&A – Concepts 192

 M&A Buyside Process

The timing of the 2nd stage depends on how detailed Buyer diligence becomes, and how quickly
Concept the Seller responds to diligence requests

Activity Description Key Participants

• “Due diligence” is all work associated with learning more
about the target and potential combined entity
• Senior bankers: Guide information requests for
• Submit information requests to the target and receive
business and financial diligence, lead
responses in a “data room”
business/financial diligence meetings
• Diligence takes many forms:
Conduct • Junior bankers: Business/financial diligence, create
• Business due diligence: learning more about the target
detailed due detailed M&A model, track outstanding
company and industry, site visits, etc.
diligence business/financial diligence items
• Financial due diligence: detailed review of target
• Lawyers: Legal diligence
financials, bottoms-up synergy assessment, projections
• Tax advisors/accountants: Tax/financial diligence
• Legal diligence: ensuring no legal issues with the target
• Company: Support all forms of diligence
• Tax diligence: understanding tax implications on the
combined company
• After appropriately progressing diligence, complete • Senior bankers: Guide final valuation assessment and
detailed valuation to determine appropriate valuation coordinate outstanding diligence questions
Detailed
(could be a tight range) • Junior bankers: Run detailed valuation and assist in
valuation and
• Submit a “LOI” (letter of intent) with the proposed price the drafting of LOI
submitting LOI
and final diligence questions that need to be answered • Company: Seek internal approval for valuation range
before the transaction can be completed and LOI terms

Initial Contact & Transaction Agreement on Pricing/ Structure,

Detailed Due Diligence
Assessment Approval/ Closing

M&A – Concepts 193

 M&A Buyside Process

Concept The 3rd stage is all about agreeing on a price and closing the transaction

Activity Description Key Participants

• Senior bankers: Interface between Buyer and Seller on
• Work with potential Seller to get answers to all
Finalize due final diligence points, instruct final valuation
outstanding due diligence
diligence • Junior bankers: Run final valuation analysis
• Arrive at the final valuation assessment for the target
• Company: Grant approval on final purchase price offering
• Prepare definitive agreement that outlines the terms • Senior bankers: Guide commercial details of agreement
Prepare (including valuation) of the proposed acquisition of • Lawyers: Draft and negotiate the legal agreements
definitive the target • Company: Give directives to advisors throughout
agreement • Send this binding document to the Seller for their negotiations and ensure internal approvals are
review and mark-up coordinated
• Capital markets team: Outreach and securing of financing
• Senior bankers: Market company/investment opportunity
• If needed, secure debt and/or equity funding to
Secure financing to potential financing sources
finance the transaction
• Company: Final approval on proposed financing terms
and selection of financing partner
• Prepare and submit all necessary SEC filings • Senior bankers: Interface between client and junior
• Gain shareholder approval for the transaction bankers and oversee fairness opinion work
Shareholder &
• Gain regulatory approval – no violation of anti-trust • Junior bankers: Support fairness opinion workstreams
regulatory
or other regulatory concerns • Lawyers: Obtain approvals with regulatory submissions
approvals
• Get a fairness opinion if needed • Company: Communicate with shareholders around
• Sign and close the transaction transaction approval, announce and close transaction

Initial Contact & Transaction Agreement on Pricing/ Structure,

Detailed Due Diligence
Assessment Approval/ Closing

M&A – Concepts 194

 M&A Buyside Process

The Deal is Closed - Congratulations!

M&A – Concepts 195

 M&A Sellside Process

In a sell-side process, your client is the potential seller who is looking to divest/ spin off a
Concept business

Action
More
Common Seller Initiates Outreach Seller Responds To Buyer
• The Seller will engage the investment bank early on, so that • In this situation, a Seller would engage an investment bank to
they can help create a potential Buyer list and organize help them evaluate interest from a Buyer
materials that will eventually be sent to potential Buyers
• While less common, these require immediate attention and
• These transactions have good odds of happening since the organization from the bank
company is interested in selling and just needs one Buyer who
will meet what they believe is an acceptable price • The Seller could accept the bid, negotiate with the Buyer,
reject the bid, or choose to enter a wider sale process to ensure
they are maximizing their potential price

In general, sell-side processes take longer than buy-side processes, given the significant upfront work required to prepare a
company for sale – normally the full process can take 6 to 12 months from engagement to completed transaction

M&A – Concepts 196

 M&A Sellside Process

While the exact timeline and sequencing of events can vary significantly by transaction, it is
Concept helpful to think about sell side processes in 4 stages

Agreement on Pricing/
Initial Buyer Contact Buyer Meetings And
Setting Up Structure, Approval/
And Gauging Interest Diligence
(2 – 3 Months) Closing
(1 – 2 Months) (1 – 3 Months)
(1 – 2 Months)

1st Stage 2nd Stage 3rd Stage 4th Stage

Note: The above timeline aligns with the more commonly seen “Seller outreach” scenario. When a potential Buyer initiates the
outreach, discussions normally advance to the 3rd stage

M&A – Concepts 197

 M&A Sellside Process

Concept The 1st stage involves preparing marketing materials for the company & sourcing potential buyers

Activity Description Key Participants

• Senior bankers: Think through potential Buyers given
• Review competitive landscape and industry players
industry knowledge, guide synergy analysis
Determine • Consider Buyer synergy estimates
• Junior bankers: Intelligence work to provide more
Buyer list and • Arrive at initial Buyer outreach list
context on potential Buyer list, run Buyer synergy
timeline • Determine rough process timetable
analysis
• Company: Final approval on potential Buyer list
• A “teaser” is a short (1-2 pages or slides) document with
summary information on a potential acquisition target
Create • Senior bankers: Oversight and guidance on teaser prep
• It is the first material shared with potential Buyers to
company • Junior bankers: Create and revise the teaser
gauge their interest without revealing too much
teaser • Company: Review and give final sign-off on teaser
• A potential Buyer will use the teaser and their in-house
knowledge to determine if they want to move forward
• A Confidential Information Memorandum (“CIM”, also
• Senior bankers: Oversight and guidance on CIM prep,
known as an Offering Memorandum or “OM”) is a more
which is much more substantial than teaser prep
detailed document with 50-100 pages or slides
Create • Junior bankers: Creation and numerous edits of the
• This is the first and most important document a Buyer
company document over a 1-2 month period
will review after signing an NDA
“CIM” • Company: Provide raw information used by bankers to
• It contains detailed investment highlights, information
draft the CIM; provide input and comments throughout
on the industry, a summary of business and segments,
the drafting process
historical and projected financials, and management

Initial Buyer Contact And Agreement on Pricing/

Setting Up Buyer Meetings And Diligence
Gauging Interest Structure, Approval/ Closing
(2 – 3 Months) (1 – 3 Months)
(1 – 2 Months) (1 – 2 Months)

M&A – Concepts 198

 M&A Sellside Process

Concept The 2nd stage involves contacting potential buyers and gauging their interest

Activity Description Key Participants

• Send out the teasers and CIMs to the Buyer list
Contact
• NDAs (non-disclosure agreements) allow for sharing • Senior bankers: Conduct actual outreach
candidates with
of confidential information between parties • Lawyers: Draft NDA and negotiate required NDA edits
teaser and sign
• Teasers are usually also sent with NDA to help across potential Buyers
NDAs
determine potential Buyers if they may be interested
• Buyers in the process are narrowed to only those
Send out the • Senior bankers: Send out the CIM, determine what other
who sign an NDA and receive a CIM
CIM to information may be provided at this phase
• Oftentimes, Sellers will respond to some initial
interested • Junior bankers: Help answer Buyer requests, as allowed
questions on the CIM, but they won’t spend a lot of
parties • Company: Help answer Buyer requests, as allowed
time with potential Buyers until later in the process

• A “data room” is a cloud location where the Seller will • Senior bankers: Guide what will documents to begin
upload all of the relevant documents to help the preparing for the data room
Buyer through their diligence • Junior bankers: Work on preparing some of the data
Begin preparing • Later in the process, the files in the data room will be room documents, organize the data room
data room in direct response to questions from potential Buyers • Lawyers: Help with legal documents for the data room
• Sellers will begin to populate the data room before • Tax advisors: Help with tax documents for the data room
opening it to Buyers to expedite the diligence • Company: Help provide documents and supporting
process information for the data room

Initial Buyer Contact And Agreement on Pricing/

Setting Up Buyer Meetings And Diligence
Gauging Interest Structure, Approval/ Closing
(2 – 3 Months) (1 – 3 Months)
(1 – 2 Months) (1 – 2 Months)

M&A – Concepts 199

 M&A Sellside Process

Concept After gaining some interest from potential buyers, the 3rd stage includes supporting due diligence

Activity Description Key Participants

• Senior bankers: Lead interaction with the potential
• Open up an initial dataroom with key company info
Buyers and determine the contents and pacing of the
• Continue to add files as they are ready to support all types
Open data dataroom
of Buyer diligence (business, financial, legal, tax, etc.)
room and • Junior bankers: Run dataroom and tracker, work with
• Buyers will get opportunities to submit requests, and Seller
support company to create files and add them to the
will manage a tracker with questions to be addressed
Buyer due dataroom
• As the Seller, you want to add information slowly since you
diligence • Lawyers: Help with legal diligence
don’t want to share extra information with competitors
• Tax advisors/accountants: Help with tax diligence
until there is more certainty about a potential transaction
• Company: Support all forms of diligence
• Senior bankers: Lead interaction with potential
• Various meetings between the management teams of the
Buyers and guide the company on how to handle the
Seller and each potential Buyer
Management meetings
• Other meetings with certain functions of the Seller and site
Meetings • Junior bankers: Attend meetings to ensure follow-ups
visits also as needed
with Buyers are handled; prepare supplementary presentations
• These can be time intensive, so need to ensure the Buyer
• Company: Lead responses to Buyer questions in
list is down to the top few prospects by this time
various meetings
• Senior bankers: Manage the timeline for LOI and
• After potential Buyers have enough information to submit a
check-in bids
near-final bid, set a date to receive LOIs
• Junior bankers: Analyze LOIs and summarize for
• Depending on how the process unfolds, there is sometimes
clients
Receive LOIs a request for a “check in” bid to further narrow the Buyer
• Lawyers: Assist in negotiating the LOI
pool following management meetings
• Company: Provide input on price expectations and
• Receive LOIs with the Buyers’ proposed prices and final key
guidance on which Buyers should remain in the
diligence questions outstanding
Initial Buyerfrom each
Contact And Agreement on Pricing/
Setting Up
Gauging Interest
process
Buyer Meetings And Diligence
Structure, Approval/ Closing
(2 – 3 Months) (1 – 3 Months)
(1 – 2 Months) (1 – 2 Months)

M&A – Concepts 200

 M&A Sellside Process

Concept Once due diligence is completed, the 4th stage involves ensuring that the deal closes

Activity Description Key Participants

• Work with potential Buyers to answer all • Senior bankers: Interface between Buyer and Seller on
Help Buyers outstanding due diligence required to get comfort final diligence points, instruct final valuation
finalize due with submitting a binding bid • Junior bankers: Help provide information for and track
diligence • Can also include any final meetings or phone calls final diligence questions
with Seller management as needed • Company: work with bankers to answer final questions
• Senior bankers: Help guide details of definitive
agreement
Request final • Issue a process letter to Bidders requesting exactly
• Junior bankers: Run analysis to contextualize value in
binding bids / what details are expected in the final binding bids
binding bids
definitive • Select final Bidder
• Lawyers: Negotiate the definitive agreements if needed
agreements • Ensure Bidder has secured transaction financing
• Company: Coordinate internal approvals and selection of
preferred Bidder
• Prepare and submit all necessary SEC filings
• Senior bankers: Lead fairness opinion
• Gain shareholder approval for the transaction
• Junior bankers: Support fairness opinion
Get shareholder • Gain regulatory approval – no violation of anti-trust
• Lawyers: Coordinate all approvals and regulatory
& regulatory or other regulatory concerns
submissions
approvals • Get a fairness opinion if needed (especially if a public
• Company: Communicate with shareholders around
company is involved)
transaction approval, announce and close transaction
• Close the transaction

Initial Buyer Contact And Agreement on Pricing/

Setting Up Buyer Meetings And Diligence
Gauging Interest Structure, Approval/ Closing
(2 – 3 Months) (1 – 3 Months)
(1 – 2 Months) (1 – 2 Months)

M&A – Concepts 201

 M&A Sellside Process

The Deal is Closed - Congratulations!

M&A – Concepts 202

 What Are M&A Models?

M&A models are created by investment bankers to help their clients assess the financial
Concept viability/impact of the contemplated transaction

Details

• These models contain information on the Buyer, Seller, and transaction; models have complex functionality that allows the
user to run various scenarios on the combined projections, synergies, and transaction funding

• The appropriate scenarios to model are determined after months of detailed due diligence by the bankers, advisors, and
the transaction counterparties

• A key output of an M&A model is the “accretion/dilution” impact of a transaction, or how the transaction affects a
company’s earnings per share

• If a transaction is accretive to the Buyer, completing the transaction will increase their earnings per share (“EPS”)

• If a transaction is dilutive to the Buyer, completing it will decrease the EPS of the company

• Companies strive to complete transactions that will increase their shareholder value (the product of the EPS and P/E
multiple); however, dilutive transactions are sometimes completed if the Company believes the transaction will result in a
higher P/E trading multiple (via the market’s perspective of better growth and profitability prospects due to the
transaction)

M&A – Concepts 203

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204
Mergers & Acquisitions – Practice Questions
 M&A Practice Questions – Basic

WHAT ARE SOME REASONS THAT TWO COMPANIES WOULD WHAT ARE SOME REASONS TWO COMPANIES WOULD NOT
WANT TO MERGE? WANT TO MERGE?

• SAMPLE ANSWER: The main reason two companies would want to • SAMPLE ANSWER: The “synergies” they seek to gain through the merger
merge would be the synergies the companies should create by combining simply will not occur. Many times, mergers are more about boosting a
their operations. management team’s ego and growing the business in order to gain the
marketability and media attention of a merger.
• However, some other reasons include gaining a new market presence, an
effort to consolidate their operations, gaining brand recognition, growing • The amount of debt capital needed to help fund the transaction could
in size, or gaining the rights to some property (physical or intellectual) that result in an unsustainable capital structure (i.e., too much annual interest
they couldn’t gain as quickly by creating or building it on their own. expense to pay, or the amount of time the company has to pay off the
principal may not be long enough if merger integration takes an extended
period of time).

M&A – Practice Questions 206

 M&A Practice Questions – Basic

WHAT DO BANKERS DO DURING A SELL-SIDE M&A DEAL? WHAT DO BANKERS DO DURING A BUY-SIDE M&A DEAL?

• In a sell-side deal, the bank will market a company to potential buyers • SAMPLE ANSWER: In a buy-side deal, the bank will go out and search for
and then helps both sides negotiate the deal and complete the sale potential companies for their client to acquire and negotiate the deal to
process. obtain the lowest price possible.

• There are four main steps. First, the bank will meet with the company • There are four main steps.
and put together informational documents, such as an offering
memorandum, which will help market the company for sale to • The first will be to do a lot of research on a very large number of potential
potential buyers. acquisition targets based on what the client has represented that they are
looking for.
• Next, the bank will create a list of potential buyers and send out an
executive summary to measure interest in the deal, following up with • After sharing the initial list with the client, you will cut the list down based
additional information if requested. on their feedback and decide which targets to approach about being
purchased.
• Next, the bank will set a deadline for prospective buyers to submit an
indication of interest, which narrows down the group. The bank will • After having meetings with each of them, you decide which to pursue
select the prospective buyers who submit acceptable indications of further based on how open they are to the idea of an acquisition.
interest and continue to send them additional information.
• The third step is to do further due diligence on each of the targets that are
• Finally, the bank will work with the company to maximize the purchase open to acquisition while further narrowing down the list and coming up
price (or the certainty of a transaction closing), select the winning with an offer price for each of the targets.
bidder, help to negotiate the terms, finalize documentation, and then
announce the deal. • Finally, you work with the client to select the final target and work to
negotiate and structure the deal and announce the transaction.

M&A – Practice Questions 207

 M&A Practice Questions – Basic

WHAT ARE SYNERGIES? WHICH WILL NORMALLY PAY A HIGHER PRICE FOR A
COMPANY, A STRATEGIC BUYER OR A FINANCIAL BUYER?
• SAMPLE ANSWER: The concept of synergies is that the combination of
two companies results in a company that is more valuable than the sum of • STRATEGIC BUYER: A corporation that wants to acquire another
the values of the two individual companies coming together. company for strategic business reasons such as synergies, growth
potential, etc. An example of this would be an automobile maker
• The reasons for synergies can be either cost-saving synergies like cutting purchasing an auto parts supplier in order to gain more control of their
employees, reduction in office size, etc., or it can include revenue- COGS and keep costs down.
generating synergies such as higher prices and economies of scale.
• FINANCIAL BUYER: A group looking to acquire another company
purely as a financial investment. An example is a private equity fund
doing a leveraged buyout of the company.

• SAMPLE ANSWER: A strategic buyer will normally pay a higher price due
to their willingness to pay a premium for the synergies of lowering costs,
improving the existing business, and/or revenue synergies.

• The financial buyer typically looks at the company purely in terms of

returns on a standalone basis unless they have other companies in their
portfolio that could significantly improve the operations of the target.

M&A – Practice Questions 208

 M&A Practice Questions – Basic

WOULD I BE ABLE TO PURCHASE A COMPANY AT ITS CURRENT ALL ELSE EQUAL, HOW WOULD ONE COMPANY PREFER TO PAY
STOCK PRICE? FOR ANOTHER?

• SAMPLE ANSWER: Due to the fact that purchasing a majority stake in a • SAMPLE ANSWER: Since cash is the cheapest source of capital, it would
company will require paying a control premium, most of the time, a buyer be the preferred way to purchase another company if the purchaser had
would not be able to purchase a company at its current stock price. sufficient cash.

• On the other hand, a company wanting to keep a significant cash buffer

would prefer other ways of financing the transaction.

• If a company feels its stock price is inflated, it would prefer to use that to
pay for the acquisition. In short, the preferred means of payment always
depends upon the circumstances of the acquisition, the company, and the
market.

M&A – Practice Questions 209

 M&A Practice Questions – Intermediate/ Advanced

IF YOU OWNED A SMALL BUSINESS AND A LARGER COMPANY DESCRIBE A RECENT M&A TRANSACTION YOU HAVE READ
CAME TO YOU OFFERING AN ACQUISITION, HOW WOULD YOU ABOUT.
THINK ABOUT THE OFFER AND WHETHER OR NOT TO TAKE IT?
• This is similar to the recent IPO question. It is simply to explore your
• SAMPLE ANSWER: Obviously, the higher the price, the better, but there general interest in the markets.
are a couple of other things to think about as well. Are you getting paid in
cash or stock? Cash is great because it is tangible, and you can spend it • Look in The Wall Street Journal, Financial Times, or
now, but you also pay taxes on it right away. dealbook.blogs.nytimes.com to get information about recent M&A
transactions.
• With stock, you only pay taxes when you sell; your stock can be worth
more if the acquirer increases in value. However, this can also work the • Know the companies involved, the price and multiples paid, whether it
opposite way if the acquirer falls in value. was a merger or an acquisition, and the banks working on the deal.
Also, know the primary reasons behind the M&A transaction.
• Also, think about what the acquirer’s plans are for you as an owner. Are
you going to continue running the business? Do you want to? The answer
to these questions all depends on your personal preferences and what
stage of life you are in.

M&A – Practice Questions 210

 M&A Practice Questions – Intermediate/ Advanced

CAN YOU NAME TWO COMPANIES THAT YOU THINK SHOULD IF COMPANY A PURCHASES COMPANY B, WHAT WILL THE
MERGE? COMBINED COMPANY’S BALANCE SHEET LOOK LIKE?

• This is another question testing your awareness of what is happening • SAMPLE ANSWER: The new Balance Sheet will be simply the sum of the
in the markets. two companies’ Balance Sheets plus the addition of “goodwill,” which
would be an intangible asset, to account for any premium paid on top of
• There is no right or wrong answer to this question; just have in mind Company B’s actual assets.
two companies that you believe would benefit from merging and have
a well-formulated rationale for the merger (think synergies, gain a
foothold in a new market, consolidation of operations, or brand
recognition).

• The important part of your answer to this question is that the two
companies you choose make sense as a combined entity, and you have
several logical reasons why.

M&A – Practice Questions 211

 M&A Practice Questions – Intermediate/ Advanced

WHAT IS THE DIFFERENCE BETWEEN AN ACCRETIVE MERGER ARE THERE CASES WHERE EPS ACCRETION/DILUTION IS NOT
AND A DILUTIVE MERGER, AND HOW WOULD YOU GO ABOUT IMPORTANT?
FIGURING OUT WHETHER A MERGER IS ACCRETIVE OR
DILUTIVE? • SAMPLE ANSWER: Yes, for example, if the buyer is private or it has
negative EPS, it won’t care about whether the deal is accretive or dilutive.
• SAMPLE ANSWER: An accretive merger is one in which the acquiring It also makes little difference if the Buyer is far bigger than the Seller (e.g.,
company’s earnings per share will increase following the acquisition. A 10x –100x its size).
dilutive merger is one in which the opposite occurs.
• Besides EPS accretion/dilution, you can also analyze the qualitative merits
• The quickest way to figure out if a merger is accretive or dilutive is to look of the deal, compare the IRR to the Discount Rate, and value the Buyer
at the P/E ratios of the firms involved in the transaction. before and after the deal.

• If the acquiring firm has a higher P/E ratio than the firm it is purchasing, • Finally, you can create a Contribution Analysis where you look at how
the merger will be accretive because the acquirer will pay less per dollar of much the Buyer and Seller “contribute” to each financial metric and then
earnings for the target company than where the target’s stock is currently base the ownership of the Combined Company (and, therefore, the
trading. purchase price) on that.

Acquirer EPS Post Acquisition PE Ratios

Accretive Greater Target PE is lower than Acquirer

Target PE is greater than

Dilutive Lesser
Acquirer

M&A – Practice Questions 212

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213
Other Common Technical Questions -Stocks
 Other Common Technical Questions - Stocks

NAME THREE STOCKS/COMPANIES THAT YOU THINK ARE WHAT DID THE S&P 500/DOW JONES INDUSTRIAL
UNDERVALUED AND EXPLAIN WHY YOU CHOSE THEM. AVERAGE/NASDAQ CLOSE AT YESTERDAY?

• This question is unique to you and is particularly common in Sales and

• This question is used to gauge your general interest in the financial
Trading interviews.
markets. You probably will not be expected to know the number to
the penny but knowing the levels of the three major
• Do some research and find a few stocks you believe are good buys at
exchanges/indices, as well as whether they were up or down and why,
the current market price. You must have a good reason behind each of
will show your interviewer that you keep track of what is going on in
your picks.
the world of finance.
• The best way to find these stocks is to use equity research reports if
you can. Many schools will have access to them through their library • You should know how the market moved (up or down) the previous
website. You also can use sites like Jim Cramer’s Thestreet.com or day and why it moved. You can find this information by watching
Motleyfool.com to look at articles about others’ stock picks and the CNBC, reading the WSJ, etc.
reasons behind them. WallStreetOasis.com is a good place to find
stock ideas.
• Yesterday, the XXXX closed at XXXX, up/down XXX from the open. I
also noticed that it was up XXX from the day before due
• If you are feeling ambitious, you could go through the process of
to .............................
valuing the stocks yourself, using any of the valuation techniques.

• Generally speaking, we have found you are better off picking a less • It would also be a good demonstration of market interest to know the
well-known company, so your interviewers have less ability to cross- overall valuation levels of the three major indices. The P/E ratios for
examine you on your reasoning. the overall Dow, S&P 500, and Nasdaq are publicly available in major
financial news publications.
• If they know a stock well, they will be able to test you and push you on
specifics about it. Go with this strategy unless you learn that you are
interviewing or applying for a position in a specific industry; then, you
may be compelled by the interviewer to focus on a relevant sector.

• Variations of this question include “Pitch me a stock” or “What stocks

would you short right now?” (The “Short” answer would be opposite to
the “Pitch” answer, in that you would short a stock you believe will
perform poorly.)

Other Technical Questions - Stocks 215

 Other Common Technical Questions - Stocks

COMPANY XYZ RELEASED INCREASED QUARTERLY EARNINGS WHAT DOES IT MEAN TO SHORT A STOCK?
YESTERDAY, BUT THEIR STOCK PRICE STILL DROPPED. WHY?

• SAMPLE ANSWER: “There are two main reasons that this could occur.
• Short selling is selling a stock that you don’t actually own.
First, the entire market or the industry to which XYZ belongs could have
been down on the day, which had more of an impact than the company’s • Investors that short-sell a stock believe they will be able to purchase
positive earnings. that stock at a lower price in the future.

• More likely, however, is that the increased earnings figures they reported
• Typically, a short-seller will borrow the stock from another investor
were not as high as the Wall Street analysts’ estimates.”
and then sell it, promising to return the stock to the lender later.
Brokerage firms can facilitate this borrowing; however, not all stocks
can be shorted.

• “Naked” short selling occurs when an investor sells the stock without
having borrowed any. It would also be a good demonstration of
market interest to know the overall valuation levels of the three major
indices. The P/E ratios for the overall Dow, S&P 500, and Nasdaq is
publicly available in major financial news publications.

• SAMPLE ANSWER: “Short selling a stock is the opposite of going long in

stock. Usually, an investor buys a stock believing it will sell for a higher
price in the future. When short-selling, investors stock they don’t own, in
the belief that they will be able to purchase it for a lower price in the
future.”

Other Technical Questions - Stocks 216

 Other Common Technical Questions - Stocks

WHAT IS LIQUIDITY? IS 15 A HIGH P/E (PRICE TO EARNINGS) RATIO?

