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CFA Level 3 > Private Wealth Management > Flashcards

Private Wealth Management Flashcards

1
Q

Stages of life for an investor

A
  • Foundation
  • Accumulation
  • Maintenance
  • Distribution
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2
Q

Asset segregation

A

The evaluation of investment choices individually, rather than in aggregate

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3
Q

Prospect theory on loss aversion

A

It appears to be human nature to prefer an uncertain loss to a certain loss but to prefer a certain gain to an uncertain gain

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4
Q

Portfolio construction according to behavioral models

A
  • Asset pricing reflects both economic considerations, such as production costs and prices of substitutes, and subjective individual considerations, such as tastes and fears
  • Portfolios are constructed as “pyramids” of assets, layer by layer, in which each layer reflects certain goals and constraints
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5
Q

Investor types

A
  • Cautious
  • Methodical
  • Spontaneous
  • Individualist
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6
Q

Investment policy requirements

A
  • Overview
  • Return objective
  • Risk tolerance (willingness and ability)
  • Economic and operational constraints of the portfolio
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7
Q

Economic and operational constraints of the portfolio

A
  • Liquidity
  • Time horizon
  • Taxes
  • Legal and regulatory environment
  • Unique circumstances
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8
Q

Liquidity constraints

A
  • Transaction costs
  • Price volatility
  • Liquidity requirements
    • Ongoing expenses
    • Emerging reserves
    • Negative liquidity events
  • Illiquid holdings
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9
Q

Capital gain tax formula

A

= price appreciation * tax rate * turnover rate

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10
Q

Marginal tax rate

A

The rate on the next $ of income

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11
Q

Future Value Interest Factor (FVIF)

A
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12
Q

Future Value Interest Factor for deferred taxes (FVIFcg)

A
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13
Q

Future Value Interest Factor for deferred taxes and cost basis (FVIFcgb)

A
  • B represent the cost as a proportion of the current price
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14
Q

Future Value Interest Factor for wealth (FVIFw)

A
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15
Q

Annual return after realized taxes

A
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16
Q

Effective capital gain tax rate

A
  • pi = proportion of interest income
  • pd = proportion of dividends
  • ptc = proportion of capital gain
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17
Q

Future Value Interest Factor for after-tax accumulation (FVIFtaxable)

A
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18
Q

Accrual equivalent return (RAE) relation to the accrual equivalent tax (TAE)

A
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19
Q

After-tax volatility

A

(1 - ti) of the pretax volatility

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20
Q

Probate

A

The legal process to confirm the validity of a will

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21
Q

Intestate (to die intestate)

A

A decedent without a valid will or with a will that does not dispose of their property

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22
Q

Civil law

A
  • Is derived from Roman law and is the world’s predominant legal system
  • In civil law states, judges apply general, abstract rules or concepts to particular cases
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23
Q

Common law

A
  • Usually trace their heritage to Britain
  • In common law states, judges draw abstract rules from specific cases
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24
Q
  • Community property regimes
  • Separate property regimes
A
  • Each spouse has an indivisible one-half interest in income earned during marriage
  • Each spouse is able to own and control property as an individual
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25
Q

Community property and forced heirship allocation

A
  • The spouse has the right to the greater of the community property or forced heirship
  • Each child has the right to the total forced heirship amount divided by the number of children
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26
Q

Forced heirship

A

Under forced heirship rules, children have the right to a fixed share of a parent’s estate

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27
Q

FV value using the average geometric return

A
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28
Q

Volatility of the geometric return

A
  • r is the arithmetic return
  • σ is the volatility of the arithmetic return
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29
Q

Relative after-tax value of a tax-free gift

A
  • Te is the estate tax
  • tig and tie are the effective tax rates on investment returns on both the gift recipient and the estate making the gift
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30
Q

Relative after-tax value of a taxable gift

A
  • Te is the estate tax
  • Tg is the gift tax
  • tig and tie are the effective tax rates on investment returns on both the gift recipient and the estate making the gift
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31
Q

Relative after-tax value of a taxable gift when the taxes are paid by the donor

A
  • g/e = percentage of giver’s wealth being gifted
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32
Q

Deemed dispositions

A

The deemed disposition triggers the realization of any previously unrecognized capital gains and liability for associated capital gains tax as if the property were sold

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33
Q

Relative after-tax value over n years of a charitable gift

A
  • Toi is the tax on ordinary income
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34
Q

