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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 are the psychological issues of low basis stock held by an executive?
Implied assets
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
- 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
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)

2. Living expenses in retirment can be referred to as what?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
Implied liabilities
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)

3. What are the diffferent types of tax jurisdictions?
1) Source jurisdiction = country levies taxes on all income generated within its borders - whether by citizens or foreigners 2) Residence jurisdiction = a country taxes income of its residents whether generated inside or outside the country (most pre
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
A positive relationship
HC = PV of future labor income

4. What are the different methods of relief from double taxation?
1) credit method 2) exemption method 3) deduction method
- a subjective assessment of financial well-being based on perceived wealth
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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

5. characteristics of distribution phase
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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
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

6. characteristics of foundation stage
Young -Building a foundation for future wealth -above avg risk tolerance
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
Excess capital

7. What are the main characteristics of fixed annuities?

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8. What is the eifference in willingness to take risk between active and passive wealth creators?
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
The reduction in return caused by the payment of taxes
Excess capital
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 main characteristics of chritable gifts?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

10. How is mortality risk typically hedged?
The reduction in return caused by the payment of taxes
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Demand for life insurance increases
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

11. As desire to leave an estate increases...
Demand for life insurance increases
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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
- cautious - methodical - individualistic - spontaneous

12. Define tax drag.
Implied liabilities
The reduction in return caused by the payment of taxes
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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

13. benefits of IPS to manager
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
The more equity-like - the less the demand for life insurance
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

14. Equation for total wealth.
Total wealth = financial assets + human capital
A positive relationship
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 used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

15. sources of wealth
Typically very loyal to the firm - views the concentrated position as a positive - does not desire diversification - b/c feels in control of the future - as entrepreneurs delegate more and more control to others - they strive for more and more divers
The government shares in both gains and losses
HC = PV of future labor income
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

16. What are the main characteristics of the accumulation phase of life?
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Methodical - cautious - individualist - spontaneous

17. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Wealth transfer stage - focus on tax min. with trusts and foundations
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up

18. What is the person called that transfers assets through a will?
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
The demand for life insurance increases - regardless of age
Excess capital
The testator

19. Human capital is sometimes referred to as what?
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
Total wealth = financial assets + human capital
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
Implied assets

20. What are the two sources of wealth?
1) active 2) passive
- 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
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
The amount of assets (i.e.present value) necessary to meet all future liabilities

21. How does the nature of human capital affect the demand for life insurance?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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)
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
The more equity-like - the less the demand for life insurance

22. What should an investor use in mean-variance optimization
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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
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
Should use accrual-equivalent returns and after-tax risk

23. 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
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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale

24. What are the psychological issues of low basis stock held by an executive?
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
Should use accrual-equivalent returns and after-tax risk
Demand for life insurance increases
- 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

25. What are the equity holding life risk attributes for an entrepreneur?
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
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)
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

26. What are the main characteristics of the foundation phase of life?
- cautious - methodical - individualistic - spontaneous
Early career 8accumulating education - developing skills - above-average ability to take risk
1) source of wealth 2) measure of wealth 3) stage of life
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

27. Any amount above core capital is considered what?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Implied assets
Excess capital
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely

28. What are the 3 categories of investors when discussing concentrated positions?
Implied assets
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
Total wealth = financial assets + human capital
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale

29. Define tax drag.
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)
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
Typically very loyal to the firm - views the concentrated position as a positive - does not desire diversification - b/c feels in control of the future - as entrepreneurs delegate more and more control to others - they strive for more and more divers
The reduction in return caused by the payment of taxes

30. What are the advantages of public exchange funds for low basis stock?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

31. Describe asset segregation in a behavioral finance context.
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) source of wealth 2) measure of wealth 3) stage of life
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
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

32. characteristics of cautious investor

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33. As probability of death increases...
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
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
The demand for life insurance increases - regardless of age
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

34. typical IPS elements
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
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
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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will

35. What is core capital?
The government shares in both gains and losses
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
A will (also known as a testament)
The amount of assets (i.e.present value) necessary to meet all future liabilities

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

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37. Describe the different types of double taxation conflicts.
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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
Early career 8accumulating education - developing skills - above-average ability to take risk
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk

38. stages 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
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
1. foundation 2. accumulation 3. maintenance 4. distribution
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

39. What are the advantages of an outright sale of low basis stock?
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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)
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

40. Investor questionnaires help to determine what?
When a decedent leaves no will or if the will is deemed invalid
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
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)
Risk tolerance and decision-making style

41. What are the main characteristics of the distribution phase of life?
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
Wealth transfer stage - focus on tax min. with trusts and foundations
- 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) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

42. 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
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Implied liabilities

43. What are the four broad categories of investor personality types (BB&K)?
- cautious - methodical - individualistic - spontaneous
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Total wealth = financial assets + human capital
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

44. What are the main characteristics of the maintenance phase of life?
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Methodical - cautious - individualist - spontaneous

45. As desire to leave an estate increases...
The risk of a premature death with accompanying loss of future human capital
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
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
Demand for life insurance increases

46. What is the eifference in willingness to take risk between active and passive wealth creators?
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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
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

47. situational profiling - considerations
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)
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Sources of wealth - measure of wealth - stage of life

48. What is an equity collar? What is the purpose of the underlying positions
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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
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
It is expenseive - time consuming - public

49. What are the psychological issues of low basis stock held by an investor?
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 reduction in return caused by the payment of taxes
- 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

50. Describe asset segregation in a behavioral finance context.
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
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
Risk tolerance and decision-making style
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses