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

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2. How does the nature of human capital affect the demand for life insurance?
The government shares in both gains and losses
The more equity-like - the less the demand for life insurance
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
Risk tolerance and decision-making style


3. What are the advantages of private exchange funds for low basis stock?
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
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
The more equity-like - the less the demand for life insurance
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


4. What are the different global tax regimes and their respective ordinary income tax structure?
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) 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)
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
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


5. What are the four broad categories of investor personality types (BB&K)?
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
- cautious - methodical - individualistic - spontaneous
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


6. What are the main characteristics of fixed annuities?

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7. characteristics of spontaneous investor

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8. typical IPS elements
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
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
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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education


9. Define tax drag.
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
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)
The reduction in return caused by the payment of taxes
Both increase with longer holding periods and higher returns


10. Describe biased expectations in a behavioral finance context.
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
- 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
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
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. What are the main types of investors?
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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)
- 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


12. Describe the equity holding life three stages from the perspective of the stock.
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
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
Demand for life insurance decreases
- 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


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


14. What are the diffferent types of tax jurisdictions?
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
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) 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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital


15. Why would an individual try to use generation skipping in estate planning?
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
1. foundation 2. accumulation 3. maintenance 4. distribution
Transferring assets directly to a third generation avoids possible double taxation


16. What are the equity holding life risk attributes for an executive?
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
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
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
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


17. Describe a cautious investor personality type.
Young -Building a foundation for future wealth -above avg risk tolerance
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
The government shares in both gains and losses


18. What are the advantages of private exchange funds for low basis stock?
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 amount of assets (i.e.present value) necessary to meet all future liabilities
A positive relationship
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


19. What are the disadvantages of hedging for low basis stock?
The demand for life insurance increases - regardless of age
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Demand for insurance decreases; less human capital to replace
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


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

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


22. Why do individuals often take steps to avoid probate?
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) credit method 2) exemption method 3) deduction method
It is expenseive - time consuming - public
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


23. What are the disadvantages of completion portfolios for low basis stock?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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


24. What are the main characteristics of the distribution phase of life?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Wealth transfer stage - focus on tax min. with trusts and foundations
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
Demand for life insurance decreases


25. What are wealth taxes.
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
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
Should use accrual-equivalent returns and after-tax risk
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


26. What is the general relationship b/t a client's perception of wealth and risk willingness?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
A positive relationship
A will (also known as a testament)


27. template for return objective
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Early career 8accumulating education - developing skills - above-average ability to take risk


28. What is the person called that transfers assets through a will?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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 testator
Risk tolerance and decision-making style


29. What is typically considered when imposing an exit tax?
The risk of a premature death with accompanying loss of future human capital
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
- 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


30. Any amount above core capital is considered what?
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Excess capital
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


31. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
Both increase with longer holding periods and higher returns
- 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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
- 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


32. What are the problems that financial advisers can face with low basis stock?
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) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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


33. Living expenses in retirment can be referred to as what?
Implied liabilities
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
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized


34. Calculating the required return component is driven by what 2 elements?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Should use accrual-equivalent returns and after-tax risk
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach


35. When calculating a required return - you typically must identify what?
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today


36. situational profiling

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37. sources of wealth
Transferring assets directly to a third generation avoids possible double taxation
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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


38. What are the general legal and regulatory considerations for individuals?
Demand for insurance decreases; less human capital to replace
The client's psychological profile
The testator
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


39. What is intestate?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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
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
When a decedent leaves no will or if the will is deemed invalid


40. What are the diffferent types of tax jurisdictions?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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
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
Methodical - cautious - individualist - spontaneous


41. Describe a spontaneous investor personality type.
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
HC = PV of future labor income
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


42. What are investment objectives and constraints?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
1) credit method 2) exemption method 3) deduction method
- 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
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


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


44. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
- 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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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


45. What are the different stages of life?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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
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
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


46. four types of investors
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
Methodical - cautious - individualist - 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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will


47. Investor questionnaires help to determine what?
Risk tolerance and decision-making style
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution


48. What are the equity holding life risk attributes for an investor?
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
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale


49. What is another name for a variable prepaid forward and What is its main purpose?
Demand for life insurance increases
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Tax drag % = tax rate - as the investment horizon increases - tax drag is unchanged - as the investment return increases - tax drag is unchanged - as the investment horizon increases - value of the tax deferral increases - as the inestment return inc
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging


50. psychological profiling
Extra investment value created by effective tax management
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
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
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