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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. Why would an individual try to use generation skipping in estate planning?
Both increase with longer holding periods and higher returns
Transferring assets directly to a third generation avoids possible double taxation
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date

2. What is mortality risk?
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 decedent's estate
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
The risk of a premature death with accompanying loss of future human capital

3. How does the nature of human capital affect the demand for life insurance?
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
Both increase with longer holding periods and higher returns
The more equity-like - the less the demand for life insurance
Risk tolerance and decision-making style

4. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
1) Entrepreneur - large position in 1 private stock 2) Executive - large position in 1 public stock 3) Investor - large positions in 1 successful public stock
Wealth transfer stage - focus on tax min. with trusts and foundations
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

5. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Both increase with longer holding periods and higher returns

6. Why would someone want to use a valuation discount?
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
The risk of a premature death with accompanying loss of future human capital

7. What are the equity holding life risk attributes for an executive?
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
The risk of a premature death with accompanying loss of future 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
Implied assets

8. As wealth increases...
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Demand for life insurance decreases
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
Sources of wealth - measure of wealth - stage of life

9. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Demand for life insurance increases
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

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

11. sources of wealth
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
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) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

12. characteristics of maintenance phase
Risk tolerance and decision-making style
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 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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses

13. What is HIFO accounting?
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)
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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

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

15. What are the general legal and regulatory considerations for individuals?
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
The amount of assets (i.e.present value) necessary to meet all future liabilities
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

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

17. What are the 3 categories of investors when discussing concentrated positions?
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
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)
Implied liabilities
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

18. typical IPS elements
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
The risk of a premature death with accompanying loss of future human capital
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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

19. Who is responsible for gains/losses in a taxable (accrual taxation) account?
The government shares in both gains and losses
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

20. What are the general legal and regulatory considerations for individuals?
The government shares in both gains and losses
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) 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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized

21. What are the disadvantages of private exchange funds for low basis stock?
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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
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) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

22. Describe a cautious investor personality type.
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
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)
- cautious - methodical - individualistic - 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

23. What are the main characteristics of chritable gifts?
The demand for life insurance increases - regardless of age
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
The government shares in both gains and losses
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses

24. 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
Implied assets
1. foundation 2. accumulation 3. maintenance 4. distribution

25. What are the equity holding life risk attributes for an investor?
Implied liabilities
The client's psychological profile
Should use accrual-equivalent returns and after-tax risk
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

26. 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
The testator
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

27. What are the main characteristics of variable annuities?

28. What are the advantages of public exchange funds for low basis stock?
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Sources of wealth - measure of wealth - stage of life
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

29. characteristics of foundation stage
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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
Young -Building a foundation for future wealth -above avg risk tolerance

30. 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
Sources of wealth - measure of wealth - stage of life
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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

31. What is the most common estate planning tool?
A will (also known as a testament)
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
The reduction in return caused by the payment of taxes

32. Describe a spontaneous investor personality type.
Demand for insurance decreases; less human capital to replace
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk

33. What is tax alpha?
Extra investment value created by effective tax management
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
- 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
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

34. characteristics of distribution phase
Decisions should be optimal -process is dynamic - thus factors in changing circumstances -focus on long-term objectives -new investment advisors should be able to use the IPS
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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

35. What are the main characteristics of the distribution phase of life?
Wealth transfer stage - focus on tax min. with trusts and foundations
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
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
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

36. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
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
Demand for insurance decreases; less human capital to replace
Transferring assets directly to a third generation avoids possible double taxation
1) source of wealth 2) measure of wealth 3) stage of life

37. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
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
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
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
A positive relationship

38. template for return objective
Methodical - cautious - individualist - 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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

39. What is the general relationship b/t a client's perception of wealth and risk willingness?
Young -Building a foundation for future wealth -above avg risk tolerance
Sources of wealth - measure of wealth - stage of life
A positive relationship
The amount of assets (i.e.present value) necessary to meet all future liabilities

40. What is tax alpha?
The risk of a premature death with accompanying loss of future human capital
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Extra investment value created by effective tax management
The reduction in return caused by the payment of taxes

41. 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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Extra investment value created by effective tax management
Income rising - assets growing - long time horizon - above-avg. ability to take risk

42. What are the 3 categories of investors when discussing concentrated positions?
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
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
The decedent's estate
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk

43. What is human capital?
HC = PV of future labor income
- a subjective assessment of financial well-being based on perceived wealth
The reduction in return caused by the payment of taxes
The risk of a premature death with accompanying loss of future human capital

44. Who is responsible for gains/losses in a taxable (accrual taxation) account?
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
The government shares in both gains and losses
1) active 2) passive
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

45. Describe asset segregation in a behavioral finance context.
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
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
- 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

46. Define tax drag.
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
Demand for life insurance increases
- a subjective assessment of financial well-being based on perceived wealth
The reduction in return caused by the payment of taxes

47. psychological profiling
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
- 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

48. Investor questionnaires help to determine what?
A will (also known as a testament)
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Risk tolerance and decision-making style
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance

49. benefits of IPS to client
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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

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