Investment Banking Interview Questions (with Answers)

Publication Date :

10 Aug, 2023

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Investment Banking Interview Questions Explained

Investment Banking Interview Questions prepare one for the interviews to help them crack the interviews and enter the field of investment banking.

The interview nowadays does not have the typical questions being asked, including the basics of financial concepts. The interviewers want the candidates to think and avoid theories that everyone usually knows. Also, since these questions are technical, there would always be a correct answer, so if you don’t know a particular answer, don’t try and fake one. It is always better to confess that you don’t know.

The key to successfully answering these technical questions is to apply the concepts you’re learning and test yourself. Hope this has helped you learn some important questions and answers on investment banking topics and brings you steps closer to cracking the high-profile interviews.

Investment Banking Interview Questions have been divided into the following six topics.

Accounting
Corporate Finance
Valuation
Merger and Acquisitions (M&A)
Initial Public Offering (IPO)
Miscellaneous

Investment Banking Interview Questions and Answers Video Explanation

#1 - Accounting

Question #1

Tell me about the three most important financial statements and their significance.

This is one of the most commonly asked investment banking interview questions.

The three main financial statements are the Income Statement, Balance Sheet, and Cash Flow Statement. Speaking about their significance, the income statement provides the revenue and expenses of a company and shows the final net income that it has made over some time.
The balance sheet signifies a company's assets such as a plant, property & equipment, cash, inventory, and other resources. Similarly, it reports the liabilities, including the Shareholders' equity, debt, and accounts payable. The balance sheet is such that the assets would always equal the Liabilities plus shareholders equity.
Lastly, a cash flow statement reports the net change in cash. It gives the cash flow from the company's operating, investing, and financing activities of the company.

Question #2

If you have the chance to evaluate the company's financial viability, which statement would you choose and why?

It would be the cash flow statement. The reason is that it provides a true picture of how much cash the business is generating in actual terms.
Hence, the cash flows are the main thing you pay attention to while you are analyzing the business's overall financial health.

Question #3

Let's say that the depreciation expense goes up by $100. How would this affect the financial statements?

Income Statement: With the depreciation expense decreasing, Operating Income would decline by $100, and assuming a 40% tax rate, Net Income would go down by $60.
Cash Flow Statement: The Net Income at the top of the cash flow statement goes down by $60, but the $100 Depreciation a non-cash expense that gets added back, so overall Cash Flow from Operations goes up by $40. With no further changes, the overall Net Change in Cash increases by $40.
Balance Sheet: On the asset side, because of the depreciation, the Plants, Property & Equipment go down by $100, and cash is up by $40 from the changes on the Cash Flow Statement.

Question #4

Imagine a situation where a customer pays for a mobile phone with a credit card. What would this look like under cash-basis vs. accrual accounting?

In the case of cash-based accounting, the revenue would not be accounted for until the company charges the customer's credit card, obtains authorization, and deposits the funds in its bank account.
After this entry would be shown as revenue in the income statement and as cash in the balance sheet.
As against accrual accounting, it would be shown as revenue right away. But it would not yet appear as cash on the Balance Sheet. Rather, it will be shown as Accounts Receivable.
It would be reported as cash only after the amount is deposited in the company's bank account.

Also, look at this detailed explanation on Cash vs Accrual Accounting.

#2 - Corporate Finance

Question #5

What is the formula for calculating WACC?

Do expect this investment banking interview question.

WACC = Cost of Equity * Proportion of Equity + Cost of debt * Proportion of debt (1-tax rate). The cost of equity is calculated using the Capital Asset Pricing Model (CAPM).
The formula is Cost of Equity = Risk-free rate + Beta* Equity risk premium
Cost of Debt = The risk-free rate yields a 10-year or 20-year U.S. Treasury.
Beta is calculated based on how risky are the comparable companies and equity.
Risk Premium is the percent by which stocks are expected to out-perform "riskless" assets.
The proportion is the percentage of how much of the company's capital structure is taken up by each component.

Question #6

There are two companies, P and Q, which are the same, but one P has debt, whereas Q doesn't have any. In this case, which of the two companies would have a higher WACC?

In this scenario, company Q would have a higher WACC because debt is less expensive than equity.

Question #7

At this juncture, the interviewer might ask you why debt is considered less expensive?

