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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 is loss aversion?
Implied assets
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
It is expenseive - time consuming - public
Implied liabilities

2. Define capital gains taxes.
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Demand for life insurance increases
Early career 8accumulating education - developing skills - above-average ability to take risk
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will

3. What are the different methods of relief from double taxation?
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
- 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) credit method 2) exemption method 3) deduction method
1. foundation 2. accumulation 3. maintenance 4. distribution

4. What are the main characteristics of chritable gifts?
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) 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)
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

5. What are the main characteristics of variable annuities?

6. What are the two sources of wealth?
Excess capital
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Taxes paid on the gain (long or short position) when an asset is sold or purchased
1) active 2) passive

7. What are the diversification techniques for low basis stock?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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
A positive relationship
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

8. What are the problems that financial advisers can face with low basis stock?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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

9. What are the four broad categories of investor personality types (BB&K)?
Total wealth = financial assets + human capital
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) 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)
- cautious - methodical - individualistic - spontaneous

10. What are the disadvantages of an outright sale of low basis stock?
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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

11. What are the psychological issues of low basis stock held by an investor?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
- 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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either

12. typical IPS elements
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
The more equity-like - the less the demand for life insurance
1) source of wealth 2) measure of wealth 3) stage of life
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

13. What is measure of wealth?
When a decedent leaves no will or if the will is deemed invalid
- 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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
- a subjective assessment of financial well-being based on perceived wealth

14. Investor questionnaires help to determine what?
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
Implied assets
Should use accrual-equivalent returns and after-tax risk
Risk tolerance and decision-making style

15. What are the advantages of the monte carlo approach to portfolio construction?
Distribution of outcomes provides a better indication of the risk/return tradeoff - show the tradeoff b/t short-term risk and ability meet long-term goals - incorporates the impact of taxes and the compounding effect of reinvestment - can build in f
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
1. foundation 2. accumulation 3. maintenance 4. distribution
HC = PV of future labor income

16. 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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
A will (also known as a testament)
Should use accrual-equivalent returns and after-tax risk

17. What are the 3 categories of investors when discussing concentrated positions?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
Single 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

18. 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
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
Early career 8accumulating education - developing skills - above-average ability to take risk
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

19. benefits of IPS to manager
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
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
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
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

20. What are the main characteristics of variable annuities?

21. What is the eifference in willingness to take risk between active and passive wealth creators?
Early career 8accumulating education - developing skills - above-average ability to take risk
The risk of a premature death with accompanying loss of future human capital
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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

22. What is another name for a variable prepaid forward and What is its main purpose?
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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)
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

23. When should you use a tax-exempt versus a tax-deferred account?
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)
Should use accrual-equivalent returns and after-tax risk
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

24. Why would someone want to use a valuation discount?
Demand for insurance decreases; less human capital to replace
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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)
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

25. How does the nature of human capital affect the demand for life insurance?
The more equity-like - the less the demand for life insurance
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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

26. What is human capital?
The client's psychological profile
Income rising - assets growing - long time horizon - above-avg. ability to take risk
HC = PV of future labor income
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

27. characteristics of spontaneous investor

28. What are the psychological issues of low basis stock held by an investor?
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Young -Building a foundation for future wealth -above avg risk tolerance

29. Living expenses in retirment can be referred to as what?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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
Implied liabilities
- 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

30. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
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)
A positive relationship
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
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

31. What are the main characteristics of the maintenance phase of life?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Implied assets
Risk tolerance = as risk tolerance increases - demand for life insurance decreases

32. characteristics of individualist investor
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) 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
Total wealth = financial assets + human capital
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk

33. What is core 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)
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up

34. characteristics of distribution phase
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
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
Transferring assets directly to a third generation avoids possible double taxation

35. What are the main characteristics of chritable gifts?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Demand for insurance decreases; less human capital to replace
The amount of assets (i.e.present value) necessary to meet all future liabilities
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

36. What is mortality risk?
The risk of a premature death with accompanying loss of future human capital
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
Demand for life insurance increases
The demand for life insurance increases - regardless of age

37. characteristics of foundation stage
Young -Building a foundation for future wealth -above avg risk tolerance
Implied assets
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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

38. What are the advantages of completion portfolios for low basis stock?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Excess capital
The government shares in both gains and losses
Income rising - assets growing - long time horizon - above-avg. ability to take risk

39. Human capital is sometimes referred to as what?
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)
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)
Implied assets
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

40. What are the benefits of an IPS to the adviser?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Young -Building a foundation for future wealth -above avg risk tolerance
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one

41. Why would an individual try to use generation skipping in estate planning?
Transferring assets directly to a third generation avoids possible double taxation
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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)
A will (also known as a testament)

42. Describe an individualistic investor personality type.
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Should use accrual-equivalent returns and after-tax risk
Implied liabilities
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

43. characteristics of cautious investor

44. What are the main characteristics of the distribution phase of life?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Wealth transfer stage - focus on tax min. with trusts and foundations
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Early career 8accumulating education - developing skills - above-average ability to take risk

45. What is the reinvestment caveat when considering tax loss harvesting?
It is expenseive - time consuming - public
- 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
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk

46. What is loss aversion?
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
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)
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Single privately-held stock - high degree of control - immature firm - very high unsystematic risk - face significant residual risk - limited or restricted liquidity - zero cost basis in the original investment - desires tax efficient transfer to hei

47. What are the advantages of public exchange funds for low basis stock?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
1. foundation 2. accumulation 3. maintenance 4. distribution
- 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
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

48. What is an equity collar? What is the purpose of the underlying positions
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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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

49. characteristics of methodical investor
1) active 2) passive
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
- 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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

50. As probability of death increases...
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
The demand for life insurance increases - regardless of age
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
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