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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 main characteristics of chritable gifts?
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 government shares in both gains and losses
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

2. What are the main characteristics of the accumulation phase of life?
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk

3. Describe a methodical investor personality type.
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
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
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale

4. What are the general legal and regulatory considerations for individuals?
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
- 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
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
- 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

5. What is intestate?
It is expenseive - time consuming - public
When a decedent leaves no will or if the will is deemed invalid
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

6. What are the main types of investors?
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) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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)
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

7. What are the main characteristics of the maintenance phase of life?
Total wealth = financial assets + human capital
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)
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance

8. Who is responsible for gains/losses in a taxable (accrual taxation) account?
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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 government shares in both gains and losses

9. As probability of death 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
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 client's psychological profile
The demand for life insurance increases - regardless of age

10. 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
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
Demand for life insurance increases
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

11. What is loss aversion?
The risk of a premature death with accompanying loss of future human capital
Implied assets
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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

12. Why would someone want to use a valuation discount?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
HC = PV of future labor income

13. Investor questionnaires help to determine what?
Risk tolerance and decision-making style
Implied assets
It is expenseive - time consuming - public
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)

14. As age increases..
Young -Building a foundation for future wealth -above avg risk tolerance
- a subjective assessment of financial well-being based on perceived wealth
The risk of a premature death with accompanying loss of future human capital
Demand for insurance decreases; less human capital to replace

15. What are the two sources of wealth?
1) active 2) passive
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
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
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

16. stages of life
1. foundation 2. accumulation 3. maintenance 4. distribution
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Total wealth = financial assets + human capital
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

17. Describe the equity holding life three stages from the perspective of the stock.
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
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
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
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

18. What are wealth taxes.
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
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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

19. Why would an individual try to use generation skipping in estate planning?
Transferring assets directly to a third generation avoids possible double taxation
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
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)
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up

20. stages of life
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
1. foundation 2. accumulation 3. maintenance 4. distribution
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) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

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

22. What are the disadvantages of private exchange funds for low basis stock?
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
HC = PV of future labor income
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk

23. What are the problems that financial advisers can face with low basis stock?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
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) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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

24. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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)
Risk tolerance = as risk tolerance increases - demand for life insurance decreases

25. What are the main characteristics of the distribution phase of life?
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
Sources of wealth - measure of wealth - stage of life
Wealth transfer stage - focus on tax min. with trusts and foundations

26. What are the 3 categories of investors when discussing concentrated positions?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
When a decedent leaves no will or if the will is deemed invalid
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 risk of a premature death with accompanying loss of future human capital

27. What is the general relationship between tax drag% and tax rate when capital gains taxes are deferred and B=1; and as investment horizon increases and return increases?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Both increase with longer holding periods and higher returns
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

28. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
- a subjective assessment of financial well-being based on perceived wealth
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
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

29. What are the different stages of life?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Should use accrual-equivalent returns and after-tax risk
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Transferring assets directly to a third generation avoids possible double taxation

30. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
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)
HC = PV of future labor income
Extra investment value created by effective tax management

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

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32. 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
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
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

33. characteristics of accumulation phase
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
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
1) source of wealth 2) measure of wealth 3) stage of life

34. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
Wealth transfer stage - focus on tax min. with trusts and foundations
Both increase with longer holding periods and higher returns
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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

35. What are the disadvantages of completion portfolios for low basis stock?
1) credit method 2) exemption method 3) deduction method
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
HC = PV of future labor income

36. What are the disadvantages of an outright sale of low basis stock?
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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

37. What are the equity holding life risk attributes for an entrepreneur?
Excess capital
Single privately-held stock - high degree of control - immature firm - very high unsystematic risk - face significant residual risk - limited or restricted liquidity - zero cost basis in the original investment - desires tax efficient transfer to hei
Taxes paid on the gain (long or short position) when an asset is sold or purchased
- cautious - methodical - individualistic - spontaneous

38. What is the person called that transfers assets through a will?
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
The testator
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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

39. Calculating the required return component is driven by what 2 elements?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

40. What are the advantages of public exchange funds for low basis stock?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
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
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

41. As desire to leave an estate increases...
The testator
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Demand for life insurance increases
Early career 8accumulating education - developing skills - above-average ability to take risk

42. characteristics of spontaneous investor

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43. What are the different retirment risks and how can they be hedged?
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)
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) 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) source of wealth 2) measure of wealth 3) stage of life

44. Why do individuals often take steps to avoid probate?
- 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
It is expenseive - time consuming - public
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Most risk averse/least risk tolerant - primary focus is financial security: preservation of wealth - hard to advise - can over-analyze - slow in making decisions and then changing investments - low portfolio turnover/volatility

45. What are investment objectives and constraints?
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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)
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

46. What is the general relationship between tax drag% and tax rate when capital gains taxes are deferred and B=1; and as investment horizon increases and return increases?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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)
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

47. What is another name for a variable prepaid forward and What is its main purpose?
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
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

48. Describe biased expectations in a behavioral finance context.
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
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
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

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

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50. situational profiling

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