List of most important investment banking interview questions and answers

25 Investment Banking Interview Questions and Answers

November 2, 2024 Ram Prakash P

Investment banking is a type of financial service that functions to raise money for individuals, corporations, and governments. An investment bank acts as a middle-man for large, complex financial transactions and investment banking supports these transactions. Investment banking covers various topics that include accounting, mergers and acquisitions, corporate finance, and valuation. More exploration of various topics is essential to decipher many of the complicated topics of investment banking interview questions and answers.

Important Investment Banking Interview Questions and Answers

1. Who Do You Think is an Investment Banker and What Are the Various Functions Associated With Investment Banking?

An investment banker is an individual of a financial institution primarily associated with raising capital for corporations, governments, and other entities.

Major investment bankers include Goldman Sachs (GS), Morgan Stanley (MS), JPMorgan Chase (JPM), Bank of America Merrill Lynch (BAC), and Deutsche Bank (DB).

Functions of investment banking majorly involve large and complex financial transactions related to capital raising including, but not limited to, preparing for initial public offering, facilitating mergers and acquisitions, underwriting new debt and equity securities, and arranging for bond offerings.

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2. Elaborate on the Three Essential Financial Statements and the Significance of Each of Them.

The three vital financial statements are the income statement, the balance sheet, and the statement of cash flows. The income statement shows the revenue, expenses, and net income for a certain period which could be for a month, quarter, half year, or full year.

Revenue could be from sales for manufacturing companies and commissions, fees, charges, or interest income for service-oriented companies.

Expenses could be operational or non-operational expenses and net income is the difference between revenue and expenses. Revenue is referred to as the top line of any business and net income is called the bottom line.

The balance sheet shows the assets on one side and the liabilities and equity on the other side as on a particular date where assets equal liabilities and equity. It aids analysts in assessing the liquidity, leverage, and financial health of a company.

Current and non-current assets are the divisions under assets, and current and long-term liabilities are the classifications of liabilities. Equity includes common stock, paid-in capital, and retained earnings.

The statement of cash flows shows the cash flows from operating, investing, and financing activities for some time. The statement shows the liquidity of a company by depicting where the cash comes from and where it is used.

The cash flow from operations is the most important aspect as the negativity of it signifies that the company is struggling to earn funds for its day-to-day operations.

In simple terms, cash flows from investments involve the purchase and sale of securities and those from financials involve borrowing and repayment of loans. (Explore investment banking interview questions and answers about the statement of change in equity as well)

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3. Briefly Elaborate on Change in Inventory and Its Implications.

Change in inventory is the difference between ending inventory and beginning inventory where ending inventory refers to the amount of the previous period’s ending inventory and beginning inventory is the amount of the current period’s ending inventory.

If the value is positive, it indicates a decrease in inventory, and if that is negative, it indicates an increase in inventory. (Look into more investment banking interview questions and answers on ABC analysis, MRO inventory, EOQ model, XYZ classification, and JIT)

4. What is Net Working Capital and the Implications of the Same?

Net working capital is the difference between current assets and current liabilities exhibiting a company’s liquidity and short-term financial health. Current assets represent assets that could be liquidated within a year which include cash and cash equivalents, inventory, accounts receivable, and prepaid expenses.

Current liabilities represent debts or payments owed to be paid within a year which include accounts payable, wages payable, short-term debt, and tax and dividend payable.

The net working capital could be positive, negative, or high depicting the operational efficiency of a company. Positive working capital is indicated by the ratio of current assets over current liabilities being greater than one or when current assets are greater than current liabilities.

It implies that a company has enough funds for its day-to-day operations and has increased scope for capital expenditure. Negative working capital is indicated by the ratio of current assets over current liabilities being lesser than one or current liabilities being higher than current assets.

It indicates that the company is struggling to pay off its short-term debts and creditors. The company could face operational disruptions if negative working capital sustains for a longer period.

High working capital is also not good for a company as it denotes improper or no utilization of excess revenue earned. High capital denotes surplus revenue lying idle with a company.

A company could improve its net working capital by increasing its current assets and decreasing its current liabilities. (Check out investment banking interview questions and answers on change in working capital and its implications as well)

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5. What is EBITDA?

EBITDA stands for earnings before interest, tax, depreciation, and amortization. It represents income from primary business operations, investments, and asset sales. EBITDA equals the addition of operating income with depreciation and amortization.

6. Can You Elaborate on the Structure of the Income Statement?

This is one of the most common and important Investment Banking Interview Questions and Answers. Revenue forms the top line and reducing the cost of goods sold from revenue forms the gross profit.

