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Private Wealth Management

Subjects : personal-finance, business-skills

Instructions:

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

1. What are the advantages of completion portfolios for low basis stock?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
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 testator

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

3. What is human capital?
HC = PV of future labor income
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
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n

4. What are the advantages of completion portfolios for low basis stock?
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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
- cautious - methodical - individualistic - spontaneous

5. Who is responsible for gains/losses in a taxable (accrual taxation) account?
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 positive relationship
The government shares in both gains and losses
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

6. What is an equity collar? What is the purpose of the underlying positions
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
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
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education

7. What are the psychological issues of low basis stock held by an executive?
Extra investment value created by effective tax management
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
- 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

8. Describe a spontaneous investor personality type.
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
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
Demand for life insurance increases
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

9. characteristics of individualist investor
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
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
The client's psychological profile
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk

10. What are the disadvantages of completion portfolios for low basis stock?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Risk tolerance and decision-making style
- 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

11. What is HIFO accounting?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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
The government shares in both gains and losses

12. What is the reinvestment caveat when considering tax loss harvesting?
Implied liabilities
- 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
Tax drag % = tax rate - as the investment horizon increases - tax drag is unchanged - as the investment return increases - tax drag is unchanged - as the investment horizon increases - value of the tax deferral increases - as the inestment return inc
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

13. What is core capital?
Young -Building a foundation for future wealth -above avg risk tolerance
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
The amount of assets (i.e.present value) necessary to meet all future liabilities
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk

14. What are the advantages of private exchange funds for low basis stock?
Can borrow and/or use derivatives to diversify - ability to borrow (monetize) increased - owners retain upside potential of the original investment - not required to hodl illiquid assets - partners can change fund composition
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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

15. How is mortality risk typically hedged?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Wealth transfer stage - focus on tax min. with trusts and foundations
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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)

16. Why do individuals often take steps to avoid probate?
It is expenseive - time consuming - public
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Extra investment value created by effective tax management
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

17. What are the main characteristics of the maintenance phase of life?
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
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) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

18. What are the main types of investors?
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) 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)
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis

19. template for return objective
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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

20. What are the advantages of an outright sale of low basis stock?
Extra investment value created by effective tax management
- a subjective assessment of financial well-being based on perceived wealth
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

21. What should an investor use in mean-variance optimization
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Should use accrual-equivalent returns and after-tax risk
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis

22. situational profiling

23. Calculating the required return component is driven by what 2 elements?
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
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
Tax drag % = tax rate - as the investment horizon increases - tax drag is unchanged - as the investment return increases - tax drag is unchanged - as the investment horizon increases - value of the tax deferral increases - as the inestment return inc
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach

24. characteristics of accumulation phase
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
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
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

25. If human capital is equity-like/fixed-income like - how should you generally allocate financial assets?
Both increase with longer holding periods and higher returns
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
Young -Building a foundation for future wealth -above avg risk tolerance
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

26. What are the advantages of hedging 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
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
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

27. What is the general relationship b/t a client's perception of wealth and risk willingness?
A positive relationship
Tax drag % = tax rate - as the investment horizon increases - tax drag is unchanged - as the investment return increases - tax drag is unchanged - as the investment horizon increases - value of the tax deferral increases - as the inestment return inc
The risk of a premature death with accompanying loss of future human capital
The reduction in return caused by the payment of taxes

28. How does the nature of human capital affect the demand for life insurance?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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
The more equity-like - the less the demand for life insurance

29. As desire to leave an estate increases...
Demand for life insurance increases
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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
The demand for life insurance increases - regardless of age

30. What should an investor use in mean-variance optimization
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
When a decedent leaves no will or if the will is deemed invalid
Should use accrual-equivalent returns and after-tax risk
Early career 8accumulating education - developing skills - above-average ability to take risk

31. What is mortality risk?
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
- a subjective assessment of financial well-being based on perceived wealth
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
The risk of a premature death with accompanying loss of future human capital

32. typical IPS elements
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
- 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

33. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
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
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
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

34. stages of life
1. foundation 2. accumulation 3. maintenance 4. distribution
Fixed income streat set at inception - usually no inflation adjustment - so real value falls over time - usually illiquid (can't withdraw funds) - lock in at the prevailing rate - which might be historically low
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either

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

36. Any amount above core capital is considered what?
Excess capital
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Extra investment value created by effective tax management
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)

37. Describe a methodical investor personality type.
HC = PV of future labor income
The decedent's estate
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)
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

38. What are the different types of trusts?
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
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) 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) source of wealth 2) measure of wealth 3) stage of life

39. benefits of IPS to manager
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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 amount of assets (i.e.present value) necessary to meet all future liabilities
Income rising - assets growing - long time horizon - above-avg. ability to take risk

40. What is the general relationship b/t a client's perception of wealth and risk willingness?
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
A positive relationship
- 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
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

41. What are the different retirment risks and how can they be hedged?
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)
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
- 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
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

42. What are the advantages of public exchange funds for low basis stock?
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
Early career 8accumulating education - developing skills - above-average ability to take risk
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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

43. Describe biased expectations in a behavioral finance context.
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
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
- a subjective assessment of financial well-being based on perceived wealth
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale

44. What are the four broad categories of investor personality types (BB&K)?
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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
- cautious - methodical - individualistic - spontaneous

45. What are the advantages of public exchange funds for low basis stock?
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
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. What is the most common estate planning tool?
A will (also known as a testament)
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

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

48. Human capital is sometimes referred to as what?
The demand for life insurance increases - regardless of age
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
Implied assets
Hedged with life insurance - think of the life insurance as a replacement for lost human capital

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

50. characteristics of distribution phase
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
Sources of wealth - measure of wealth - stage of life
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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one