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Private Wealth Management

Subjects : personal-finance, business-skills

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Answer 50 questions in 15 minutes.
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Match each statement with the correct term.
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1. As desire to leave an estate increases...
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
Demand for life insurance increases
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

2. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
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) 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)
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 higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm

3. What is HIFO accounting?
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
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) 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)
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

4. Describe biased expectations in a behavioral finance context.
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
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
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
Transferring assets directly to a third generation avoids possible double taxation

5. Describe a spontaneous investor personality type.
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
- 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
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 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

6. What are the benefits of an IPS to the adviser?
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
The more equity-like - the less the demand for life insurance

7. How does the nature of human capital affect the demand for life insurance?
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
1) active 2) passive
The more equity-like - the less the demand for life insurance

8. What are the main types of investors?
- a subjective assessment of financial well-being based on perceived wealth
Both increase with longer holding periods and higher returns
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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)

9. Describe asset segregation in a behavioral finance context.
Iinvestors analyze ind. investments on a stand-alone basis - do not consider how the asset will affect portfolio risk and return - manifests itself as mental accounting/pyramiding - lack of diversification
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

10. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
- a subjective assessment of financial well-being based on perceived wealth
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Risk tolerance = as risk tolerance increases - demand for life insurance decreases

11. An investor's willingness to take risk is determined by what?
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
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 client's psychological profile
1) source of wealth 2) measure of wealth 3) stage of life

12. typical IPS elements
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
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
- 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
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

13. What is the eifference in willingness to take risk between active and passive wealth creators?
The risk of a premature death with accompanying loss of future human capital
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
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
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

14. What is an equity collar? What is the purpose of the underlying positions
It is expenseive - time consuming - public
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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

15. situational profiling
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
- a subjective assessment of financial well-being based on perceived wealth
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
The client's psychological profile

16. What is another name for a variable prepaid forward and What is its main purpose?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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

17. Why do individuals often take steps to avoid probate?
The decedent's estate
It is expenseive - time consuming - public
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
1) credit method 2) exemption method 3) deduction method

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

19. When calculating a required return - you typically must identify what?
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
The client's psychological profile
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
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

20. What are the different retirment risks and how can they be hedged?
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
Demand for life insurance increases
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)
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

21. What is loss aversion?
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)
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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

22. characteristics of spontaneous investor
The risk of a premature death with accompanying loss of future human capital
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
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

23. template for return objective
1) source of wealth 2) measure of wealth 3) stage of life
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
- 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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one

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

25. What are the steps involved in creating an IPS?
Demand for life insurance decreases
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
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

26. What is human capital?
The risk of a premature death with accompanying loss of future human capital
HC = PV of future labor income
It is expenseive - time consuming - public
Both increase with longer holding periods and higher returns

27. As desire to leave an estate increases...
Demand for life insurance increases
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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
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

28. What are the different stages of life?
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 risk of a premature death with accompanying loss of future human capital
1) active 2) passive
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

29. benefits of IPS to manager
HC = PV of future labor income
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
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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized

30. How is mortality risk typically hedged?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
Implied liabilities
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

31. What is the difference b/t a required and desired return objective?
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

32. characteristics of methodical investor
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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)

33. What is measure of wealth?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
- a subjective assessment of financial well-being based on perceived wealth
When a decedent leaves no will or if the will is deemed invalid
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

34. What is the difference b/t a required and desired return objective?
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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)

35. What is measure of wealth?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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
- a subjective assessment of financial well-being based on perceived wealth

36. What are the main characteristics of the accumulation phase of life?
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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
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)
Young -Building a foundation for future wealth -above avg risk tolerance

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

38. When calculating a required return - you typically must identify what?
- 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
HC = PV of future labor income
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date

39. What is intestate?
When a decedent leaves no will or if the will is deemed invalid
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

40. What are the disadvantages of completion portfolios for low basis stock?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
The demand for life insurance increases - regardless of age

41. What is tax alpha?
Extra investment value created by effective tax management
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
When a decedent leaves no will or if the will is deemed invalid
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

42. What is the most common estate planning tool?
- 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
A will (also known as a testament)
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
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)

43. Describe biased expectations in a behavioral finance context.
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
The government shares in both gains and losses
Implied liabilities

44. What are typical characteristics of active wealth creators?
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
Methodical - cautious - individualist - spontaneous
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
- 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

45. characteristics of methodical investor
Demand for life insurance decreases
The reduction in return caused by the payment of taxes
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

46. benefits of IPS to manager
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
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
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) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

47. What are the different types of trusts?
Demand for life insurance increases
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
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)

48. 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
Extra investment value created by effective tax management
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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

49. What is the most common estate planning tool?
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
A will (also known as a testament)
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

50. What are the four broad categories of investor personality types (BB&K)?
Implied liabilities
- cautious - methodical - individualistic - spontaneous
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)
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will

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