Vault Guide to Advanced Finance & Quantitative Interviews

301 Pages·2003·6.402 MB·English

by  Jennifer Voitle

VAULT GUIDE TO
ADVANCED
FINANCE AND
QUANTITATIVE
INTERVIEWS
©2002VaultInc.
Copyright©2002byVaultInc. Allrightsreserved.
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reliabilityoftheinformationcontainedwithinanddisclaimsallwarranties. Nopartofthisbookmaybereproducedor
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permissionofVaultInc.
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ISBN 1-58131-172-9
PrintedintheUnitedStatesofAmerica
VaultGuidetoAdvancedFinanceandQuantitativeInterviews
TableofContents
INTRODUCTION 1
YourFirstStep .......................................1
ProblemSolvingStrategies .............................2
SampleQuestionsandAnswers ..........................3
BOND FUNDAMENTALS 5
BondBasics .........................................7
TimeValueofMoney .................................9
BondPricesandRelationshipstoYields...................15
TaylorSeriesExpansion ...............................18
BondPriceDerivatives ...............................21
SampleQuestionsandAnswers .........................30
SummaryofFormulas ................................33
STATISTICS 35
RandomVariables ...................................37
KeyStatisticalFigures ................................41
PermutationsandCombinations .........................50
FunctionsofRandomVariables .........................52
Distributions .......................................56
RegressionAnalysis ..................................59
SampleQuestionsandAnswers .........................72
SummaryofFormulas ................................78
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VaultGuidetoAdvancedFinanceandQuantitativeInterviews
TableofContents
DERIVATIVES 81
IntroductiontoDerivatives .............................83
ForwardContracts ...................................83
FuturesContracts ....................................89
Swaps ............................................95
Options:AnOverview+RC ............................96
CombiningOptions .................................110
OptionValuationI:IntroducingBlack-Scholes .............121
OptionValuationII:OtherSolutionTechniques ............130
OptionSensitivities:theGreeks ........................155
Exchange-tradedoptions .............................160
ExoticOptions .....................................166
SampleQuestionsandAnswers ........................170
SummaryofFormulas ...............................180
FIXED INCOME 187
BondandFixedIncomeMarketIssuers ..................189
TypesofFixedIncomeSecurities .......................195
QuotingBondandFixedIncomePrices ..................196
AnalyzingandValuingBondsandFixedIncomeSecurities ...196
Fixed-incomeSpecificDerivatives ......................205
Mortage-backedSecurities ............................229
SampleQuestionsandAnswers ........................242
SummaryofFormulas ...............................248
EquityMarkets.....................................249
EquityValuationOverview ...........................251
DividendDiscountModel ............................253
MultiplesAnalysis ..................................254
ReturnonanAsset ..................................258
CAPM ...........................................259
EquityIndexes .....................................266
Hybrids ..........................................268
Equity-specificderivatives ............................273
SampleQuestionsandAnswers ........................278
©2002Vault.comInc.
VaultGuidetoAdvancedFinanceandQuantitativeInterviews
TableofContents
CURRENCY AND COMMODITY MARKETS 283
CurrencySwaps ....................................285
ComoditySwaps ...................................288
SampleQuestionsandAnswers ........................292
RISK MANAGEMENT 297
MeasuringMarketRisk:ValueatRisk ...................299
TypesofRisk ......................................302
CurrencyRisk .....................................304
Fixed-incomeRisk ..................................305
EquityRisk .......................................310
CurrencyandCommodityRiskintheNews ...............313
HedgingRisk ......................................317
PortfolioRiskandCorrelation .........................320
Arbitrage .........................................322
SampleQuestionsandA+R[-47]Cnswers .................324
APPENDIX
AdvancedFinanceGlossary
AbouttheAuthor
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profiles,messageboards,theVaultFinanceJobBoard,andmore. http://finance.vault.com
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INTRODUCTION
VaultGuidetoAdvancedandQuantitativeFinanceInterviews
Introduction
Your First Step
Congratulations on taking your first step to succeeding in your advanced finance interviews. This book
was written to give you the technical background needed to master that interview – compiled into one
convenient volume. Quantitative and Wall Street interviews are notoriously tough, and with good reason.
These types of jobs pay very well – and a lot of people want them.
This book will give you the edge you need to succeed. This is the book the writers and editors wishthey
had when they were interviewing. It is the distillation of years of experience in the finance field, in
teaching finance and in numerous interviews. Vault editors have even taken interviews just to find out
whatkindsofquestionsinterviewersarecurrentlyasking,inordertobringyouthelatestinthisbook.
In quantitative interviews, mastery of the subject matter is assumed – it is your starting point. You will also
have to convince your interviewer(s) you are the right fit for the firm and have the experience and
background that they are looking for. Of course, no book can give you that – though the Vault Guide to
