Private Wealth Management

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• Answer 50 questions in 15 minutes.
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This is a study tool. The 3 wrong answers for each question are randomly chosen from answers to other questions. So, you might find at times the answers obvious, but you will see it re-enforces your understanding as you take the test each time.

1. Define capital gains taxes.
It is expenseive - time consuming - public
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Total wealth = financial assets + human capital


2. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
Implied liabilities
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
- 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
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


3. What are the different types of trusts?
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
Demand for insurance decreases; less human capital to replace
- 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) 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. What are the advantages of private exchange funds for low basis stock?
- a subjective assessment of financial well-being based on perceived wealth
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
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
Diligently gather the best possible investment info - tend to be conservative and - since they base decision on facts - they rarely form emotional attachments to investments - continually seek better info to confirm past investment decisions


5. What is the person called that transfers assets through a will?
The testator
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Implied liabilities
Income rising - assets growing - long time horizon - above-avg. ability to take risk


6. Define capital gains taxes.
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
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) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Taxes paid on the gain (long or short position) when an asset is sold or purchased


7. What are the psychological issues of low basis stock held by an executive?
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
- 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
- cautious - methodical - individualistic - spontaneous


8. What are the disadvantages of completion portfolios for low basis stock?
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification


9. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
1) source of wealth 2) measure of wealth 3) stage of life
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
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
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


10. typical IPS elements
Demand for insurance decreases; less human capital to replace
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
When a decedent leaves no will or if the will is deemed invalid
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


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

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12. benefits of IPS to manager
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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 subjective assessment of financial well-being based on perceived wealth
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. What are the two sources of wealth?
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)
1) active 2) passive
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
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


14. What are the advantages of the monte carlo approach to portfolio construction?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
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)
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education


15. What are the main characteristics of fixed annuities?

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16. What is human capital?
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
A will (also known as a testament)
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)
HC = PV of future labor income


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

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18. What are the main types of investors?
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
- 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) 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) 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)


19. Investor questionnaires help to determine what?
Total wealth = financial assets + human capital
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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
Risk tolerance and decision-making style


20. Describe biased expectations in a behavioral finance context.
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)
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) 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


21. When calculating a required return - you typically must identify what?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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
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


22. Equation for total wealth.
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Total wealth = financial assets + human capital
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification


23. What are the different stages of life?
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) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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
Methodical - cautious - individualist - spontaneous


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

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25. What are the psychological issues of low basis stock held by an entrepreneur?
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
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
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution


26. What is the eifference in willingness to take risk between active and passive wealth creators?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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


27. What are typical characteristics of passive recipients of wealth?
- 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
Both increase with longer holding periods and higher returns
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
1. foundation 2. accumulation 3. maintenance 4. distribution


28. As wealth increases...
Demand for life insurance decreases
Demand for life insurance increases
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Taxes paid on the gain (long or short position) when an asset is sold or purchased


29. Who is responsible for gains/losses in a taxable (accrual taxation) account?
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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 government shares in both gains and losses
The testator


30. As age increases..
Demand for insurance decreases; less human capital to replace
Young -Building a foundation for future wealth -above avg risk tolerance
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Hedged with life insurance - think of the life insurance as a replacement for lost human capital


31. What is an equity collar? What is the purpose of the underlying positions
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
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
The government shares in both gains and losses


32. What are the different methods of relief from double taxation?
- 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
1) credit method 2) exemption method 3) deduction method
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today


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

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34. 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
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
Transferring assets directly to a third generation avoids possible double taxation
1) source of wealth 2) measure of wealth 3) stage of life


35. What are the psychological issues of low basis stock held by an executive?
- 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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Risk tolerance = as risk tolerance increases - demand for life insurance decreases


36. What are the diffferent types of tax jurisdictions?
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
Implied assets
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax


37. typical IPS elements
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
HC = PV of future labor income
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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. characteristics of spontaneous investor

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39. What should an investor use in mean-variance optimization
- cautious - methodical - individualistic - spontaneous
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
Should use accrual-equivalent returns and after-tax risk
Demand for insurance decreases; less human capital to replace


40. What are the benefits of an IPS to the adviser?
- cautious - methodical - individualistic - spontaneous
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Excess capital


41. What are the different retirment risks and how can they be hedged?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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) 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)
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances


42. Define tax drag.
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
The reduction in return caused by the payment of taxes
1) source of wealth 2) measure of wealth 3) stage of life
Should use accrual-equivalent returns and after-tax risk


43. What is human capital?
Demand for life insurance decreases
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
HC = PV of future labor income
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase


44. What are the diffferent types of tax jurisdictions?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
1. foundation 2. accumulation 3. maintenance 4. distribution


45. characteristics of cautious investor

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46. What are the problems that financial advisers can face with low basis stock?
Early career 8accumulating education - developing skills - above-average ability to take risk
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
- cautious - methodical - individualistic - spontaneous


47. What is core capital?
The amount of assets (i.e.present value) necessary to meet all future liabilities
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool


48. What is the reinvestment caveat when considering tax loss harvesting?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
- 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
Total wealth = financial assets + human capital


49. When dealing with low basis stock - emotional issues can arise from what?
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one


50. 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?
1) active 2) passive
Tax drag % = tax rate - as the investment horizon increases - tax drag is unchanged - as the investment return increases - tax drag is unchanged - as the investment horizon increases - value of the tax deferral increases - as the inestment return inc
1) 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)
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