You are here
Home > Life & Work > Interview Questions > Can You Answer These 5: Leveraged Buyout Questions V7

Can You Answer These 5: Leveraged Buyout Questions V7

Investment bankers... are the masters of the universe

Investment Banking Inteview Questions
Sales and Trading Interview Questions
Brain Teasers

Past Editions

Can You Answer These 5 Investment Banking Questions 1
Can You Answer These 5 Investment Banking Questions 2
Can You Answer These 5 Investment Banking Questions 3
Can You Answer These 5 Investment Banking Questions 4
Can You Answer These 5 Investment Banking Questions 5
Can You Answer These 5 Investment Banking Questions 6

Quite a few investment banking postings out there right now, with 5 in Calgary across JP Morgan, BMO, National Bank, GMP First Energy and some boutique. We know quite a few internal candidates who are also going through the investment banking interview process, and everyone is giving the same feedback.

Many industry groups are asking a lot of LBO questions – even  industry groups that rarely partake in leveraged buy outs.

Given this insider information, we figured that we would throw in a few LBO questions this time. Also, (one of) the big news story of the week has been the crackdown on heavily leveraged purchases of foreign assets by Chinese megaconglomerates such as HNA Group and Anbang via the pullback of Chinese State Owned Lenders. Leverage is cool! Until it’s not.

This Week’s Questions

  1. How does Loan-to-Value drive an LBO’s returns? (Mergers & Acquisitions/Corporate Banking)
  2. Assuming the terms of the debt are exactly the same except for the amortization schedule (i.e. coupon, final maturity, seniority) would a financial sponsor prefer a Term Loan A or Term Loan B? (Private Equity)
  3. The offer price moves up by 5% and the IRR falls by 25% – why?
  4. What are some historical LBO failures?
  5. Walk through purchase price allocation in an acquisition. (Accounting)

Last Week’s Questions

What is yield-to-worst? (Debt Capital Markets)

Yield to worst is the lowest yield a bondholder can realize from holding a bond – between the yield to maturity, the yield to call or yield to whatever depending on the embedded features of the bond.

This is important to bondholders as it gives them an idea of floor scenarios where interest rates do not move favorably. As embedded options will kick in given thresholds are met earlier than the bond’s final maturity, the yield to call would be calculated using the call date.

What is a busted convertible? (Debt Capital Markets/Equity Capital Markets)

A busted convertible is a convertible security that is so far out of the money (the underlying stock price trades far below its strike price) for its option that its equity content is close to zero and it trades like a straight bond.

Valuing busted convertibles properly is hard and can be very profitable investments for fixed income investors who perform comprehensive credit analysis.

What does the Delta One desk do? (Sales & Trading)

The Delta One desk or Linear Derivatives is the desk that deals with derivatives that move 1 to 1 with the underlying asset. As such, forwards, swaps and futures fall into this jurisdiction but options (which do not have 1 to 1 payoffs) do not.

Given that relatively simple math, these derivatives are not as complex as the name conveys. Delta One is associated with large volumes and low profit margins.

In an M&A accretion/dilution context, when is equity cheaper than debt? (Mergers & Acquisitions/Investment Banking)

The cost of equity from an accretion dilution perspective is the inverse of the price-earnings ratio. As such, if the inverse of the price earnings, or the earnings yield, is lower than the after-tax cost of debt, it is technically a lower cost of funding than the debt. In reality, company stock is not good currency for a merger as it is bad signalling to shareholders and a low earnings yield often times suggests that the market thinks that the company has good growth prospects.

What companies would this apply to? Any company with a price/earnings over 40x – which includes many of the hottest technology stocks from Facebook to Amazon to Netflix.

Johnson & Johnson buys delicious Campbell’s Soup for a 50x multiple – however the deal is accretive. Why?

A quick glance at J&J’s P/E (being a big, blue chip cash cow) is nowhere close to the multiples that would apply in the previous example.

As such, the accretion must stem from cheap debt or cash. The answer lies in that J&J is one of a few (and decreasing still) AAA-rated corporate borrowers, which means that they have an extremely low cost of debt.

A recent case study in a similar vein is Microsoft’s purchase of LinkedIn, which was immediately accretive to earnings.

A reminder to anyone looking to move into corporate finance that accretion does not always mean a sensible merger.

Related Reading for Interviews

InterviewsStock Pitch: Long Canada Goose (TSE:GOOS) · How to Quickly Research a Company or Industry · Stress Interview Questions for Investment Banking · How To Answer: “Do You Have Any Questions For Us?” · Things Not to Say in an Investment Banking Interview · Encouragement before Full-Time Recruiting for 2018 · Macro Brief for Interviews on Equities · How Long Before Hearing Back from an Interview? · How to Answer “Why Investment Banking”? · 2 Common Interview Mistakes · How to Show Your Passion for Finance · Off-Cycle Investment Banking and Finance Recruiting · Landing an Investment Banking Interview in Canada ·
Interview QuestionsHow to Answer “What Two Companies Do You Think Should Merge?” · Investment Banking Interview Challenge Questions · 30 Minute Technical IB Interview Prep · Defending Your Stock Pitch in an Investment Banking Interview · Accounting Questions for Investing and Equity Research · Pitch Me an Oil & Gas Stock · Can You Answer These 5: Investment Banking Questions V8 · Fixed Income Analyst Interview Questions · Corporate Banking Interview Questions · Can You Answer These 5: Investment Banking Questions V6 · Can You Answer These 5: Investment Banking Questions V5 · Investment Banking Accounting Questions: Three Statement Walkthrough · Can You Answer These 5: Investment Banking Questions V4 · Can You Answer These 5: Investment Banking Questions V3 · Can You Answer These 5: Investment Banking Questions V2 · Can You Answer These 5: Investment Banking Questions · Walk Me Through a DCF · Common Oil and Gas Investment Banking Interview Questions ·
Avatar
Matt
ex investment banking associate
https://www.linkedin.com/in/matt-walker-ssh/

Leave a Reply

Top