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• Answer 50 questions in 15 minutes.
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This is a study tool. The 3 wrong answers for each question are randomly chosen from answers to other questions. So, you might find at times the answers obvious, but you will see it re-enforces your understanding as you take the test each time.

1. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
Tax on the entire value of assets held - principal + earnings - not just earnings - has the same effect as an accrual tax - only taxes are paid at a (usually) reduced rate
Single privately-held stock - high degree of control - immature firm - very high unsystematic risk - face significant residual risk - limited or restricted liquidity - zero cost basis in the original investment - desires tax efficient transfer to hei
The testator
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase


2. Define capital gains taxes.
Investors have too much confidence in their ability to forecast - they tend to discount or even ignore info that does not support their choices - they interpret info based on their current frame of mind and the medium through which it is received
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
1) credit method 2) exemption method 3) deduction method
Taxes paid on the gain (long or short position) when an asset is sold or purchased


3. Investor questionnaires help to determine what?
High need for financial security - High need to avoid losses - Don't like to make own investment decisions - Don't trust others to make investment decisions - either - Tend to select least volatile assets - Low asset turnover - Frequently miss invest
Using HIFO accounting - an investor assumes the lot with the highest tax basis was sold to either maximize the loss for harvesting or minimize the taxable gain
Payments are based on the performance of a mixed-asset class portfolio selected by the investor (client) - investor receives a fixed number of 'units' each period - value of each unit increases (decreases) during periods of rising (falling) market re
Risk tolerance and decision-making style


4. What is loss aversion?
Distribution of outcomes provides a better indication of the risk/return tradeoff - show the tradeoff b/t short-term risk and ability meet long-term goals - incorporates the impact of taxes and the compounding effect of reinvestment - can build in f
The client's psychological profile
An investor focuses on gains and losses - prefer certain (riskless) gains and uncertain losses - are willing to face incerased risk to avoid losses - causes investors to exhibit risk-seeking behavior
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses


5. What are the main characteristics of the foundation phase of life?
Early career 8accumulating education - developing skills - above-average ability to take risk
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances


6. What are the main characteristics of fixed annuities?

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7. Describe a methodical investor personality type.
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
Implied assets
Diligently gather the best possible investment info - tend to be conservative and - since they base decision on facts - they rarely form emotional attachments to investments - continually seek better info to confirm past investment decisions
It is expenseive - time consuming - public


8. characteristics of spontaneous investor

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9. As desire to leave an estate increases...
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
1) Residence-residence = 2 individuals claim residence for the same individual 2) Source-Source = 2 countries claim authority over the same income (i.e. multinational company) 3) Residence-Source = individual is subject to residence jurisdiction and
Demand for life insurance increases
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized


10. What are the advantages of an outright sale of low basis stock?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Risk tolerance and decision-making style
1) Traders (all gains short term) 2) Active investors (less churn - some gains taxed at reduced rates) 3) Passive investor (buy and hold - most gains are deferred) 4) Exempt investors (no investment taxes)


11. Any amount above core capital is considered what?
Excess capital
1) Traders (all gains short term) 2) Active investors (less churn - some gains taxed at reduced rates) 3) Passive investor (buy and hold - most gains are deferred) 4) Exempt investors (no investment taxes)
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift


12. What are the main characteristics of chritable gifts?
Early career 8accumulating education - developing skills - above-average ability to take risk
High need for financial security - High need to avoid losses - Don't like to make own investment decisions - Don't trust others to make investment decisions - either - Tend to select least volatile assets - Low asset turnover - Frequently miss invest
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Should use accrual-equivalent returns and after-tax risk


13. Describe asset segregation in a behavioral finance context.
Payments are based on the performance of a mixed-asset class portfolio selected by the investor (client) - investor receives a fixed number of 'units' each period - value of each unit increases (decreases) during periods of rising (falling) market re
A positive relationship
Determine: the client's contraints - as well as risk/return objectives - the best strategy - given capital market expectations for achieving the client's objectives - the appropriate strategic (long term) asset allocation which meets those goals
Iinvestors analyze ind. investments on a stand-alone basis - do not consider how the asset will affect portfolio risk and return - manifests itself as mental accounting/pyramiding - lack of diversification


14. What are typical characteristics of active wealth creators?
Starts as a private stock held by an entrepreneur - Sold publicly in IPO (now held by exec - still major part of wealth - less specific risk b/c more mature) - Contributes less and less specific risk as other securities are added to portfolio - ends
The reduction in return caused by the payment of taxes
The amount of assets (i.e.present value) necessary to meet all future liabilities
- extrepreneurs - for example - are usually familiar with taking business risk - they are willing to take risk b/c they feel they control their business and personal circumstances