• Liquidity is how freely an asset or security can be bought and sold on • This is not a yes or no question. A firm’s P/E ratio is important in
the open markets. comparison with other companies in its industry. P/E can be thought
of as how many dollars an investor is willing to pay for one dollar of
• Money market accounts, publicly traded large-cap stocks and
earnings.
bonds, ETFs, and open-ended mutual funds are very liquid.
• Micro-cap stocks, bonds, loans, or investments in privately-owned • A high P/E represents high anticipated growth in earnings. In high-
companies could be considered relatively illiquid due to the limited growth industries, such as technology, a P/E ratio of 15 may be
market for them. considered relatively low since the company is expected to grow its
earnings at a high rate and therefore deserves a higher valuation
• Liquidity also describes how quickly an asset can be converted into
relative to current earnings.
cash.
• Cash itself is the most liquid asset. • For a large pharmaceutical company, however, a P/E of 15 may be
considered high since earnings growth may be expected to be slow but
• A large pharmaceutical production plant is not a very liquid asset
steady in future years.
because it would take the owner of the plant a long time to sell the
plant and convert it into usable cash.
• SAMPLE ANSWER: “It depends on the industry. A P/E ratio of 15 in an
industry like basic materials may be considered a bit high, but if the
• A more liquid investment is relatively safer, all else equal since the
company is a high-growth tech company, 15 may be considered rather
investor can sell it anytime.
low.”
• SAMPLE ANSWER: “Liquidity is how easily an asset can be bought and
sold by an investor. Some examples of liquid assets include money market
accounts and large-cap stocks. Some non-liquid assets include many
micro-cap stocks or a large, specialized factory or production plant that
could take years to convert into cash.”

Other Technical Questions - Stocks 217

 Other Common Technical Questions - Stocks

WHAT DO BANKERS DO DURING AN INITIAL PUBLIC OFFERING WHERE DO YOU THINK THE STOCK MARKET WILL BE IN 3/6/12
(IPO)? MONTHS?

• You can’t go into a tremendous amount of detail here because there is • This is another question that can show your interest in the markets.
just so much that goes into this process. Focus on hitting the main, There is no right or wrong answer since everyone has different
high-level steps, and you will be just fine. opinions on where the market is going.

• SAMPLE ANSWER: “The purpose of an IPO is to issue the least number • You need to have an opinion and well-thought-out reasoning for that
of shares possible for the highest price per share, therefore raising the most opinion.
money for the lowest possible ownership percentage of the company.
• If you think the market is going to drop in the next three months, hit
• You do this by selling shares of the company at an attractive valuation and bottom, and then begin to bounce back, have a reason to explain why
recruiting institutional investors (hedge funds, mutual funds, etc.) to you think it is going to drop, why it is going to bottom out, and why it
support the client’s share price once the company lists its stock on the will begin to rise.
public exchange.
• It is more important to display logical reasoning than to be right.
• First, you will meet with the client to gather information like historical
financials, industry information, customer data, company overview, etc. • Do some research before your interview; see what writers for major
newspapers are saying and predicting, and then use some of their
• Then, you will meet with lawyers to draft the company’s registration reasons in your explanation.
documents (called an S-1 in the US), which detail the business, its
operations, its customers, its financials, etc., to potential investors. • Also, stick to your reasoning. Your interviewer may challenge you and
question your reasoning. If you have come up with a solid theory
• This goes through many revisions working with the lawyers and the SEC behind your response, be confident in your answer and try to explain
until all parties accept it. The bankers then take the client on a “road show” your rationale. If your logic makes sense, don’t change your opinion
where the company is presented to institutional investors in different cities just to agree with your interviewer.
around the country (or globe).

• After the roadshow, and after the company has raised the capital from the
institutional investors, the shares of the stock will begin trading on one of
the public exchanges.”

Other Technical Questions - Stocks 218

 Other Common Technical Questions - Stocks

HOW DO YOU VALUE A COMPANY DIFFERENTLY IN AN IPO WHY DO COMPANIES OFFER PRICING DISCOUNTS ON IPO?
THAN IN AN M&A DEAL? / HOW DO YOU BUILD AN IPO MODEL
FOR A COMPANY? • Even if a company believes its shares are worth $100.00, it usually lets
new investors in an IPO purchase them at a discount of ~15% (so,
• The main difference is that you focus on the forward multiples of the $85.00 here) because those investors assume significant risk by
Public Comps because investors pay so much attention to them when purchasing the shares before the company is a publicly traded entity.
a company goes public.
• Anything could happen between pricing and the first few minutes of
• A company’s pricing in an IPO is based on these metrics as well. So, if trading – the company’s share price might plunge by 20%, for example.
the median 1-year forward P / E multiple for similar public companies To compensate investors for that risk, companies offer this discount.
is 20x, you might suggest a range of 1-year forward P / E multiples
around 20x for your company as well.

• SAMPLE ANSWER: “You start by assuming a range of forward multiples

(often P / E multiples) and then applying them to the company’s projected
financial metrics. If you’re using P / E multiples, that gets you the
company’s implied post-money Equity Value when it starts trading.

• But companies almost always offer new investors a pricing discount in

IPOs, so you have to apply that discount (10-15%) to determine the post-
money Equity Value at pricing.

• Then, you can determine the Offering Price per Share by taking the post-
money Equity Value at pricing, subtracting the offering size, and dividing by
the company’s pre-IPO share count. Based on that, you can calculate the
Primary Shares issued in the offering.

• For example, a post-money Equity Value of $10 billion / $50.00 Offering

Price = 200 million shares, and if the company currently has 150 million
shares, it must issue 50 million new ones.

• You can then determine the Secondary Shares and Overallotment Shares
based on separate assumptions for those. Finally, you calculate the % of
the company sold in the IPO and its valuation multiples at pricing and
trading, reflecting the Net IPO Proceeds in its Equity Value and Enterprise
Value.”
Other Technical Questions - Stocks 219
 Other Common Technical Questions - Stocks

HOW DOES A COMPANY DECIDE ON THE AMOUNT OF CAPITAL WHAT IS THE SIGNIFICANCE OF PRIMARY VS. SECONDARY
TO RAISE IN AN IPO? SHARES IN AN IPO OR FOLLOW-ON? / HOW MIGHT THE
MARKET INTERPRET AN IPO WITH 100% SECONDARY SHARES?
• It depends on the reason why the company is going public: If it needs
capital for a specific purpose, Technical Interview Guide - Preparation • A primary offering occurs when the company issues new shares in an
for Finance Interviews such as acquiring, paying down debt, or buying equity offering. They dilute the company’s existing investors by
a factory, it will aim to raise that amount of capital. reducing their ownership stake, but they also allow the company to
raise capital.
• But if the company is going public to provide existing investors with an
exit and liquidity, it often raises capital such that it sells a certain • Secondary shares are existing shares sold to new investors in the
percentage of the company (often between 20% and 40%). offering. They do not dilute existing investors at all, but the company
also receives no cash from them.
• The company wants to offer enough new shares to make investors
commit to the company, but not so many that it gives up control. • The percentages of primary and secondary shares should be within
Some companies can get around these guidelines if they’re “hot” and reasonable ranges in an equity offering, or the market may not buy
there’s a huge amount of demand for their shares – they can often sell into it. For example, new investors may be skeptical if too many
much smaller percentages of their equity, such as 5-10%, in initial existing investors want to sell their shares.
public offerings.
• SAMPLE ANSWER: “The market would typically interpret this deal
negatively since the company is not issuing any new shares, which implies
that growth expectations are low.

• Also, if so, many existing investors sell their shares in the company; they’re
sending a signal to the market that they don’t believe in the company’s
long-term prospects. In most market environments, it would be difficult-to-
impossible to conduct an IPO with no primary shares.

• Interestingly, one of the hottest public company offerings in 2018 was the
IPO of music streaming service Spotify, which was a 100% secondary
share offering, providing a liquidity solution to existing investors. The public
equity markets received the offering well, as the price stabilized in its IPO
range. This was the first successful IPO that was a 100% secondary share
offering in quite a while.”

Other Technical Questions - Stocks 220

 Other Common Technical Questions - Stocks

CAN YOU TELL ME ABOUT A RECENT IPO YOU HAVE IF YOU READ THAT A CERTAIN MUTUAL FUND ACHIEVED 50%
FOLLOWED? RETURNS LAST YEAR, WOULD YOU INVEST IN IT?

• Again, this is a question you need to research around the time of your • Past performance is not an indication of future results. This is the
interview. You can find an IPO discussed in the Wall Street Journal or disclaimer you hear at the end of nearly every commercial that
Financial Times. Another option is to go to presents a fund’s past performance as a selling point.
dealbook.blogs.nytimes.com and click on the IPO/Offerings tab to see
what recent IPOs have occurred. • The reason for this is that a specific investment type could perform
remarkably well in one year and then significantly underperform in the
• Know what company went public, a little information about the following year.
company, what the offer price was, which banks completed the IPO,
etc. Many of these news services have daily newsletters, which will • SAMPLE ANSWER: “To make an investment decision, you need to
detail the list of public offerings each day the market is open. research more in-depth into the fund’s holdings, management, fee
structure, etc., because past performance—especially a single year—is not
an indicator of future results. A mutual fund full of mortgage-backed
securities could have been up 50% a few years ago and then been down
90% the year after the market for MBSs collapsed.”

Other Technical Questions - Stocks 221

 Other Common Technical Questions - Stocks

IF A COMPANY’S STOCK HAS GONE UP 20% IN THE LAST 12 WHAT IS INSIDER TRADING, AND WHY IS IT ILLEGAL?
MONTHS, IS THE COMPANY’S STOCK, IN FACT, DOING WELL?
• Insider trading is buying or selling public securities based on
• SAMPLE ANSWER: “The answer to that question depends on a few information that is not available to the public.
factors, including the company’s beta and the market’s performance.
• Examples include an investment banker buying or selling a company's
• If the stock’s beta is 1 (meaning it should be as volatile as the market and stock before an M&A deal is announced or a CEO buying or selling
therefore produce market returns) and the market was up 30% over the his/her company’s stock before making a major announcement.
past 12 months, then the stock is doing relatively poorly.”
• SAMPLE ANSWER: “Insider trading is buying or selling stock based on
information that is not publicly available. For example, if a CEO of a
pharmaceutical company knows that one of his or her company’s drugs is
going to be pulled from the shelves by the FDA, that CEO cannot sell his or
her stock until the information has been released to the public.”

Other Technical Questions - Stocks 222

 Other Common Technical Questions - Stocks

WHO IS A MORE SENIOR CREDITOR, A BONDHOLDER OR HOW CAN A COMPANY RAISE ITS STOCK PRICE?
STOCKHOLDER?
• A company can repurchase stock, which lowers the number of shares
• SAMPLE ANSWER: “A bondholder is always senior to a stockholder. In outstanding and therefore increases the value per share.
the event of bankruptcy/liquidation, the bondholder will be repaid first.
Additionally, interest payments are paid to bondholders before equity • It can improve operations to produce higher earnings, causing its EPS
holders receive any profits in the form of dividends.” to be higher than anticipated by industry analysts, which will send a
positive signal to the market.

• It can announce a change to its organizational structure, such as cost-

cutting or consolidation, which would lead to increased earnings.

• It could announce the institution of a dividend policy or an increase in

an existing dividend.

• It can announce an accretive merger or an acquisition that will increase

earnings per share.

• SAMPLE ANSWER: “Any positive news about the company can

potentially raise the stock price. If the company repurchases stock, it
lowers the shares outstanding and raises the EPS, which would raise the
stock price.

• A repurchase is also seen as a positive signal in the market. A company

could announce operational efficiencies, other cost cuts, or changes to its
organizational structure, such as consolidations. It could announce an
accretive merger or acquisition that would increase earnings per share. Any
of these occurrences would most likely raise the company’s stock price.”

Other Technical Questions - Stocks 223

 Other Common Technical Questions - Stocks

A STOCK IS TRADING AT $5, AND ANOTHER STOCK IS TRADING WHAT IS CORRELATION?

AT $50. WHICH HAS GREATER GROWTH POTENTIAL?
• Correlation is how two stocks move in relation to each other.
• It depends. The stock with the higher growth potential is most likely
the stock with the lower market cap, so if the $5 stock has 1 billion • If two stocks have a strong positive correlation, they move up or down
shares outstanding and the $50 stock has 10,000 shares outstanding, together.
the $50 stock would most likely have higher growth potential.
• If two stocks have a strong negative correlation, when one moves up,
the other should move down, and vice versa.

• Correlation ranges between –1 and 1.

• SAMPLE ANSWER: “Correlation is the way that two investments move in

relation to one another. If two investments have a strong positive
correlation, they will have a correlation near 1, and when one goes up or
down, the other will do the same.

• When you have two with a strong negative correlation, they will have a
correlation near -1, and when one investment moves up in value, the other
should move down.”

Other Technical Questions - Stocks 224

 Other Common Technical Questions - Stocks

WHAT IS DIVERSIFICATION? IF YOU ADD A RISKY STOCK TO A PORTFOLIO, WHAT HAPPENS

TO THE OVERALL RISK OF YOUR PORTFOLIO?
• Diversification is mixing a wide variety of investments in your portfolio
in search of a better risk/return ratio than putting all your capital into • SAMPLE ANSWER: “It depends on the correlation between the new
only one or a few investments. investment and the rest of the portfolio. It could lower the overall risk of
the portfolio if the new stock has a negative correlation compared to the
• To diversify your portfolio, you may want to pick investments that rest of the portfolio.”
have a low correlation. When economic conditions push one
investment to have a good period, the other may have its own period WHAT IS THE DIFFERENCE BETWEEN TECHNICAL ANALYSIS AND
and vice versa. FUNDAMENTAL ANALYSIS?

• Systematic risk is the risk that affects the entire market, while • SAMPLE ANSWER: “Technical analysis is the process of picking stocks
unsystematic risk affects only specific industries. If properly based on quantitative, statistical analyses, historical trends and stock
diversified, investors can essentially eliminate all unsystematic risk movements. Fundamental analysis is examining a company’s
from their portfolios. fundamentals, financial statements, industry, etc., and then picking stocks
that are ‘undervalued.’”
• SAMPLE ANSWER: “Diversification is creating a portfolio of different
types of investments. It means investing in stocks, bonds, alternative
investments, etc. It also means investing across different industries.

• If investors are properly diversified, they can essentially eliminate all

unsystematic risk from their portfolios, meaning that they can limit the risk
associated with individual stocks so that their portfolios will be affected
only by factors affecting the entire market.”

Other Technical Questions - Stocks 225

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226
Other Common Technical Questions - Bonds,
Loans And Interest Rates
 Other Common Technical Questions - Bonds, Loans And Interest Rates

WHAT IS THE DEFAULT PREMIUM? WHAT IS THE DEFAULT RISK?

• SAMPLE ANSWER: “The default premium is the difference between the • SAMPLE ANSWER: “The default risk is the risk of a given company not
yield on a corporate bond and the yield on a government bond with the being able to make its interest payments or pay back the principal amount
same time to maturity to compensate the investor for the default risk of of its debt. All else equal, the higher a company’s default risk, the higher
the corporation, compared with the “risk-free” comparable government the interest rate a lender will require it to pay.”
security.”
WHAT IS “FACE VALUE”?
HOW DO YOU DETERMINE THE DISCOUNT RATE ON A BOND?
• SAMPLE ANSWER: “Technical analysis is the process of picking stocks
• SAMPLE ANSWER: “The company’s default risk determines the discount based on quantitative, statistical analyses, historical trends, and stock
rate. Some of the factors that influence the discount rate include a movements. Fundamental analysis is examining a company’s
company’s credit rating, the volatility of their cash flows, the interest rate fundamentals, financial statements, industry, etc., and then picking stocks
on comparable U.S. Bonds, the amount of current debt outstanding, that are ‘undervalued.’”
leverage and interest coverage.”

Other Technical Questions – Bonds, Loans & Interest Rates 228

 Other Common Technical Questions - Bonds, Loans And Interest Rates

WHAT IS THE COUPON PAYMENT? WHAT IS THE DIFFERENCE BETWEEN AN INVESTMENT GRADE
BOND AND A “JUNK BOND”?
• The coupon payment on a bond or loan is the interest payment a
company will pay to holders of the bond/loan. • Bonds with higher credit ratings, typically rated BBB- or higher by
Standard & Poor's (S&P) or Fitch Ratings, or Baa3 or higher by Moody's
• This coupon payment is the stated interest rate times the face amount Investors Service, are considered investment grade. These bonds are
of the bond or loan. Bonds typically make coupon payments annually perceived to have a lower risk of default and are often issued by stable
or semi-annually, while loans typically make interest payments once and creditworthy entities, such as governments, municipalities, and
per quarter. financially sound corporations.

• If a company issues 10% 7-year annual bonds with a face value of • Bonds with lower credit ratings, typically rated below BBB- by S&P or
$1,000 each, annual coupon payments will be $100 each: Fitch Ratings, or below Baa3 by Moody's, fall into the category of
high-yield or speculative-grade bonds. These bonds are considered
• (10% interest * $1,000 face value / 1 payment per year) riskier due to a higher likelihood of default, and they generally offer
higher yields to compensate for the increased risk. They are often
• The chart below shows the hypothetical cash flows with a $1,000 issued by companies with lower credit quality or those undergoing
purchase in year zero, then a $100 coupon payment each year from financial challenges.
years one through seven, and the repayment of principal in year seven
in addition to the final coupon payment. • SAMPLE ANSWER: “An investment grade bond is a bond issued by a
company that has a relatively low risk of bankruptcy and therefore has a
• SAMPLE ANSWER: “The coupon payment is the amount a company pays low-interest payment. A “junk bond” is one issued by a company that has a
its loan and bondholders, usually on an annual, semi-annual, or quarterly high risk of bankruptcy but is paying high-interest payments.”
basis. It is the coupon rate, or interest rate, times the face value of the
bond. For example, the coupon payment on an annual 10% bond with a
$1,000 face value would be $100.”

Other Technical Questions – Bonds, Loans & Interest Rates 229

 Other Common Technical Questions - Bonds, Loans And Interest Rates

WHAT IS THE DIFFERENCE BETWEEN A CORPORATE BOND AND WHAT ARE THE MAIN FACTORS INFLUENCING A BOND'S PRICE?
A CONSUMER LOAN?
• SAMPLE ANSWER: “The bond’s coupon rate, prevailing interest rates on
• In theory, a bond and a loan are similar in that they are both forms of similar bonds in the market, and the company’s creditworthiness make the
debt. The “issuer” of a bond is like the “borrower” on a loan, and the biggest impact on the bond’s market price.
“holder” of the bond is like the “creditor”.
• All of them appear in the pricing formula for a bond, but the company’s
• Let’s draw a parallel between a bond issuance from General Electric creditworthiness makes a more indirect impact since it affects the
and a home loan taken out by John Smith. GE and John Smith are both “Redemption” term (lower creditworthiness means that the expected
looking to borrow money. GE is looking to borrow quite a bit more, so repayment percentage may be below 100%).”
they need to go to the public markets and borrow money from lots of
different sources, while John Smith can just go to his local bank.

• GE structures a bond issuance for X dollars, with a term (say 10 years)

and an interest rate (say 5%), which will be paid in a “coupon” payment
each year. John Smith goes to the local bank and borrows Y dollars,
agreeing to pay it back over a term (say 30 years) at an agreed-upon
interest rate (say 7%), which will be paid every year. Both loans and
bonds have additional terms built into their structures.

• As you can see, the similarities are numerous. However, in order to

raise the money, John simply borrows all his money from the bank.
GE’s process is a bit more complicated in that they must go out and
market their bonds to the public, selling them to individuals and
institutional investors across the globe with the help of their
investment bank of choice.

• SAMPLE ANSWER: “The main difference between a corporate bond and

a consumer loan is the market that it is traded on. Bond issuance is usually
for a larger amount of capital, is sold in the public market, and can be
traded. A bank issues a loan and is not traded on a public market.”

Other Technical Questions – Bonds, Loans & Interest Rates 230

 Other Common Technical Questions - Bonds, Loans And Interest Rates

HOW DO YOU PRICE A BOND? IF THE PRICE OF A BOND GOES UP, WHAT HAPPENS TO THE
YIELD?

• SAMPLE ANSWER: “The price and yield of a bond move inversely to one
another. Therefore, when the price of a bond goes up the yield goes down.”

• SAMPLE ANSWER: “The price of a bond is the net present value of all
future cash flows (coupon payments and par value) expected from the
bond using the current interest rate.

• For the example below, assume the current interest rate is 7% on

comparable bonds. The bond you are looking to invest in has a $100
face value and pays 10% annual interest.

• Since the bond you are investing in pays a higher coupon than bonds
of comparable companies, you will be required to pay a premium for
that higher interest rate, hence the $112.30 price, which brings the
yield on the bond down to levels in line with comparables.”

Other Technical Questions – Bonds, Loans & Interest Rates 231

 Other Common Technical Questions - Bonds, Loans And Interest Rates

IF YOU BELIEVE INTERESTS RATES WILL FALL AND ARE LOOKING IF THE PRICE OF THE 10-YEAR TREASURY NOTE RISES, WHAT
TO MAKE MONEY DUE TO THE CAPITAL APPRECIATION ON HAPPENS TO THE NOTE’S YIELD?
BONDS, SHOULD YOU BUY THEM OR SHORT-SELL THEM?
• The chart above showing the relation between bond prices and yields
• If you believe interest rates are going to fall, bond prices should rise. If also applies to the relationship between Treasury notes and their yield.
you are looking to make money on the capital appreciation of the
bonds, you should be looking to buy the bonds. • SAMPLE ANSWER: “The price and yield are inversely related, so when
the price goes up, the yield goes down.”
• SAMPLE ANSWER: “Since price moves inversely to interest rates if you
believe interest rates will fall, bond prices will rise, and therefore you WHAT WOULD CAUSE THE PRICE OF A TREASURY NOTE TO
should buy bonds.” RISE?

WHAT IS THE CURRENT YIELD ON THE 10-YEAR TREASURY • SAMPLE ANSWER: “If the stock market is extremely volatile, and
NOTE? investors are fearful of losing money, they will desire risk-free securities,
which are government bonds. The increase in demand for these securities
• This information changes daily and is available in The Wall Street will drive the price up, and therefore the yield will fall.”
Journal or any financial website.

• As of July 15, 2023, the yield on the 10-year was 3.83%

Other Technical Questions – Bonds, Loans & Interest Rates 232

 Other Common Technical Questions - Bonds, Loans And Interest Rates

IF YOU BELIEVE INTEREST RATES WILL FALL, SHOULD YOU BUY WHAT IS THE ORDER OF CREDITOR PREFERENCE IN THE EVENT
BONDS OR SELL BONDS? OF COMPANY BANKRUPTCY?

• SAMPLE ANSWER: “If interest rates fall, bond prices will rise, so you • The order of preference is shown in the chart below. Those at the top
should buy bonds.” of the pyramid have the first claim on the firm’s assets in the event of
liquidation or sale, followed in order by those below them.
HOW MANY BASIS POINTS EQUAL 0.5 PERCENT?
• SAMPLE ANSWER: “The first creditors to get paid in the event of
• One basis point = 0.01 percent. Therefore 0.5 percent = 50 basis liquidation are the senior debt holders—usually banks and senior
points bondholders. They likely have some of the firm’s assets as collateral. Next
come those holding subordinated debt, followed by preferred stockholders.
• SAMPLE ANSWER: “Since one basis point is to one-hundredth of a Common stockholders have the last claim on assets in the event of
percent, half a percent is fifty basis points.” liquidation or bankruptcy.”

Other Technical Questions – Bonds, Loans & Interest Rates 233

 Other Common Technical Questions - Bonds, Loans And Interest Rates

WHY WOULD A COMPANY USE BANK DEBT RATHER THAN WHAT IS THE DIFFERENCE BETWEEN SENIOR SECURED DEBT OR
HIGH-YIELD BONDS? “BANK DEBT” AND BONDS?

• SAMPLE ANSWER: “The assets of the company secure bank debt and, • SAMPLE ANSWER: “The first difference is the assets of the company
therefore, normally command lower interest rates. The trade-off is that it secure that bank debt, and bonds many times are not, so the interest rate
will typically amortize and may have maintenance covenants.” on bank debt is typically lower.

WHY MIGHT TWO BONDS WITH THE SAME MATURITY AND THE • Second, bank debt tends to have floating interest rates based on SOFR
SAME COUPON FROM THE SAME ISSUER BE TRADING AT plus a spread, whereas bonds normally pay at a fixed rate.
DIFFERENT PRICES?
• Third, bank debt may carry financial maintenance covenants that require
• One of the bonds could be callable. the company to maintain certain leverage levels, interest coverage levels,
etc., while bonds do not.
• One of the bonds could be puttable.
• Fourth, bank debt is normally amortized at a certain percentage per year.
• One of the bonds could be convertible.
• The fifth and final difference is that bank debt tends to be pre-payable at
• SAMPLE ANSWER: “There are a couple of explanations for the observed any time, whereas bonds tend to have call protection for some years after
price difference. A bond that is puttable or convertible would demand a issuance, ensuring that bonds remain outstanding.
premium, and a callable bond would trade at a discount.”
• In smaller transactions, the deal may be uni-tranche (all bank debt), but in
large transactions, the capital structure could include first-lien bank debt,
second-lien bank debt, AND bonds.”

Other Technical Questions – Bonds, Loans & Interest Rates 234

 Other Common Technical Questions - Bonds, Loans And Interest Rates

WHAT ARE BOND RATINGS? WHAT IS THE YIELD TO MATURITY ON A BOND?

• A bond rating is a grade given to a bond according to its risk of default. • The yield to maturity (YTM) is the rate of return on a bond if it is
purchased today for its current price, held through its maturity date,
• The three best-known and most trusted rating agencies are Standard and is paid off in full at maturity.
& Poor’s, Moody’s, and Fitch.
• Normally, the yield to maturity is expressed as an annual rate.
• Recently, rating agencies have faced some skepticism about their
rating techniques because so many of the mortgage-backed securities • The calculation of YTM includes the current market price, the face
that were given very high ratings ended up defaulting. value, the coupon payments, and the time to maturity.

• The lower the grade, the more speculative the stock, and all else equal, • If the coupon yield of a bond (coupon/face) is lower than its current
the higher the yield. yield (coupon/price), it is selling at a discount.

• See the chart from earlier for a visualization of the different ratings • If the coupon yield of a bond (coupon/face) is higher than its current
and agencies. yield (coupon/price), it is selling at a premium.

• SAMPLE ANSWER: “A bond rating is a grade given to a bond based on its • SAMPLE ANSWER: “The yield to maturity on a bond is its rate of return if
risk of default. This rating is issued by an independent firm and updated held through its maturity date, based on its current price, coupon
over the life of the bond. payments, face value, and maturity date.”

