Vault guide to private equity pdf free download

Companies with low credit ratings are unable to access investment grade investors and would have to borrow at higher rates in the high-yield markets. Other companies might have specific riskier investments that they must pay a higher cost of capital for. What is the relationship between a bonds price and its yield? They are inversely related. That is, if a bonds price rises, its yield falls and vice versa. What are the factors that affect option pricing? An option conveys the right, but not obligation, to engage in a future transaction on some underlying security.

There are several factors that influence an options premium, which is intrinsic value plus time value. A change in the price of the underlying security either increases or decreases the value of an option, and the price changes have an opposite effect on calls and puts.

The strike price determines whether the option has intrinsic value, and it generally increases as the option becomes further in the money. Time influences option pricing because as expiration approaches, the time value of the option decreases. A securitys volatility impacts the time value of a premium, and higher volatility estimates generally result in higher option premiums for both puts and calls alike. Finally, dividends and the current risk-free interest rate have a small effect known as the cost of carry of shares in an underlying security.

Explain put-call parity. It demonstrates the relationship between the price of a call option and a put option with an identical strike price and expiration date. The relationship is derived using arbitrage arguments, and shows that a portfolio of call options and x amount of cash equal to the PV of the options strike price has the same expiration value as a portfolio comprising the corresponding put option and the underlying option.

The parity shows that the implied volatility of calls and puts are identical. Also, in a delta-neutral portfolio, a call and a put can be used interchangeably. Say you have a normal bond that you buy at par and you get the face amount at maturity. Is that most similar to buying a put, selling a put, buying a call or selling a call?

You can liken it to selling a put because if the stock decreases in value, you lose money, like a bond defaulting. But if its neutral, youre neutral in both cases. What should the interest rate be on the junior debt? What if this was an LBO scenario and you had a sponsor putting in million of equity? The company would be less risky because it has more liquidity now. Whats its stock price? The company doubled its cash and thus its value.

Whats the share price today if the repurchase is in one month? You have 1 million - 0. The 0. The remaining 0. HFs favor these more than PE firms because they test mental math skills.

Resume Tip Junior Positions Finance people really are obsessed with standardized testing. Show the breakout; firms especially care about your math score. Obviously, accuracy is key but so is your thinking process. You should expect to explain your reasoning, and a logical verbal breakout followed by a wrong answer is better than just a wrong answer.

Pay attention to your interviewers face for clues to whether you are going in the right or wrong direction. Brainteasers are meant to be tough, so its fine to take a minute to collect your thoughts and outline the steps to calculating the answer. To help you get in the tricky probability mindset, refer to a famous brainteaser known as the Monty Hall problem.

It is notorious for having a counterintuitive solution. Suppose youre on a game show and you're given the choice of three doors. Behind one door is a car; behind the others, goats. The car and the goats were placed randomly behind the doors before the show. The rules of the game show are as follows: After you have chosen a door, the door remains closed for the time being. The game show host, Monty Hall, who knows what is behind the doors, now has to open one of the two remaining doors, and the door he opens must have a goat behind it.

If both remaining doors have goats behind them, he chooses one randomly. After Monty Hall opens a door with a goat, he will ask you to decide whether you want to stay with your first choice or to switch to the last remaining door. Imagine that you chose Door 1 and the host opens Door 3, which has a goat. He then asks you, Do you want to switch to Door Number 2?

Is it to your advantage to change your choice? Krauss and Wang Think of it this way: lets say Door 1 is the winning door. Look at the outcome for each door that the player could pick and decide to switch. Picks Door 1 win. Monty shows Door 2 or 3 with goat.

Player switches, and loses. Picks Door 2 goat. Monty shows Door 3 with goat. Player switches and wins. Picks Door 3 goat. Monty shows Door 2 with goat. The probability that the door Monty Hall chooses conceals the car is 0, since he never chooses the door that contains the prize. Therefore, switching is more advantageous due to the doubled probability. You play a game of dice where you are paid the equivalent amount of dollars to the number you roll i.

You roll one fair six-sided die. How much are you willing to pay for this roll? The expected return is every possibility multiplied by the probability of the possibility. How much would you pay to play the same game, but with the option to roll again? If you only roll once you get that score, if you choose to roll again you get the score of the second roll. Intuitively, you know the price should be higher since youre given the option to roll again if youre dissatisfied with your first roll.

