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Private Wealth Management

Subjects : personal-finance, business-skills

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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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1. What are the disadvantages of an outright sale of low basis stock?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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
Demand for insurance decreases; less human capital to replace
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale

2. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
1. foundation 2. accumulation 3. maintenance 4. distribution
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)
Both increase with longer holding periods and higher returns
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

3. What are the advantages of completion portfolios for low basis stock?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
It is expenseive - time consuming - public
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Taxes paid on the gain (long or short position) when an asset is sold or purchased

4. How does the nature of human capital affect the demand for life insurance?
Wealth transfer stage - focus on tax min. with trusts and foundations
1) credit method 2) exemption method 3) deduction method
The demand for life insurance increases - regardless of age
The more equity-like - the less the demand for life insurance

5. An investor's ability to take risk depends on what?
Wealth transfer stage - focus on tax min. with trusts and foundations
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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
1) credit method 2) exemption method 3) deduction method

6. Human capital is sometimes referred to as what?
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
Methodical - cautious - individualist - spontaneous
Implied assets
Transferring assets directly to a third generation avoids possible double taxation

7. What is HIFO accounting?
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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
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
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

8. psychological profiling
More subjective than situational profiling -helps to understand how an investor perceives risk and return. -Bridges the differences between traditional finance and behavioral finance -Methodical - cautious - individualist - spontaneous
1) 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
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
Risk tolerance and decision-making style

9. characteristics of individualist investor
- cautious - methodical - individualistic - spontaneous
Demand for life insurance increases
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification

10. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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
- 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
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

11. characteristics of spontaneous investor
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Demand for insurance decreases; less human capital to replace
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
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

12. What is an equity collar? What is the purpose of the underlying positions
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Decisions should be optimal -process is dynamic - thus factors in changing circumstances -focus on long-term objectives -new investment advisors should be able to use the IPS
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
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

13. characteristics of maintenance phase
The amount of assets (i.e.present value) necessary to meet all future liabilities
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
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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

14. What are wealth taxes.
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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
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

15. Describe the equity holding life three stages from the perspective of the stock.
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
The more equity-like - the less the demand for life insurance
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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax

16. What are the advantages of hedging for low basis stock?
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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
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

17. What are the equity holding life risk attributes for an executive?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach

18. What is another name for a variable prepaid forward and What is its main purpose?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
A positive relationship

19. What are the problems that financial advisers can face with low basis stock?
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
More subjective than situational profiling -helps to understand how an investor perceives risk and return. -Bridges the differences between traditional finance and behavioral finance -Methodical - cautious - individualist - spontaneous
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

20. What is the general relationship between tax drag% and tax rate when capital gains taxes are deferred and B=1; and as investment horizon increases and return increases?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
The reduction in return caused by the payment of taxes

21. What is the person called that transfers assets through a will?
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
The more equity-like - the less the demand for life insurance
The testator
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)

22. four types of investors
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
Methodical - cautious - individualist - 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
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

23. What is the eifference in willingness to take risk between active and passive wealth creators?
The client's psychological profile
A positive relationship
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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

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

25. When should you use a tax-exempt versus a tax-deferred account?
HC = PV of future labor income
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
A will (also known as a testament)
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

26. Who is responsible for gains/losses in a taxable (accrual taxation) account?
The government shares in both gains and losses
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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

27. As wealth increases...
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
Demand for life insurance decreases
Early career 8accumulating education - developing skills - above-average ability to take risk
The amount of assets (i.e.present value) necessary to meet all future liabilities

28. As probability of death increases...
A will (also known as a testament)
Income rising - assets growing - long time horizon - above-avg. ability to take risk
The demand for life insurance increases - regardless of age
Implied assets

29. What is the difference b/t a required and desired return objective?
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
The risk of a premature death with accompanying loss of future human capital
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)
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will

30. What are the equity holding life risk attributes for an entrepreneur?
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)
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
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

31. What are the main characteristics of the distribution phase of life?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Wealth transfer stage - focus on tax min. with trusts and foundations
Both increase with longer holding periods and higher returns
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

32. characteristics of methodical investor
A positive relationship
- a subjective assessment of financial well-being based on perceived wealth
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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

33. What are the benefits of an IPS to the client?
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
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
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
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

34. What are the four broad categories of investor personality types (BB&K)?
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
- cautious - methodical - individualistic - spontaneous
Wealth transfer stage - focus on tax min. with trusts and foundations
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

35. What is the general relationship b/t a client's perception of wealth and risk willingness?
A positive relationship
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
- 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
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

36. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
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) source of wealth 2) measure of wealth 3) stage 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)

37. As age increases..
HC = PV of future labor income
Demand for insurance decreases; less human capital to replace
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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

38. What are the psychological issues of low basis stock held by an investor?
It is expenseive - time consuming - public
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
1) source of wealth 2) measure of wealth 3) stage of life
Excess capital

39. What are the main characteristics of fixed annuities?
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
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
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

40. What is the eifference in willingness to take risk between active and passive wealth creators?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired 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
Demand for life insurance increases
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

41. stages of life
1. foundation 2. accumulation 3. maintenance 4. distribution
Both increase with longer holding periods and higher returns
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
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

42. What are the psychological issues of low basis stock held by an entrepreneur?
Demand for life insurance increases
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) source of wealth 2) measure of wealth 3) stage of life
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

43. What are the equity holding life risk attributes for an investor?
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)
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
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
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

44. What are the different global tax regimes and their respective ordinary income tax structure?
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)
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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

45. Living expenses in retirment can be referred to as what?
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Implied liabilities
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

46. What are the disadvantages of an outright sale of low basis stock?
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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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

47. What are the 3 categories of investors when discussing concentrated positions?
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)
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) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

48. What are the main characteristics of chritable gifts?
Wealth transfer stage - focus on tax min. with trusts and foundations
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

49. What are the disadvantages of public exchange funds for low basis stock?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

50. Define capital gains taxes.
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Should use accrual-equivalent returns and after-tax risk
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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

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