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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.
Don't refresh. All questions and answers are randomly picked and ordered every time you load a test.

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 is loss aversion?
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
Early career 8accumulating education - developing skills - above-average ability to take risk
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)
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

2. What are the equity holding life risk attributes for an entrepreneur?
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
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
Demand for life insurance decreases
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

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

4. Who is responsible for gains/losses in a taxable (accrual taxation) account?
- 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
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
The government shares in both gains and losses
Can be implemented quickly - can facilitate low cost borrowing (to monetize) - borrowing costs may be tax-deductible

5. What is typically considered when imposing an exit tax?
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
- 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
The demand for life insurance increases - regardless of age
The testator

6. sources of wealth
Entrepreneurial activity (likely to have highly concentrated portfolio) -inheritance - one-time windfalls (may be more willing to diversify) -built up over long periods of safe employment (e.g. middle mgr - easier to divest than huge entrepreneurial
Decisions should be optimal -process is dynamic - thus factors in changing circumstances -focus on long-term objectives -new investment advisors should be able to use the IPS
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase

7. four types of investors
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
Determine: the client's contraints - as well as risk/return objectives - the best strategy - given capital market expectations for achieving the client's objectives - the appropriate strategic (long term) asset allocation which meets those goals
Methodical - cautious - individualist - spontaneous
1) credit method 2) exemption method 3) deduction method

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

9. How is mortality risk typically hedged?
1) active 2) passive
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
- 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

10. What is mortality risk?
A positive relationship
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
The risk of a premature death with accompanying loss of future human capital
Sources of wealth - measure of wealth - stage of life

11. What is HIFO accounting?
The decedent's estate
Demand for life insurance increases
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 testator

12. Any amount above core capital is considered what?
Excess capital
1) active 2) passive
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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale

13. characteristics of distribution phase
Long stock position + long put + short call - long put protects downside (like purchasing insurance) - short call generates income to at least partially offset the cost of the put
If board of director member = inside - prudent investor rules usually applies - recommend legal counsel for setting up personal trust or family foundation - if a trust - balance the needs of income beneficiaries and remainderment
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
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

14. What are the main characteristics of fixed annuities?

15. As age 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
Demand for insurance decreases; less human capital to replace
Excess capital
Wealth transfer stage - focus on tax min. with trusts and foundations

16. Why would an individual try to use generation skipping in estate planning?
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Demand for insurance decreases; less human capital to replace
Transferring assets directly to a third generation avoids possible double taxation

17. What is human capital?
HC = PV of future labor income
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
1) active 2) passive
- 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

18. What are the main characteristics of the distribution phase of life?
Methodical - cautious - individualist - spontaneous
Demand for insurance decreases; less human capital to replace
Wealth transfer stage - focus on tax min. with trusts and foundations
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

19. Describe biased expectations in a behavioral finance context.
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
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) 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

20. What are the diversification techniques for low basis stock?
Demand for life insurance increases
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
When a decedent leaves no will or if the will is deemed invalid
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)

21. What happens to both tax drag $ and tax drag % with holding period changes and return changes?
Excess capital
Both increase with longer holding periods and higher returns
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
Methodical - cautious - individualist - spontaneous

22. What are the four broad categories of investor personality types (BB&K)?
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
- 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) growing the portfolio (capital gains) 2) liquidity needs - total return approach

23. benefits of IPS to client
The more equity-like - the less the demand for life insurance
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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

24. situational profiling

25. benefits of IPS to client
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
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
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
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

26. How does the nature of human capital affect the demand for life insurance?
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
The reduction in return caused by the payment of taxes
Sources of wealth - measure of wealth - stage of life
The more equity-like - the less the demand for life insurance

27. What are the problems that financial advisers can face with low basis stock?
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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification

28. What is tax alpha?
Extra investment value created by effective tax management
Demand for life insurance increases
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
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

29. What risks must be considered when discussing each concentrated investor category?
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)
Total wealth = financial assets + human capital
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

30. Define tax drag.
The reduction in return caused by the payment of taxes
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
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
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

31. What are the psychological issues of low basis stock held by an entrepreneur?
Depends on the investor's goals and time horizon and the volatility the portfolio can bear b/f those goals are jeopardized
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
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
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)

32. Why do individuals often take steps to avoid probate?
1. foundation 2. accumulation 3. maintenance 4. distribution
It is expenseive - time consuming - public
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
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

33. What are the main characteristics of the foundation phase of life?
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
Early career 8accumulating education - developing skills - above-average ability to take risk
Young -Building a foundation for future wealth -above avg risk tolerance
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

34. What are the main characteristics of the accumulation phase of life?
1) Traders (all gains short term) 2) Active investors (less churn - some gains taxed at reduced rates) 3) Passive investor (buy and hold - most gains are deferred) 4) Exempt investors (no investment taxes)
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
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Income rising - assets growing - long time horizon - above-avg. ability to take risk

35. characteristics of foundation stage
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
Total wealth = financial assets + human capital
The reduction in return caused by the payment of taxes
Young -Building a foundation for future wealth -above avg risk tolerance

36. What are typical characteristics of active wealth creators?
Methodical - cautious - individualist - spontaneous
Demand for life insurance increases
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
- 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

37. The client's risk tolerance (mostly willingness) is affected by what personal characteristics?
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
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely
1) source of wealth 2) measure of wealth 3) stage of life

38. situational profiling

39. psychological profiling
Both increase with longer holding periods and higher returns
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
- a subjective assessment of financial well-being based on perceived wealth
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

40. As probability of death increases...
Implied liabilities
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)
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
The demand for life insurance increases - regardless of age

41. benefits of IPS to manager
1. foundation 2. accumulation 3. maintenance 4. distribution
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
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
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

42. Define tax drag.
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 reduction in return caused by the payment of taxes
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)
Excess capital

43. What is another name for a variable prepaid forward and What is its main purpose?
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
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today
Implied assets
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

44. What are the main characteristics of variable annuities?

45. What are typical characteristics of passive recipients of wealth?
1. foundation 2. accumulation 3. maintenance 4. distribution
Demand for life insurance decreases
HC = PV of future labor income
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education

46. What are the disadvantages of an outright sale of low basis stock?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
Implied liabilities

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

48. As age increases..
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Demand for insurance decreases; less human capital to replace
- 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
The client's psychological profile

49. Human capital is sometimes referred to as what?
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
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 more equity-like - the less the demand for life insurance
Implied assets

50. Human capital is sometimes referred to as what?
Early career 8accumulating education - developing skills - above-average ability to take risk
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
1) active 2) passive
Implied assets