You should only roll a second time if the first roll is less than 3. Thus, you have the following six scenarios: rolling 4, 5, 6 and stopping, or rolling 1, 2, 3, and rolling again. Again, the expected roll is 3. Again, same games, option for a third roll now. How much will you pay? Follow the same logic as before; two rolls have an expected return of 4. You have an expected return of 4. You are given a length of rope, which can be lit to burn for an hour.

However, the rope burns unevenly meaning half of it burnt does not indicate a half-hour has passed. How would you burn the rope to know that a half-hour has passed? To measure a half-hour, burn both ends at once. One side will burn faster than the other, but the opposite side will burn slower such that when they meet, the equivalent of half the time has passed.

If you were given two ropes, how would you measure 45 minutes? For two ropes, take one rope and burn both ends like the previous situation.

At the same time, light the second rope on only one end. When the first rope burns out, a half hour has passed. The second rope only has 30 more minutes on it. Immediately burn the opposite end of the second rope. The fire will meet at both ends again, which is fifteen minutes. What is 22 times 22? The interviewer wants you to solve these types of questions quickly and without using paper. Just break down the numbers to simple ones you can do in your head.

There is an additional two instances of 22, which is 44 and then you can add it to so that the answer is What is the sum of the numbers between ? The trick is you have 50 pairs, which each sum to e. You have stacks of quarters, dimes, nickels and pennies. The number of coins in the stacks is irrelevant.

You can take coins from a stack in any amount, any order, and place them in your hand. What is the greatest dollar value in coins you can have in your hands without being able to make change for a dollar with the coins in your hand?

Start adding the highest coin to your hand, the quarter. What is the probability of drawing two sevens in a card deck? You can multiply the individual probabilities to get the cumulative probability. There are four 7s in a deck of 52 cards.

Dont expect to be able to use paper or a calculator for 13 times You can just simplify the math in your head by saying 17 times 10 is , plus 3 times 13 which is 39, and yields Youve got a 10 x 10 x 10 cube made up of 1 x 1 x 1 smaller cubes.

The outside of the larger cube is completely painted. On how many of the smaller cubes is there any paint? First, note that the larger cube is made up of smaller cubes. Think about how many cubes are NOT painted.

What is the square root of 7,, approximately? Edge closer in, 2. A closet has three light bulbs inside. Next to the door outside are three switches for each light bulb. If you can only enter the closet one time, how do you determine which switch controls which light bulb?

Turn on two switches, A and B, and leave them on for a few minutes. Then turn off switch B and enter the room. The bulb that is lit is controlled by switch A. Touch the other two bulbs, which are off. The one that is still warm is controlled by switch B. The third bulb, off and cold, is controlled by switch C.

Four investment bankers need to cross a bridge at night to get to a meeting. They have only one flashlight and 17 minutes left to get to the meeting.

The bridge must be crossed with the flashlight and can only support two bankers at a time. The analyst can cross in one minute, the associate can cross in two minutes, the VP can cross in five minutes and the MD takes 10 minutes to cross.

How can they all make it to the meeting in time? First, the analyst takes the flashlight and crosses the bridge with the associate. This takes two minutes. The analyst then returns across the bridge with the flashlight, taking one more minute three minutes passed so far.

The analyst gives the flashlight to the VP and the VP and MD cross together, taking 10 minutes 13 minutes passed so far. The VP gives the flashlight to the associate, who re-crosses the bridge taking two minutes 15 minutes passed so far. The analyst and associate now cross the bridge together taking two more minutes. Now, all are across the bridge for the meeting in exactly 17 minutes. A lily in a pond doubles every minute.

After an hour, the lily fills the entire pond. When is it one-eighth full? Work backwards. At 59 minutes, it is half full. At 58 minutes, its one-fourth full. Thus, after 57 minutes, it is one-eighth full. Say you are driving two miles on a one-mile track. You do one lap at 30 miles per hour. How fast do you need to go to average 60 miles an hour?