15. As wealth increases...
Required = critical financial objectives (e.g. living expenses - kids' college expenses) Desired = objectives the client would like to meet (e.g. - large bequests to family or charity - early retirement)
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Demand for life insurance decreases
Decisions should be optimal -process is dynamic - thus factors in changing circumstances -focus on long-term objectives -new investment advisors should be able to use the IPS


16. Describe the equity holding life three stages from the perspective of the stock.
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
Demand for life insurance decreases
- the higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm
Starts as a private stock held by an entrepreneur - Sold publicly in IPO (now held by exec - still major part of wealth - less specific risk b/c more mature) - Contributes less and less specific risk as other securities are added to portfolio - ends


17. What are the steps involved in creating an IPS?

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18. stages of life
Retirement -Wealth has been accumulated -Liabilities paid off -Investor looking to live off of portfolio and/or considering distributions to others -need + ability to bear risk really starts to decline
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
1. foundation 2. accumulation 3. maintenance 4. distribution
- the higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm


19. Why do individuals often take steps to avoid probate?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
It is expenseive - time consuming - public
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance


20. What are the equity holding life risk attributes for an investor?
The more equity-like - the less the demand for life insurance
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Multiple-security holding with one superstar - the result is a concentrated equity position - high specific risk - diversifies from concentrated - active and core concentrations into passive index positions


21. What are the different methods of relief from double taxation?
If board of director member = inside - prudent investor rules usually applies - recommend legal counsel for setting up personal trust or family foundation - if a trust - balance the needs of income beneficiaries and remainderment
1) credit method 2) exemption method 3) deduction method
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Deterministic = use point estimates to generate a forecasted value such as an expected return or terminal value Monte Carlo = use probability distributions of inputs to generate expected returns with accompanying probability distributions


22. Describe a cautious investor personality type.
Most risk averse/least risk tolerant - primary focus is financial security: preservation of wealth - hard to advise - can over-analyze - slow in making decisions and then changing investments - low portfolio turnover/volatility
Active wealth creators typically have an above-avg. willingness to take risk - passive recipients of wealth typically have an average or below-average willingness to take risk
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
It is expenseive - time consuming - public


23. What are the advantages of hedging for low basis stock?
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Single privately-held stock - high degree of control - immature firm - very high unsystematic risk - face significant residual risk - limited or restricted liquidity - zero cost basis in the original investment - desires tax efficient transfer to hei
Should use accrual-equivalent returns and after-tax risk
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


24. What are the main characteristics of fixed annuities?

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25. benefits of IPS to client
Decisions should be optimal -process is dynamic - thus factors in changing circumstances -focus on long-term objectives -new investment advisors should be able to use the IPS
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Diligently gather the best possible investment info - tend to be conservative and - since they base decision on facts - they rarely form emotional attachments to investments - continually seek better info to confirm past investment decisions
1) common progressive (progressive) 2) heavy dividend tax (progressive) 3) heavy capital gain tax (progressive) 4) heavy interest tax (progressive) 5) light capital gain tax (progressive) 6) flat and light (flat) 7) flat and heavy (flat)


26. What are the equity holding life risk attributes for an executive?
Single publicly traded mature company stock or vested options - greater appetite for specific risk due to higher degree of control - less residual risk - b/c the firm is more mature - less liquidity risk - but may have restrictions - desires tax effi
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
High need for financial security - High need to avoid losses - Don't like to make own investment decisions - Don't trust others to make investment decisions - either - Tend to select least volatile assets - Low asset turnover - Frequently miss invest
Wealth transfer stage - focus on tax min. with trusts and foundations


27. As age increases..
Demand for insurance decreases; less human capital to replace
Excess capital
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock


28. What are the main characteristics of variable annuities?

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29. What are the disadvantages of an outright sale of low basis stock?
Should use accrual-equivalent returns and after-tax risk
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
The amount of assets (i.e.present value) necessary to meet all future liabilities
- extrepreneurs - for example - are usually familiar with taking business risk - they are willing to take risk b/c they feel they control their business and personal circumstances


30. When calculating a required return - you typically must identify what?
When a decedent leaves no will or if the will is deemed invalid
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Young -Building a foundation for future wealth -above avg risk tolerance
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date


31. What is HIFO accounting?
Investors have too much confidence in their ability to forecast - they tend to discount or even ignore info that does not support their choices - they interpret info based on their current frame of mind and the medium through which it is received
Single publicly traded mature company stock or vested options - greater appetite for specific risk due to higher degree of control - less residual risk - b/c the firm is more mature - less liquidity risk - but may have restrictions - desires tax effi
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Using HIFO accounting - an investor assumes the lot with the highest tax basis was sold to either maximize the loss for harvesting or minimize the taxable gain


32. characteristics of cautious investor

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33. What are the advantages of completion portfolios for low basis stock?
- the higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm
High need for financial security - High need to avoid losses - Don't like to make own investment decisions - Don't trust others to make investment decisions - either - Tend to select least volatile assets - Low asset turnover - Frequently miss invest
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


