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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. Why would an individual try to use generation skipping in estate planning?
Transferring assets directly to a third generation avoids possible double taxation
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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Wealth transfer stage - focus on tax min. with trusts and foundations

2. What are the benefits of an IPS to the client?
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
A positive relationship
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
- cautious - methodical - individualistic - spontaneous

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

4. What are the general legal and regulatory considerations for individuals?
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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

5. What are the main characteristics of the foundation phase of life?
Early career 8accumulating education - developing skills - above-average ability to take risk
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale

6. What is HIFO accounting?
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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

7. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
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) source of wealth 2) measure of wealth 3) stage of life
Implied liabilities
Young -Building a foundation for future wealth -above avg risk tolerance

8. Describe a methodical investor personality type.
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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

9. 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?
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)
Implied assets
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

10. four types of investors
Methodical - cautious - individualist - spontaneous
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
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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase

11. typical IPS elements
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
HC = PV of future labor income
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
The more equity-like - the less the demand for life insurance

12. An investor's willingness to take risk is determined by what?

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13. When should you use a tax-exempt versus a tax-deferred account?
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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
The more equity-like - the less the demand for life insurance
Early career 8accumulating education - developing skills - above-average ability to take risk

14. psychological profiling
- 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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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
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

15. What are the disadvantages of hedging for low basis 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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Young -Building a foundation for future wealth -above avg risk tolerance
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

16. Calculating the required return component is driven by what 2 elements?
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 amount of assets (i.e.present value) necessary to meet all future liabilities
Sources of wealth - measure of wealth - stage of life
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach

17. What are the general legal and regulatory considerations for individuals?
The risk of a premature death with accompanying loss of future human capital
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
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
Risk tolerance and decision-making style

18. characteristics of methodical investor
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
The client's psychological profile
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
The demand for life insurance increases - regardless of age

19. When dealing with low basis stock - emotional issues can arise from what?
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
A positive relationship
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
The testator

20. What are the main characteristics of the maintenance phase of life?
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
A positive relationship
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
The demand for life insurance increases - regardless of age

21. What is the eifference in willingness to take risk between active and passive wealth creators?
The client's psychological profile
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
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
A positive relationship

22. How does the nature of human capital affect the demand for life insurance?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
The more equity-like - the less the demand for life insurance
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
A positive relationship

23. stages of life
1. foundation 2. accumulation 3. maintenance 4. distribution
- 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) 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
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

24. What are the different methods of relief from double taxation?
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Implied liabilities
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) credit method 2) exemption method 3) deduction method

25. characteristics of distribution phase
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
HC = PV of future labor income
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)
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

26. As age increases..
A will (also known as a testament)
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
Demand for insurance decreases; less human capital to replace
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

27. What are the main characteristics of the distribution phase of life?
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
Wealth transfer stage - focus on tax min. with trusts and foundations
Transferring assets directly to a third generation avoids possible double taxation
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance

28. What are the four broad categories of investor personality types (BB&K)?
- cautious - methodical - individualistic - spontaneous
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

29. What is the general relationship b/t a client's perception of wealth and risk willingness?
Implied assets
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
A positive relationship
- cautious - methodical - individualistic - spontaneous

30. Who is responsible for gains/losses in a taxable (accrual taxation) account?
The government shares in both gains and losses
Total wealth = financial assets + human capital
1) credit method 2) exemption method 3) deduction method
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

31. 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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
- a subjective assessment of financial well-being based on perceived wealth

32. What are the disadvantages of an outright sale of low basis stock?
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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

33. What are the main characteristics of variable annuities?

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34. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
1) source of wealth 2) measure of wealth 3) stage of life
Demand for life insurance increases

35. What are typical characteristics of active wealth creators?
When a decedent leaves no will or if the will is deemed invalid
Total wealth = financial assets + human capital
Methodical - cautious - individualist - spontaneous
- 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

36. What are the main characteristics of variable annuities?

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37. characteristics of accumulation phase
- 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
1) credit method 2) exemption method 3) deduction method
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
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

38. What is intestate?
The more equity-like - the less the demand for life insurance
When a decedent leaves no will or if the will is deemed invalid
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
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

39. What are the different types of trusts?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
- 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
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
The risk of a premature death with accompanying loss of future human capital

40. characteristics of accumulation phase
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) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

41. sources of wealth
When a decedent leaves no will or if the will is deemed invalid
Implied liabilities
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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

42. Calculating the required return component is driven by what 2 elements?
The amount of assets (i.e.present value) necessary to meet all future liabilities
Both increase with longer holding periods and higher returns
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Income rising - assets growing - long time horizon - above-avg. ability to take risk

43. What are the disadvantages of completion portfolios for low basis stock?
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
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

44. situational profiling

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45. What are typical characteristics of active wealth creators?
Risk tolerance and decision-making style
- cautious - methodical - individualistic - spontaneous
Sources of wealth - measure of wealth - stage of life
- 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

46. characteristics of individualist investor
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
Risk tolerance and decision-making style
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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

47. What are the equity holding life risk attributes for an executive?
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
- 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
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
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

48. What are ways that individuals can avoid probate?
Diligently gather the best possible investment info - tend to be conservative and - since they base decision on facts - they rarely form emotional attachments to investments - continually seek better info to confirm past investment decisions
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
The client's psychological profile

49. What are the diffferent types of tax jurisdictions?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
Hedged with life insurance - think of the life insurance as a replacement for lost 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

50. What should an investor use in mean-variance optimization
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Should use accrual-equivalent returns and after-tax risk
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
The government shares in both gains and losses