Dont be inclined to guess 90, because the average of 90 and 30 mph is 60 mph. You completed half your goal by going 30 mph. So that first mile took you one30th of an hour or two minutes. However, if you averaged 60 mph for two miles, then that should take twoths of an hour or two minutes to drive two miles.

You already drove for two minutes on that first lap, so its impossible to average 60 mph. This was a trick question. Great candidates quickly ask the fundamental questions and then concisely summarize the situational highlights and risks.

Usually, there is no one right answer, but there is usually at least one targeted point that you should hit. Interviewers expect you to walk through your thought process aloud to note your logic skills. Ask a few questions and then take five seconds to think of your starting point. As you speak, watch his body language for any clues that you are going in the right or wrong direction.

These questions are among the toughest since there is no specific mathematical formula to memorize. Think of what constitutes a great investment as per the capital markets chapter for HFs and the leveraged buyout chapter for PE firms. Use those criteria as a starting point for probing questions like, What kind of experience does the current management have?

The maximum amount of time spend on these questions is probably 15 minutes; ideally you ask a few specific questions that attack the heart of the situation and then provide a neat explanation of your viewpoint. Porters Five Forces In combination with knowing what is the criteria for good investments, Porters Five Forces nicely frames the parameters of the competition in an industry. A successful investment is one that outperforms competitors; HF and PE firms constantly stake opinions and, subsequently, money on which companies or industries will competitively succeed.

Take, for example, entry into the copy store market, like Kinkos. How attractive is the copy store market? Potential entrants: What is the threat of new entrants into the market?

Copy stores are not very expensive to openyou can conceivably open a copy store with one copier and one employee. Therefore, barriers to entry are low, so theres a high risk of potential new entrants. Buyer power: How much bargaining power do buyers have? Copy store customers are relatively price sensitive. Between the choice of a copy store that charges 5 cents a copy and a store that charges 6 cents a copy, buyers will usually head for the cheaper store.

Because copy stores are common, buyers have the leverage to bargain with copy store owners on large print jobs, threatening to take their business elsewhere. The only mitigating factors are location and hours. On the other hand, price is not the only factor. Copy stores that are willing to stay open 24 hours may be able to charge a premium, and customers may simply patronize the copy store closest to them if other locations are relatively inconvenient.

Supplier power: How much bargaining power do suppliers have? While paper prices may be on the rise, copier prices continue to fall. The skill level employees need to operate a copy shop for basic services, like copying, collating, and so on are relatively low as well, meaning that employees will have little bargaining power.

Suppliers in this situation have low bargaining power. Threat of substitutes: What is the risk of substitution? For basic copying jobs, more people now possess color printers at home. Additionally, fax machines have the capability of fulfilling copy functions. Large companies will normally have their own copying facilities. However, for large-scale projects, most individuals and employees at small companies will still use the services of a copy shop.

The internet is a potential threat to copy stores as well, because some documents that formerly would be distributed in hard copy will now be posted on the Web or sent through e-mail. However, for the time being, there is still relatively strong demand for copy store services. Competition: Competition within the industry appears to be intense. Stores often compete on price and are willing to underbid one another to win printing contracts.

Stores continue to add new features to compete as well, such as expanding hours to hour service and offering free delivery. From this analysis, you can ascertain that copy stores are something of a commodity market.

Consumers are very pricesensitive, copy stores are inexpensive to set up, and the market is relatively easy for competitors to enter. Advances in technology may reduce the size of the copy store market. Value-added services, such as late hours, convenient locations or additional services, such as creating calendars or stickers, may help copy stores differentiate themselves.

But overall, the copy store industry does not appear to an attractive one. Product life cycle If youre considering a product case, figure out how mature your product or service is.

Big to small When giving an answer, a logical outline always sounds more harmonious during an interview. Aim for a flowing conversational tone, bulleting each point so the interviewer can mentally check off the requisite answers you covered. The easiest way to do this is to begin with the most general relevant points and work to the specifics.

Go from macro economics to industry to operations to structural considerations, leaving out or minimizing whatever is not applicable. There are additional frameworks that can organize your thoughts. There are many types; you can read the Vault Guide to Consulting Careers for a more comprehensive review.

However, understanding what constitutes a good investment is the best framework to use in HF and PE interviews.

