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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 is human capital?
Income rising - assets growing - long time horizon - above-avg. ability to take risk
HC = PV of future labor income
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
The more equity-like - the less the demand for life insurance

2. Describe an individualistic investor personality type.
Methodical - cautious - individualist - spontaneous
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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
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

3. What are the different types of trusts?
Excess capital
Should use accrual-equivalent returns and after-tax risk
Demand for life insurance decreases
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

4. 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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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

5. 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
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
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

6. What is human capital?
- a subjective assessment of financial well-being based on perceived wealth
HC = PV of future labor income
Excess 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

7. Describe a cautious investor personality type.
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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
When a decedent leaves no will or if the will is deemed invalid
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

8. What are the equity holding life risk attributes for an executive?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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
- 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
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

9. What is typically considered when imposing an exit tax?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
- 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
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) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

10. 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
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
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
The demand for life insurance increases - regardless of age

11. Who is responsible for gains/losses in a taxable (accrual taxation) account?
Young -Building a foundation for future wealth -above avg risk tolerance
The government shares in both gains and losses
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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will

12. What are the main characteristics of the foundation phase of life?
The amount of assets (i.e.present value) necessary to meet all future liabilities
Early career 8accumulating education - developing skills - above-average ability to take risk
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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

13. What are the two sources of wealth?
- a subjective assessment of financial well-being based on perceived wealth
1) active 2) passive
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
- cautious - methodical - individualistic - spontaneous

14. 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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n

15. characteristics of spontaneous investor

16. What is the eifference in willingness to take risk between active and passive wealth creators?
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

17. 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
Sources of wealth - measure of wealth - stage of life
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Excess capital

18. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
The demand for life insurance increases - regardless of age
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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax

19. Human capital is sometimes referred to as what?
Implied assets
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
1) active 2) passive
- 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

20. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

21. What is the person called that transfers assets through a will?
The amount of assets (i.e.present value) necessary to meet all future liabilities
The testator
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
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

22. As probability of death increases...
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
The government shares in both gains and losses
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either

23. Living expenses in retirment can be referred to as what?
Extra investment value created by effective tax management
Risk tolerance and decision-making style
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
Implied liabilities

24. Describe biased expectations in a behavioral finance context.
Young -Building a foundation for future wealth -above avg risk tolerance
Should use accrual-equivalent returns and after-tax risk
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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

25. template for return objective
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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

26. benefits of IPS to client
- 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
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

27. What are the main characteristics of chritable gifts?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

28. What are the 3 categories of investors when discussing concentrated positions?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes

29. Define tax drag.
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
The reduction in return caused by the payment of taxes
Decisions should be optimal -process is dynamic - thus factors in changing circumstances -focus on long-term objectives -new investment advisors should be able to use the IPS

30. characteristics of foundation stage
Total wealth = financial assets + human capital
Young -Building a foundation for future wealth -above avg risk tolerance
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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

31. As age increases..
Demand for insurance decreases; less human capital to replace
Early career 8accumulating education - developing skills - above-average ability to take risk
- 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
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

32. What are the equity holding life risk attributes for an investor?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
- 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
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

33. What is intestate?
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
When a decedent leaves no will or if the will is deemed invalid
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
Transferring assets directly to a third generation avoids possible double taxation

34. characteristics of methodical investor
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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)
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

35. What are the main characteristics of the accumulation phase of life?
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Income rising - assets growing - long time horizon - above-avg. ability to take risk

36. What are the benefits of an IPS to the client?
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
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Demand for life insurance decreases

37. How is mortality risk typically hedged?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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

38. As probability of death increases...
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 demand for life insurance increases - regardless of age
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach

39. As desire to leave an estate increases...
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
Sources of wealth - measure of wealth - stage of life
Demand for life insurance increases
Demand for life insurance decreases

40. Any amount above core capital is considered what?
Tax on the entire value of assets held - principal + earnings - not just earnings - has the same effect as an accrual tax - only taxes are paid at a (usually) reduced rate
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
Excess capital
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

41. What are investment objectives and constraints?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
- cautious - methodical - individualistic - spontaneous
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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

42. 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
Implied assets
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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

43. What are the problems that financial advisers can face with low basis stock?
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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

44. What is tax alpha?
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
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
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

45. characteristics of accumulation phase
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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)
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

46. What are the different types of trusts?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Total wealth = financial assets + human capital
The more equity-like - the less the demand for life insurance
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

47. What is typically considered when imposing an exit tax?
Transferring assets directly to a third generation avoids possible double taxation
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
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
- 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

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

49. What are typical characteristics of active wealth creators?
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
Total wealth = financial assets + human capital
Demand for life insurance increases
- 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

50. What is intestate?
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
When a decedent leaves no will or if the will is deemed invalid
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)
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