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Private Wealth Management

Subjects : personal-finance, business-skills

Instructions:

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

1. Why would an individual try to use generation skipping in estate planning?
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
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)
Transferring assets directly to a third generation avoids possible double taxation
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)

2. What are the main characteristics of fixed annuities?

3. What is the person called that transfers assets through a will?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
The testator
Young -Building a foundation for future wealth -above avg risk tolerance
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n

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

5. 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
The reduction in return caused by the payment of taxes
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
Sources of wealth - measure of wealth - stage of life

6. typical IPS elements
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
Demand for insurance decreases; less human capital to replace
Methodical - cautious - individualist - spontaneous
The risk of a premature death with accompanying loss of future human capital

7. What are the diversification techniques for low basis stock?
Risk tolerance = as risk tolerance increases - 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
HC = PV of future labor income
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

8. characteristics of methodical investor
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
1. foundation 2. accumulation 3. maintenance 4. distribution
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up

9. What should an investor use in mean-variance optimization
Should use accrual-equivalent returns and after-tax risk
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
If board of director member = inside - prudent investor rules usually applies - recommend legal counsel for setting up personal trust or family foundation - if a trust - balance the needs of income beneficiaries and remainderment

10. What are the main characteristics of variable annuities?

11. How is mortality risk typically hedged?
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
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
The government shares in both gains and losses

12. What are the main characteristics of the accumulation phase of life?
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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
Sources of wealth - measure of wealth - stage of life
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

13. As desire to leave an estate increases...
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
When a decedent leaves no will or if the will is deemed invalid
Demand for life insurance increases
The risk of a premature death with accompanying loss of future human capital

14. What are the main characteristics of the foundation phase of life?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Early career 8accumulating education - developing skills - above-average ability to take risk
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

15. What are the advantages of public exchange funds for low basis stock?
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
1) common progressive (progressive) 2) heavy dividend tax (progressive) 3) heavy capital gain tax (progressive) 4) heavy interest tax (progressive) 5) light capital gain tax (progressive) 6) flat and light (flat) 7) flat and heavy (flat)

16. typical IPS elements
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)
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
A positive relationship

17. Describe a spontaneous investor personality type.
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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
Methodical - cautious - individualist - spontaneous
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

18. Living expenses in retirment can be referred to as what?
- 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
The amount of assets (i.e.present value) necessary to meet all future liabilities
Implied liabilities
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

19. What are wealth taxes.
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
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)
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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

20. Human capital is sometimes referred to as what?
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)
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) credit method 2) exemption method 3) deduction method
Implied assets

21. What are the psychological issues of low basis stock held by an investor?
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Risk tolerance and decision-making style
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Single 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

22. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
The amount of assets (i.e.present value) necessary to meet all future liabilities
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Risk tolerance = as risk tolerance increases - demand for life insurance decreases

23. What are the psychological issues of low basis stock held by an entrepreneur?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk

24. What is HIFO accounting?
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
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
A positive relationship
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

25. What are the benefits of an IPS to the client?
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
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
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
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

26. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
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
Total wealth = financial assets + human capital
When a decedent leaves no will or if the will is deemed invalid
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax

27. What is loss aversion?
Early career 8accumulating education - developing skills - above-average ability 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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
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

28. What should an investor use in mean-variance optimization
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
The decedent's estate
Should use accrual-equivalent returns and after-tax risk
Risk tolerance and decision-making style

29. What is an equity collar? What is the purpose of the underlying positions
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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
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

30. stages of life
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
1. foundation 2. accumulation 3. maintenance 4. distribution

31. situational profiling

32. What are the disadvantages of an outright sale of low basis stock?
Methodical - cautious - individualist - spontaneous
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
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

33. What is another name for a variable prepaid forward and What is its main purpose?
Implied liabilities
Should use accrual-equivalent returns and after-tax risk
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

34. Describe a cautious investor personality type.
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
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
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

35. What is the reinvestment caveat when considering tax loss harvesting?
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)
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
- 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

36. What risks must be considered when discussing each concentrated investor category?
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
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely

37. What is mortality risk?
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
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
The risk of a premature death with accompanying loss of future 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

38. All costs associated with probate are born by whom?

39. What are the advantages of the monte carlo approach to portfolio construction?
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
Young -Building a foundation for future wealth -above avg risk tolerance
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)
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

40. Why would someone want to use a valuation discount?
- 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
Implied liabilities
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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

41. characteristics of individualist investor
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk

42. What are the different types of trusts?
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
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
When a decedent leaves no will or if the will is deemed invalid
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

43. Describe the different types of double taxation conflicts.
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
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Total wealth = financial assets + human capital
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

44. 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) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
- cautious - methodical - individualistic - spontaneous
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

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

46. What is loss aversion?
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

47. As age increases..
Demand for insurance decreases; less human capital to replace
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
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
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)

48. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
The risk of a premature death with accompanying loss of future human capital
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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
Both increase with longer holding periods and higher returns

49. What are the psychological issues of low basis stock held by an investor?
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
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either

50. characteristics of accumulation phase
- 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 testator
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
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