Gross profit minus operating expenses forms the EBITDA and removing depreciation and amortization from EBITDA forms the operating profit or earnings before interest and tax.

Reducing interest expenses from operating profit gives earnings before tax, and reducing tax expenses from earnings before tax forms the net income, which is referred to as the bottom line of the income statement.

(Delve into more investment banking interview questions and answers on the structure of balance sheet and cash flow statement as well)

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7. What Are Deferred Tax Assets and Deferred Tax Liabilities?

Deferred tax asset is recorded if tax expenses are lesser than accounting expenses or if tax income is greater than accounting income. Similarly, deferred tax liability is recorded if tax expenses are greater than accounting expenses or if tax income is less than accounting income.

If less tax is to be paid in the future, it is recorded as deferred tax asset, and if more tax has to be paid in the future, it’s recorded as deferred tax liability.

8. How Do You Differentiate Goodwill From Other Tangible Assets?

Tangible assets are physical assets such as cash, furniture, plant and machinery, buildings, stock, equipment, etc. that can be touched or measured.

Goodwill is an intangible or non-physical asset depicting the value of a business associated with the purchase of one company by another.

Customer loyalty, brand reputation, and public trust are all considered as goodwill. Reducing the fair value of assets acquired from the purchase price gives the goodwill amount.

(Try to look for more investment banking interview questions and answers on various other intangible assets such as a patent, brand, trademark, or copyright)

9. Distinguish Between Cash-based Accounting and Accrual-based Accounting.

The differences between them are exhibited when revenue and expenses are recognized. In cash-based accounting, revenue and expenses are recognized only when cash is transferred, and in accrual-based accounting, revenue is recognized when they are earned and expenses when they are incurred.

For instance, when a company purchases raw materials in September and pays for them in October, cash-based accounting records it in October whereas accrual-based accounting records it in September.

Cash-based accounting is used for tax purposes while accrual-based accounting is used for major financial decisions.

10. What Are the Differences Between Operating Leverage and Financial Leverage?

Operating leverage is the ability of a firm to use its operating costs and financial leverage is the ability of a firm to use its capital structure. Operating leverage is preferred when it’s lower and financial leverage is preferred when it’s higher.

Operating leverage is the ratio of fixed costs over total costs and financial leverage is the ratio of total liabilities over total equity. The degree of operating leverage (DOL) is the contribution margin over EBIT or the percentage change in EBIT over the percentage change in units sold.

Degree of financial leverage (DFL) is the EBIT over net income or the percentage change in net income over the percentage change in EBIT. (Also focus on investment banking interview questions and answers on combined leverage)

11. Throw Light on Mergers, Acquisition, Amalgamation, and Joint Venture.

A merger is an act of combining two companies of similar size and scope where both companies cease to exist to form another legal entity. Examples include the merger of Vodafone India and Idea Cellular forming Vodafone Idea; L & T Infotech and Mindtree merging to form LTI Mindtree; and PVR and Inox Leisure forming PVR Inox.

Amalgamation is seeking merging involving more than two companies to form a conglomerate with each of the companies involved in related or unrelated businesses.

Reliance Industries Limited, Berkshire Hathaway, and ITC Limited are examples of amalgamations involving unrelated businesses.

Among public sector banks involving related business amalgamation, Oriental Bank of Commerce and United Bank of India were amalgamated with Punjab National Bank; Andhra Bank and Corporation Bank were amalgamated with Union Bank of India; and Dena Bank and Vijaya Bank were amalgamated with Bank of Baroda.

A joint venture is a partnership between two companies to form another entity where the two companies continue to exist. Examples of joint ventures include Maruti Suzuki, ICICI Prudential Life Insurance, Tata AIG Insurance, and Hindustan Unilever Limited.

The acquisition is an act of one company completely taking over the control of another company where the acquiring company becomes the parent company and the acquired company becomes its subsidiary.

In acquisition too, both companies continue to exist with one company having a controlling stake over the other. Examples include Walmart’s acquisition of Flipkart, Tata Steel’s acquisition of Corus Steel, and Zomato’s acquisition of Uber Eats.

(Also study about investment banking interview questions and answers on takeovers, corporate restructuring, and strategic alliances)

12. What Are the Factors That Cause Mergers or Acquisitions?

Synergies, access to new resources and markets, economies of scale, diversification, tax optimization, and knowledge transfer of new technology or expertise are some of the factors behind mergers and acquisitions.