The answer is as follows; Interest on debt is tax-deductible (hence the (1 – Tax Rate) multiplication in the WACC formula).
Debt holders would be paid first in a liquidation or bankruptcy.
Instinctively, interest rates on debt are usually lower than the Cost of Equity numbers you see.
As a result, the Cost of Debt portion of WACC will contribute less to the total figure than the Cost of Equity portion.

#3 - Valuations

Question #8

Describe how a company is valued

This is another very common investment banking interview question.

Precedent transaction analysis

This is also called Transaction Multiple Valuation
This is when you look at how much others have paid for similar companies to determine how much the company is worth.
To use this method effectively, you need to be extremely familiar with the industry of the company you are valuing and the normal premiums paid for such a company.

Comparable Company Analysis

Comparable company analysis is similar to Precedent Transactions Analysis, except you are using the whole company as an assessment unit, not the purchase of a company.
So to use this method, you would also look for similar companies to the one you are valuing and look at their price to earnings, EBITDA, stock price, and any other variables you think would be a pointer to the health of a company.

Discounted Cash Flow Analysis

This is when you use future cash flow, or what the company will make in the upcoming years, to determine what the company is worth now.
To calculate DCF, you need to work out the probable or future cash flow for a company for the next ten years.
Then work out how much that would be in today's terms by "discounting" it at the rate that would return on investment.
Then you add in the terminal value of the company will tell you how much the company is worth.

Question #9

Which are the situations in which we do not use a DCF in the valuation?

We would not use a DCF in the valuation if the company has unstable or unpredictable cash flow or when debt and working capital serve a fundamentally different role.
For example, financial institutions like banks do not re-invest debt, and working capital forms a major part of their balance sheets, so we do not use a DCF for such companies.

Question #10

List the most common multiples used in a valuation

Valuation questions are very common in investment banking interviews.

These are relative valuation techniques given below-

Question #11

Briefly explain leveraged buyout?

One of the technical questions.

A leveraged buyout (LBO) is when a company or investor buys another company using mostly borrowed money, loans, or even bonds to make the purchase.
The company's acquired assets are usually used as collateral for those loans.
Sometimes, an LBO's ratio of debt to equity can be 90-10.
Any debt percentage higher than that can lead to bankruptcy.

Question #12

Explain the PEG ratio?

This stands for Price/earnings to growth ratio, takes the P/E ratio, and then accounts for how fast the EPS for the company will grow.
A stock that is growing rapidly will have a higher PEG ratio. A finely priced stock will have the same P/E ratio and PEG ratio.
So if a company's P/E ratio is 20 and its PEG ratio is also 20, some might argue that the stock is too expensive if another company with the same EPS has a lower P/E ratio, but that also means that it's growing faster because the PEG rate is 20.

Question #13

What is the formula for Enterprise Value?

The formula for enterprise value is the market value of equity (MVE) + debt + preferred stock + minority interest – cash.

Question #14

Why do you think the cash is subtracted in the formula for enterprise value?

The reason cash is subtracted is that it is regarded as a non-operating asset and because Equity Value indirectly accounts for it.

Question #15

Why do we consider both enterprise value and equity value?

Enterprise value signifies the company's value that is attributable to all investors, whereas equity value the portion available to equity shareholders.
We consider both because equity value is the number the public sees, while enterprise value represents its true value.

Question #16

What does it signify if a company has a negative enterprise value?

The company could have negative enterprise value when the company has extremely large cash balances, an extremely low market capitalization or both.
This could occur in companies on the brink of bankruptcy or Financial institutions such as banks with large cash balances.

#4 - Mergers and Acquisitions

Question #17

Briefly explain the process of a buy-side M&A deal.

Lots of time is spent completing research on the potential acquisition targets, and with the company you are representing, go through multiple cycles of selection and filtering.
Based on their feedback, narrow down the list and decide which ones are to be further approached.
Meetings are conducted to gauge the receptivity of potential sellers.
Serious discussions with the seller occur, which calls for in-depth due diligence and figuring out the offer price.
Negotiate the price and other key terms of the purchase agreement.
Announce the M&A deal/transaction.

Question #18

Briefly explain accretion and dilution analysis.

This one is another technical question.

Accretion and dilution analyses are undertaken to gauge the acquisition's impact on the acquirer's earnings per share (EPS) and compare it with the company's EPS if the acquisition has not been executed.
In simple words, we could say that in the scenario of the new EPS being higher, the transaction will be called "accretive," while the opposite would be called "dilutive."

