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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. What are wealth taxes.
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax

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

3. Who is responsible for gains/losses in a taxable (accrual taxation) account?
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
- 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 government shares in both gains and losses
The client's psychological profile

4. What are the equity holding life risk attributes for an investor?
The demand for life insurance increases - regardless of age
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
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

5. characteristics of cautious investor

6. What are the disadvantages of an outright sale of low basis stock?
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
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
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

7. What are the advantages of hedging for low basis 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)
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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
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

8. What is the reinvestment caveat when considering tax loss harvesting?
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
- 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
Implied assets
Methodical - cautious - individualist - spontaneous

9. template for return objective
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
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. What is human capital?
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
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)
HC = PV of future labor income
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

11. What are the diffferent types of tax jurisdictions?
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) 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) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education

12. What are the disadvantages of completion portfolios for low basis stock?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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

13. When should you use a tax-exempt versus a tax-deferred account?
Demand for life insurance increases
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
The government shares in both gains and losses

14. 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
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
- 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

15. An investor's willingness to take risk is determined by what?

16. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
Sources of wealth - measure of wealth - stage of life
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Extra investment value created by effective tax management

17. What are the advantages of completion portfolios for low basis 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
1. foundation 2. accumulation 3. maintenance 4. distribution
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses

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

19. What are the different methods of relief from double taxation?
1) credit method 2) exemption method 3) deduction method
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses

20. What is the general relationship between tax drag% and tax rate when capital gains taxes are deferred and B=1; and as investment horizon increases and return increases?
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) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

21. characteristics of distribution phase
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
The more equity-like - the less the demand for life insurance
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
1. foundation 2. accumulation 3. maintenance 4. distribution

22. As wealth increases...
- 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
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

23. typical IPS elements
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
1. foundation 2. accumulation 3. maintenance 4. distribution
A will (also known as a testament)

24. What are the psychological issues of low basis stock held by an entrepreneur?
Demand for life insurance decreases
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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
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

25. How is mortality risk typically hedged?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
The more equity-like - the less the demand for life insurance
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

26. What are the disadvantages of public exchange funds for low basis stock?
It is expenseive - time consuming - public
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

27. What is the most common estate planning tool?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
A will (also known as a testament)
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
1) source of wealth 2) measure of wealth 3) stage of life

28. What are the advantages of public exchange funds for 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
Excess capital
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

29. What are the four broad categories of investor personality types (BB&K)?
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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
- cautious - methodical - individualistic - spontaneous
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

30. What are the psychological issues of low basis stock held by an entrepreneur?
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
Excess capital
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
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

31. What are the main characteristics of the accumulation phase of life?
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Transferring assets directly to a third generation avoids possible double taxation
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
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

32. What are the equity holding life risk attributes for an entrepreneur?
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses

33. 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
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) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
- 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

34. What are the different retirment risks and how can they be hedged?
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) 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)
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
The testator

35. Define tax drag.
HC = PV of future labor income
Demand for insurance decreases; less human capital to replace
The reduction in return caused by the payment of taxes
Demand for insurance decreases; less human capital to replace

36. Describe a cautious investor personality type.
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
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

37. What is HIFO accounting?
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
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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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

38. What are the main characteristics of the maintenance phase 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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance

39. benefits of IPS to client
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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) 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
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

40. What is tax alpha?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
Extra investment value created by effective tax management
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

41. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
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)

42. benefits of IPS to manager
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
Both increase with longer holding periods and higher returns
Total wealth = financial assets + human capital
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

43. What are the main characteristics of the distribution phase of life?
Wealth transfer stage - focus on tax min. with trusts and foundations
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
1) credit method 2) exemption method 3) deduction method
- 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

44. What are the benefits of an IPS to the client?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
The government shares in both gains and losses
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
The risk of a premature death with accompanying loss of future human capital

45. characteristics of individualist investor
- 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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk

46. Define capital gains taxes.
Taxes paid on the gain (long or short position) when an asset is sold or purchased
- 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
Demand for life insurance decreases
The demand for life insurance increases - regardless of age

47. What are the main characteristics of fixed annuities?

48. What are the benefits of an IPS to the client?
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
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
Young -Building a foundation for future wealth -above avg risk tolerance
- a subjective assessment of financial well-being based on perceived wealth

49. What is loss aversion?
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) 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 more equity-like - the less the demand for life insurance
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

50. What are the disadvantages of completion portfolios for low basis stock?
Both increase with longer holding periods and higher returns
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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
Transferring assets directly to a third generation avoids possible double taxation