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

303 Pages·2002·4.19 MB·English
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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. All information in this book is subject to change without notice. Vault makes no claims as to the accuracy and reliability of the information contained within and disclaims all warranties. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, for any purpose, without the express written permission of Vault Inc. Vault.com, and the Vault logo are trademarks of Vault Inc. For information about permission to reproduce selections from this book, contact Vault Inc., 150 West 22nd Street, New York, New York 10011-1772, (212) 366-4212. Library of Congress CIP Data is available. 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 Visit the Vault Finance Channel, the complete online resource for finance careers, featuring firm CAREER profiles, message boards, the Vault Finance Job Board, and more. http://finance.vault.com LIBRARY 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 CAREER LIBRARY © 2002 Vault.com Inc. 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 Visit the Vault Finance Channel, the complete online resource for finance careers, featuring firm CAREER profiles, message boards, the Vault Finance Job Board, and more. http://finance.vault.com LIBRARY Competition on the Street – and beyond – is heating up. With the finance job market tightening, you need to be your best. We know the finance industry. And we’ve got “Thank you, thank you, thank experts that know the finance environment you! I would have never come up standing by to review your resume and give you with these changes on my own!” the boost you need to snare the financial – W.B., Associate, Investment position you deserve. Banking, NY Finance Resume Writing and “Having an experienced pair of eyes looking at the resume Resume Reviews made more of a difference than I thought.” • Have your resume reviewed by a practicing – R.T., Managing Director, SF finance professional. • For resume writing, start with an e-mailed “I found the coaching so helpful I made three appointments!” history and 1- to 2-hour phone discussion. – S.B., Financial Planner, NY Our experts will write a first draft, and deliver a final draft after feedback and discussion. • For resume reviews, get an in-depth, detailed critique and rewrite within TWO BUSINESS DAYS. Finance Career Coaching Have a pressing finance career situation you need Vault’s expert advice with? We’ve got experts who can help. • Trying to get into investment banking from business school or other careers? • Switching from one finance sector to another – for example, from commercial banking to investment banking? • Trying to figure out the cultural fit of the finance firm you should work for? For more information go to http://finance.vault.com ADVA FINAN 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! 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 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 2

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I am not quite sure who is supposed to read this book. I am about to finish my M.Sc (Industrial management and engineering) and almost everything (98%) in this book was known to me. Regarding all the errors, I stopped marking them at about the 20th page. It is really terrible how there can be so man
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