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How to make a coding challenge to hire a new engineer?
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I do a code review in the problem domain for my applicants. For instance, for my devops/sre interviews, I have some shell, docker, python, terraform, helm, and circleci files in a repo that all have some issues. For frontend dev, I do the same but with the frameworks we use (next/react, jest, cypress), and the same for backend (python, sam, flask, flyway, and pytest).
Some of these problems are logical, some are syntactic, and some are obvious poor practices, and some are esoteric issues that would only be obvious to an SME (and may not be obvious then, because it should become a discussion of the tradeoffs of one approach over another). The projects are not any bigger than they need to be to function for the interview, and they should not take more than an hour or two to read and assess for the caliber of candidates we seek.
I give candidates access to the repo a week ahead of time and ask for them to come to the interview with a list issues to discuss.