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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. Describe asset segregation in a behavioral finance context.
Early career 8accumulating education - developing skills - above-average ability to take risk
Risk tolerance and decision-making style
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)
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

2. What are the main characteristics of the distribution phase of life?
Wealth transfer stage - focus on tax min. with trusts and foundations
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
Risk tolerance and decision-making style
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

3. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
The reduction in return caused by the payment of taxes
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
Should use accrual-equivalent returns and after-tax risk
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase

4. What is core capital?
A positive relationship
The amount of assets (i.e.present value) necessary to meet all future liabilities
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
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

5. Any amount above core capital is considered what?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Excess capital
1) Traders (all gains short term) 2) Active investors (less churn - some gains taxed at reduced rates) 3) Passive investor (buy and hold - most gains are deferred) 4) Exempt investors (no investment taxes)
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

6. Describe a cautious 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
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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

7. Why would an individual try to use generation skipping in estate planning?
Should use accrual-equivalent returns and after-tax risk
Transferring assets directly to a third generation avoids possible double taxation
- 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) growing the portfolio (capital gains) 2) liquidity needs - total return approach

8. Describe a spontaneous 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
HC = PV of future labor income
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
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

9. What are the disadvantages of hedging for low basis stock?
Extra investment value created by effective tax management
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
Demand for life insurance increases
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)

10. What are the equity holding life risk attributes for an executive?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

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

12. What is measure of wealth?
- a subjective assessment of financial well-being based on perceived wealth
The demand for life insurance increases - regardless of age
The reduction in return caused by the payment of taxes
Demand for life insurance decreases

13. What are the different methods of relief from double taxation?
1) credit method 2) exemption method 3) deduction method
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
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

14. Why would someone want to use a valuation discount?
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
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
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

15. What is the most common estate planning tool?
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
A will (also known as a testament)
The client's psychological profile

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

17. What is measure of wealth?
Demand for insurance decreases; less human capital to replace
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
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
- a subjective assessment of financial well-being based on perceived wealth

18. What are the psychological issues of low basis stock held by an executive?
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
- 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
- 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
The amount of assets (i.e.present value) necessary to meet all future liabilities

19. What are the advantages of hedging for low basis stock?
HC = PV of future labor income
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

20. What are the advantages of completion portfolios for low basis stock?
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
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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

21. What are the diffferent types of tax jurisdictions?
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
Implied assets
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
Early career 8accumulating education - developing skills - above-average ability to take risk

22. What are the general legal and regulatory considerations for individuals?
If human capital is equity-like - allocate financial assets more to fixed income - if the human capital is fixed-income like - allocate financial assets more to equities
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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
Demand for life insurance increases

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

24. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
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
Implied assets
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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax

25. situational profiling

26. sources of wealth
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)

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

28. What is HIFO accounting?
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) 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
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
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

29. Human capital is sometimes referred to as what?
Implied assets
The amount of assets (i.e.present value) necessary to meet all future liabilities
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) 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)

30. As wealth increases...
- 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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
Demand for life insurance decreases

31. What are the two sources of wealth?
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) active 2) passive
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses

32. stages of life
A positive relationship
1. foundation 2. accumulation 3. maintenance 4. distribution
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
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

33. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
Sources of wealth - measure of wealth - stage of life
The demand for life insurance increases - regardless of age
The client's psychological profile
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

34. Why would someone want to use a valuation discount?
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 testator
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
- 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

35. What is the general relationship b/t a client's perception of wealth and risk willingness?
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
A positive relationship
Methodical - cautious - individualist - spontaneous

36. What are wealth 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
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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

37. Investor questionnaires help to determine what?
The risk of a premature death with accompanying loss of future human capital
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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
Risk tolerance and decision-making style

38. What are the advantages of hedging for low basis stock?
Should use accrual-equivalent returns and after-tax risk
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

39. Calculating the required return component is driven by what 2 elements?
Implied liabilities
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
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
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach

40. What are the diffferent types of tax jurisdictions?
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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

41. What is another name for a variable prepaid forward and What is its main purpose?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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
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
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

42. What are the main characteristics of the foundation phase of life?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
A will (also known as a testament)
Early career 8accumulating education - developing skills - above-average ability to take risk
Total wealth = financial assets + human capital

43. typical IPS elements
1) credit method 2) exemption method 3) deduction method
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
Early career 8accumulating education - developing skills - above-average ability to take risk
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

44. What is human capital?
HC = PV of future labor income
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk

45. What is the person called that transfers assets through a will?
The demand for life insurance increases - regardless of age
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
The more equity-like - the less the demand for life insurance
The testator

46. 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?
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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) credit method 2) exemption method 3) deduction method

47. characteristics of maintenance phase
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
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
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) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

48. What are the main types of investors?
Excess capital
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) 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. foundation 2. accumulation 3. maintenance 4. distribution

49. When should you use a tax-exempt versus a tax-deferred account?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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

50. What is typically considered when imposing an exit tax?
- 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
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
- 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