Top 13 Investment Banking Interview Questions and Answers
Getting ready for an investment banking interview? Are you unsure of the questions you must answer? Well, allow me to assist you. Investment banking is a vibrant, highly competitive profession with several career options. It is quite crucial to have a thorough understanding of investment banking. We have provided a list of typical interview questions that you may encounter during an investment banking interview, as well as advice on how to effectively respond to them, whether you are a recent graduate looking to break into the industry or an experienced professional looking to advance your career. Consequently, if you want to advance your investment banking profession, this article on investment banking interview questions and answers is for you.
First Let’s Get Started With the Details of Investment Banking With Examples:
Before moving to Investment Banking Interview Questions, let’s look at investment bank in detail. Investment banking emerged in America in the nineteenth century when the American economy was growing so fast that commercial banks could not serve the expansion of railroads, mining companies and heavy industry.
The phrase “investment banking” refers to a variety of activities performed by a financial services company or corporate division that entail advisory-based financial transactions on behalf of private individuals, public companies, and governmental agencies.
Let’s say you invest some money in starting a business and achieve some initial success. You decide to grow it and invest more money as you consider a favourable atmosphere and a promising future. You are not wealthy enough to invest all the necessary money, though. Nobody is (in general).
Your initial step should be to visit a bank and request a loan. However, the private banks are bound by rigorous laws that prohibit them from making loans at interest rates below, say, x%. What is the current interest rate? It is a levy made against the potential for bankruptcy. Suppose Bill Gates and you both apply for loans at the same bank. Bill Gates would pay less interest because there is a lower possibility that he won’t be able to repay the loan.
But if you think the bank is charging you excessive interest in light of your creditworthiness and you think the general public has more faith in you, it might be preferable for you to borrow money from them directly at a lower interest rate than the bank would charge you. People will be pleased because they receive an interest rate that is higher than what they would receive from a fixed deposit with a bank. It may be important to remember that you or your company normally have lower creditworthiness than the bank. But to make up for that, you offer the general public higher interest rates than a bank would offer on a fixed-term deposit. Raising money using “Bonds” is the name given to this method of funding. Regardless of how well your company does, you/your corporation must pay the public, the interest, and the principal. If not, you or your business may need to think about filing for bankruptcy protection.
Advertising to the public to become partners in your company is another way to solicit funds from the general public. They make an initial capital investment, join the company as a partner, and share in its gains and losses. In contrast to bonds, you are not required to pay “interest” as such in this situation; instead, the person who provided the capital shares in the gains or losses proportionately. Consequently, “Equity Capital” is raised.
An investment banker’s role is finding a company that might require financing or be able to raise capital at a price less expensive than what a private bank would charge them, and then suggesting to that company that they raise capital from the public by demonstrating why doing so would be beneficial. Once the company agrees the proposal has potential, the investment bank determines the ideal moment, opportunity, and currency or exchange to issue the bonds or stocks in. The IB must also draft the legal paperwork for the bond or equity issuance.
The IB then starts looking for potential investors who would lend money to the company that is raising the money. If it is a bond offering, the IB persuades the investor that the likelihood of the company going bankrupt is extremely low and that, as a result, he will receive the principal amount and a higher interest rate than an FD will. When issuing stock, the IB persuades the investor that the earnings (and thus the returns) will be extremely high to generate money for the original firm in issue.
For this service, the IB receives payment. Additionally, most of the time the IB itself turns into an investor and purchases some of the issued bonds or shares.
Dealing with mergers and acquisitions is another crucial duty of IBs. For instance, Amazon is a hugely popular online buying destination in many nations. Amazon struggles to establish itself in India, where Flipkart has a bigger market share. Amazon would therefore aim to buy a smaller company in India, such as the online clothing retailer Jabong. It (does) attempt to acquire Jabong. As a result, Amazon can immediately take advantage of Jabong’s infrastructure and gain a foothold in at least one online shopping category, the clothes market. Similar mergers can take place when two sizable businesses join forces to establish a single entity, resulting in improved performance beyond what would be possible through competition. An IB’s responsibility is to recognize that Amazon is looking to expand into India and is consequently trying to acquire a company. IBs identify the smaller companies that can be acquired and recommend to Amazon that they make a profit from the transaction. Following that, there will be a massive transfer of shares from the smaller company to Amazon, the larger company. IBs receive payment once again for completing this merger or acquisition.