Consulting backgrounds If you can tell that many of current employees are ex-consultants like PE firms Audax and Bain Capital, or if the firms strategy centers on operational improvements, beware! You can bet that youll get some consulting-focused questions.

Hit the highs It cannot be stressed enough: try to narrow your answer down to the most key elements as soon as possible. For instance, one large PE firm requested, Estimate the annual revenue a pizza shop makes. However, the firm wanted to see if you could identify the limiting factor, which was that pizza shops only have X amount of registers which limits how many customers can be handled at a time.

When given business scenarios to evaluate, always begin with the biggest value drivers. Say you had a bullet proof vest manufacturer. Given only this information, what are weaknesses you can envision for this company? Starting with weaknesses, the first major one is the uncompromising need for quality.

Lives are on the line if the product fails! Expenses need to accommodate the high cost of testing. The threat of potential liabilities is enormous here; an insurance company will charge a higher premium if it elects to represent this company at all.

To some extent, this item is a commodity, but there will definitely be brand differentiation for the players who show consistent quality. A large portion of the buyers will comprise a few government contracts. This is good, in that contracts are usually long-term, which gives certainty to future revenues and inventory needs.

However, governments pick a supplier based on bidding auctions, so there is significant pressure to present the lowest price. How much pizza is sold in New York City every year? This is a strict consulting case question; youll encounter fewer of these in your interviews. These guestimations can be solved either top down or bottom up. Top down approach: Assume that 10 million people live in New York City and that 80 percent of them, or eight million people, eat pizza.

Lets say that the average New Yorker eats pizza twice a month, and will eat two slices each time. Lets assume that 80 percent of the 10 million people in New York City eat pizza. You are giving the following opportunity. A company wants to sell trees in water. In the s, a smelting plant redirected water flow, which flooded a forest used for timberland.

A logger, who is also a scuba driver, has discovered this and wants to sell the wood. How would you look at this investment? This was a real opportunity that this company looked at. Its easy for interviewers to ask questions about actual investments theyve looked at because they know all the answers. Ask if the product is actually saleable. It isbeing 40 feet under water means the wood is not oxizable and, thus, doesnt rot. Ask if there is already an industry that does this. There is, and it is profitable.

Ask about all the regular factors that comprise a good investment, including the experience of management. The interviewing firm passed on this opportunity because the scuba driver had no industry experience. Management is incredibly important because finance guys need to rely on current management to turn around the company relying on equity incentives or else hire industry experts.

Hummus Palace sells gourmet hummus throughout New York City. It distributes its tubs of hummus primarily through two channels: high-end grocery stores and specialty food retailers. Over the past few years, the company has been experiencing a slowdown in its sales. What are three potential growth strategies the company could pursue? To find out why theres been a slowdown in sales, start with asking questions about the industrywhat is the market size, what are some of the key trends and what does the competitive landscape look like?

Then inquire about the companywhat is its growth profile and value proposition? Is it a scalable business, and does management have the knowledge and experience to turn the company into a market leader? These questions should provide you with some context to help you come up with growth strategies for the company.

Hummus Palace could grow through acquisition or organically. It could expand into new product lines gourmet falafel , new channels hummuspalace.

After debating the merits of each, the interviewer says that the CEO wants to pursue a geographic expansion strategy. Which market should she expand into? San Francisco could be an interesting market because of its similarity to New York. San Francisco has a young urban population that would likely enjoy ethnic foods and be open to trying new cuisines.

The city also would have a large number of high-end grocery stores and specialty food retailers to sell to. The CEO thinks that San Francisco is a great idea, but this new operation must break even in five years. Should Hummus Palace expand into this new market? Ask questions about the revenue and cost structure. How much will each tub of hummus cost and how many do they expect to sell?

What are the variable and fixed costs? What are the needed capital expenditures, both maintenance and growth? What are the working capital needs? You think you can sell , plates per year. You own a Christmas tree business. What are your working capital needs throughout the course of the year? Inventory would likely need to be accumulated starting in November, since many people start hanging up Christmas lights and putting up Christmas trees the weekend after Thanksgiving.

The inventory buildup would continue through late December. After Christmas however, demand for Christmas trees disappears. Hopefully by then there is very little inventory left, if managed properly. Since this is a cash business, where customers are paying for the trees in cash, receivables have little effect on the working capital balance and are insignificant relative to the companys inventory requirements.