• The most trusted rating agencies are S&P, Moody, and Fitch, and their
ratings range from AAA to C or even D. The top rating of AAA goes to
highly rated “investment grade” bonds with a low default risk; the C-rated
bond is “non-investment grade” or “junk,” and a rating of D means the
bond is already in default and not making payments.”

Other Technical Questions – Bonds, Loans & Interest Rates 235

 Other Common Technical Questions - Bonds, Loans And Interest Rates

IF YOU PURCHASE A $100 BOND AT A 5% DISCOUNT TO PAR WHAT IS THE DIFFERENCE BETWEEN YIELD TO MATURITY AND
VALUE. THE BOND'S COUPON RATE IS 8% AND MATURES IN 5 YIELD TO WORST?
YEARS. WHAT IS THE BOND'S APPROXIMATE YTM?
• SAMPLE ANSWER: “Yield to maturity assumes the debt holder will
• SAMPLE ANSWER: “You can approximate the YTM with (Annual Interest maintain the investment through its maturity date, collecting all interest
+ (Redemption Value – Bond Price) / # Years to Maturity) / ((Redemption payments and being repaid in full when it matures.
Value + Bond Price) / 2). The annual interest is$8, the redemption value is
100 (since full repayment is assumed with YTM), the bond price is 95, and • Yield to worst is the lowest potential yield an investor can earn on a debt
the # years to maturity is 5, so: investment short of default by the issuer. This means that if a bond is
callable or has other provisions, an investor could earn less than yield to
• YTM = (8 + (100 – 95) / 5) / ((100 + 95) / 2) >> YTM = (8 + 1) / 97.5 = maturity should the company exercise a prepayment option to get out of
9.2%. the bond early.”

• You could say, “Between 9% and 10%” in an interview. The intuition is that WHAT WILL HAPPEN TO THE PRICE OF A BOND IF THE FED
we earn 8% interest per year and also 1% on the bond’s principal per year RAISES INTEREST RATES?
since it increases from 95% to 100% over 5 years.”
• SAMPLE ANSWER: “If interest rates rise, newly issued bonds offer higher
WHAT HAPPENS TO THE YTM AND THE CURRENT YIELD ON A yields to keep pace. This makes existing bonds with lower coupon
BOND IF THE COMPANY'S CREDIT RATINGS FALL payments less attractive, and their price must fall to raise the yield enough
DRAMATICALLY BUT PREVAILING INTEREST RATES AND THE to compete with the new bonds.”
BOND'S COUPON RATE STAY THE SAME?

• The bond will start to trade at a discount to par value if the company’s
credit rating falls dramatically, so the bond’s Current Yield will increase
above the coupon rate.

• The bond’s YTM should also increase because it’s based on the
assumption of full repayment upon maturity – even if that’s no longer
realistic.

• The bond’s YTM should increase to a figure above the Current Yield
because investors now earn interest plus an annualized gain from
buying the bond at a discount and earning back its par value upon
maturity.

Other Technical Questions – Bonds, Loans & Interest Rates 236

 Other Common Technical Questions - Bonds, Loans And Interest Rates

WHAT IS A EURODOLLAR BOND? WHAT IS A PUT BOND?

• Note that a Eurodollar bond does not have to be issued by a company • SAMPLE ANSWER: “A put bond is essentially the opposite of a callable
actually in Europe; it can be a bond issued by any foreign company. bond. A put bond gives the owner of the bond the right to force the issuer
to buy back the security (usually at face value) prior to maturity.”
• SAMPLE ANSWER: “A Eurodollar bond is one issued by a foreign
company but in U.S. Dollars rather than the home currency.” WHAT IS A CONVERTIBLE BOND?

WHAT IS A CALLABLE BOND? • Within the bond indenture of a convertible bond are a specified
number of shares of common stock that each bond can be “converted”
• A callable bond has a price (or prices) built into the bond indenture into at a time of the bondholders’ choosing. If the value of those
that allows the issuer to buy back the bond on a certain date (or dates), shares exceeds the face value of the bond, the investor typically will
usually for a premium over the face value of the bond. convert the bond.

• SAMPLE ANSWER: “A callable bond allows the issuer of the bond to • SAMPLE ANSWER: “A convertible bond can be “converted” into equity
redeem the bond prior to its maturity date, thus ending coupon payments. during the bond’s lifetime. Therefore, the bond can be converted before
However, a premium is usually paid by the issuer to redeem the bond maturity should the bondholder decide that equity in the company is worth
early.” more than the bond.”

Other Technical Questions – Bonds, Loans & Interest Rates 237

 Other Common Technical Questions - Bonds, Loans And Interest Rates

WHAT IS A PERPETUAL BOND? WHEN SHOULD A COMPANY ISSUE DEBT INSTEAD OF EQUITY?

• A perpetual bond, also known as a perpetuity or a perpetual annuity, is • SAMPLE ANSWER: “A company will normally prefer to issue debt
a type of bond that has no fixed maturity date. Unlike traditional because it is cheaper than issuing equity. In addition, interest payments are
bonds that have a defined maturity, perpetual bonds have no specific tax deductible and therefore provide tax shields.
redemption date, meaning they do not have a maturity date when the
principal amount must be repaid by the issuer. • However, a company has to have a steady cash flow to make coupon
payments, which is not necessary when issuing equity. A company may
• SAMPLE ANSWER: “A perpetual bond is a bond that simply pays a also try to raise debt if it feels its stock is particularly undervalued such
coupon payment indefinitely (or until the company goes into default) and that an equity offering would not raise the capital needed.”
never returns a principal amount.”
WHY MIGHT A COMPANY ISSUE A CONVERTIBLE BOND RATHER
WHAT IS THE VALUE OF A PERPETUAL BOND? THAN TRADITIONAL DEBT OR EQUITY?

• Value of Perpetual Bond = Coupon / Interest Rate on Comparable • SAMPLE ANSWER: “A Convertible Bond is a compromise solution that
Bond lets companies borrow more cheaply than they could with traditional debt
– but with possible share dilution in the future if the bonds convert into
• SAMPLE ANSWER: “A perpetual bond is one that pays coupon payments shares.
regularly for eternity, with no repayment of principal (par value). The value
of the bond will be coupon payment divided by the current interest rate. If • A company might issue a Convertible Bond if debt is cheaper than equity
the interest rate on comparable bonds were 10%, a bond paying a $1,000 for the company, but it has trouble meeting its targeted credit stats and
coupon would be $1,000/10% or $10,000.” ratios with normal debt issuance.

• Also, the company must be in an appropriate industry and at the right

growth stage. High-risk, high-growth companies in industries such as
technology and biotech tend to issue Convertible Bonds more often than
those in other industries.”

Other Technical Questions – Bonds, Loans & Interest Rates 238

 Other Common Technical Questions - Bonds, Loans And Interest Rates

WHICH IS RISKIER, A 30-YEAR COUPON BOND OR A 30-YEAR HOW COULD INFLATION HURT CREDITORS?
ZERO-COUPON BOND?
• Inflation cuts into the real percentage return that creditors make when
• A zero-coupon bond is riskier since you will receive no payments until they lend out money at a fixed rate.
the final redemption date, whereas on a coupon bond, you will receive
payments over the life of the bond. • When a bank sets its lending rate, it projects a certain rate of inflation
and then assigns a level of return it wants to capture, over and above
• According to the chart below, if the company were to default in Year the inflation rate, based on the riskiness of the borrower.
4, an investor in the coupon bond would have collected $30, while the
holder of the zero-coupon bond would have received nothing. • For example, if a bank lends at 7%, expecting 2% inflation, they expect
to make a 5% real gain based on the riskiness of the loan. However, if
• The price of a zero-coupon bond is also more sensitive to interest rate inflation increases to 4%, they are only making a 3% real return on
fluctuations, increasing its level of risk. their loan.

• To make up for the fact that a zero-coupon pays no coupon, the bond • SAMPLE ANSWER: “Inflation can severely injure creditors. Creditors
will be sold at a steep discount to its face value. assign interest rates based on the risk of default as well as the expected
inflation rate. Creditors lending at 7%, with inflation expected at 2%, are
• SAMPLE ANSWER: “A zero-coupon bond will yield $0 until its date of expecting to make 5%. But if inflation actually increases to 4%, they are
maturity, while a coupon bond will pay out some cash every year. This only making 3%.”
makes the coupon bond less risky since even if the company defaults prior
to the bond’s maturity date, you will have received some payments with
the coupon bond.”

Other Technical Questions – Bonds, Loans & Interest Rates 239

 Other Common Technical Questions - Bonds, Loans And Interest Rates

HOW WOULD YOU VALUE A ZERO-COUPON PERPETUAL BOND? WHY IS A FIRM’S CREDIT RATING IMPORTANT?

• This is a trick question. A perpetual bond has no maturity date and is • SAMPLE ANSWER: “The lower a firm’s credit rating, the higher its risk of
not redeemable; therefore, it pays only coupon payments. A zero- bankruptcy, according to rating agencies, and therefore the higher its cost
coupon bond makes no interest payments; it just pays back its face of borrowing capital.”
value at maturity. If a zero-coupon bond is also a perpetual bond, it will
never pay out anything and is, therefore, worth nothing. WHAT IS THE DIFFERENCE BETWEEN A CORPORATE BOND AND
A CORPORATE LOAN?
• SAMPLE ANSWER: “Since a zero-coupon bond doesn’t have any interest
payments, and a perpetual bond has no par value, the value of a zero- • Bonds and loans are both forms of debt a company will use to finance
coupon perpetual bond is zero because it will pay out nothing.” operations.

IF THE STOCK MARKET FALLS, WHAT WOULD YOU EXPECT TO • When issuing a loan, a bank or other financial institution will lend a
HAPPEN TO BOND PRICES AND YIELDS? company a certain amount of money and then may syndicate the loan
to institutional investors that are required to meet certain
• The easiest way to determine a company’s credit risk is to look at its requirements in order to invest.
credit rating, available from Standard & Poor’s, Moody’s, and Fitch.
• In a bond offering, an investment bank will go to market with the size
• If you wanted to perform your own analysis, some metrics to look at and interest rate required by the company. The bank will then offer
would be the Current Ratio, Quick Ratio, Interest Coverage Ratio, and the bond to institutional investors such as mutual funds. The
Leverage Ratio. requirements for investing in bonds are less stringent than those for
investing in loans.
• Compare these ratios to those of similar companies in the same
industry. • The assets of the firm usually secure a corporate loan; a bond may or
may not be secured. Bonds are also normally subordinated to bank
• Look at a company’s cash flows and evaluate how steady/consistent loans. Therefore, if a company issues both bank loans and bonds, their
they are. A company with more predictable cash flows poses less bonds will typically pay a higher interest rate (all else equal).
default risk.
• SAMPLE ANSWER: “A Convertible Bond is a compromise solution that
• SAMPLE ANSWER: “Determining the credit risk of a company takes an lets companies borrow more cheaply than they could with traditional debt
incredible amount of work and research. However, some quick checks can – but with possible share dilution in the future if the bonds convert into
include credit ratings from Moody’s and Standard and Poor’s, the current shares. A company might issue a Convertible Bond if debt is cheaper than
ratio, quick ratio, interest coverage ratio, leverage ratio, and debt to equity equity for the company, but it has trouble meeting its targeted credit stats
ratio, compared to those of similar companies in the same industry.” and ratios with a normal debt issuance. Also, the company must be in an
appropriate industry and at the right growth stage. High-risk, high-growth
companies in industries such as technology and biotech tend to issue
Other Technical Questions – Bonds, Loans & Interest Rates 240 Convertible Bonds more often than those in other industries.”
 Other Common Technical Questions - Bonds, Loans And Interest Rates

WHAT IS A FLOATING INTEREST RATE? WHAT IS PIK INTEREST?

• Floating rate interest is used to protect against fluctuations in interest • PIK stands for Paid In Kind
rates.
• When a company issues PIK interest, rather than making cash
• A floating interest rate is typically seen on bank loans and is set at payments to bond/loan holders, the face value of its investment will
SOFR (the Secured Overnight Financing Rate) plus a certain number of increase.
basis points (the spread).
• A company may look to issue debt with PIK interest if it wants to limit
• For example, a company may get a term loan at SOFR + 600bps cash interest payments in the near term and is willing to make slightly
(6.00%). If SOFR is at 1%, interest payments will be 7% (1% + 6%) per higher future payments.
year. However, if SOFR increases to 4%, the company will be required
to pay 10% annually. The higher the borrower’s default risk, the higher • A company may also issue debt that has both a PIK and a cash
the spread. component. For example, if a company’s cost of debt is 10%, it may
negotiate a bank loan that pays interest at 5% cash and 5% PIK.
• Many floating rate loans will have a “SOFR floor” because SOFR is so
low right now. This SOFR floor is typically between 1% and 1.5%, • For simplicity’s sake, let’s take a $1,000 bond that pays an annual
which means the company will pay the higher of SOFR plus the spread coupon of 10% and has a 5-year maturity.
or the SOFR floor plus the spread. In 2012, since SOFR is below 0.4%,
most loans will pay interest based on their SOFR floors. • As shown in the following chart, the bond will accrete in value over its
lifetime, and due to compounding, it will actually return a higher
• SAMPLE ANSWER: “Floating rate interest is typically seen on bank loans money multiple than if the investor were to receive annual cash
when a bank makes a loan to a company at a rate that will move with interest payments. A $1,000 investment will be repaid $1,611 at the
interest rates. The loan’s rate typically is SOFR plus a certain spread based end of five years, whereas an equivalent bond paying cash would
on the default risk of the borrower.” return $1,500 spread over the course of the five years.

• SAMPLE ANSWER: “PIK interest is interest that is Paid In Kind. This

means that rather than making a cash interest payment, the bond or loan
will increase in face value each period by the PIK interest rate. Because of
compounding, the company will be required to pay more overall, but the
cash outflow will be at maturity rather than annually, semi-annually, or
quarterly.”

Other Technical Questions – Bonds, Loans & Interest Rates 241

 Other Common Technical Questions - Bonds, Loans And Interest Rates

WHAT ARE COVENANTS? WHAT IS AMORTIZATION?

• Covenants are requirements a company must comply with according • Amortization is a feature that may be built into a loan requiring the
to the legal documents governing a loan or bond in order to avoid borrowing company to pay off the loan over its term rather than
defaulting on it. paying the entire face value at maturity.

• Covenants can be either financial or technical in nature. Financial • Each payment period, the company pays its lenders the interest
covenants may include maintaining a certain leverage ratio, limiting payment and a portion of the loan’s face value.
spending on capital expenditures, paying dividends, etc. Technical
covenants may include financial reporting requirements, such as • Since the paydown of face value reduces the amount outstanding,
producing monthly financial statements within 30 days of month end. interest payments will grow successively smaller.

• If a company breaches a covenant, it is technically in default; however, • In the below example, the company borrows $1,000 at a 10% interest
a lender may elect to waive the covenant (normally for a fee) and not rate with a $100/year amortization schedule and a 5-year maturity.
force the company into bankruptcy.
• SAMPLE ANSWER: “PIK interest is interest that is Paid In Kind. This
• Not all loans and bonds have covenants; many recent loans have been means that rather than making a cash interest payment, the bond or loan
issued “covenant-lite,” which means the company is required to will increase in face value each period by the PIK interest rate. Because of
comply with no covenants at all. compounding, the company will be required to pay more overall, but the
cash outflow will be at maturity rather than annually, semi-annually, or
• SAMPLE ANSWER: “A covenant is a requirement included in the legal quarterly.”
documents governing a bond or loan. The company must comply with
these requirements during the life of the bond or loan in order to avoid a
default.”

Other Technical Questions – Bonds, Loans & Interest Rates 242

 Other Common Technical Questions - Bonds, Loans And Interest Rates

HOW ARE CONVERTIBLE BONDS ACCOUNTED FOR IN HOW MIGHT YOU DETERMINE THE NUMBERS FOR REVENUE
CALCULATING ENTERPRISE VALUE? GROWTH, MARGINS, AND CAPEX IN DOWNSIDE CASES OF A
CREDIT MODEL?
• SAMPLE ANSWER: “If the convertible bonds are “in the money,” meaning
the conversion price is below the current market price, then you account • SAMPLE ANSWER: “First, you could look at the company’s historical
for the bonds as additional dilution to the Equity Value. However, if the performance in recessions and see how its growth and margins have fallen
bonds are out of the money, then you would account for them as debt at and how its CapEx spending has changed when the economy has
their face value.” contracted.

WOULD LENDERS EVER PAY ATTENTION TO SCENARIOS OTHER • You could also look at peer companies that have not performed well and
THAN THE DOWNSIDE CASES IN A CREDIT MODEL? see how much their growth and margins have declined. Finally, you also
have to consider the company’s industry and maturity.
• SAMPLE ANSWER: “Yes, potentially. Lenders focus on the Downside
cases because their upside is limited to the interest rate on the Debt, while • A mature retailer with high fixed costs and inventory could easily crash and
their downside consists of losing everything. However, some forms of Debt, burn if demand falls, while a professional services company could adapt
such as Mezzanine, may offer warrants or equity co-investment options, more smoothly by reducing its headcount.”
which could affect the numbers significantly.
YOU ARE BUILDING A CREDIT MODEL FOR A FURNITURE
• For example, if the Downside case numbers look bad (e.g., a decent chance RETAILER, A LUXURY HOTEL CHAIN, AND A REAL ESTATE
of recovering only 80% of a loan’s principal), the lender might do the deal COMPANY THAT OWNS MULTIFAMILY UNITS (IE RENTAL
anyway if the equity options make the IRR high enough in the Base or APARTMENTS). WHICH WOULD YOU EXPECT TO HAVE THE
Upside cases.” MOST EXTREME DOWNSIDE CASE?

• SAMPLE ANSWER: “The luxury hotel chain will have the most extreme
Downside case because hotel spending, especially in the luxury segment,
declines far more than furniture spending or apartment rent in a downturn.

• There might be a modest decline in apartment rents (e.g., 3-5%) during a

recession as landlords try to attract new tenants, and furniture sales might
also decline modestly (e.g., 5-10%) as fewer people buy homes and
redecorate. But luxury hotel spending falls off a cliff in a downturn –
declines of 20-30% would not be unusual.”

Other Technical Questions – Bonds, Loans & Interest Rates 243

 Other Common Technical Questions - Bonds, Loans And Interest Rates

WHAT WOULD CAUSE A COMPANY’S CREDIT RATING TO WHAT CONCLUSIONS CAN YOU DRAW IF A COMPANY'S EBITDA
CHANGE? CUSHION FOR ITS INTEREST COVERAGE RATIO COVENANT IS
10% IN THE DOWNSIDE CASE, BUT ITS LEVERAGE RATIO
• SAMPLE ANSWER: “A company’s credit rating might change if its credit COVENANT HAS A CUSHION OF 50%?
statistics, such as Debt / EBITDA or EBITDA / Interest, improve or worsen
significantly, or its qualitative risk factors change. • SAMPLE ANSWER: “This means the company’s Debt / EBITDA ratio is
acceptable if things go wrong, but its EBITDA / Interest covenant is in
• For example, if peer companies with “BB+” credit ratings have Debt / danger of being breached if the company underperforms.
EBITDA between 4x and 5x, and the Debt / EBITDA of the company you’re
analyzing suddenly jumps to 6x, rating agencies will be likely to downgrade • The company could solve this issue by negotiating for Debt with lower
the company. interest rates but offering other terms that are more favorable to the
lender or by raising Debt with no maintenance covenants.”
• But even if a company’s financial stats stay the same, its credit rating
might decline if its industry experiences a downturn, a major new IF A COMPANY’S CASH FLOW FLUCTUATES GREATLY FROM
competitor enters, or the growth outlook falls.” YEAR TO YEAR, WHICH FINANCING SOURCE IS MOST
APPROPRIATE FOR IT?
WHY ARE RATIOS SUCH AS DEBT/EBITDA AND
EBITDA/INTEREST IMPORTANT EVEN IF A COMPANY'S DEBT • SAMPLE ANSWER: “Anything that lacks maintenance covenants” is the
HAS NO MAINTENANCE COVENANTS? best answer here. But, more specifically, it depends on how much the
company’s cash flow fluctuates.
• SAMPLE ANSWER: “Because lenders and rating agencies still judge a
company based on these metrics, even if the company is not “required” to • If the fluctuations are moderate, and the company never moves into crazy
keep them above or below certain levels. territory with its credit stats and ratios (e.g., nothing like 15x Debt /
EBITDA), then it may be able to issue Senior Notes or Subordinated Notes,
• For example, rating agencies often establish credit rating “bands” of Debt / which have higher interest rates than Term Loans but which lack
EBITDA ratios (e.g., investment- grade companies might have Debt / maintenance covenants.
EBITDA below 2x) and use them as guidelines to determine the ratings.
• But if the company’s cash flows are so unstable that it can’t maintain
• Also, some Debt investors become unwilling to invest in a company’s Debt reasonable leverage or coverage ratios, then it will have to use more Equity
beyond certain thresholds. For example, Term Loan investors might go up and possibly skip Debt altogether.”
to 2x Debt / EBITDA, and Senior Note investors might go up to 3- 4x
Debt / EBITDA. But if the company wants to raise Debt beyond those
levels, it will have to consider sources like Subordinated Notes or
Mezzanine.”

Other Technical Questions – Bonds, Loans & Interest Rates 244

 Other Common Technical Questions - Bonds, Loans And Interest Rates

WHY IS VALUING A BOND MORE DIFFICULT THAN IT APPEARS?

• SAMPLE ANSWER: “When a company initially issues a bond to investors

to raise capital, it is straightforward to model. But in the secondary
markets – where investors buy and sell bonds from other investors – it gets
more complicated.

• First off, the bond’s market price can change over time. The timing also
gets tricky because bonds pay interest at different intervals, and a new
investor may have to pay for “Accrued Interest” if he/she purchases the
bond in between interest payments.

• Also, bonds often have embedded call, put, and conversion options, all of
which complicate the analysis. Finally, some bonds also have warrants or
equity options attached, which make it trickier to calculate the yields.”

Other Technical Questions – Bonds, Loans & Interest Rates 245

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246
Other Common Technical Questions - Currencies
 Other Common Technical Questions - Currencies

WHAT IS THE SPOT EXCHANGE RATE? WHAT FACTORS AFFECT FOREIGN EXCHANGE RATES?

• The spot exchange rate is the rate of a foreign-exchange contract for • Differences in interest rates
immediate delivery. Spot rates are the price a buyer will pay “on the
spot” for a foreign currency. • Differences in inflation

WHAT IS THE FORWARD EXCHANGE RATE? • Budget deficits

• The forward rate is the price at which currencies will be exchanged at • Public debt
some given date in the future.
• Trade policies
• The forward rate is used by speculators as well as companies looking
to hedge their foreign exchange risk and lock in a future exchange • Capital market equilibrium
rate.
WHAT IS THE DIFFERENCE BETWEEN A “STRONG” AND A
• For example, a company that will be receiving payment in the future “WEAK” CURRENCY?
(in a foreign currency) may want to budget the receivable. If it cannot
lock in an exchange rate for future incoming cash flows, the company • SAMPLE ANSWER: “A strong currency is one with a rising value relative
will have difficulty setting an accurate budget. to other currencies. A weak currency is one with a falling value relative to
other currencies.”
• However, with a forward exchange rate contract, a company can enter
into an agreement to convert those future cash flows of foreign
currency into their local currency at a set rate, thus eliminating its
foreign exchange risk.

• SAMPLE ANSWER: “The forward exchange rate is what a foreign

currency is agreed to be worth at some time in the future. A company can
enter into a forward contract on exchange rates to help hedge against
exchange rate fluctuations.”

Other Technical Questions - Currencies 248

 Other Common Technical Questions - Currencies

WHAT ARE SOME WAYS THE MARKET EXCHANGE RATE IF THE U.S. DOLLAR WEAKENS, SHOULD U.S. INTEREST RATES
BETWEEN TWO COUNTRIES’ CURRENCIES IS DETERMINED? GENERALLY RISE, FALL, OR STAY THE SAME?

• The exchange rate may be determined by the interest rates in the two • Generally speaking, when the U.S. dollar weakens, interest rates in the
countries: U.S. will rise.

• If the interest rate in a foreign country goes up relative to the • A weak dollar means that the price of imported goods will rise. This
home country rate, the home currency weakens. means higher inflation and pressures The Fed to raise interest rates.

• When interest rates in a country rise, investments held in that • SAMPLE ANSWER: “Most times, when the U.S. dollar weakens, the price
country’s currency will earn a higher rate of return, and the of imported goods will rise, causing higher inflation. This, in turn, puts
demand for that country’s currency will rise because people will pressure on The Fed to raise interest rates. So, if the dollar weakens, U.S.
want to invest in that country (all else equal). The rise in demand interest rates should generally rise.”
will cause the currency to strengthen.
IF INFLATION RATES IN THE UNITED STATES FALL RELATIVE TO
• The exchange rate may be determined by the rates of inflation in GREAT BRITAIN’S, WHAT HAPPENS TO THE EXCHANGE RATE?
the two countries. If inflation in Country A is expected to be higher
than that in Country B, Country A’s currency will become less • If inflation rates in the U.S. become lower than those in Great Britain,
valuable (theoretically, all else equal). then more pounds than dollars will be in circulation.

• SAMPLE ANSWER: “A few factors determine the exchange rate between • When this occurs, a dollar becomes worth more in pounds.
two countries’ currencies.
• This means that the dollar strengthens compared to the pound.
• One is the interest rates in the two countries. If the interest rate in the
home country increases relative to that in the foreign country, demand for • SAMPLE ANSWER: “If the United States’ inflation rate is expected to fall
the home country’s currency tends to increase because investors can get relative to Great Britain’s, relatively more pounds will be in circulation, and
higher rates of return, and increased demand strengthens the home dollars will be worth more pounds. This means that each dollar will cost
currency. more pounds than it did before inflation.”

• Another factor affecting exchange rates is expectations about inflation in

the two countries If one country is expected to experience relatively high
inflation, the inflating currency will become less valuable in the long run, all
else equal.”

Other Technical Questions - Currencies 249

 Other Common Technical Questions - Currencies

BELOW IS A CHART THAT EXPLAINS THE EFFECT OF CHANGES WHAT IS THE DIFFERENCE BETWEEN CURRENCY DEVALUATION
IN THE EXCHANGE RATE ON THE EARNINGS OF U.S. AND CURRENCY DEPRECIATION?
MULTINATIONAL COMPANIES.
• SAMPLE ANSWER: “Currency devaluation occurs in a fixed-exchange-
rate system like China’s when the government arbitrarily alters the
exchange rate of its currency. Currency depreciation occurs in a system
where the currency is allowed to move with the currency exchange market,
and the country’s currency loses value on that market.”

