Term
|
Definition
| EBIT (1-t) + Depreciation - Change in Net Working Cap - CapEx |
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Term
|
Definition
|
|
Term
| how do you value a company? |
|
Definition
| Relative valuation (transaction comps or trading comps) or intrinsic valuation (DCF) or market value (market cap) |
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Term
|
Definition
|
|
Term
| what's the value of a company? |
|
Definition
|
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Term
|
Definition
| share price * # of outstanding shares |
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|
Term
| FCF calculation in a given year for UFCF |
|
Definition
| EBIT (1-t) + Depreciation - Change in Net Working Cap - CapEx |
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Term
|
Definition
|
|
Term
| how do you value a company? |
|
Definition
| Relative valuation (transaction comps or trading comps) or intrinsic valuation (DCF) or market value (market cap) |
|
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Term
|
Definition
|
|
Term
| what's the value of a company? |
|
Definition
|
|
Term
|
Definition
| share price * # of outstanding shares |
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Term
| what counts as cash flows from operating activities? |
|
Definition
| cash effects of transactions involved in calculating net income |
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Term
| what are the 4 statements investment bankers care about? |
|
Definition
| income statement, balance sheet, cash flow statement, statement of retained earnings |
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Term
| what does an income statement show? |
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Definition
| if a company can obtain resources in 3 ways (financing via equity, debt, or revenues), this dives into the last point. it explains where income is coming from. shows revenues, expenses, and then total income is the bottom line |
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Term
| what does a balance sheet show? |
|
Definition
| shows the economic resources of a company at a point in time, based on the simple assumption that assets = liabilities + equity |
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Term
| what does a cash flow statement show? |
|
Definition
shows the actual inflows and outflows of cash on a quarterly or yearly basis. unlike the balance sheet which shows just a snapshot of the company at a point in time, this allows us to track sources and uses of cash
separated into 3 sections: cash from financing, operating, and investing activities |
|
|
Term
| what does the statement of retained earnings show? |
|
Definition
| This is the portion of profit that a company reinvests in itself (i.e. not used to pay down debt or distributed to shareholders as a dividend). It’s a reconciliation of the Retained Earnings account from the beginning to the end of the year. When a company announces income or declares dividends, this information is reflected in the Statement of Retained Earnings. Net income increases the Retained Earnings account. Net losses and dividend payments decrease it |
|
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Term
| what counts as cash flows from financing activities? |
|
Definition
| Involves items classified as liabilities and equity in the Balance Sheet; it includes the payment of dividends as well as issuing payment of debt or equity |
|
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Term
| what counts as cash flows from investing activities? |
|
Definition
| cash from non-operating activities or activities outside the normal scope of business. This involves items classified as assets in the Balance Sheet and includes the purchase and sale of equipment and investments |
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Term
|
Definition
| cash, inventory, equipment |
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Term
|
Definition
| usually the top line of the balance, sheet, the pure cash profits you initially produce by selling your core product/service |
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Term
|
Definition
| costs incurred while producing revenue. these are considered a "loss" when incurred outside of the normal operating procedures (one-time or incidental losses) |
|
|
Term
| define a "loss" (aka one-time loss or incidental loss) |
|
Definition
| an expense that is incurred outside of the normal operating procedures |
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Term
|
Definition
| Earnings before interest, tax, depreciation, and amortization. a larger than EBIT, also larger than earnings |
|
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Term
|
Definition
SIMPLY THE SUM OF ALL FUTURE CASH FLOWS, DISCOUNTED TO THE PRESENT AT A RATE THAT IMPLIES THE RISKINESS OF THE CASH FLOWS
1. predict the financials going forward 5 ish years or so, so you can calculate FCFs for the next few years
2. find the FCFs for the next few years (using EBIT * (1-t) + depreciation - change in net working capital - CapEx)
3. use the perpetuity formula to estimate a TV of all FCFs generated after stage 1
4. sum the terminal value with free cash flows
5. find the discount rate (WACC or APV)
4. Use the discount rate to find net present value |
|
|
Term
|
Definition
| The required rate of return for the investors; is a function of the riskiness of the cash flows |
|
|
Term
| what are the 2 DCF approaches? |
|
Definition
directly value equity (levered)
directly value enterprise (unlevered) |
|
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Term
|
Definition
| SUM of cash flows t / (1 + discount rate) ^t |
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|
Term
| perpetuity formula (terminal value) |
|
Definition
| cash flows (of t+1 time) * (1+growth rate) / (discount rate - growth rate) |
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Term
|
Definition
UFCF projections
sum of FCF/(1+rate) ^t |
|
|
Term
|
Definition
market-based weighted average cost of capital
cost of equity (equity weight) + cost of debt (debt weight) (1-tax rate) |
|
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Term
|
Definition
| current YTM of company's long-term debt |
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Term
|
Definition
| risk free rate + (beta * Equity Risk Premium) |
|
|
Term
|
Definition
Current yield on U.S. 10-year bond is the preferred proxy
for the risk-free rate for U.S. companies |
|
|
Term
| generally accepted range for ERP |
|
Definition
|
|
Term
| what asset would you expect to carry a beta of 0? |
|
Definition
|
|
Term
| what asset would you expect to carry a negative beta? |
|
Definition
|
|
Term
| what asset would you expect to carry a very low beta? |
|
Definition
|
|
Term
|
Definition
only company-specific variable in CAPM.
A co whose equity has a beta of 1 has on avg seen
returns in line with the overall stock market. A beta of 2 means on avg returns rise or drop 2x as fast
Higher beta = Higher cost of equity because the increased risk investors take (via higher sensitivity to market
fluctuations) should be compensated via a higher return |
|
|
Term
| what asset would you expect to carry a very high beta? |
|
Definition
| Highly discretionary items like luxury watches |
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Term
|
Definition
The rate at which you choose to discount the future value of your money, aka the expected return from a project that matches the risk profile of the project in which you'd invest. Note: The discount rate is different than the opportunity cost of the money. Opportunity cost is a measure of the opportunity lost. Discount rate is a measure of the risk. These are two separate concepts. Method of determining it is different depending on which method you use (APV or WACC).
APV – for this, you calculate a different discount rate. Instead of using CAPM, you do risk free rate + beta (market risk-risk free rate). This is the unleveraged DCF
WACC – Equity over (D+E) times discount rate for leveraged equity PLUS Debt over (D+E) times discount rate for debt times (1-tax rate). Leads to a leveraged DCF
If a company has debt, APV won’t really give you the full value of the company because it doesn’t take into account the fact that the company’s interest payments are tax deductible. So when you’re doing APV you want to add back the debt tax shield (tax rate times debt times weighted avg interest rate on debt calculated for each year of projected cash flows)
Note: The debt tax shield is similarly calculated for the terminal year and discounted to the present year. So APV with DTS = APV without DTS + APV |
|
|
Term
| how do you calculate debt tax shield (DTS)? |
|
Definition
| APV without DTS * (tax rate * long term debt ratio) where long term debt ratio is D/(D+E) |
|
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Term
|
Definition
risk free rate + beta(market return-risk free rate)
AKA beta (excess market return).
Unlevered beta can be found on yahoo. To do levered beta for levered analyses, you can convert unleveraged beta by doing 1 + (1-t) + (D/E) and multiplying by unleveraged beta.
Capital asset pricing model—what you use to find the equity discount rate of a company (for when you're doing a levered DCF).
Also used to calculate expected return on investment—return on equity
Depends on beta |
|
|
Term
| Find leveraged beta using Unlevered beta |
|
Definition
Unlevered beta can be found on yahoo.
then multiply by the result of 1 + (1-t) + (D/E) |
|
|
Term
|
Definition
scalar measure of risk relative to the overall market. A financial
instrument with a beta of 1 is perceived to be as risky as the market, and moves with the market. Note: Betas (bs) are always the weighted average of market values, not book values |
|
|
Term
| how do you calculate an equity beta? |
|
Definition
| You can perform a linear regression of the historical stock returns against market returns. The slope of the regression line is beta. Value Line, S&P and so on are data providers of equity beta. If you can’t get beta (for example, if the company is private), use the beta of a comparable company as an estimate. |
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|
Term
| how do you calculate a discount rate? |
|
Definition
| Use the CAPM. While beta is an admittedly flawed estimate of risk, it is the best risk measure we have. The CAPM says that the proper discount rate to use is the risk-free rate plus the company risk premium, which reflects the particular company’s market risk or beta. |
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|
Term
| Walk me through the major line items of an Income Statement. |
|
Definition
Revenues
- Cost of Goods Sold
=Gross Margin
-Operating Expenses
=Operating Income
-Other Expenses
-Income Taxes
=Net Income |
|
|
Term
| what's the difference between the income statement and cash flow statement? |
|
Definition
The IS is a record of Revenues and Expenses while the CFS records the actual cash that has either come into or left the company. The CFS has the following categories: Operating-, Investing-, and Financing-Cash Flows.