34. What are the disadvantages of completion portfolios for low basis stock?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Distribution of outcomes provides a better indication of the risk/return tradeoff - show the tradeoff b/t short-term risk and ability meet long-term goals - incorporates the impact of taxes and the compounding effect of reinvestment - can build in f
The testator


35. What is the person called that transfers assets through a will?
- cautious - methodical - individualistic - spontaneous
The decedent's estate
The testator
Demand for life insurance decreases


36. What is tax alpha?
If board of director member = inside - prudent investor rules usually applies - recommend legal counsel for setting up personal trust or family foundation - if a trust - balance the needs of income beneficiaries and remainderment
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Extra investment value created by effective tax management
A will (also known as a testament)


37. Describe a spontaneous investor personality type.
Extra investment value created by effective tax management
More risk toelrant than than methodical investors - do their own research; very confident in their ability to make investment decisions - confidence in their ability to achieve their long-term investment objectives - unlike methodical investors - th
Demand for life insurance increases
Most risk tolerant - fear that failing to respond to changing market conditions will negatively impact their portfolio - constantly adjust their portfolios in response to changing market conditions - tend to doubt investment advice. - high turnover a


38. How does the nature of human capital affect the demand for life insurance?
The more equity-like - the less the demand for life insurance
Multiple-security holding with one superstar - the result is a concentrated equity position - high specific risk - diversifies from concentrated - active and core concentrations into passive index positions
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
1. foundation 2. accumulation 3. maintenance 4. distribution


39. What are the benefits of an IPS to the client?
Multiple-security holding with one superstar - the result is a concentrated equity position - high specific risk - diversifies from concentrated - active and core concentrations into passive index positions
Acts as an operational guideline that represents the long-term - best interests of the investor - the process is dynamic and can incorporate changed circumstances (review at least annually) - the IPS allows continuity over time and portability to new
Tax drag % = tax rate - as the investment horizon increases - tax drag is unchanged - as the investment return increases - tax drag is unchanged - as the investment horizon increases - value of the tax deferral increases - as the inestment return inc
The amount of assets (i.e.present value) necessary to meet all future liabilities


40. Why do individuals often take steps to avoid probate?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
It is expenseive - time consuming - public
The government shares in both gains and losses


41. What are the disadvantages of private exchange funds for low basis stock?
Provides clarification in the event of questions regarding suitability -process for resolution of disputes with client -helps identify issues to be resolved to avoid problems
An investor focuses on gains and losses - prefer certain (riskless) gains and uncertain losses - are willing to face incerased risk to avoid losses - causes investors to exhibit risk-seeking behavior
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Forced heirship rules (children have the right to parents' estate) - community property rights (each spouse has right to 1/2 the estate) - separate property rights (each spouse's estate considered separately)


42. What are the two sources of wealth?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
1) active 2) passive
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification


43. As desire to leave an estate increases...
Demand for life insurance increases
A will (also known as a testament)
1) credit method 2) exemption method 3) deduction method
A will (also known as a testament)


44. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
- cautious - methodical - individualistic - spontaneous
Entrepreneurial activity (likely to have highly concentrated portfolio) -inheritance - one-time windfalls (may be more willing to diversify) -built up over long periods of safe employment (e.g. middle mgr - easier to divest than huge entrepreneurial
Implied assets
1) exhibit loss aversion rather than risk aversion 2) exhibit biased expectations rather than rational expectations 3) tend to segregate investments rather than considering them in a portfolio perspective


45. What are ways that individuals can avoid probate?
Most risk averse/least risk tolerant - primary focus is financial security: preservation of wealth - hard to advise - can over-analyze - slow in making decisions and then changing investments - low portfolio turnover/volatility
Total wealth = financial assets + human capital
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Excess capital


46. What are the advantages of an outright sale of low basis stock?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
If human capital is equity-like - allocate financial assets more to fixed income - if the human capital is fixed-income like - allocate financial assets more to equities
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification


47. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Earnings start to accelerate -Expenses increase - but so do savings -Long time horizon over which to recover from short-term losses -above-average risk tolerance
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up


48. As wealth increases...
Demand for life insurance increases
Demand for life insurance decreases
Wealth transfer stage - focus on tax min. with trusts and foundations
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax


49. What is human capital?
The reduction in return caused by the payment of taxes
HC = PV of future labor income
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Investors have too much confidence in their ability to forecast - they tend to discount or even ignore info that does not support their choices - they interpret info based on their current frame of mind and the medium through which it is received


50. Describe biased expectations in a behavioral finance context.
Investors have too much confidence in their ability to forecast - they tend to discount or even ignore info that does not support their choices - they interpret info based on their current frame of mind and the medium through which it is received
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n