Question #19

Given a situation where a company with a low P/E acquires a company with a high P/E in an all-stock deal, will the deal likely be accretive or dilutive?

Other things being equal, in a situation where a company with a low P/E acquires a company with a high P/E, the transaction would be dilutive to the acquirer's Earnings per Share (EPS).
This is because the acquirer will have to shell out more for each rupee of earnings than the market values its earnings.
Therefore, the acquirer would have to issue proportionally more shares in the transaction in such a situation.

Question #20

What are the synergies and their types?

Synergies are where the buyer gets more value out of an acquisition than what the financials would predict. There are two types of synergies –
Revenue synergy: The combined company can cross-sell products to new customers or up-sell new products to existing customers. Because of the deal, it could expand in new geographies.
Cost synergies: The combined company could amalgamate buildings and administrative staff and lay off redundant employees. It could also be able to close down redundant stores or locations.

Question #21

How does Goodwill get created in an acquisition?

Goodwill is an intangible asset that mostly stays the same over the years and is not amortized like other intangibles. It only changes when there is an acquisition.
Goodwill is the valuable assets that are not shown like financial assets on the balance sheet. For example, brand name, customer relationship, intellectual property rights, etc.
Goodwill is the subtraction of a company's book value from its equity purchase price. It signifies the value over the "fair market value" of the seller that the buyer has paid.

#5 - Initial Public Offerings (IPO)

Question #22

Briefly describe what you would do if you were working on an IPO for a client?

First of all, we would meet the client, gather all the necessary information such as their financial details, customers, and learn about the sector they belong to.
After this, you would meet other bankers and lawyers with the registration statement, which would describe the company's business and market to its investors.
Next, you would receive comments from the SEC and keep revising the document until it is acceptable.
Now you would spend the coming weeks organizing roadshows to present the company to the institutional clients and convince them to invest in them.
After raising capital for the clients, the company would start trading on the exchange.

Question #23

What are the benefits of a company getting listed on an exchange?

It is an important step for a company to achieve liquidity.
Certain investors would want to invest only in exchange-listed issuers.
It helps the company establish a recognized value for its stock, which could also help it use the stock for acquisitions rather than cash.

#6 - Miscellaneous Questions

Question #24

What is in a pitch book?

Pitchbook depends on the kind of deal the company is pitching for, but the common structure would include:

Bank credentials to prove their expertise in completing similar deals before.
Summary of company's options
Appropriate financial models and valuation
Investment Banking Charts
Potential acquisition targets or potential buyers
Summary and key recommendations

Question #25

Tell me a company you admire/follow and pitch me a stock

It would help if you structured your answer for such investment banking interview questions keeping in mind the following;

Give the name of the stock you have been following and the reason for the same.
Quickly summarize the company's business.
Provide a quick overview of the financials to indicate its size and its profitability. Also if you can provide specific details on Revenue, EBITDA multiples, or its P/E multiple
Provide reasons for how the stock or their business is more attractive than its rivals.
It would be best if you spoke about the stock trend at least in the past 3-5 years.
You could also talk about the future outlook for the company.

Question #26

When buying a company why do private equity firms use leverage?

The private equity firm reduces the amount of equity to the deal by using significant amounts of leverage (debt) to help finance the purchase price.
Doing this will increase the private equity firm's rate of return substantially when exiting the investment.

Question #27

What is convexity?

Convexity is a more accurate measure of the relationship between yield and bond price changes in interest rates.
Duration calculates this as a straight line, when in actuality, it is a convex curve, hence the name.
This is used as a risk calculation to tell how a bond yield will respond to interest rate changes.

Question #28

Define the risk-adjusted rate of returns

When looking at an investment, you cannot simply look at the projected return. If the profit from investment A is greater than the profit from investment B, you may immediately want to go with investment A.
But investment A might have a greater chance of a total loss than investment B. Hence, even though the profit may be larger, it is a lot riskier and not necessarily a better investment.
The adjusted rate of return is when you not only look at the return that an investment may give you, but you also measure the risk of that investment.
The adjusted rate of return is usually denoted as a number or rating.
If you are technically minded, you may also want to mention how risk is measured: beta, alpha, and the Sharpe ratio, r-squared, and standard deviation.