IF THE SPOT EXCHANGE RATE OF DOLLARS TO POUNDS IS

$1.60/£1 AND THE ONE-YEAR FORWARD RATE IS $1.50/£1,
WOULD WE SAY THE DOLLAR IS FORECAST TO BE STRONGER
OR WEAKER RELATIVE TO THE POUND?

• When the spot exchange rate is higher than the forward exchange
rate, the dollar is expected to strengthen.

• SAMPLE ANSWER: “Since 1-pound costs more dollars now than it will in
the future, the dollar is expected to strengthen in the next year.”

BELOW IS A CHART OF THE EFFECTS OF CHANGES IN INTEREST

RATES AND INFLATION RATES ON THE EXCHANGE RATE OF THE
U.S. DOLLAR.

Other Technical Questions - Currencies 250

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Other Common Technical Questions - Options and
Derivatives
 Other Common Technical Questions – Options and Derivatives

WHAT IS A DERIVATIVE? WHAT IS HEDGING?

• SAMPLE ANSWER: “A derivative is a type of investment that derives its • Hedging is a strategy used by an investor or a company to try to
value from the value of other assets like stocks, bonds, commodity price, or mitigate the risks of an investment. Hedging usually involves investing
market index values. Some derivates are futures contracts, forward in derivative products that will be profitable if the market moves in the
contracts, calls, puts, etc.” opposite direction the investor expects. It usually lowers the upside
potential return while providing downside protection.
WHAT ARE OPTIONS?
• SAMPLE ANSWER: “Hedging is a financial strategy designed to reduce
• Call Options: Gives the holder the right to purchase an asset for a risk by balancing a position in the market. For example, an investor that
specified exercise price on or before a specified expiration date but owns a stock could hedge the risk of the stock going down by buying put
does not force them to do so. options on that security or on related businesses in the same industry.”

• If you sell a call option and the value of the asset drops below the WHAT ARE FORWARD CONTRACTS?
exercise price (the price the option holder can buy the asset at), then
the option is worthless (since they could buy the asset on the open • A forward is an agreement that calls for the future delivery of an asset
market for a lower price) and you would profit the amount you sold at an agreed-upon price.
the option for.
• Forwards are similar to forward currency exchange contracts and are
• Put Options: Gives the holder the right to sell an asset for a specified used in a similar fashion, but they are typically contracts for goods
exercise price on or before a specified expiration date but does not rather than for currencies.
force them to do so.
• No money is exchanged initially. Forwards are designed to protect the
• If you sell a put option and the value of the asset rises above the parties from future price fluctuations.
exercise price (the price the option holder can sell the asset at), then
the option is worthless (since they could sell the asset on the open • SAMPLE ANSWER: “A forward contract is a type of derivative that
market for a higher price) and you would profit the amount you sold arranges for the future delivery of an asset (oil, grain, currencies, etc.) on a
the option for. specific date at an agreed price.”

• SAMPLE ANSWER: “Options are derivatives that give the bearer the
“option” to buy or sell a security at a given date but without the obligation
to do so. The buyer of the option pays an amount less than the actual
value of the stock and has the OPTION to buy or sell the stock for a fixed
price on or before a specified date.”

Other Technical Questions – Options & Derivatives 253

 Other Common Technical Questions – Options and Derivatives

WHAT ARE FUTURES CONTRACTS? WHAT FACTORS INFLUENCE THE PRICE OF AN OPTION?

• Futures contracts are almost the same as forward contracts, except • Factors affecting option prices include current stock price, exercise
that they are strictly defined quantities of certain products that are price, volatility of the stock, time to expiration, interest rate, and
traded publicly. dividend rate of the stock.

• SAMPLE ANSWER: “Futures are a financial contract obligating the buyer • Below is a chart of how these factors influence the price of an option.
to purchase an asset such as a commodity or another financial instrument
at a specified price on a specified date. Futures have very strictly defined • Look for online option pricing calculators you can play with to see how
terms and are traded publicly on the exchanges.” each variable affects the price.

WHAT IS THE MAIN DIFFERENCE BETWEEN FUTURES

CONTRACTS AND FORWARD CONTRACTS?

• There are a few slight differences between futures and forwards.

• Futures are traded on exchanges; forwards are traded over-the-

counter.

• Futures are highly standardized, which is why they can be traded on

exchanges.

• Forwards are privately negotiated, can be customized to the

satisfaction of the parties, and can be revised throughout their
duration with the consent of the parties.

• SAMPLE ANSWER: “Futures are highly standardized in all their terms so

as to be traded publicly on the exchanges. Forwards are privately
negotiated, customizable contracts that can be revised to suit the buyer
and seller, which is why they must be traded over the counter.”

Other Technical Questions – Options & Derivatives 254

 Other Common Technical Questions – Options and Derivatives

IF AN OPTION IS “IN THE MONEY,” WHAT DOES THAT MEAN? WHAT ARE SWAPS?

• An option is “in the money” when exercising the option will result in a • A swap is an agreement between companies that they will exchange
profit. future cash flows for a period of time. A swap can be an exchange of
interest rates, currency exchange rates, etc.
• A call option is in the money when its exercise price is below the
market price since an investor can purchase the asset at the exercise • Swaps can benefit both companies if one has access to a lower floating
price and immediately sell it at the (higher) market price. rate, and one has access to a lower fixed rate, and each desires the
other company’s rate.
• A put option is in the money when its exercise price is above the
market price since an investor can buy the asset at the market price • SAMPLE ANSWER: “A swap is an agreement to exchange future cash
and immediately sell it at the (higher) exercise price. flows for a set period. The best known recent “swap” has been the credit
default swaps issued by banks as a kind of insurance against companies
• SAMPLE ANSWER: “When an investor exercises an option that is “in the not being able to repay their debt.”
money,” the difference between the exercise price and the market price will
create value. A call option is in the money if the exercise price is below the SUPPOSE YOU HOLD A PUT OPTION ON MICROSOFT STOCK
market price, and a put option is in the money when its exercise price is WITH AN EXERCISE PRICE OF $60. THE EXPIRATION DATE IS
above the market price.” TODAY, AND MICROSOFT IS TRADING AT $50. ABOUT HOW
MUCH IS YOUR PUT WORTH AND WHY?

• SAMPLE ANSWER: “This put is worth $10. It gives you the option to sell
your shares at $60, and you can buy them in the open market at $50. You,
therefore, would buy shares of Microsoft at $50 per share and immediately
sell them for $60, making a profit of $10 per share.”

Other Technical Questions – Options & Derivatives 255

 Other Common Technical Questions – Options and Derivatives

THIS PUT IS WORTH $10. IT GIVES YOU THE OPTION TO SELL ALL ELSE BEING EQUAL, WHICH WOULD BE LESS VALUABLE: A
YOUR SHARES AT $60, AND YOU CAN BUY THEM IN THE OPEN DECEMBER PUT OPTION ON A SMALL-CAP TECH STOCK OR A
MARKET AT $50. YOU, THEREFORE, WOULD BUY SHARES OF DECEMBER PUT OPTION ON A LARGE-CAP HEALTHCARE
MICROSOFT AT $50 PER SHARE AND IMMEDIATELY SELL THEM STOCK?
FOR $60, MAKING A PROFIT OF $10 PER SHARE.
• SAMPLE ANSWER: “The put option on the healthcare stock would
• An option is “in the money” when exercising the option will result in a usually be less valuable because the healthcare industry and large-cap
profit. stocks, in general, are usually less volatile than small-cap tech stocks. The
more volatile the underlying asset, the more valuable the option on the
• A call option is in the money when its exercise price is below the stock.”
market price since an investor can purchase the asset at the exercise
price and immediately sell it at the (higher) market price. ALL ELSE BEING EQUAL, WHICH WOULD BE MORE VALUABLE: A
DECEMBER CALL OPTION FOR APPLE OR A JANUARY CALL
• A put option is in the money when its exercise price is above the OPTION FOR APPLE?
market price since an investor can buy the asset at the market price
and immediately sell it at the (higher) exercise price. • SAMPLE ANSWER: “The January option would be more valuable because
the later an option expires, the more valuable it is.”
• SAMPLE ANSWER: “When an investor exercises an option that is “in the
money,” the difference between the exercise price and the market price will WHY DO INTEREST RATES MATTER WHEN FIGURING THE PRICE
create value. A call option is in the money if the exercise price is below the OF OPTIONS?
market price, and a put option is in the money when its exercise price is
above the market price.” • SAMPLE ANSWER: “Interest rates matter due to net present value. A
higher interest rate lowers an option’s value because the PV of that
option will be lower.”

Other Technical Questions – Options & Derivatives 256

 Other Common Technical Questions – Options and Derivatives

WHAT IS RHO? EQUATIONS OF THE BLACK-SCHOLES MODEL

• Rho measures the sensitivity of a derivative’s price in relation to

fluctuations in the risk-free interest rate.

• If a derivative has a Rho of 10, every one-point rise in interest rates

will be accompanied by a 10% rise in the price of the derivative.

WHAT IS THETA?

• Theta measures how quickly a derivative’s price will decline with the
passage of time as the instrument approaches its exercise date (Time
Decay). • After giving your summary answer (next bullet), be ready to answer
follow-up questions like those below about the definitions of the
• All else equal, the shorter the time to expiration of a derivative, the variables and the effect of an increase or decrease in any of the
lower the option’s value. variables.

WHAT IS VEGA? • If you are applying for a trading job or heavily quant-focused position,
you should do additional research on the Black-Scholes model so you
• Vega is a measure of how much a derivative’s price will move with a are more comfortable speaking about it in depth.
1% change in volatility of the market.
• SAMPLE ANSWER: “The Black-Scholes model is the industry standard for
• A more volatile market makes derivatives more valuable; therefore, if pricing options. The formula is pretty complicated, with 6 inputs that affect
Vega is high, the instrument’s value will increase significantly as the the price. They are the current price of the asset, the exercise price of the
market becomes more volatile.10% rise option, the time until expiration, the current risk-free rate, the asset’s
variance, and the dividend yield.”

Other Technical Questions – Options & Derivatives 257

 Other Common Technical Questions – Options and Derivatives

WHAT IS ALPHA? WHAT IS BETA?

• SAMPLE ANSWER: “Alpha is the risk-adjusted performance of an • Beta is the volatility of an investment compared with the market as a
investment. It represents the return in excess of the return expected for the whole; it is used in the CAPM (Capital Assets Pricing Model) formula to
risk of the investment.” determine the appropriate cost of equity.

• Beta is calculated using a regression of past returns compared to the

returns of the market as a whole but can also be found on sources like
Bloomberg, Yahoo! Finance, etc.

• Large, stable stocks tend to have a Beta of less than one, while smaller,
riskier stocks tend to have higher Betas.

• SAMPLE ANSWER: “Beta is the volatility of a given investment compared

to the volatility of the market as a whole. Large, stable stocks tend to have
a lower beta while smaller, riskier ones tend to have a higher one.”

Other Technical Questions – Options & Derivatives 258

 Other Common Technical Questions – Options and Derivatives

WHAT WOULD YOU EXPECT TO HAVE A HIGHER BETA: A

SMALL-CAP TECHNOLOGY COMPANY OR A LARGE-CAP
MANUFACTURER?

• SAMPLE ANSWER: “A small-cap technology company is expected to be a

riskier investment than a large manufacturing company. Therefore, all else
equal, the technology company should have a higher beta.”

WHAT IS DELTA?

• Delta is the relationship between the price of an option/derivative and

the price of the underlying security.

• If a call option has a Delta of 0.5, then if the price of the stock rises by
$1.00, the price of the option will rise by $0.50.

WHAT IS GAMMA?

• Gamma is the first derivative of Delta and is used to gauge the price of
an option relative to how far in or out of the money it is.

• When an option is well in or well out of the money, Gamma is very

large; but when the option is on the verge of being in or out of the
money, Gamma is very small.

Other Technical Questions – Options & Derivatives 259

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260
Behavioral Interview - Concepts
 Behavioral Interviews - Introduction

Concept The behavioral interview section is designed to assess your fit with the company

Details
• Interviewers are trying to figure out if they will enjoy spending 80 hours+ with you per week

• An inappropriate response to a behavioral question will hurt far more than than missing a technical question

• Missing a technical question is fine because when hired you will undergo rigorous training, but it’s not really possible to
train someone to have a good personality

• A successful interview demonstrates solid technical ability, exceptional enthusiasm, and strong answers to behavioral
questions

How to give the best first impression

Being Punctual Confident Presentation

M&A – Concepts 262

 Behavioral Interviews – Introduction

According to the NYC head of HR at a prominent international investment bank, you need to
Concept emphasize three main traits.

Most Important Characteristics

Burning Desire To Learn Great Attitude And Personality Appetite For Work

• Make it clear that you view this • Finance professionals spend • Back to back 80 – 100 work weeks
job as a learning opportunity countless of hours together are commonplace in this industry

• Everyone on the team is going to • You have to portray a positive • Show that you understand and
know more than you attitude in the workplace accept the physical and mental
demands of this job
• You would learn more being • Not being enjoyable around people
three months on the job than the means you aren’t getting hired
four years spent on your
undergraduate degree

Note: An important rule is to show, not tell. Anyone can say they are willing to work until 3 AM. But in order to be convincing,
you need to tell a story that demonstrates the quality you are trying to exhibit. These examples don’t have to be finance related.

M&A – Concepts 263

What Is The STAR technique?

STAR stands for Situation, Task, Action, Result. It is the most efficient and focused way of telling
Concept a story.

Situation
Example: Working in finance is very stressful. What makes you
Describe the situation. This provides context and think that you’ve got what it takes to succeed in this industry?
sets the background for your story
Scenario: You won a recent swimming tournament

Task • Situation: “Let me tell you about a swimming tournament that I

participated in. It was an interschool competition organized by my
What was your task? This is where you share the school that had 500+ participants…”
objective assigned to you
• Task: “The fastest swimmers would be selected to participate on
the state level, so there was definitely pressure to win...”

Action • Action: “So here’s what I did. I trained 10+ hours a week on top of
my academic classes & extracurricular activities. No matter how
Outline all the steps you took to achieve the task. tired I was, I had to be resilient and follow my training schedule
Be precise and explain how it achieves the task because I knew how much was at stake…”

• Results: “During the competition, I broke my personal best and

swam 25 seconds in a 50 meters freestyle race, ranking 3rd place.
Result This definitely demonstrated my ability to succeed in high pressure
situations, especially when there is a lot at stake.”
End your story with its outcome. What did you
learn? How did this demonstrate a strength?

264
What Is The STAR technique?

STAR stands for Situation, Task, Action, Result. It is the most efficient and focused way of telling
Concept a story.

Additional Tips

Be Prepared Be Concise Be Natural

• Reflect throughout your academic, • Never ramble, and keep your story • Compared to technical questions,
extracurricular, and professional succinct and to the point behavioral questions don’t have a
experiences to really flesh out definitive answer.
characteristics that are unique to • Each story shouldn’t take too long
you • Behavioral answers must be
• Show that you are well rounded unique, personal, and natural—
• Practice several of your favorite and not just a superstar student and they must sound
stories that can be molded to fit spontaneous
different type of questions • Don’t memorize your stories and
just practice walking through them • These examples don’t have to be
• Place emphasis on your work ethic, until you are sure not to miss any business or finance related.
leadership experience, varsity crucial points Interviewers prefer candidates
sports, and clubs you started who are open about other parts
of their lives

265
Interview Preparation

Here are some general topics you should review in preparation of each and every interview

Preparation
Know The Industry Know The Firm Self – Evaluate Ask Questions
• This is a given • Know what differentiates • Identify at least three • You must always ask
them from their strengths and weaknesses questions at the end of the
• Read up on the latest competition interview
financial news at WSJ • Think hard about why
• Ask alumni or other those strengths are • Listen for information that
• Have enough of a general network to understand the relevant to finance you can use in later
background to hold an firm better interviews
intelligent conversation • Come up with stories that
• Know specifically why this demonstrates those
firm and the position strengths

Remember

• Create a great first impression • Body language is important; • Know what your resume says
exude confidence not arrogance
• Be courteous to everyone you • Always pay attention to the
meet especially receptionists • Study the company before your interviewer; never drift off
and assistants interview
• Send thank you emails within 24
hours

266
The Interview Process

While the interview process may vary by country and by firm, sophomores in the US and second year students in
the UK generally will have the following elements

First Round
Networking CV Submission Online Tests Superdays
Interviews

Aug - Dec Jan - Mar Feb - Apr Jan - Mar Mar - May

Networking CV Submission Online Test

• The purpose of networking is two fold: • During the end of your networking • The online tests are a mandatory
you need to learn more about the firm calls, you would typically “ask for section of the interview process
and you are making yourself known to advice” on how you could break into
employees within the firm the firm • It should take anywhere between 20
minutes to 1 hour
• Reach out to alumni, friends, family, • If the networking session went well,
university professors, etc. the employee would typically ask for • It will cover areas like numerical
you CV to pass on to HR. This is good reasoning, situational judgement, or
• You should be using LinkedIn or cold – because it’s considered a stamp of behavioral tests
emailing as many people as possible approval
• Just practice through them and you’ll
• Ask to set up coffee chats or • You’ll probably still have to make an do just fine
informational interviews over the application online and submit your CV
phone as well

Note: This timeline is for investment banking analyst positions. Associate recruiting post MBA is different
267
The Interview Process

While the interview process may vary by country and by firm, sophomores in the US and second year students in
the UK generally will have the following elements

First Round
Networking CV Submission Online Tests Superdays
Interviews

Aug - Dec Jan - Mar Feb - Apr Jan - Mar Mar - May

First Round Interviews Superdays

• This will typically be on campus if you • At this stage, firms think you have
are at a target school, or over the some serious potential. Around 1– 2
phone if you are at a non – target candidates out of every 10 will end up
school with an offer

• Can also be one way video – • They will be either onsite if the firm
interviews using platforms like wants to fly you out to their office or
Hirevue online

• Will cover a range of behavioral and • During this process, you will likely
technical interview questions meet with people at various levels
including analysts, associates, VPs and
• Can span from anywhere between 20 MDs
minutes to 1 hour in duration
• Generally, senior bankers will focus on
fit, juniors will focus on technical

Note: This timeline is for investment banking analyst positions. Associate recruiting post MBA is different
268
Types Of Behavioral Questions

The rest of this guide will cover a range of behavioral interview questions

Behavioral
Questions

Guaranteed Industry Personal Situational Tricky Your

Question Questions Questions Questions Questions Questions

269
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Question Type, and much more…

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270
Behavioral Questions - Guaranteed
 Behavioral Practice Questions – Guaranteed Question

TELL ME ABOUT YOURSELF WHY INVESTMENT BANKING/ SALES AND TRADING

• Variation: Walk me through your resume • Begin your response with a strong opening statement to grab the
interviewer’s attention. For example, express how you have always
• If asked, this question almost always comes first because the been interested in finance, enjoyed your finance classes, and want a
interviewer wants to get comfortable with you and set the stage for job where you can gain practical financial experience at a junior level.
more specific probing questions. If this is a boring option, at least it’s relatively safe.

• A good standard answer is your professional life story which highlights • Emphasize your interest in learning.
every major stop, explains the reasons for the transitions, and ends
with why you are now having the current interview. This response • Tell them you are excited about a job where you can take on
should be less than 3 minutes significant responsibility at a junior level

Standard Talking Points • Say you work best in high-pressure, fast-paced situations. This is an
especially important trait for a potential trader.
• Where you grew up
• SAMPLE ANSWER: After talking to a number of people in the industry, I
• Personal Interests that led to your undergrad college and major find two aspects of this job especially attractive. First, I see it as an
incredible learning experience. I know that with the number of hours I will
• Why do you have an ultimate passion for investing, business, etc be working, I will essentially be gaining four years of work experience in
only two years. I will learn so much, so fast, and this job will prepare me for
• What made you take your first job out of undergrad anything I decide to do for the rest of my life.

• What skills you learned on your first job, what you liked about it, and • Additionally, I expect to thrive in an environment where I am rewarded for
what you didn’t like about it my performance, rather than for just showing up. I look forward to having
the chance to take on responsibility at an entry level and prove my value
• Highlight skills and attributes which recruiters are looking for through the quality of my work. I know this job can be extremely difficult
both physically and mentally. However, I want to emphasize that I am well-
• Why do you like and dislike the industry while downplaying your prepared and fully ready to tackle this challenge.
dislikes

272
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273
Behavioral Questions - Industry
 Behavioral Practice Questions – Industry Question

WHY INVESTMENT BANKING/ SALES AND TRADING WHAT DO INVESTMENT BANKERS DO?

• Begin your response with a strong opening statement to grab the • They raise capital for companies through debt or equity offerings.
interviewer’s attention. For example, express how you have always
been interested in finance, enjoyed your finance classes, and want a • They provide advice to companies on mergers, acquisitions,
job where you can gain practical financial experience at a junior level. restructuring, refinancing, etc.
If this is a boring option, at least it’s relatively safe.
• They evaluate companies and pitch the bank’s expertise to companies
• Emphasize your interest in learning. looking for help.

• Tell them you are excited about a job where you can take on • At junior and middle levels, bankers are focused on executing services
significant responsibility at a junior level at the highest possible level of quality to ensure repeat business.

• Say you work best in high-pressure, fast-paced situations. This is an • At senior levels, investment bankers are more focused on clients and
especially important trait for a potential trader. building relationships that will generate deal flow.

• SAMPLE ANSWER: After talking to a number of people in the industry, I • SAMPLE ANSWER: Investment bankers do a variety of work. Some
find two aspects of this job especially attractive. First, I see it as an specialize in raising capital for companies through debt or equity offerings.
incredible learning experience. I know that with the number of hours I will Others focus on providing advice and valuation services to companies
be working, I will essentially be gaining four years of work experience in involved in mergers and acquisitions. The area that interests me the most,
only two years. I will learn so much, so fast, and this job will prepare me for especially here at Firm X and in this market, is financial restructuring. The
anything I decide to do for the rest of my life. deal flow in this group, in this economy, should be steady and I would get a
lot of exposure.
• Additionally, I expect to thrive in an environment where I am rewarded for
my performance, rather than for just showing up. I look forward to having
the chance to take on responsibility at an entry level and prove my value
through the quality of my work. I know this job can be extremely difficult
both physically and mentally. However, I want to emphasize that I am well-
prepared and fully ready to tackle this challenge.

275
 Behavioral Practice Questions – Industry Question

WHAT IS THE DIFFERENCE BETWEEN INVESTMENT BANKING AND WHAT DO BANKERS DO DURING A SELL-SIDE M&A DEAL?
COMMERCIAL BANKING?
• SAMPLE ANSWER: In a sell-side deal, the bank will market a company to
• Investment banks offer advisory services in M&A and help connect potential buyers and then helps both sides negotiate the deal and complete
investors and companies in need of capital. the sale process. There are four main steps:

• Commercial banks work more on the monetary/transactional side, • First, the bank will meet with the company and put together informational
where they take deposits from clients and lend money to individuals documents such as an offering memorandum, which will help market the
and institutions. company for sale to potential buyers.

WHAT DO YOU THINK YOU WOULD BE DOING ON A DAY-TO-DAY

• Next, the bank will create a list of potential buyers and send out an
executive summary to measure interest in the deal, following up with
BASIS AS AN ANALYST?
additional information if requested.
• SAMPLE ANSWER: Well, I have done a lot of research, talking to alumni
• Next, the bank will set a deadline for prospective buyers to submit and
contacts at different banks, to find out what I will really be doing on this
indication of interest, which narrows down the group. The bank will select
job. My understanding is that I will be responsible on a day- to-day basis
the prospective buyers who submit acceptable indications of interest, and
for a lot of financial modeling, comparable company analysis and
continue to send them additional information. Finally, the bank will work
precedent transaction analysis in Excel, preparing pitch books and other
with the company to maximize the purchase price, select the winning
PowerPoint presentations for clients, and any other grunt work the firm
bidder and help to negotiate the terms, finalize documentation and then
needs.
announce the deal.
• I know I can expect to be the first one in and the last one out of the office. I
know what I am signing up for, and will make sure everything that is asked
of me is done perfectly.

276
 Behavioral Practice Questions – Industry Question

WHAT DO BANKERS DO DURING A BUY-SIDE M&A DEAL? WHAT DO BANKERS DO DURING AN INITIAL PUBLIC OFFERING
(IPO)?
• Sample Answer: In a buy-side deal, the bank will go out and search for
potential companies for their client to acquire and negotiate the deal to • You can’t go into a tremendous amount of detail here because there is
obtain the lowest price possible. There are four main steps. just so much that goes into this process. Focus on hitting the main,
high-level steps and you will be just fine.
• The first step will be to do a lot of research on a very large number of
potential acquisition targets based on what the client has represented that • SAMPLE ANSWER: The purpose of an IPO is to issue the least number of
they are looking for. After sharing the initial list with the client, you will cut shares possible for the highest price per share, therefore raising the most
the list down based on their feedback and decide which targets to money for the lowest possible ownership percentage of the company. This
approach for potential purchase. is achieved by selling shares of the company at an attractive valuation and
recruiting institutional investors (hedge funds, mutual funds, etc.) to
• After having meetings with each of them, you decide which to pursue support the client’s share price once the company lists its stock on the
further based on how open they are to the idea of an acquisition. The third public exchange.
step is to do further due diligence on each of the targets which are open to
acquisition while further narrowing down the list and determining an offer • First, you will meet with the client to gather information like historical
price for each of the targets. financials, industry information, customer data, company overview, etc.
Then, you will meet with lawyers to draft the company’s registration
• Finally, you work with the client to select the final target and work to documents (called an S-1 in the US), which details the business, its
negotiate and structure the deal before announcing the transaction. operations, its customers, its financials, etc. to potential investors. This
goes through many revisions working with the lawyers and the SEC, until
all parties accept it.

• The bankers then take the client on a “road show” where the company is
presented to institutional investors in different cities around the country
(or globe). After the roadshow and once the company has successfully
raised capital from institutional investors the shares of the stock will begin
trading on one of the public exchanges.

