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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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1. What should an investor use in mean-variance optimization
Demand for life insurance decreases
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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
Should use accrual-equivalent returns and after-tax risk

2. What is human capital?
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
HC = PV of future labor income
- 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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

3. characteristics of individualist investor
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
The testator
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
The amount of assets (i.e.present value) necessary to meet all future liabilities

4. What are the equity holding life risk attributes for an investor?
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
Extra investment value created by effective tax management

5. What are wealth taxes.
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
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
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
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)

6. What are the main characteristics of fixed annuities?

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7. Describe an individualistic investor personality type.
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)
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale

8. What are the main characteristics of the foundation phase of life?
Early career 8accumulating education - developing skills - above-average ability to take risk
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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
Wealth transfer stage - focus on tax min. with trusts and foundations

9. characteristics of spontaneous investor

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10. What is human capital?
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
HC = PV of future labor income
Sources of wealth - measure of wealth - stage of life
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

11. What are the general legal and regulatory considerations for individuals?
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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)
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
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

12. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
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
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
1) credit method 2) exemption method 3) deduction method

13. What are the main types of investors?
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
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
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) 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)

14. What are the different retirment risks and how can they be hedged?
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
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
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)

15. What is typically considered when imposing an exit tax?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
- 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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

16. 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
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
Extra investment value created by effective tax management
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

17. Equation for total wealth.
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
Total wealth = financial assets + human capital
1) credit method 2) exemption method 3) deduction method
Extra investment value created by effective tax management

18. What is tax alpha?
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
Extra investment value created by effective tax management
Implied liabilities
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift

19. What is mortality risk?
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)
The risk of a premature death with accompanying loss of future human capital
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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

20. As desire to leave an estate increases...
Sources of wealth - measure of wealth - stage of life
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)
Young -Building a foundation for future wealth -above avg risk tolerance
Demand for life insurance increases

21. situational profiling - considerations
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
Sources of wealth - measure of wealth - stage of life
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
Both increase with longer holding periods and higher returns

22. What is intestate?
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
Sources of wealth - measure of wealth - stage of life
When a decedent leaves no will or if the will is deemed invalid
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up

23. What are the two sources of wealth?
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
1) active 2) passive
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

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

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25. characteristics of methodical investor
The client's psychological profile
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
More subjective than situational profiling -helps to understand how an investor perceives risk and return. -Bridges the differences between traditional finance and behavioral finance -Methodical - cautious - individualist - spontaneous
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

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

27. Investor questionnaires help to determine what?
Risk tolerance and decision-making style
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
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) 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

28. What are the advantages of an outright sale of low basis stock?
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 liabilities
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

29. psychological profiling
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
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
Risk tolerance and decision-making style
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)

30. What is core capital?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
The amount of assets (i.e.present value) necessary to meet all future liabilities
- a subjective assessment of financial well-being based on perceived wealth
Excess capital

31. typical IPS elements
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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)
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

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

33. sources of wealth
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
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
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
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

34. What are the advantages of hedging for low basis stock?
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
- 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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education

35. characteristics of distribution phase
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
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
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging

36. As age increases..
Transferring assets directly to a third generation avoids possible double taxation
- cautious - methodical - individualistic - spontaneous
Demand for insurance decreases; less human capital to replace
The reduction in return caused by the payment of taxes

37. situational profiling - considerations
Excess capital
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one

38. What are the psychological issues of low basis stock held by an entrepreneur?
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
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
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
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

39. What are the psychological issues of low basis stock held by an executive?
- 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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
1. foundation 2. accumulation 3. maintenance 4. distribution
Implied assets

40. four types of investors
Sources of wealth - measure of wealth - stage of life
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
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
Methodical - cautious - individualist - spontaneous

41. What is measure of wealth?
Sources of wealth - measure of wealth - stage of life
- a subjective assessment of financial well-being based on perceived wealth
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n

42. 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
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
HC = PV of future labor income
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

43. Describe a cautious investor personality type.
Most risk averse/least risk tolerant - primary focus is financial security: preservation of wealth - hard to advise - can over-analyze - slow in making decisions and then changing investments - low portfolio turnover/volatility
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
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

44. Calculating the required return component is driven by what 2 elements?
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
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
1) active 2) passive
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)

45. What are the equity holding life risk attributes for an executive?
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
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)
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

46. What is measure of wealth?
The risk of a premature death with accompanying loss of future human capital
- a subjective assessment of financial well-being based on perceived wealth
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either

47. characteristics of individualist investor
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Implied assets
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

48. four types of investors
A positive relationship
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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education
Methodical - cautious - individualist - spontaneous

49. stages of life
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Income rising - assets growing - long time horizon - above-avg. ability to take risk
1. foundation 2. accumulation 3. maintenance 4. distribution

50. What is the eifference in willingness to take risk between active and passive wealth creators?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
A positive relationship
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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