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CFA Book 1 Flashcards

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1
Q
A
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2
Q

Asset Manager Code of Professional Conduct (AMCPC)

A
  1. loyalty to clients
  2. investment process and actions
  3. trading
  4. risk management, compliance, support
  5. performance & valuation
  6. disclosures
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3
Q

Asset Manager Ethics Responsibilities

A
  1. always act ethically & professionally
  2. acit in the best interest of the client
  3. act in an objective and independent manner
  4. perform actions using skill, competence and diligence
  5. communicate accurately with clients on a regular basis
  6. comply with legal and regulatory reqs regarding capital mkts
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4
Q

AMCPC | Loyalty to Clients policies (3B1 p 123)

A
  1. align incentives (no undue risk)
  2. client confidential info
  3. AML
  4. def of a token gift
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5
Q

AMCPC | Investment Process and Actions (3B1 p 124)

A
  1. never manipulate mkt prices
  2. deal fairly when doing ARA
  3. reasonable basis
  4. diff levels of service
  5. explainable strategies
  6. ability to cash out
  7. IPS
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6
Q

AMCPC | Trading (3B1 p 125)

A
  1. no insider trading
  2. priority of transactions
  3. soft dollars use
  4. best execution
  5. equitable share allocation
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7
Q

AMCPC | Risk management, Compliance, Support (3B1 p 125)

A
  1. Policies/procedures for AMCPC, SPC, regs, law
  2. firm-wide risk system
  3. compliance officer
  4. portfolio info is correct & reviewed by 3rd party
  5. record retention 7 yrs
  6. sufficient, qualified staff
  7. disaster recovery plan
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8
Q

AACPC | Performance & Valuation (3B1 p 126)

A
  1. see GIPS
  2. 3rd party valuations
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9
Q

AMCPC | Disclosure (3B1 p 127)

A

Absolutely EVERYTHING

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10
Q

3 Behavioral models

A
  1. Barnewall 2 way model
  2. Bailard, Biehl, Kaiser 5 way model
  3. Pompain model
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11
Q

Behavior models | Barnewall 2 way model

A

2 investor categories: active and passive

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12
Q

Behavior models | Bailard, Biehl, Kaiser 5 way model

A

• 2 investeror dimensions:
◎ confidence: confident (C) to anxious (A)
◎ method of action: careful (F) to impetuous (I)
• 5 investor categories:
◎ straigt arrow (middle)
◎ Individualist (CF)
◎ Adventurer (CI)
◎ Guardian (AF)
◎ Celebrity (AI)

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13
Q

Behavior models | Pompian model

A

• 4 step assesment
• 2 dimensions: risk tolerance / investment style
• 4 Behavior Investor Types (BITs):
◎ passive preserver
◎ friendly follower
◎ independent individualist
◎ active acumulator

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14
Q

Behavior models | Pompian model - 4 step assessment

A
  1. active/passive
  2. risk tolerance scale
  3. behaviorial biases
  4. classify investor in BITS
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15
Q

Behavior models | Pompian model - BITs

A

Behavior Investor Types: Risk tolerance (low > high) & Investment style (conservative > aggressive):
◎ Least: Passive preserver (emotional: bad)
◎ Moderate low: Friendly follower (cognative: good)
◎ Moderate high: Independent individualist (cognative: good)
◎ Most: Active accumulator (emotional: bad)

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16
Q

Behavior models | Pompian model biases - Passive preserver

A
  • Emotional: endowment, loss aversion, status quo, regret aversion
  • Cognative: mental accouting, anchoring and adjustment
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17
Q

Behavior models | Pompian model biases - Friendly follower

A
  • Emotional: regret aversion
  • Cognative: availability, hindsight, framing
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18
Q

Behavior models | Pompian model biases - Independent individualist

A
  • Emotional: overconfidence, self-attribution
  • Cognative: conservatism, availability, confirmation, representativeness
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19
Q

Behavior models | Pompian model biases - Active accumulator

A
  • Emotional: overconfidence, self-control
  • Cognative: illusion of control
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20
Q