277
 Behavioral Practice Questions – Industry Question

WHAT IS THE DIFFERENCE BETWEEN EQUITY CAPITAL MARKETS WHY THIS FIRM?
AND DEBT CAPITAL MARKETS AND OTHER GROUPS LIKE INDUSTRY
GROUPS OR M&A? • The interviewer wants to know whether there is a fit between you and
the firm, its values and its culture.
• SAMPLE ANSWER: In ECM and DCM you are much more focused on the
markets and trends while assisting the industry groups in building the • If you are interviewing at a boutique, talk about how you feel you will
materials they need for their offerings and financings. ECM and DCM have get greater deal exposure and more responsibility in the smaller
a little bit of both investment banking and sales and trading. Those in these environment with smaller teams.
groups like following the markets, but also want to be more involved in
doing deals (IPOs, Financings, M&A, etc.) than those in pure sales and • If you are interviewing at a bulge bracket, talk about how you are
trading roles. interested in working on big-name deals that you read about in the
paper or that you are excited about specializing in a specific group you
find interesting.
WE WORK MOSTLY WITH COMPANIES IN XXX INDUSTRY; CAN
YOU TELL ME ABOUT A RECENT INDUSTRY TREND? • Finally, never disparage another firm. What if you were bashing
Jefferies and your interviewer happened to have come from there?
• This requires you to not only have an understanding in a specific
industry, but also requires you to be up to speed on current events in • SAMPLE ANSWER: In talking to a number of people at your bank, I get
that industry. the sense that your culture is what really distinguishes it from its
competitors. While this firm provides top-notch service and competes with
• If the firm does have a specialty, try and find some industry reports or all the major firms, those I have spoken with say it maintains a boutique
read up on some recent articles in the Wall Street Journal, which will feel. This allows for smaller deal teams, which will give me more
give you something to talk about. responsibility and—I hope—more exposure to live deals.

• Additionally, as many hours as are worked in finance, I think one of the

most important things is to get along with your colleagues. All those I
spoke with here said they respect their colleagues and are friends with
them both in and out of the office.

278
 Behavioral Practice Questions – Industry Question

WHAT DO YOU KNOW ABOUT OUR FIRM? WHO HAVE YOU SPOKEN WITH AT OUR FIRM?

• Talk a bit about the firm’s history, whether it is public or private, its • Name alumni or contacts you have spoken with and maybe quickly
areas of specialization (M&A, restructuring, etc.), branches, or mention positive things they had to say about working there and why
international offices. this appeals to you.

• If possible, mention some deals they have been working on. Most of • The interviewer may go to those you name and ask them what they
this information can be easily found on the firm’s website. think, so make sure your contacts will speak well of you.

• SAMPLE ANSWER: I have actually done a lot of research on Lazard. It • If you don’t have any contacts at the firm, speak about your findings
was founded in 1848 and was a private company until 2005. While you from other research you have done to learn about why this firm is the
are a smaller firm, you still maintain a strong global presence. one for you.

• You have two main divisions, Asset Management and Financial Advisory, • If you haven’t spoken with anyone at the firm, you should be prepared
and you are one of the most respected players in the M&A world. to offer a reason why not. Maybe no alumni work there and you have
According to my alumni contacts, you maintain a boutique feel, with small, no other contacts, or they didn’t respond to your emails, but at least
lean deal teams, which provides great experience for analysts, but you still explaining this shows you put forth an effort.
compete for the largest M&A clients.
• SAMPLE ANSWER: Luckily, I actually know a number of people here. My
fraternity brother Michael Riley and a friend from my finance class, Scott
Stevens, both graduated last year and are analysts in your natural
resources group. I spoke to them a few times to try and get a feel for the
firm.

• I also found the name of Andrea Krigman in our alumni directory. She is an
MD in consumer products and was nice enough to meet me for lunch a few
weeks ago to talk about her experience here.

279
 Behavioral Practice Questions – Industry Question

WHY NOT FIRM X INSTEAD? WHAT ARE YOU DOING RIGHT NOW?

• Ideally, you know something about Firm X, so you can draw a coherent • The interviewer is just looking to know what you are doing right now,
comparison. If not, simply reiterate what you find so appealing about whether it be a job or at school. They primarily are interested in what
the firm you are interviewing with, emphasizing that since this is the kinds of tasks you are responsible or activities you are involved in,
place you want to be, you haven’t done much research elsewhere. especially if they are relevant to the job you are applying for.

• SAMPLE ANSWER: The thing that separates you from them in my mind is • Be sure to spin your most impressive attributes or job functions into
size. While there is nothing wrong with working at a firm of that size, it things that are related. This is a much more common question for an
isn’t the kind of environment where I feel I fit best. I prefer your smaller, experienced hire than an intern or first year applicant.
close-knit deal teams where everyone knows one another and works
effectively together. I hope this will allow me to gain a lot of experience
learning from my superiors on deals, rather than being one of 15 analysts HOW DID YOU FIRST GET INTERESTED IN FINANCE?
staffed on a deal where my MD doesn’t even know my name.
• This is a pretty straightforward question. Who inspired you? Was it a
specific event?
WHY WOULD WE HIRE YOU WITH NO FINANCE EXPERIENCE?

• Talk about your qualities and characteristics (backed up by S.T.A.R.

• SAMPLE ANSWER: During my senior year in high school, I had to
complete an internship in order to graduate. A family friend who ran a
stories) that will make it clear that you are going to be a great
small hedge fund offered to let me work for him for a few months. I had no
performer.
experience in finance but figured it would be a good opportunity to test the
waters and see if it was something that interested me. I had a great
• SAMPLE ANSWER: While I may not have direct finance experience, I
experience, and that is what led me to pursue this career.
know that everything is learned on the job. The important thing is that I
have the intangibles that will allow me to be successful. I am incredibly
hard working and dedicated, which is something I have developed in my
time as a college athlete, and I have the intellectual ability to perform this
job at a high level.

280
 Behavioral Practice Questions – Industry Question

WHICH OF OUR GROUPS INTERESTS YOU? WHAT DEPARTMENTS ARE YOU INTERESTED IN?

• If there are different groups, have in mind a few that you think you • You want to be focused on one department. You don’t want to say
may be interested in, along with good reasons for your interest. you are interested in Sales and Trading, Leveraged Finance, and
Groups vary from firm to firm, so do some research. Research because they are three very different jobs.

• Make sure they know you are open to working in any group, and that • The main groups within an investment bank include Sales and Trading,
the most important thing is to be working at this firm. Research, M&A, Leveraged Finance, Equity Capital Markets, and Debt
Capital Markets.
• SAMPLE ANSWER: Two of your groups really pique my interest. First, the
natural resources group would involve deals that affect the everyday lives • SAMPLE ANSWER: I think my ideal job would be in the equity capital
of so many people. I have a good friend who is an analyst in that group, markets group. The idea of working with companies to help them raise
and he says the culture and people there are great; he really enjoys the capital in the public markets is exciting to me. I feel like in that role you get
work he does, and is getting a lot of exposure to live deals. to know a lot about different companies, different industries, and different
capital structures. In addition, I think working with a company on their IPO
• The other group that interests me is consumer retail. I think working on would be really exciting.
headline deals with companies I know would be extremely rewarding.
However, as long as I am working at this firm I would work in any group.

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 Behavioral Practice Questions – Industry Question

CAN YOU HANDLE THE GRUNT WORK? WHAT IS ONE CONCERN YOU HAVE ABOUT A CAREER IN FINANCE?

• YES! Show them that your college experience and past jobs involved a • For this, talk about a real concern you have (long hours, attention to
lot of grunt work. Have your S.T.A.R. stories ready to roll. Show them detail, etc) but talk about how and why you are sure you can handle
you are well aware of the grunt work, but excited to learn. the challenge and succeed.

• Have a story ready that shows you can put your personal life and
leisure second to job demands. WHAT DO YOU THINK IS THE MOST IMPORTANT CHARACTERISTIC
FOR THIS JOB?
• Show them you that have performed tasks in the past that were bland
and boring and you did them well with drive, determination, • Show that you will bring a positive attitude when you walk through
enthusiasm, and a positive attitude. the door every morning and will get the job done right with a smile on
your face, no matter what.
• SAMPLE ANSWER: I know this job involves a ton of grunt work, but it
won’t be anything new. I feel that crunching numbers and formatting • SAMPLE ANSWER: There are a lot of traits that make a successful
presentations is a small price to pay for the learning opportunity this job analyst, but the one that really stands out in my mind is positive attitude.
will provide. I feel I am as prepared as anyone is for this work According to the analysts I’ve talked to, the most difficult aspect of finance
is the day-to-day grind and long hours.
• I had to do a lot of grunt work in college. Once, my team and I were writing
our business plan, we needed to conduct market research on college • I think if I keep my head up and maintain a positive attitude while getting
students. To get what we needed, we went door to door across our entire my work done, I will be successful. Most of the candidates you’re
campus collecting nearly 3,500 surveys in a week. While it was tedious interviewing are probably smart enough to do a good job. What I think
beyond belief, the results were invaluable. A positive attitude and the makes a great analyst is someone smart who can also stay positive when
proper perspective, realizing that it has to get done and it better be done the job becomes demanding. A person with this mentality gets the job done
right, can make even the most boring work feel like it’s worth doing. and is going to be easier to work with in team situations, which seem to be
common in finance.

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 Behavioral Practice Questions – Industry Question

IF YOU WERE RUNNING THIS FIRM, IN WHAT DIRECTION WOULD

YOU TAKE IT?

• Focus on something the bank could do to improve business; don’t

focus on fixing something that has not been going well. Be careful not
to bash the bank for anything they may have been doing “wrong.”

• SAMPLE ANSWER: One thing I believe most firms can improve upon is
their attention to alternative energy. With billions of dollars being injected
into research and exploration of alternative energy sources, this could
become the next bubble. If I were at the helm, I think I would create a
group that specializes in alternative energy and aim to become the industry
leader
CAN ETHICAL REQUIREMENTS IN A FIRM BE TOO HIGH?

• A firm must have high ethical requirements to ensure moral business

operations and avoid legal trouble.

• At the same time, rules and regulations that are too strict can inhibit
creativity, posing a threat to product development, exploration of
alternative business models, and flexible client relationships.

• SAMPLE ANSWER: This is a tough debate. As a newcomer to the field, I

am by no means qualified to give the answer. With what has gone on in the
past few years on Wall Street, there was evidently insufficient regulation.
Too-heavy regulation may slow growth and limit profitability, but right
now what’s on everybody’s mind is how too-loose regulation can drive
even a hugely successful firm into the ground—practically overnight in
Lehman’s case.

• With the general public and corporate clients viewing Wall Street with
suspicion and regulatory standards still inadequate, I believe a firm
establishing and adhering to high ethical requirements is not just good for
business but a necessity to survive...

283
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Behavioral Questions - Personal
 Behavioral Practice Questions – Personal Questions

WHAT ARE SOME OF YOUR STRENGTHS? DISCUSS YOUR MATHEMATICAL AND QUANTITATIVE SKILLS
RELATIVE TO WHAT A JOB IN FINANCE REQUIRES.
• Going into the interview, you should have your three top strengths in
mind and a story ready to go for each of them. When you answer this • Talk about how you have managed your own portfolio, successfully
question, make sure you identify your greatest strength and make very completed a self-study modeling course, taken the finance or
clear what it is. Don’t dance around the answer. The strength you economics courses offered at your school, etc.
describe must be a quality that will help you become a great junior
employee. • Be prepared to share one or more specific S.T.A.R. stories or examples
to demonstrate your proficiency in the quantitative skills demanded by
• When you mention a strength, it should be followed by, “For example, the job.
there was a time when...” so you can back up your claim with a story.
• SAMPLE ANSWER: Although I majored in English, I have had an
• SAMPLE ANSWER: As you can probably tell from my resume, I have independent interest in the financial markets since I did an internship at a
strong quantitative skills and performed well in school. However, I think hedge fund as a high school senior. My assignment was to analyze a
one of my greatest strengths is vital for finance but not necessarily surgical technology company and build a simple revenue model in Excel.
something that can be documented. During my internship last summer, I
was brought into the office by my boss, given an old version of an Excel • Ever since I completed that project, I have managed my own portfolio of
model and a list of variables he wanted to be able to tweak, and instructed limited savings, investing in companies that I view as safe, long-term
to rebuild the model from scratch. growth plays through simple fundamental analysis. I have achieved an
average annual return of 15% on my portfolio over the past four years.
• At the time, I had no previous modeling experience, no training, and no
idea what I was doing. I knew my boss didn’t have time to hold my hand
through the process, so I had to teach myself. I bought a book and used
Internet resources to learn how to rebuild the model to my boss’s
specifications in a very short amount of time. My boss was amazed at the
quality of the model, and it is now being used for his analysis and in
presentations to clients.

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 Behavioral Practice Questions – Personal Questions

WHAT IS YOUR SKILL LEVEL IN EXCEL? WHAT MOTIVATES YOU?

• As an analyst or an associate in finance, you will likely be living in • Whatever you say, don’t say money. Everyone in finance knows they
Excel. Having a strong background in Excel will give you a big leg up are in finance at least partially for the money. Instead, say you are
on the competition. motivated by success, or learning, or seeing the direct results of
something that you have created.
• If your school has any classes that are focused on Excel, enrolling in
those classes would be a good idea. If you are feeling motivated, check
out some online courses. WHAT MAKES YOU SPECIAL?

• Have a concise 30-second pitch prepared. Concentrate on the three

WHAT IS YOUR SKILL LEVEL IN POWERPOINT? main bullets highlighted in the introduction, and identify three of your
traits that manifest those qualities.
• Similar to Excel, banking analysts, and associates are expected to be
wizards in PowerPoint. A good portion of your day, if you are staffed • Examples include things like being extremely driven, never giving up,
on a live deal or a pitch may be focused on creating and formatting wanting to learn, looking for challenges, etc. Make sure you take only
perfect PowerPoint pitchbooks. 20-30 seconds and speak with confidence, but make sure to avoid
arrogance.
• If you are able to say you already have strong experience in the
program, it will likely save your managing analyst or associate a lot of • SAMPLE ANSWER: Something that differentiates me from other
headaches in the future. candidates you may be interviewing is my dedication. Because I’m from a
non-target, your firm doesn’t recruit on our campus. In order to get here, I
cold-called and wrote letters to all the alumni I could find, looking for
someone to speak with me.

• I got in touch with Jim Stevens, had an informal lunch to talk about the
industry, and he offered to help get me an interview. I couldn’t just drop my
resume; I had to work to get here — an accomplishment I am proud of. You
can be sure that if I am hired, I will show the same level of dedication to
this job.

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 Behavioral Practice Questions – Personal Questions

WHY DO YOU THINK YOU WILL BE A GOOD ANALYST? WHAT DO YOU SEE YOURSELF CONTRIBUTING TO OUR FIRM IN
BOTH THE SHORT TERM AND THE LONG TERM?
• Highlight the following strengths: Work ethic, positive attitude,
quantitative and analytical skills, team spirit, communication ability, • Short-term goal should just be to accomplish everything that you are
eagerness to learn, appetite for work, efficiency of organization, detail given quickly and correctly, while learning as much as you possibly can
orientation during your first few years. Longer-term goals can be things such as
learning to lead and manage a team, bringing in new business, etc.
• SAMPLE ANSWER: To be a successful analyst, you really have to be well
rounded. No single quality makes a good analyst, but I think three
characteristics are probably most important: maintaining a positive WHAT ARE YOU LOOKING FOR IN THIS JOB?
attitude, being extremely hard working, and knowing how to be a strong
team player. • You should acknowledge the long hours and the heavy workload,
while making it clear that you are ready to take on the challenge.
WHAT’S THE SINGLE MOST IMPRESSIVE EXPERIENCE THAT IS ON
Emphasize the appeal of a great learning experience that you would be
YOUR RESUME?
unable to get in any other job straight out of school.
• Have one experience in mind that you feel is your most impressive to
• Explain how you relish the prospect of pushing yourself and being
the position you are applying for and talk about it in depth. Explain the
challenged to do your best work in this job. Emphasize your eagerness
important facets of the experience and how they relate to the job you
to work with and learn from a team of accomplished professionals who
are applying for.
can serve as mentors.
• SAMPLE ANSWER: “The most impressive experience on my resume was
• SAMPLE ANSWER: I see this job as an unparalleled learning experience
my experience last year as an intern at a hedge fund after my sophomore
Everyone I have spoken with in the industry tells me you learn everything
year. As the only intern at the firm, I was able to effectively manage
on the job. While my undergraduate studies prepared me for business, I
multiple tasks from multiple bosses and learned over the course of the
know that most of the skills I need will be acquired on the job.
summer how to accomplish everything asked of me efficiently and
accurately.
• I understand the hours and the workload, and I want to work incredibly
hard to gain real world experience that isn’t available in any other
• I took on tasks such as some basic modeling of a company’s projected
profession at this stage in my career. I believe that these skills will prepare
revenues based on different drivers and qualitative analysis of a few
me for whatever I choose to pursue in my future career.
different industries, putting together PowerPoint presentations for the
senior members of the team.

• Even though I was just an unpaid intern, I was considered an integral part
of the team and was expected to work long, intense hours which gave me a
feel of what I should be expecting as I enter the workforce.”
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 Behavioral Practice Questions – Personal Questions

WHAT DO YOU CONSIDER YOUR GREATEST ACCOMPLISHMENT WHAT IS THE NUMBER ONE THING YOUR RESUME WON’T TELL ME
THAT I SHOULD KNOW?
• Your answer to this can go any direction. If you want it to be related to
education, talk about how you worked on a given project that you • Talk about a skill that is unique to you (something that makes you
didn’t understand at first, struggled through it, and got an A. memorable), and that cannot be documented on a resume.

• If you want to relate it to personal life, talk about something you are • Think about things like your communication skills, teamwork skills,
proud of in your family life. You can even relate it to athletic success, etc...not your math skills, which can be seen in GPA or SAT scores.
recovery from illness, or community service.
• Once you decide on the quality you want to present, illustrate it with a
• Whatever you choose to address, make sure you spin it to story from your life.
demonstrate one or more of the qualities especially valued in finance—
willingness to learn, positive attitude, drive, and determination. • SAMPLE ANSWER: Ever since my freshman year of high school, I have
loved to perform. I was in the musical each year of high school and have
• SAMPLE ANSWER: Personally, I consider my greatest accomplishment to had a lead role in a play each year in college. This has allowed me to
be the balance I have been able to achieve between keeping my grades up develop a comfort speaking in public situations and with people I don’t
while being captain of the hockey team. Leading our varsity team through know or have just met. I think that this will be an extremely valuable skill in
fall and spring workouts, in addition to playing the entire season has finance, speaking with clients on the phone, and when presenting my work
required time management skills that are invaluable. I also wouldn’t trade to my coworkers.
the friendships I made for anything.

WHAT IS ONE WORD THAT DESCRIBES YOU BEST?

• Motivated, smart, driven, humble, efficient. All good options along

those lines. Just have an example to back up whatever word you
chose.

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 Behavioral Practice Questions – Personal Questions

COMING OUT OF THIS INTERVIEW, WHAT ARE THREE THINGS WHAT FEEDBACK DID YOU RECEIVE FROM YOUR LAST
ABOUT YOU THAT I SHOULD TAKE WITH ME? JOB/INTERNSHIP?

• Choose three traits you have that would (a) make you a good banker • Your interviewer is looking for specific examples of what you are good
and (b) show that you are unique and memorable compared to other at, what you have room for improvement on, and the steps you have
candidates. taken to better yourself in your areas of weakness.

• SAMPLE ANSWER: The three biggest things that I would like you to take • Discuss very specific examples of what you did well first, such as drive,
from this interview are (1) that I am extremely hard working and will bust attention to detail, teamwork skills or the ability to work on your own
my tail every day on the job; (2) that I have great communication skills and and figure out what needs to get done.
a positive attitude; and (3) that your firm is my number one choice and I
would be thrilled to come to work here every day. • Then, discuss a few areas that your superiors mentioned you could
improve upon. Talk about real weaknesses (you should have these
from your three strengths and three weaknesses preparation), and
then explain the steps you've taken to enhance your skills. As an
example, assume they said your Excel skills need to be improved, so
you signed up for an Excel course your next semester at school.

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 Behavioral Practice Questions – Personal Questions

WHAT SERVES AS YOUR BIGGEST MOTIVATION? WHAT MAKES YOU THINK YOU CAN PUT UP WITH THE STRESS,
PRESSURE, AND LONG HOURS OF A CAREER IN FINANCE?
• Rather than just saying what motivates you, have a story prepared that
shows you are motivated by whatever you answer. • Tell a story of a time in your life when you managed a lot of different
tasks and worked long hours.
• Outperforming expectations, hitting deadlines, respect from your
peers, maximizing efficiency, learning, etc. are all acceptable answers. • Make sure to explain that you know your past experience has not
been as intense as what you will face as a finance professional, but you
• SAMPLE ANSWER: My biggest motivation is earning the respect of my feel as well prepared as anyone, and you are 100% dedicated to
peers and boss. In my job last summer, I was the sole intern responsible for succeeding, whatever it takes.
building a model for a client. My boss, Mike, gave me the specifications and
told me when he needed it. I wanted to make a positive impression so I • SAMPLE ANSWER: I feel I am as prepared as anyone else coming out of
worked almost around the clock, including time at home, to get it built in college to handle the long hours. In fact, when you add up all the time I
only three days. spent doing all my different activities, school hours were almost as long.

• This allowed me time to sit down and go through it with Mike before it was • Every day I was up at 7:30 for classes that ran from 8:15 until 1:00. After
actually needed and still get it edited well before the deadline. Mike class, I would grab lunch and then go to golf practice, which didn’t get me
respected me for getting it done early, and earning that kind of respect is back until 5:00. Then I would grab dinner, and work in either my room or
what keeps me going. the library until I was done, which usually wasn’t until pretty late at night
or into the morning. While I know it isn’t the same stress and time
commitment as finance requires, I feel my experience has left me well
prepared.

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 Behavioral Practice Questions – Personal Questions

HOW ARE YOU GOING TO HANDLE THE FINANCE LIFESTYLE AND HOW HARD DO YOU WORK TO ACHIEVE YOUR GOALS?
ITS EFFECT ON YOUR PERSONAL LIFE AND HEALTH?
• The interviewer is checking to make sure that you are a hard worker.
• On average, the bankers in the study worked between 80 and 120
hours per week, essentially eliminating their social lives. • Present your personal drive through a S.T.A.R. story that backs it up.

• Talk about the active steps that you are going to take to endure this • SAMPLE ANSWER: To me, you must accomplish your objective no
lifestyle matter how hard you have to work to get there. I know that in finance,
there are going to be times when I feel like I just don’t want to do what I
• SAMPLE ANSWER: I know that the finance lifestyle can have an adverse have to do. But if it is something that needs to get done, I will work as long
impact on personal life and health. I have been able to raise this concern and hard as necessary.
with a lot of junior-level people I know and ask their advice.
• In one of my finance classes this past year, I was assigned the task of
• A few things they recommended are eating healthy and trying to get to the pulling data from CapIQ for 30 different stocks for a project. While it was
gym a couple of times a week, even if it means going early before work, just one of the most boring tasks I have ever seen, it had to be done, so I did it.
to get in a little bit of cardio. I am going to try to walk to work, control my As I worked through it, I figured out more efficient ways to do it. I worked
weight, and avoid bad habits. I think staying in touch with friends and until 4:00 a.m. and made sure it was ready for my group meeting the next
family, even if only electronically, is important to handling the mental morning.
stress.

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 Behavioral Practice Questions – Personal Questions

WHAT IS THE MOST INTELLECTUALLY CHALLENGING THING YOU DESCRIBE YOUR IDEAL WORK ENVIRONMENT.
HAVE DONE?
• Talk about the fact that you want to be in an environment with others
• Talk about a project, thesis, or use a story that shows you as a problem who are all as dedicated, driven, and hard working as you are, where
solver, going above and beyond your assigned role, helping to add everyone can rely on one another to get tasks done efficiently.
value to your company or group.
• Say you excel in an environment with great communication and
• SAMPLE ANSWER: In my internship last year, I was responsible for teamwork, one that will allow you to grow professionally and
aggregating data my company collected and summarizing it using intellectually, where you are evaluated and rewarded based on your
Microsoft Excel. When I started, the analysts on the team had been doing performance.
the aggregating, manually collecting all the data, applying formulas, etc.
• SAMPLE ANSWER: In my mind, at least in finance, the most important
• It seemed like they were wasting a lot of time. I had a little bit of aspect of the working environment is the people you are working with.
experience with VBA, and over the course of about a week, I taught myself When working side-by-side for countless hours per week, for years, if you
to automate the entire process whenever new data became available. It do not enjoy the company of your colleagues, the environment will be
was great that as a summer intern I was able to implement a system that is difficult.
still saving time today.
• My ideal workplace is one where everyone communicates well, works hard,
and trusts each other to get the job done right and on time—and then the
team is evaluated and rewarded based on performance.

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 Behavioral Practice Questions – Personal Questions

WHAT WAS THE MOST IMPORTANT THING YOU GOT OUT OF WHAT WOULD YOUR LAST BOSS TELL ME ABOUT YOU?
YOUR JOB LAST SUMMER?
• Tell a story about a time when your boss praised you for a job you
• Talk about something you learned in your job that cannot be learned in performed especially well.
a classroom.
• Talk about a quality your boss observed that is not clearly represented
• Maybe you learned how to build a basic model (be careful with this on your resume.
and do not exaggerate what you have done unless you are
comfortable describing it in detail on the spot), or maybe you gained a • Maybe you can put clients at ease upon meeting them, or you’re a
lot of experience presenting so you got more comfortable with public great leader who gets the best from every team member.
speaking.
• SAMPLE ANSWER: My boss from last summer would say I worked
• Whatever skill or concept you discuss, make sure it transfers to the exceptionally hard with minimal supervision and maximum dedication. He
finance world. would actually tell me to go home when it was getting late and I was still at
my desk; he would remind me it was just a summer internship.
• SAMPLE ANSWER: Of all I learned last summer, perhaps most important
was how to make effective presentations to my superiors. At the end of • Since I really wanted to get the most out of my time there, I guess I just
each week, as part of the internship program, we were each required to didn’t want to leave anything unfinished, even if it would have been OK
make a presentation to our boss. with my boss. At the end of the summer, that was the biggest compliment
he had to give me—that I was so dedicated.
• We had to put together a PowerPoint and a 10- minute summary of what
we had accomplished during the week. The first few presentations, we
didn’t know how to use PowerPoint and honestly, I was nervous standing
in front of our boss and all the other interns.

