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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. characteristics of cautious investor

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2. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
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) source of wealth 2) measure of wealth 3) stage of life
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

3. What are the 3 categories of investors when discussing concentrated positions?
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) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
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

4. How does the nature of human capital affect the demand for life insurance?
The more equity-like - the less the demand for life insurance
- 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
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

5. How does the nature of human capital affect the demand for life insurance?
The more equity-like - the less the demand for life insurance
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
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
Excess capital

6. What are the main characteristics of the accumulation phase of life?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
Transferring assets directly to a third generation avoids possible double taxation
Income rising - assets growing - long time horizon - above-avg. ability to take risk

7. template for return objective
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
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Excess capital

8. situational profiling - considerations
Sources of wealth - measure of wealth - stage of life
Both increase with longer holding periods and higher returns
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)
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

9. When calculating a required return - you typically must identify what?
Early career 8accumulating education - developing skills - above-average ability to take risk
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
The government shares in both gains and losses

10. What are the different retirment risks and how can they be hedged?
- 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) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
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)

11. characteristics of individualist investor
Excess capital
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

12. What is the reinvestment caveat when considering tax loss harvesting?
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
Wealth transfer stage - focus on tax min. with trusts and foundations
- 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
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

13. Define capital gains taxes.
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
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased

14. What are the main characteristics of the maintenance phase of life?
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance

15. What are the main characteristics of the accumulation phase of life?
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
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
The government shares in both gains and losses
Income rising - assets growing - long time horizon - above-avg. ability to take risk

16. 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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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
The client's psychological profile

17. Why do individuals often take steps to avoid probate?
Demand for life insurance increases
Extra investment value created by effective tax management
It is expenseive - time consuming - public
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

18. What are the advantages of an outright sale of low basis stock?
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Implied assets

19. What is human capital?
The risk of a premature death with accompanying loss of future human capital
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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
HC = PV of future labor income

20. What are the diversification techniques for low basis stock?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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
Demand for life insurance decreases

21. What should an investor use in mean-variance optimization
Should use accrual-equivalent returns and after-tax risk
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
A positive relationship
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up

22. What are the main characteristics of variable annuities?

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23. What are wealth taxes.
1. foundation 2. accumulation 3. maintenance 4. distribution
Early career 8accumulating education - developing skills - above-average ability to take risk
Demand for insurance decreases; less human capital to replace
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

24. template for return objective
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Both increase with longer holding periods and higher returns
- 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
- a subjective assessment of financial well-being based on perceived wealth

25. What are the general legal and regulatory considerations for individuals?
Total wealth = financial assets + human capital
High need for financial security - High need to avoid losses - Don't like to make own investment decisions - Don't trust others to make investment decisions - either - Tend to select least volatile assets - Low asset turnover - Frequently miss invest
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
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

26. As age increases..
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)
Demand for insurance decreases; less human capital to replace
Transferring assets directly to a third generation avoids possible double taxation
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

27. How is mortality risk typically hedged?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Income rising - assets growing - long time horizon - above-avg. ability to take risk
The more equity-like - the less the demand for life insurance
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)

28. What are the advantages of private exchange funds for low basis stock?
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
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer 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

29. What are the advantages of the monte carlo approach to portfolio construction?
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
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
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
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

30. Describe a spontaneous investor personality type.
- a subjective assessment of financial well-being based on perceived wealth
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
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)

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

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32. Describe asset segregation in a behavioral finance context.
The more equity-like - the less the demand for life insurance
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) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
- 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

33. Describe biased expectations in a behavioral finance context.
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
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
1) source of wealth 2) measure of wealth 3) stage of life
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

34. What are the disadvantages of an outright sale of low basis stock?
The demand for life insurance increases - regardless of age
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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

35. What are the main characteristics of fixed annuities?

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36. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing 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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
- cautious - methodical - individualistic - spontaneous

37. When should you use a tax-exempt versus a tax-deferred account?
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
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
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)
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

38. What is an equity collar? What is the purpose of the underlying positions
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
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
Early career 8accumulating education - developing skills - above-average ability to take risk
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

39. characteristics of accumulation phase
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Total wealth = financial assets + human capital
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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

40. As desire to leave an estate increases...
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Demand for life insurance 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

41. characteristics of methodical investor
1) credit method 2) exemption method 3) deduction method
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

42. What are the disadvantages of hedging for low basis stock?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Early career 8accumulating education - developing skills - above-average ability to take risk
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Excess capital

43. characteristics of maintenance phase
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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

44. What is HIFO accounting?
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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
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
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

45. Describe the different types of double taxation conflicts.
Excess 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
The government shares in both gains and losses
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

46. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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)
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

47. What are the main characteristics of the distribution phase of life?
Wealth transfer stage - focus on tax min. with trusts and foundations
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
The government shares in both gains and losses

48. characteristics of foundation stage
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
Total wealth = financial assets + human capital
Young -Building a foundation for future wealth -above avg risk tolerance
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

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

50. What are the different types of trusts?
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) 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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Should use accrual-equivalent returns and after-tax risk