Investment bankers need skills in understanding financial statements, identifying capital-raising opportunities, and negotiating mergers and acquisitions. They can develop this by closely observing sector performance and convincing firms.
Eligibility for Entering Into Investment Banking:
You must possess certain qualifications, such as a bachelor’s degree or an MBA in finance from a reputable financial institution, to enter this sector. An in-depth understanding of business, finance, economics, and mathematics might provide you with an advantage over typical candidates who lack a background in business and finance. This is in addition to the educational requirements starting with graduation and going as high as Chartered Accountant.
Investment Banking Interview Questions and Answers:
First of all, like all interviews, investment banking interviews start with a meeting of the minds. The interviewer will probably give you a summary of the business and the role while also asking you some personal questions. I would like to convey that there could be four types of questions that could be asked in an interview.
The first one could be Technical Questions related to Accounting, Financial Modeling, and Valuations. The second type of question could be an Analytical question, the third could be a Situational question and the last that is the fourth one could be a Personal question.
We are going to infer valuation questions
Q1. What is the difference between valuation and pricing?
Only those assets that generate some cashbook could be valued rest of the other assets are priced. Examples of the assets could be a company, debt, or project. Examples of the assets that could be priced are gold, bitcoin, and currencies. So, valuation is determined because of the characteristics of an asset, and price is determined because of demand and supply in the market.
Q2. What are the three major valuation methodologies?
1) The multiples valuation method, commonly known as the “comps” method, involves multiplying a company’s earnings by the P/E ratio of the sector in which it operates (along with other ratios).
2) The transactional valuation method (often known as the “precedents” strategy), involves contrasting the company with others in the same industry that have recently been acquired or sold.
3) The discounted cash flow method, in which you retroactively discount the present value of anticipated future cash flows.
Q3. Walk me through each of the three financial statements, please.
The three financial statements are the cash flow statement, balance sheet, and income statement.
The income statement is a document that shows the company’s profitability. The revenue line serves as the beginning point, and the removal of various expenses yields net income. The income statement is particular to a given period, like a quarter or year.
The balance sheet is a snapshot of the business at a certain point in time, such as the end of the quarter or year, unlike the income statement, which accounts for the full period. The balance sheet lists the company’s assets along with the obligations and stockholders’ equity used to fund those assets. Equity plus liabilities must always equal assets.
Last but not least, the statement of cash flows magnifies the cash account on the balance sheet and accounts for the full period, resolving the cash balance at the start and end of the period. In most cases, cash from operating is obtained by starting with net income and then adjusting it for various non-cash expenses and non-cash income. Afterwards, cash flow from operations is added to cash from investment and financing to calculate the year’s total net change in cash.
Q4. What are some advantages and disadvantages of issuing stock?
Ans- Companies issue stock for several reasons. Companies issue stock to obtain funding and produce cash for daily operations, company growth, or debt repayment.
To give existing shareholders, the ability to liquidate their shares following a company’s successful years and significant cash reserve, companies issue stock.
Finally, by offering employee stock options, issuing stock can draw and keep top people while also encouraging further business expansion.
There are numerous benefits to stock issuance. First, it gives companies a way to raise money without getting loans. This could be advantageous for companies who wish to avoid taking on debt. Second, stock issuing can provide shareholders who wish to withdraw a portion of their investment with liquidity. Finally, releasing stock can help recruit and retain top employees.
There are various ways to dilute stock, each with benefits and drawbacks. It entails the issuance of extra shares through an offering, which may reduce the value of the holdings of current owners. As a result, there are more shares available, which lowers ownership ratios. Additionally, the issuance of new shares could be a symptom of monetary problems, which could lead to a decline in the stock price and further dilution of shareholder holdings.