Payables would likely increase in the fall as the company accumulates inventory in anticipation of the upcoming holiday season and pays for the trees with credit.

Say you have a phone book business. If you increase your price by 10 percent but lose 10 percent of your advertisers, whats your revenue change? Mathematically speaking, originally you had 1. Now you have. Say there is City 1 and City 2. Which city do you want to advertise in?

Make this apples to apples. City 2 has 16, businesses with 32, people. Thus you are paying the same for more competition and fewer target consumers. City 1 is the obvious choice now. What do you think about the paper phone book business? Its a maturing business, so future growth rate is likely to be negative.

It is an increasingly outdated form of advertising, especially in comparison to the internet. Also, the growth rate in the U. The key age demographic to focus on is the elderly, who may not use other prevalent forms of advertising. The main advantage of a phone book that it appeals to a niche audiencethe local city population who refers to the phone book to look for local businesses. But the industry continues to mature rapidly because this niche information is increasingly being uploaded to the internet.

Paper phone books need to take advantage of the internet channel, which enjoys lower distribution costs, and focus on ways to make online. However, competition is fierce; Google already provides a similar function.

A good company that has created a value-added twist on the business is Yelp, a website that posts user-generated reviews of businesses. Businesses can pay to advertise in designated spots of the site based on what the user is searching for. Generally, a hedge fund aims to beat the overall market and produce outsized returns. Usually at the cost of being aggressive, some succeed and others implode. HFs would love to hire psychics: candidates who could effortlessly tell them which stocks will go up in the next year, but no one has a crystal ball.

So the hardest part about the HF interview is that your interviewer will grill you on your market opinion and outlook, but both of you may make the wrong predictions. To ace the interview, have a strong opinion on whatever your interviewer asks about, but also be prepared to equally argue the opposite side. Furthermore, show depth over breadth. Its the tiny tidbits of knowledge that demonstrate your prowess as an investor.

Enunciate a logical and succinct thought process; quickly separate the big factors that affect value the most. Always discuss an investment in light of its rationale, risks, peers, industry and macroeconomics.

Furthermore, remember that anyone can argue the case for a hypothetical good investment, but hedge funds would like to put their limited amount of money to work in the best investments. The best investments have the lowest risk and highest growth.

Finance: Many of the technical questions zero in on the time value of money and free cash flow. Valuation measures a companys future cash flows. Unlevered, free cash flow is the focus of many investors because it provides a good measure of a firms ability to generate cash, independent of its capital structure.

Markets: You will be quizzed on your knowledge of the current market, like todays interest rate. Investment ideas: You may also be asked specific investment ideas, like stock pitches; this occurs in over 50 percent of interviews. Have at least two ideas prepared. Hedge fund definition During the early years of the hedge fund industry ss , the term hedge fund was used to describe the hedging strategy used by managers at the time.

Hedging refers to the hedge fund manager making additional trades in an attempt to counterbalance any risk involved with the existing positions in the portfolio. Hedging can be accomplished in many different ways but the most basic technique is to purchase a long position and a secondary short position in a similar security.

This is used to offset price fluctuations and is an efficient way of neutralizing the effects of market conditions. Today, the term hedge fund tells an investor nothing about the underlying investment activities, similar to the term mutual fund. Technically, a hedge fund is a private, unregistered investment pool encompassing all types of investment funds, companies and private partnerships that can use a variety of investment techniques such as borrowing money through leverage, selling short, derivatives for directional investing and options.

Given the devastation that the current economic crisis has wreaked on the market, hedge funds have seen millions to billions of dollars disappear under their management. Many will cease to exist in the near future try to suss this out before taking an offer! For interviews, the absolutely essential thing to understand is what kind of investment strategy your interviewing firm employs.

There are many different ways for managers to value stocks, but that is beyond the scope of this book; there are many popular trading investment theory books that you can read.

Here is a basic overview of the valuation process that a hedge fund manager or analyst goes through in picking stocks to invest in. Valuation process When an analyst is looking to value a company to determine what he thinks should be the correct stock price he goes through a process to determine what he believes the stock price to be. This is similar to the process of buying new clothes or buying a car or house when you figure out how much it is worth to you and how much you are willing to pay.

