Private Wealth Management

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• Answer 50 questions in 15 minutes.
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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 steps involved in creating an IPS?

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2. What are the main characteristics of chritable gifts?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
1. foundation 2. accumulation 3. maintenance 4. distribution
The risk of a premature death with accompanying loss of future human capital
The amount of assets (i.e.present value) necessary to meet all future liabilities


3. What are the main characteristics of the accumulation phase of life?
Income rising - assets growing - long time horizon - above-avg. ability to take risk
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
The client's psychological profile


4. What is an equity collar? What is the purpose of the underlying positions
Excess 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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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. Why do individuals often take steps to avoid probate?
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
- cautious - methodical - individualistic - spontaneous
It is expenseive - time consuming - public
When a decedent leaves no will or if the will is deemed invalid


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

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7. Calculating the required return component is driven by what 2 elements?
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
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) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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


8. What should an investor use in mean-variance optimization
Should use accrual-equivalent returns and after-tax 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
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
Transferring assets directly to a third generation avoids possible double taxation


9. What are the diversification techniques for low basis stock?
Demand for insurance decreases; less human capital to replace
1) revocable trust = the settlor can rescind the trust and resume ownership of the assets 2) irrevocable trust = the settlor relinquishes ownership and control 3) fixed trust = pattern of distributions to the beneficiaris is predetermined by the sett
- the higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging


10. What is the reinvestment caveat when considering tax loss harvesting?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
Young -Building a foundation for future wealth -above avg risk tolerance
- 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


11. 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
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
1) active 2) passive


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

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13. four 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) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Methodical - cautious - individualist - spontaneous
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


14. What are the equity holding life risk attributes for an executive?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Quick to make decisions in the heat of moment (don't want to miss opportunities) - High PTO - Focus on return w/out considering risk - Don't consider themselves experts - Don't trust professionals
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
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


15. 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
The decedent's estate
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
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach


16. 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?
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
Risk tolerance and decision-making style
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis


17. four types of investors
Demand for life insurance increases
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Methodical - cautious - individualist - spontaneous
Implied assets


18. situational profiling

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19. What are ways that individuals can avoid probate?
Extra investment value created by effective tax management
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n


20. What are the diffferent types of tax jurisdictions?
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 risk of a premature death with accompanying loss of future 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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis


21. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
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
Transferring assets directly to a third generation avoids possible double taxation
Total wealth = financial assets + human capital
1) source of wealth 2) measure of wealth 3) stage of life


22. Describe the equity holding life three stages from the perspective of the stock.
Transferring assets directly to a third generation avoids possible double taxation
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
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale


23. What risks must be considered when discussing each concentrated investor category?
It is expenseive - time consuming - public
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
Risk tolerance and decision-making style
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)


24. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
- 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
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
Implied assets


25. Why would an individual try to use generation skipping in estate planning?
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
- cautious - methodical - individualistic - spontaneous
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
Transferring assets directly to a third generation avoids possible double taxation


26. When dealing with low basis stock - emotional issues can arise from what?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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 rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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


27. What are the main characteristics of the distribution phase of life?
A positive relationship
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Wealth transfer stage - focus on tax min. with trusts and foundations


28. What is an equity collar? What is the purpose of the underlying positions
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date


29. What are the different methods of relief from double taxation?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
1) credit method 2) exemption method 3) deduction method
Implied assets
The amount of assets (i.e.present value) necessary to meet all future liabilities


30. What are the equity holding life risk attributes for an investor?
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
- 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
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
Implied liabilities


31. What is loss aversion?
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
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
An investor focuses on gains and losses - prefer certain (riskless) gains and uncertain losses - are willing to face incerased risk to avoid losses - causes investors to exhibit risk-seeking behavior
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)


32. What is human capital?
The more equity-like - the less the demand for life insurance
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
HC = PV of future labor income
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


33. When dealing with low basis stock - emotional issues can arise from what?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Excess capital
The decedent's estate
1) credit method 2) exemption method 3) deduction method


34. Describe the equity holding life three stages from the perspective of the stock.
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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
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
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)


35. As wealth increases...
- if you sell a security to harvest its loss and then reinvest the proceeds in a very similar security - the selling price fo the old security becomes the tax basis for the new security - in that case - the loss harvest only delays the payment of t
Investors 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
Demand for life insurance decreases
The amount of assets (i.e.present value) necessary to meet all future liabilities


36. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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


37. What are the main characteristics of the foundation phase of life?
A positive relationship
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
Early career 8accumulating education - developing skills - above-average ability to take risk
1) credit method 2) exemption method 3) deduction method


38. What are the problems that financial advisers can face with low basis stock?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool


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

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40. What are the disadvantages of completion portfolios for low basis stock?
Implied liabilities
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool


41. What are the psychological issues of low basis stock held by an investor?
It is expenseive - time consuming - public
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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


42. What are the psychological issues of low basis stock held by an executive?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
- 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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today


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

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44. What are the main characteristics of variable annuities?

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45. What are the disadvantages of completion portfolios for low basis stock?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
The client's psychological profile
Young -Building a foundation for future wealth -above avg risk tolerance
Total wealth = financial assets + human capital


46. What are the different retirment risks and how can they be hedged?
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)
Implied liabilities
1) revocable trust = the settlor can rescind the trust and resume ownership of the assets 2) irrevocable trust = the settlor relinquishes ownership and control 3) fixed trust = pattern of distributions to the beneficiaris is predetermined by the sett
The government shares in both gains and losses


47. As wealth increases...
Wealth transfer stage - focus on tax min. with trusts and foundations
It is expenseive - time consuming - public
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Demand for life insurance decreases


48. characteristics of accumulation phase
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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
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


49. What are the main characteristics of fixed annuities?

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50. characteristics of maintenance phase
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
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
HC = PV of future labor income
Investors begin to shift portfolios into less volatile assets -Reduced focus on accumulating additional wealth and more focus on preserving current wealth -Reduced ability to recover from market downturns -diminishing risk tolerance