Private Wealth Management

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• Answer 50 questions in 15 minutes.
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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 benefits of an IPS to the client?
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Methodical - cautious - individualist - spontaneous
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


2. Why would someone want to use a valuation discount?
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Demand for life insurance decreases


3. characteristics of cautious investor

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4. What are the different methods of relief from double taxation?
Early career 8accumulating education - developing skills - above-average ability to take risk
- cautious - methodical - individualistic - spontaneous
1) credit method 2) exemption method 3) deduction method
The demand for life insurance increases - regardless of age


5. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase


6. When calculating a required return - you typically must identify what?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
1) credit method 2) exemption method 3) deduction method
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


7. characteristics of foundation stage
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Young -Building a foundation for future wealth -above avg risk tolerance
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
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


8. What are wealth taxes.
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk


9. 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
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up


10. typical IPS elements
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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) growing the portfolio (capital gains) 2) liquidity needs - total return approach


11. What are typical characteristics of active wealth creators?
- 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
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
1) active 2) passive


12. Describe a cautious investor personality type.
Implied assets
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
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased


13. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
Demand for life insurance increases
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
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
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


14. What is mortality risk?
The risk of a premature death with accompanying loss of future human capital
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
The reduction in return caused by the payment of taxes
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


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

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16. benefits of IPS to client
Wealth transfer stage - focus on tax min. with trusts and foundations
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) 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 liabilities


17. characteristics of methodical investor
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Demand for life insurance decreases
Implied liabilities


18. What is human capital?
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
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
HC = PV of future labor income


19. What are the main characteristics of the foundation phase of life?
Early career 8accumulating education - developing skills - above-average ability to take risk
The amount of assets (i.e.present value) necessary to meet all future liabilities
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
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


20. situational profiling - considerations
1) credit method 2) exemption method 3) deduction method
Demand for insurance decreases; less human capital to replace
Sources of wealth - measure of wealth - stage of life
Risk tolerance = as risk tolerance increases - demand for life insurance decreases


21. characteristics of methodical investor
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
- 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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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


22. What is mortality risk?
The decedent's estate
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
The risk of a premature death with accompanying loss of future human capital
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase


23. What are the main types of investors?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Young -Building a foundation for future wealth -above avg risk tolerance
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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)


24. characteristics of cautious investor

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25. Describe a methodical investor personality type.
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
Methodical - cautious - individualist - spontaneous
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 and decision-making style


26. What are the general legal and regulatory considerations for individuals?
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) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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
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


27. An investor's ability to take risk depends on what?

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28. What are the psychological issues of low basis stock held by an entrepreneur?
The decedent's estate
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
Demand for life insurance increases
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach


29. What are the psychological issues of low basis stock held by an entrepreneur?
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Both increase with longer holding periods and higher returns
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)
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


30. What are the disadvantages of an outright sale of low basis stock?
1) source of wealth 2) measure of wealth 3) stage of life
The risk of a premature death with accompanying loss of future human capital
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool


31. What are ways that individuals can avoid probate?
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
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


32. situational profiling - considerations
Sources of wealth - measure of wealth - stage of life
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either


33. What are the disadvantages of public exchange funds for low basis stock?
The reduction in return caused by the payment of taxes
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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


34. What are the psychological issues of low basis stock held by an executive?
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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 higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm


35. What are the problems that financial advisers can face with low basis stock?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification


36. What are the problems that financial advisers can face with low basis stock?
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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


37. What is the person called that transfers assets through a will?
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
The testator
Implied liabilities
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible


38. What are investment objectives and constraints?
Implied assets
The client's psychological profile
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique 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


39. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
1) exhibit loss aversion rather than risk aversion 2) exhibit biased expectations rather than rational expectations 3) tend to segregate investments rather than considering them in a portfolio perspective
1. foundation 2. accumulation 3. maintenance 4. distribution
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


40. What are the disadvantages of public exchange funds for low basis stock?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis


41. All costs associated with probate are born by whom?

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42. What are the advantages of completion portfolios for low basis stock?
The demand for life insurance increases - regardless of age
The reduction in return caused by the payment of taxes
- cautious - methodical - individualistic - spontaneous
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses


43. What are the advantages of the monte carlo approach to portfolio construction?
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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
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
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


44. What are the different retirment risks and how can they be hedged?
When a decedent leaves no will or if the will is deemed invalid
1. foundation 2. accumulation 3. maintenance 4. distribution
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)
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale


45. What is the eifference in willingness to take risk between active and passive wealth creators?
Active wealth creators typically have an above-avg. willingness to take risk - passive recipients of wealth typically have an average or below-average willingness to take risk
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Demand for life insurance increases
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education


46. Define capital gains taxes.
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


47. What are the disadvantages of completion portfolios for low basis stock?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Excess capital
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


48. characteristics of individualist investor
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
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) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


49. What is the most common estate planning tool?
A will (also known as a testament)
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
Both increase with longer holding periods and higher returns
1) source of wealth 2) measure of wealth 3) stage of life


50. What are the different stages of life?
The government shares in both gains and losses
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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase