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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 typical characteristics of passive recipients of wealth?
The client's psychological profile
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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

2. What are the main characteristics of fixed annuities?

3. What are the equity holding life risk attributes for an investor?
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
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
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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized

4. Any amount above core capital is considered what?
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)
Excess 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)
Should use accrual-equivalent returns and after-tax risk

5. What are the advantages of public exchange funds for low basis stock?
Implied liabilities
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

6. What are the advantages of hedging for low basis 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
Wealth transfer stage - focus on tax min. with trusts and foundations
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

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

8. characteristics of accumulation phase
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
- 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
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
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

9. If human capital is equity-like/fixed-income like - how should you generally allocate financial assets?
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) growing the portfolio (capital gains) 2) liquidity needs - total return approach
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Starts as a private stock held by an entrepreneur - Sold publicly in IPO (now held by exec - still major part of wealth - less specific risk b/c more mature) - Contributes less and less specific risk as other securities are added to portfolio - ends

10. Why would an individual try to use generation skipping in estate planning?
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) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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

11. What are the main characteristics of variable annuities?

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

13. What are the psychological issues of low basis stock held by an executive?
The decedent's estate
Demand for insurance decreases; less human capital to replace
1) active 2) passive
- 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

14. What are the 3 categories of investors when discussing concentrated positions?
- 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
Both increase with longer holding periods and higher returns
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
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

15. What is core capital?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
The amount of assets (i.e.present value) necessary to meet all future 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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)

16. benefits of IPS to manager
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
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
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
- cautious - methodical - individualistic - spontaneous

17. What is the most common estate planning tool?
A will (also known as a testament)
The reduction in return caused by the payment of taxes
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
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

18. What is loss aversion?
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
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
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
Methodical - cautious - individualist - spontaneous

19. Living expenses in retirment can be referred to as what?
Should use accrual-equivalent returns and after-tax risk
Client description -purpose of IPS -identification of duties - responsibilities -formal statement of objectives and constraints -calendar schedule for portfolio performance and IPS review -performance measures and benchmarks -considerations for devel
Implied liabilities
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

20. What are typical characteristics of active wealth creators?
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer 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
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

21. Living expenses in retirment can be referred to as what?
Implied liabilities
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
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
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

22. What is tax alpha?
The government shares in both gains and losses
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
Extra investment value created by effective tax management
The amount of assets (i.e.present value) necessary to meet all future liabilities

23. stages of life
The more equity-like - the less the demand for life insurance
Income rising - assets growing - long time horizon - above-avg. ability to take risk
1. foundation 2. accumulation 3. maintenance 4. distribution
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

24. What is another name for a variable prepaid forward and What is its main purpose?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

25. What risks must be considered when discussing each concentrated investor category?
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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

26. situational profiling

27. What are the advantages of an outright sale of low basis stock?
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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

28. Describe a cautious investor personality type.
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
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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized

29. What are wealth taxes.
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
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
The client's psychological profile
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

30. What are investment objectives and constraints?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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)
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

31. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
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
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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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

32. Calculating the required return component is driven by what 2 elements?
The decedent's estate
Young -Building a foundation for future wealth -above avg risk tolerance
The demand for life insurance increases - regardless of age
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach

33. What is HIFO accounting?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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
Implied liabilities
Transferring assets directly to a third generation avoids possible double taxation

34. What is another name for a variable prepaid forward and What is its main purpose?
Extra investment value created by effective tax management
Demand for insurance decreases; less human capital to replace
The reduction in return caused by the payment of taxes
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

35. 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?
Early career 8accumulating education - developing skills - above-average ability to take risk
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
1) credit method 2) exemption method 3) deduction method

36. 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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Should use accrual-equivalent returns and after-tax risk

37. What are the advantages of the monte carlo approach to portfolio construction?
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
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
Demand for insurance decreases; less human capital to replace
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

38. What are the equity holding life risk attributes for an entrepreneur?
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
1. foundation 2. accumulation 3. maintenance 4. distribution
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

39. What are the main characteristics of the maintenance phase of life?
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
- a subjective assessment of financial well-being based on perceived wealth
The more equity-like - the less the demand for life insurance

40. benefits of IPS to client
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
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
Transferring assets directly to a third generation avoids possible double taxation
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis

41. An investor's ability to take risk depends on what?

42. What are the disadvantages of hedging for low basis stock?
- 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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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
Implied liabilities

43. characteristics of accumulation phase
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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
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)

44. What are the problems that financial advisers can face with low basis stock?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification

45. Define tax drag.
The reduction in return caused by the payment of taxes
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase

46. Any amount above core capital is considered what?
Excess capital
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Demand for life insurance decreases

47. Why would someone want to use a valuation discount?
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

48. What is typically considered when imposing an exit tax?
Single publicly traded mature company stock or vested options - greater appetite for specific risk due to higher degree of control - less residual risk - b/c the firm is more mature - less liquidity risk - but may have restrictions - desires tax effi
The decedent's estate
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
- 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

49. 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
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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax

50. 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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)