Interestingly, a co can be profitable as shown in the IS, but still go bankrupt if it doesn’t have the cash flow to meet interest payments. |
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|
Term
| what's the main link between the BS and IS? |
|
Definition
| The main link between the 2 is that profits generated in the IS get added to shareholder’s equity on the BS as Retained Earnings. Also, debt on the BS is used to calculate interest expense in the IS. |
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|
Term
| What's the link between the BS and CFS? |
|
Definition
The CFS starts with the beginning cash balance, which
comes from the BS. Also, Cash from Operations is derived using the changes in BS accounts (such as AP, AR, etc.). The net increase in cash flow for the prior year goes back onto the next year’s BS. |
|
|
Term
|
Definition
| A proxy for cash flow; Earnings Before Interest, Taxes, Depreciation, and Amortization. |
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|
Term
| Say you knew a company’s net income. How would you figure out its “free cash flow”? |
|
Definition
Start with the company’s Net Income. Add back D&A. Subtract
“CapEx” (how much $ the company invests each yr in plant and equipment). The number you get is the company’s FCF:
Net Income
+ Depreciation and Amortization
– Capital Expenditures
– Increase (or + decrease) in net working capital
= Free Cash Flow (FCF) |
|
|
Term
| walk me through the main line items on the statement of free cash flows |
|
Definition
First the Beginning Cash Balance, then Cash from Operations,
then Cash from Investing Activities, then Cash from Financing Activities, and finally the Ending Cash Balance. |
|
|
Term
| What happens to each of the three primary financial statements when you change a) gross margin b) capital expenditures c) any other change? |
|
Definition
Think about the definitions of the variables that change.
For ex, gross margin is gross profit/sales, or the extent to which sales of sold inventory exceeds costs. Hence, if a) gross margin were to decrease, then gross profit decreases relative to sales. Thus, for the IS, you'd probably pay lower taxes, but if nothing else changed, you would likely have lower net income. The CFS would be affected in the top line with less cash likely coming in. Hence, if everything else remained the same, you would likely have less cash. Going to the BS, you would not only have less cash, but to balance that effect, you would have lower shareholder’s eqt
b) If CapEx were to say, decrease, then first, the level of CapEx would decrease on the CFS. This would increase the level of cash on the BS, but decrease the level of PP&E, so total assets stay the same. On the IS, the depreciation expense would be lower in subsequent years, so net income would be higher, which would increase cash and shareholder’s eqt in the future.
c) Just be sure you understand the interplay between the 3 sheets. Remember that changing one sheet has ramifications on all the other statements both today and in the future. |
|
|
Term
| how do you value a company? |
|
Definition
1 answer to this Q is to discount the co's projected cash flows using a “risk-adjusted discount rate.” This involves several steps. First you must project a co's cash flows for 10 yrs. Then you must choose a constant growth rate after 10 yrs going forward. Finally, you must choose an appropriate discount rate. After projecting the first 5 or 10 yrs performance, you add in a “Terminal Value,” which represents the PV of all the future cash flows another 10 yrs. You can calculate the TV in 1 of 1 ways: (1) you take the earnings of the last yr you projected, say yr 10, and multiply it by some market multiple like 20x earnings, use that as your TV; or
(2) take the last yr, say yr 10, and assume some constant growth rate after that like 10%. The PV of this growing stream of pymnts after yr 10 is the TV. Finally, to figure out what “discount rate” you use to discount the co's cash flows, tell your interviewer you would use the CAPM. (In a nutshell, CAPM says that the proper discount rate is the risk-free interest rate adjusted upwards to reflect this particular co’s market risk or “Beta.”) For a more advanced answer, discuss the APV and WACC methods.
