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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 another name for a variable prepaid forward and What is its main purpose?
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
- a subjective assessment of financial well-being based on perceived wealth
- 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

2. What are the advantages of an outright sale of low basis stock?
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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)
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

3. What are the psychological issues of low basis stock held by an executive?
1. foundation 2. accumulation 3. maintenance 4. distribution
The decedent's estate
- 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 higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm

4. What is core capital?
1. foundation 2. accumulation 3. maintenance 4. distribution
The amount of assets (i.e.present value) necessary to meet all future liabilities
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
- 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

5. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
- a subjective assessment of financial well-being based on perceived wealth
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Both increase with longer holding periods and higher returns

6. Investor questionnaires help to determine what?
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Risk tolerance and decision-making style

7. What is human capital?
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
HC = PV of future labor income
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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

8. What is intestate?
When a decedent leaves no will or if the will is deemed invalid
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will

9. Describe biased expectations in a behavioral finance context.
Investors have too much confidence in their ability to forecast - they tend to discount or even ignore info that does not support their choices - they interpret info based on their current frame of mind and the medium through which it is received
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
The decedent's estate
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

10. What are the benefits of an IPS to the client?
1) source of wealth 2) measure of wealth 3) stage of life
1) credit method 2) exemption method 3) deduction method
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) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

11. Describe the different types of double taxation conflicts.
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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
Young -Building a foundation for future wealth -above avg risk tolerance
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

12. situational profiling - considerations
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
Sources of wealth - measure of wealth - stage of life
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
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

13. What are the diffferent types of estate ownership rights?

14. What are the advantages of the monte carlo approach to portfolio construction?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
The decedent's estate
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
The government shares in both gains and losses

15. As desire to leave an estate increases...
The client's psychological profile
Demand for life insurance increases
The testator
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date

16. characteristics of cautious investor

17. What are the equity holding life risk attributes for an executive?
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
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 testator
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

18. What are the equity holding life risk attributes for an entrepreneur?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

19. What are the different stages of life?
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
Should use accrual-equivalent returns and after-tax risk
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

20. Describe an individualistic investor personality type.
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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
Sources of wealth - measure of wealth - stage of life
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

21. What are the psychological issues of low basis stock held by an investor?
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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
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

22. What are the advantages of private exchange funds for low basis stock?
- a subjective assessment of financial well-being based on perceived wealth
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
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)
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

23. situational profiling - considerations
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Sources of wealth - measure of wealth - stage of life
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
Total wealth = financial assets + human capital

24. characteristics of maintenance phase
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
Should use accrual-equivalent returns and after-tax 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)
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification

25. What are the psychological issues of low basis stock held by an entrepreneur?
Wealth transfer stage - focus on tax min. with trusts and foundations
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
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
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

26. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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

27. 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
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Should use accrual-equivalent returns and after-tax risk

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

29. How does the nature of human capital affect the demand for life insurance?
1) source of wealth 2) measure of wealth 3) stage of life
When a decedent leaves no will or if the will is deemed invalid
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
The more equity-like - the less the demand for life insurance

30. What are the main characteristics of the maintenance phase of life?
- a subjective assessment of financial well-being based on perceived wealth
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
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance

31. What are the disadvantages of an outright sale of low basis stock?
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 higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one

32. How is mortality risk typically hedged?
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
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
- 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. An investor's willingness to take risk is determined by what?

34. What are the disadvantages of hedging for low basis stock?
Excess capital
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
When a decedent leaves no will or if the will is deemed invalid

35. What are the psychological issues of low basis stock held by an executive?
Implied liabilities
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
- 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

36. Describe the equity holding life three stages from the perspective of the stock.
Demand for life insurance decreases
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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

37. What are the main characteristics of the distribution phase of life?
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
Wealth transfer stage - focus on tax min. with trusts and foundations
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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

38. 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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Investors have too much confidence in their ability to forecast - they tend to discount or even ignore info that does not support their choices - they interpret info based on their current frame of mind and the medium through which it is received
1) 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)

39. What are the two sources of wealth?
Implied assets
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
1) active 2) passive
The more equity-like - the less the demand for life insurance

40. stages of life
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. foundation 2. accumulation 3. maintenance 4. distribution
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
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

41. What are the psychological issues of low basis stock held by an investor?
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

42. What are the main characteristics of chritable gifts?
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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
HC = PV of future labor income

43. What are the main characteristics of fixed annuities?

44. What is human capital?
HC = PV of future labor income
Excess capital
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

45. What are the main types of investors?
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
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) 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)
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)

46. benefits of IPS to manager
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date

47. Human capital is sometimes referred to as what?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Implied assets
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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

48. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
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
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
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) 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)

49. Living expenses in retirment can be referred to as what?
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
- 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
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
Implied liabilities

50. 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
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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