Introduction to Investment Banking Interview Questions
The purpose of this article on Investment Banking Interview Questions and Answers is to help you learn about the world of investment banking and assist you while preparing for these tough interviews. The questions may differ and can cover various topics, and since it is difficult to cover all of them, we have listed the top 10 questions which are most commonly used in investment banking interviews.
Some of the most important Investment Banking Interview Questions that are frequently asked in an interview are as follows:
Part 1 – Investment Banking Interview Questions (Basic)
This first part covers basic Investment Banking Interview Questions and Answers.
1. Walk me through the three financial statements
Answer:
The three main financial statements are the Income Statement, Balance sheet, and Cash Flow statement.
1. Balance sheet – The balance sheet is recorded as on date and provides a snapshot of the company at a point. The balance sheet is divided into three parts Assets, Liabilities, and shareholders’ equity (also known as net worth). Both assets and liabilities are listed as per liquidity and separated under Current and Non-Current. Assets include plant, property, cash, and other resources. Similarly, liabilities include long-term and short-term debt, accounts payable. The balance sheet is calculated as –
Assets = Shareholders Equity + Liabilities
Income Statement – The income statement is a profit and loss statement of the company and covers all the incomes and expenses made by the company in that financial year. It begins with revenue and comes down to net income after deducting the expenses.
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Cash Flow Statement – The cash flow statement has three types – Cash flow from operating, Cash flow from Financing, and Cash flow from Investing. There are different methods used to calculate this statement.
2. How will the Financial Statements be Affected if Depreciation goes up by $50?
Answer:
- Income Statement – If depreciation expense increased by $50, operating income will decrease by $50, assuming a tax rate of 30% net income will go down by $15.
- Cash Flow Statement – Net income in the cash flow from the operating statement will go down by $15, but since depreciation is a non-cash expense, $50 will be added back, so the overall change in the cash flow statement will be of $35.
- Balance Sheet – The Asset side will be down by $50, and the cash will be up by $35 from the changes on the Cash flow statement.
Let us move to the next Investment Banking Interview Questions.
3. When should a Debt be Considered Over Equity?
Answer:
A company can issue debt instead of equity because debt is a much cheaper and less risky source of finance as compared to equity if the company is not already debt-ridden. Debt also provides a tax benefit. Higher financial leverage also helps in maximizing the returns on invested capital. Also, issuing debt yields lower costs than issuing equity.
4. What are the Different Methods of Valuation?
Answer:
The common methods used in valuation are –
Discounted Cash Flow: In this method, cash flows are forecasted for a period of a minimum of five years. These future cash flows are then discounted at the current rate to the present value.
Transactions Approach: This approach is also called a precedent, and the valuation is derived by using the valuations of the companies that have been recently sold, acquired, or merged in a similar industry
Multiples Approach: In this approach, relevant ratios are calculated based on the industry. For example, the PE ratio of the industry is calculated, and the earnings of the company are multiplied with this ratio to arrive at a price.
The use of these valuation methods depends on the sector in which the company operates. Often, a company is valued by using all these methods, and the average of these prices is considered.
5. What is the Average PE Ratio of the S&P 500 Index?
Answer:
PE ratio changes by industry and period cycle. The current PE ratio is 15 to 20 times.
Part 2 – Investment Banking Interview Questions and Answers (Advanced)
Let us now have a look at the advanced Investment Banking Interview Questions
6. When DCF can not be Used?
Answer:
DCF cannot be used in case a company has unstable and unpredictable cash flows. It also cannot be used when debt and working capital do not fundamentally play the same role. For example, banks who do not re-invest debt and a major part of the balance sheet is working capital.
7. What is the Formula for Calculating EV?
Answer:
Enterprise value can be calculated as = Market Value of Equity + Debt + Preferred Stock + Minority Interest – Cash.
Let us move to the next Investment Banking Interview Questions.
8. Why is Cash Deducted from the Enterprise Value Formula?
Answer:
Cash is subtracted from enterprise value because it is considered a non-operating asset. However, it is always included in equity.
9. What is Beta, and How is it calculated?
Answer:
Beta measures the riskiness of a particular stock. Beta is calculated as covariance of the stock and the market divided by the return of the market. Stock with a beta higher than 1 is considered to be riskier than the market. Stock with a beta lower than 1 is considered to be riskier than the market.
Unlevered and levered beta is also used to calculate the beta of private companies. This is done by using the debt by equity ratio of a comparable public company. To Unilever, the effect of this component from the beta calculation Debt/Equity of the comparable company is divided. This is then multiplied by the Debt/Equity of your company to arrive at the right beta.
Beta can be calculated in two ways –
- Unlevered Beta = Beta (Levered) / ([1 + Debt/Equity] * [1 – T])
- Levered Beta = Beta (Unlevered) * ([1 + Debt/Equity] * [1 – T])
10. List Down all the Important Qualities Needed in a Banking Analyst?
Answer:
Research is the most important part of an Analyst day to day job. This is because there is no scope for analysis unless the correct data is mined by using research skills. This skill requires understanding the problem or a scenario, list down all the questions, and finding out the answers.
Other Qualities required are –
- Fast Learner
- Energetic
- Team player
- Strong attention to detail
- Analytical skills
- Ease with Technology
- Communication and Writing
- Leadership
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