13. What Are the Different Types of Synergies in Mergers and Acquisitions?

Revenue synergies and cost synergies are the two categories of synergies. Revenue synergy suggests that combined sales of merged entities could overtake the addition of sales of individual companies.

It results from access to new markets and a reduction in competition; however, developing new workflow and sales strategies poses challenges to achieving revenue synergies.

Cost synergies refer to cost advantages arising out of the reduction of duplicate expenses and cost-cutting initiatives. Cost synergies can be achieved through higher bargaining power, better asset utilization, reduced workforce, and streamlined processes.

(Also understand investment banking interview questions and answers on financial synergy, operational synergy, and strategic synergy)

14. Differentiate Between Enterprise Value and Equity Value.

Enterprise value is the market value of operating assets whereas equity value is the market value of shareholders’ equity. Enterprise value represents equity value plus net debt plus preferred stock plus minority interest.

Equity value is equivalent to enterprise value excluding net debt, preferred debt, and minority interest. Net debt represents total debt without cash and cash equivalents.

15. Please Describe a Swap About Financial Instruments.

A swap is a type of over-the-counter derivative contract through which cash flows or liabilities are exchanged from two different financial instruments by two parties.

The two parties can be banks, businesses, hedge funds, or investors. Interest rate swaps, currency swaps, inflation swaps, commodity swaps, credit default swaps, and equity swaps are some types of swaps.

16. Can You Briefly Explain the Various Types of Swaps?

An interest rate swap is a contract between two parties to exchange different streams of interest payments over a set period.
A currency swap is a contract between two parties to exchange the principal amount and interest of a loan in one currency for the principal amount and interest in another currency.

It is used as a hedging strategy against forex fluctuations involving three steps, initial exchange of principal, periodic interest payment, and re-exchange of principal on maturity. In an inflation swap, one party transfers inflation risk to another through the exchange of fixed cash flows.

It is used as a hedging instrument to combat the inflation risk. A commodity swap is an exchange of cash flows between two parties that are dependent on an underlying commodity which could be agricultural commodities, bullions and gems, base metal, or energy commodities.

A credit default swap is a type of derivative instrument acting as a protection against the default of an underlying borrower or debt instrument.

In this contract, a buyer pays the premium and the seller pays the underlying security’s value and interest payments if there is a default. An equity swap is a contract to exchange a set of future cash flows at a set future date between two parties.

One of the two legs of the swap could be a floating leg and the other could be an equity leg or else both the legs could be equity legs.

17. What is Beta and What Does the Value of It Interpret?

Beta is the measurement of the volatility of a security concerning a broader market index. The beta of 1 indicates that security moves along with the market.

Beta lesser than 1 indicates that the security is less volatile with the movement of the market and that greater than 1 indicates that the security is more volatile than the market.

It is used to evaluate a security’s risk and return. Securities with a beta lesser than 1 are of low risk and low return and those with a beta greater than 1 are referred to as high-risk and high-return securities.

However, various other factors affect the risk and return of a security other than beta. (Focus on investment banking interview questions and answers related to the formula for the calculation of beta)

18. What Are PE and PEG Ratios and How Are They Interpreted?

PE ratio represents the price-to-earnings ratio used to identify the valuation of a stock. Price is the market price per share and earnings denote earnings per share. The PE ratio is negative if a company makes a loss.

A high PE ratio indicates that a stock is overvalued or expensive and a low PE ratio indicates that a stock is undervalued or cheap. PEG ratio refers to price/earnings to growth ratio which is calculated by dividing the P/E ratio by the growth rate of earnings per share over a while.

A PEG ratio below 1.0 indicates that a stock is undervalued or cheap and a PEG ratio above 1.0 indicates that a stock is overvalued or expensive.

(Study investment banking interview questions and answers on other valuation ratios such as price-to-sales ratio, price-to-book ratio, dividend yield ratio, and cash reinvestment ratio)

19. What Are the Various Methods of Project Evaluation?

The various methods of project evaluation include net present value (NPV), internal rate of return (IRR), benefit–cost ratio or profitability index, payback period, and accounting rate of return.

Two factors majorly affect the present value of a company: expected future cash flow and discount rate.

The present value is higher if the expected future cash is higher and lower when the future cash flow is also lower, whereas the present value has an inverse relationship with the discount rate, increasing when the discount rate decreases and decreasing when the discount rate increases.

Other factors affecting present value include risk, inflation, and corporate governance.

20. What Does the Internal Rate of Return Mean?

Internal rate of return (IRR) is the discount rate that makes net present value equal to zero. Net cash inflow during the period, total initial investment costs, net present value, and the number of periods are the factors to be considered in the calculation of IRR.