You should also mention other methods of valuing a co, including looking at “comps” – that is, how other similar cos were valued recently as a multiple of their sales, net income, or some other measure. |
|
|
Term
|
Definition
used to calculate the expected return on an investment. Beta for a company is a measure of the relative volatility of the given investment with respect to the market, i.e., if Beta is 1, the returns on the investment (stock/bond/portfolio) vary identically with the market’s returns:
risk free rate + beta (market return - risk free rate) |
|
|
Term
| why might there be multiple valuations for a single company? |
|
Definition
| there are several different methods to valuing a company. And even if you use the rigorously academic DCF, the 2 main methods (WACC vs APV) make different assumptions about interest tax shields, which can lead to different valuations |
|
|
Term
| how do you calculate the terminal value (TV) of a company |
|
Definition
perpetuity formula = FCF of t+1 year * (1+growth rate)/ (discount rate - growth rate)
Terminal year value is calculated by taking a given yr in the future at which a co is stable (usually yr 10), assuming perpetually stable growth after that yr, using a perpetuity formula to come up with the value in that yr based on future cash flows, and discounting that value back to the present. |
|
|
Term
| Why are the P/E multiples for a company in London different than that of the same company in the States? |
|
Definition
| P/E multiples can be different in the two countries even if all other factors are constant because of the difference in the way earnings are recorded. Overall market valuations in American markets tend to be higher than those in the U.K. |
|
|
Term
| what are the different multiples that can be used to value a company? |
|
Definition
The most commonly used mult is price-to-earnings multiple, or “P/E ratio.” Other mults that are used include rev, EBITDA, EBIT, and book val. The relevant multiple depends on the ind. For ex, Internet cos are often valued with revenue mults; this explains why cos w low profits can have such high market caps. Cos in the metals and mining industry are valued using EBITDA.
As discussed in the section on valuation, not only should you be aware of the financial metric being used, you should know the time period the metric used represents: for ex, earnings in a P/E ratio can be for the prev or projected 12 mos, or for the prev or projected fiscal yr. |
|
|
Term
| how do you get the discount rate for an all equity firm?/ |
|
Definition
| cost of equity, using CAPM |
|
|
Term
| can you apply CAPM in Latin markets? |
|
Definition
| CAPM was developed for use in US markets, however, it is presently the best known tool for calculating discount rates. Hence, while it's not exact, it's a good framework for thinking about and analyzing discount rates outside of the US as fundamentally, markets are based on similar principles. |
|
|
Term
| How much would you pay for a company with $50 million in revenue and $5 million in profit? |
|
Definition
If this is all the information you are given you can use the comparable transaction or multiples method to value this company (rather than the DCF method). To use the multiples method, you can examine common stock information of comparable companies in the same industry, to get avg
industry P/E mults. You can then apply that mult to
find the given co's value. |
|
|
Term
| what's the difference between APV and WACC? |
|
Definition
WACC incorporates the effect of tax shields into the discount rate used to calculate the PV of cash flows. WACC is typically calculated using actual data and numbers from BS for cos or industries.
APV adds the present value of the financing effects (most commonly, the debt tax shield) to the NPV assuming an all-equity value, and calculates the adjusted PV. The APV approach is particularly useful in cases where subsidized costs of financing are more complex, such as in an LBO. |
|
|
Term
| how would you value a co with no revenue? |
|
Definition
| First you'd make reasonable assumptions about the co's projected revs (and projected cash flows) for future yrs. Then you'd calculate the NPV of these cash flows |
|
|
Term
|
Definition
| value that represents a stock’s volatility with respect to overall mkt volatility |
|
|
Term
| how do you unlever a co's beta? |
|
Definition
calculating the Beta under the assumption that it is an all-equity firm. The formula is as follows:
Levered beta = unlevered beta * [1(1-t)(D/E)] |
|
|
Term
| Name 3 cos that are undervalued and tell me why you think they are undervalued |
|
Definition
Here you have to do your HW. Study the stocks
you like and value them using various methods: DCF, multiples, comparable transactions, etc. Then choose several undervalued (and overvalued) stocks, and be prepared to back up your assessment, using financial and strategy info.
For ex, let’s say that Coke received some bad PR recently and its stock took a hammering in the market. However, the earnings of Coke are not expected to decrease significantly because of the negative publicity (or at least that’s your analysis). Thus, Coke is trading at a lower P/E relative to Pepsi and others in the industry: it is undervalued. This is an example of a line of reasoning you might offer when asked this question (the more thorough and insightful the reasoning, the better). Using some of the techniques discussed earlier as well as regular readings of the WSJ and other publications, will help you formulate real-world examples.
