Low Basis Stock Flashcards
"a explain the psychological considerations, investment risk, and tax issues related to concentrated holdings of low-basis stock; b discuss how exposure to stock-specific risk is expected to change over the entrepreneurial, executive, and investor stages of an individual’s “equity holding life;” c explain individual investors’ attitudes toward holding their own company stock during the entrepreneurial, executive, and investor stages; d critique the effectiveness of outright sales, exchange fu
Psychological consideration
- Attachments
Investment Risk
Risk and return issues
Am I being rewarded? Is there any other investment capable of providing the kind of returns expected from this one?
tax issues
“How much will I need to pay just to sell some, or all, of this holding? How sure am I of getting the benefits that I hope to get, in exchange for the certainty associated with the initial tax-based transaction cost?”
Stock specific risk exposure
It changes over the following
1. Entrepreneurial stage
2. Executive Stage
3. Investor Stage
Entrepreneurial Stage
Specific Risk is high
Company: Immature
New ideas developed and growing business eventually taken public
Executive stage
Specific Risk: Still high but lower than Stage 1
Company: More matured
Equity holding still not diversified
Indivdiual who is in the management of the firm and whose compensation incorporates stocks of the company
Investor stage
Multi company portfolio
shift from growing wealth to protecting wealth
Two variants:
Diversified investor: “multistock portfolio that can be concentrated, actively managed or highly diversified through a core strategy”
(Institute 310)
Indexing stage: “the investor aims to replicate the risk of the relevant index and thus holds a portfolio that has virtually eliminated specific risk.”
Applying the above model (3 stages) to individual circumstances
Entrepreneurial stage:
No diversification. They want to grow. They would want to structure it in a way as to expand the business
Executive Stage:
Extent of diversification depends on the control he or she has over the fortune of the company.
Investor Stage:
Requires them to think that there are no longer in the executive or entrepreneurial stage and its just a financial holding.
Reducing a concentrated exposure
-Outright sale
- Exchange funds
- Completion portfolios
- Hedging strategies
Outright sale
- Simplest, most expensive
- Outright sale of security for cash
- No more risk associated with it.
- Lesser money left to invest
Exchange Funds
- Advisor brings all the investors with concentrated postion together and creates a pool
Types:
Public Exchange Funds
Private Exchange Funds
Completion portfolios
Create a portfolio that behaves like a desired index or basket by combining the low basis stock with some or all of other liquid assets
Types:
Single Asset Class portfolios
Multiple Asset class portfolios
Drawbacks:
- investors who do not have a pool of other financial assets
- diversification process takes time
Hedging strategies
Two steps
- risk in low basis stock is diversified
- borrows money against the portfolio and proceeds reinvested
Types
Equity collars
Monetization of position
