Private Wealth Management

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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 HIFO accounting?
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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
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
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


2. As probability of death increases...
Required = critical financial objectives (e.g. living expenses - kids' college expenses) Desired = objectives the client would like to meet (e.g. - large bequests to family or charity - early retirement)
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
The demand for life insurance increases - regardless of age
Methodical - cautious - individualist - spontaneous


3. Define tax drag.
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
The reduction in return caused by the payment of taxes
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool


4. What are the psychological issues of low basis stock held by an executive?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
- the higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm
The more equity-like - the less the demand for life insurance
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses


5. Who is responsible for gains/losses in a taxable (accrual taxation) account?
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)
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
The testator
The government shares in both gains and losses


6. If human capital is equity-like/fixed-income like - how should you generally allocate financial assets?
The more equity-like - the less the demand for life insurance
- 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
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
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


7. What are the 3 categories of investors when discussing concentrated positions?
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)
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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


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


9. What are the problems that financial advisers can face with low basis stock?
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
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
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


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

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11. What is an equity collar? What is the purpose of the underlying positions
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
Early career 8accumulating education - developing skills - above-average ability to take risk
Implied assets
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


12. Calculating the required return component is driven by what 2 elements?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
- 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
Demand for life insurance decreases
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


13. Describe a spontaneous investor personality type.
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
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


14. characteristics of cautious investor

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15. What are the main types of investors?
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)
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
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Taxes paid on the gain (long or short position) when an asset is sold or purchased


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


17. situational profiling - considerations
Sources of wealth - measure of wealth - stage of life
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis


18. 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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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
Early career 8accumulating education - developing skills - above-average ability to take risk


19. What are the problems that financial advisers can face with low basis stock?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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


20. What are investment objectives and constraints?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
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
Demand for life insurance increases


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

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22. As wealth increases...
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
Demand for life insurance decreases
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


23. What is the most common estate planning tool?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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
A will (also known as a testament)
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today


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


25. As wealth increases...
Demand for life insurance decreases
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
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 decedent's estate


26. Equation for total wealth.
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)
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
Total wealth = financial assets + human capital
When a decedent leaves no will or if the will is deemed invalid


27. What are the different methods of relief from double taxation?
1) credit method 2) exemption method 3) deduction method
The risk of a premature death with accompanying loss of future human capital
Should use accrual-equivalent returns and after-tax risk
Demand for insurance decreases; less human capital to replace


28. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
1) exhibit loss aversion rather than risk aversion 2) exhibit biased expectations rather than rational expectations 3) tend to segregate investments rather than considering them in a portfolio perspective
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today


29. Describe a methodical investor personality type.
Implied assets
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
Both increase with longer holding periods and higher returns
1) source of wealth 2) measure of wealth 3) stage of life


30. What is the eifference in willingness to take risk between active and passive wealth creators?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
- a subjective assessment of financial well-being based on perceived wealth
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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


31. What is loss aversion?
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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
Methodical - cautious - individualist - spontaneous
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


32. What are the different methods of relief from double taxation?
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
1) credit method 2) exemption method 3) deduction method
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk


33. What are wealth 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
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
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
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


34. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
Transferring assets directly to a third generation avoids possible double taxation
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Both increase with longer holding periods and higher returns
Risk tolerance = as risk tolerance increases - demand for life insurance decreases


35. What are the main characteristics of the maintenance phase of life?
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
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
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance


36. characteristics of cautious investor

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37. What are the main characteristics of the distribution phase of life?
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
A positive relationship
Wealth transfer stage - focus on tax min. with trusts and foundations
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


38. What should an investor use in mean-variance optimization
The government shares in both gains and losses
Should use accrual-equivalent returns and after-tax risk
The testator
Demand for insurance decreases; less human capital to replace


39. What are the general legal and regulatory considerations for individuals?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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) active 2) passive


40. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
The reduction in return caused by the payment of 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


41. As probability of death increases...
The demand for life insurance increases - regardless of age
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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


42. What is mortality risk?
The risk of a premature death with accompanying loss of future human capital
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
Transferring assets directly to a third generation avoids possible double taxation
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


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

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44. What are the disadvantages of public exchange funds for low basis stock?
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining 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


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

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

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47. What is human capital?
The client's psychological profile
HC = PV of future labor income
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification


48. Describe the different types of double taxation conflicts.
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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


49. Describe the equity holding life three stages from the perspective of the stock.
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
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
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased


50. What are the main characteristics of chritable gifts?
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
Should use accrual-equivalent returns and after-tax risk
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift