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. benefits of IPS to client
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Income rising - assets growing - long time horizon - above-avg. ability to take risk


2. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
Wealth transfer stage - focus on tax min. with trusts and foundations
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
The testator


3. psychological profiling
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
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
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
Methodical - cautious - individualist - spontaneous


4. What is measure of wealth?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
- a subjective assessment of financial well-being based on perceived wealth
Taxes paid on the gain (long or short position) when an asset is sold or purchased


5. Human capital is sometimes referred to as what?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Early career 8accumulating education - developing skills - above-average ability to take risk
Implied assets
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase


6. What is the person called that transfers assets through a will?
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
The testator
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Risk tolerance = as risk tolerance increases - demand for life insurance decreases


7. What are the equity holding life risk attributes for an entrepreneur?
Risk tolerance and decision-making style
Demand for life insurance increases
A positive relationship
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 are the different types of trusts?
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
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) 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
A will (also known as a testament)


9. What should an investor use in mean-variance optimization
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
Should use accrual-equivalent returns and after-tax risk
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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


10. 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
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. foundation 2. accumulation 3. maintenance 4. distribution
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


11. situational profiling

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12. characteristics of foundation stage
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
- 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
Young -Building a foundation for future wealth -above avg risk tolerance


13. What are the different methods of relief from double taxation?
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
Sources of wealth - measure of wealth - stage of life
1) credit method 2) exemption method 3) deduction method


14. When calculating a required return - you typically must identify what?
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)
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date


15. Describe a methodical investor personality type.
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
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
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)
- 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


16. Any amount above core capital is considered what?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Excess capital
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


17. What is an equity collar? What is the purpose of the underlying positions
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
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
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
The amount of assets (i.e.present value) necessary to meet all future liabilities


18. characteristics of foundation stage
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
Young -Building a foundation for future wealth -above avg risk tolerance
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification


19. How is mortality risk typically hedged?
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
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
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


20. What are the main characteristics of variable annuities?

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21. Define tax drag.
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
The reduction in return caused by the payment of taxes


22. What is tax alpha?
Extra investment value created by effective tax management
Demand for life insurance increases
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up


23. Living expenses in retirment can be referred to as what?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Implied liabilities
Early career 8accumulating education - developing skills - above-average ability to take risk
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


24. What is HIFO accounting?
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
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about 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)
Excess capital


25. What are the main characteristics of the distribution phase of life?
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
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
Wealth transfer stage - focus on tax min. with trusts and foundations
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


26. Why would someone want to use a valuation discount?
The demand for life insurance increases - regardless of age
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education


27. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
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) 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
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
Extra investment value created by effective tax management


28. What is loss aversion?
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
Implied assets
Extra investment value created by effective tax management
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


29. 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
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
Demand for life insurance increases
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)


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

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31. What are the advantages of the monte carlo approach to portfolio construction?
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
The government shares in both gains and losses
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


32. What are the different retirment risks and how can they be hedged?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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) 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)
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


33. characteristics of distribution phase
Demand for insurance decreases; less human capital to replace
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
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase


34. Investor questionnaires help to determine what?
Risk tolerance and decision-making style
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification


35. What are the equity holding life risk attributes for an executive?
Transferring assets directly to a third generation avoids possible double taxation
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
The decedent's estate
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


36. When should you use a tax-exempt versus a tax-deferred account?
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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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


37. 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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
A positive relationship
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)


38. characteristics of spontaneous investor

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39. What are the disadvantages of private exchange funds for low basis stock?
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
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Demand for life insurance increases


40. typical IPS elements
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis


41. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
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
Transferring assets directly to a third generation avoids possible double taxation


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

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43. What are the equity holding life risk attributes for an entrepreneur?
Risk tolerance and decision-making style
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
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)
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


44. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
The decedent's estate
1) source of wealth 2) measure of wealth 3) stage of life
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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education


45. What are the disadvantages of hedging for low basis stock?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Transferring assets directly to a third generation avoids possible double taxation


46. Define tax drag.
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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 reduction in return caused by the payment of 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


47. What are the four broad categories of investor personality types (BB&K)?
1) source of wealth 2) measure of wealth 3) stage of life
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
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
- cautious - methodical - individualistic - spontaneous


48. Who is responsible for gains/losses in a taxable (accrual taxation) account?
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
- 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 government shares in both gains and losses
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale


49. characteristics of accumulation phase
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)
HC = PV of future labor income
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 demand for life insurance increases - regardless of age


50. What are typical characteristics of active wealth creators?
The demand for life insurance increases - regardless of age
- 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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Hedged with life insurance - think of the life insurance as a replacement for lost human capital