Also, keep in mind that there are no absolute right answers for a Q like this: If everyone in the market believed a stock was undervalued, the price would go up and it wouldn’t be undervalued anymore. What the interviewer is looking for is your chain of thought, ability to communicate convincingly, interest in the markets, and prep for the interview. |
|
|
Term
| walk me through the major items of an IS |
|
Definition
| Know all the items that go into the three major components: revenues, expenses and net income |
|
|
Term
| Which industries are you interested in? What are the multiples that you use for those industries? |
|
Definition
| As discussed, different inds use different mults. Answering the first part of the question, pick an ind and know any major events that are happening. Next, if you claim interest in a certain ind, you better know how cos in the industry are commonly valued. |
|
|
Term
|
Definition
The answer to this or any question like this is, “it depends.” P/E ratios are relative measurements, and in order to know whether a P/E ratio is high or low, we need to know the general P/E ratios of comparable companies.
Generally, higher growth firms will have higher P/E ratios because their earnings will be low relative to their price, w the idea that the earnings will eventually grow more rapidly that the stock's price |
|
|
Term
| Describe a typical co's cap structure? |
|
Definition
A co's cap structure is just what it sounds like: the structure of the capital that makes up the firm: its debts and equity. Cap structure includes permanent, long-term financing of a co, including long-term debt, preferred stock and common stock, and retained earnings. The statement of a co's cap structure as expressed above reflects the order in which contributors to the cap structure are paid back, and the order in which they have claims on co's assets should it liquidate.
Debt has first priority, then preferred stock holders, then common stock holders. Anything left over is put into the retained earnings acct. |
|
|
Term
Value the following company given the following information (a
written finance interview question): |
|
Definition
BE ABLE TO DO THIS
1. Figure out FCFs
2. figure out a discount rate (APV or WACC)
3. Figure out a TV
4. Figure out the NPV of all cash flows
5. put it all together and figure out the co's value
6. |
|
|
Term
| preferred stock conversion price |
|
Definition
| liquidation (redemption) value / (preferred shares out. * conversion ratio) |
|
|
Term
| convertible bond conversion price |
|
Definition
| book value of convertible debt/common shares debt is convertible into |
|
|
Term
| what's the difference between the IS and the CFS |
|
Definition
The Income Statement is a record of Revenues and Expenses while the CFS records the actual cash that has either come into or left the co. The Statement of Cash Flows has the following categories: Operating CFs, Investing Cash Flows, and Financing CFs.
Interestingly, a co can be profitable as shown in the IS, but still go bankrupt if it doesn’t have the cash flow to meet interest payments. |
|
|
Term
| what is the link between the BS and the IS? |
|
Definition
The main link between the two statements is that profits generated in the
Income Statement get added to shareholder’s equity on the Balance Sheet as
Retained Earnings. Also, debt on the Balance Sheet is used to calculate
interest expense in the Income Statement. |
|
|
Term
| what is the link between the BS and the CFS? |
|
Definition
The Statement of Cash Flows starts with the beginning cash balance, which
comes from the Balance Sheet. Also, Cash from Operations is derived using
the changes in Balance Sheet accounts (such as Accounts Payable, Accounts
Receivable, etc.). The net increase in cash flow for the prior year goes back
onto the next year’s Balance Sheet . |
|
|
Term
|
Definition
proxy for cash flow
earnings before interest, taxes, depreciation, and amortization |
|
|
Term
| Say you knew a company’s net income. How would you figure out its FCF? |
|
Definition
Start with Net Income. Then add back Depreciation and
Amortization. Subtract the company’s CapEX (how much $ the Co invests each yr in plant and equipment). The number you get is the co's FCF:
Net Income
+ Depreciation and Amortization
– Capital Expenditures
– Increase (or + decrease) in net working capital
= Free Cash Flow (FCF) |
|
|
Term
| Walk me through the major line items of a CFS. |
|
Definition
| The answer: first the Beginning Cash Balance, then Cash from Operations, then Cash from Investing Activities, then Cash from Financing Activities, and finally the Ending Cash Balance. |
|
|
Term
| What happens to each of the three primary financial statements when you change a) gross margin b) capital expenditures c) any other change? |
|
Definition
Think about the definitions of the variables that change. For example, gross margin is gross profit/sales, or the extent to which sales of sold inventory exceeds costs. Hence, if a) gross margin were to decrease, then gross profit decreases relative to sales. Thus, for the IS, you'd prob pay lower taxes, but if nothing else changed, you would likely have lower net income. The CFS would be affected in the top line with less cash likely coming in. Hence, if everything else remained the same, you'd likely have less cash. Going to the BS, you'd not only have less cash, but to balance that effect, you'd have lower shareholder’s eqt.
b) If CapEx were to say, decrease, then first, the level of CapEx would decrease on the CFS. This would increase the level of cash on the BS, but decrease the level of PP&E, so total assets stay the same. On the IS, the D expense would be lower in subsequent yrs, so net income would be higher, which would increase cash and shareholder’s eqt in the future.
c) Just be sure you understand the interplay between the 3 sheets. Remember that changing 1 has ramifications on all others both today and in the future |
|
|
Term
|
Definition
Valuing a co is 1 of the most popular technical tasks you will be asked to perform. Remember the several methods that
we discussed, and good luck.
One basic answer to this question is to discount the company’s projected CFs using a “risk-adjusted discount rate.” This process involves several steps. First you must project a co's cash flows for 10 yrs. Then choose a constant growth rate after 10 yrs going fwd. Finally, choose an appropriate discount rate. After projecting the
first 5 or 10 years perf, you add in a TV (represents the PV of all the future CFs another 10 yrs). You can calculate the TV in one of two ways: (1) you take the earnings of the last yr you projected, say ur 10, and multiply it by some market mult like 20x earnings, use that as your TV; or
(2) you take the last yr, say yr 10, and assume some constant growth rate after that like 10%. The present value of this growing stream of pymnts after yr 10 is the TV. Finally, to figure out what “discount rate” you would use to discount the company’s cash flows, tell your interviewer you would use the CAPM. (In a nutshell, CAPM says the proper discount rate to use is the risk-free IR adjusted upwards to reflect this particular co's market risk or “Beta.”)
For a more advanced answer, discuss the APV and WACC methods.
You should also mention other methods of valuing a company, including transaction and trading comps |
|
|
Term
| how do you measure the riskiness of a portfolio? |
|
Definition
std dev of a port's expected returns
std dev is a measure of volatility, so the more predictable the returns, the less risky it is |
|
|
Term
| what's a useful tool for determining portfolio-level risk? |
|
Definition
|
|
Term
|
Definition
tendency for two investments in a portfolio to move together in price
under the same circumstances |
|
|
Term
| what is fundamental analysis? |
|
Definition
| using financial analysis to analyze the co's underlying business, such as sales growth, its balance sheet, etc., to decide whether and when to buy and sell. |
|
|
Term
| what is technical analysis? |
|
Definition
looking at charts and patterns associated with a stock’s historical price movements to try to profit from predictable patterns, regardless of fundamentals such as revenue growth or expense trends.
While many on Wall St. look down upon technical analysis (and it's rarely taught at business schools), some Wall St. traders still rely on it or use it in conjunction with fundamental analysis to decide whether and when to buy/sell |
|
|
Term
| what is financial ratio analysis? |
|
Definition
looking at a co's various financial ratios and how they have changed over time to spot trends or trouble spots in the co's operations. A financial ratio by itself doesn’t necessary tell you very much. More impt is comparing how a co's financial ratios are changing from one Q to the next, and how they compare a co's financial ratios w other companies in its ind.
Below are the most common ratios used in finance to analyze cos.
