Private Wealth Management

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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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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 the equity holding life three stages from the perspective of the stock.
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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
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


2. How is mortality risk typically hedged?
- 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
HC = PV of future labor income
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Risk tolerance and decision-making style


3. What are the main characteristics of the foundation phase of life?
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
1. foundation 2. accumulation 3. maintenance 4. distribution
Early career 8accumulating education - developing skills - above-average ability to take risk


4. What are the advantages of an outright sale of low basis stock?
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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


5. What are the advantages of the monte carlo approach to portfolio construction?
Client description -purpose of IPS -identification of duties - responsibilities -formal statement of objectives and constraints -calendar schedule for portfolio performance and IPS review -performance measures and benchmarks -considerations for devel
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
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes


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

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7. Who is responsible for gains/losses in a taxable (accrual taxation) account?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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
The government shares in both gains and losses


8. Describe the different types of double taxation conflicts.
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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


9. What is the person called that transfers assets through a will?
The testator
Both increase with longer holding periods and higher returns
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
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)


10. What are the main characteristics of fixed annuities?

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

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12. As wealth increases...
- 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
Demand for life insurance decreases
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


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

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14. What is human capital?
HC = PV of future labor income
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach


15. When should you use a tax-exempt versus a tax-deferred account?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale


16. If human capital is equity-like/fixed-income like - how should you generally allocate financial assets?
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
It is expenseive - time consuming - public
- a subjective assessment of financial well-being based on perceived wealth
- if you sell a security to harvest its loss and then reinvest the proceeds in a very similar security - the selling price fo the old security becomes the tax basis for the new security - in that case - the loss harvest only delays the payment of t


17. 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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Should use accrual-equivalent returns and after-tax risk
Extra investment value created by effective tax management


18. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
- 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
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
Both increase with longer holding periods and higher returns


19. template for 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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n


20. 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
It is expenseive - time consuming - public
The testator
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis


21. What is the reinvestment caveat when considering tax loss harvesting?
- 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
- 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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale


22. What is intestate?
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
When a decedent leaves no will or if the will is deemed invalid
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification


23. 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?
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
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
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
If board of director member = inside - prudent investor rules usually applies - recommend legal counsel for setting up personal trust or family foundation - if a trust - balance the needs of income beneficiaries and remainderment


24. What risks must be considered when discussing each concentrated investor category?
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
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)


25. 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
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
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


26. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
The demand for life insurance increases - regardless of age
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) 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
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


27. Why would someone want to use a valuation discount?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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) source of wealth 2) measure of wealth 3) stage of life


28. What are typical characteristics of passive recipients of wealth?
Demand for life insurance decreases
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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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


29. four types of investors
Methodical - cautious - individualist - spontaneous
The amount of assets (i.e.present value) necessary to meet all future liabilities
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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)


30. What are the advantages of hedging for low basis stock?
Risk tolerance and decision-making style
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution


31. sources of wealth
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Implied assets
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


32. What are the benefits of an IPS to the adviser?
It is expenseive - time consuming - public
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
Demand for life insurance increases


33. As desire to leave an estate increases...
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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
Demand for life insurance increases
Wealth transfer stage - focus on tax min. with trusts and foundations


34. What are the disadvantages of public exchange funds for low basis stock?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase


35. What are the main characteristics of variable annuities?

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36. What are the psychological issues of low basis stock held by an executive?
Demand for life insurance decreases
- 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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
- 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


37. characteristics of spontaneous investor

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38. benefits of IPS to manager
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)
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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
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


39. What are investment objectives and constraints?
Demand for insurance decreases; less human capital to replace
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
1) credit method 2) exemption method 3) deduction method


40. What are the different retirment risks and how can they be hedged?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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)


41. characteristics of cautious investor

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42. What are the disadvantages of hedging for low basis stock?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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


43. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
1) source of wealth 2) measure of wealth 3) stage of life
1) credit method 2) exemption method 3) deduction method


44. What is the most common estate planning tool?
A will (also known as a testament)
Excess capital
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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


45. Why would someone want to use a valuation discount?
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification


46. characteristics of methodical investor
1. foundation 2. accumulation 3. maintenance 4. distribution
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis


47. Describe a cautious investor personality type.
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
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
The decedent's estate


48. psychological profiling
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)
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing 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
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


49. stages of life
1. foundation 2. accumulation 3. maintenance 4. distribution
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk


50. What is measure of wealth?
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
- a subjective assessment of financial well-being based on perceived wealth
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)
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification