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5 intervew questions for someone applying for an analytical hedge fund position


claphands22
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I just got done reading Money Mavericks: Confessions of Hedge Fund Manager by Lars Kroijer. It was pretty good, but then again, I'll read anything financial related (especially if I read it for free; thank you public library)...cockroaches have higher standards than I do. Yet, I thought the list of five questions were pretty interesting. They weren't really "value" questions, but I thought I had a pretty good handle on this financial stuff - but I didn't feel confidant with my answers to #1, #2, partially #4, and #5. Basically, I would have bombed this guys interview.

 

I thought I give this board a go.  More talk about analysis, the better I figure. 

 

"

I devised ten simple questions that I would ask everyone we interviewed for an analytical position. here are five of them (and if you want to work in a hedge fund, it would be useful for you to work out the answers):

 

1. When you try to separate out the stake Company A owns in listed Company B, what role does minority interest on the balance sheet of Company A play in finding the deconsolidated financial statements?

 

2. French company Renault has a large stake in Japanese Nissan. discuss currency exposures and what you could do to limit them. Suppose Renaut guaranteed Nissan's debt: how would you think about the magnitude of this potential liability?

 

3. A company changes depreciation of an asset from 10 to 12 years. What will this mean to its stated cash flows and earnings? What does it mean to cash flow and earnings if you change AR (accounts receivable) days from 25 to 35 next year?

 

4. Company A has a large unfunded pension liability. Is this a real liability? Should it be counted as debt? If you know that the net deficit is $10 million do you care about the gross assets and liabilities? What else do you want to find out?

 

5. What is 'duration' in the context of bonds? Does a bond have beta exposure to a market? 

 

I found many of those I interviewed unable to answer the questions to the level we required, however nice they were as people."

pg 93

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If you are looking for a resource on interviewing in the hedge fund industry, Hunter at Distressed Debt investing has a good website on it:

 

http://howtogetahedgefundjob.com/blog

 

There are several posts of interest.

 

Now, at some point, this person will ask you questions. In my past experiences, these questions will fall into one of five broad categories. Here are the categories and examples, in decreasing order or frequency…i.e. #1 = you will always see:

1. Personal Experience Questions: Give me a 5 minute run down of your education and past experiences? What was it like working on a trading floor? Did you enjoy investment banking? How were portfolio decisions made at your old shop? What industries have you worked in? Etc.

2. Case Study Questions: How did you go about your research? Did you talk to management and if so, what did they say? Who are the competitors and what is the margin structure of the industry? What do the covenants look like?

3. Views on the Market/Individual Stocks: What do you think about the market? Have you looked at XYZ Situation? What do you think about it? Where are interest rates going? Any sectors you currently bearish/bullish on? Any stocks you like here? (as an aside, above all single questions, that is the most frequent one of the whole list)

4. Technical Knowledge: How do you calculate FCF? How do you calculate the cash conversion cycle? Do unsecured note holder want a high or low valuation in a bankruptcy? What is fraudulent conveyance? Etc.

5. How you think Questions: Why are manhole covers round? How many Christmas Trees are sold in the United States? If you had two companies with identical capital structures, how would you decide which one to invest in? What is the most important thing you look for on the balance sheet?

Rapport has been established. Questions asked. You should have impressed him/her by now and they probably should already think you deserve a round #2. They will then ask if you have any questions for them. Yes. You always have questions for them. The questions I always ask:

• How does an analyst get ideas in the book? Is there a give and take with the PM, group discussions? How is the idea generation process performed? Etc.

• If they have not already delved into it, the history of the fund and its founders and the background of the interviewer.

• Historically, what has distinguished the people succeed in the culture of the firm and moved up their responsibility?

 

Here is his main blog:

 

http://www.distressed-debt-investing.com/

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Here is my answer to 3. (not good?)

 

When a company changes their depreciation - it's an accounting change not a business change. Therefore, the GAAP earnings will rise, but the cash flow will stay the same. If you increase the AR - the net income will not change since the GAAP earnings depend on accrual accounting, but the cash flow will decrease since you'll have to wait 10 more extra days each billing cycle to get paid.

 

Partial answer to 4. (I don't know if this is a good enough answer)

 

Large unfunded liability is a real liability. In terms of creditors of the company, the pensioners are a head of the common stock holder. Although in the short term they might get away with not getting funded - the long term they won't - especially if there is a bankruptcy/liquidation.  It should be counted as debt, but it should be an intalicized portion of the debt since they probably don't have the same covenant restrictions of other debt.  Yet, it's important to know the deficit size in relation to the asset size of the company. A large company like JNJ will have an easier time confronting this problem (generally) than a small company with have a larger problem with a larger amount of debt. You would also want to find out what kind of actuarial assumptions they made about the returns they expect on their investments. If they expected a very significant return, then the deficit could even larger since the actuarial estimates are too large. If they expected a small return, then the deficit might be counterbalanced by the the conservative estimates.

 

1) not entirely sure. I know 80%+ is fully consolidated, 20% is equity consolidated, 50% is consolidated somehow else...? not sure

 

2) Not sure how to handle the currency exposures. I would say hedge them. Yet, not sure what kind of tool I would use. In terms of the magnitude of the liability, I would have to see how strong Renaults earning power/assets are to sustain whatever liability they were given.  (my answer to way too vague & in partial ego defense, I'm tired)

 

3.) answered above

 

4.) tried to answer above

 

5.) duration - how long the bond will last until it's due? I am not even sure what beta means for stocks... I really don't know.

