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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. How does the nature of human capital affect the demand for life insurance?
The more equity-like - the less the demand for life insurance
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
Implied liabilities
- 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

2. What are the advantages of hedging for low basis stock?
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
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

3. What is loss aversion?
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
Excess capital
Implied liabilities

4. What are typical characteristics of passive recipients of wealth?
HC = PV of future labor income
Demand for life insurance increases
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education

5. What are investment objectives and constraints?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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) active 2) passive
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

6. What are the psychological issues of low basis stock held by an executive?
Young -Building a foundation for future wealth -above avg risk tolerance
1) active 2) passive
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
- 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

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

8. What are the main characteristics of chritable gifts?
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
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

9. What are the psychological issues of low basis stock held by an entrepreneur?
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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. foundation 2. accumulation 3. maintenance 4. distribution

10. What are the benefits of an IPS to the adviser?
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Income rising - assets growing - long time horizon - above-avg. ability to take risk

11. What are the main characteristics of the maintenance phase of life?
Methodical - cautious - individualist - spontaneous
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
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

12. As desire to leave an estate increases...
The decedent's estate
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Demand for life insurance increases

13. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

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

15. What are the equity holding life risk attributes for an investor?
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 more equity-like - the less the demand for life insurance
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
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

16. What are the four broad categories of investor personality types (BB&K)?
- cautious - methodical - individualistic - spontaneous
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Should use accrual-equivalent returns and after-tax risk
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

17. situational profiling - considerations
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
Sources of wealth - measure of wealth - stage of life

18. What are the benefits of an IPS to the client?
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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
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

19. What are the diversification techniques for low basis stock?
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Excess capital
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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

20. Equation for total wealth.
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Total wealth = financial assets + human capital
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

21. What are the advantages of the monte carlo approach to portfolio construction?
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
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
A positive relationship

22. What are the different global tax regimes and their respective ordinary income tax structure?
HC = PV of future labor income
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) 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)
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

23. 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
1. foundation 2. accumulation 3. maintenance 4. distribution
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
- 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

24. Human capital is sometimes referred to as what?
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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
- 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
Implied assets

25. characteristics of foundation stage
Young -Building a foundation for future wealth -above avg risk tolerance
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
A positive relationship
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. An investor's ability to take risk depends on what?

27. What are the problems that financial advisers can face with low basis stock?
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
The government shares in both gains and losses
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

28. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Implied assets
Both increase with longer holding periods and higher returns
Total wealth = financial assets + human capital

29. What are the equity holding life risk attributes for an executive?
HC = PV of future labor income
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
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
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

30. What are the different stages of life?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

31. What are the benefits of an IPS to the adviser?
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
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

32. What are the advantages of hedging for low basis stock?
Excess capital
Taxes paid on the gain (long or short position) when an asset is sold or purchased
- 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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

33. What are the main characteristics of variable annuities?

34. If human capital is equity-like/fixed-income like - how should you generally allocate financial assets?
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
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
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
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

35. What are the main types of investors?
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)
Sources of wealth - measure of wealth - stage of life
- 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
A will (also known as a testament)

36. Why would an individual try to use generation skipping in estate planning?
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Transferring assets directly to a third generation avoids possible double taxation
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized

37. What are the disadvantages of public exchange funds for low basis stock?
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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) credit method 2) exemption method 3) deduction method

38. What is an equity collar? What is the purpose of the underlying positions
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
Both increase with longer holding periods and higher returns
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one

39. As wealth increases...
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 decedent's estate
Demand for life insurance decreases
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

40. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Deterministic = use point estimates to generate a forecasted value such as an expected return or terminal value Monte Carlo = use probability distributions of inputs to generate expected returns with accompanying probability distributions
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

41. 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
Young -Building a foundation for future wealth -above avg risk tolerance
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one

42. How is mortality risk typically hedged?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
It is expenseive - time consuming - public

43. What are the main characteristics of the foundation phase of life?
Transferring assets directly to a third generation avoids possible double taxation
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
Early career 8accumulating education - developing skills - above-average ability to take risk
When a decedent leaves no will or if the will is deemed invalid

44. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
When a decedent leaves no will or if the will is deemed invalid
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)
Risk tolerance = as risk tolerance increases - demand for life insurance decreases

45. What are the main types of investors?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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)
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
- cautious - methodical - individualistic - spontaneous

46. When dealing with low basis stock - emotional issues can arise from what?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
When a decedent leaves no will or if the will is deemed invalid
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

47. Why would someone want to use a valuation discount?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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
Should use accrual-equivalent returns and after-tax risk
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

48. benefits of IPS to client
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
Early career 8accumulating education - developing skills - above-average ability to take risk
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase

49. Who is responsible for gains/losses in a taxable (accrual taxation) account?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
- a subjective assessment of financial well-being based on perceived wealth
The government shares in both gains and losses
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

50. characteristics of cautious investor