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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 different methods of relief from double taxation?
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
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
1) credit method 2) exemption method 3) deduction method
Risk tolerance = as risk tolerance increases - demand for life insurance decreases

2. In contrast to standard finance (MPT) - behavioral finance assumes individuals do what?
1) Residence-residence = 2 individuals claim residence for the same individual 2) Source-Source = 2 countries claim authority over the same income (i.e. multinational company) 3) Residence-Source = individual is subject to residence jurisdiction and
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
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)
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

3. Describe a spontaneous investor personality type.
1. foundation 2. accumulation 3. maintenance 4. distribution
The amount of assets (i.e.present value) necessary to meet all future liabilities
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
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

4. What are the two sources of wealth?
1) active 2) passive
Transferring assets directly to a third generation avoids possible double taxation
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
1) specific risk (unsystematic risk) 2) market risk (systematic risk) 3) residual risk (counterparty risk and regulatory risk)

5. Describe a cautious investor personality type.
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
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
- 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
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

6. As probability of death increases...
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
- 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
The demand for life insurance increases - regardless of age

7. What are investment objectives and constraints?
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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)
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

8. characteristics of spontaneous investor

9. What is loss aversion?
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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) active 2) passive

10. How is demand for insurance affected by risk tolerance - financial wealth - probability of death - age - and bequest desire?
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Taxes paid on the gain (long or short position) when an asset is sold or purchased
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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

11. What are the main characteristics of variable annuities?

12. Why would an individual try to use generation skipping in estate planning?
Transferring assets directly to a third generation avoids possible double taxation
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
The client's psychological profile

13. What are the main characteristics of the accumulation phase of life?
1) Source jurisdiction = country levies taxes on all income generated within its borders - whether by citizens or foreigners 2) Residence jurisdiction = a country taxes income of its residents whether generated inside or outside the country (most pre
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Income rising - assets growing - long time horizon - above-avg. ability to take risk
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses

14. Describe an individualistic investor personality type.
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
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
- a subjective assessment of financial well-being based on perceived wealth
The testator

15. What is the person called that transfers assets through a will?
The testator
Achieves diversification slowly over time - capital gains taxes avoided to extent of matching gains and harvesting losses
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance
Wealth attained through inheritance - windfalls - long steady employment - etc. - might have less experience and less understanding of risk/return - might require investment education

16. characteristics of individualist investor
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take risk
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
The government shares in both gains and losses
Total wealth = financial assets + human capital

17. When calculating a required return - you typically must identify what?
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
Methodical - cautious - individualist - spontaneous
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date
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

18. What are the advantages of private exchange funds for low basis stock?
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach
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) 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)
Risk tolerance and decision-making style

19. What are the main characteristics of fixed annuities?

20. What are the main characteristics of chritable gifts?
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)
- gifts to charitable organizations are not taxed - donor is allowed to take a tax deduction in the amount of the gift
Must partner with an outside - unrelated investor - lock up period - taxesdeferred but not avoided - potential regulatory (IRS) risk
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

21. stages of life
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)
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
- 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. foundation 2. accumulation 3. maintenance 4. distribution

22. Equation for total wealth.
Should use accrual-equivalent returns and after-tax risk
Total wealth = financial assets + human capital
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Methodical - cautious - individualist - spontaneous

23. What is another name for a variable prepaid forward and What is its main purpose?
A positive relationship
Wealth transfer stage - focus on tax min. with trusts and foundations
1) Residence-residence = 2 individuals claim residence for the same individual 2) Source-Source = 2 countries claim authority over the same income (i.e. multinational company) 3) Residence-Source = individual is subject to residence jurisdiction and
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

24. What should an investor use in mean-variance optimization
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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
Should use accrual-equivalent returns and after-tax risk

25. What are the different types of trusts?
Total wealth = financial assets + human capital
1) source of wealth 2) measure of wealth 3) stage of life
Multiple-security holding with one superstar - the result is a concentrated equity position - high specific risk - diversifies from concentrated - active and core concentrations into passive index positions
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

26. sources of wealth
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
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
1) foundation phase 2) accumulation phase 3) maintenance phase 4) distribution phase
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances

27. What are the different global tax regimes and their respective ordinary income tax structure?
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)
Simple and quick - removes all residual risk - allows reinvestment of proceeds to achieve desired diversification
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)
Both increase with longer holding periods and higher returns

28. typical IPS elements
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
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
HC = PV of future labor income

29. sources of wealth
Self confident - Gather information from a wide variety of sources to make their own decisions - Willing to take 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
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
- does not ordinarily exhibit the same attachments to the firm as an entrepreneur or top executive - does not have any degree of control either

30. Describe biased expectations in a behavioral finance context.
HC = PV of future labor income
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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