 

 

---

That was my crappy crack at it.  Was hoping this smart crowd can fill in the blanks and show the error of my thinking.

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Hey Junto,

 

Thanks for the links. I am not really preparing for a hedge fund interview, not that I wouldn't mind working at one, but I rather set my goals on something more attainable - like doing a load of laundry before I go to bed. haha

 

I am just interested in the analysis and trying to figure out the best answers. Thanks again for the links, I enjoy distress debt investing.

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These mostly look like CFA leve 2 questions.  I was able to answer them mostly in me head & out loud without any time constraint or pressure of the interview so take that into account.  Under an interview scenario I think I would have had some difficulty on some.

 

1) It depends on the size of the investment as it pertains to company B.  There different ways for accounting for a minority interest passive vs minority interest active, a controlling interest and a joint venture.  The interviewer is asking about minority interest on the balance sheet which implies it's most likely accounted for using the full consolidation method.  Companies must fully consolidate if company A owns more than 50% but less than 100% if company B.  Assets and Liabilities are consolidated fully on the parent company and a line item titled minority interest is added to equity as a contra balance.  Company A subtracts the percent not owned of company B's net assets.

 

2) The value of the investment in Nissan would fluctuate depending on the Yen's movement.  Renault wouldn't mind if the Yen appreciated against the Euro, post investment, because that would increase the value of the investment when translated back to Renault's balance sheet.  You would however protect against Yen depreciation using either a future or forward.  You would (and this is where I would most likely slip up) sell Yen and Buy Euro's (please correct me if I'm wrong).  If Renault guaranteed Nissan's debt then you would add that debt to Renault's balance sheet and from there you would have currency risk related to the Yen denominated debt.  You would have interest rate risk if it was variable debt.

 

3) Increasing the depreciated life of assets will decrease the annual depreciation expense on the income statement.  With a lower expense on the IS, you will then increase net income.  On the cash flow statement you start with NI and add back depreciation so I don't believe changing the depreciated life of an asset would change the companies cash flows.  Increasing AR days would imply a longer cash collection time, and therefore decrease cash flow from operation.  Changes in AR aren't recorded on the income statement so NI would not change.

 

4) The unfunded pension liability is a real liability and should be on the balance already as a pension liability.  You would want to know about the size of the asset and liability together with the size of the underfunded status.  The bigger the asset base, the easier it would be to possibly earn $10m on those assets.  Additionally you would want to know what rate of return and discount assumptions the company is using.  Whether the plan is closed or open to new employees, and the age of the plan's participants.  Also you would want to know whether the company's cash flows could sustain the negative cash flow's that would be required to fund the pension liability.

 

5) Duration is a bond's price change given a 1% up or down movement in interest rates, so in some ways it is a beta to the general interest rate.  Bond's with a longer maturity typically have a higher duration than shorter term bonds. 

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Wow, flashbacks of the CFA exam in reading those questions

 

Duration, this is the percentage change in the bond/s/fund for a 1% change in interest rates.  So if you have a bond with a duration of 2.2 a 1% increase in rates will mean a 2.2% drop in the value of the bond.

 

Nissan and Renault, just spent some time on this recently.  You can hedge with futures or synthetic options.  So for example if Renault wanted to hedge their position they could do this call option + treasury - underlying = synthetic put (I think, bit rusty on the formula).

 

As for Renault guaranteeing Nissan's debt I'd look at it two ways.  The first is consider a liquidation, can Nissan's assets support the debt?  Probably not, that's why they need the guarantee, so look at under what condition an impairment would occur for Nissan such as % drop in sales or % rise in costs, then examine the impact on Renault.  Secondly I'd consider this a full debt for Renault less any expected recovery from a liquidation.  Maybe Nissan can support 60% of the debt so 40% is Renault's.

 

Change in depreciation doesn't affect cash flows, but increases earnings if it's lengthened.  AR means nothing for earnings, but cash flow will drop.

 

Pension is a real liability, look at GM, pension owns part of the company along with the Gov, where are equity holders?  They're writing off their losses, some bond holders were trumpted as well.

 

As for the minority stake it depends on how much the company owns.  Different thresholds mean different things in breaking out the consolidation.

 

So that's my best shot.

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If I ran a hedge fund I wouldn't ask any of these questions as they are largely irrelevant. I don't care if the guy or girl knows anything about money or finance, that can be easily taught. What I care about is the operating system in their head. For that, you have to ask questions about how the person thinks about problems, what is his/her ability to concentrate, partnership dynamics, what is their general approach and principles. Like Munger says, I want to know if the person has the right mental models to approach any problem in any field and that they don't suffer as much from the psychological and behavioural pitfalls that many people do.

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Increasing the length of depreciation will boost earnings but lower cash flow b/c the tax shield is lower (assuming the D&A on the income statement is same as the company's tax returns - i.e using double-declining D&A for tax purposes versus straight line on the income statement).

 

EBITDA = $1,000

D&A = $100 (initial base of $1,000 depreciated over 10 years)

EBIT = $900

Taxes = $360 @ 40%

Net Income = $540

Cash flow = $540 + $100 = $640

 

EBITDA = $1,000

D&A = $83 (initial base of $1,000 depreciated over 12 years as oppose to 10)

EBIT = $917

Taxes = $367 @ 40%

Net Income = $550

Cash flow = $550 + $83= $633

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