• By the end of the ten weeks, though, I had built a pretty solid foundation in
PowerPoint, and I was completely at ease in front of the group.

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 Behavioral Practice Questions – Personal Questions

HOW WOULD YOUR BEST FRIENDS DESCRIBE YOU? WHY DID YOU CHOOSE THE SCHOOL YOU ATTEND(ED)?

• You want to be able to say that your friends would describe you as • Connect the culture of your school to the culture of the firm.
someone who works very hard but still likes to have a good time.
• You can use this as an opportunity to emphasize extracurricular
• Your interviewer is looking for someone who is not only smart but also activities and/or particular classes your school offered that you found
a pleasure to know. helpful (and that will pay off for your employer).

• SAMPLE ANSWER: My friends are extremely important to me. I would • If you went to a specific school on an athletic scholarship or were
hope that first and foremost they would say that I am a good person, loyal, recruited to play a varsity sport, make sure you emphasize that!
someone who is enjoyable to be around, and someone that they can rely
on if they need me. • Your actual response to this question doesn’t matter as much as your
reasoning and the quality of the story that backs it up and connects it
• I think they would say I have a good sense of humor, I love to have a good to your application.
time, and that I enjoy spending time with them but also prioritize my work.
They know I try to get my work done efficiently so we can have a good • SAMPLE ANSWER: Coming out of high school, I was looking at two
time together when possible. I think they also would say that we all share choices: the one I chose and School X. While I knew both schools would
the same work ethic, and right now in our careers, it’s not all about the fun. provide me with an excellent education, I went for the one I felt fit me best
culturally. I graduated from a high school class of just 80 students and did
well there.

• For me, a smaller environment is the best way to learn. I enjoy getting to
know my teachers and peers. My largest class has been only 60 students,
so my professors actually knew my name and face, whether I was present,
and how I was doing.

• This is part of what draws me to your firm. The analysts I have spoken to
talk about its boutique feel and smaller deal teams, claiming that the MD
on your deal will always know you personally. In my opinion, having the
opportunity to learn from working closely with experienced bankers is
going to be vital to my career development.

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 Behavioral Practice Questions – Personal Questions

TELL ME ABOUT YOUR EXPERIENCE STUDYING ABROAD. CAN YOU EXPLAIN A CONCEPT TO ME THAT YOU LEARNED IN ONE
OF YOUR CLASSES IN 60 SECONDS?
• Start by explaining what you did academically while you were abroad
to enhance your business/finance skills. • While this may seem a bit daunting, as long as you have thought about
it at least a little bit in advance of your interview, you should be able to
• Then, talk about what experiences you had that helped you grow as a come up with a pretty good response.
person (think travel, cultural experiences, friends, etc.).
• Typically the interviewer is looking for something that’s quantitative;
• SAMPLE ANSWER: While I was abroad, I tried to focus on growing both likely from a finance, accounting, engineering, etc. class.
academically and as a human being. Academically, I was fortunate enough
to take advantage of the finance and economics courses offered at the • However, if you are explaining something from engineering or
London School of Economics and the amazing faculty teaching them. biochemistry, make sure it’s in plain English and you aren’t throwing
around acronyms that the average person wouldn’t understand.
• Culturally, I took advantage of how easy it was to travel around the
European Union and managed to get to 13 cities in 7 countries over the • If you can explain something that maybe the interviewer doesn’t
course of my three months abroad. It was an amazing experience to see already know, in layman’s terms, that may be more engaging. But, if
the stark contrast between living situations both country to country and you are more comfortable explaining a financial or accounting topic,
even city to city. that’s fine too.

• SAMPLE ANSWER: Let’s take the theory of time value of money. This
theory says basically that a dollar in hand today is worth more than a
dollar in hand in the future.

• The reasoning behind this is two fold. First, due to inflation, the dollar
today is worth more than a dollar in X years because it can buy more
goods. Second, if you have a dollar today, you can invest that dollar and it
will appreciate in value.

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 Behavioral Practice Questions – Personal Questions

HOW DID YOU CHOOSE YOUR MAJOR? WHY DO YOU WANT TO GO INTO FINANCE RATHER THAN
ENTERING SOME OTHER INDUSTRY OR STARTING YOUR OWN
• Use this answer to emphasize attributes and skills you learned from BUSINESS?
your major that will allow you to be successful on the job.
• Talk about the learning experience banking will provide.
• Emphasize that some relevant skills may not be demonstrated on your
resume: problem solving, teamwork, presentation, writing, teaching, or • Acknowledge that the idea of starting your own business someday
research. sounds exciting, but at this point, you don’t even know what it takes
for a business to succeed; working in finance will teach you the skills
• SAMPLE ANSWER: I chose economics for a few reasons. First, during my and give you the experience to help make that happen.
sophomore year I realized that finance was what interested me. Since my
school didn’t offer a finance major, I chose economics to give me a broad • SAMPLE ANSWER: My school was focused on entrepreneurship and that
perspective on the issues and ideas that shape the financial world. is definitely something that appeals to me. However, I concentrated in
finance because I knew I wanted to get experience before ever trying to
• My second reason for choosing economics was that I like an intellectual start something on my own.
challenge, and I like solving problems in teams. My school’s economics
program emphasizes group work, math, and intensive analysis, so I thought • I knew that getting into finance would give me exposure to a lot of
it would be a good fit for my interests and personality. different businesses and how they really work, allowing me to have a solid
foundation for anything that I would want to do, whether staying in
• I managed to supplement my econ degree by taking the two finance finance, going back to school, or starting a new venture. I know that this is
courses my school does offer, so I feel as prepared as I can be for the the best step to building my career coming out of college.
transition to a career in finance.

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 Behavioral Practice Questions – Personal Questions

WHAT ELSE DO/DID YOU DO AT SCHOOL BESIDES STUDY? WHAT HAS BEEN YOUR FAVORITE CLASS IN COLLEGE AND WHAT
WAS YOUR GRADE?
• Emphasize any leadership roles you took. These activities can include
anything from student organizations to athletic teams to community • The course you name should have something to do with
service. business/finance/economics, and the grade you report should be a
good one.
• Describe how doing many different extracurricular activities
developed your time management skills. As a result, you can complete • If you say your favorite class was African Tribal Dance, why are you
everything you need to accomplish much more efficiently than if you looking to go into finance? Why do they want you?
had not been so busy.
• SAMPLE ANSWER: During my junior year, I started taking finance classes
• Discuss activities that put you under pressure (sports?). Your at school. While I took three finance courses over the two semesters and
interviewer wants to know if your experience has prepared you for the enjoyed and learned a lot from them all, my Security Valuation class was
stress you will encounter on the job. the one I found most interesting and most useful.

• Talk about time spent with your friends. You want to show your • This class was my introduction to finance. Through the class, we learned
human side and emphasize that you always put schoolwork first while brief overviews of a number of different valuation techniques on stocks,
still having fun. bonds, and companies. We learned how to build a basic DCF, as well as
perform comparable company analysis and precedent company analysis in
• SAMPLE ANSWER: At school, my biggest time commitment other than a case study where we tried to determine the appropriate sale price of a
academics has been student government. Starting freshman year, I worked company.
my way up and am now the president of my school’s student government
association. • One of the best parts of this class was that my professor spent eight years
as an investment banker before coming to teach so he had first-hand
• Taking on greater and greater responsibility through the years has taught experience. I got an A in the class and the relationship I built with my
me how to lead a team and improve my time management skills. I learned professor has allowed me to turn to him throughout the application
the most efficient ways to complete all of my work, allowing me to process to help answer a lot of my questions.
effectively lead the SGA and still have some time for a social life. I cherish
my time with friends these last years in school since our chances to get
together once we start working may be few and far between.

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 Behavioral Practice Questions – Personal Questions

WHAT HAS BEEN YOUR LEAST FAVORITE CLASS IN COLLEGE AND TELL ME ABOUT YOUR COLLEGE EXPERIENCE.
WHAT WAS YOUR GRADE?
• Be positive about your college experience and confident in what you
• With this question, your best bet is to pick a class you did not enjoy have accomplished.
but still aced.
• Talk about the time you were taking six classes, playing on the golf
• You can say something like, “I really wasn’t passionate about the team, working a part time job, and still managing to enjoy the little bit
material, but I pushed myself to work that much harder and received of time you had to hang out with your friends.
an A in the class.”
• Take advantage of this invitation to discuss the qualities, experiences,
• This shows that you are willing to do your best even at something you and interests that make you unique, particularly when compared with
do not enjoy. You will have to do this in finance. the other candidates this interviewer is considering.

• SAMPLE ANSWER: In our freshman year there are some required courses • SAMPLE ANSWER: My college experience has been difficult financially. I
you are not able to choose. The general literature courses at my school come from a family that couldn’t help with my expenses, so I have been
were a bit strange in that your professor was at liberty to choose the paying for school entirely on my own. In order to keep down my student
curriculum rather than having something set by the school. loans, I’ve had to work since freshman year.

• My professor was “an expert” in the field of vampires, which meant we • Fortunately, in Boston, you can make good money waiting tables. I started
spent the entire semester reading and writing vampire novels and short out at a lower end restaurant because I had no experience. Now I work at
stories. I had no interest whatsoever in vampires. Worse yet, I found this one of the highest rated restaurants in the city. While it is tough to balance
professor uninteresting. Nonetheless, I knew it was a class I had to take classes, extracurricular activities, and work and still have some time with
and slacking off wouldn’t make it any better. So, I told myself I had to work my friends, the effort has definitely been worthwhile.
even harder, pushed myself, and managed to get an A- in a class I had no
interest in taking. • I’ve had a great college experience and I’ve made a good group of friends.
Working at the restaurant five times a week, I’ve paid off most of my
student loans and have learned to focus, prioritize, and manage a schedule
efficiently.

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 Behavioral Practice Questions – Personal Questions

DO YOU REGRET CHOOSING THE SCHOOL YOU CHOSE? WHY DO YOU WANT A JOB THAT IS SO MUCH MORE DEMANDING
THAN THE WORK YOU HAVE DONE IN THE PAST?
• Never bash your own school. Whatever your story, be confident about
your school and speak to how it prepared you for a career in finance. • Talk about the fact that you are looking for a job where you will have a
great learning experience.
• If you are at a top tier school, talk about how great the education has
been and how it has created great opportunities for you, such as the • SAMPLE ANSWER: While my past work experience has been rewarding
current interview. in many ways, I feel as though there is much more I can learn. Even though
a career in investment banking may be extremely time consuming and
• If you are not coming from a top tier school, speak about how you got challenging, I believe that there is much to be learned through hard work
a great education, and coming from a non-target made you work that while I am young.
much harder to get to where you are today, interviewing at X bank.
• Successfully completing the “crash course” I would receive in investment
• SAMPLE ANSWER: Not at all. My university has been amazing and I have banking would set me up for any career path I may chose, whether that is
loved my time there for so many reasons. First and foremost, the education continuing a career in banking, or onto other professions.
has been great. Coming into college, I chose University X partially for its
reputation in the business world, and it has not disappointed me.

• My professors have been top notch and actually care that I understand the
material, rather than just lecturing aimlessly. My coursework has been a
great basic preparation for a career in finance. Second, the social life there
has been great. I have developed a great group of friends that I know I will
be close with throughout my life, which is very important to me.

• Finally, coming out of a top-tier school like University X has made the job
search process easier, even in tough economic times. My friends at other
schools have been having a tough time getting interviews because firms do
not come to their campuses.

• Our career center works endlessly to ensure that as many firms as possible
interview on our campus. While I believe I would have been able to get
interviews through networking, as I have at some other firms, my career
center has been helpful throughout the process.

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 Behavioral Practice Questions – Personal Questions

WHAT IS AN EXAMPLE OF A BIG RISK YOU HAVE TAKEN IN YOUR WHAT IS THE BIGGEST OBSTACLE OR CHALLENGE YOU HAVE
LIFE? FACED AND OVERCOME IN YOUR LIFE?

• Think of the biggest risk you ever took in your life and describe the • Describe any challenge you are comfortable discussing which you
thought process you went through when deciding to take the risk. overcame after facing the challenge head on.

• Tell how you weighed the positives and negatives of all the alternative • Find an example that exemplifies your desire/willingness to learn, as
scenarios. Discuss and evaluate the outcome of that risk and what you well as your initiative and determination.
learned from the experience.
• SAMPLE ANSWER: The biggest obstacle I have had to overcome was
• Here are some questions to help generate other ideas. Did you ever paying for college. I managed to do it in a combination of ways. Initially, I
travel abroad or afar alone at a young age? Have you ever started a took out student loans, but then I began paying my tuition in cash and
small business? Have you ever made a risky financial investment? paying off some of my student debt early. I’ve waited tables several nights
a week throughout all my college years, and I now work at a very popular
• SAMPLE ANSWER: One of the biggest risks I have taken was during the restaurant, which pays me pretty well on a consistent basis.
final match of my conference golf tournament last spring. We were on the
18th hole and I was 1-up playing match play. I drove the ball a little offline • However, what I have most enjoyed doing to support myself is graphic
and ended up partially blocked by a tree. My opponent was in great shape, design. In high school, I was into art and photography and my graphic
and I knew he was going to make par at worst. design skills are pretty strong. When I began my business education, I
didn’t have time for those types of classes, and I missed it. However, I have
• I had to decide whether to try to hit a riskier shot that could result in a big been able to earn extra money developing logos, letterhead, business cards,
number, or play it safe, try to make par, and hope my opponent didn’t and presentations for student start-ups as well as some local businesses.
make birdie. I weighed my options. It was a shot I had hit before, and I All of this extra work has helped me to pay for a good portion of my college
knew that if I executed, chances were good that I would win or halve the costs.
hole and win the match.

• Even on the downside, if I didn’t hit the shot, I could still possibly make par
and halve, and if I lost the hole, we would go into a playoff. I decided to
take the risk, trust my game, and go for the win. I pulled it off beautifully,
made my par, halved the hole, and won the match and the championship
for my team.

301
 Behavioral Practice Questions – Personal Questions

WHAT IS THE TOUGHEST DECISION YOU HAVE EVER HAD TO HOW WOULD YOU COMPARE YOUR WRITING SKILLS TO YOUR
MAKE? ORAL SKILLS?

• Give an example of a time that you had to make a difficult decision • This is a bit of a trick question. You cannot say that one skill is stronger
under pressure. than the other. You must convince your interviewer that both your
written and oral skills are strong, because they are both vital in
• Explain the thought process you used to make that decision. finance.

• To help you generate ideas of your own... Has your education or • SAMPLE ANSWER: Honestly, I don’t think one skill is stronger than the
career required you to move away from your family and friends? Have other is. Both are vital to a successful career in finance, especially as you
you been at the final table of a major poker tournament heads-up with move up, and I’ve paid attention to developing both.
an open-ended straight flush draw and your opponent puts you all- in,
making your decision worth thousands of dollars? • Throughout college, I took several classes that relied heavily on writing
skills, which allowed me to improve. Nearly every business course I took
• SAMPLE ANSWER: The toughest decision of my life was choosing to required both individual and group presentations, which allowed me to
study abroad second semester of junior year. Since I play soccer in the fall, learn to make oral presentations and interact with others in conversation
leaving in the first semester wasn’t an option. I knew that second semester or debate.
is normally when you apply for internships, which you hope will turn into
full-time offers, but I really wanted to spend a semester abroad.

• I knew I would be risking not getting that “essential” internship, but in order
to take advantage of a once in a lifetime opportunity, I went for it,
minimizing the risk as much as possible. I networked and interviewed right
up to the day I left for South Africa, and I did secure an internship. I am so
glad that I did; I would have hated to miss out on either my semester in
South Africa or the internship.

302
 Behavioral Practice Questions – Personal Questions

WHAT DO YOU LIKE TO DO IN YOUR FREE TIME? WHAT COMPETITIVE ACTIVITIES HAVE YOU PARTICIPATED IN, AND
HAVE THEY BEEN WORTHWHILE?
• Don’t be the guy who says you like to sit around and watch CNBC all
day, unless you actually are that guy. Remember, they want someone • Firms are always competing for business and colleagues can even be
they could potentially end up being friends with outside the office. competitive with one another (although most won’t admit it). You need
Prove that you are a fun person. to show that you are comfortable in competitive situations, but still are
able to act with class and show respect.
• Some ideas to spark your imagination could include sporting events,
golfing, trying new restaurants, cooking, photography, concerts, going • SAMPLE ANSWER: In college, I played varsity hockey. Two of my four
to the gym, pick-up basketball, etc. years, we won our conference and went to the NCAA tournament.
Working with my teammates to accomplish a common goal and beat the
• SAMPLE ANSWER: In my free time at school, I like to do things that competition was an amazing experience, really exhilarating.
allow me to spend time with my closest friends. I am a huge sports fan, so
we just watch games in our apartment or maybe go out to a restaurant or
sports bar. We will even go to a game live if we can get tickets. I also try to WHAT WOULD YOU DO FOR A LIVING IF YOU DIDN’T HAVE TO
stay healthy, so I spend some of my free time in the gym. WORRY ABOUT MONEY?

• What is your favorite thing to do? If you love football, maybe you want
to coach high school football. If you enjoy music, maybe you would be
a musician.

• SAMPLE ANSWER: In high school, I was a tri-sport athlete, playing

football, hockey, and lacrosse. Coming into college, I was recruited for
football and planned on playing at my school. During my freshman year,
unfortunately, I repeatedly dislocated my shoulder, leading to a torn
labrum that knocked me out for good. Not even surgery would help.

• I really miss football and the camaraderie that comes with it. If I could do
anything for a living, without having to worry about money, I would love to
coach high school football. I think teaching kids the lessons I learned in my
years as a football player would be fun and rewarding.

303
 Behavioral Practice Questions – Personal Questions

WHAT ARE YOU GOING TO DO IF YOU DON’T GET A JOB IN HOW DO YOU MANAGE STRESS IN YOUR LIFE?
INVESTMENT BANKING THIS YEAR?
• Talk about your time management practices. Your task management
• The one thing that you don’t want to do here is say that you will go strategies (how you stay very organized, your self-management
into a job in a completely different industry. methods, and how you avoid procrastinating while things pile up) are
vital in banking.
• Talk about how you have offers or options (hopefully) in other finance-
related jobs like accounting, corporate finance, valuation, etc. • SAMPLE ANSWER: Between taking five classes a semester and
participating in a few extracurricular activities, I have had a lot of tasks
• Maintain a level of modest optimism by stating that you know you may and assignments to keep track of. I managed stress by staying organized,
not receive offers, but that you feel you have prepared yourself well using the planner on my phone to keep track of what is due when, and
and are in a good position to break in. maintaining a folder or binder for each task.

• SAMPLE ANSWER: That’s a legitimate question since this process is so • This organization allows me to make sure I space out my work on projects
competitive, but I believe I have positioned myself well to obtain an offer that are due around the same time, make sure nothing gets lost or
from your firm. However, if I don’t end up with an offer from your firm, I neglected, and avoid surprises. I try to follow a regular schedule throughout
will likely look to go to the Big 4 accounting firm where I already have an the week that assures I won’t let things go; I have found that if I don’t
offer. allow tasks to pile up, I create less stress for myself to manage.

• My ultimate goal is to end up with a job in banking, so I think that going

and getting some solid accounting experience under my belt for a year will
help me tremendously when I re-apply next year.

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 Behavioral Practice Questions – Personal Questions

WHAT IS YOUR FAVORITE WEBSITE? WHAT ARE YOU INTERESTED IN?

• One piece of advice you should heed is to be aware of your • There are two ways that you can answer this question properly and
surroundings and think about the type of person your interviewer is. If you may want to explore both in your answer. First, you can mention
the office you are in is littered with sports memorabilia and you are a things that you are interested in that are job related like keeping up
sports fanatic, by all means, say ESPN.com if you are able to back it up with current events, studying for the CFA, etc.
with a conversation about sports.
• Second, you can speak about your hobbies and your interests outside
• If you want to take a more conservative approach, keep your answers of work. The latter works great if you happen to share an interest with
finance related. Pick a site like WallStreetJournal.com and explain that your interviewer. Hint: If you know the names of your interviewer, you
you like to keep up with the financial news. NOTE: This answer is not can do a little research beforehand and see if you can find any
memorable and you better be ready to discuss what’s been in the common interests so you can push the convo in that direction.
news lately.

• Another option is to pick a site that you find particularly interesting, IF YOU HAD A MILLION DOLLARS THAT YOU WEREN’T ALLOWED
maybe a site with a unique business model you expect to become very TO INVEST, HOW WOULD YOU SPEND IT?
successful, and explain to your interviewer why it intrigues you.
Whatever answer you give, be ready to back it up with a reason why it • Make sure your background backs up whatever answer you give. If
is your favorite site. you have never volunteered in your life, don’t say you’re going to
donate your money to a non-profit and go work for them. Have it
• SAMPLE ANSWER: Actually, my favorite site is a start-up called relate to something you are interested in, and make sure that
Zaang.com that one of my college roommates is working on. It is a social whatever you are spending it on can cost roughly a million dollars.
network for connecting users who are interested in similar topics. They
post content in any form, including photos, videos, art, music, etc, and they
are rewarded by other users for quality content.

• Once a month, the ad revenue generated by the site is distributed among

users based on how many points they have earned. Essentially, people can
earn money by posting the same quality content they have been posting on
other websites.

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 Behavioral Practice Questions – Personal Questions

WHAT WAS YOUR FAVORITE JOB YOU HAVE HAD? DESCRIBE TO ME YOUR IDEAL WORK ENVIRONMENT

• If possible, pick a job that requires similar skills to the job for which • This requires a little bit of background research on the company you
you are applying and explain why those skills or requirements made it are applying to. You don’t want to walk into a firm that has massive
your favorite. Talk about how you were forced to learn on the fly, or deal teams where you don’t know you your VP and say that you really
multi-task, or think critically, because those are all skills you will need thrive in small, close knit environments where you have direct
in finance. interaction with the most senior people at the firm. Craft your answer
here based on what you know about the firm.
WHAT WAS YOUR LEAST FAVORITE JOB?

• Talk about a job where you were bored, or not challenged, or not busy. WHAT ROLE DO YOU LIKE TO TAKE IN A TEAM SITUATION?
None of those things will be the case in finance so they won’t be an
issue. • You should be comfortable as a leader and a follower. This is
important because you will need to be able to do both.

• Talk about your teamwork skills (communication, collaboration, etc.)

and how those skills are effective when you are the leader and when
you are supporting someone else’s leadership.

• SAMPLE ANSWER: I’m comfortable leading a team or taking instructions

from another leader. When the leadership isn’t appointed, I think it’s useful
to consider my teammates’ concerns and preferences. In one of my classes
last year, I was placed in a group where nobody was confident about the
subject matter. In that particular group, I thought I could help by taking the
initiative, so I stepped up to coordinate the group’s assignments.

• In another group situation, where one student was insisting on taking

charge, I was happy to support him. He was able to communicate his ideas
and organize a plan, which allowed the rest of us to deliver our tasks on
time with high quality. Overall, I think the quality of leadership is more
important than who provides it, and most important of all is the quality of
the team’s work. Since every situation presents a unique set of
personalities, it’s important to read those personalities and identify how
you best fit into the group dynamic.

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 Behavioral Practice Questions – Personal Questions

DO YOU FEEL MORE COMFORTABLE WORKING IN A GROUP OR BY HOW DID YOU GO ABOUT PREPARING FOR YOUR INTERVIEWS?
YOURSELF?
• Your answer to this needs to demonstrate how much you want this
• The answer to this question has to be that you feel entirely job, how determined you are, and how systematically you have
comfortable in either situation. prepared.

• Think of two S.T.A.R. stories, one that shows you contributing to a • Describe how you researched the firm on the website, on
successful team and one that shows you performing successfully on an WallStreetOasis.com, at WSJ.com, and through alumni contacts.
individual assignment. Give strong evidence that you thrive in either
set of circumstances. • Tell them that talking to alumni and bankers who are currently at the
firm gave you a good idea of what will be required of you as an analyst
• SAMPLE ANSWER: I know that finance will include both group and and what to expect during your interview. Make sure your enthusiasm
individual assignments, and I’m comfortable with both. At school, much of for finance and for their firm comes across!
our work was done in teams. In fact, one of my freshman classes actually
had us starting our own businesses in teams of 30. • SAMPLE ANSWER: I didn’t want to waste anyone’s time during my
interviews, so I tried to be careful in my selections and preparations. I
• I was one of the VPs in our business, so I was reporting to our CEO but still reached out to nearly twenty alumni and asked if they would speak with
had several people working for me. I was in charge of planning and me; over half of them were gracious enough to talk to me about what goes
organizing work assignments to make sure we completed the jobs our CEO into the analyst’s job.
requested.
• They also had some useful information that helped me narrow down the
firms where I most wanted to work. I sought out employees from those
firms who helped me understand their firms better and briefed me about
what I could expect during interviews.

• Then I made sure that I was ready to discuss technical questions:

WallStreetOasis.com helped me out with that. I did mock interviews at my
career center to become comfortable with the interview format and with
telling my story. Finally, I used your website and studied your annual report
to become more familiar with your firm.

307
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308
Behavioral Questions – Situational
 Behavioral Practice Questions – Situational Questions

DESCRIBE A TIME WHEN YOU WORKED AS PART OF A TEAM. DESCRIBE A TIME WHEN YOU TOOK A LEADERSHIP ROLE IN A
TEAM SITUATION.
• You can discuss a group project at school, a project from a previous
job, a sports experience, or a community service project in which you • Talk about a situation in which you worked within a team and decided
collaborated with others to accomplish more than you could have to take the lead. Explain why you took the lead, how the project
done alone. worked out, and what you learned from the situation.