Relative value of skipping generations to transfer capital

A
  • = 1 / (1 − T1) where T1 is the tax rate of capital transferred from the first to the second
  • In at least one jurisdiction (e.g., the United States), the taxing authorities discourage this strategy by imposing a special generation skipping transfer tax
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35
Q
  • Trust
  • Foundation
A
  • Common law concept
  • Civil law concept
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36
Q

Trust basics

A
  • Is created by the settlor (or grantor)
  • Assets are being transferred to a trustee
  • Assets are being managed for the beneficiaries
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37
Q
  • Revocable trust
  • Irrevocable trust
  • Fixed trust
  • Discretionary trust
A
  • The settlor retains the right to rescind the trust relationship and regain title to the trust assets and is generally considered to be the owner of the assets for tax purposes
  • The trustee may be responsible for tax payments and reporting in his or her capacity as owner of the trust assets for tax purposes
  • The terms of the distributions are pre-determined in the trust documents
  • The terms of the distributions are at the discretion of the trustee
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38
Q

Controlled foreign corporation (CFC)

A

A company located outside a taxpayer’s home country and in which the taxpayer has a controlling interest as defined under the home country law

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39
Q

Deemed distribution

A

When shareholders of a CFC company are taxed on the company’s earnings as if the earnings were distributed to shareholders even though no distribution has been made

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40
Q
  • Source jurisdiction (territorial tax system)
  • Residence jurisdiction
A
  • A country that taxes income as a source within its borders
  • A country that taxes income based on residency
41
Q

Residence-source conflict relief methods

  • Credit method
  • Exemption method
  • Deduction method
A
  • TCreditMethod = Max [TResidence , TSource]
  • TExemptionMethod = TSource
  • TDeductionMethod = TResidence + TSource (1 - TResidence) = TResidence + TSource - TResidenceTSource
42
Q
  • Tax avoidance
  • Tax evasion
A
  • Developing strategies that conform to both the spirit and the letter of the tax codes of jurisdictions with taxing authority
  • Circumventing tax obligations by illegal means such as misreporting or not reporting relevant information to tax authorities
43
Q

Monetize

A

To monetize something is to access its cash value without transferring ownership of it, as would be the case in a sale

44
Q

Margin lending rules

  • Rule-based
  • Risk-based (portfolio margining)
A
  • Depends on strict rules dealing with the use of the loan
  • Depends on the risk associated with the loan
45
Q

Prepaid variable forward

A

Collar and loan combined within a single instrument

46
Q

Risk buckets of the goal-based approach

A
  • Primary capital
    • Personal risk
    • Market risk
  • Surplus capital
    • Aspirational risk
47
Q

Goal-based approach allocation

A
  • Personal risk → Home, treasury bills and other “safe havens” investments
  • Market risk → Stocks and bonds
  • Aspirational risk → Concentrated positions, investment real estates, stock options and the like
48
Q

Main advantage of a goal-based approach

A

The advantage to the client is to see how high priority goals are less likely to be endangered by market declines and, thus, help the client stick with the investment plan during stressful market periods

49
Q
  • Primary capital
  • Surplus capital
A
  • Assets held outside a concentrated position that are at least sufficient to provide for the owner’s lifetime spending needs (personal and market risk bucket)
  • Capital that is in excess of primary capital
50
Q

Estate tax freeze

A

A plan usually involving a corporation, partnership, or limited liability company with the goal to transfer future appreciation to the next generation at little or no gift or estate tax cost

51
Q

The three primary strategies that investors use in the case of a concentrated position in a common stock

A
  • Equity monetization
  • Hedging
  • Yield enhancement
52
Q

Equity monetization techniques

A
  • Short sale against the box
  • Total return equity swap
  • Forward conversion with options
  • Equity forward sale contract
53
Q

Hedging techniques

A
  • Purchase of puts
  • Cashless (zero-premium) collars
  • Prepaid variable forwards
54
Q

Knock-out options

A

The protection disappears before its stated expiration if the stock price reaches a certain level

55
Q

Cashless collar

A
  • Long put
  • Short call
  • The premium paid on the put is offset by the premium received on the call
56
Q

Prepaid variable forward

A

A collar and loan combined within a single instrument

57
Q

Mismatch in character

A

The potential tax inefficiency that can result if the instrument being hedged, and the tool that is being used to hedge it, produce income and loss of a different character

