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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 mortality risk?
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)
The testator
The risk of a premature death with accompanying loss of future human capital
Income rising - assets growing - long time horizon - above-avg. ability to take risk

2. Describe biased expectations in a behavioral finance context.
Extra investment value created by effective tax management
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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

3. 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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
Excess capital

4. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

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

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6. What is another name for a variable prepaid forward and What is its main purpose?
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
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
Both increase with longer holding periods and higher returns

7. Equation for total wealth.
The risk of a premature death with accompanying loss of future 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
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Total wealth = financial assets + human capital

8. What is loss aversion?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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
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
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

9. What is the general relationship b/t a client's perception of wealth and risk willingness?
A positive relationship
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)
The amount of assets (i.e.present value) necessary to meet all future liabilities
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

10. Describe a spontaneous investor personality type.
- 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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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
Sources of wealth - measure of wealth - stage of life

11. Human capital is sometimes referred to as what?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Implied assets
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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

12. As desire to leave an estate increases...
Demand for insurance decreases; less human capital to replace
Anticipate individual investors' concerns and risk tolerance by specifying the investor's source of wealth - measure or adequacy of wealth in relation to needs - and stage of life -observables - reasonably objective
Demand for life insurance increases
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

13. What are the different types of trusts?
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) 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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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

14. characteristics of maintenance phase
- 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
Risk tolerance and decision-making style
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

15. What is intestate?
The demand for life insurance increases - regardless of age
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
When a decedent leaves no will or if the will is deemed invalid

16. What are the psychological issues of low basis stock held by an executive?
HC = PV of future labor income
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
It is expenseive - time consuming - public
- 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

17. situational profiling - considerations
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
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
Sources of wealth - measure of wealth - stage of life
Implied liabilities

18. What are the equity holding life risk attributes for an executive?
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
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
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk

19. 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)
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
HC = PV of future labor income
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

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

21. characteristics of distribution phase
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
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. foundation 2. accumulation 3. maintenance 4. distribution
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

22. When calculating a required return - you typically must identify 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
1) source of wealth 2) measure of wealth 3) stage of life
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis

23. What are ways that individuals can avoid probate?
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Excess capital
Extra investment value created by effective tax management

24. What are the diversification techniques for low basis stock?
Extra investment value created by effective tax management
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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
The more equity-like - the less the demand for life insurance

25. What are the different methods of relief from double taxation?
1) credit method 2) exemption method 3) deduction method
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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

26. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
The testator
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
A will (also known as a testament)

27. What is the reinvestment caveat when considering tax loss harvesting?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
- 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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax

28. When dealing with low basis stock - emotional issues can arise from what?
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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)

29. Describe a methodical investor personality type.
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
Young -Building a foundation for future wealth -above avg risk tolerance
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
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)

30. What risks must be considered when discussing each concentrated investor category?
- 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
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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

31. How is mortality risk typically hedged?
Risk tolerance and decision-making style
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
- Deemed disposition = amount is usually based on the gains on assets leaving - as if the individuals sold the assets and realized the gains - Shadow period = could include a tax on income earned for a period after leaving

32. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
Wealth transfer stage - focus on tax min. with trusts and foundations
It is expenseive - time consuming - public
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase

33. characteristics of methodical investor
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
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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

34. What is the person called that transfers assets through a will?
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
The testator
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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)

35. What are the equity holding life risk attributes for an investor?
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
Extra investment value created by effective tax management
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

36. situational profiling

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37. What is the most common estate planning tool?
A will (also known as a testament)
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
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 life insurance decreases

38. What is core capital?
- cautious - methodical - individualistic - spontaneous
Total wealth = financial assets + human capital
Wealth transfer stage - focus on tax min. with trusts and foundations
The amount of assets (i.e.present value) necessary to meet all future liabilities

39. What are investment objectives and constraints?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
It is expenseive - time consuming - public
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

40. characteristics of spontaneous investor

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41. 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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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
- cautious - methodical - individualistic - spontaneous

42. characteristics of maintenance phase
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
- cautious - methodical - individualistic - spontaneous
Implied assets
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one

43. What is HIFO accounting?
- 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
Transferring assets directly to a third generation avoids possible double taxation
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
Excess capital

44. What is measure of wealth?
Total wealth = financial assets + human capital
- a subjective assessment of financial well-being based on perceived wealth
The client's psychological profile
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

45. What are the disadvantages of an outright sale of low basis stock?
The government shares in both gains and losses
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale

46. Why would an individual try to use generation skipping in estate planning?
Transferring assets directly to a third generation avoids possible double taxation
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Tax on the entire value of assets held - principal + earnings - not just earnings - has the same effect as an accrual tax - only taxes are paid at a (usually) reduced rate
1) exhibit loss aversion rather than risk aversion 2) exhibit biased expectations rather than rational expectations 3) tend to segregate investments rather than considering them in a portfolio perspective

47. Describe the different types of double taxation conflicts.
The reduction in return caused by the payment of taxes
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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
- 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

48. What are the advantages of public exchange funds for low basis stock?
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Single privately-held stock - high degree of control - immature firm - very high unsystematic risk - face significant residual risk - limited or restricted liquidity - zero cost basis in the original investment - desires tax efficient transfer to hei
Wealth transfer stage - focus on tax min. with trusts and foundations

49. What are the four broad categories of investor personality types (BB&K)?
- cautious - methodical - individualistic - spontaneous
The more equity-like - the less the demand for life insurance
Entrepreneurial activity (likely to have highly concentrated portfolio) -inheritance - one-time windfalls (may be more willing to diversify) -built up over long periods of safe employment (e.g. middle mgr - easier to divest than huge entrepreneurial
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

50. What is core capital?
Young -Building a foundation for future wealth -above avg risk tolerance
The amount of assets (i.e.present value) necessary to meet all future liabilities
Should use accrual-equivalent returns and after-tax risk
Both increase with longer holding periods and higher returns