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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 are the main characteristics of the distribution phase of life?
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
The testator
Wealth transfer stage - focus on tax min. with trusts and foundations
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

2. What are the disadvantages of private exchange funds for low basis 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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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 attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education

3. What is the person called that transfers assets through a will?
The testator
Extra investment value created by effective tax management
Extra investment value created by effective tax management
Should use accrual-equivalent returns and after-tax risk

4. 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
Extra investment value created by effective tax management
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 risk of a premature death with accompanying loss of future human capital

5. What are the advantages of the monte carlo approach to portfolio construction?
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
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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)

6. What are the psychological issues of low basis stock held by an entrepreneur?
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Total wealth = financial assets + human capital
The more equity-like - the less the demand for life insurance

7. What are the advantages of private exchange funds for low basis stock?
Young -Building a foundation for future wealth -above avg 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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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

8. What are the psychological issues of low basis stock held by an entrepreneur?
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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
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

9. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
The testator
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
- 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

10. situational profiling

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11. Why would an individual try to use generation skipping in estate planning?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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
Transferring assets directly to a third generation avoids possible double taxation
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

12. What is tax alpha?
The testator
Extra investment value created by effective tax management
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
The demand for life insurance increases - regardless of age

13. Why would an individual try to use generation skipping in estate planning?
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Transferring assets directly to a third generation avoids possible double taxation
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

14. Describe a cautious investor personality type.
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
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
- 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

15. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
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
Risk tolerance and decision-making style
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up

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

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17. What are the disadvantages of public exchange funds for low basis stock?
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
1) active 2) passive

18. What are the 3 categories of investors when discussing concentrated positions?
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
A will (also known as a testament)
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
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

19. characteristics of accumulation phase
Demand for life insurance decreases
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk

20. What are the advantages of public exchange funds for low basis stock?
Demand for life insurance increases
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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) 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

21. 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?
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Excess capital
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

22. What are the main characteristics of the distribution phase of life?
Wealth transfer stage - focus on tax min. with trusts and foundations
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

23. Why would someone want to use a valuation discount?
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

24. Why would someone want to use a valuation discount?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Demand for life insurance decreases
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

25. Define capital gains taxes.
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Taxes paid on the gain (long or short position) when an asset is sold or purchased

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

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27. What is HIFO accounting?
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
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
Excess capital
The reduction in return caused by the payment of taxes

28. What is intestate?
1) source of wealth 2) measure of wealth 3) stage of life
When a decedent leaves no will or if the will is deemed invalid
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases

29. What are the different retirment risks and how can they be hedged?
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)
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
When a decedent leaves no will or if the will is deemed invalid
The risk of a premature death with accompanying loss of future human capital

30. What are the main characteristics of fixed annuities?

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31. What are the different stages of life?
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) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

32. characteristics of maintenance phase
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
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)
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
- 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

33. What are the psychological issues of low basis stock held by an investor?
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Methodical - cautious - individualist - spontaneous
Demand for life insurance decreases
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

34. benefits of IPS to manager
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
Demand for life insurance decreases
Risk tolerance and decision-making style
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

35. What are the benefits of an IPS to the adviser?
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis

36. How is mortality risk typically hedged?
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

37. What are the main characteristics of the maintenance phase of life?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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)
The testator
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance

38. benefits of IPS to client
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) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
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
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

39. What are typical characteristics of active wealth creators?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
- 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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Demand for insurance decreases; less human capital to replace

40. What are the diversification techniques for low basis stock?
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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
Excess capital
Income rising - assets growing - long time horizon - above-avg. ability to take risk

41. What are investment objectives and constraints?
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
Should use accrual-equivalent returns and after-tax risk

42. characteristics of accumulation phase
Methodical - cautious - individualist - spontaneous
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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

43. psychological profiling
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
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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

44. What are the advantages of the monte carlo approach to portfolio construction?
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
Extra investment value created by effective tax management
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

45. What are the different stages of life?
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
- 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) source of wealth 2) measure of wealth 3) stage of life

46. What are the equity holding life risk attributes for an entrepreneur?
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
1) active 2) passive
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

47. What are the different global tax regimes and their respective ordinary income tax structure?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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)
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

48. What is core capital?
The decedent's estate
- 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
The amount of assets (i.e.present value) necessary to meet all future liabilities
Demand for life insurance decreases

49. What are the disadvantages of completion portfolios for low basis stock?
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
Demand for life insurance decreases
The testator
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely

50. What is human capital?
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
1) active 2) passive
HC = PV of future labor income