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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. Calculating the required return component is driven by what 2 elements?
- a subjective assessment of financial well-being based on perceived wealth
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
The more equity-like - the less the demand for life insurance


2. sources of wealth
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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
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
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


3. As probability of death increases...
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
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
The demand for life insurance increases - regardless of age


4. Describe the equity holding life three stages from the perspective of the stock.
Wealth transfer stage - focus on tax min. with trusts and foundations
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
Should use accrual-equivalent returns and after-tax risk
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized


5. stages of life
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
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 amount of assets (i.e.present value) necessary to meet all future liabilities
1. foundation 2. accumulation 3. maintenance 4. distribution


6. What are the psychological issues of low basis stock held by an executive?
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Transferring assets directly to a third generation avoids possible double taxation
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
- 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


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

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8. What are the disadvantages of an outright sale of low basis stock?
- cautious - methodical - individualistic - spontaneous
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will


9. psychological profiling
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
When a decedent leaves no will or if the will is deemed invalid
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
1) source of wealth 2) measure of wealth 3) stage of life


10. What are the main types of investors?
The reduction in return caused by the payment of taxes
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)
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
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


11. characteristics of individualist investor
1) credit method 2) exemption method 3) deduction method
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
When a decedent leaves no will or if the will is deemed invalid
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


12. Investor questionnaires help to determine what?
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
When a decedent leaves no will or if the will is deemed invalid
Risk tolerance and decision-making style
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses


13. When calculating a required return - you typically must identify what?
The decedent's estate
- cautious - methodical - individualistic - spontaneous
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Wealth transfer stage - focus on tax min. with trusts and foundations


14. What are the main characteristics of chritable gifts?
- 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
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either


15. What are the disadvantages of an outright sale of low basis stock?
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
Demand for life insurance decreases
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase


16. What is measure of wealth?
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
1. foundation 2. accumulation 3. maintenance 4. distribution
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
- a subjective assessment of financial well-being based on perceived wealth


17. Describe a cautious investor personality type.
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
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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


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

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19. What are the main characteristics of the foundation phase of life?
- 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
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
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
Early career 8accumulating education - developing skills - above-average ability to take risk


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


21. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
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
Both increase with longer holding periods and higher returns
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances


22. What is an equity collar? What is the purpose of the underlying positions
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
Excess capital
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
The risk of a premature death with accompanying loss of future human capital


23. Why do individuals often take steps to avoid probate?
The risk of a premature death with accompanying loss of future 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
It is expenseive - time consuming - public
Transferring assets directly to a third generation avoids possible double taxation


24. What are the problems that financial advisers can face with low basis stock?
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification


25. Human capital is sometimes referred to as what?
Implied assets
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


26. Who is responsible for gains/losses in a taxable (accrual taxation) account?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
- 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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
The government shares in both gains and losses


27. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
1) source of wealth 2) measure of wealth 3) stage of life


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

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29. What are the psychological issues of low basis stock held by an investor?
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Methodical - cautious - individualist - spontaneous
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either


30. What are the main characteristics of the distribution phase of life?
Wealth transfer stage - focus on tax min. with trusts and foundations
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Transferring assets directly to a third generation avoids possible double taxation
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)


31. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
1) credit method 2) exemption method 3) deduction method
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
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up


32. Define capital gains taxes.
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use 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
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased


33. When dealing with low basis stock - emotional issues can arise from what?
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)
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)


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

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35. What are the advantages of the monte carlo approach to portfolio construction?
Should use accrual-equivalent returns and after-tax risk
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one


36. situational profiling - considerations
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
- a subjective assessment of financial well-being based on perceived wealth
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
Sources of wealth - measure of wealth - stage of life


37. What are the equity holding life risk attributes for an executive?
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
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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax


38. If human capital is equity-like/fixed-income like - how should you generally allocate financial assets?
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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
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


39. What are the benefits of an IPS to the adviser?
Should use accrual-equivalent returns and after-tax risk
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax


40. Describe a spontaneous investor personality type.
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
Early career 8accumulating education - developing skills - above-average ability to take risk
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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


41. What are the advantages of an outright sale of low basis stock?
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) 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)
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification


42. What are the psychological issues of low basis stock held by an entrepreneur?
When a decedent leaves no will or if the will is deemed invalid
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
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
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


43. Why would someone want to use a valuation discount?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Implied liabilities
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Can borrow and/or use derivatives to diversify - ability to borrow (monetize) increased - owners retain upside potential of the original investment - not required to hodl illiquid assets - partners can change fund composition


44. What are the main characteristics of fixed annuities?

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45. What is measure of wealth?
- a subjective assessment of financial well-being based on perceived wealth
The more equity-like - the less the demand for life insurance
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk


46. Living expenses in retirment can be referred to as what?
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Implied liabilities
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


47. Any amount above core capital is considered what?
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
Excess capital
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
- cautious - methodical - individualistic - spontaneous


48. What risks must be considered when discussing each concentrated investor category?
1. foundation 2. accumulation 3. maintenance 4. distribution
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) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
The testator


49. What is the reinvestment caveat when considering tax loss harvesting?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Demand for life insurance decreases
- 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


50. Why would someone want to use a valuation discount?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
1) source of wealth 2) measure of wealth 3) stage of life