Particularly if you are interviewing for investment management, eqt research or similar finance positions, you may be asked questions about how to calculate common financial ratios and what they signify. |
|
|
Term
| how do you calculate a co's current ratio? |
|
Definition
| current assets/current liabilities |
|
|
Term
| 3 types of company filings ("corps") |
|
Definition
|
|
Term
| when does a co generate "equity"? |
|
Definition
at the time of "incorporation"
all a co needs to do to have stock is be incorporated and owned |
|
|
Term
| tax benefit to owning pref stock over bonds |
|
Definition
| Corporate invs are taxed for only 30% of the dividends they receive on pref stock. On the other hand, 100% of the interest pymnts on bonds paid to corp invs are taxed. This tax rule comes in handy when structuring mergers |
|
|
Term
| Chapter 7 vs. Chapter 11 bankruptcy |
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Definition
| If a Chap 11 bankruptcy filing is approved, the court puts a stay order on all interest pymnts – management is given a pd of protection during which it can clean up its financial mess and try to get the house marching toward profitability. If the mgmnt fails to do so within the given time, there can be a Chap 7 bankruptcy filing, when the assets of the co are liquidated.) This action, in theory, wipes out the value of the co's eqt |
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Term
| why do stock splits happen? |
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Definition
as co grows, make sure:
1. stock price doesnt get insanely high
2. enable liquidity
usually viewed as a positive signal for the co, and stock usually rises in value after a stock split |
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Term
| why does a co buy back its stock and what does it usually imply? |
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Definition
usually a positive signal, usually makes stock price increase afterwards bc:
1. fewer out. shares = increased EPS
2. good sign when a co invests in its own stock
3. debt tax shield. when a co buys back its stock, its net debt goes up, which means its debt tax shield will also go up, and thus its valuation will go up |
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Term
| what usually happens to a co's share price after a new stock issuance? |
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Definition
price usually goes down bc
1. diluted EPS
2. signaling effect - implies that mgmnt believes the valuation of their stock is high (possibly inflated) and that by issuing stock they can take advantage of this high price
3. if a co believes that the project it's raising money for will be successful, they would have issued debt to keep upside to eqt within the firm
4. debt tax shield will drop significantly |
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Term
| what kind of stock would you issue for a startup? |
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Definition
| A startup typically has more risk than a well-established firm. The kind of stocks that one would issue for a startup would be those that protect the downside of eqt holders while giving them upside. Hence the stock issued may be a combo of common, preferred stock and debt notes with warrants (options to buy stock) |
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Term
| when should a co buy back stock? |
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Definition
| When it believes the stock is undervalued, has extra cash, and believes it can make $ by investing in itself. This can happen in a variety of situations. For ex, if a company has suffered some decreased earnings bc of an inherently cyclical ind (such as semis), and believes its stock price is unjustifiably low, it will buy back its own stock. On other occasions, a company will buy back its stock if invs are driving down the price precipitously. In this situation, the co is attempting to send a signal to the market that it is optimistic that its falling stock price is not justified. It’s saying: “We know more than anyone else about our co. We are buying our stock back. Do you really think our stock price should be this low?” |
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Term
Is the dividend paid on common stock taxable to shareholders?
Preferred stock? Is it tax deductible for the co? |
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Definition
| The dividend paid on common stock is taxable on 2 levels in the U.S. First at the firm level, as a dividend comes out from the net income after taxes (i.e., the $ has been taxed once already). The shareholders are then taxed for the dividend as ordinary income (O.I.) on their personal income tax. Dividend for preferred stock is treated as an interest expense and is tax-free at the corporate level. |
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Term
| When should a company issue stock rather than debt to fund its ops? |
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Definition
| There are several reasons for a co to issue stock rather than debt. If the co believes its stock price is inflated it can raise $ (on very good terms) by issuing stock. Second, if the projects for which the $ is being raised may not generate predictable cash flows in the immediate future, it may issue stock. A simple ed of this is a startup company. The owners of startups generally will issue stock rather than take on debt because their ventures will probably not generate predictable cash flows, which is needed to make regular debt payments, and also so that the risk of the venture is diffused among the co's shareholders. A third reason for a co to raise $ by selling eqt is if it wants to change its debt-to-equity ratio. This ratio in part determines a company’s bond rating. If a co's bond rating is poor because it is struggling with large debts, it may decide to issue eqt to pay down the debt. |
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Term
| why would an inv buy pref stock? |
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Definition
1) They want the upside potential of eqt while minimizing risk. They'd receive steady interest-like pymnts (dividends) from the pref stock that are more assured than the dividends from common.
2) The preferred stock owner gets a superior right to the co's assets should it go bankrupt.
