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. psychological profiling
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
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
Should use accrual-equivalent returns and after-tax risk
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances


2. What are the main characteristics of the distribution phase of life?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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
Wealth transfer stage - focus on tax min. with trusts and foundations
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


3. Define capital gains taxes.
HC = PV of future labor income
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)
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
Taxes paid on the gain (long or short position) when an asset is sold or purchased


4. Equation for total wealth.
Both increase with longer holding periods and higher returns
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Total wealth = financial assets + human capital


5. What is the most common estate planning tool?
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
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
A will (also known as a testament)
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education


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

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7. characteristics of methodical investor
1) credit method 2) exemption method 3) deduction method
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis


8. What is another name for a variable prepaid forward and What is its main purpose?
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
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
The government shares in both gains and losses
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today


9. Define tax drag.
The reduction in return caused by the payment of taxes
A will (also known as a testament)
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
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


10. 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
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
The decedent's estate
Both increase with longer holding periods and higher returns


11. What are the different stages of life?
1) active 2) passive
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
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 phase 2) accumulation phase 3) maintenance phase 4) distribution phase


12. Describe a cautious investor personality type.
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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
Excess capital


13. What is the person called that transfers assets through a will?
1. foundation 2. accumulation 3. maintenance 4. distribution
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) 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)
The testator


14. What is an equity collar? What is the purpose of the underlying positions
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Methodical - cautious - individualist - spontaneous


15. What is the difference b/t a required and desired return objective?

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16. What is core capital?
The amount of assets (i.e.present value) necessary to meet all future liabilities
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Extra investment value created by effective tax management
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n


17. What are wealth taxes.
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
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 higher in the ranks - the more the executive acts like an entrepreneur - the more control = the more attached the executie is to the firm
1. foundation 2. accumulation 3. maintenance 4. distribution


18. What are the main types of investors?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
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)
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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


19. benefits of IPS to client
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
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
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible


20. What is tax alpha?
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Extra investment value created by effective tax management
A positive relationship
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk


21. Define tax drag.
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
The reduction in return caused by the payment of taxes
Wealth transfer stage - focus on tax min. with trusts and foundations
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


22. What are the four broad categories of investor personality types (BB&K)?
- cautious - methodical - individualistic - spontaneous
A will (also known as a testament)
Methodical - cautious - individualist - spontaneous
HC = PV of future labor income


23. Equation for total wealth.
Total wealth = financial assets + human capital
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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
- 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


24. 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
The decedent's estate
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Sources of wealth - measure of wealth - stage of life


25. Why do individuals often take steps to avoid probate?
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
It is expenseive - time consuming - public


26. Describe the equity holding life three stages from the perspective of the stock.
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
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
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
1. foundation 2. accumulation 3. maintenance 4. distribution


27. psychological profiling
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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


28. When dealing with low basis stock - emotional issues can arise from what?
- 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) 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)
Total wealth = financial assets + human capital
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one


29. stages of life
- 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
HC = PV of future labor income
1. foundation 2. accumulation 3. maintenance 4. distribution
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


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

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31. What are the advantages of an outright sale of low basis stock?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
The demand for life insurance increases - regardless of age
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
- 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


32. What are the four broad categories of investor personality types (BB&K)?
- cautious - methodical - individualistic - spontaneous
Demand for life insurance decreases
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible


33. Investor questionnaires help to determine what?
Implied liabilities
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
Risk tolerance and decision-making style
Both increase with longer holding periods and higher returns


34. 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
Both increase with longer holding periods and higher returns
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Methodical - cautious - individualist - spontaneous


35. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
When a decedent leaves no will or if the will is deemed invalid
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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


36. What are the advantages of public exchange funds for low basis stock?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
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
Demand for insurance decreases; less human capital to replace


37. What are the different retirment risks and how can they be hedged?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Income rising - assets growing - long time horizon - above-avg. ability to take 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)
Taxes paid on the gain (long or short position) when an asset is sold or purchased


38. What are the benefits of an IPS to the adviser?
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
The more equity-like - the less the demand for life insurance
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale


39. What are the benefits of an IPS to the client?
Taxes paid on the gain (long or short position) when an asset is sold or purchased
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) 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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education


40. Any amount above core capital is considered what?
Excess capital
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
Risk tolerance and decision-making style
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


41. What are the advantages of hedging for low basis stock?
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
- a subjective assessment of financial well-being based on perceived wealth
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible


42. What is loss aversion?
Excess capital
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging


43. What risks must be considered when discussing each concentrated investor category?
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
- a subjective assessment of financial well-being based on perceived wealth
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool


44. characteristics of distribution phase
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
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
- 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


45. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
Early career 8accumulating education - developing skills - above-average ability to take risk
Wealth transfer stage - focus on tax min. with trusts and foundations
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
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


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

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47. Describe asset segregation in a behavioral finance context.
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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
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
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. characteristics of cautious investor

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49. Who is responsible for gains/losses in a taxable (accrual taxation) account?
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Young -Building a foundation for future wealth -above avg risk tolerance
The government shares in both gains and losses
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach


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

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