Client / Adviser success measure

A
  1. Adviser understands long term financial goals of client
  2. Adviser maintains consistent approach with client
  3. Adviser acts as client expects
  4. Both client and advisor benefit
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21
Q

Analyst behavioral biases

A
  1. overconfidence
  2. way management presents information
  3. biased research
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22
Q

Analyst behavioral biases | self calibration

A
  • Mitigate overconfidence
  • accurately remembering forecasts and accurate self-evaluations
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23
Q

Analyst behavioral biases | Company management influence

A
  1. framing
  2. anchoring and adjustment
  3. availablity
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24
Q

Investment committee behavioral biases

A
  • Often no better than individual
  • All individual + social proof bias: person follows the group
  • To counteract, need independence
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25
Q

Excess return anomolies that are not

A
  • Excess return before, but not after expenses
  • Excess return with too low associated risk
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26
Q

Behavioral bias | Disposition effect

A

more willing to sell winners than losers

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27
Q

Behavioral bias | Biases creating excess returns

A
  1. Momentum effect
    ◎ Herding
  2. Bubble and crash: panic buying/selling
  3. Value vs Growth
    ◎ Halo effect
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28
Q

Behavioral bias | Biases that contribute to overconfidence

A
  1. illusion of knowledge
  2. self-attribution
  3. representativeness
  4. availability
  5. illusion of control
  6. hindsight
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29
Q

Behavioral bias | Methods to avoid bias

A
  1. seek counter evidence/opinions
  2. defined systematic decision process
  3. verifiable data
  4. correct framing
  5. documenting decisions
  6. bayes formula
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30
Q

Behavioral bias | Quantitative indication of bubbles/crashes

A
  • Bubble: 2 std dev from mean price
  • Crash: 30% drop in a few months
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31
Q

Behavioral bias | Bubble/Crash biases

A
  1. overconfidence
  2. confirmation
  3. self-attribution
  4. hindsight
  5. regret aversion
  6. disposition effect
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32
Q

Behavioral finance | macro vs micro

A
  • macro: mkt deviaition from traditional finance theory
  • micro: individuals’ decision making process deviation from traditional finance (REM: rational economic men)
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33
Q

Rational economic men (REM)

A

The rational actor assumption in traditional finance theory

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34
Q

Bayes formula

A

P(A|B) = P(B|A) * P(A) / P(B)

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35
Q

Behavioral finance | Utility theory

A

• Foundation of traditional finance theory
• diminishing marginal utility return
◎ >> concave risk averse utility function
◎ >> convex indifference curves

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36
Q

Behavioral finance | Satisfice

A
  • sufficient satisfaction, but not optimal, are sufficient
  • satis+ficent = satisfice
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37
Q

Behavioral finance | Decision theory

A

• associated with traditional finance theory • process of making optimal decision when decision maker is informed, math able, rational (REM)

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38
Q

Behavioral finance | Bounded rationality

A
  • associated with behavioral finance theory
  • Knowledge and cognative limitations of decision maker
  • Satisfice
  • More constrained that prospect theory
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39
Q

Behavioral finance | Prospect theory

A
  • associated with behavioral finance theory
  • similar to bounded theory
  • risk aversion is replaced by loss aversion
  • 2 phases: Editing phase, then Evaluation phase
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40
Q

Behavioral finance | Prospect theory : Editing phase

A

First three steps

  1. Codification: gain/loss & prob
  2. Combination: Combines similar outcomes
  3. Segregation: separation of risk-free and risky aspect of each outcome
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41
Q

Behavioral finance | Prospect theory: Evaluation phase

A
  1. assign weights and prob
    ◎ weights and prob are based on behavioral biases
    ◎ >>gains < losses, large prob < tail events
  2. calc expected utility
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42
Q

IPS | Situational profiling and risk tolerance

A
  1. source of wealth
    ◎ active (entrepreneurial) vs passive (steady accum & inherit)
  2. measure of wealth
    ◎ perceived wealth vs needs >> percieved risk tolerance
  3. stage of life
    ◎ foundation, accumulation, maintenance, distribution
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43
Q

IPS | Situational profiling: Source of wealth

A
  • Active: more risk tol, but possible business risk vs investment risk difference
  • Passive: less risk tol
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44
Q

IPS | Situational profiling: Stage of life

A
  1. Foundation (mod risk)
  2. Accumulation (highest risk)
  3. Maintenance [retirement] (low-mod risk)
  4. Distribution: old wealthy giving to others (low - high risk)
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45
Q

Traditional finance assumes investors have 3 traits

A
  1. risk aversion: min risk; risk is volatility
  2. rational expectations: unbiased view of the world
  3. asset integration: all investments are correlated
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46
Q

Traditional vs Behavioral investor traits

A
  1. risk aversion vs loss aversion
  2. rational expectations vs biased expectiations
  3. asset integration vs ass segregation
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47
Q

IPS | 4 Personality types

A
  1. cautious: low risk, indecisive, difficult
  2. methodical: conservative, lots of data
  3. confident, decisive
  4. spontaneous: high portfolio turnover, chase fads, doubt self and others
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48
Q

IPS | for exam, IPS = O&C (objectives & constraint section of IPS)

A

*only front of card*

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49
Q

IPS | IPS benefits to clients

A
  1. id’s and documents objectives/constraints
  2. dynamic in response to changes w/client or mkt
  3. easy to understand
  4. education about self and investing
  5. understand manager’s actions
  6. transferable across managers
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50
Q

IPS | IPS benefits to manager

A
  1. knowledge of client
  2. guidance for investment decisions
  3. resolution of disputes (signed documentation)
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51
Q

IPS | RRTTLLU breakdown by O&C

A
  • O: RR
  • C: TTLLU
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52
Q

IPS | arrving at RRTTLLU

A

TTLLU >> risk >> return

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53
Q

IPS | SAA must conform to IPS

A

*only front of card*

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54
Q

IPS | RRTTLLU abbrev for notes in test

A
  • return: rn
  • risk: rs
  • time horizon: tm
  • taxes: tx
  • liquidity: lq
  • legal: ll
  • unique: u
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55
Q

IPS | calcing returns with inflation

A

add inflation in initially so that you include the inflated numbers when calcing taxes

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56
Q

IPS | are residences included in investment calculations?

A

no

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57
Q

IPS | remember to watch for…

A
  • pre vs after tax
  • real vs nominal
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58
Q

IPS | Return objective: 2 categories

A

required vs desired return

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59
Q

IPS | Risk objective: 2 categories

A
  • ability (time horizon, wealth & outflow) vs willingness to take risk
  • always state conclusion
  • if they differ, pick conservative choice
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60
Q

IPS | assessing clients’ preferences

A

look at actions as well as statements

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61
Q

IPS | 4 Risk objective factors

A
  1. time horizon
  2. critical goals/expenditures
  3. liquidity needs
  4. portfolios proportion of overall wealth
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62
Q

IPS | Time horizon constraint assessment

A
  1. state:
    ◎ number of stages
    ◎ each stage objective
    ◎ # yrs in each stage
  2. other involved people (eg giving/receiving inheritance)
  3. multi-generational horizon
  4. retirement time horizon default: 20-25 yrs
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63
Q

IPS | 4 Tax constraint: tax types

A
  1. income
  2. capital gains
  3. wealth transfer
  4. personal property (eg car, house)
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64
Q

IPS | 4 Tax mitigation strategies

A
  1. Tax deferral (eg cap gain investment, loss harvesting, low turnover)
  2. Tax avoidance: tax free securities
  3. Tax reduction: investments with lower tax rates (eg cap gains vs income)
  4. Wealth transfer timing: (eg. no sales)
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65
Q

IPS | Complicated tax situation

A

state that tax situation is complex and manager should seek qualified tax advice

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66
Q

IPS | 5 Liquidity constraints

A
  1. ongoing, known expense (or in return jbj)
  2. emergnecy reserves (if requested)
  3. one-off, infrequent outflows (college falls under time horizon)
  4. one off positive inflows
  5. illiquid assets: restricted from sale, illiquid (eg house)(or in unique), large tax cost (or in unique or tax)
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67
Q

IPS | Legal: 2 common issues

A
  1. Trust: revocable vs irrevocable
  2. Family foundation
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68
Q

IPS | Legal: notes

A
  1. If no big legal issues state there are none beyond normal Code & Standards responsibilities
  2. manager must follow the trust document; weigh needs of different stakeholders
  3. mention other legal issues or lack of
  4. if complex issues, state manager will seek qualified expert advice
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69
Q

IPS | Unique constraints

A
  1. Special investment concerns (eg social)
  2. Special instructions (liquidate holdings)
  3. Restrictions on sales
  4. Forbidden asset / asset classes
  5. Assets outside of portfolio (eg. houses)
  6. Bequests
  7. Unattainable objectives
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70
Q

IPS | General notes

A
  • State what is there and what is NOT there
  • Complex issues, seek qualified expert
  • Re-state all the facts
  • point out conflicting factors
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71
Q

Strategic Asset Allocation (SAA)

A

is the mix of asset classes that will meet the IPS objectives and constraints

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72
Q

IPS & SAA | important return is pre or after tax?

A

after tax

73
Q

SAA process

A
  1. eliminate portfolios that violate stated or appropriate constraints
  2. assess return to risk ranking
    ◎ sharpe ratio
    ◎ most often you will never need to get to this stage bc/only one portfolio remains
74
Q

SAA portfolio elimination process

A
  1. excess/insufficient cash equivalents
  2. hold/fail to hold assets specified in constraints
  3. violates risk constraints
    4.generate insuffient return (after-tax)
    5.inappropriate asset classes or weightings (even if not specificed)
    ◎ 60 equity/40 bond&cash is default
    ◎ do not ignore home ownership >> too much real estate holdings
    • address concentration issues (eg. low-basis inheritance, former employer stock)
75
Q

exam note: don’t give extra answers - they will not be counted (eg 5 reasons vs 3 asked for)

A

blank

76
Q

IPS & SAA | monte carlo simulation pro/cons vs deterministic method

A

• Pros:
1. path dependency
2. better display of risk/return by providing multiple possible outcomes
3. better tax analysis
4. better display of short-term & long-term performance (eg more ST vol, but better LT return)
5. better analysis of multi-period effects
6. can look at different points in timeline (major decision/event points)
• Cons:
1. if simplistic model of returns is used
2. if generalized asset class returns are used rather than specific investments (w/costs)
3. if simplistic tax model is used

77
Q

Taxes | 3 types of taxes

A
  1. income
  2. wealth: assets and asset transfers
  3. consumption: sales & VAT
78
Q

Taxes | marginal tax rate

A

tax rate paid on the last dollar of income

79
Q

Taxes | how US taxes work in regards to different tax rates over a single income

A
  • every one pays same rate on 1st dollar
  • each dollar after is taxed on whichever tax rate basket that dollar falls into
  • for example: $20K income: first $8,350 is taxed at 10%, remaining is taxed at 15%
  • the overall rate (avg tax rate) is the weighted average of the different rates * the amount taxed at that rate
80
Q

Taxes | 2 most common tax regimes

A 
#1: common progressive (progressive, light on all investment) 
#2: LIght capital gains tax (progressive, light on cap gains)
81
Q

Taxes | accrual taxes

A

• paid periodically (eg annually)

82
Q

Taxes | FVIF - accrual tax

A

FVIF = [1 + R*(1 - T)]^N
R = pre-tax return
◎ or FVIF = (1 + Rart)^N
T = tax rate
N = number of investment periods
• = after-tax value of each dollar invested

83
Q

Taxes | accrual (annual) tax drag % is less/more than tax rate

A

more, due to effect on compounding

84
Q

Taxes | tax drag

A
  • gain lost to taxes
  • stated as a dollar value or %
85
Q

Taxes | FVIF - deferred tax

A 
FVIF = [(1 - T) \* (1 + R)^N + T\*B] 
R = investment return 
N = # periods 
T = tax rate 
B = % of original investment ALREADY taxed
86
Q

Taxes | Tax drag: deferred vs accrual

A
  • accrual $ and % > deferred
  • deferred is constant % of total gain (horizon and return do not affect it) and equal to tax rate
  • accrual $ and % grow with return and horizon
87
Q

Taxes | FVIF - wealth based

A 
FVIF = [(1 + R) \* (1 - T)]^N 
R = investment return 
N = # periods 
T = tax rate
88
Q

Taxes | wealth tax attributes

A
  • tax drag > tax rate
  • horizon increase >> greater $ and % tax drag
  • return increase >> greater $ lower % tax drag
89
Q

Taxes | accrual tax attributes

A
  • tax drag > tax rate
  • horizon or return increase >> greater $ and % tax drag
90
Q

Taxes | deferred tax attributes

A

constant % tax drag regardless of horizon or return
• tax drag % = tax rate

91
Q

Taxes | annual return after realized (cummulative) taxes sans deferred taxes

A

Rart = R(1 - Trealized) = R[1 - (PiTi + PdTd + PcgTcg)]
Pi, Pd, Pcg = % of gain attributed to interest, div, realized cap gains
Ti, Td, Tcg = tax rate on interest, div, realized cap gains

92
Q

Taxes | Tax loss harvesting

A
  • using investment loses ot offset investment gains
  • main gain reducing tax bill in near term and those saving can be invested
93
Q

Taxes | HIFO

A
  • Highest In (basis), First Out
  • allowed by some govts
  • Also LIFO if you believe taxes will rise
94
Q

Taxes | trading activity and taxes

A

usually the frequent trader falls under a higher tax rate, which leads to lower returns, especially over longer horizons and higher return rates

95
Q

Taxes | year end sales

A
  • if gain, wait until next year
  • if loss, sell this year to harvest the loss
96
Q

Taxes | Mean variance optimization

A

Optimizing portfolio allocation should be done on an after tax basis using equivalent after-tax returns and risk on an after tax basis

97
Q

Taxes | effective unrealized cap gains tax rate adjusting for annual taxes

A

Tecg = Tcg*[1 - (Pi + Pd + Pcg)] / [1 - (PiTi + PdTd + PcgTcg)]

98
Q

Taxes | FVIF - all taxes

A

FVIFt = (1 - Tecg) * (1 + Rart)^N + Tecg - (1-B)*Tcg
• Tecg = effective cap gains adj for annual taxes
• Rart = return after realized taxes

99
Q

Taxes | accrual equivalent (after tax) return

A

Rae = (ending balance after all taxes / beginning balance)^N
N = number of periods
• as horizon or amount deferred increases Rae approaches pre-tax return

100
Q

Taxes | accrual equivalent tax rate

A

Tae = 1 - (Rae / Rpre-tax)

101
Q

Taxes | tax deferred account (TDA)

A
  • pre-tax income
  • entire balance when withdrawn
  • FVIFtda = (1 + R)^N * (1 - Tfuture)
102
Q

Taxes | tax-exempt account (TEA)

A
  • not Tea (equivalent accrual tax rate)
  • after-tax income
  • no tax upon withdrawl
  • FVIFtea = (1 + R)^N * (1 - Tnow)
103
Q

Taxes | TDA vs TEA

A
  • if Tfuture < Tnow, then TDA is better
  • if Tfuture > Tnow, then TEA is better
  • if Tfuture = Tnow, then no difference
  • if $ amounts are restricted and equal then compare FV’s of each, but remember to include extra taxed $ for TDA
104
Q

Taxes | FVIF

A

Future Value Interest Factor

105
Q

Taxes | List of FVIF’s

A
  1. tax deferred acct
  2. tax exempt acct
  3. all taxes
  4. accrued annual tax
  5. wealth tax
  6. deferred cap gains
106
Q

Taxes | FVIF - deferred capital gains

A

FVIFcgt = (1 - Tcg)*(1 + R)^N + Tcg * B
• Tcg = cap gains tax rate
• B = cost basis PERCENT
• R = annual return

107
Q

Taxes | Taxes and investment risk (volatility)

A

after tax risk = stan dev * (1 - T)
• govt absorbs part of variability
• tax exempt accts (TDA & TEA): investor bears all risk

108
Q

Taxes | asset location

A

type of acct asset is located (eg tax advantaged acct)

