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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 are the disadvantages of an outright sale of low basis stock?
Extra investment value created by effective tax management
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

2. How is mortality risk typically hedged?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Young -Building a foundation for future wealth -above avg risk tolerance
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

3. Living expenses in retirment can be referred to as 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) 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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Implied liabilities

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

5. 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
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
Extra investment value created by effective tax management
Wealth transfer stage - focus on tax min. with trusts and foundations

6. What is tax alpha?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Extra investment value created by effective tax management
1. foundation 2. accumulation 3. maintenance 4. distribution
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

7. characteristics of methodical investor
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
1) source of wealth 2) measure of wealth 3) stage of life
- 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

8. As desire to leave an estate increases...
Demand for life insurance increases
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
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
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

9. Define tax drag.
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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
The reduction in return caused by the payment of taxes
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

10. What are the equity holding life risk attributes for an investor?
Total wealth = financial assets + human capital
- 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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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

11. What should an investor use in mean-variance optimization
Should use accrual-equivalent returns and after-tax risk
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Demand for life insurance decreases

12. Human capital is sometimes referred to as what?
- 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. foundation 2. accumulation 3. maintenance 4. distribution
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
Implied assets

13. situational profiling - considerations
Young -Building a foundation for future wealth -above avg risk tolerance
Sources of wealth - measure of wealth - stage of life
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)
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

14. template for return objective
Both increase with longer holding periods and higher returns
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Demand for life insurance decreases

15. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
1) source of wealth 2) measure of wealth 3) stage of life
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
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

16. What are the main types of investors?
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
Early career 8accumulating education - developing skills - above-average ability to take risk
- 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
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)

17. characteristics of methodical investor
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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
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

18. Human capital is sometimes referred to as what?
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
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
Implied assets
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

19. As desire to leave an estate increases...
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
Demand for life insurance increases
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

20. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
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
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

21. 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
The demand for life insurance increases - regardless of age
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Implied liabilities

22. What are the different stages of life?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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
The risk of a premature death with accompanying loss of future human capital

23. What are the psychological issues of low basis stock held by an executive?
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
Total wealth = financial assets + 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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

24. What are the advantages of completion portfolios for low basis stock?
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
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
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

25. What is intestate?
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
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Extra investment value created by effective tax management

26. What are the disadvantages of completion portfolios for low basis 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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis

27. When dealing with low basis stock - emotional issues can arise from what?
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
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one

28. Why do individuals often take steps to avoid probate?
It is expenseive - time consuming - public
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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
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

29. 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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
1. foundation 2. accumulation 3. maintenance 4. distribution

30. Calculating the required return component is driven by what 2 elements?
The testator
Methodical - cautious - individualist - spontaneous
Should use accrual-equivalent returns and after-tax risk
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach

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

32. characteristics of individualist investor
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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) growing the portfolio (capital gains) 2) liquidity needs - total return approach

33. psychological profiling
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
A will (also known as a testament)
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
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

34. stages of life
It is expenseive - time consuming - public
Transferring assets directly to a third generation avoids possible double taxation
- a subjective assessment of financial well-being based on perceived wealth
1. foundation 2. accumulation 3. maintenance 4. distribution

35. What are the advantages of the monte carlo approach to portfolio construction?
Distribution of outcomes provides a better indication of the risk/return tradeoff - show the tradeoff b/t short-term risk and ability meet long-term goals - incorporates the impact of taxes and the compounding effect of reinvestment - can build in f
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Implied liabilities
Excess capital

36. characteristics of spontaneous investor

37. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up

38. 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?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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
The risk of a premature death with accompanying loss of future human capital
Implied liabilities

39. four types of investors
Methodical - cautious - individualist - spontaneous
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis

40. What are the disadvantages of hedging for low basis stock?
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification

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

42. What are the different methods of relief from double taxation?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
1) credit method 2) exemption method 3) deduction method
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)

43. What are the advantages of an outright sale of low basis stock?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
1) credit method 2) exemption method 3) deduction method
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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

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

45. What are the two sources of wealth?
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
1. foundation 2. accumulation 3. maintenance 4. distribution
Fixed income streat set at inception - usually no inflation adjustment - so real value falls over time - usually illiquid (can't withdraw funds) - lock in at the prevailing rate - which might be historically low
1) active 2) passive

46. situational profiling

47. Describe a spontaneous investor personality type.
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) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Both increase with longer holding periods and higher returns
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

48. Calculating the required return component is driven by what 2 elements?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
Should use accrual-equivalent returns and after-tax risk

49. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
1) active 2) passive
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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

50. situational profiling - considerations
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Sources of wealth - measure of wealth - stage of life
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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