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 main characteristics of fixed annuities?

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2. What is the reinvestment caveat when considering tax loss harvesting?
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
- 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
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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


3. Define capital gains 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
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)
Taxes paid on the gain (long or short position) when an asset is sold or purchased
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either


4. Investor questionnaires help to determine what?
Transferring assets directly to a third generation avoids possible double taxation
Risk tolerance and decision-making style
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
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


5. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
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
- 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) credit method 2) exemption method 3) deduction method
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible


6. What are the four broad categories of investor personality types (BB&K)?
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 testator
- cautious - methodical - individualistic - spontaneous
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)


7. What are the psychological issues of low basis stock held by an investor?
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
- 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) 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 testator


8. What are the two sources of wealth?
Both increase with longer holding periods and higher returns
Sources of wealth - measure of wealth - stage of life
1) active 2) passive
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


9. Human capital is sometimes referred to as 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
Implied assets
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
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


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


11. What is another name for a variable prepaid forward and What is its main purpose?
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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


12. benefits of IPS to manager
1) exhibit loss aversion rather than risk aversion 2) exhibit biased expectations rather than rational expectations 3) tend to segregate investments rather than considering them in a portfolio perspective
- a subjective assessment of financial well-being based on perceived wealth
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
The risk of a premature death with accompanying loss of future human capital


13. What is core capital?
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
- a subjective assessment of financial well-being based on perceived wealth
The amount of assets (i.e.present value) necessary to meet all future liabilities
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


14. Describe a cautious investor personality type.
Transferring assets directly to a third generation avoids possible double taxation
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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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


15. What are the main characteristics of fixed annuities?

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16. characteristics of maintenance phase
When a decedent leaves no will or if the will is deemed invalid
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
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
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


17. What are the four broad categories of investor personality types (BB&K)?
Implied assets
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
- cautious - methodical - individualistic - spontaneous


18. What are the advantages of private exchange funds for low basis stock?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
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
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
- a subjective assessment of financial well-being based on perceived wealth


19. Who is responsible for gains/losses in a taxable (accrual taxation) account?
The government shares in both gains and losses
Demand for life insurance decreases
1) credit method 2) exemption method 3) deduction method
- 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


20. What are the diffferent types of tax jurisdictions?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
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
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


21. What are the benefits of an IPS to the client?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
- a subjective assessment of financial well-being based on perceived wealth
Early career 8accumulating education - developing skills - above-average ability to take risk
Acts as an operational guideline that represents the long-term - best interests of the investor - the process is dynamic and can incorporate changed circumstances (review at least annually) - the IPS allows continuity over time and portability to new


22. 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
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
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
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


23. Define tax drag.
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
The reduction in return caused by the payment of taxes
The amount of assets (i.e.present value) necessary to meet all future liabilities
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


24. Describe a cautious investor personality type.
The demand for life insurance increases - regardless of age
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
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
Implied liabilities


25. What is measure of wealth?
- a subjective assessment of financial well-being based on perceived wealth
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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
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


26. What are the different retirment risks and how can they be hedged?
The reduction in return caused by the payment of taxes
1) Financial market risk (reduced with efficient diversification) 2) Longevity risk (hedged w/ annuities) 3) Savings risk (hedged by employing a savings program and consuming less)
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
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


27. What are the problems that financial advisers can face with low basis stock?
A positive relationship
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Should use accrual-equivalent returns and after-tax risk
1) source of wealth 2) measure of wealth 3) stage of life


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


29. What are typical characteristics of active wealth creators?
- 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
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 reduction in return caused by the payment of taxes
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)


30. What is another name for a variable prepaid forward and What is its main purpose?
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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


31. What are the main characteristics of the distribution phase of life?
Wealth transfer stage - focus on tax min. with trusts and foundations
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
A positive relationship
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


32. What risks must be considered when discussing each concentrated investor category?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Total wealth = financial assets + human capital
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today


33. What are ways that individuals can avoid probate?
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
Implied assets
Methodical - cautious - individualist - spontaneous
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will


34. How does the nature of human capital affect the demand for life insurance?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
The more equity-like - the less the demand for life insurance
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


35. Living expenses in retirment can be referred to as what?
HC = PV of future labor income
Implied liabilities
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Methodical - cautious - individualist - spontaneous


36. four types of investors
Methodical - cautious - individualist - spontaneous
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
- cautious - methodical - individualistic - spontaneous
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution


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

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38. When should you use a tax-exempt versus a tax-deferred account?
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
- cautious - methodical - individualistic - spontaneous


39. What are ways that individuals can avoid probate?
Implied assets
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
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
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


40. What is the difference between a deterministic approach and a monte carlo approach to portfolio construction?
It is expenseive - time consuming - public
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
Deterministic = use point estimates to generate a forecasted value such as an expected return or terminal value Monte Carlo = use probability distributions of inputs to generate expected returns with accompanying probability distributions
The decedent's estate


41. Describe a methodical investor personality type.
Young -Building a foundation for future wealth -above avg risk tolerance
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Demand for life insurance increases
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


42. When dealing with low basis stock - emotional issues can arise from what?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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
The demand for life insurance increases - regardless of age
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one


43. psychological profiling
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
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


44. What are the different retirment risks and how can they be hedged?
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
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)
Excess capital


45. As age increases..
Demand for insurance decreases; less human capital to replace
Both increase with longer holding periods and higher returns
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
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


46. What are the diffferent types of tax jurisdictions?
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
Methodical - cautious - individualist - spontaneous
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
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)


47. What are typical characteristics of active wealth creators?
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
- 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
Demand for life insurance decreases
Both increase with longer holding periods and higher returns


48. 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
Should use accrual-equivalent returns and after-tax risk
The risk of a premature death with accompanying loss of future human capital
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


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

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50. situational profiling

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