109
Q

Taxes | tax alpha

A

value created by effective tax management

110
Q

Taxes | Taxes and trading behavior

A
  1. Traders: high turn-over, ST cap gains >> bad
  2. Active investors: med-turn-over, LT cap gains >> so-so
  3. Passive investors: LT cap gains over many years >> good
  4. Exempt investors: hold assets in tax-exempt accts
111
Q

Estate

A

Every thing a person owns
• financial
• real estate (aka immovable property)
• collections (eg art)
• businesses
• non-tangible (eg trademarks, patents

112
Q

Estate planning

A

Planning of transfer of person’s estate to other during lifetime or at death

113
Q

Will

A
  • aka testament
  • legal doc that states rights of others to person’s estate
114
Q

Probate

A

• Legal process that takes place at death
• court determines
◎ will validity
◎ decedent’s property inventory
◎ claims against decedent
◎ distributes property according to will

115
Q

Intestate

A

Dying without a valid will

116
Q

Avoiding probate

A

• There are ways to avoid probate
◎ joint ownership w rights of survivorship
◎ living trusts
◎ retirement plans
◎ life insurance

117
Q

Estate | gifts

A
  • aka lifetime gratuitous transfer or inter vivos transfer
  • given while living
  • subject to gift taxes; who pays is up to govt law
118
Q

Estate | wealth transfer methods

A
  1. gifts
  2. bequests
119
Q

Estate | bequests

A
  • testamentary gratuitous transfer
  • given after death
  • estate taxe (paid by grantor/transferor); inheritance tax (paid by recipient); who pays is up to govt law
  • taxes can vary based on relationship to decedent
120
Q

Roman law

A

civil law system based on old Roman law; top down system where laws are handed down from legislative body

121
Q

English law

A

common law system; bottom up; judges create precedents that are applied in future cases

122
Q

Estate | forced heirship

A
  • children or spouse have a right to a portion of parent’s estate
  • all assets are usually included
123
Q

Estate | community property rights

A
  • each spouse entitled to half of the estate earned during mariage
  • gift and inheritence can be held separately
  • part of forced heirship
124
Q

Estate | separate property rights

A
  • each spouse owns their property separately
  • common in civil law countries
125
Q

Human capital

A
  • aka net employment
  • PV of net employment income over lifetime
126
Q

Individual balance sheet

A
  • Assets: all tangible and intangible assets including human capital and any other future income
  • Liabilities: all current and future liabilities incurred by living life plus any required reserve fund (Core capital)
  • Equity is anything left over (Excess capital)
127
Q

Core capital

A

equals liabilities on Individual Balance Sheet
• sum product of expected annual spending x prob of living that long

128
Q

Excess capital

A

equals equity on Individual Balance Sheet

129
Q

Mortality table

A

death table (fun)
• combined prob: prob either one is alive next year
• real annual spending: living exp for coming year
• exp real spending: real annual spending * combined prob
• present value:PV of real annual spending
• total: PV of core capital required to meeting exp THROUGH the given year (row)
• 0 prob to live past 100 in table

130
Q

monte carlo simulation advantage

A

gives a distribution of outcomes vs just a mean

131
Q

longevity risk

A
  • risk of running out of money in retirement prior to death (ruin)
  • generally, retiree should spend
132
Q

Estate | giver and givee terms before and after death

A
  • before death: donor, recipient
  • after death: testator, beneficiary
133
Q

Estate | return and tax rate symbols

A
  • Rg, Tig = investment return and annual tax rate of recipient
  • Re, Tie = investment return and annual tax rate of giver
  • Te = estate tax rate paid by the estate
  • Tg = gift tax rate paid by either giver, receiver
134
Q

Estate | relative value of gift / bequest

A 
RV = FVgift / FVbequest 
◎ = (1 - Tg)\*(1 + Rg\*(1 - Tig))^N / (1 - Te)\*(1 + Re\*(1 - Tie))^N 
F = future vale
135
Q

Estate | relative value of gift when donor pays gift tax

A
  • add in + Tg*Te due to reduced estate taxes
  • RVg = (1 - Tg + Tg*Te)*(1 + Rg*(1 - Tig))^N / (1 - Te)*(1 + Re*(1 - Tie))^N
136
Q

