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 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?
Sources of wealth - measure of wealth - stage 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
The government shares in both gains and 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


2. What is the person called that transfers assets through a will?
The reduction in return caused by the payment of taxes
The testator
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today


3. characteristics of foundation stage
Young -Building a foundation for future wealth -above avg risk tolerance
Sources of wealth - measure of wealth - stage of life
- 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
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)


4. situational profiling - considerations
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
- a subjective assessment of financial well-being based on perceived wealth
Sources of wealth - measure of wealth - stage of life
A will (also known as a testament)


5. What are the general legal and regulatory considerations for individuals?
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)


6. four types of investors
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
Demand for insurance decreases; less human capital to replace
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Methodical - cautious - individualist - spontaneous


7. stages of life
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
1. foundation 2. accumulation 3. maintenance 4. distribution
Demand for insurance decreases; less human capital to replace
The amount of assets (i.e.present value) necessary to meet all future liabilities


8. How is mortality risk typically hedged?
A positive relationship
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)
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Hedged with life insurance - think of the life insurance as a replacement for lost human capital


9. situational profiling - considerations
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
Both increase with longer holding periods and higher returns
Sources of wealth - measure of wealth - stage of life
1) credit method 2) exemption method 3) deduction method


10. What are the advantages of public exchange funds for low basis stock?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
When a decedent leaves no will or if the will is deemed invalid


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

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12. What are the benefits of an IPS to the client?
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
It is expenseive - time consuming - public
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
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


13. Define tax drag.
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 reduction in return caused by the payment of taxes
- 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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today


14. Why would someone want to use a valuation discount?
Fixed income streat set at inception - usually no inflation adjustment - so real value falls over time - usually illiquid (can't withdraw funds) - lock in at the prevailing rate - which might be historically low
The reduction in return caused by the payment of taxes
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)
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes


15. When should you use a tax-exempt versus a tax-deferred account?
The risk of a premature death with accompanying loss of future human capital
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
The reduction in return caused by the payment of taxes
Extra investment value created by effective tax management


16. Describe a cautious investor personality type.
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification


17. What are the advantages of private exchange funds for low basis stock?
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
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
The decedent's estate
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


18. What are the psychological issues of low basis stock held by an executive?
Implied liabilities
- 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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education


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

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20. Living expenses in retirment can be referred to as what?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Implied liabilities
Should use accrual-equivalent returns and after-tax risk
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging


21. characteristics of methodical investor
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
It is expenseive - time consuming - public
1) credit method 2) exemption method 3) deduction method
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis


22. What is an equity collar? What is the purpose of the underlying positions
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
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
- cautious - methodical - individualistic - spontaneous
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


23. What are the equity holding life risk attributes for an investor?
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
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory 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
The demand for life insurance increases - regardless of age


24. What are the equity holding life risk attributes for an executive?
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Risk tolerance and decision-making style
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


25. Human capital is sometimes referred to as what?
Young -Building a foundation for future wealth -above avg risk tolerance
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Implied assets
1) credit method 2) exemption method 3) deduction method


26. characteristics of spontaneous investor

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27. What is an equity collar? What is the purpose of the underlying positions
Demand for life insurance increases
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
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
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


28. Equation for total wealth.
It is expenseive - time consuming - public
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
Total wealth = financial assets + human capital


29. Why do individuals often take steps to avoid probate?
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
When a decedent leaves no will or if the will is deemed invalid
Income rising - assets growing - long time horizon - above-avg. ability to take risk
It is expenseive - time consuming - public


30. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Both increase with longer holding periods and higher returns
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
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


31. benefits of IPS to client
Using HIFO accounting - an investor assumes the lot with the highest tax basis was sold to either maximize the loss for harvesting or minimize the taxable gain
Single publicly traded mature company stock or vested options - greater appetite for specific risk due to higher degree of control - less residual risk - b/c the firm is more mature - less liquidity risk - but may have restrictions - desires tax effi
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
Extra investment value created by effective tax management


32. characteristics of accumulation phase
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
- cautious - methodical - individualistic - 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
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


33. What are typical characteristics of active wealth creators?
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
- 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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
1) credit method 2) exemption method 3) deduction method


34. Who is responsible for gains/losses in a taxable (accrual taxation) account?
The government shares in both gains and losses
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
- a subjective assessment of financial well-being based on perceived wealth
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


35. Living expenses in retirment can be referred to as what?
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
1) credit method 2) exemption method 3) deduction method
Implied liabilities
The amount of assets (i.e.present value) necessary to meet all future liabilities


36. What are the main types of investors?
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
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
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) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)


37. Why would someone want to use a valuation discount?
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
The decedent's estate
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Risk tolerance and decision-making style


38. What are the advantages of completion portfolios for low basis stock?
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)
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
- 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


39. characteristics of maintenance phase
Demand for insurance decreases; less human capital to replace
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Demand for life insurance decreases


40. What are the main characteristics of the accumulation phase of life?
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
The government shares in both gains and losses
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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)


41. characteristics of cautious investor

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42. What are wealth taxes.
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 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
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
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


43. What are the benefits of an IPS to the adviser?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Methodical - cautious - individualist - spontaneous
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
Young -Building a foundation for future wealth -above avg risk tolerance


44. 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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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)
Income rising - assets growing - long time horizon - above-avg. ability to take risk


45. What is loss aversion?
Demand for life insurance increases
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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
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


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

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47. What is the reinvestment caveat when considering tax loss harvesting?
Implied assets
- 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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Risk tolerance and decision-making style


48. What are the disadvantages of completion portfolios for low basis stock?
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
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
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
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely


49. What are the psychological issues of low basis stock held by an investor?
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
- 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 higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm


50. sources of wealth
- a subjective assessment of financial well-being based on perceived wealth
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
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) 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