A higher IRR indicates favorable conditions for a project. IRR is mostly used in scenarios where preference has to be decided between establishing new operations and expanding existing operations.

(Understand investment banking interview questions and answers on the other methods of project evaluation as well)

21. What Are the Factors to Be Considered in the Calculation of WACC?

Weighted average cost of capital (WACC) depicts a company’s cost of capital with proportional weightage of each category of capital. It is also the average rate of return the company offers to its shareholders.

It is used as the discount rate which is a required factor in the computation of NPV. The market value of a firm’s equity and that of a firm’s debt, cost of equity, cost of debt, and corporate tax rate are the factors considered in the computation of WACC.

(Investment banking interview questions and answers could also focus on the formula for the computation of WACC)

22. What is DCF And What Are the Components to Be Considered for Its Evaluation?

This is also one of the important investment banking interview questions and answers. Discounted cash flow (DCF) is a valuation method that computes the present value of an investment from its expected future cash flows.

It’s the individual addition of cash flows for each future year over 1 plus discount rate the whole power the corresponding future year. The discount rate is usually the weighted average cost of capital.

If the present value of an investment computed using the DCF is higher than the cost of investment, then the business owner or manager can go ahead with the investment.

But there are other factors such as market demand, economy, technological advancement, and competition to be considered before deciding the future cash flow.

23. Elaborate on the Computation of Terminal Value.

Terminal value is the projected value of a business in the future after the period of current forecasts. Terminal value is computed on two common methods namely perpetual growth method and exit multiple method.

The perpetual growth method assumes that a business continues as a going concern in the future generating constant cash flows whereas the exit multiple method assumes that a business will end in the future.

In the perpetual growth method, terminal value equals free cash flow times 1 plus terminal growth rate the whole over WACC minus terminal growth rate where free cash flow is the amount of cash available with a company to pay creditors and investors and weighted average cost of capital is the combined cost of debt and equity of a company.

In the exit multiple method, the terminal value is calculated as EBITDA times a common factor considered for acquiring business.

24. What is CAPM?

Capital asset pricing model (CAPM) is a model for pricing a security depicting the relationship between expected return and the risk associated with investing in the security.

The formula of the model reads: capital asset expected return equals the risk-free rate of interest plus volatility or sensitivity in terms of beta value times the whole of the expected return of the market minus the risk-free rate of interest.

(Have an understanding of other investment banking interview questions and answers such as option pricing model, cost-plus pricing model, value-based pricing model, and equity pricing model)

25. What Do You Mean by the LBO Model?

The leveraged buyout (LBO) model involves the acquisition of a company with a significant amount of debt where the assets of both the acquiring and the acquired company are used as collateral.

The transaction is designed to involve less equity and more debt. The model is suited for private equity acquisitions. The model involves four stages: finding the company to be acquired, finding the appropriate capital provider, receiving the capital, and completing of the acquisition process.

(Have a view on investment banking interview questions and answers related to the other financial models such as the three-statement financial model, discounted cash flow model, comparable company analysis, precedent transactions analysis, and accretion and dilution merger and acquisition model)

Frequently Asked Questions

1. What is the scope of an investment banker?

An investment banker can join as an analyst and move up to the level of a chief financial officer (CFO) depending on the experience and expertise. An investment banker could be involved in underwriting, mergers and acquisitions, portfolio management, securities trading, risk management guidance, and other associated services.

2. What are the institutes offering courses on investment banking?

IIM Skills, Wall Street, Imarticus Learning, Edubridge, CFI Education, Hindustan Institute of Capital Market, IB Institute, and National Institute of Bank Management are some of the institutes offering courses on investment banking.

3. How about the course fees offered by the institutes?

The course fees range from Rs. 40,000 to Rs. 1,50,000 depending upon the institute.

4. What are the companies involved in investment banking?

J.P. Morgan, Goldman Sachs, Morgan Stanley, Bank of America Merrill Lynch, Barclays, Credit Suisse, Deutsche Bank, BNP Paribas, Crisil, BNY Mellon, and UBS are some of the investment banking companies operating in India.

5. What is the average salary of an investment banker?

According to ambitionbox.com, the average salary of an investment banker ranges between 2.0 lakhs and 50.0 lakhs depending upon the experience and expertise. The estimates are based on 338 salary reviews received from investment bankers.

Conclusion:

In the above article, we have shortlisted the most commonly asked investment banking interview questions and answers. We hope this article was informative and provided all the important information and guidance.

Vaibhav Kakkar