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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 two sources of wealth?
Early career 8accumulating education - developing skills - above-average ability to take risk
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
1) active 2) passive
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification

2. What are the main characteristics of fixed annuities?

3. What are the 3 categories of investors when discussing concentrated positions?
Implied liabilities
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
- a subjective assessment of financial well-being based on perceived wealth
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

4. sources of wealth
Methodical - cautious - individualist - spontaneous
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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
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

5. Investor questionnaires help to determine what?
Risk tolerance and decision-making style
- a subjective assessment of financial well-being based on perceived wealth
Extra investment value created by effective tax management
1) source of wealth 2) measure of wealth 3) stage of life

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

7. If human capital is equity-like/fixed-income like - how should you generally allocate financial assets?
Implied assets
The client's psychological profile
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
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

8. 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
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)
Excess capital
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

9. When should you use a tax-exempt versus a tax-deferred account?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
The government shares in both gains and losses
A positive relationship
The testator

10. What are the advantages of an outright sale of low basis stock?
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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
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

11. What is an equity collar? What is the purpose of the underlying positions
When a decedent leaves no will or if the will is deemed invalid
It is expenseive - time consuming - public
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
Methodical - cautious - individualist - spontaneous

12. benefits of IPS to manager
Excess capital
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
Methodical - cautious - individualist - spontaneous
The demand for life insurance increases - regardless of age

13. What are the different stages of life?
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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
Demand for life insurance decreases
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

14. Why would someone want to use a valuation discount?
Wealth transfer stage - focus on tax min. with trusts and foundations
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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

15. 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
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
The risk of a premature death with accompanying loss of future human capital

16. Why would an individual try to use generation skipping in estate planning?
Transferring assets directly to a third generation avoids possible double taxation
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
Should use accrual-equivalent returns and after-tax risk
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

17. What are the psychological issues of low basis stock held by an investor?
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
Young -Building a foundation for future wealth -above avg risk tolerance
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Most risk 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

18. What are the equity holding life risk attributes for an entrepreneur?
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
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
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
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

19. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
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) 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)
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax

20. What are the psychological issues of low basis stock held by an entrepreneur?
The amount of assets (i.e.present value) necessary to meet all future liabilities
The decedent's estate
HC = PV of future labor income
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

21. Any amount above core capital is considered what?
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
Excess capital
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) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification

22. What are the four broad categories of investor personality types (BB&K)?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
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
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

23. What is the person called that transfers assets through a will?
The testator
The more equity-like - the less the demand for life insurance
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
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)

24. As desire to leave an estate increases...
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)
Demand for life insurance increases
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
When a decedent leaves no will or if the will is deemed invalid

25. If human capital is equity-like/fixed-income like - how should you generally allocate financial assets?
The demand for life insurance increases - regardless of age
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
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

26. What is HIFO accounting?
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
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
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool

27. What are the main characteristics of chritable gifts?
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
The client's psychological profile
1) credit method 2) exemption method 3) deduction method
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

28. How does the nature of human capital affect the demand for life insurance?
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
The government shares in both gains and losses
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
The more equity-like - the less the demand for life insurance

29. Define tax drag.
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
The reduction in return caused by the payment of taxes
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
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance

30. What are typical characteristics of active wealth creators?
Both increase with longer holding periods and higher returns
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
The government shares in both gains and losses
- 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

31. What are the advantages of the monte carlo approach to portfolio construction?
Implied liabilities
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
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
- a subjective assessment of financial well-being based on perceived wealth

32. Living expenses in retirment can be referred to as what?
Implied liabilities
1) credit method 2) exemption method 3) deduction method
Joint ownership with rights of survivorship - living trusts - retirement plans - life insurance - other means that transfer assets without the need for a will
Extra investment value created by effective tax management

33. What is core capital?
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
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
The amount of assets (i.e.present value) necessary to meet all future liabilities
The decedent's estate

34. What are the disadvantages of hedging for low basis stock?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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
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
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

35. As age increases..
Risk tolerance and decision-making style
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
Demand for insurance decreases; less human capital to replace
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

36. What are the equity holding life risk attributes for an executive?
The testator
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
- cautious - methodical - individualistic - spontaneous
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution

37. characteristics of individualist investor
- extrepreneurs - for example - are usually familiar with taking business risk - they are willing to take risk b/c they feel they control their business and personal circumstances
The reduction in return caused by the payment of taxes
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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

38. As probability of death increases...
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
The demand for life insurance increases - regardless of age
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk

39. What are the benefits of an IPS to the adviser?
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Implied liabilities
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

40. How is mortality risk typically 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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
The more equity-like - the less the demand for life insurance
Active wealth creators typically have an above-avg. willingness to take risk - passive recipients of wealth typically have an average or below-average willingness to take risk

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

42. situational profiling - considerations
Implied liabilities
Iinvestors analyze ind. investments on a stand-alone basis - do not consider how the asset will affect portfolio risk and return - manifests itself as mental accounting/pyramiding - lack of diversification
- 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
Sources of wealth - measure of wealth - stage of life

43. What are the advantages of an outright sale of low basis stock?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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
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
Risk tolerance = as risk tolerance increases - demand for life insurance decreases

44. What are the steps involved in creating an IPS?

45. situational profiling - considerations
Sources of wealth - measure of wealth - stage of life
- 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
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
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

46. characteristics of maintenance phase
1. foundation 2. accumulation 3. maintenance 4. distribution
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
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
The testator

47. What is another name for a variable prepaid forward and What is its main purpose?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

48. What is core capital?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
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 amount of assets (i.e.present value) necessary to meet all future liabilities

49. four types of investors
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
Methodical - cautious - individualist - spontaneous
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
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

50. What are the different types of trusts?
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
- 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
- cautious - methodical - individualistic - spontaneous
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