Vault Guide to Advanced Finance & Quantitative Interviews (Vault Guide to Advanced Finance & Quantitative Interviews)

303 Pages·2002·4.19 MB·English

by  Jennifer Voitle

VAULT GUIDE TO
ADVANCED FINANCE
AND QUANTITATIVE
INTERVIEWS
Vault Inc.
ADVA
FINAN
VAULT GUIDE TO
ADVANCED
FINANCE AND
QUANTITATIVE
QINTUERVIEAWS N
© 2002 Vault Inc.
Copyright © 2002 by Vault Inc. All rights reserved.
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ISBN 1-58131-172-9
Printed in the United States of America
Vault Guide to Advanced Finance and Quantitative Interviews
Table of Contents
INTRODUCTION 1
Your First Step . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1
Problem Solving Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2
Sample Questions and Answers . . . . . . . . . . . . . . . . . . . . . . . . . .3
BOND FUNDAMENTALS 5
Bond Basics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7
Time Value of Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9
Bond Prices and Relationships to Yields . . . . . . . . . . . . . . . . . . .15
Taylor Series Expansion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18
Bond Price Derivatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21
Sample Questions and Answers . . . . . . . . . . . . . . . . . . . . . . . . .30
Summary of Formulas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33
STATISTICS 35
Random Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37
Key Statistical Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41
Permutations and Combinations . . . . . . . . . . . . . . . . . . . . . . . . .50
Functions of Random Variables . . . . . . . . . . . . . . . . . . . . . . . . .52
Distributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .56
Regression Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59
Sample Questions and Answers . . . . . . . . . . . . . . . . . . . . . . . . .72
Summary of Formulas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .78
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Vault Guide to Advanced Finance and Quantitative Interviews
Table of Contents
DERIVATIVES 81
Introduction to Derivatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83
Forward Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83
Futures Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .89
Swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95
Options: An Overview+RC . . . . . . . . . . . . . . . . . . . . . . . . . . . .96
Combining Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110
Option Valuation I: Introducing Black-Scholes . . . . . . . . . . . . .121
Option Valuation II: Other Solution Techniques . . . . . . . . . . . .130
Option Sensitivities: the Greeks . . . . . . . . . . . . . . . . . . . . . . . .155
Exchange-traded options . . . . . . . . . . . . . . . . . . . . . . . . . . . . .160
Exotic Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166
Sample Questions and Answers . . . . . . . . . . . . . . . . . . . . . . . .170
Summary of Formulas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .180
FIXED INCOME 187
Bond and Fixed Income Market Issuers . . . . . . . . . . . . . . . . . .189
Types of Fixed Income Securities . . . . . . . . . . . . . . . . . . . . . . .195
Quoting Bond and Fixed Income Prices . . . . . . . . . . . . . . . . . .196
Analyzing and Valuing Bonds and Fixed Income Securities . . .196
Fixed-income Specific Derivatives . . . . . . . . . . . . . . . . . . . . . .205
Mortage-backed Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . .229
Sample Questions and Answers . . . . . . . . . . . . . . . . . . . . . . . .242
Summary of Formulas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .248
Equity Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .249
Equity Valuation Overview . . . . . . . . . . . . . . . . . . . . . . . . . . .251
Dividend Discount Model . . . . . . . . . . . . . . . . . . . . . . . . . . . .253
Multiples Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .254
Return on an Asset . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .258
CAPM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .259
Equity Indexes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .266
Hybrids . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .268
Equity-specific derivatives . . . . . . . . . . . . . . . . . . . . . . . . . . . .273
Sample Questions and Answers . . . . . . . . . . . . . . . . . . . . . . . .278
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Vault Guide to Advanced Finance and Quantitative Interviews
Table of Contents
CURRENCY AND COMMODITY MARKETS 283
Currency Swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .285
Comodity Swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .288
Sample Questions and Answers . . . . . . . . . . . . . . . . . . . . . . . .292
RISK MANAGEMENT 297
Measuring Market Risk: Value at Risk . . . . . . . . . . . . . . . . . . .299
Types of Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .302
Currency Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .304
Fixed-income Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .305
Equity Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .310
Currency and Commodity Risk in the News . . . . . . . . . . . . . . .313
Hedging Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .317
Portfolio Risk and Correlation . . . . . . . . . . . . . . . . . . . . . . . . .320
Arbitrage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .322
Sample Questions and A+R[-47]Cnswers . . . . . . . . . . . . . . . . .324
APPENDIX
Advanced Finance Glossary
About the Author
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INTRODUCTION
QUAN
Vault Guide to Advanced and Quantitative Finance Interviews
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 wish they
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
what kinds of questions interviewers are currently asking, in order to bring you the latest in this book.

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
Finance Interviews gives you helpful pointers in that direction.

What this book can do is help you review and master the required subject matter, without which no amount
of charm will get you by. (Although charm is always good.)

Also unique to this book are strategies to help you succeed on those tough interview questions that you may
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
easy problems have already been solved. The problems you will see on the job will likely be things that no
one has quite seen before.

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).

It is our hope that you will find the problem solving strategies and the material in this book indispensable to
you even after you land your job. Good luck!

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message boards, the Vault Finance Job Board and more. http://finance.vault.com

1
Vault Guide to Advanced and Quantitative Finance Interviews
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 Cite from memory
Strategy #2 Draw a figure
Strategy #3 Work backwards
Strategy #4 Formulate an equivalent problem
Strategy #5 Enumerate all cases
Strategy #6 Search for a pattern
Strategy #7 Bracket the answer – solve the extreme cases
Strategy #8 Relate to something you know
Strategy #9 Take advantage of symmetry

Remember to RELAX. Try to see these interviews simply as conversations. It is a chance for interviewers
to evaluate you, but remember, you are also deciding if you want to work there as well. The more relaxed
and calm you are, the easier it will be for you to think creatively, which is often what is required in finance
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, interest rate parity and so on. When the job seeker finally reported being unsure of the 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, sometimes you will be able to use one strategy by itself to answer a question, but imagine what
a powerful approach it is when you can combine two or more. Those tough interview questions won’t have
a chance. You will see the above strategies used throughout this book, and identified to help you remember
them. Often, problems can be approached from more than one angle, so don’t feel that you must use the
approach we show.

Visit the Vault Finance Channel, the complete online resource for finance careers, featuring firm profiles,
message boards, the Vault Finance Job Board and more. http://finance.vault.com

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