Updated July 25, 2023
Introduction to Investment Banking Interview Questions
This article on Investment Banking Interview Questions and Answers aims 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.
In investment banking interviews, interviewers frequently ask candidates the following important questions:
Part 1 – Investment Banking Interview Questions (Basic)
This first part covers basic Investment Banking Interview Questions and Answers.
Q1. 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 of date and provides a snapshot of the company. The balance sheet divides into Assets, Liabilities, and shareholders’ equity (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 and accounts payable.
The balance sheet is calculated as follows:
Assets = Shareholders Equity + Liabilities
- Income Statement – The income statement represents the company’s profit and loss statement, encompassing all the income and expenses incurred by the company in that financial year. It begins with revenue and comes down to net income after deducting the expenses.
- 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.
Q2. How will the Financial Statements be Affected if Depreciation goes up by $50?
Answer:
- Income Statement – If depreciation expense increases by $50, operating income will decrease by $50, assuming a tax rate of 30%, and 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 $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.
Q3. When should 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 than 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.
Q4. What are the Different Methods of Valuation?
Answer:
The common methods used in valuation are:
- Discounted Cash Flow: This method forecasts cash flows for at least 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: This approach calculates relevant ratios based on the industry. For example, one calculates the PE ratio of the industry and multiplies it by the company’s earnings to arrive at a price.
These valuation methods depend on the sector in which the company operates. Often, a company is valued using all these methods, and the average prices are considered.
Q5. 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
Q6. When can DCF not be Used?
Answer:
You cannot use DCF if a company has unstable and unpredictable cash flow. You cannot use this when debt and working capital do not fundamentally play the same role. For example, banks do not re-invest debt, and working capital is a major part of the balance sheet.
Q7. What is the Formula for Calculating EVs?
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.
Q8. 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.
Q9. What is Beta, and How is it Calculated?
Answer:
Beta measures the riskiness of a particular stock. Beta is calculated as the covariance of the stock and the market divided by the market’s return. A stock with a beta higher than 1 is riskier than the market. A stock with a beta lower than 1 is considered riskier than the market.
In calculating the beta of private companies, using unleveled and levered beta involves utilizing the comparable public company’s debt-to-equity ratio. To determine the impact of this component on Unilever’s beta calculation, one divides the Debt/Equity of the comparable company. Then, this result is multiplied by the Debt/Equity of your company to arrive at the appropriate 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])
Q10. 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 using research skills. This skill requires understanding the problem or scenario, listing all the questions, and finding 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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