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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 an equity collar? What is the purpose of the underlying positions
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
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
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
- a subjective assessment of financial well-being based on perceived wealth

2. characteristics of distribution phase
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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
Total wealth = financial assets + human capital

3. What are the different methods of relief from double taxation?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
1) credit method 2) exemption method 3) deduction method
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Risk tolerance and decision-making style

4. What are the equity holding life risk attributes for an entrepreneur?
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
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
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

5. What is tax alpha?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Implied liabilities
The government shares in both gains and losses
Extra investment value created by effective tax management

6. What are the psychological issues of low basis stock held by an entrepreneur?
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
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
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
1) active 2) passive

7. Equation for total 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
Total wealth = financial assets + human capital
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
Sources of wealth - measure of wealth - stage of life

8. What is the reinvestment caveat when considering tax loss harvesting?
- 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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
1) active 2) passive
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

9. What should an investor use in mean-variance optimization
Should use accrual-equivalent returns and after-tax risk
Transferring assets directly to a third generation avoids possible double taxation
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
The demand for life insurance increases - regardless of age

10. What are ways that individuals can avoid probate?
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Young -Building a foundation for future wealth -above avg risk tolerance
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will

11. What are the advantages of hedging for low basis stock?
The client's psychological profile
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Sources of wealth - measure of wealth - stage of life

12. stages of life
1) Financial market risk (reduced with efficient diversification) 2) Longevity risk (hedged w/ annuities) 3) Savings risk (hedged by employing a savings program and consuming less)
1. foundation 2. accumulation 3. maintenance 4. distribution
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) credit method 2) exemption method 3) deduction method

13. characteristics of methodical investor
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
HC = PV of future labor income
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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

14. What are wealth taxes.
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
A will (also known as a testament)
When a decedent leaves no will or if the will is deemed invalid
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

15. situational profiling

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16. situational profiling - considerations
Sources of wealth - measure of wealth - stage of life
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
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

17. 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
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. foundation 2. accumulation 3. maintenance 4. distribution
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

18. When should you use a tax-exempt versus a tax-deferred account?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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

19. What are the main characteristics of chritable gifts?
1. foundation 2. accumulation 3. maintenance 4. distribution
Demand for life insurance increases
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

20. What are the psychological issues of low basis stock held by an entrepreneur?
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
Typically very loyal to the firm - views the concentrated position as a positive - does not desire diversification - b/c feels in control of the future - as entrepreneurs delegate more and more control to others - they strive for more and more divers
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk

21. What are the two sources of wealth?
Extra investment value created by effective tax management
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
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) active 2) passive

22. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
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)
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
Risk tolerance and decision-making style
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

23. When calculating a required return - you typically must identify what?
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance

24. What are the disadvantages of private exchange funds for low basis stock?
Demand for life insurance decreases
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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

25. What are the disadvantages of public exchange funds for low basis stock?
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)
Transferring assets directly to a third generation avoids possible double taxation
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis

26. What is core capital?
Both increase with longer holding periods and higher returns
- a subjective assessment of financial well-being based on perceived wealth
The amount of assets (i.e.present value) necessary to meet all future liabilities
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

27. What are the diversification techniques for low basis stock?
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
- cautious - methodical - individualistic - spontaneous
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
The client's psychological profile

28. What are the different types of trusts?
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
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
- cautious - methodical - individualistic - 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

29. situational profiling

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30. Why would someone want to use a valuation discount?
Wealth transfer stage - focus on tax min. with trusts and foundations
Methodical - cautious - individualist - spontaneous
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

31. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
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
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
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)

32. What is tax alpha?
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Extra investment value created by effective tax management
Early career 8accumulating education - developing skills - above-average ability to take risk

33. What are the disadvantages of hedging for low basis stock?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Both increase with longer holding periods and higher returns
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Implied assets

34. Any amount above core capital is considered what?
Excess capital
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) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
- a subjective assessment of financial well-being based on perceived wealth

35. What are the equity holding life risk attributes for an investor?
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
- 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
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely

36. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
Demand for life insurance increases
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Taxes paid on the gain (long or short position) when an asset is sold or purchased
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax

37. Describe the equity holding life three stages from the perspective of the stock.
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. foundation 2. accumulation 3. maintenance 4. distribution
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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

38. What is the most common estate planning tool?
Should use accrual-equivalent returns and after-tax risk
Both increase with longer holding periods and higher returns
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
A will (also known as a testament)

39. Describe the different types of double taxation conflicts.
- 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
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
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

40. What are the four broad categories of investor personality types (BB&K)?
- cautious - methodical - individualistic - spontaneous
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. foundation 2. accumulation 3. maintenance 4. distribution
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)

41. What are the different global tax regimes and their respective ordinary income tax structure?
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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)
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

42. Why do individuals often take steps to avoid probate?
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
Young -Building a foundation for future wealth -above avg risk tolerance
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
It is expenseive - time consuming - public

43. What is loss aversion?
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
Sources of wealth - measure of wealth - stage of life
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
- 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

44. What is loss aversion?
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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
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

45. What are the equity holding life risk attributes for an entrepreneur?
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
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

46. Describe biased expectations in a behavioral finance context.
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

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

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48. How is mortality risk typically hedged?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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
Demand for insurance decreases; less human capital to replace

49. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
The demand for life insurance increases - regardless of age
Risk tolerance = as risk tolerance increases - demand for life insurance decreases

50. benefits of IPS to client
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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
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