6 Finance Interview Questions that Test Your Market Knowledge

In light of the credit crunch of late 2008, students are going to see the same How did we get here? question
masked in a variety of forms. A solid understanding of subprime and other credit-related products, write-downs,
and leverage is key to answering these kind of questions. Below are some examples of questions you might
expect. All of these are designed to test your knowledge rather than assess your past behavior.
1.

What is meant by market-to-market? Why is this important to hedge funds, banks, etc.? Why is it
relevant now, more than ever?

Market-to-market is the process by which securities are recorded on financial statements using current market
prices, as opposed to purchase prices or accounting values. As the credit unraveled, many banks and investors
were forced to write down assets to current market values. This had a dramatic impact for a multitude of
reasons. For example, many banks and investors and banks could borrow. Secondly, as assets are marked
down, investors are often likely to sell (and/or forced to sell) their assets so that they dont keep losing value.
Selling naturally depresses market values further, causing a ripple effect: As more and more is sold more and
more value is lost. As we saw in late 2008, this can cause a panic, where people seek to move large amounts
of personal investments into cash and are willing to sell at any cost.
2.

How do you think the credit crisis happened?

Although this cant be summed up in a sentence, paragraph, chapter, or even a book, there were a number of
important events that caused and/or fueled the crisis. First, over the previous few years, consumer and
corporate borrowing reached record levels due to low interest rates and friendly borrowing conditions. This led
to a significant expansion in corporate growth from personal spending. In this expansionary cycle, many
individuals and corporations were lent money they should not have been, which led to a massive amount of
supply in the new-issue securities markets, most notably the mortgage market and the credit markets. People
were buying new homes at record rates, and companies were completing a record number of deals.
However, as demand from investors for these new types of assets evaporated and the economy slowed, a
massive amount of new supply that had not yet been sold (new mortgages, LBOs, etc.) was stuck in the
system. These new deals were then sold at a discount (or never even sold at all), thus depressing market
values. Furthermore, this oversupply and the effects of the slowing economy led to increased consumer
defaults on mortgages, increased corporate defaults on loans and bonds, massive write-downs by financial
institutions, and significant losses in the financial markets.
The true difference between this and other cycles was the record amount of consumer and corporate leverage,
as well as the creation of significant investor value that led to a period of insatiable demand and new innovative
financial products. However, once the demand slowed in 2007, the markets were left to deal with
repercussions.
3. What is meant by recovery value?
Recovery value is the amount an investor receives in bankruptcy liquidation from his investment in a particular
financial instrument (and recovery rate is the associated percentage). For example, if an investor received 40
cents on the dollar for every bond that she purchased in a particular company, the recovery value would be
0.40 and the recovery rate would be 40 percent. Distressed credit investors are particularly concerned with
recovery values. It is also to note that the more senior the investment an investor makes in an companys
capital structure (debt vs. equity), the more likely the investor will recover his investment in bankruptcy.
4. What is a NINJA loan?
NINJA is a standard acronym for a type of a loan to a homeowner that requires no income, no job, and no
assets. Its often categorized as a subprime loan, as it is typically made with little to no paperwork, generally to
borrowers with less than an average credit score. Many economists pointed to these types of loans as a sign of
the impending subprime meltdown and the deterioration of lending standards by banks and mortgage
originators. These, as well as other types of loans, were packaged (i.e., grouped together) and sold to investors
as CDOs (Collateralized Debt Obligations). The fundamental argument in favor of CDOs is that these
mortgages were well diversified across different geographies, loan sizes, and income levels, such that the only

way they would all default is if there was a major collapse in the mortgage market in general, due to oversupply
and a widespread economic slowdown. This is precisely what happened in late 2007.
5. What are some examples of defensive stocks?
In general, a defensive stock is one that performs well during a period of economic shutdown, such as that of a
basic goods company or even a discount retailer. These stocks do not generally outperform the market during
periods of rapid economic growth, and thus they typically trade at lower P/E ratios than many competitors, as
well as have significantly lower volatility. Defensive stocks are often mature, dividend-paying stocks.
6. What do you think are some good investments in an economic downturn?
Although similar to the previous questions, this question is likely to be posed in todays volatile markets. A good
answer will have a practical view, as well as show some fundamental research. For example, if you were to
recommend an investment in discount retailers, you might be asked some sector fundamentals (i.e., historical
P/E ratios, performance during past downturns, etc.), as well as what you personally think about a particular
companys market position (i.e., whether or not you like the product offerings, what you think of the companys
strategic positioning, etc.). In a tough job market, its especially advised to prepare your own market view and
have investment ideas and clear examples before heading into an interview.