Private Wealth Management

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• Answer 50 questions in 15 minutes.
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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 a spontaneous investor personality type.
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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


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

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3. What are the diversification techniques for low basis stock?
The reduction in return caused by the payment of taxes
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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
The more equity-like - the less the demand for life insurance


4. What is human capital?
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Using HIFO accounting - an investor assumes the lot with the highest tax basis was sold to either maximize the loss for harvesting or minimize the taxable gain
The more equity-like - the less the demand for life insurance
HC = PV of future labor income


5. What are the disadvantages of hedging for low basis stock?
HC = PV of future labor income
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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
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


6. characteristics of spontaneous investor

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7. What are wealth taxes.
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
HC = PV of future labor income
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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


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

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9. Investor questionnaires help to determine what?
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Transferring assets directly to a third generation avoids possible double taxation
Risk tolerance and decision-making style


10. What are the main characteristics of the distribution phase of life?
The risk of a premature death with accompanying loss of future human capital
A will (also known as a testament)
Wealth transfer stage - focus on tax min. with trusts and foundations
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


11. four types of investors
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Methodical - cautious - individualist - spontaneous
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
Extra investment value created by effective tax management


12. What is the person called that transfers assets through a will?
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
A positive relationship
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
The testator


13. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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
Extra investment value created by effective tax management
Both increase with longer holding periods and higher returns


14. characteristics of accumulation phase
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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
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


15. What are the advantages of public exchange funds for low basis stock?
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
The client's psychological profile
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool


16. What are the different types of trusts?
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 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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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


17. Describe biased expectations in a behavioral finance context.
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
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
Methodical - cautious - individualist - spontaneous
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


18. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
Demand for life insurance decreases
Early career 8accumulating education - developing skills - above-average ability to take risk
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)
Risk tolerance = as risk tolerance increases - demand for life insurance decreases


19. What are the psychological issues of low basis stock held by an investor?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Young -Building a foundation for future wealth -above avg risk tolerance
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either


20. What is core capital?
The reduction in return caused by the payment of 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
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 amount of assets (i.e.present value) necessary to meet all future liabilities


21. What are the disadvantages of private exchange funds for low basis stock?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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


22. Human capital is sometimes referred to as what?
Demand for insurance decreases; less human capital to replace
Methodical - cautious - individualist - spontaneous
Implied assets
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification


23. Describe asset segregation in a behavioral finance context.
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
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


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

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25. Any amount above core capital is considered what?
Should use accrual-equivalent returns and after-tax risk
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Excess capital
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


26. Why do individuals often take steps to avoid probate?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
An investor focuses on gains and losses - prefer certain (riskless) gains and uncertain losses - are willing to face incerased risk to avoid losses - causes investors to exhibit risk-seeking behavior
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
It is expenseive - time consuming - public


27. What are the two sources of wealth?
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
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
1) active 2) passive
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


28. What are the disadvantages of an outright sale of low basis stock?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
1. foundation 2. accumulation 3. maintenance 4. distribution
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
The client's psychological profile


29. What is typically considered when imposing an exit tax?
- 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
The decedent's estate
- 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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance


30. What are the diffferent types of tax jurisdictions?
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
Extra investment value created by effective tax management
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale


31. Describe biased expectations in a behavioral finance context.
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
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
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
Both increase with longer holding periods and higher returns


32. Living expenses in retirment can be referred to as what?
Implied liabilities
The demand for life insurance increases - regardless of age
Excess 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


33. four types of investors
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Methodical - cautious - individualist - spontaneous
Sources of wealth - measure of wealth - stage of life
1) source of wealth 2) measure of wealth 3) stage of life


34. What are typical characteristics of active wealth creators?
- 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) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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


35. Calculating the required return component is driven by what 2 elements?
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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


36. What are the main characteristics of the distribution phase of life?
Wealth transfer stage - focus on tax min. with trusts and foundations
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) source of wealth 2) measure of wealth 3) stage of life
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


37. What are the main characteristics of the accumulation phase of life?
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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
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
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


38. What are the different types of trusts?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


39. What are the main types of investors?
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)
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
Implied liabilities
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)


40. characteristics of cautious investor

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41. When calculating a required return - you typically must identify what?
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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
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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will


42. characteristics of methodical investor
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today


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

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44. Define tax drag.
The reduction in return caused by the payment of taxes
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
- 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
It is expenseive - time consuming - public


45. Describe the different types of double taxation conflicts.
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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)
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
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)


46. What is loss aversion?
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
An investor focuses on gains and losses - prefer certain (riskless) gains and uncertain losses - are willing to face incerased risk to avoid losses - causes investors to exhibit risk-seeking behavior
1) credit method 2) exemption method 3) deduction method
Transferring assets directly to a third generation avoids possible double taxation


47. When should you use a tax-exempt versus a tax-deferred account?
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) 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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up


48. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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


49. Who is responsible for gains/losses in a taxable (accrual taxation) account?
1. foundation 2. accumulation 3. maintenance 4. distribution
Implied liabilities
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
The government shares in both gains and losses


50. What are typical characteristics of passive recipients of wealth?
- the higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
The risk of a premature death with accompanying loss of future human capital