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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. characteristics of maintenance phase
Methodical - cautious - individualist - spontaneous
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
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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

2. As probability of death increases...
The demand for life insurance increases - regardless of age
A will (also known as a testament)
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)
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education

3. psychological profiling
Implied liabilities
Sources of wealth - measure of wealth - stage of life
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
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

4. As age increases..
Demand for insurance decreases; less human capital to replace
1) active 2) passive
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
A positive relationship

5. As probability of death increases...
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
The demand for life insurance increases - regardless of age

6. Describe the equity holding life three stages from the perspective of the stock.
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 rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Methodical - cautious - individualist - spontaneous
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized

7. What are the different methods of relief from double taxation?
Early career 8accumulating education - developing skills - above-average ability to take risk
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
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
1) credit method 2) exemption method 3) deduction method

8. As desire to leave an estate increases...
Demand for life insurance increases
A positive relationship
Implied liabilities
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

9. 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
Total wealth = financial assets + human capital
The decedent's estate
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

10. What are the problems that financial advisers can face with low basis stock?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
- cautious - methodical - individualistic - spontaneous
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification

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

12. What are the main characteristics of the maintenance phase of life?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
- a subjective assessment of financial well-being based on perceived wealth

13. Describe a methodical investor personality type.
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
- 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
The more equity-like - the less the demand for life insurance
Should use accrual-equivalent returns and after-tax risk

14. What is the eifference in willingness to take risk between active and passive wealth creators?
The decedent's estate
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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)

15. Equation for total wealth.
Total wealth = financial assets + human capital
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
1) active 2) passive

16. What are the advantages of an outright sale of low basis stock?
Implied liabilities
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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

17. Describe biased expectations in a behavioral finance context.
The amount of assets (i.e.present value) necessary to meet all future liabilities
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
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

18. benefits of IPS to client
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)
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
Demand for life insurance increases
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

19. What are the equity holding life risk attributes for an entrepreneur?
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)
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
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
- 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

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

21. What are the benefits of an IPS to the adviser?
Demand for insurance decreases; less human capital to replace
It is expenseive - time consuming - public
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

22. What is an equity collar? What is the purpose of the underlying positions
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
The risk of a premature death with accompanying loss of future human capital
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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. As wealth increases...
Demand for life insurance decreases
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
1. foundation 2. accumulation 3. maintenance 4. distribution

24. What are ways that individuals can avoid probate?
Risk tolerance and decision-making style
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized

25. What are the disadvantages of an outright sale of low basis stock?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date

26. What are the advantages of public exchange funds for low basis stock?
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
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
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

27. What are the diffferent types of tax jurisdictions?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
Single privately-held stock - high degree of control - immature firm - very high unsystematic risk - face significant residual risk - limited or restricted liquidity - zero cost basis in the original investment - desires tax efficient transfer to hei
1) 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

28. How does the nature of human capital affect the demand for life insurance?
- cautious - methodical - individualistic - spontaneous
The amount of assets (i.e.present value) necessary to meet all future liabilities
Taxes paid on the gain (long or short position) when an asset is sold or purchased
The more equity-like - the less the demand for life insurance

29. 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
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)
It is expenseive - time consuming - public
Both increase with longer holding periods and higher returns

30. What are the advantages of an outright sale of 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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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

31. When dealing with low basis stock - emotional issues can arise from what?
When a decedent leaves no will or if the will is deemed invalid
The decedent's estate
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
The testator

32. What are the psychological issues of low basis stock held by an executive?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
It is expenseive - time consuming - public
When a decedent leaves no will or if the will is deemed invalid
- 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

33. What are the different retirment risks and how can they be hedged?
Methodical - cautious - individualist - spontaneous
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)
The testator
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

34. 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?
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
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Excess capital
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)

35. What are the main characteristics of fixed annuities?

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

37. What are investment objectives and constraints?
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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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

38. How is mortality risk typically hedged?
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
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

39. What are the diversification techniques for low basis stock?
Deterministic = use point estimates to generate a forecasted value such as an expected return or terminal value Monte Carlo = use probability distributions of inputs to generate expected returns with accompanying probability distributions
Tax on the entire value of assets held - principal + earnings - not just earnings - has the same effect as an accrual tax - only taxes are paid at a (usually) reduced rate
The demand for life insurance increases - regardless of age
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

40. Why do individuals often take steps to avoid probate?
It is expenseive - time consuming - public
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses

41. What are the disadvantages of public exchange funds for low basis stock?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)

42. What is another name for a variable prepaid forward and What is its main purpose?
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
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)
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

43. When should you use a tax-exempt versus a tax-deferred account?
1. foundation 2. accumulation 3. maintenance 4. distribution
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
- 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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

44. What should an investor use in mean-variance optimization
Total wealth = financial assets + human capital
The client's psychological profile
Should use accrual-equivalent returns and after-tax risk
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

45. characteristics of cautious investor

46. four types of investors
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Methodical - cautious - individualist - spontaneous
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis

47. What are the equity holding life risk attributes for an investor?
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)
The client's psychological profile
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
Transferring assets directly to a third generation avoids possible double taxation

48. What is the reinvestment caveat when considering tax loss harvesting?
The amount of assets (i.e.present value) necessary to meet all future liabilities
Methodical - cautious - individualist - spontaneous
- 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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

49. 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
The risk of a premature death with accompanying loss of future human capital
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

50. stages of life
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
The risk of a premature death with accompanying loss of future 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
1. foundation 2. accumulation 3. maintenance 4. distribution