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Private Wealth Management

Subjects : personal-finance, business-skills

Instructions:

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. How is mortality risk typically hedged?
The amount of assets (i.e.present value) necessary to meet all future liabilities
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

2. benefits of IPS to client
1. foundation 2. accumulation 3. maintenance 4. distribution
Should use accrual-equivalent returns and after-tax risk
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
Demand for life insurance decreases

3. What are the different methods of relief from double taxation?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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) credit method 2) exemption method 3) deduction method
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

4. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
It is expenseive - time consuming - public
1) source of wealth 2) measure of wealth 3) stage of life
HC = PV of future labor income
1) active 2) passive

5. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
Tax drag % = tax rate - as the investment horizon increases - tax drag is unchanged - as the investment return increases - tax drag is unchanged - as the investment horizon increases - value of the tax deferral increases - as the inestment return inc
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
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)

6. characteristics of cautious investor

7. What are the advantages of private exchange funds for low basis stock?
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
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
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

8. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
1) source of wealth 2) measure of wealth 3) stage of life
Wealth transfer stage - focus on tax min. with trusts and foundations

9. What is the most common estate planning tool?
Implied assets
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
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
A will (also known as a testament)

10. Define capital gains taxes.
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Both increase with longer holding periods and higher returns
The risk of a premature death with accompanying loss of future human capital
The decedent's estate

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

12. What are the disadvantages of an outright sale of low basis stock?
Demand for life insurance decreases
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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

13. Living expenses in retirment can be referred to as what?
The more equity-like - the less the demand for life insurance
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Implied liabilities
Demand for life insurance decreases

14. four types of investors
Methodical - cautious - individualist - spontaneous
The decedent's estate
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased

15. As probability of death increases...
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)
The demand for life insurance increases - regardless of age
Extra investment value created by effective tax management
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance

16. What are the main characteristics of the maintenance phase of life?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
The demand for life insurance increases - regardless of age
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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

17. characteristics of foundation stage
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Young -Building a foundation for future wealth -above avg risk tolerance
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
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

18. What are the main characteristics of the foundation phase of life?
Early career 8accumulating education - developing skills - above-average ability to take risk
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Extra investment value created by effective tax management
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

19. What is typically considered when imposing an exit tax?
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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
- 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

20. Define tax drag.
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
If human capital is equity-like - allocate financial assets more to fixed income - if the human capital is fixed-income like - allocate financial assets more to equities
The reduction in return caused by the payment of taxes

21. What are typical characteristics of passive recipients of wealth?
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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
HC = PV of future labor income

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

23. Describe asset segregation in a behavioral finance context.
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
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up

24. What are the main characteristics of the foundation phase of life?
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Early career 8accumulating education - developing skills - above-average ability to take risk
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
Demand for life insurance increases

25. What is tax alpha?
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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
Extra investment value created by effective tax management

26. What are the advantages of hedging for low basis stock?
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
A will (also known as a testament)
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
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

27. Describe the different types of double taxation conflicts.
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

28. What is typically considered when imposing an exit tax?
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 reduction in return caused by the payment of taxes
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
- 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

29. What is HIFO accounting?
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
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
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
It is expenseive - time consuming - public

30. As wealth increases...
Demand for life insurance decreases
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
- 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
Both increase with longer holding periods and higher returns

31. characteristics of individualist investor
- 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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
1) source of wealth 2) measure of wealth 3) stage 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

32. Describe biased expectations in a behavioral finance context.
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
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)
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
The reduction in return caused by the payment of taxes

33. What are the equity holding life risk attributes for an entrepreneur?
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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
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
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

34. What are the advantages of private exchange funds for low basis stock?
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
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
- 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) 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)

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

36. What are typical characteristics of active wealth creators?
The client's psychological profile
- 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
The risk of a premature death with accompanying loss of future human capital
Acts as an operational guideline that represents the long-term - best interests of the investor - the process is dynamic and can incorporate changed circumstances (review at least annually) - the IPS allows continuity over time and portability to new

37. What are the advantages of the monte carlo approach to portfolio construction?
Transferring assets directly to a third generation avoids possible double taxation
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Distribution of outcomes provides a better indication of the risk/return tradeoff - show the tradeoff b/t short-term risk and ability meet long-term goals - incorporates the impact of taxes and the compounding effect of reinvestment - can build in f
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either

38. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
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)
The decedent's estate
HC = PV of future labor income
Risk tolerance = as risk tolerance increases - demand for life insurance decreases

39. What is loss aversion?
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
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

40. Human capital is sometimes referred to as what?
The reduction in return caused by the payment of taxes
- 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
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
Implied assets

41. situational profiling

42. What are the different types of trusts?
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
More subjective than situational profiling -helps to understand how an investor perceives risk and return. -Bridges the differences between traditional finance and behavioral finance -Methodical - cautious - individualist - spontaneous
If board of director member = inside - prudent investor rules usually applies - recommend legal counsel for setting up personal trust or family foundation - if a trust - balance the needs of income beneficiaries and remainderment
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

43. benefits of IPS to manager
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 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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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

44. characteristics of methodical investor
Excess capital
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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

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

46. As desire to leave an estate increases...
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
Demand for life insurance 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
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)

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

48. What is the eifference in willingness to take risk between active and passive wealth creators?
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Risk tolerance and decision-making style
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
HC = PV of future labor income

49. What are the four broad categories of investor personality types (BB&K)?
- cautious - methodical - individualistic - 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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date

50. What is another name for a variable prepaid forward and What is its main purpose?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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
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