Private Wealth Management

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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 are the benefits of an IPS to the client?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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


2. What are the main characteristics of chritable gifts?
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
Excess capital
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)
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift


3. What are the disadvantages of public exchange funds for low basis stock?
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
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
HC = PV of future labor income
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis


4. What is measure of wealth?
- a subjective assessment of financial well-being based on perceived wealth
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
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


5. Describe a spontaneous investor personality type.
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Sources of wealth - measure of wealth - stage of life
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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax


6. When should you use a tax-exempt versus a tax-deferred account?
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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


7. What is the difference b/t a required and desired return objective?

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8. Describe an individualistic investor personality type.
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
The risk of a premature death with accompanying loss of future human capital
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory 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


9. What are the benefits of an IPS to the adviser?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
- 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


10. Why do individuals often take steps to avoid probate?
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
1) source of wealth 2) measure of wealth 3) stage of life
1) source of wealth 2) measure of wealth 3) stage of life
It is expenseive - time consuming - public


11. Define tax drag.
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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
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 reduction in return caused by the payment of taxes


12. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
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) source of wealth 2) measure of wealth 3) stage of life
Both increase with longer holding periods and higher returns
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


13. situational profiling

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14. What are the main characteristics of chritable gifts?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Starts as a private stock held by an entrepreneur - Sold publicly in IPO (now held by exec - still major part of wealth - less specific risk b/c more mature) - Contributes less and less specific risk as other securities are added to portfolio - ends
1. foundation 2. accumulation 3. maintenance 4. distribution
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift


15. Why do individuals often take steps to avoid probate?
It is expenseive - time consuming - public
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes


16. What are the main characteristics of fixed annuities?

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17. What are the equity holding life risk attributes for an executive?
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
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
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. What risks must be considered when discussing each concentrated investor category?
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
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) 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)
Implied assets


19. What are the four broad categories of investor personality types (BB&K)?
Risk tolerance and decision-making style
- cautious - methodical - individualistic - 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) 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)


20. Human capital is sometimes referred to as what?
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
The more equity-like - the less the demand for life insurance
Implied assets
The decedent's estate


21. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
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
Methodical - cautious - individualist - spontaneous
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
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


22. What are the different stages of life?
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
Sources of wealth - measure of wealth - stage of life
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) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase


23. 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
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)
A positive relationship
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


24. characteristics of foundation stage
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
- 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 amount of assets (i.e.present value) necessary to meet all future liabilities
Young -Building a foundation for future wealth -above avg risk tolerance


25. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
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
Excess capital
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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


26. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
- cautious - methodical - individualistic - spontaneous
The government shares in both gains and losses
1) source of wealth 2) measure of wealth 3) stage of life
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance


27. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
Total wealth = financial assets + human capital
Both increase with longer holding periods and higher returns
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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax


28. What is HIFO accounting?
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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


29. What is the difference b/t a required and desired return objective?

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30. Describe a cautious investor personality type.
Implied assets
The testator
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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


31. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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
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


32. What are the benefits of an IPS to the client?
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
Transferring assets directly to a third generation avoids possible double taxation
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


33. Any amount above core capital is considered what?
Excess capital
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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


34. Why would an individual try to use generation skipping in estate planning?
Transferring assets directly to a third generation avoids possible double taxation
The more equity-like - the less the demand for life insurance
1) active 2) passive
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. Equation for total wealth.
Total wealth = financial assets + human capital
Risk tolerance and decision-making style
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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


36. What are typical characteristics of active wealth creators?
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
- 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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Tax drag % = tax rate - as the investment horizon increases - tax drag is unchanged - as the investment return increases - tax drag is unchanged - as the investment horizon increases - value of the tax deferral increases - as the inestment return inc


37. What are the equity holding life risk attributes for an entrepreneur?
Single privately-held stock - high degree of control - immature firm - very high unsystematic risk - face significant residual risk - limited or restricted liquidity - zero cost basis in the original investment - desires tax efficient transfer to hei
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
- cautious - methodical - individualistic - spontaneous
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


38. What is human capital?
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)
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
HC = PV of future labor income
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


39. characteristics of foundation stage
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Young -Building a foundation for future wealth -above avg risk tolerance
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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


40. characteristics of individualist investor
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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
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) credit method 2) exemption method 3) deduction method


41. Who is responsible for gains/losses in a taxable (accrual taxation) account?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
The government shares in both gains and losses
Implied liabilities
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


42. What are the different stages of life?
1) Financial market risk (reduced with efficient diversification) 2) Longevity risk (hedged w/ annuities) 3) Savings risk (hedged by employing a savings program and consuming less)
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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)
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


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

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44. What is the general relationship b/t a client's perception of wealth and risk willingness?
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
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
1) credit method 2) exemption method 3) deduction method
A positive relationship


45. What are ways that individuals can avoid probate?
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will


46. What are the disadvantages of public exchange funds for low basis stock?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis


47. As desire to leave an estate increases...
Demand for life insurance increases
Implied assets
Methodical - cautious - individualist - spontaneous
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


48. typical IPS elements
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
Methodical - cautious - individualist - spontaneous
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


49. When calculating a required return - you typically must identify what?
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
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


50. benefits of IPS to client
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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
Total wealth = financial assets + human capital
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance