Private Wealth Management

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. Why do individuals often take steps to avoid probate?
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
It is expenseive - time consuming - public
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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized


2. characteristics of spontaneous investor

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3. Any amount above core capital is considered what?
Excess capital
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Risk tolerance and decision-making style
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


4. Calculating the required return component is driven by what 2 elements?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Risk tolerance and decision-making style
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Should use accrual-equivalent returns and after-tax risk


5. four types of investors
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Methodical - cautious - individualist - spontaneous
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
- 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


6. Equation for total wealth.
Total wealth = financial assets + human capital
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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


7. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
The testator
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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) 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


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

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9. What are the disadvantages of completion portfolios for low basis stock?
Both increase with longer holding periods and higher returns
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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


10. What is an equity collar? What is the purpose of the underlying positions
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
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
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
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


11. What are the advantages of an outright sale of low basis stock?
The reduction in return caused by the payment of taxes
The amount of assets (i.e.present value) necessary to meet all future liabilities
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


12. What are the disadvantages of private exchange funds for low basis stock?
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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
Methodical - cautious - individualist - spontaneous
Early career 8accumulating education - developing skills - above-average ability to take risk


13. Living expenses in retirment can be referred to as what?
- cautious - methodical - individualistic - spontaneous
Implied liabilities
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) 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 probability of death increases...
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
The demand for life insurance increases - regardless of age
Wealth transfer stage - focus on tax min. with trusts and foundations


15. What is human capital?
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
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
When a decedent leaves no will or if the will is deemed invalid
HC = PV of future labor income


16. What are the different methods of relief from double taxation?
1) credit method 2) exemption method 3) deduction method
- 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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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)


17. What is the person called that transfers assets through a will?
The government shares in both gains and losses
The testator
It is expenseive - time consuming - public
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale


18. characteristics of methodical investor
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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


19. benefits of IPS to client
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
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Early career 8accumulating education - developing skills - above-average ability to take risk


20. What are the psychological issues of low basis stock held by an investor?
Income rising - assets growing - long time horizon - above-avg. ability to take risk
The more equity-like - the less the demand for life insurance
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Excess capital


21. Describe a methodical investor personality type.
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
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
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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either


22. As desire to leave an estate increases...
- cautious - methodical - individualistic - spontaneous
Both increase with longer holding periods and higher returns
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Demand for life insurance increases


23. What is an equity collar? What is the purpose of the underlying positions
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
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
Demand for insurance decreases; less human capital to replace
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances


24. What are the advantages of public exchange funds for low basis stock?
Transferring assets directly to a third generation avoids possible double taxation
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date


25. What are the different stages of life?
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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
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


26. What are the benefits of an IPS to the adviser?
HC = PV of future labor income
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution


27. When dealing with low basis stock - emotional issues can arise from what?
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
The risk of a premature death with accompanying loss of future human capital
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


28. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
When a decedent leaves no will or if the will is deemed invalid
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Excess capital
The more equity-like - the less the demand for life insurance


29. What are the main characteristics of fixed annuities?

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30. characteristics of cautious investor

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31. characteristics of foundation stage
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
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
Young -Building a foundation for future wealth -above avg risk tolerance
Risk tolerance = as risk tolerance increases - demand for life insurance decreases


32. Describe the equity holding life three stages from the perspective of the stock.
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
Risk tolerance and decision-making style
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
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


33. As wealth increases...
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 decreases
1) active 2) passive
When a decedent leaves no will or if the will is deemed invalid


34. 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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification


35. situational profiling - considerations
Sources of wealth - measure of wealth - stage of life
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
A will (also known as a testament)
The risk of a premature death with accompanying loss of future human capital


36. What are the equity holding life risk attributes for an investor?
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
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
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


37. What are the psychological issues of low basis stock held by an investor?
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Transferring assets directly to a third generation avoids possible double taxation


38. 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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
Demand for insurance decreases; less human capital to replace


39. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
Demand for life insurance decreases
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
The amount of assets (i.e.present value) necessary to meet all future liabilities
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up


40. What are the main types of investors?
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
Risk tolerance and decision-making style
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) 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)


41. What are the problems that financial advisers can face with low basis stock?
- cautious - methodical - individualistic - spontaneous
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
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Risk tolerance and decision-making style


42. What is mortality risk?
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
The risk of a premature death with accompanying loss of future human capital


43. typical IPS elements
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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
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


44. situational profiling

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45. Describe an individualistic investor personality type.
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
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
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 client's psychological profile


46. What is another name for a variable prepaid forward and What is its main purpose?
Both increase with longer holding periods and higher returns
1. foundation 2. accumulation 3. maintenance 4. distribution
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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


47. As age increases..
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Both increase with longer holding periods and higher returns
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)
Demand for insurance decreases; less human capital to replace


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


49. What are the problems that financial advisers can face with low basis stock?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
- 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
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


50. characteristics of accumulation phase
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
1) Residence-residence = 2 individuals claim residence for the same individual 2) Source-Source = 2 countries claim authority over the same income (i.e. multinational company) 3) Residence-Source = individual is subject to residence jurisdiction and
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