Chapter 7 Flashcards
What is your primary role as a wealth advisor?
To minimize the risk that your clients will lose money
Wealth management begins with
risk management
Defined as the sum total of a worker’s knowledge, skills, and experience in terms of their economic value. In financial terms, it is considered to be the present value of the money a person will earn in the future.
Human Capital
In creating a personal risk management plan for clients and their families, you should consider five major concepts:
- How should we think about risk in the context of strategic wealth management? (How your clients view risk, and how it differs from your view as a professional)
- How do we measure risk?
- What is at risk within the client’s net worth?
- How does the family life cycle affect risk management and wealth management?
- What is the process for managing risk, however it is defined?
What does it mean to take a holistic approach to risk and wealth management?
It means managing risks and wealth as a whole.
Integrated wealth management requires that you
consider all of the client’s assets and liabilities and create an integrated plan to mitigate risk.
What to attributes must goals have?
A set monetary amount
A specific time frame
Describe pure vs. speculative risk
pure risk is one in which there is a possibility of either loss or no loss. For example, premature death and a house fire are both pure risks.
Speculative risk has the possibility of either a loss or a gain. For example, equity investments carries speculative risk
Describe Objective versus subjective risk
An objective risk is one that most people (especially experts) agree is a risk.
A subjective risk may be perceived as a risk by one person (especially a non-expert) but not by another.
This statistical measure of risk is standard deviation and was pioneered by who?
Harry Markowitz
Measures the fluctuation around a central tendency; the greater the fluctuation, the riskier the asset.
Standard Deviation
What is the fundamental weakness of standard deviation as a risk measure?
It assigns equal importance to the probability that a result will be higher than the mean and the probability that a result will be lower than the mean. However, the chance of getting a better result than expected is not considered a risk; only the downside is a concern.
In many processes, random variation adheres to a certain probability distribution known as normal distribution.
This distribution is commonly referred to as the….
bell curve
In a lognormal distribution, one cannot lose more than _____%
In a normal distribution, one can lose….
100%
an infinite amount in both directions
This type of risk can be diversified away
unsystematic risk also know as non-market risk or business risk
This type of risk cannot be diversified away
Systematic risk (Market risk)
This risk of not meeting a specified target is called…
That target could be a rate of return, a lump sum by retirement date, or a periodic payment such as monthly retirement income.
Shortfall risk
This concept of risk is used by insurers
Pure Risk
This risk of loss with no upside possibility, such as a housefire
Pure Risk
What are examples of objective risks?
Standard deviation
Shortfall risk
Pure risk
Derives from human capital in the form of deferred wages
Pension Plans
The main risk underlying a family home is the…
For that reason, advisors recommend that homeowners obtain life insurance at least matching the amount of the
Amount of debt outstanding against it
Mortgage
________ risks can be statistically measured
Objective risk
This refers to something that could be perceived as a risk by one person but not another person.
Subjective
The life cycle could be said to have five approximate stages:
- Early earning years
- Family commitment years
- Mature earning years
- Nearing retirement
- Retirement
The 5 steps of the personal risk management process:
- Identify risk.
- Evaluate risk.
- Control risk.
- Cover and insure risk.
- Monitor and revise the risk management plan.
This is another term for unsystematic risk
Non-market risk, specific risk, business risk, diversifiable risk
Concept pioneered by Harry Markowitz where he used the properties of means and standard deviations of investments that are positively, but not perfectly, correlated to derive an optimal set of portfolios.
efficient frontier
This is a type of risk in which there is a possibility of either a loss or a gain.
Speculative Risk
It is a tool used to estimate failure probabilities of investments. It randomly generates values for uncertain variables repeatedly to mimic a model.
Monte Carlo simulation
The global economy contains an irreducible amount of risk. No amount of diversification can reduce the risk in an investment portfolio below this level.
Systematic Risk
These returns move in patterns over time. For example, bond returns have a predictable pattern largely related to inflation, which changes more slowly and less erratically over time than equity returns.
Serially correlated returns
Financial goals must have two attributes:
A monetary amount and a date
What is the first issue advisors should identify in the first step of the risk management process?
Risks associated with the client’s assets
