Private Wealth Management

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• Answer 50 questions in 15 minutes.
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• Match each statement with the correct term.
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This is a study tool. The 3 wrong answers for each question are randomly chosen from answers to other questions. So, you might find at times the answers obvious, but you will see it re-enforces your understanding as you take the test each time.

1. What is the person called that transfers assets through a will?
The testator
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
1) source of wealth 2) measure of wealth 3) stage of life
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax


2. typical IPS elements
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
A positive relationship
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances


3. What are the main characteristics of the distribution phase of life?
Demand for insurance decreases; less human capital to replace
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
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


4. What is tax alpha?
The testator
Extra investment value created by effective tax management
1) credit method 2) exemption method 3) deduction method
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


5. What is another name for a variable prepaid forward and What is its main purpose?
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
Excess capital
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes


6. What are the different methods of relief from double taxation?
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
1) credit method 2) exemption method 3) deduction method
The reduction in return caused by the payment of taxes
A will (also known as a testament)


7. Describe a methodical investor personality type.
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
When a decedent leaves no will or if the will is deemed invalid
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
The amount of assets (i.e.present value) necessary to meet all future liabilities


8. Why do individuals often take steps to avoid probate?
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
Extra investment value created by effective tax management
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
It is expenseive - time consuming - public


9. Describe the equity holding life three stages from the perspective of the stock.
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Young -Building a foundation for future wealth -above avg risk tolerance
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
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


10. What are the main characteristics of the accumulation phase of life?
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Income rising - assets growing - long time horizon - above-avg. ability to take risk
The reduction in return caused by the payment of taxes
Tax on the entire value of assets held - principal + earnings - not just earnings - has the same effect as an accrual tax - only taxes are paid at a (usually) reduced rate


11. Describe asset segregation in a behavioral finance context.
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
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
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


12. characteristics of cautious investor

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13. What are the benefits of an IPS to the adviser?
1. foundation 2. accumulation 3. maintenance 4. distribution
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
The risk of a premature death with accompanying loss of future human capital


14. Human capital is sometimes referred to as what?
- 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
The more equity-like - the less the demand for life insurance
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
Implied assets


15. What are the problems that financial advisers can face with low basis stock?
The reduction in return caused by the payment of taxes
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about 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
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)


16. What is an equity collar? What is the purpose of the underlying positions
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 higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm
Both increase with longer holding periods and higher returns
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution


17. What are the main characteristics of the maintenance phase of life?
Early career 8accumulating education - developing skills - above-average ability to take risk
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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


18. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
Transferring assets directly to a third generation avoids possible double taxation
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up


19. What are the advantages of public exchange funds for low basis stock?
Total wealth = financial assets + human capital
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Wealth transfer stage - focus on tax min. with trusts and foundations
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


20. What is intestate?
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
When a decedent leaves no will or if the will is deemed invalid
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)


21. four types of investors
Demand for insurance decreases; less human capital to replace
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
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
Methodical - cautious - individualist - spontaneous


22. What are the psychological issues of low basis stock held by an investor?
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
Total wealth = financial assets + human capital
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Taxes paid on the gain (long or short position) when an asset is sold or purchased


23. Describe the different types of double taxation conflicts.
Should use accrual-equivalent returns and after-tax risk
Excess capital
Both increase with longer holding periods and higher returns
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


24. What are the advantages of public exchange funds for low basis stock?
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
HC = PV of future labor income
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool


25. 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)
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
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
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


26. What are the psychological issues of low basis stock held by an executive?
Total wealth = financial assets + human capital
Implied assets
- 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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up


27. Human capital is sometimes referred to as what?
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
Implied assets
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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


28. When dealing with low basis stock - emotional issues can arise from what?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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


29. What is core capital?
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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


30. What are investment objectives and constraints?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
The risk of a premature death with accompanying loss of future human capital
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education


31. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
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) source of wealth 2) measure of wealth 3) stage of life


32. Why do individuals often take steps to avoid probate?
It is expenseive - time consuming - public
Young -Building a foundation for future wealth -above avg risk tolerance
1) source of wealth 2) measure of wealth 3) stage of life
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


33. What should an investor use in mean-variance optimization
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
- 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
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
Should use accrual-equivalent returns and after-tax risk


34. stages of life
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
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
1. foundation 2. accumulation 3. maintenance 4. distribution
Early career 8accumulating education - developing skills - above-average ability to take risk


35. What are the different retirment risks and how can they be hedged?
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)
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 partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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


36. What is intestate?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
When a decedent leaves no will or if the will is deemed invalid
Demand for life insurance increases
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


37. What are the different methods of relief from double taxation?
1) credit method 2) exemption method 3) deduction method
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
The risk of a premature death with accompanying loss of future 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


38. Who is responsible for gains/losses in a taxable (accrual taxation) account?
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
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
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)


39. If human capital is equity-like/fixed-income like - how should you generally allocate financial assets?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Demand for life insurance decreases


40. Equation for total wealth.
1) source of wealth 2) measure of wealth 3) stage of life
The amount of assets (i.e.present value) necessary to meet all future liabilities
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Total wealth = financial assets + human capital


41. What are the 3 categories of investors when discussing concentrated positions?
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
1) 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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale


42. situational profiling

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

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44. What are the different types of trusts?
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
Excess capital
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
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


45. characteristics of spontaneous investor

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46. four types of investors
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
Implied liabilities
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
Methodical - cautious - individualist - spontaneous


47. characteristics of foundation stage
- a subjective assessment of financial well-being based on perceived wealth
Demand for life insurance decreases
Young -Building a foundation for future wealth -above avg risk tolerance
The risk of a premature death with accompanying loss of future human capital


48. psychological profiling
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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)
More subjective than situational profiling -helps to understand how an investor perceives risk and return. -Bridges the differences between traditional finance and behavioral finance -Methodical - cautious - individualist - spontaneous


49. What are the main characteristics of the distribution phase of life?
Wealth transfer stage - focus on tax min. with trusts and foundations
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
The testator


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

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