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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. As probability of death increases...
The demand for life insurance increases - regardless of age
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will

2. Why would an individual try to use generation skipping in estate planning?
Transferring assets directly to a third generation avoids possible double taxation
Methodical - cautious - individualist - spontaneous
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

3. What are the equity holding life risk attributes for an executive?
Wealth transfer stage - focus on tax min. with trusts and foundations
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
The testator
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

4. What are the main characteristics of the foundation phase of life?
Methodical - cautious - individualist - spontaneous
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
Early career 8accumulating education - developing skills - above-average ability to take risk

5. What are the four broad categories of investor personality types (BB&K)?
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
1) source of wealth 2) measure of wealth 3) stage of life
The decedent's estate
- cautious - methodical - individualistic - spontaneous

6. sources of wealth
Sources of wealth - measure of wealth - stage of life
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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
Methodical - cautious - individualist - spontaneous

7. 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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
A positive relationship
The decedent's estate

8. What are typical characteristics of active wealth creators?
The risk of a premature death with accompanying loss of future human capital
- 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
It is expenseive - time consuming - public
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date

9. What is the general relationship between tax drag% and tax rate when capital gains taxes are deferred and B=1; and as investment horizon increases and return increases?
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)
Fixed income streat set at inception - usually no inflation adjustment - so real value falls over time - usually illiquid (can't withdraw funds) - lock in at the prevailing rate - which might be historically low
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
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

10. Investor questionnaires help to determine what?
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
Risk tolerance and decision-making style
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
The client's psychological profile

11. situational profiling - considerations
Sources of wealth - measure of wealth - stage of life
1) Source jurisdiction = country levies taxes on all income generated within its borders - whether by citizens or foreigners 2) Residence jurisdiction = a country taxes income of its residents whether generated inside or outside the country (most pre
Transferring assets directly to a third generation avoids possible double taxation
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

12. Describe a spontaneous investor personality type.
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)
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
Total wealth = financial assets + human capital
The reduction in return caused by the payment of taxes

13. What is the general relationship b/t a client's perception of wealth and risk willingness?
The risk of a premature death with accompanying loss of future human capital
A positive relationship
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
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

14. What are ways that individuals can avoid probate?
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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
The reduction in return caused by the payment of taxes
Extra investment value created by effective tax management

15. What is typically considered when imposing an exit tax?
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)
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Demand for life insurance decreases
- 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

16. What are the disadvantages of private exchange funds for low basis stock?
Both increase with longer holding periods and higher returns
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will

17. What risks must be considered when discussing each concentrated investor category?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
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
Investors begin to shift portfolios into less volatile assets -Reduced focus on accumulating additional wealth and more focus on preserving current wealth -Reduced ability to recover from market downturns -diminishing risk tolerance

18. What is human capital?
Should use accrual-equivalent returns and after-tax risk
HC = PV of future labor income
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
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

19. What are the different methods of relief from double taxation?
1) credit method 2) exemption method 3) deduction method
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
When a decedent leaves no will or if the will is deemed invalid
1) active 2) passive

20. What risks must be considered when discussing each concentrated investor category?
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Should use accrual-equivalent returns and after-tax risk
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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

21. As desire to leave an estate increases...
Demand for life insurance 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
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
Typically very loyal to the firm - views the concentrated position as a positive - does not desire diversification - b/c feels in control of the future - as entrepreneurs delegate more and more control to others - they strive for more and more divers

22. What are the different methods of relief from double taxation?
Typically very loyal to the firm - views the concentrated position as a positive - does not desire diversification - b/c feels in control of the future - as entrepreneurs delegate more and more control to others - they strive for more and more divers
1) credit method 2) exemption method 3) deduction method
The decedent's estate
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach

23. Why do individuals often take steps to avoid probate?
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
More subjective than situational profiling -helps to understand how an investor perceives risk and return. -Bridges the differences between traditional finance and behavioral finance -Methodical - cautious - individualist - spontaneous
It is expenseive - time consuming - public
The more equity-like - the less the demand for life insurance

24. benefits of IPS to client
Should use accrual-equivalent returns and after-tax risk
The demand for life insurance increases - regardless of age
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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

25. What are the main characteristics of the accumulation phase of life?
The amount of assets (i.e.present value) necessary to meet all future liabilities
The risk of a premature death with accompanying loss of future human capital
When a decedent leaves no will or if the will is deemed invalid
Income rising - assets growing - long time horizon - above-avg. ability to take risk

26. Describe an individualistic investor personality type.
The more equity-like - the less the demand for life insurance
The amount of assets (i.e.present value) necessary to meet all future liabilities
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
Risk tolerance and decision-making style

27. What are the advantages of an outright sale of low basis stock?
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
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)
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

28. What is the difference b/t a required and desired return objective?

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29. Describe asset segregation in a behavioral finance context.
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) Source jurisdiction = country levies taxes on all income generated within its borders - whether by citizens or foreigners 2) Residence jurisdiction = a country taxes income of its residents whether generated inside or outside the country (most pre
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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

30. When should you use a tax-exempt versus a tax-deferred account?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

31. typical IPS elements
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
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 more equity-like - the less the demand for life insurance
It is expenseive - time consuming - public

32. What are the main characteristics of fixed annuities?

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33. What are the different retirment risks and how can they be hedged?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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)
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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

34. What are the advantages of private exchange funds for low basis stock?
- 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
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
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
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)

35. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
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
Excess capital
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
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

36. sources of wealth
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
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
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
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)

37. What are typical characteristics of passive recipients of wealth?
- 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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax

38. What are the general legal and regulatory considerations for individuals?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Implied liabilities
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) active 2) passive

39. Describe a methodical investor personality type.
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
1) source of wealth 2) measure of wealth 3) stage of life
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

40. What are the psychological issues of low basis stock held by an executive?
The client's psychological profile
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
- 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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one

41. Describe biased expectations in a behavioral finance context.
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
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) source of wealth 2) measure of wealth 3) stage of life
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

42. Describe a spontaneous investor personality type.
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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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
Investors begin to shift portfolios into less volatile assets -Reduced focus on accumulating additional wealth and more focus on preserving current wealth -Reduced ability to recover from market downturns -diminishing risk tolerance

43. Why would someone want to use a valuation discount?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n

44. Human capital is sometimes referred to as what?
Implied assets
The more equity-like - the less the demand for life insurance
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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

45. characteristics of accumulation phase
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
Fixed income streat set at inception - usually no inflation adjustment - so real value falls over time - usually illiquid (can't withdraw funds) - lock in at the prevailing rate - which might be historically low
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
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

46. What are the advantages of public exchange funds for low basis stock?
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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)

47. What are the main types of investors?
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)
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
The amount of assets (i.e.present value) necessary to meet all future liabilities

48. What are the different stages of life?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
More subjective than situational profiling -helps to understand how an investor perceives risk and return. -Bridges the differences between traditional finance and behavioral finance -Methodical - cautious - individualist - spontaneous

49. Living expenses in retirment can be referred to as what?
Implied liabilities
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
- 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

50. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
1) source of wealth 2) measure of wealth 3) stage of life
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
Demand for life insurance decreases