A further risk linked with issuing new shares is the possibility of insider abuse. To obtain money when facing financial difficulties, management may issue shares at a discount, eroding the holdings of both existing shareholders and activist investors.
Finally, issuing new shares may have unfavourable tax repercussions for the business and shareholders, sometimes resulting in taxable events and alternative minimum taxes.
There are advantages and disadvantages to this financial decision, therefore businesses should carefully weigh all risks before deciding to issue new shares.
Q5. What exactly is a discount rate, and how is it calculated?
The rate of interest used to calculate the present value of future cash flows by discounting them is referred to as the “discount rate” in finance. It helps investors figure out the net present value of the investment to judge the viability of the investment.
The several discount rates that can be used to calculate an investment’s net present value (NPV) are listed below:
- Risk-free Rate
- Hurdle Rate
- Cost of Equity,
- Weighted Average Cost of Capital (WACC)
- Cost of Debt
It is common to use the Weighted Average Cost of Capital (WACC) or the expected rate of return on an investment. According to the time value of money theory, future money will be worth less than current money, hence discounting future cash flows is crucial. Therefore, discounting helps in determining the current value of future money.
Q6. Why is the cost of capital U-shaped?
You can use the example of asking how much it would cost to make bread at home to illustrate this response. We will undoubtedly claim that purchasing from a store would be feasible, but this is untrue. When you decide to create a product on your own, the initial investment will be very high because you will need everything, including baking flour, an oven, salt, sugar, and other ingredients. As a result, the cost of your first product, which is bread, will be very high, but as you continue to create bread, the cost will decrease. As you boost your output, you achieve economies of scale, which makes your product viable. But after a certain point, when diseconomies follow economies of scale, your costs start to rise, and this is the reason why the cost curve is U-shaped.
If a candidate can answer these questions smartly then they are required to answer some more complex questions like
Q7. How can two companies with identical earnings in the same industry have different P/E?
The fundamental improvement in profitability is the main driver of the disparity in PE ratios or EV/EBIT multiples between two businesses operating in the same industry.
A company with a larger rise in profits than another company in the same sector will command a higher multiple from investors for the same dollar of earnings.
Other, less significant factors that affect why multiples vary include the company’s unsystematic risk profile, the sustainability of its profitability, and the possibility of an acquisition premium, to name a few.
Q8. Tell me about a typical firm’s capital structure.
A company’s capital structure is the combination of financial instruments it utilizes to raise money for its operations, including equity shares, preference shares, long-term loans, debentures, bonds, and retained earnings. A company’s capital structure is its combination of debt and equity. Retained earnings plus common and preferred stock make up a company’s equity. Debt often consists of operating leases, redeemable preferred stock, a portion of the principal amount of long-term loans, and short-term borrowing. An illustration of a company’s capital structure is as follows:
Let’s look at two distinct capital structure examples: For our purposes, Company A has assets worth $150,000 and liabilities worth $50,000. Therefore, the equity of Company A is $100,000. Therefore, the capital structure of the corporation is such that it generates $1 in equity for every $50 in debt.
So, what does a company’s capital structure reveal about it?
The capital structure refers to the sum of money used to fund a company’s operations and to finance its assets. Additionally, it might display corporate investments and acquisitions that may have an impact on the bottom line of the corporation.
Q9. What distinguishes a merger from an acquisition?
The term “merger” refers to the joining of two or more commercial enterprises to create a single joint entity with a new management structure, ownership, and name that benefits from its competitive advantage and synergies.
In contrast, an acquisition happens when a financially strong organization buys or takes control of a less financially sound business by buying all or some of its entire shares.
Q10. Investment Banking Interview Questions – Why is money today worth more than money tomorrow?
A financial concept called time value of money (TVM) explains why a dollar is worth more today than it will be tomorrow. Money in the present is more valuable than an equal amount in the future for two basic reasons: Opportunity Cost and Inflation.
