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Private Wealth Management

Subjects : personal-finance, business-skills

Instructions:

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

1. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
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
Wealth transfer stage - focus on tax min. with trusts and foundations
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
More 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

2. What are the advantages of hedging for low basis stock?
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
The risk of a premature death with accompanying loss of future human capital
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

3. What are the problems that financial advisers can face with low basis stock?
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
The client's psychological profile

4. What are the advantages of private exchange funds for low basis stock?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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
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

5. What are investment objectives and constraints?
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Both increase with longer holding periods and higher returns
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

6. Describe the equity holding life three stages from the perspective of the stock.
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) 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
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

7. What are the different methods of relief from double taxation?
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) credit method 2) exemption method 3) deduction method
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Total wealth = financial assets + human capital

8. What is the eifference in willingness to take risk between active and passive wealth creators?
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)
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
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
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

9. 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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

10. What are the different retirment risks and how can they be hedged?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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)
- a subjective assessment of financial well-being based on perceived wealth
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

11. What is the general relationship b/t a client's perception of wealth and risk willingness?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
1) active 2) passive
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
A positive relationship

12. sources of wealth
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
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
Excess capital
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

13. What is core capital?
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
Demand for life insurance decreases
1) credit method 2) exemption method 3) deduction method

14. When dealing with low basis stock - emotional issues can arise from what?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Sources of wealth - measure of wealth - stage of life
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

15. characteristics of individualist investor
Young -Building a foundation for future wealth -above avg risk tolerance
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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

16. Describe a spontaneous investor personality type.
Implied liabilities
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis

17. psychological profiling
Young -Building a foundation for future wealth -above avg risk tolerance
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
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
1) active 2) passive

18. What are the main characteristics of variable annuities?

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19. What are ways that individuals can avoid probate?
The amount of assets (i.e.present value) necessary to meet all future liabilities
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Methodical - cautious - individualist - 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

20. What are wealth taxes.
Sources of wealth - measure of wealth - stage of life
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) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

21. What are the disadvantages of an outright sale of low basis stock?
Early career 8accumulating education - developing skills - above-average ability to take risk
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
The testator
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale

22. Define capital gains taxes.
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
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

23. characteristics of methodical investor
The demand for life insurance increases - regardless of age
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk

24. What is typically considered when imposing an exit tax?
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Demand for life insurance decreases
- 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

25. What are typical characteristics of passive recipients of wealth?
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing 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

26. As desire to leave an estate increases...
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
Demand for life insurance increases
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)

27. What are the advantages of private exchange funds for low basis stock?
Can borrow and/or use derivatives to diversify - ability to borrow (monetize) increased - owners retain upside potential of the original investment - not required to hodl illiquid assets - partners can change fund composition
Should use accrual-equivalent returns and after-tax risk
Implied liabilities
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

28. What are the main characteristics of the accumulation phase of life?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Early career 8accumulating education - developing skills - above-average ability to take risk

29. characteristics of distribution phase
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 risk of a premature death with accompanying loss of future human capital
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk

30. How does the nature of human capital affect the demand for life insurance?
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
- 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 more equity-like - the less the demand for life insurance
- 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

31. template for return objective
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Young -Building a foundation for future wealth -above avg risk tolerance

32. benefits of IPS to client
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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
The testator

33. What are the four broad categories of investor personality types (BB&K)?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
- cautious - methodical - individualistic - spontaneous
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Deterministic = use point estimates to generate a forecasted value such as an expected return or terminal value Monte Carlo = use probability distributions of inputs to generate expected returns with accompanying probability distributions

34. As wealth increases...
Wealth transfer stage - focus on tax min. with trusts and foundations
Demand for life insurance decreases
It is expenseive - time consuming - public
The risk of a premature death with accompanying loss of future human capital

35. four types of investors
Methodical - cautious - individualist - spontaneous
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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
Total wealth = financial assets + human capital

36. What are the advantages of public exchange funds for low basis stock?
- 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
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

37. What is mortality risk?
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
- 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
The risk of a premature death with accompanying loss of future human capital
1) source of wealth 2) measure of wealth 3) stage of life

38. Define capital gains taxes.
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
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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

39. Define tax drag.
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
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
The reduction in return caused by the payment of taxes
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

40. As desire to leave an estate increases...
The government shares in both gains and losses
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
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
Demand for life insurance increases

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

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42. 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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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)

43. What are the advantages of an outright sale of low basis stock?
Transferring assets directly to a third generation avoids possible double taxation
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Total wealth = financial assets + human capital

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

45. characteristics of foundation stage
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Young -Building a foundation for future wealth -above avg risk tolerance
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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

46. What is another name for a variable prepaid forward and What is its main purpose?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

47. Why would an individual try to use generation skipping in estate planning?
Transferring assets directly to a third generation avoids possible double taxation
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

48. What are the benefits of an IPS to the adviser?
A positive relationship
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
The government shares in both gains and losses
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

49. Define tax drag.
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
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)
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
The reduction in return caused by the payment of taxes

50. As probability of death increases...
The demand for life insurance increases - regardless of age
The testator
Both increase with longer holding periods and higher returns
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