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• 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 benefits of an IPS to the adviser?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
Demand for life insurance decreases


2. What are the advantages of the monte carlo approach to portfolio construction?
The demand for life insurance increases - regardless of age
A will (also known as a testament)
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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


3. What are wealth taxes.
Transferring assets directly to a third generation avoids possible double taxation
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date


4. How does the nature of human capital affect the demand for life insurance?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
The more equity-like - the less the demand for life insurance
Implied assets
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date


5. 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
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Early career 8accumulating education - developing skills - above-average ability to take risk
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach


6. What are the disadvantages of public exchange funds for low basis stock?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
- cautious - methodical - individualistic - spontaneous
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


7. What are the different types of trusts?
Implied assets
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Risk tolerance and decision-making style
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


8. What is mortality risk?
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 higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm
The risk of a premature death with accompanying loss of future human capital
The more equity-like - the less the demand for life insurance


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

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10. What are the diffferent types of estate ownership rights?

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11. Living expenses in retirment can be referred to as what?
Implied liabilities
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)
1) credit method 2) exemption method 3) deduction method
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification


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

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13. Calculating the required return component is driven by what 2 elements?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Income rising - assets growing - long time horizon - above-avg. ability to take risk
- 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
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


14. What are typical characteristics of active wealth creators?
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
- 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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up


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

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16. 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
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)
Young -Building a foundation for future wealth -above avg risk tolerance
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


17. What are the disadvantages of private exchange funds for low basis stock?
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
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)
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Methodical - cautious - individualist - spontaneous


18. What are the disadvantages of completion portfolios for low basis stock?
Extra investment value created by effective tax management
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)
Implied liabilities
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely


19. What are ways that individuals can avoid probate?
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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
- a subjective assessment of financial well-being based on perceived wealth
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will


20. What are the two sources of wealth?
Using HIFO accounting - an investor assumes the lot with the highest tax basis was sold to either maximize the loss for harvesting or minimize the taxable gain
The decedent's estate
Risk tolerance and decision-making style
1) active 2) passive


21. benefits of IPS to client
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
Decisions should be optimal -process is dynamic - thus factors in changing circumstances -focus on long-term objectives -new investment advisors should be able to use the IPS
1) 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
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


22. What are the different stages of life?
1) source of wealth 2) measure of wealth 3) stage of life
Typically very loyal to the firm - views the concentrated position as a positive - does not desire diversification - b/c feels in control of the future - as entrepreneurs delegate more and more control to others - they strive for more and more divers
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution


23. Equation for total wealth.
1. foundation 2. accumulation 3. maintenance 4. distribution
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
Total wealth = financial assets + human capital


24. What are the main characteristics of the distribution phase of life?
Sources of wealth - measure of wealth - stage of life
Wealth transfer stage - focus on tax min. with trusts and foundations
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification


25. As wealth increases...
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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 life insurance decreases
Extra investment value created by effective tax management


26. What are the different stages of life?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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)


27. What are the equity holding life risk attributes for an entrepreneur?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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
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
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


28. What is HIFO accounting?
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
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
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital


29. What is the reinvestment caveat when considering tax loss harvesting?
The risk of a premature death with accompanying loss of future human capital
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
- 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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes


30. What are the main characteristics of fixed annuities?

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31. What are the disadvantages of public exchange funds for low basis stock?
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Sources of wealth - measure of wealth - stage of life
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Income rising - assets growing - long time horizon - above-avg. ability to take risk


32. Why do individuals often take steps to avoid probate?
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
It is expenseive - time consuming - public
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
The reduction in return caused by the payment of taxes


33. What are the advantages of an outright sale of low basis stock?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Risk tolerance = as risk tolerance increases - demand for life insurance decreases


34. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Fixed income streat set at inception - usually no inflation adjustment - so real value falls over time - usually illiquid (can't withdraw funds) - lock in at the prevailing rate - which might be historically low
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


35. What are the equity holding life risk attributes for an executive?
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) 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
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
- 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


36. How is mortality risk typically hedged?
1) source of wealth 2) measure of wealth 3) stage of life
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
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital


37. characteristics of cautious investor

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38. What are the different global tax regimes and their respective ordinary income tax structure?
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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)
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


39. As probability of death increases...
Total wealth = financial assets + human capital
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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 demand for life insurance increases - regardless of age


40. characteristics of spontaneous investor

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41. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
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
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) source of wealth 2) measure of wealth 3) stage of life
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses


42. 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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Transferring assets directly to a third generation avoids possible double taxation
Taxes paid on the gain (long or short position) when an asset is sold or purchased


43. What is the general relationship b/t a client's perception of wealth and risk willingness?
A positive relationship
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Wealth transfer stage - focus on tax min. with trusts and foundations
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses


44. What are the main characteristics of the maintenance phase of life?
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
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase


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

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46. Describe the different types of double taxation conflicts.
The risk of a premature death with accompanying loss of future human capital
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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
Methodical - cautious - individualist - spontaneous


47. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Should use accrual-equivalent returns and after-tax risk
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax


48. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
1) source of wealth 2) measure of wealth 3) stage of life
Decisions should be optimal -process is dynamic - thus factors in changing circumstances -focus on long-term objectives -new investment advisors should be able to use the IPS
1) 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
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)


49. characteristics of maintenance phase
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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
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


50. What are the psychological issues of low basis stock held by an investor?
- 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 used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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 rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either