Estate | relative value: generation skipping

A 
RV = 1 / 1 - T 
T = wealth transfer tax
137
Q

Estate | calcing generation skipping

A
  1. calc excess above core capital requirements for giver and next generation
  2. give excess to third generaiton
138
Q

Estate | spousal exemptions

A

some govts allow tax-free transfers between spouses

139
Q

Estate | Valuation discounts

A

discount value of estate assets, such as discounting value of family business

140
Q

Estate | Charitable gratuitous transfers

A

• tax deduction to giver, no taxes for recipient
• FVchar gift = (1 + Rg) + Toi * [1 + Re * (1 - Tie)]^N * (1 - Te)
Rg = return at charity
Toi = ordinary income tax rate of giver

141
Q

Estate | Relative value: charity gifts

A

• giving a gift to charity NOW vs giving gift to beneficiary in N years
• RVgift = FVchar gift / FVbequest
◎ = [(1 + Rg) + Toi * [1 + Re * (1 - Tie)]^N * (1 - Te)] / [1 + Re * (1 - Tie)]^N * (1 - Te)]

142
Q

Estate | Trust

A
  • grantor (settlor) transfers assets to beneficiaries outside of probate
  • ownership is fuzzy
  • ownership and tax obligations can be split (eg beneficiary owns, but settlor or trust owes taxes)
143
Q

Estate | revocable trust

A
  • settlor can revoke trust and resume ownership of assets
  • settlor is owner of assets for tax purposes
  • assets included in claims against the settlor
144
Q

Estate | irrevocable trust

A
  • settlor relinquishes ownership and control, trustee (not beneficiary) is the owner
  • protected from claims against the settlor; not protected if judged to be set up in anticipation of a claim
145
Q

Estate | fixed trust

A

distributions to beneficiary is predetermined by settlor

146
Q

Estate | discretionary trust

A

trustee determines how assets will be distributed to beneficiary (settlor can convery wishes)
• beneficiaries have no legal right to assets or income >> trust is protected from claims against beneficiaries

147
Q

Estate | spendthrift trust

A

beneficiary is unable to manage trust responsibly; settlor maintains some control

148
Q

Estate | trusts vs foundations in civil and common law countries

A

trusts more common in common law; foundations more common in civil law

149
Q

Estate | trusts: ownership vs taxes

A

some countries, settlor responsible for taxes, even when trust owns the assets

150
Q

Estate | life insurance

A
  • efficient transfer of wealth
  • often not taxed
  • sometimes tax-free accumulation of weath to policy holder
  • sometimes source of loans to policy holder
  • trusts can be beneficiaries
151
Q

Taxes | 2 types of jurisdiction

A
  1. source jurisdiction (aka territorial tax system): tax on assets/income generated in jurisdiction
  2. residence jurisdiction (majority of countries): tax on all resident’s assets/income, regardless of source
152
Q

Taxes | Exit taxes

A

• response to residents leaving to tax havens
• tax on gains
• deemed disposition: tax on assets as if they were liquidated
◎ shadow period: taxes on earnings even after the resident leaves

153
Q

Taxes | 3 types of overlapping tax jursidiction conflicts

A
  1. residence-residence
  2. source-source
  3. residence-source
154
Q

Taxes | resolutions for tax jurisdiction conflicts

A
  1. res-res: OECD tie-breaker
  2. source-source: none
  3. res-source:
    ◎ credit: full resolution
    ◎ exemption (lowest tax rate): full resolution
    ◎ deduction (highest tax rate)
    • on exam: rem to calc tax on non-disputed income
155
Q

Taxes | Tax jurisdiction resolution residence vs source

A

• credit: full resolution; res pays source and deducts that from res tax bill (ie pays higher of two tax rates)
• exemption (lowest tax rate): full resolution; res pays source, no res tax (even if higher rate)
• deduction: worst for res; res can deduct from INCOME taxes paid to source
◎ T = Tres - Tsrc * (1 - Tres)
• on exam: rem to calc tax on non-disputed income

