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Private Wealth Management

Subjects : personal-finance, business-skills

Instructions:

Answer 50 questions in 15 minutes.
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Match each statement with the correct term.
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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 progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
The client's psychological profile
The testator
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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

2. What are the main characteristics of chritable gifts?
1) credit method 2) exemption method 3) deduction method
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
1. foundation 2. accumulation 3. maintenance 4. distribution

3. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
Implied assets
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up

4. As desire to leave an estate increases...
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)
Demand for life insurance increases
Demand for insurance decreases; less human capital to replace
The government shares in both gains and losses

5. benefits of IPS to manager
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
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
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

6. When calculating a required return - you typically must identify what?
HC = PV of future labor income
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
When a decedent leaves no will or if the will is deemed invalid
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

7. characteristics of accumulation phase
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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
Wealth transfer stage - focus on tax min. with trusts and foundations

8. What is the person called that transfers assets through a will?
- cautious - methodical - individualistic - spontaneous
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
The testator

9. Human capital is sometimes referred to as what?
- 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
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
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)
Implied assets

10. What are the advantages of the monte carlo approach to portfolio construction?
Both increase with longer holding periods and higher returns
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
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
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

11. When should you use a tax-exempt versus a tax-deferred account?
Early career 8accumulating education - developing skills - above-average ability to take risk
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

12. What are the diffferent types of estate ownership rights?

13. What are the disadvantages of completion portfolios for low basis stock?
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
Can borrow and/or use derivatives to diversify - ability to borrow (monetize) increased - owners retain upside potential of the original investment - not required to hodl illiquid assets - partners can change fund composition
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Anticipate individual investors' concerns and risk tolerance by specifying the investor's source of wealth - measure or adequacy of wealth in relation to needs - and stage of life -observables - reasonably objective

14. As age increases..
The amount of assets (i.e.present value) necessary to meet all future liabilities
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Demand for insurance decreases; less human capital to replace
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

15. As probability of death increases...
Client description -purpose of IPS -identification of duties - responsibilities -formal statement of objectives and constraints -calendar schedule for portfolio performance and IPS review -performance measures and benchmarks -considerations for devel
The government shares in both gains and losses
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
The demand for life insurance increases - regardless of age

16. What are the different types of trusts?
1) revocable trust = the settlor can rescind the trust and resume ownership of the assets 2) irrevocable trust = the settlor relinquishes ownership and control 3) fixed trust = pattern of distributions to the beneficiaris is predetermined by the sett
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Both increase with longer holding periods and higher returns

17. What are the disadvantages of hedging for low basis stock?
1) active 2) passive
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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Methodical - cautious - individualist - spontaneous

18. An investor's willingness to take risk is determined by what?

19. What are the disadvantages of an outright sale of low basis stock?
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
- 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
Demand for life insurance increases
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale

20. What are the main characteristics of the accumulation phase of life?
1) Financial market risk (reduced with efficient diversification) 2) Longevity risk (hedged w/ annuities) 3) Savings risk (hedged by employing a savings program and consuming less)
Client description -purpose of IPS -identification of duties - responsibilities -formal statement of objectives and constraints -calendar schedule for portfolio performance and IPS review -performance measures and benchmarks -considerations for devel
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk

21. situational profiling - considerations
- Deemed disposition = amount is usually based on the gains on assets leaving - as if the individuals sold the assets and realized the gains - Shadow period = could include a tax on income earned for a period after leaving
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Sources of wealth - measure of wealth - stage of life

22. What is intestate?
When a decedent leaves no will or if the will is deemed invalid
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach

23. What is the reinvestment caveat when considering tax loss harvesting?
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)
- if you sell a security to harvest its loss and then reinvest the proceeds in a very similar security - the selling price fo the old security becomes the tax basis for the new security - in that case - the loss harvest only delays the payment of t
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Excess capital

24. sources of wealth
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
- a subjective assessment of financial well-being based on perceived wealth
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

25. When dealing with low basis stock - emotional issues can arise from what?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Implied assets

26. Why would an individual try to use generation skipping in estate planning?
Transferring assets directly to a third generation avoids possible double taxation
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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
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

27. What are typical characteristics of active wealth creators?
The risk of a premature death with accompanying loss of future human capital
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
A positive relationship
- 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

28. Describe asset segregation in a behavioral finance context.
Long stock position + long put + short call - long put protects downside (like purchasing insurance) - short call generates income to at least partially offset the cost of the put
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification

29. What are the main characteristics of chritable gifts?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Transferring assets directly to a third generation avoids possible double taxation
Both increase with longer holding periods and higher returns
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

30. What are the main characteristics of the accumulation phase of life?
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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

31. template for return objective
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
- if you sell a security to harvest its loss and then reinvest the proceeds in a very similar security - the selling price fo the old security becomes the tax basis for the new security - in that case - the loss harvest only delays the payment of t
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

32. What are investment objectives and constraints?
The client's psychological profile
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized

33. What is typically considered when imposing an exit tax?
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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)
- Deemed disposition = amount is usually based on the gains on assets leaving - as if the individuals sold the assets and realized the gains - Shadow period = could include a tax on income earned for a period after leaving
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

34. What is measure of wealth?
- a subjective assessment of financial well-being based on perceived wealth
1) source of wealth 2) measure of wealth 3) stage of life
1) Financial market risk (reduced with efficient diversification) 2) Longevity risk (hedged w/ annuities) 3) Savings risk (hedged by employing a savings program and consuming less)
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

35. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
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
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Demand for insurance decreases; less human capital to replace

36. What are the equity holding life risk attributes for an entrepreneur?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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
Sources of wealth - measure of wealth - stage of life
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

37. situational profiling

38. What is the general relationship b/t a client's perception of wealth and risk willingness?
A positive relationship
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
The risk of a premature death with accompanying loss of future human capital
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

39. What is the eifference in willingness to take risk between active and passive wealth creators?
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
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
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
1. foundation 2. accumulation 3. maintenance 4. distribution

40. What are the main characteristics of fixed annuities?

41. What is HIFO accounting?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
It is expenseive - time consuming - public
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
Transferring assets directly to a third generation avoids possible double taxation

42. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
- cautious - methodical - individualistic - spontaneous
1. foundation 2. accumulation 3. maintenance 4. distribution
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases

43. What are the problems that financial advisers can face with low basis stock?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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)
Long stock position + long put + short call - long put protects downside (like purchasing insurance) - short call generates income to at least partially offset the cost of the put
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education

44. characteristics of spontaneous investor

45. Describe asset segregation in a behavioral finance context.
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
The client's psychological profile
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

46. What are the two sources of wealth?
When a decedent leaves no will or if the will is deemed invalid
The amount of assets (i.e.present value) necessary to meet all future liabilities
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
1) active 2) passive

47. When should you use a tax-exempt versus a tax-deferred account?
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)
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

48. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
1) source of wealth 2) measure of wealth 3) stage of life
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)
Risk tolerance and decision-making style
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

49. What are the four broad categories of investor personality types (BB&K)?
- 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
- cautious - methodical - individualistic - spontaneous
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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized

50. When dealing with low basis stock - emotional issues can arise from what?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Implied liabilities
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
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