You are looking for the best deal availableif a price is above what you are willing to pay, you do not buy the product; if the price is below what you are willing to pay, you do buy it.

According to Reilly and Brown in their book Investment Analysis and Portfolio Management, there are two basic approaches to valuing stocks: the top down and the bottom up process: 1 The top down three step process The manager believes that the economy, the stock market and the industry all have a significant effect on the total returns for stocks.

The three-step process is: i. Analysis of alternative economies and security markets. Decide how to allocate investment funds among countries and within countries to bonds, stocks and cash. Analysis of alternative industries. Decide based upon the economic and market analysis, determine which industries will prosper and which will suffer on a global basis and within countries. Analysis of individual companies and stocks. Investors who employ the bottom up stock picking approach believe that it is possible to find stocks that are under and overvalued, and that these stocks will provide superior returns, regardless of market conditions.

How to value these assets? Without going into the complex valuation methodologies, the basic process of valuation requires estimates of 1 the stream of expected returns and 2 the required rate of return in the investment. Once the analyst has calculated these expected returns he can then compute his expected value of the stock. The hedge fund trading strategies aim to maximize investor return while hedging market risk.

Lets now take a look at these strategies in detail. Fixed income arbitrage Fixed income arbitrage also known as relative value arbitrage involves taking long and short positions in bonds and other interest rate-sensitive securities. The positions could include corporate debt, sovereign debt, municipal debt, swaps and futures.

The Vault Career Guide to Venture Capital, Sixth Edition provides an insider's perspective on what's happening in the venture capital industry, what it takes to break in and how to advance your career, helping you master every step of your job search. Vault Career Guides offer an industry insider's view of what it takes to land a job in your chosen profession.

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Acknowledgments Alice Doos acknowledgments: The author would like to thank her family, friends, and colleagues for all their support and help. First, thanks to Vault editor, Matt Thornton for taking a random chance. Mom and Dad, thank you for a lifetime of encouragement. Thanks to all the firms who interviewed me and said no, because how else could I have gained the credentials to write this book? Vaults acknowledgments: We are extremely grateful to Vaults entire staff for all their help in the editorial, production and marketing processes.

Vault also would like to acknowledge the support of our investors, clients, employees, family and friends. Thank you! Preparation is Key. The Right Background. Overview of the Interview. Switch Perspectives. Solid Foundation. Sample Questions. Standardized Acumen. Case Questions. Hedge Funds. Private Equitys Golden Egg.

Visit the Vault Finance Career Channel at www. Getting a coveted position in the prestigious industry of hedge funds HF and private equity PE boils down to one question: Will you make money for the firm?

The entire interview is devoted to determining that answer. All answers should be prepared accordingly. If you have focused on industry expertise, be sure you can pick out specific companies that would be ideal investments based on the specific criteria of the investment strategy of the interviewing firm.

Seriously, why you? Most likely, you are already in the industry or working in a breeder field like investment banking, sales and trading, or consulting. Even more likely, you are at a prestigious firm that you already sacrificed blood, sweat, and tears to break into. First, pat yourself on the back for being successful. But next, realize the competition for buy-side gets much worse. If you arent already at Goldman Sachs or Morgan Stanley with an Ivy League education, then you better fine-tune your strategy.

Also, unfortunately, this book is being written in early when buy-side jobs are particularly scarce. Youll need to make it past the headhunters who pre-judge you, answer technical finance and accounting questions about a field in which you may have zero experience, and even be tested on the spot by being creating an Excel model from scratch or presenting a case study.

In addition to being intelligent and capable, you absolutely must fit into the culture. Note to the audience This guide covers all levels in the private equity and hedge fund space. However, the more junior the position, the more regimented the interviews and thus they are easier to catalog. Therefore, this guide will highlight the junior, pre-MBA interviews, which are very similar across firms. As the position gets more senior, the more the interview will focus on real work and deal experience over technical questions.

Wash, rinse and repeat Practice as much as you can. This author didnt get comfortable with interviewing until she bombed her first bunch.

By the 10th interview, she slept with her eyes open while she spewed out packaged answers.