156
Q

Taxes | tax avoidance vs tax evasion

A

tax avoidance is legal; tax evasion is illegal

157
Q

Cost basis

A

Reference (starting) point for calculating capital gains on assets

158
Q

Low basis, concentrated stock positions: 3 types of personalities

A
  1. entrepreneurs
  2. Executive
  3. Investor (less attached)
    • psychological issues selling stock for all three; tied to control of firm
159
Q

Specific risk

A

• aka unsystemic risk
• risk associated with the individual security
• companions to this are market risk (systemic) and residual risk (trading strategy: counter party and regulatory)
◎ broker may screw up; irs may dispute valuation

160
Q

3 components of total portfolio risk

A
  1. specific
  2. systemic
  3. residual
161
Q

3 psychological investor stages of owning concentrated stock position

A
  1. entrepreneurial
  2. executive
  3. investor (still attached to stock)
  4. investor indexing; unattached to stock)
162
Q

4 ways to deal with concentrated security position

A
  1. sale: simple, max flexibility, complete, but realize gains
  2. public and private exchnage funds: better collateral, but 7 yr lock up and management fees
  3. completion portfolio: build diversified portfolio over time, but can take a while
  4. heding: fast, but danger of ‘constructive sale’
163
Q

Taxes | constructive sale

A
  • IRS term to indicate a hedging strategy is effectively a sale and that gains must be realized
  • exps: a collar without any risk, a forward without any risk
  • risk must be > 15% of the asset price
164
Q

pre-paid forward

A

same as a forward, but payment for the asset is made up-front

165
Q

asset management | human capital

A

PV of future earnings
• social security and pensions are included

166
Q

asset management | financial capital

A

current market value of portfolio

167
Q

asset management | total wealth

A

human capital + financial capital

168
Q

asset management | human capital and earnings risk

A
  • risk earnings could stop due to health or economics (job loss)
  • minimized by higher savings, picking uncorrelated financial capital investments
169
Q

asset management | longevity risk

A
  • risk of out living financial capital (ruin)
  • hedged with life time payout annuities
170
Q

asset management | annuities & life insurance

A

good things to have in portfolio

171
Q

assest management | individual utility function

A

untility (U) = exp(hc + fc)^(1 - d) / (1 - d)
hc + fc = human + financial capital
d = risk aversion score

172
Q

asset management | including human capital into the portfolio

A
  • use capital mkt theory (CML)
  • if income is corr to equity mkt and volatile treat as an equity asset and overweight financial cap in low risk assets (eg bonds), otherwise treat as fixed income asset and do opposite
173
Q

asset management | utility function with life insurance

A

max E[(1 - Pdeath,t)*(1 - D)*(Ualive)*(FCt+1 + HCt+1)] + (Pdeath,t)*(D)*(Udead)(FCt+1 + LIPO)
Pdeath,t = subjective prob of dying before t+1
D = scale 0 to 1 of desire to leave bequest; 1 is strong
U = utility from total wealth (if alive or if dead)
LIPO = life insurance payout

174
Q

asset management | utility function with life insurance take-aways

A
  • asset allocation and life insurance holdings should be solved for jointly
  • if HC is risky (higher discount rate) or small, this reduces the amount of life insurance needed to replace it
  • individual’s subjective belief of Pdeath
  • If FC is large, then it should begin to mirror HC risk as HC decreases to balance risk in portfolio (???)
175
Q

asset management | spending uncertianty risk

A

inability to predict spending per year and number of years

176
Q

asset management | annuities

A
  • contract paid for upfront (sometimes over time)
  • pays out over life of beneficiary
  • removes longevity risk
  • 2 types: fixed, variable (combo is good in retirement)
177
Q

asset management | 2 types of annuities

A
  1. fixed: constant nominal payment (eg $3,000/mo)
    ◎ inflation risk
  2. variable: constant variable payment tied to underlying asset (eg market index, interest rate)
    ◎ exp. pays 6% of mkt val of initial principal
    ◎ reduces inflation risk
178
Q

asset management | mortality risk

A

sudden death and follow on effects
• hedge is life insurance

179
Q

asset management | 3 risks to maintaining lifestyle or bequests

A
  1. mkt risk
  2. longevity risk
  3. savings risk (aka spending uncertainty)

CFA (11 decks)

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