• Make sure you are able to describe clearly your role within the team • Be sure to show a situation that demonstrates your ability to take on
(leader, follower), and how the team process played out. Be sure to use responsibility, communicate clearly, make decisions, and delegate
an example where the team worked successfully together to produce a tasks effectively.
positive result.
• SAMPLE ANSWER: I was voted captain of my varsity golf team this year.
• SAMPLE ANSWER: Last year, in one of my classes, our final project was a I had been close with my previous captains but didn’t have any idea how
paper to be prepared in a group of five. We all agreed that group papers much work was involved in the job. I coordinate practice carpools and
could be difficult to organize. It’s tough to write a paper that sounds fluent tournament transportation, food, and registration.
if different people write different sections, since everyone has an individual
writing style. • What I learned about leadership was that, to be effective, you have to
make sure everyone knows what’s going on, you have to pay constant
• We solved this by dividing the paper into five sections, while creating a attention to organizing, and you have to take care of your people. The
very detailed outline of each section together before we began writing on leader has to be sure all the details are covered and all the dots are
our own. This ensured effective communication of all our ideas and connected, but he can’t do everything. I learned to delegate some of my
information within the team, allowing us to produce a cohesive paper. We tasks to the junior who will probably be captain next year.
then came back together and revised it as a group.

• The result was a paper with coherent organization, consistent style, and
logical flow. This worked very efficiently and smoothly, I think perhaps
because we all sort of came up with the idea together and agreed to it
before we started. I took responsibility for collecting and circulating and
assembling the sections, and another member scheduled the revision
sessions, while a third member took care of the final printing, binding, and
submission.

310
 Behavioral Practice Questions – Situational Questions

DOES THE LEADER OF A TEAM MAKE THE TEAM? TELL ME ABOUT A TIME WHEN YOU ACTED AS A LEADER EVEN
WHEN YOU WERE NOT IN AN OFFICIAL LEADERSHIP POSITION.
• No, the leader of a team doesn’t make the team, because if a leader is
paired with a weak team, he or she will not be able to complete all of • You need to show your interviewer that you are able to recognize
the work assigned for the entire group and therefore the work product when you SHOULD be a leader, not when you are a member of a team
will suffer. It’s critical that every member of the team is able to that is overzealous and tries to take control of a situation that they
effectively pull his/her own weight. shouldn’t.

• SAMPLE ANSWER: The leader doesn’t “make” the team. While a great • Think of a team situation where there was a very serious problem, or
leader will provide his or her team with direction and mentoring, it’s vital the leader was slacking, and you stepped up to take control and
that everyone on the team pulls their own weight. successfully lead your team across the finish line.

• For example, there was one time when I was on a team last year during my
internship and I was working with my favorite VP. The VP was great, but
we were assigned a research project and at the end of the day, while the
leadership and direction was there and the jobs were very clearly outlined,
a couple members of the team didn’t complete their tasks on time, and
therefore the project didn’t get done.

• A leader needs to be able to trust their team to get their individual tasks
completed in order for the team as a whole to succeed.

311
 Behavioral Practice Questions – Situational Questions

DESCRIBE HOW YOU HAVE DEALT WITH CONFLICT IN A TEAM DESCRIBE WHAT YOU DID WHEN YOU OR YOUR GROUP RISKED
SITUATION. MISSING A DEADLINE.

• Pick a situation where you had a conflict and you were the one who • First, offer a good reason for cutting it too close to the deadline...
defused it. Explain what happened, what you decided was the best Avoiding explanations like “We forgot about the project until Sunday
course of action and why, and the outcome. night, and it was due at noon on Monday.”

• Whatever the situation, make sure you discuss how you stepped back • Talk about a time you were at risk of missing a deadline, worked
to evaluate the conflict before taking action. You also want to get endlessly to meet it, and still finished it with successful results.
across that you are not afraid of confrontation and you are able to
approach conflicts with maturity. • SAMPLE ANSWER: For my management class last semester, I spent
several weeks preparing my final presentation and producing a lot of data
• SAMPLE ANSWER: As president of the Student Government Association, and graphs. As I was reviewing it one last time on the night before it was
I deal with conflicts every day. Last year, there was disagreement within due, I realized that all the graphs I had pulled into my PowerPoint were
the SGA over what we should do for our spring fundraiser. from an earlier Excel file, so it wasn’t the final data set and the numbers
were slightly off.
• Half the SGA was set on an auction, while the other half wanted a casino
night. Neither side was willing to budge; we were at a standstill. I called a • I was almost certain I could have presented those graphs, and nobody ever
meeting to discuss some viable options. Since neither side was willing to would have noticed. Still, I would have known and after all the work I had
give up its own idea, I proposed a solution that included both. put into the project, I wanted it to be right. I stayed up all night, changing
the data in 47 graphs to show my actual findings. I made the presentation
• We decided we would have a casino night, where people would get a on Red Bull and coffee but it went great. My professor commended the
number of chips based on the size of their donations. They could play those accuracy of my data and gave me an A on the project.
chips and use their winnings to purchase items in the auction at the end of
casino night. Instead of getting prizes, guests were able to bid on what they
wanted. Both sides were happy with the solution, and the event ended up
being a great success, raising over $10,000 for student activities.

312
 Behavioral Practice Questions – Situational Questions

TELL ME ABOUT A TIME WHEN YOU HAD TO WORK LONG HOURS DESCRIBE WHAT YOU DID IN A GROUP WHERE SOMEONE WASN’T
TO ACCOMPLISH A TASK OR PROJECT. CONTRIBUTING.

• This is one of the more common situational questions since your • Think of a situation where this happened to you either in school or at
interviewer wants to be sure you can cope with the long hours, so be the workplace and how you addressed the situation.
prepared with a good example.
• Do not say you went to your boss or professor to complain. Show how
• This should be a situation where you had to work long hours for a you brought the team together, had a group conversation with the
relatively extended period of time, not just a day or two. Talk about a person that was not pulling their weight, expressed your concerns
situation where you were forced to work hours similar to that which maturely, and managed to move on successfully to complete the
you will encounter in finance... weeks of 60, 70, 80+ hours. project.

• SAMPLE ANSWER: In the spring of last year, I was the lead in my school’s • SAMPLE ANSWER: I have encountered this a few times. One example
play, editor of the school paper, and taking a full course load. In the comes to mind from my job last summer. One member of our group never
months leading up to the play, I would have 3 hours of rehearsals per day, seemed to take on the same level of responsibility as the rest of us but still
constant work for the newspaper, in addition to my classes and homework. took full credit whenever our team did well. We didn’t feel right simply
During that time, I had almost no free time and was working from 8am throwing him under the bus, and we figured our boss probably didn’t want
until midnight every single day, even many weekends. to hear about it.

• After this became an obvious pattern, we sat him down and expressed our
concern about the situation with an intervention style approach. We were
firm but not overly critical, letting him understand how we saw his
behavior and how it affected the rest of the team. We emphasized that we
didn’t want to punish him; we just wanted a solution because we would be
working together throughout the summer.

• He actually was extremely apologetic and said he hadn’t realized he wasn’t

pulling his weight. After that conversation, he stepped up and we worked
great as a team for the rest of the summer.

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 Behavioral Practice Questions – Situational Questions

TALK ABOUT A TIME WHEN YOU HAD TO DEAL WITH A VERY WHAT WOULD YOU DO IF YOU FOUND YOUR COMPANY DOING
UPSET TEAMMATE OR CO- WORKER. SOMETHING ILLEGAL?

• You need to show that you have the ability to be a good leader. • This is a tough question to respond to, but there is only one right
Show that you can be empathetic but at the same time evaluate the answer.
legitimacy of your teammate or co-worker’s feelings.
• By observing a crime and not reporting it, you become guilty as well;
• Your answer should reflect that you sat the person down, listened to therefore, you must report it.
their complaints, and discussed the best way to remedy the situation.
Your story should end positively, with you taking the initiative, • If it is something that you overheard, tread lightly; without proper
resolving the situation, and moving forward with your group in an evidence, you could put yourself into a bad situation.
effective manner.
• While you may feel like a snitch or traitor, you have to report to
• SAMPLE ANSWER: There was a time last year when I was a member of a Compliance in writing, keeping a copy of all the evidence in order to
three-person team. One of my two partners was consistently missing protect yourself and your own reputation.
deadlines. After the third time, my other partner had had enough and really
went to town on the kid, about how irresponsible and lazy he was being. • SAMPLE ANSWER: This would be a tough situation for me. After working
with the people supposedly involved in the alleged crime, I would feel some
• I realized that yelling and insulting him wasn’t going to help, so I tried to sense of loyalty to them and would not want to report them.
defuse the situation by calming down my upset teammate, and explaining
to my other teammate that he really had to pull himself together. Luckily, • However, not reporting the issue makes me guilty as well, so I would have
they both got the message; after that, we all got along and did our jobs. no real choice but to report the crime to Compliance. I would try to get
everything in writing and have copies of everything relating to what I had
observed. While I may feel like a traitor to those particular individuals,
reporting the crime could save the firm a lot of headaches.

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 Behavioral Practice Questions – Situational Questions

HOW DO YOU MANAGE TO DEAL SUCCESSFULLY WITH A TELL ME ABOUT A TIME WHEN YOU MOTIVATED OTHERS.
DIFFICULT BOSS, CO-WORKER, OR TEAMMATE?
• Tell a story about a time you acted as a leader (see the ‘What makes a
• In dealing with a difficult person that you must work with, good leader?’ question for those qualities), and effectively motivated
communication and perception is the key. You must command respect your team/group to step up and produce results.
but at the same time be willing to make compromises in order to
interact effectively. • School and work situations are most common, but if you captained a
varsity sport at your school, by all means, use the story of the time you
• In resolving conflict, ensure that you get what you need to work huddled them up and gave a “win one for the Gipper” speech.
effectively; at the same time, try to give what the other person needs
as well. • SAMPLE ANSWER: In one of my finance classes last year, we had a final
project and a final exam. The professor made a deal that if we did well on
• There should be open discussion and compromise between you and the final project, the exam would be optional. My group finished the
the person in question in order to allow effective teamwork. project hoping that we would place out of the exam.

• SAMPLE ANSWER: Luckily, I haven’t had too many tough situations with • The rest of my team members were satisfied with the project and were
classmates or co-workers. However, I can think of one time when a about to call it a night, but I wasn’t 100% convinced. I wanted to
teammate and I didn’t get along. I joined a course late and was assigned to guarantee that I wouldn’t have to take the final; I had an A in the class and
a group with a student I didn’t particularly get along with for a variety of didn’t want to risk bringing down my grade.
reasons.
• I needed a way to motivate my team to put in a few more hours and
• He was a pretty good student, and I knew he was concerned with grades, decided the best way to do that was through their stomachs. I called up
so I just laid it out at the beginning. I said something like, “Look, I know we Domino’s, ordered some pizzas, and gave a little speech to get the rest of
don’t really get along, but for both of our sakes, let’s put everything aside the group to spend a few more hours with me perfecting the project. It
while we are working together in this class, get through it with our best worked, and we placed out of the final.
work, and not let it affect our grades.”

• He respected me for handling the situation this way; we put our past
disagreements aside and worked effectively together. Since the class has
ended, we still don’t really get along, but we managed to make it work
when it mattered.

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 Behavioral Practice Questions – Situational Questions

GIVE AN EXAMPLE OF A PROJECT THAT REQUIRED YOU TO THINK TELL ME ABOUT A TIME WHEN YOU SUBMITTED A PROJECT WITH
QUANTITATIVELY AND ANALYTICALLY. GRAMMATICAL, FORMATTING OR OTHER MISTAKES?

• Pick a project you can speak confidently about, that was successful, • Don’t say that you have never done that, because that’s just not a
and that shows you have quantitative skills as well as the ability to realistic answer. Everyone has made mistakes.
analyze a situation or problem effectively and come up with a solution.
• Explain the situation to your interviewer and what your mistake was.
• The project doesn’t necessarily have to be business or education Then, proceed to explain how you learned from your mistake and
related, just make sure it emphasizes your personal strengths, and the never made that mistake again.
strengths you need in finance.
• SAMPLE ANSWER: Last year in my marketing class we had to hand in a
• SAMPLE ANSWER: In my corporate financial management class, our presentation, which contained a lot of market data about the private
final project was to analyze a company’s financials, look at their balance aviation industry. After turning in the report, I realized that I had
sheet, compare them to their competitors’, and recommend adjustments mislabeled one of the statistics as the mean when in reality it was the
the company should make to its balance sheet to increase shareholder median.
value.
• After realizing the mistake, I considered not saying anything since it was
• We did a valuation of the company using a basic DCF and wanted to look such a minor error, but in the end I decided to just mention it quickly to my
at ways we could lower their WACC in order to increase the valuation. professor during the next class.
Since the company was nearly 100% equity financed, we recommended
they issue bonds and repurchase stock with that new cash, as well as • Since then, I have learned to always print out my presentations before
keeping some as a buffer against an economic downturn. handing them in and edit them with a pen in hand. For some reason it just
seems much easier to catch mistakes when something is on paper in front
of you than on a computer screen.

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 Behavioral Practice Questions – Situational Questions

GIVE AN EXAMPLE OF A PROJECT YOU ENJOYED WORKING ON. HAVE YOU EVER HAD TO WORK ON A PROJECT OR PRESENTATION
THAT WAS DISTRIBUTED OR PRESENTED TO A LARGE GROUP?
• Here’s another opportunity to highlight your quantitative, analytical,
communication, and teamwork skills through a story of a successful • If a number of your classes emphasized team situations in which you
project. were required to present to the rest of the class, you can talk about
that. If you had a task at a previous job or internship where a boss
• SAMPLE ANSWER: Looking back on my college experience, the project I asked you to create a PowerPoint for a group of investors, that is a
most enjoyed was working with my team on a business plan my junior year. great one to discuss.
I found that writing a business plan takes an incredible amount of work.
We did hours of market research about our product and how popular it • With this question, the interviewer is looking for a few things. First,
might be on campuses across the country. they are looking to make sure you have presented to large groups in
the past, which requires attention to detail and proper preparation.
• We actually took road trips to colleges as far as six hours away to do focus
groups and collect data. Then we worked together to compile the data we • Second, they are looking to see whether you have the poise to present
collected and make projections based on that information. It took a lot of what you have created to a large group clearly and effectively.
teamwork and communication to get the plan written, but I enjoyed the
people on my team and loved the project as a whole. • SAMPLE ANSWER: At my school, they really tried to emphasize group
work and presenting since they know it is an important skill to have in the
• The final product was something I was extremely proud to present to my working world. In my freshman year class, we were broken up into groups
professor since I knew how hard we had worked on it together. and required to pitch ideas to start a business.

• Eventually, the 60 person class had two teams, each responsible for
running a business. Each week, we had to present our results to the whole
class. As a “VP,” I was responsible for presenting a portion of the week’s
results and took responsibility for creating the PowerPoint that was shown
during the meeting.

317
 Behavioral Practice Questions – Situational Questions

GIVE AN EXAMPLE OF A GOAL YOU SET AND HOW YOU ACHIEVED GIVE AN EXAMPLE OF YOUR EXPERIENCE WITH MULTITASKING.
IT.
• Tell a story of a time when you had to manage a lot of different tasks
• Give a situation where you challenged yourself to achieve something and work long hours.
that you hadn’t previously accomplished.
• SAMPLE ANSWER: I do a lot of multitasking at school with all my
• This can be from your personal life, school, sports, etc. It does not different activities. A specific instance that stands out in my mind would be
matter what the topic is; do not feel as though you have to force it finals week this past semester. I had final exams in three of my classes and
towards finance. papers due in the other two. I also was working on finishing the winter
edition of the school newspaper, where I was the lead photographer, and I
• This should be something impressive and challenging, a situation that had to attend basketball practice or games every day.
demonstrates that you have the skills needed to succeed in finance.
• I was able to get everything done only by doing a few things at once. I
• SAMPLE ANSWER: After my freshman year, I was near the bottom of the edited photos on my laptop on the bus to away games. I maximized my
roster on the golf team. I am a competitive person and hated not being on time studying and editing papers on the treadmill during workouts. I made
the traveling team and going to tournaments. sure that when I had time to focus on my work, I made the most of it by
hiding on the quiet floor of the library, allowing me to concentrate
• That summer, I set a goal for myself to lower my handicap from a 9 down completely.
to a 3, so I could make the top five, allowing me to travel. Every daylight
hour that I wasn’t working, I spent either at the range or on the course
practicing. All my hard work paid off. My hard work paid off, and I
managed to lower my handicap to 2.3. I became the number three player
on the team in the fall and had the chance to travel to every tournament.

318
 Behavioral Practice Questions – Situational Questions

GIVE AN EXAMPLE OF A TIME WHEN YOU PERSUADED OTHERS TO GIVE AN EXAMPLE OF GOING ABOVE AND BEYOND WHAT WAS
DO SOMETHING OR CONVINCED SOMEONE TO SEE YOUR POINT EXPECTED OF YOU.
OF VIEW.
• Choose a situation where you were assigned a task and decided to do
• At the senior level, you will be making pitches to companies, more than what was asked of you. If you have an example that ended
convincing them that your firm is the best one to handle a job, with your efforts being officially commended by a boss or professor,
maintaining relationships, etc. that’s even better.

• You need to be persuasive. Come up with a situation where you • Talk about a time when you completed a task to the requirements,
persuaded someone to do what you wanted. then continued working on the task to take it above and beyond.
Maybe talk about a time you had to pull an all-nighter at your summer
• You should present this in the form of a conflict, an action, and a internship last year, or if you caught a mistake in a presentation just
resolution, just like your other stories. before it was too late.

• SAMPLE ANSWER: Last year, I launched a small business at school with • SAMPLE ANSWER: Honestly, I am a bit of a perfectionist when it comes
two of my classmates. We all enjoyed cooking and had a contact at a local to presentations. A few months back, I worked on a project that my group
meat wholesaler, so we were going to start selling chicken sandwiches from had finished, but some of the formatting was a bit off.
our house at night.
• After we broke up, I worked until 3:00 a.m. redoing all of the graphics,
• My two partners wanted to marinate three different flavors and offer a making sure the formatting was perfect. My team was stunned and very
selection. I thought it would be better if we cooked all the chicken the appreciative the next morning when they saw the work I had done, and our
same way and just offered different sauces; This approach would prevent professor commented on how professional the presentation looked.
us from having leftover chicken with flavors that might not sell well. I
thought about what would change my mind if I were in their shoes, then
showed them how expensive it would be to maintain multiple marinating
processes and how challenging it would be to avoid excessive inventory
using their proposed method. They agreed with me, and we decided to go
with the sauce model.

319
 Behavioral Practice Questions – Situational Questions

GIVE AN EXAMPLE OF A TIME WHEN YOU WERE REQUIRED TO PAY WHAT IS THE BIGGEST MISTAKE YOU EVER MADE SO FAR IN YOUR
CLOSE ATTENTION TO DETAIL. PROFESSIONAL LIFE?

• This should be a time when you have been under the stress of a • This is similar to the ‘What is your greatest failure?’ question discussed
deadline, still managed to pay close attention to the details of your later. You want to come up with a circumstance that was clearly a
project, and produced a flawless result. mistake but doesn’t make you look hopeless. Make sure you
emphasize what you learned from this mistake and how you have
• In finance, it will be expected that the pitch book you finished at 3:00 avoided repeating it.
a.m. is flawless when it is presented to a prospective client the
following morning. There is no acceptable excuse for error, so you • If you have had a summer internship, talk about a mistake you made
need to prove to your interviewer that you have the ability to produce the first week on the job in pulling data from a certain source (i.e.
perfect work. Bloomberg terminal). You can say you immediately learned to triple-
check your work before handing it in.
• SAMPLE ANSWER: Last summer at my internship, I was responsible for
building some models for my boss to use in generating fund projections, • SAMPLE ANSWER: At the beginning of my internship last year, I made
which he would present to senior management and prospective clients. the mistake of pulling numbers from a company’s 2007 annual report
rather than from the 2008 version.
• Any error in a formula or variable in these models could have a drastic
impact on the financial projections, so everything I produced needed to be • I put the information into a PowerPoint for my boss and handed it in. As
error-free or it could really make my boss and me look bad. By the end of he was looking it over, he caught the mistake and was naturally upset.
the summer, I had built several satisfactory models and gained the trust of Luckily, we had enough time to make corrections before he presented it to
my boss. clients. I felt terrible, and I always remember to now triple-check my work
and haven’t done anything like that since.

320
 Behavioral Practice Questions – Situational Questions

TELL ME ABOUT YOUR PREVIOUS WORK EXPERIENCES AND WALK WHAT DO YOU DO WHEN WORK CONFLICTS WITH YOUR
ME THROUGH A PROJECT FROM YOUR WORK. PERSONAL LIFE?

• Speak clearly and succinctly about the responsibilities you had at your • Here’s an example... You are supposed to be meeting a close friend for
last job. These duties and projects should exhibit the qualities and dinner but something comes up and you have to stay late. What would
skills required for success in finance. you do? Talk about a similar conflict you actually have experienced.

• Do not exaggerate. Do not say you built an LBO model if you are not • This is a question about attitude. Show that you will be dedicated to
prepared to build one from scratch on the spot. Spin what you did do the job.
to sound positive, even impressive, but do not mislead. You do not
want to invite your interviewer to call your bluff or test you with the • Make it clear that you understand that this is a normal occurrence in
most complex technical questions. finance, that these are sacrifices you expect to make.

• SAMPLE ANSWER: Last year I was able to network my way into an • If you have experienced a situation like this in the past, use it as an
internship with a boutique investment bank. The nice thing about having example. How you acted in the past is evidence of how you will act in
an internship at a small firm was that even as a rising junior, I worked as an the future.
analyst, at least with the simpler tasks.
• SAMPLE ANSWER: First, I would look at the project, consider when it
• I got a lot of experience doing things that a full time analyst would have to was due, and see how far along in the process it was. If the project hadn’t
do, like building PowerPoint presentations and editing pitch books. I was even been started, and had to be finished the next morning, I would cancel
even lucky enough to work with another analyst building a model from dinner and get started on it right away.
scratch. While I only did it once, it was a great experience and gave me
some insight into what I hope I will be doing on the job this summer and in • However, if it was already in progress and I was sure it would only take
the future. another hour or two to complete, I would ask my boss if I could go to
dinner and come back to the office to finish it. I know these occurrences
happen a lot in finance and I expect to make sacrifices in my personal life. I
am prepared to make those sorts of changes.

321
 Behavioral Practice Questions – Situational Questions

GIVE AN EXAMPLE OF A TIME WHEN YOU HAD TO MAKE A SPLIT TELL ME ABOUT A TIME WHEN YOU ANTICIPATED POTENTIAL
SECOND DECISION. PROBLEMS AND TOOK MEASURES TO PREVENT THEM.

• Prove this ability to your interviewer by talking about a time when you • Give an example where you showed the ability to see a storm brewing
had to make a very quick decision and mention that you quickly and made adjustments to mitigate or avoid the damage.
analyzed the information you did have and made a decision that made
sense based on that information. • SAMPLE ANSWER: There was one time when I was working in a group
last semester. I could see that one of the team members, Tim, was not
• SAMPLE ANSWER: Last fall I bought some shares of Stock X in my particularly strong in a skill that we needed on the project.
personal account online. After I bought it, the stock had been flat until last
quarter when they announced earnings that were below the estimates. • As leader of the team, I wanted to make sure this didn’t become a problem.
I carefully approached Tim and worked with him to get the resources he
• I knew their stock was going to take a hit, and I had to decide whether I needed to be able to complete the project. He studied up on what he didn’t
believed in holding onto the stock and letting it weather the storm, or understand and ended up producing great work.
whether I should dump it and take a little loss from when I bought it.

• I decided that since I bought the stock as a long-term investment, not a

day trade, and I believed in its fundamentals, I should hold onto it. I’m glad
I did, because it has recovered from that one day and is now up 35% from
where I bought it!

322
 Behavioral Practice Questions – Situational Questions

TELL ME ABOUT A TIME WHEN YOU LEARNED SOMETHING NEW IN TELL ME ABOUT A TIME YOU DEALT WITH A MAJOR
A VERY SHORT TIME. DISAPPOINTMENT AND TURNED IT INTO A LEARNING EXPERIENCE.

• Demonstrate that you can grasp new topics quickly and put your new • Choose a time in your past where you achieved something only to
skills to good use. have it taken away from you unexpectedly.

• You would be best served here by an answer that is finance related. • Pick a time when you were disappointed but then worked hard to
Try a situation where your professor assigned a quantitative project recover and learned something worthwhile in the process.
without really explaining how to do it. You took it upon yourself to do
research in the library and on the Internet and taught yourself the • SAMPLE ANSWER: The biggest disappointment I ever experienced
skills you needed. occurred last winter. Before studying abroad, I was able to network with a
few firms to get early interviews for summer internships. I accepted an
• SAMPLE ANSWER: In one of my finance courses last year, my professor offer from Firm X since they were able to extend me one before I left the
wasn’t great at explaining new concepts in class. She assigned us a project country.
that required us to put together a portfolio of securities and calculate a
number of statistics on the portfolio by running an optimizer program, but • Due to the economic situation, they later had to revoke their offer, and it
she gave us no guidance on how to use the program. I managed to was too late for me to re-interview elsewhere. However, to make the most
complete the project by doing research on the Internet and learning on my of a bad break, I took a job outside of finance and continued networking
own how to use the program. for another finance-related internship.

• Finally, I was able to secure an internship at an investment management

company, which ended up being one of the best experiences of my life and
turned into a full time offer. Though initially disappointed, I learned that if
you have a passion for something, you can persevere through the tough
times until you accomplish your objective.

323
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324
Behavioral Questions – Tricky
 Behavioral Practice Questions – Tricky Questions

WHAT IS YOUR BIGGEST WEAKNESS? WHAT DO YOU CONSIDER YOUR GREATEST FAILURE?

• First, do not say that you don’t have any weakness. This will make you • Do not discount your ability in a skill-set that is critical to finance. You
sound arrogant, and it is false. never want to say something like, “I failed my corporate finance course
last semester,” since it is very hard to spin that in a positive way.
• Second, do not say something stupid like “kryptonite.” It is not likely to
amuse your interviewer. • Allow the story of the failure to be the shortest part of your response,
and then turn the question around to focus on how you turned the
• Third, do not be obvious by saying something like, “I work too hard.” failure into a positive experience.

