ADVA 

FINAN VAULT GUIDE TO ADVANCED FINANCE AND QUANTITATIVE 

INTERVIEWS 

QUAN 

Customized for: Jason (jason.barquero@cgu.edu) 
© 2002 Vault Inc. 
Customized for: Jason (jason.barquero@cgu.edu)
Copyright © 2002 by Vault Inc. All rights reserved.
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Library of Congress CIP Data is available.
ISBN 1581311729
Printed in the United States of America
Customized for: Jason (jason.barquero@cgu.edu)
Vault Guide to Advanced Finance and Quantitative Interviews
Table of Contents
INTRODUCTION 
1 

. Problem Solving Strategies Your First Step . Sample Questions and Answers . . . . . . . . . . . . 
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BOND FUNDAMENTALS 
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. Time Value of Money . Bond Basics . . . . . . . . . . . . . . 
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Bond Prices and Relationships to Yields 
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Taylor Series Expansion Bond Price Derivatives . . . . . . 
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Sample Questions and Answers 
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Summary of Formulas . . . . 
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STATISTICS 
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Permutations and Combinations Functions of Random Variables 
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Distributions . . . . . . . . . . . 
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Regression Analysis . . . . . . 
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Sample Questions and Answers 
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Summary of Formulas . . . . 
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.78 
Visit the Vault Finance Channel, the complete online resource for finance careers, featuring firm profiles, message boards, the Vault Finance Job Board, and more. http://finance.vault.com
C A R E E R L I B R A R Y
Customized for: Jason (jason.barquero@cgu.edu)
Vault Guide to Advanced Finance and Quantitative Interviews
Table of Contents
DERIVATIVES 
81 

Introduction to Derivatives 
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Forward Contracts . . . . . . 
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Futures Contracts . . . . . . . 
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Swaps . . . . . . . . . . . . . . . 
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Options: An Overview+RC 
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Combining Options . . . . . 
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Option Valuation I: Introducing BlackScholes Option Valuation II: Other Solution Techniques 
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Option Sensitivities: the Greeks 
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Exchangetraded options . 
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Exotic Options . . . . . . . . . 
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Sample Questions and Answers 
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Summary of Formulas . . . 
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FIXED INCOME 
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Bond and Fixed Income Market Issuers Types of Fixed Income Securities Quoting Bond and Fixed Income Prices 
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Analyzing and Valuing Bonds and Fixed Income Securities Fixedincome Specific Derivatives 
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Mortagebacked Securities 
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Sample Questions and Answers 
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Summary of Formulas . . . 
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Equity Markets . . . . . . . . . 
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Equity Valuation Overview Dividend Discount Model 
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Multiples Analysis Return on an Asset . . . . . . . . . . . . 
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CAPM . . . . . . . . . . . . . . . 
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Equity Indexes . . . . . . . . . 
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. Equityspecific derivatives Hybrids . Sample Questions and Answers . . . . . . . . . . . . . . . . . . 
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C A R E E R L I B R A R Y 
© 2002 Vault.com Inc. 
Customized for: Jason (jason.barquero@cgu.edu)
Vault Guide to Advanced Finance and Quantitative Interviews
Table of Contents
CURRENCY AND COMMODITY MARKETS 
283 

Currency Swaps . . 
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. Sample Questions and Answers Comodity Swaps . . . . . . . . . 
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RISK MANAGEMENT 
297 

Measuring Market Risk: Value at Risk 
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Types of Risk Currency Risk . . . . . . . 
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Fixedincome Risk 
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Equity Risk . . . . . 
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Currency and Commodity Risk in the News 
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Hedging Risk . . . . 
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Portfolio Risk and Correlation 
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. Sample Questions and A+R[47]Cnswers Arbitrage . . . . . . . . . . . . . . . . . . . . . . 
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APPENDIX
Advanced Finance Glossary About the Author
Visit the Vault Finance Channel, the complete online resource for finance careers, featuring firm profiles, message boards, the Vault Finance Job Board, and more. http://finance.vault.com
C A R E E R L I B R A R Y
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ADV
FINAN
INTRODUCTION
QUA
Customized for: Jason (jason.barquero@cgu.edu)
Your First Step
Vault Guide to Advanced and Quantitative Finance Interviews Introduction
Congratulations on taking your first step to succeeding in your advanced finance interviews. This book was written to give you the technical background needed to master that interview – compiled into one convenient volume. Quantitative and Wall Street interviews are notoriously tough, and with good reason. These types of jobs pay very well – and a lot of people want them.
This book will give you the edge you need to succeed. This is the book the writers and editors wish they had when they were interviewing. It is the distillation of years of experience in the finance field, in teaching finance and in numerous interviews. Vault editors have even taken interviews just to find out what kinds of questions interviewers are currently asking, in order to bring you the latest in this book.
In quantitative interviews, mastery of the subject matter is assumed – it is your starting point. You will also have to convince your interviewer(s) you are the right fit for the firm and have the experience and background that they are looking for. Of course, no book can give you that – though the Vault Guide to Finance Interviews gives you helpful pointers in that direction.
What this book can do is help you review and master the required subject matter, without which no amount of charm will get you by. (Although charm is always good.)
Also unique to this book are strategies to help you succeed on those tough interview questions that you may not be prepared for. Some questions you may get are deliberately designed to be impossible to answer. The interviewer just wants to see how you think and how you approach problems. Remember, all of the easy problems have already been solved. The problems you will see on the job will likely be things that no one has quite seen before.
Still, you will find some interviewers who will ask questions straight out of textbooks (one insider reports receiving the following question in a recent interview with Bloomberg: “What is an equivalence statement in FORTRAN and why would it be used?”) It is simply the style of certain companies and interviewers to ask questions from textbooks, so you should be prepared for this if you want to land a job. For inside information on interviewer style, you may want to check out the Vault message boards. For everything else, let this book be your guide. Wherever possible, we’ve used questions from actual interview experience, including the interviewer’s comments on what they were looking for (when we could get it).
It is our hope that you will find the problem solving strategies and the material in this book indispensable to you even after you land your job. Good luck!
Visit the Vault Finance Channel, the complete online resource for finance careers, featuring firm profiles, message boards, the Vault Finance Job Board and more. http://finance.vault.com
1
Vault Guide to Advanced and Quantitative Finance Interviews Introduction
Problem Solving Strategies
Customized for: Jason (jason.barquero@cgu.edu)
What do you do when confronted with an interview question you have absolutely no idea how to solve? We recommend the following strategies – it should help you handle most anything thrown at you.
Strategy #1 
Cite from memory 
Strategy #2 
Draw a figure 
Strategy #3 
Work backwards 
Strategy #4 
Formulate an equivalent problem 
Strategy #5 
Enumerate all cases 
Strategy #6 
Search for a pattern 
Strategy #7 
Bracket the answer – solve the extreme cases 
Strategy #8 
Relate to something you know 
Strategy #9 
Take advantage of symmetry 
Remember to RELAX. Try to see these interviews simply as conversations. It is a chance for interviewers to evaluate you, but remember, you are also deciding if you want to work there as well. The more relaxed and calm you are, the easier it will be for you to think creatively, which is often what is required in finance interviews. Also, try to think of the tough interview questions as amusing little problems (the interviewer probably does). One recent interviewee reports having an interviewer grill her relentlessly on currency forwards, interest rate parity and so on. When the job seeker finally reported being unsure of the approach to one question, “The interviewer laughed and said, ‘Don’t worry. If you had known the answer to this problem, I would have found something else that you don’t know. That’s my job.’”
Remember, sometimes you will be able to use one strategy by itself to answer a question, but imagine what
a powerful approach it is when you can combine two or more. Those tough interview questions won’t have
a chance. You will see the above strategies used throughout this book, and identified to help you remember them. Often, problems can be approached from more than one angle, so don’t feel that you must use the approach we show.
Visit the Vault Finance Channel, the complete online resource for finance careers, featuring firm profiles, message boards, the Vault Finance Job Board and more. http://finance.vault.com
2
Sample Questions
Vault Guide to Advanced and Quantitative Finance Interviews Introduction
Customized for: Jason (jason.barquero@cgu.edu)
1. You have a sheet of paper and an infinite supply of tokens.
tokens. We take turns placing tokens on the paper, one token at a time. We cannot place tokens on top of other tokens (no overlapping), and the tokens cannot extend over the edges of the paper. The last player to place a token on the paper wins. What is your winning strategy? (This is called a “strategy game” question, and is an actual question recently asked on a hedge fund interview.)
I also have an infinite supply of
Solution: Don’t freak out if you see something like this. The interviewer is just trying to get a sense of how you attack a new problem. Let’s go through our list of tactics. Tactic #1 will not work here. Tactic #2 has promise: Try breaking it down into smaller subproblems. What if the paper were so small that only a single coin could fit on it?
In this case your strategy would be to go first.
place his, and you win. Next, what if the paper were big enough for two coins? Here, you place your coin in the dead center of the sheet so your opponent can’t place his coin. Again, your strategy would be to go first.
After you place your coin, your opponent has no place to
Prohibited
This tactic can be repeated until you have derived the correct answer: You always move first, and if you play the game properly, you will always win.
2. What do you think is the major factor impacting the profitability of an airline? (This was an actual question asked in a Goldman Sachs equity quantitative research interview.)
Solution: This is another question that the interviewer doesn’t expect you to have memorized, but expects you to go through a reasoning process enumerating possible factors affecting airline profitability to come up with the most important one. You could say, “passenger meals, labor costs, weather delays, leasing costs, marketing, maintenance, price wars,” but the major cost driver is probably “fuel.”
3. Would the volatility of an enterprise be higher or lower than the volatility of its equity? (Actually
asked by a Goldman Sachs interviewer who kept coming back to this in one form or another during the interview.)
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3
Customized for: Jason (jason.barquero@cgu.edu)
Vault Guide to Advanced and Quantitative Finance Interviews Introduction
Solution: This is a straightforward Statistics or Corp Finance 101 question. Even if you have never seen this exact question before, it can be reasoned out. In the following response we employ a combination of tactics #1 and #5.
Corporations usually have both debt and equity (we reason.) So, suppose you have a portfolio consisting of w percent equity and (1w) percent debt. We calculate volatility as the square of the standard deviation of
stock returns. Then
2
p
w
2
E
1
2
D
w
Assume that the covariance is zero. Then
Now, consider three cases.
2
w
1
2
p
w
2
E
1
w Cov
E
2
D E
,
w
D
D
Case one: There is no debt. Then the variance of the enterprise ( _{p} above) is equal to the variance of the equity.
Case two: There is no equity. Then the variance of the enterprise ( _{p} above) is equal to the variance of the debt.
Case three: There is a combination of the two. We have bracketed the answer already in cases one and two: the result must lie in between these. Now a judgment must be made. Assume that the volatility of the debt is lower than the volatility of the equity. Then the volatility of the enterprise with both debt and equity will be lower than the volatility of the equity alone, since the volatility of the enterprise is somewhat of a weighted average of both debt and equity. Also, note that we multiply the volatility of the equity by w, a fraction assumed to be less than one. The only way that we could have volatility of the enterprise higher than that of equity alone would be if _{D} > _{E}
and if w were negative (impossible). To see this, rearrange the equation to
vol of debt equals vol of equity, vol of the enterprise still equals vol of the equity.
2
2
w . If the
p
E
D
D
2
2
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