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 main characteristics of the distribution phase of life?
Wealth transfer stage - focus on tax min. with trusts and foundations
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
Implied assets
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. What is HIFO accounting?
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) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing 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


3. Describe a methodical investor personality type.
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either


4. What are investment objectives and constraints?
When a decedent leaves no will or if the will is deemed invalid
Young -Building a foundation for future wealth -above avg risk tolerance
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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


5. What are the psychological issues of low basis stock held by an executive?
- 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) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)


6. An investor's willingness to take risk is determined by what?

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7. If human capital is equity-like/fixed-income like - how should you generally allocate financial assets?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Risk tolerance and decision-making style
- 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
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


8. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
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
1. foundation 2. accumulation 3. maintenance 4. distribution
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up


9. characteristics of spontaneous investor

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10. As wealth increases...
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
Demand for life insurance decreases
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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


11. What are typical characteristics of active wealth creators?
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
The reduction in return caused by the payment of taxes
- 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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date


12. Human capital is sometimes referred to as what?
Implied assets
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 attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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


13. What is the eifference in willingness to take risk between active and passive wealth creators?
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
Both increase with longer holding periods and higher returns
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)
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


14. Define capital gains taxes.
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
A positive relationship
A will (also known as a testament)


15. As wealth increases...
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Demand for life insurance decreases
- a subjective assessment of financial well-being based on perceived wealth
Young -Building a foundation for future wealth -above avg risk tolerance


16. What are the advantages of private 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
Should use accrual-equivalent returns and after-tax risk
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
HC = PV of future labor income


17. How is mortality risk typically hedged?
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
1) source of wealth 2) measure of wealth 3) stage of life
When a decedent leaves no will or if the will is deemed invalid


18. four types of investors
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Methodical - cautious - individualist - spontaneous
Demand for life insurance decreases


19. What are the disadvantages of public exchange funds for low basis stock?
Extra investment value created by effective tax management
Young -Building a foundation for future wealth -above avg 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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis


20. Define capital gains taxes.
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Excess capital
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
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


21. What are the disadvantages of private exchange funds for low basis stock?
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis


22. Human capital is sometimes referred to as what?
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Implied assets
- 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
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)


23. template for return objective
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
A positive relationship
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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


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

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25. Describe a methodical investor personality type.
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up


26. What are typical characteristics of passive recipients of wealth?
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Implied liabilities
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances


27. What should an investor use in mean-variance optimization
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Demand for life insurance increases
Should use accrual-equivalent returns and after-tax 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


28. What are the main characteristics of chritable gifts?
Young -Building a foundation for future wealth -above avg risk tolerance
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Wealth transfer stage - focus on tax min. with trusts and foundations


29. What is 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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
HC = PV of future labor income


30. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
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
Active wealth creators typically have an above-avg. willingness to take risk - passive recipients of wealth typically have an average or below-average willingness to take risk
1) credit method 2) exemption method 3) deduction method
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


31. characteristics of maintenance phase
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
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
Sources of wealth - measure of wealth - stage of life


32. What are the advantages of public exchange funds for low basis stock?
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
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)


33. What are typical characteristics of passive recipients of wealth?
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
- 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
Total wealth = financial assets + human capital
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase


34. situational profiling

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35. What are the different retirment risks and how can they be hedged?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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) 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) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)


36. What are the problems that financial advisers can face with low basis stock?
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
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
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education


37. What are the benefits of an IPS to the adviser?
Sources of wealth - measure of wealth - stage of life
Earnings start to accelerate -Expenses increase - but so do savings -Long time horizon over which to recover from short-term losses -above-average risk tolerance
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


38. What is typically considered when imposing an exit tax?
1) credit method 2) exemption method 3) deduction method
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
Early career 8accumulating education - developing skills - above-average ability to take risk
- 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


39. What are the equity holding life risk attributes for an entrepreneur?
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
Total wealth = financial assets + human capital
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n


40. template for return objective
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Transferring assets directly to a third generation avoids possible double taxation
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either


41. What are the psychological issues of low basis stock held by an investor?
- 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) credit method 2) exemption method 3) deduction method
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
Young -Building a foundation for future wealth -above avg risk tolerance


42. What are the advantages of hedging for low basis stock?
1) source of wealth 2) measure of wealth 3) stage of life
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
A will (also known as a testament)


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

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44. 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
Excess capital
Transferring assets directly to a third generation avoids possible double taxation
Implied liabilities


45. Describe the equity holding life three stages from the perspective of the stock.
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
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
The amount of assets (i.e.present value) necessary to meet all future liabilities


46. benefits of IPS to manager
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Demand for life insurance increases
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
Sources of wealth - measure of wealth - stage of life


47. What are the 3 categories of investors when discussing concentrated positions?
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
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
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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will


48. What is core capital?
The decedent's estate
The amount of assets (i.e.present value) necessary to meet all future liabilities
When a decedent leaves no will or if the will is deemed invalid
Demand for life insurance decreases


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


50. 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
The decedent's estate
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