Inflation is the gradual increase in the cost of goods and services over time, reducing purchasing power and affecting the number of items a dollar can buy. The same meal costs several dollars today, indicating that a dollar today will buy fewer goods and services. Inflation is measured by average price changes for goods and services in the Consumer Price Index (CPI), encompassing various goods and services. A dollar today is more valuable than a dollar in ten years.
Opportunity Cost refers to the cost an individual incurs when choosing one alternative over others, such as choosing vanilla from a 100-flavored ice cream shop. This decision results in the loss of the opportunity to enjoy the other 99 flavours, highlighting the importance of considering options.
Q11. Investment Banking Interview Questions If interest rate rises what will happen to the price of a bond?
Bond investment is based on the fundamental idea that market interest rates and bond prices often move in opposite ways as market interest rates rise, the price of fixed-rate bonds declines.
Bond prices and interest rates can follow different trends. Bond prices generally decline as rates do, and vice versa. Even though the coupon rates stay the same, when interest rates rise, the price of current bonds tends to decline and yields increase. In contrast, prices of existing bonds tend to increase when interest rates drop, although their coupon stays the same and yields decrease.
This connection means that when buying bonds in a low-interest rate environment, investors should pay special attention to interest rate risk.
Q 12. Investment Banking Interview Questions What is WACC and how is it determined?
The weighted average cost of capital (WACC) is a measure of the regular expenses organizations face while financing capital assets.
Capital expenses may include long-term liabilities and debts, such as preferred and common stocks and bonds, that corporations issue to shareholders and capital investors.
The WACC uses the weighted average of each source of capital for which a firm is liable, unlike capital expense calculations.
WACC= (E/V * Re) + (D/V * Rd * (1-T))
- Equation E: Equity Market Value
- R is the equity cost
- D is the debt market value.
- V is the total value of the equities and debt markets.
- Rd = debt expense
- TC is the current corporate tax rate.
Q13. Investment Banking Interview Questions – Which cost—that of equity or that of debt—is higher?
The cost of equity is always greater than the cost of debt since interest on debt is tax-deductible. Since equity investors do not receive predictable payouts, unlike lenders, the cost of equity is also higher.
Debt is less expensive because interest payments are considered costs. Debt is also given priority in the capital structure of a corporation. Due to this, in the case of a liquidation or bankruptcy, debt holders receive payment before equity owners.
These are some queries and answers related to an investment banking interview. There are many more to be trained.
- Financial Modeling Course
- Digital Marketing Course
- SEO Course
- Technical Writing Course
- GST Course
- Content Writing Course
- Business Accounting And Taxation Course
- CAT Coaching
- Investment Banking Course
- Data Analytics Course
Frequently Asked Questions Regarding Investment Banking Interview Questions and Answers:
Q1. Which four components make up investment banking?
Capital Markets, Advisory, Trading and Brokerage, and Asset Management are the four primary sectors of investment banking activity.
Q2. What obstacles must an investment bank overcome, in your opinion?
Effective capital resource allocation is the responsibility of investment bankers. The business for investment bankers generally declines if there are fewer capital resources available for allocation. Due to the prospect of a protracted recession, this has become a challenge for the entire industry.
Q3. What are the top 5 inquiries to make while investing?
5 things to consider before investing
- Am I at ease with the risk’s magnitude? Am I willing to risk losing my money?
- Do I comprehend the investment and could I quickly withdraw my money?
- Are the investments I make governed?
- Am I covered if my adviser or the investment provider goes out of business?
- Should I seek financial counsel?
Conclusion On Investment Banking Interview Questions and Answers:
The concept of investment banking has been thoroughly described with examples in this article investment banking interview questions and answers. Working in investment banking means raising money for other companies, governments, and other organizations. It’s not that difficult to find jobs in this industry. You could crack and nail it if you have strong willpower and a firm determination. Although the majority of the crucial questions that could be asked during the interview have been covered in this article, you should still strive to work independently and get ready for the interview.