3) A corp would invest in pref bc the divs on pref are taxed at a lower rate than the IRs on bonds. |
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Term
| why would a co distribute its earnings thru divs to common stockholders? |
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Definition
Regular div pymnts are signals that a co is healthy and profitable. Also, issuing divs can attract invs (shareholders). Finally, a co may distribute earnings to shareholders if it lacks
profitable investment oppt'ys |
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Term
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Definition
| This is a Q often asked of those applying for all eqt (S&T, rsrch, etc.) positions. (Applicants for IB and trading positions, as well as investment mgmnt positions, have also reported receiving this Q.) If you’re interviewing for these, you should prepare to talk about a couple of stocks you believe are good buys and some you don’t |
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Term
| where did the S&P close yesterday? |
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Definition
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Term
| Why did the stock price of XYZ company decrease yesterday when it announced increased Q'ly earnings? |
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Definition
A couple possible explanations:
1) entire market was down, (or its sector was)
2) even though XYZ announced increased earnings, the Street was expecting earnings to increase even more |
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Term
| Can you tell me about a recent IPO that you have followed? |
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Definition
| read WSJ, stay up on this |
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Term
| What is your investing strategy? |
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Definition
| Different invs have different strats. Some look for undervalued stocks, others for stocks with growth potential and yet others for stocks with steady perf. A strat could also be focused on LT or ST, and be more risky or less risky. Whatever your strat, you should be able to articulate these attributes. |
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Term
| If you read that a given mutual fund has achieved 50% returns last year, would you invest in it? |
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Definition
You should look for more info, as past performance is not
necessarily an indicator of future results. How has the overall mkt done? How'd it do in the yrs before? Why did it give 50% returns last yr? Can that strat be expected to work continuously over the next 5-10 yrs? You need to look for answers to these Qs before making a decision. |
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Term
| You are on the board of dirs of a co and own a significant chunk of it. The CEO, in his annual presi, states the stock is doing well, as it has gone up 20% in the last 12 mos. Is the co's stock in fact doing well? |
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Definition
Another trick stock Q you shouldn't answer too quickly. First,
ask what the Beta of the co is (i.e. the vol of the stock wrt the mkt.) If the Beta is 1 and the mkt has gone up 35%, the co actually has not done too well compared to the broader mkt. |
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Term
Which do you think has higher growth potential, a stock that is
currently trading at $2 or a stock that is trading at $60? |
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Definition
in short, it depends
price doesn't tell the whole story. Suppose the $2 stock has 1 bn shares out. That means it has $2 billion market cap, hardly a small cap stock. On the flip side, if the $60 stock has 20,000 shares gives it a market cap of $1,200,000, and hence it is extremely small and is probably seen as having higher growth potential. Generally, high growth potential has little to do with a stock's price, and has more to do with it's operations and rev prospects |
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Term
| What do you think is happening with ABC stock? |
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Definition
| Expect to be asked this Q if you say you like to follow a given sector like tech or pharma. Interviewers will test you to see how well you know your ind. In case you don’t know that stock, admit it, and offer to describe a stock in that sector that you like or have been following |
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Term
| Where do you think the DJIA will be in 3 months and 6 mos – and why? |
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Definition
Nobody knows the answer to this. However, you should at least have some thoughts on the subject and be able to articulate why. If you've been following the performance of major
macroecon indicators (which will be reviewed in the next section), you can state your case well. |
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Term
| Why do some stocks rise so much on the first day of trading after their IPO and others don’t? How is that money left on the table? |
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Definition
By “$ left on the table,” bankers mean that the co could have
successfully completed the offering at a higher price, and that the difference in valuation thus goes to initial invs rather than the co. Why this happens is not easy to predict from responses received from invs during roadshows. Moreover, if the stock rises a lot the 1st day it is good publicity for the firm. But in many ways it is money left on the table because the co could have sold the same stock in its IPO at a higher price. However, bankers must honestly value a co and its stock over the long-term, rather than simply trying to guess what the market will do. Even if a stock trades up significantly initially, a banker looking at the LT would expect it to come down as the mkt eventually correctly values it |
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Term
| what is insider trading and why is it illegal? |
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Definition
| Insider trading describes the illegal activity of buying or selling stock based on information that is not public info. The law against it exists to prevent those with privileged info (co execs, I-bankers and lawyers) from using this info to make a tremendous amount of $ unfairly. |
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Term
| Who is a more senior creditor, a bondholder or stockholder? |
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Definition
| bondholder is always more senior. Stockholders (including those who own pref stock) must wait until bondholders are paid during a bankruptcy before claiming co assets. |
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