Private Wealth Management

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This is a study tool. The 3 wrong answers for each question are randomly chosen from answers to other questions. So, you might find at times the answers obvious, but you will see it re-enforces your understanding as you take the test each time.

1. What 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?
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
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
The more equity-like - the less the demand for life insurance
The government shares in both gains and losses


2. What are the main characteristics of the distribution phase of life?
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
Wealth transfer stage - focus on tax min. with trusts and foundations
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either


3. Equation for total wealth.
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Total wealth = financial assets + human capital
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
Implied liabilities


4. What are the disadvantages of private exchange funds for low basis stock?
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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
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


5. If human capital is equity-like/fixed-income like - how should you generally allocate financial assets?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
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


6. What are the different retirment risks and how can they be hedged?
The demand for life insurance increases - regardless of age
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
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)
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


7. What is the eifference in willingness to take risk between active and passive wealth creators?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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) 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)
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification


8. What are the main characteristics of the maintenance phase of life?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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
The reduction in return caused by the payment of taxes
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


9. As wealth increases...
Demand for life insurance decreases
Excess capital
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
When a decedent leaves no will or if the will is deemed invalid


10. When should you use a tax-exempt versus a tax-deferred account?
Should use accrual-equivalent returns and after-tax risk
Implied assets
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either


11. characteristics of individualist investor
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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)
The government shares in both gains and losses
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


12. 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
Early career 8accumulating education - developing skills - above-average ability to take risk
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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


13. Why would an individual try to use generation skipping in estate planning?
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
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
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
Transferring assets directly to a third generation avoids possible double taxation


14. characteristics of accumulation phase
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Earnings start to accelerate -Expenses increase - but so do savings -Long time horizon over which to recover from short-term losses -above-average risk tolerance
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach


15. What is another name for a variable prepaid forward and What is its main purpose?
When a decedent leaves no will or if the will is deemed invalid
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
The reduction in return caused by the payment of taxes
Early career 8accumulating education - developing skills - above-average ability to take risk


16. What are the disadvantages of an outright sale of low basis stock?
Total wealth = financial assets + human capital
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
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale


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

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18. What are the disadvantages of hedging for low basis stock?
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance


19. What are the benefits of an IPS to the adviser?
Extra investment value created by effective tax management
- 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
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


20. What are the main characteristics of chritable gifts?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
It is expenseive - time consuming - public
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift


21. situational profiling

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22. What are the main characteristics of the maintenance phase of life?
The reduction in return caused by the payment of taxes
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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


23. Describe a spontaneous investor personality type.
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
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n


24. characteristics of methodical investor
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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
Sources of wealth - measure of wealth - stage of life
Hedged with life insurance - think of the life insurance as a replacement for lost human capital


25. Describe a cautious investor personality type.
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
Income rising - assets growing - long time horizon - above-avg. ability to take 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
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging


26. What is tax alpha?
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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 client's psychological profile
Extra investment value created by effective tax management


27. What are wealth taxes.
Risk tolerance and decision-making style
The government shares in both gains and losses
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
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


28. 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
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 more equity-like - the less the demand for life insurance
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


29. typical IPS elements
Methodical - cautious - individualist - spontaneous
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
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


30. What are the advantages of the monte carlo approach to portfolio construction?
Excess capital
Distribution of outcomes provides a better indication of the risk/return tradeoff - show the tradeoff b/t short-term risk and ability meet long-term goals - incorporates the impact of taxes and the compounding effect of reinvestment - can build in f
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Sources of wealth - measure of wealth - stage of life


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

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32. characteristics of foundation stage
1) source of wealth 2) measure of wealth 3) stage of life
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
Young -Building a foundation for future wealth -above avg risk tolerance
1. foundation 2. accumulation 3. maintenance 4. distribution


33. What are the psychological issues of low basis stock held by an executive?
Transferring assets directly to a third generation avoids possible double taxation
- 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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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


34. situational profiling

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35. situational profiling - considerations
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Sources of wealth - measure of wealth - stage of life
Implied liabilities
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


36. What should an investor use in mean-variance optimization
Total wealth = financial assets + human capital
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
Sources of wealth - measure of wealth - stage of life
Should use accrual-equivalent returns and after-tax risk


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

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38. Why would an individual try to use generation skipping in estate planning?
1) credit method 2) exemption method 3) deduction method
The decedent's estate
Transferring assets directly to a third generation avoids possible double taxation
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either


39. Any amount above core capital is considered what?
Total wealth = financial assets + human capital
Excess capital
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) source of wealth 2) measure of wealth 3) stage of life


40. What are the main characteristics of the foundation phase of life?
Early career 8accumulating education - developing skills - above-average ability to take risk
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
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
Transferring assets directly to a third generation avoids possible double taxation


41. Describe the different types of double taxation conflicts.
- a subjective assessment of financial well-being based on perceived wealth
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)
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) 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


42. Describe a methodical investor personality type.
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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


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


44. benefits of IPS to manager
When a decedent leaves no will or if the will is deemed invalid
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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)
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


45. Equation for total wealth.
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
Total wealth = financial assets + human capital
Transferring assets directly to a third generation avoids possible double taxation


46. What is HIFO accounting?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
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
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


47. Define tax drag.
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
The reduction in return caused by the payment of taxes
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)


48. 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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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 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


49. Describe the different types of double taxation conflicts.
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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
Early career 8accumulating education - developing skills - above-average ability to take risk


50. Define capital gains taxes.
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)
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased