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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 should an investor use in mean-variance optimization
Early career 8accumulating education - developing skills - above-average ability to take risk
Should use accrual-equivalent returns and after-tax 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)
When a decedent leaves no will or if the will is deemed invalid

2. Describe asset segregation in a behavioral finance context.
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
It is expenseive - time consuming - public
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
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

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

4. Calculating the required return component is driven by what 2 elements?
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
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) growing the portfolio (capital gains) 2) liquidity needs - total return approach

5. What are the different retirment risks and how can they be hedged?
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
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)
The government shares in both gains and losses
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

6. What are the disadvantages of public exchange funds for low basis stock?
Total wealth = financial assets + human capital
Should use accrual-equivalent returns and after-tax risk
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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

7. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
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) credit method 2) exemption method 3) deduction method
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
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

8. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
Both increase with longer holding periods and higher returns
1) active 2) passive
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
- a subjective assessment of financial well-being based on perceived wealth

9. What are typical characteristics of active wealth creators?
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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Income rising - assets growing - long time horizon - above-avg. ability to take risk
- 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

10. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
Young -Building a foundation for future wealth -above avg risk tolerance
Both increase with longer holding periods and higher returns
Quick to make decisions in the heat of moment (don't want to miss opportunities) - High PTO - Focus on return w/out considering risk - Don't consider themselves experts - Don't trust professionals
- cautious - methodical - individualistic - spontaneous

11. What are the two sources of wealth?
Implied assets
1) active 2) passive
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
The government shares in both gains and losses

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

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13. When dealing with low basis stock - emotional issues can arise from what?
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
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)

14. What are the equity holding life risk attributes for an investor?
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) 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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Wealth transfer stage - focus on tax min. with trusts and foundations

15. Describe an individualistic investor personality type.
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
1) active 2) passive
Extra investment value created by effective tax management
The testator

16. How does the nature of human capital affect the demand for life insurance?
Total wealth = financial assets + human capital
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
The more equity-like - the less the demand for life insurance
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

17. Describe the different types of double taxation conflicts.
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

18. Describe the equity holding life three stages from the perspective of the stock.
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
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education

19. What are the different methods of relief from double taxation?
1) credit method 2) exemption method 3) deduction method
Implied assets
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
Transferring assets directly to a third generation avoids possible double taxation

20. What are the diversification techniques for low basis stock?
The demand for life insurance increases - regardless of age
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
- 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
Quick to make decisions in the heat of moment (don't want to miss opportunities) - High PTO - Focus on return w/out considering risk - Don't consider themselves experts - Don't trust professionals

21. When should you use a tax-exempt versus a tax-deferred account?
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

22. stages of life
HC = PV of future labor income
1. foundation 2. accumulation 3. maintenance 4. distribution
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Should use accrual-equivalent returns and after-tax risk

23. As desire to leave an estate increases...
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Demand for life insurance increases
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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

24. As wealth increases...
Implied assets
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
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

25. What is core capital?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
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

26. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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)
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
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

27. What are investment objectives and constraints?
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. foundation 2. accumulation 3. maintenance 4. distribution
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
The testator

28. What are the main characteristics of the foundation phase of life?
Extra investment value created by effective tax management
It is expenseive - time consuming - public
The government shares in both gains and losses
Early career 8accumulating education - developing skills - above-average ability to take risk

29. 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
Demand for life insurance decreases
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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

30. 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
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
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
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

31. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
- cautious - methodical - individualistic - spontaneous
1. foundation 2. accumulation 3. maintenance 4. distribution
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) 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

32. characteristics of foundation stage
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
- cautious - methodical - individualistic - spontaneous
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
Young -Building a foundation for future wealth -above avg risk tolerance

33. characteristics of spontaneous investor

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34. psychological profiling
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) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
A positive relationship
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

35. typical IPS elements
Excess capital
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
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

36. What are the 3 categories of investors when discussing concentrated positions?
Demand for life insurance decreases
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)
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
1) active 2) passive

37. What risks must be considered when discussing each concentrated investor category?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
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

38. sources of wealth
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
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)
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

39. Who is responsible for gains/losses in a taxable (accrual taxation) account?
Demand for insurance decreases; less human capital to replace
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
The government shares in both gains and losses

40. Describe biased expectations in a behavioral finance context.
The risk of a premature death with accompanying loss of future human capital
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
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)
Income rising - assets growing - long time horizon - above-avg. ability to take risk

41. four types of investors
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
The decedent's estate
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
Methodical - cautious - individualist - spontaneous

42. What are the benefits of an IPS to the client?
- 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
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)
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

43. characteristics of accumulation phase
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
It is expenseive - time consuming - public
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

44. Describe a cautious investor personality type.
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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
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

45. characteristics of accumulation phase
1) source of wealth 2) measure of wealth 3) stage 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
The testator
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date

46. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
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) 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
Young -Building a foundation for future wealth -above avg risk tolerance
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

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

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

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49. What are the disadvantages of hedging for low basis stock?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Excess capital
- 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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

50. What are the equity holding life risk attributes for an entrepreneur?
1) source of wealth 2) measure of wealth 3) stage of life
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
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