31. What are the psychological issues of low basis stock held by an entrepreneur?
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
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
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
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

32. What are the disadvantages of public exchange funds for low basis stock?
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
Lock up period (7-10 yrs) - must hold >20% illiquid assets - lack of control (no changes - manager determines asset mix) - original cost basis
Objectives = required return; risk tolerance - Constraints = time horizon - tax concerns; liquidity needs - legal/regulatory; unique circumstances
Must have a very large portfolio or be willing to borrow - may take a long time to diversifiy completely

33. What are the advantages of private exchange funds for low basis stock?
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
Income rising - assets growing - long time horizon - above-avg. ability to take risk
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 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

34. Living expenses in retirment can be referred to as what?
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Risk tolerance = as risk tolerance increases - demand for life insurance decreases
Implied liabilities
1) growing the portfolio (capital gains) 2) liquidity needs - total return approach

35. typical IPS elements
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
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
Implied assets
Income rising - assets growing - long time horizon - above-avg. ability to take risk

36. How is mortality risk typically hedged?
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
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
Young -Building a foundation for future wealth -above avg risk tolerance
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

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

38. What is the general relationship between tax drag% and tax rate with accrual taxes; and as investment horizon increases and return increases?
Demand for life insurance increases
- tax drag% > tax rate - as investment horizon increases - tax drag $ and tax drage % increase - as investment return increases - tax drag $ and tax drag % increase
Client is a foundign family member - the firm still bears the family name - the shares were acquired by a loved one
Number of years to retirement/death - investable assets - annual liquidity requirement - specific amount (if any) needed at a future date

39. psychological profiling
The amount of assets (i.e.present value) necessary to meet all future liabilities
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
Valuation discounts can reduce the value of wealth transfers - so high net worth indiiduals utilize them whenever possible to minimize transfer taxes
Taxes paid on the gain (long or short position) when an asset is sold or purchased

40. What progressive tax regimes do not have favorable treatment for interest income/dividend income/capital gains?
INTEREST = heavy interest tax; light capital gain tax DVIDIDEND = heavy capital gain tax; light capital gain tax CAPITAL GAIN = heavy capital gain tax
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) Residence-residence = 2 individuals claim residence for the same individual 2) Source-Source = 2 countries claim authority over the same income (i.e. multinational company) 3) Residence-Source = individual is subject to residence jurisdiction and
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. situational profiling

42. What are the two sources of wealth?
- cautious - methodical - individualistic - spontaneous
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
1) active 2) passive
- 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

43. What are the problems that financial advisers can face with low basis stock?
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up
Demand for life insurance decreases
The amount of assets (i.e.present value) necessary to meet all future liabilities
1) Taxes - outright sale produces large capital gains taxes 2) Psychological factors - client might have emotional attachment or not care about diversification

44. What are the equity holding life risk attributes for an executive?
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
To earn a total ______-tax __________ return of ______% covering: -expense 1 -expense 2 -expense n
Should use accrual-equivalent returns and after-tax risk
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

45. How is mortality risk typically hedged?
- 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
Hedged with life insurance - think of the life insurance as a replacement for lost human capital
Retired - focus on lifestyle maintenance and security - preservation of wealth - shortening time horizon and declining risk tolerance

46. Generally - how does portfolio size - liquidity - time horizon - and/or importance of spending affect ability to tolerate risk?
Transferring assets directly to a third generation avoids possible double taxation
The government shares in both gains and losses
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
Portfolio size incr. = ability up - Liquidity needs up = ability down - Time horizon up = ability up - Spending importance down = ability up

47. What are the advantages of public exchange funds for low basis stock?
Tax rate lower today = use tax-exempt - tax rate lower in future = use tax deferred - not expected to change = use either
Immediate diersification - ability to borrow (monetize) - at end of partnership receive proportional share of pool
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
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

48. What is another name for a variable prepaid forward and What is its main purpose?
Upside potential of hedged position limited - regulatory risk (avoid constructive sale - some risk exposure required)
Triggers tax on unrealized capital gains - requires liquidity - shares must be publicly traded or have low restrictions on sale
1) outright sale 2) exhcange funds (public or priate) 3) completion portfolios 4) hedging
Aka - unbalanced collar - forward sale of shares with an agreed delivery date in exchange for cash today

49. characteristics of methodical investor
Relies on hard facts -decisions tend to be conservative in nature -more risk averse -thinking/analysis
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
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
- cautious - methodical - individualistic - spontaneous

50. What are the diffferent types of tax jurisdictions?
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
The client's psychological profile
Can be used for clarification if questions areise about specific invesetment decisions - should outline a process for dispute resolution
The reduction in return caused by the payment of taxes