FinanceInterviewsgivesyouhelpfulpointersinthatdirection.
Whatthisbookcandoishelpyoureviewandmastertherequiredsubjectmatter,withoutwhichnoamount
ofcharmwillgetyouby.(Althoughcharmisalwaysgood.)
Alsouniquetothisbookarestrategiestohelpyousucceedonthosetoughinterviewquestionsthatyoumay
not be prepared for. Some questions you may get are deliberately designed to be impossible to answer.
The interviewer just wants to see how you think and how you approach problems. Remember, all of the
easyproblemshavealreadybeensolved. Theproblemsyouwillseeonthejobwilllikelybethingsthatno
onehasquiteseenbefore.
Still, you will find some interviewers who will ask questions straight out of textbooks (one insider reports
receiving the following question in a recent interview with Bloomberg: “What is an equivalence statement
in FORTRAN and why would it be used?”) It is simply the style of certain companies and interviewers to
ask questions from textbooks, so you should be prepared for this if you want to land a job. For inside
information on interviewer style, you may want to check out the Vault message boards. For everything
else, let this book be your guide. Wherever possible, we’ve used questions from actual interview
experience, including the interviewer’s comments on what they were looking for (when we could get it).
Itisourhopethatyouwillfindtheproblemsolvingstrategiesandthematerialinthisbookindispensableto
youevenafteryoulandyourjob. Goodluck!
VisittheVaultFinanceChannel,thecompleteonlineresourceforfinancecareers,featuringfirmprofiles,
messageboards,theVaultFinanceJobBoardandmore. http://finance.vault.com
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VaultGuidetoAdvancedandQuantitativeFinanceInterviews
Introduction
Problem Solving Strategies
What do you do when confronted with an interview question you have absolutely no idea how to solve?
We recommend the following strategies – it should help you handle most anything thrown at you.
Strategy#1 Citefrommemory
Strategy#2 Drawafigure
Strategy#3 Workbackwards
Strategy#4 Formulateanequivalentproblem
Strategy#5 Enumerateallcases
Strategy#6 Searchforapattern
Strategy #7 Bracket the answer – solve the extreme cases
Strategy#8 Relatetosomethingyouknow
Strategy#9 Takeadvantageofsymmetry
RemembertoRELAX. Trytoseetheseinterviewssimplyasconversations. Itisachanceforinterviewers
to evaluate you, butremember, youare also decidingifyouwantto workthere aswell. The more relaxed
andcalmyouare,theeasieritwillbeforyoutothinkcreatively,whichisoftenwhatisrequiredinfinance
interviews. Also, try to think of the tough interview questions as amusing little problems (the interviewer
probably does). One recent interviewee reports having an interviewer grill her relentlessly on currency
forwards, interestrateparityandsoon. Whenthejobseekerfinallyreportedbeingunsureofthe approach
to one question, “The interviewer laughed and said, ‘Don’t worry. If you had known the answer to this
problem, I would have found something else that you don’t know. That’s my job.’”
Remember,sometimesyouwillbeabletouseonestrategybyitselftoansweraquestion,butimaginewhat
a powerful approach it is when you can combine two or more. Those tough interview questions won’t have
achance. Youwillseetheabovestrategiesusedthroughoutthisbook,andidentifiedtohelpyouremember
them. Often, problems can be approached from more than one angle, so don’t feel that you must use the
approachweshow.
VisittheVaultFinanceChannel,thecompleteonlineresourceforfinancecareers,featuringfirmprofiles,
messageboards,theVaultFinanceJobBoardandmore. http://finance.vault.com
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VaultGuidetoAdvancedandQuantitativeFinanceInterviews
Introduction
Sample Questions
1. You have a sheet of paper and an infinite supply of tokens. I also have an infinite supply of
tokens. We take turns placing tokens on the paper, one token at a time. We cannot place tokens on
topof othertokens (no overlapping), andthe tokenscannotextendovertheedgesofthepaper. The
last player to place a token on the paper wins. What is your winning strategy? (This is called a
“strategy game” question, and is an actual question recently asked on a hedge fund interview.)
Solution: Don’t freak out if you see something like this. The interviewer is just trying to get a sense of
how you attack a new problem. Let’s go through our list of tactics. Tactic #1 will not work here. Tactic
#2 has promise: Try breaking it down into smaller sub-problems. What if the paper were so small that
onlyasinglecoincouldfitonit?
In this case your strategy would be to go first. After you place your coin, your opponent has no place to
placehis,andyouwin. Next,whatifthepaperwerebigenoughfortwocoins? Here,youplaceyourcoin
in the dead center of the sheet so your opponent can’t place his coin. Again, your strategy would be to go
first.
Prohibited
This tactic can be repeated until you have derived the correct answer: You always move first, and if you
playthegameproperly,youwillalwayswin.
2.Whatdoyouthinkisthemajorfactorimpactingtheprofitabilityofanairline? (Thiswasanactual
questionaskedinaGoldmanSachsequityquantitativeresearchinterview.)
Solution: This is another question that the interviewer doesn’t expect you to have memorized, but expects
you to go through a reasoning process enumerating possible factors affecting airline profitability to come
up with the most important one. You could say, “passenger meals, labor costs, weather delays, leasing
costs, marketing, maintenance, price wars,” but the major cost driver is probably “fuel.”
3. Wouldthevolatilityofanenterprisebehigherorlowerthanthevolatilityofitsequity? (Actually
asked by a Goldman Sachs interviewer who kept coming back to this in one form or another during the
interview.)
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