• Describe a real weakness here, or your interviewer will end up rolling • If you are debating between two failures, pick the one that is farther in
his eyes. the past, because it gives you more of a chance to have changed since
the failure. If you pick a failure that happened last week, you will have
• The key to answering this question is to pick a “flaw” that you can flip a difficult time convincing anyone that you have succeeded in similar
to make it into an area for improvement. Take something that could be situations since then.
seen as a weakness, and turn it into a positive.
• Do not pick an example that doesn’t allow you to show how you have
• SAMPLE ANSWER: In the past, I found myself taking on too much of the improved or how you succeeded as a result.
responsibility in team situations because I haven’t trusted others to
produce work I would be comfortable with. • SAMPLE ANSWER: I consider not getting an internship last year to be my
biggest failure. I know that the hiring situation was difficult, but I feel like I
• Over the past few semesters, I have worked on allowing others to do their let down my family and myself by not getting an internship after having the
fair share, but also encouraging multiple drafts so we can all review the opportunity to study at a school like The University of X.
work before the final submission.
• I went through the traditional channels and applied through my career
• I am also learning to listen more and not be so controlling. I am confident center and websites. When that didn’t work, I realized that networking is
this will be especially valuable in finance where I will be surrounded by essential. This year, I reached out to almost everyone I know and now have
others who have the same drive and high standards I have. interviews at a lot of great firms like this one.

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 Behavioral Practice Questions – Tricky Questions

WHAT DO YOU CONSIDER THE BIGGEST NEGATIVE ABOUT THIS WHY IS YOUR GPA SO LOW?
JOB?
• This is a stress-test question. Whatever you do, do not admit that your
• Your interviewer is giving you a chance to give a “negative” about the GPA is low or apologize for whatever it is.
job and explain why you don’t really see it as a negative.
• Do not make excuses unless something EXTREMELY drastic happened
• The overwhelmingly popular response to this question is the lack of that dropped your GPA one semester (parent dying, major surgery,
work-life balance, long hours, very unpredictable schedule, etc. etc.).

• Quickly mention the negative and then move onto why it doesn’t • Show you are well rounded and you know you will have very little or
bother you. no time for a social life once you get into finance, so while maybe your
GPA isn’t a 4.0, you are happy that you had fun while you could and
• SAMPLE ANSWER: I have been fortunate enough to have a lot of are confident you have the skills to be a great employee now.
contacts who work in finance, and their usual response to this question is
the long hours. However, every single person I have spoken with has said • SAMPLE ANSWER: Personally, I do not consider my GPA especially low.
that they enjoy their job and they think the hours are worth it. With my commitment to the hockey team as well as the student
government association, I think my GPA is actually at a solid level. I am
• This job will give me 4-5 years of work experience in only two years. It’s an more satisfied with the combination of my GPA and my variety of
opportunity I crave and a learning experience I don’t want to miss. I am extracurricular activities than if I had a 4.0 doing nothing except going to
ready for the challenges and I want to show that I can handle them. class and studying.

327
 Behavioral Practice Questions – Tricky Questions

AT THE END OF THE SUMMER INTERNSHIP, YOU DON’T GET A FULL YOU WORKED AT BANK X LAST YEAR. WHY WOULDN’T YOU GO
TIME OFFER. WHAT COULD CAUSE THIS TO HAPPEN? BACK THERE TO WORK FULL TIME?

• Make sure you tell them you plan on working so hard that you do not • This question is probing to see if you failed to receive a return offer.
see it happening. Be confident but not cocky. Show you have done Similar to the question above, if you didn’t actually receive an offer to
your research. You understand the demands of the job, but you are up return full time, think about discussing a lack of cultural fit, poor
to the challenge. performance of the group as a whole leading to them not hiring
many/any interns to return full time, or just the overall performance of
• That being said, say that after talking to friends and alumni in the the bank requiring them to cut back on hiring.
industry, you understand that the biggest cause of burnout seems to
be the long hours. • SAMPLE ANSWER: Unfortunately, the group I was working in at Bank X
was very slow while I was there last summer. The group underperformed
• You can also say that you might not have succeeded in receiving a full which allowed them to hire only 2 of 28 interns to return full time.
time offer because you didn’t feel 100% comfortable with the people
you were working with, and in this industry, fit is crucial since you will • While I received strong performance reviews from all my superiors, I was
be spending most of your waking hours in the office. not one of the two. However, I feel as though not receiving the offer may
have been a blessing in disguise since I wasn’t crazy about the culture at
• SAMPLE ANSWER: Well, I really don’t see that happening but if I had to that firm. I think the environment here suits me much better.
guess, I think the most likely reason would be that I was not comfortable
with my colleagues. I know about the long hours and I’m completely
prepared for them, so I don’t expect that to be a problem.

• However, since I don’t know the people in my group, I cannot predict how
we will interact. Working 80+ hours per week with a group you don’t mesh
with can be difficult and I suppose that could impact me receiving an offer.

328
 Behavioral Practice Questions – Tricky Questions

WHERE ELSE ARE YOU APPLYING? WHERE DO YOU SEE YOURSELF IN 5-10 YEARS?

• While you want to show that you are in demand by a lot of firms, you • If you are applying for an analyst position, your answer to this
also need to make sure you come across as focused. If you are lucky question can vary. It’s OK not to be 100% certain you will be a banker
enough to get interviews with a number of bulge brackets and a for life. If you see yourself going back for your MBA, you can say so. If
number of boutiques, you may not want to mention the BB’s to the you would rather stay with the firm, do a third year as an analyst, and
boutiques or vice versa. try for promotion directly to associate, that’s fine too.

• While most interviewers are aware that you are probably applying • No interviewer actually expects you to know what you will be doing in
everywhere, you need to show that you have studied the culture and 10 years. Anyone who says they know what they want to be doing in
focus of this firm and want to be at this particular firm for specific 10 years, right out of school, is lying. Your answer is to show that you
reasons. have thought about your future and have a rationale for your
thoughts.
• DO NOT tell an investment bank you are interviewing at an
accounting firm, management consulting firm, etc. You want to appear • However, if you are applying for an Associate position coming out of
highly focused on Investment Banking, Sales and Trading, or whatever your years in business school, you need to appear more certain that
your current interview is for. this position is a career choice, not just a decision for a couple of years.

• If you do not have interviews lined up with other firms, say something • SAMPLE ANSWER: I cannot honestly sit here and say I know what I will
to the effect that, “I am in contact with a number of different firms.” If be doing in five or ten years. I am enthusiastic about this program as a
they push, name some firms you applied to and/or are waiting to hear learning experience. I am thrilled at the opportunity to be an analyst. As I
back from. work through the program, I will be considering my next steps.

• Do not lie. You don’t want to run the risk that the interviewer knows • My feeling now is that if I were performing successfully and enjoying my
someone at the other firm and checks up on your false claim. group, I would want to do a third year as an Analyst and then move
directly up to Associate. If I were less satisfied, I could apply to business
• SAMPLE ANSWER: I have been lucky to get some interviews at some school.
other great firms. I have Superdays coming up at Bank X, Bank Y, and Bank
Z. However, I really hope I don’t even have to go to those interviews
because I already will have accepted an offer here; this is where I want to
be and where I think I fit best.

329
 Behavioral Practice Questions – Tricky Questions

IF YOU RECEIVED AN OFFER FROM A PE FIRM OR HEDGE FUND IF I GAVE YOU AN OFFER RIGHT NOW, WOULD YOU SIGN IT?
BEFORE YOUR TWO-YEAR CONTRACT IS UP WOULD YOU TAKE IT?
• Even if this is a lie, you have to say yes. You have to show your
• SAMPLE ANSWER: No. I am committed to staying here and finishing at interviewer that this is your number one choice.
least my two year contract and I hope that if all goes well I would have the
opportunity to continue to progress up the ranks within this firm. • That being said, we haven’t heard of an interviewer actually putting an
offer letter in front of a candidate and forcing them to sign on the
spot, so don’t worry about it too much.

• SAMPLE ANSWER: Absolutely. Show me where to sign, and I’m all yours.

330
 To Access 400+ Behavioral Questions

Use the Flashcard Module in WSO’s

IB Interview Guide to get access to:

• 30k+ questions from 100+ banks

• Online flashcard module

• Filter by Bank, Industry, Group, Division,

Question Type, and much more…

• Video lectures for conceptual

understanding

• Access to WSO’s Company Database

• Start acing your interviews today…

331
Behavioral Questions - Others
 Behavioral Practice Questions – Other Questions

TELL ME A (CLEAN) JOKE. WHAT IS THE MOST INTERESTING THING YOU HAVE READ IN THE
WALL STREET JOURNAL LATELY?
• This is part of the “airport test,” meaning your interviewer wants to see
if you are someone they could stand being stuck with in an airport for • Pick something that is not on the front page. The reasoning behind
an extended period. this is two-fold. First, it shows that you don’t just glance at the front
page to grab any old story in preparation for your interview. Second, it
• You should rehearse this joke and tell it several times to others in is less likely that your interviewer will know a lot about the topic and
order to test its effectiveness and get your presentation down. therefore push you to an in-depth discussion.

• There are plenty of resources online to help you find a good clean joke • For a few days before your interview, read The Wall Street Journal and
to tell in an interview. outline a few articles you feel comfortable discussing. What are the
main idea, supporting arguments, and main conclusion of the article?
What is your opinion of the article/topic? It is probably best to stay
clear of highly controversial topics like politics and/or war and focus
on financial stories.

• SAMPLE ANSWER: A few days ago, I read an article about Roger Penske
buying Saturn. I was interested in finding out why he would want to own a
company that recorded a $1.1 billion loss last year, and has terrible car
sales.

• Turns out that he has a lot of plans for cost cutting, including outsourcing
production. At the same time, by buying the company he will help save
13,000 jobs since before they found a buyer, GM was planning on slowly
phasing out the Saturn line.

333
 Behavioral Practice Questions – Other Questions

WHAT ARE THE QUALITIES OF A SUCCESSFUL LEADER? TELL ME THE FULL NAMES OF THE PEOPLE WHO INTERVIEWED
YOU BEFORE ME.
• A great leader must embody a combination of qualities.
Leaders must be trustworthy, enthusiastic, confident, organized, • The only way to prepare for this encounter is to pay close attention
tolerant, calm, focused, committed, and great communicators. during the interview and to make careful notes afterward. Bring to
your interviews mental notes of the full names of all previous
• Great leaders also empower those around them, allowing group interviewers. Titles wouldn’t be a bad idea either.
members to make decisions on their own rather micromanaging, and
making sure to express appreciation for those they are working with. • You will be meeting new people every day in this job; you want to
show you will have no trouble remembering clients’ names after a
• Pick a few of those qualities and explain why in your mind they are the single brief meeting.
most important qualities.
• If you can’t remember, you are better off smiling and just saying so
• SAMPLE ANSWER: I think there are two main qualities that determine rather than getting flustered and apologizing or making excuses.
whether someone is a successful leader. First, they need to listen to those
they are leading. Communication is essential to successful teamwork, and
great communication starts with great listening. Second, a great leader
needs to empower those working below them.

• While it is important for a leader to be in control and understand what’s

going on, they can’t lead effectively and efficiently if they are
micromanaging. When it comes to less important decisions, team members
must be empowered to make them and then be held responsible for them.

334
 Behavioral Practice Questions – Other Questions

WHY ARE YOU LOOKING TO SWITCH JOBS? WHAT IS YOUR FAVORITE/LEAST FAVORITE PART OF YOUR
CURRENT JOB?
• Be sure to talk about what you weren’t learning or achieving at your
prior job and how you will be able to accomplish new objectives at the • Make sure this is relevant. Don’t say something like “I like the free
position you are interviewing for. snacks we get in the breakroom,” say something like “I like that I am
challenged on a daily basis and get to learn new skills from senior
• Focus on bringing out the positives of the position at hand, rather than members of my team.”
the negatives of your prior job. Again, this is a question reserved for
experienced hires.
WHY DID YOU QUIT YOUR JOB AT XXXX? YOU SEEMED TO HAVE
BEEN MOVING UP THE RANKS AND PERFORMING WELL, WHAT
WHAT ARE YOUR DAY TO DAY RESPONSIBILITIES? WENT WRONG?

• Describe the tasks and responsibilities that you had and that are • Be sure to discuss something that job wasn’t providing you, which will
relevant to the potential position, and how you were able to be provided by the job for which you are applying. Whether this is a
accomplish them effectively. learning experience, live deal exposure, or culture; whatever forced
you to quit your previous job should be something that is supplied by
• If you don’t have anything directly relevant, try and relate a skill you the new job you are applying to.
had or learned at your previous job to skills that are needed at the new
job (organization, multi tasking, attention to detail, etc.). • This is another question that is really applicable for those changing
jobs, not those first entering the workforce.

335
 Behavioral Practice Questions – Other Questions

IF YOU WERE A VEGETABLE, WHAT KIND OF VEGETABLE WOULD

YOU BE?

• This is a ridiculous question, and isn’t one we can answer for you. Just
throwing it into the guide so it doesn’t completely blindside you if
someone randomly pulls it out of his or her back pocket!

WHY ARE YOU SO OLD?

• If you are older than 30 years old and applying for a relatively junior
position, you can anticipate getting this question.

• Focus your answer to this question on why you can add value to the
team due to your maturity level and experience in X, Y, and Z jobs.

• Talk about how you have been both a leader and a non-leader in team
settings before and have worked well with a wide variety of people
throughout your career.

• Make sure you emphasize that you are well aware of the time
commitment that it will take to be a successful junior member of the
team and why you are willing to make the sacrifices in your personal
life to make that happen.

336
 To Access 400+ Behavioral Questions

Use the Flashcard Module in WSO’s

IB Interview Guide to get access to:

• 30k+ questions from 100+ banks

• Online flashcard module

• Filter by Bank, Industry, Group, Division,

Question Type, and much more…

• Video lectures for conceptual

understanding

• Access to WSO’s Company Database

• Start acing your interviews today…

337
Behavioral Questions – Your Questions
Behavioral Practice Questions – Your Questions

The impression you leave in interviews is not limited to the passive role of answering questions.
Concept You could stand out further by asking genuine and insightful questions.

Details

Type Of Questions

Financial Firm/Lifestyle Non-substantive

339
Behavioral Practice Questions – Your Questions

The impression you leave in interviews is not limited to the passive role of answering questions.
Concept You could stand out further by asking genuine and insightful questions.

Details

Financial Firm/Lifestyle
• Where do you see the economy going in the • What was your career path/how did you get
next year? into finance?

• Have you seen a change in deal flow due to the • Why did you choose investment banking/sales
economic downturn? and trading over something like consulting or
corporate finance?
• In your opinion, what desks or product groups
have the best reputation and/or the most • Did you do an internship here?
promising future at your firm?
• What group are you in?
• Do you think more “investment banks” will end
up going under in the coming years? • Have you enjoyed your finance experience?

• What do you see as the future of investment • Why did you choose this firm?
banking/sales and trading?
• Have you worked at other firms? How does this
experience compare to that?

340
Behavioral Practice Questions – Your Questions

The impression you leave in interviews is not limited to the passive role of answering questions.
Concept You could stand out further by asking genuine and insightful questions.

Details

Firm/Lifestyle

• What do you think is the biggest positive with • How have you handled the intense finance
this firm? lifestyle?

• What do you think is the biggest negative of this • I know there is no “typical” day, but I wonder if
firm? you walk me through one of your normal days.

• What kind of training program does your firm • What advice would you give me going into my
have? analyst stint?

• What is the team experience like at this bank? • What personal qualities do you value most in an
Will I be mentored? employee?

• How is the interaction between junior and senior • What do you think makes a great analyst?
professionals here?
• What should I do during the first month on the
• Are you “friends” with your colleagues? job to make the most positive impact?

• If I were an analyst on your current deal team,

what would my role be?

341
Behavioral Practice Questions – Your Questions

The impression you leave in interviews is not limited to the passive role of answering questions.
Concept You could stand out further by asking genuine and insightful questions.

Details

Non-substantive General Advice

• Is there anything else that you would like to • Keep your questions short
know or anything else I can clarify about my
resume during our conversation? • Don’t ask yes or no questions

• What are the next steps in this process? When • Be ready for questions that you ask to be turned
should I expect to hear from you? back on you, especially on financial questions

• Most interviewers enjoy talking about

themselves; get them to do that

• Your questions should show that you are truly

interested in learning; be genuine

• Ask follow up questions after a response – you

want to turn these questions into a conversation

• Don’t do any damage by asking a dumb question

342
Investment Banking or S&T
Bonus Module
Investment Banking Or Sales And Trading?

This is an important decision given that preparation for both roles are vastly different. It’s more
Concept efficient to prepare for one role especially since many banks limit the number of applications.

Details
• Classes don’t help: Your classes actually teach you NADA about the real world. Figuring out CAPM is great, but help me find a job!

• Info sessions don’t help: You’re interested in finance for whatever reason, but the several info sessions you’ve been to do a terrible job at
explaining to you what the actual job entails

• The bros/sisters don’t help: Everything you’ve heard from your frat bros/sorority sisters who’ve come back for homecoming or to recruit
sounds like they’re “making it rain” (NOT true), but it’s still not helpful anyway because they don’t take the time to break it down for you

• Finance clubs don’t help: All the finance clubs you’re a part of are run by kids who’ve at most completed an internship in IBD/S&T and
don’t know enough themselves to be qualified to advise you on your career decisions

• The career center never helped: Most folks at your career center have actually never worked outside a career center, so can’t be too
helpful

The only person that can help you is yourself. Therefore, make sure you spend some time to reflect on this decision!

344
Where Does A Role In Investment Banking Take You?

There are three products offered: Equity, Debt and M&A. This is corporate finance- you advise in
Concept all matters related to capital raising and allocation.

Details

Product Groups Exit Opportunities

• Private Equity
Equity Capital Debt Capital Leveraged
Markets Markets Finance • Hedge Funds

• Corporate development/Strategy
Mergers &
Restructuring • Startups
Acquisition

• Anything!

Coverage Groups Pros Cons

• Understand high level how • Zero work life balance

Financial corporations make capital
Healthcare Institutions Oil & Gas allocation decisions • Repetitive work
Group (FIG) • Financial modeling • Political environment

• Dissect business models • Pressure on personal

Technology financially relationships
Any Other
Media Telecom • Time management • Drain of fitness/ energy
Industry
(TMT)

345
Where Does A Role In Sales & Trading Take You?

Sales & Trading is a market making service provided to institutional investors such as corporates,
Concept pension funds, hedge funds, etc.

Details

Desks Exit Opportunities

• Hedge funds
Sales Trading Structuring
• Pension funds

• Brokerages

Research Quantitative • Investor relations

Asset Classes Pros Cons

• Level playing field as everyone • Some desks can be tough to

to get recognized and work on for incoming
Equities Fixed Income Commodities compensated analysts

• Great understanding of • Not much structure

markets • Limited exit opportunities

Currencies Derivatives

346
Investment Banking Or Sales And Trading?

A suggested scorecard

Metric Investment Banking Sales And Trading

• M&A
• IPOs
Interest Level • Debt raising • Public markets
• Restructuring
• Large complex transaction

• Finance/business • Finance/business
Background
• Engineering • Engineering
Required
• Liberal arts • Quant degrees

• Financial modeling/ valuation • Trade structuring

Skills Developed • Transaction structuring • Product knowledge
• Presentation • Quick thinking, macro insight

Career
• Hierarchical/ rigid • Meritocratic
Progression

Cons • Work life balance • Narrow focus/exit opportunities

347
International Student Recruiting Strategies
Bonus Module
Recruiting As An International Candidate

Concept International students have a tougher time than local students when it comes to recruiting

Why is it harder?

Visa Costs • You cost extra money to employers and fresh graduates don’t typically offer additional skills that
domestic students already have

Visa
Complications • Additional vacation time required for visa stamping/ other issues etc.

Employee • Employers are afraid about the fact that you could leave at any moment, which makes it difficult to
Tenure justify your added cost

Cultural
Misfits • This is especially true for employers with smaller teams

349
Recruiting As An International Candidate

Concept A targeted approach is especially important for international students since they have it harder

Details
• As important as it is to follow your passion, it is critical to balance it with a major/career that keeps your options as
open as possible

• Generic majors like engineering/business/computer science are usually extremely sought after and offer the
highest probability of gaining employment as a non–citizen. You can always double major in whatever else you
may be interested in

• Target careers that generally employ international students (finance/consulting/tech)

Important tip: it is always easier to transfer jobs once sponsored than struggle with convincing an “ideal” employer who may be
willing to sponsor you

350
Securing An Offer As An International Candidate

Concept You’ll have to do everything that a local student does, but do it better

Details
• Consider “gaming” the online on-campus recruitment platforms by unchecking the “I’m a non-citizen” box. A lot of
online campus placement websites won’t allow you to jobs that you’re actually eligible for

• Leverage LinkedIn. This is a godsend resource most people are still too worried to use. The goal is to get to
someone high up in HR or strategically contact key decision-makers.

• Reach out to your alumni network, and place an extra focus on international alumni in your target firm since they
should be particularly empathetic and more willing to help

• Leverage your international experience and remember that internships abroad at “brand names” are easier to
obtain abroad vis-à-vis the US. Always choose the brand name shop instead of a local no-name shop

• Keep your grades up and show a track record of being able to balance extracurriculars with academics

A risky tip is that you could offer to pay for the legal costs incurred to hire you. This could make you sound desperate, but at
the very least, it conveys to employers your strong desire to work there

351
The H1–B Dance

Concept Make sure you very carefully understand your visa situation

Details
• Contact your international education offices ASAP to clear any misconceptions

• You’ll get a Curricular Practical Training (CPT) visa after you spend your first 12 months in the US

• For the first 12 months after graduation, you get an Optional Practical Training (OPT) Visa, which is a transition
visa between your F-1 and H-1B

• The H-1B can be valid for up to 6 years. It is easier to transfer than to get sponsored. There is an annual quota of
85,000 new H-1B visas, with 20,000 reserved for candidates with advanced degrees.

• The H-1B visa costs $4-5k in application fees with $1-2k in legal attorney fees to apply

• Transfer fees typically cost another $4-5K if you are switching jobs

A helpful link you could refer to is here.

352
Essential Interviewing & Networking Strategies
Bonus Module
Three Rules To Remember When Recruiting

Rule #1 Rule #2 Rule #3

The Odds Are Always Against You Impressive Credentials Aren’t Enough Differentiate Yourself
• Boutique investment banks can have • There are students with 4.0 GPAs • Stress what makes you different,
dozens to several hundreds of from Ivy League schools and Bulge whether it be through background or
applicants Bracket internships getting rejected experience

• Bulge Brackets and Elite Boutiques • On the other hand, there are non- • Did you do an exchange abroad?
have thousands to tens of thousands targets with 3.5 GPAs and no-name Stress it
of applicants boutique internships who succeed
• Do you have an international
• The success rate of working at background? Stress it
Goldman is lower than getting into
Harvard • Worked at a startup? Stress it

354
Developing A Strong Network

Concept It’s important to develop a strong network

Details
1. Develop a networking document
• Start with friends, relatives, fraternity alumni, friends of friends, club members parents, then move to second degree connections
• Reach out to develop rapport weeks and months in advance

2. Invest in LinkedIn Premium and take full advantage of the messenger feature
• Customise each message to the banker’s background and do not exceed 3 sentences
• Communicate clearly and express interest early on

3. You are potentially making life-long friends in this process; approach with this mindset
• After the call, ask to speak to other bankers and continue to express interest in their recruiting process
• Develop a real connection with your contacts. Did his favorite football team win last night’s game? Send an email congratulating him

4. Do NOT…
• Send too many messages to the same people
• Use the same message template for multiple people at the same bank

355
What Do You Do After Networking?

If you’ve done your networking properly and built rapport across several banks, landing
Concept interviews should be relatively easy

Details
1. Travel
• Book a trip to New York City and meet with the new friends you have made. Ask for office tours and coffee chats before you fly up
• Travel to cities with regional offices like Charlotte, Houston, San Francisco, and Los Angeles to maximize your chances

2. Realize that sometimes things are beyond your control

• You can do everything right and still not land an interview
• If things don’t work out, do not hesitate to ask your contacts for references at other banks

3. Please don’t focus solely on networking and forget to practice interviewing skills
• Devote at least one hour per day for technical interview prep
• Purchase WSO guides or any other guide you think is useful. A few hundred dollars is worth the investment

4. Read some books!

• Pearl and Rosenbaum
• Monkey Business
• An intermediate accounting textbook
• A non-finance book you enjoy

356
Investment Banking Internship Survival
Bonus Module
Surviving A Summer Investment Banking Internship

The corporate environment is extremely different from your school. Here are some following tips
Concept to survive your internship.

Details
1. Smile ☺
• Many interns come across as nervous on their first day, but that makes you less approachable to your colleagues
• You should come across as enthusiastic and confident, to everyone from the analyst to MD level
2. Familiarize yourself as fast as possible
• Write down everyone’s name and try to make a mental note of where they sit (where the analysts/associates/VP etc. are seated)
• Make a note of where all the items/locations are (restrooms, printers, IT helpdesk, etc.)
3. Be aware of what you want
• Reflect upon what you’re trying to get out of this internship, then subsequently communicate it to your staffer/analyst
• Try to find out what expectations your team might have for you, so you know how to exceed them
4. Perception is reality
• What people perceive of you is, whether it is true or not, becomes the reality
• Give off the image that you are a hard worker, enthusiastic, and really keen on learning as you want people to have that perception of
you
• Always under-promise but over-deliver
5. Health is wealth
• Exercise where you can, eat healthy foods, prioritize sleep over nights out
• Keeping your health up is critical to surviving this industry
6. Midterm reviews
• Most large banks will have midterm reviews and you can expect to receive the collective responses from all the people you worked
with from your staffer
• Even if you do well in the mid term review, you should still ask about how you could improve
358
Surviving A Summer Investment Banking Internship

The corporate environment is extremely different from your school. Here are some following tips
Concept to survive your internship.

Details
7. Leaving office early
• It’s not recommended to leave before your analyst does, even if you don’t have any outstanding work
• You could leverage those hours to build rapport with your colleagues, get better at modeling, etc.
8. Speed vs accuracy
• During the 1st half of your internship, accuracy is much more important than speed
• During the 2nd half of your internship, speed is going to somewhat matter
9. Type of work
• Presentation decks – charts, graphs, overviews, keeping the numbers updated
• Reports & official documents – analysis on a sector/industry, market conditions, company financial performance, etc.
• Financial models – typically once you’ve demonstrated that you are competent
10. Relationships matter a lot
• Get close with your analysts and associates. Interns are your friends, not just your competitors
• Work is long so remember that humor matters, you can expect to work long hours with these people, so remember to stay pleasant
11. You might not get a return offer
• Make sure you properly record everything that you have done so that you can write a solid resume
• The full time recruiting timeline moves quickly so you need a back up plan if you don’t get a return offer
• Leverage your contacts to maximize your chances

359