58
Q

Cross hedge

A

A hedge involving a hedging instrument that is imperfectly correlated with the asset being hedged; an example is hedging a bond investment with futures on a non-identical bond

59
Q
  • Strategic buyers
  • Financial buyers
A
  • A buyer that will benefit from synergies
  • A buyer focused on investment management
60
Q

Leveraged recapitalization

A

A leveraging of a company’s balance sheet, usually accomplished by working with a private equity firm

61
Q

Stepped-up basis

A

Upon death of the grantor, the shares received by the estate or beneficiaries would receive a tax cost basis equal to the fair market value on the date of the grantor’s death

62
Q

Donor-advised fund

A

A fund administered by a tax-exempt entity in which the donor advises on where to grant the money that he or she has donated

63
Q

Sale and leaseback

A

A transaction wherein the owner of a property sells that property and then immediately leases it back from the buyer at a rate and term acceptable to the new owner and on financial terms consistent with the marketplace

64
Q

Human capital definition

A

The net present value of an investor’s future expected labor income weighted by the probability of surviving to each future age

65
Q

Financial capital definition

A

The tangible and intangible assets (outside of human capital) owned by an individual or household

66
Q

Human capital formula (HC)

A
  • wt is the wage in year t
67
Q

Human capital formula (HC) including wage growth and mortality probability

A
  • y is the risk adjustment based on occupational income volatility
  • p(st) is the probability of surviving to a given year (or age)
68
Q

Financial capital assets

A
  • Personnal assets
  • Investment assets
  • Publicly traded marketable assets
  • Non-publicly traded marketable assets
    • Real estate
    • Annuities
    • Cash-value life insurance
    • Business assets
    • Collectibles
  • Non-marketable assets
    • Employer pensions
    • Government pensions
69
Q

Mortality-weighted net present value of defined benefit pension plans

70
Q

Financial stages of life

A
  • Education phase
  • Early career
  • Career development
  • Peak accumulation
  • Pre-retirement
  • Early retirement
  • Late retirement
71
Q

Individual risk exposures

A
  • Earning risk
  • Premature death risk
  • Longevity risk
  • Property risk
  • Liability risk
  • Health risk
72
Q

Types of life insurance

A
  • Temporary
    • Term
  • Permanent
    • Whole
    • Universal
73
Q

Life insurance pricing elements

A
  • Mortality expectations
  • Discount rate
  • Loading
74
Q

Deductibles

A

The amount of a loss that must be absorbed by the policy owner before the insurance company will make any payment

75
Q

Automobile insurance coverage

A
  • Collision coverage
  • Comprehensive coverage (other sources)
76
Q

Umbrella insurance

A

Refers to liability insurance that is in excess of specified other policies and also potentially primary insurance for losses not covered by the other policies

77
Q

Classification of annuities

A
  • Immediate versus deferred
  • Fixed versus variable
78
Q

Single Premium Immediate Annuities (SPIAs)

A

The individual permanently exchanges a lump sum for a contract that promises to pay the annuitant an income for life

79
Q

An insurance rider

A

An add-on provision to a basic insurance policy that provides additional benefits to the policyholder at an additional cost.

80
Q

Advanced Life Deferred Annuities (ALDA )

A

Involves the permanent exchange of a lump sum for an insurance contract that promises to pay an income

81
Q

Risk management techniques

A
  • Risk avoidance
  • Risk transfer
  • Risk retention
  • Loss prevention
  • Loss reduction
82
Q

Yield Enhancement

A

Investors can enhance the yield of a concentrated stock position while decreasing its volatility by writing covered calls against some or all of the shares

83
Q

The joint probability that either the husband or the wife survives

84
Q

The present value of spending needs given the probability of survival (also called the capitalized valued of core capital spending needs)

A
  • r is the risk-free rate
85
Q
  • Core capital
  • Excess capital
A
  • The amount of capital required to fund spending to maintain a given lifestyle
  • The amount of capital in excess of core capital
86
Q

Monte Carlo Simulation (MCS) benefits over mortality tables

A
  • MCS focuses the client and manager on the most important risk, outliving the assets, instead of short term volatility
  • MCS can visually display for the client the prospects of outliving the assets
  • MCS can incorporate path dependency issues such as how changes in inflation affect both distributions and market value
  • MCS can incorporate taxes and other factors in addition to return
87
Q

Typical Objectives in Dealing with Concentrated Positions

A
  • Reduce the risk of wealth concentration
  • Generate liquidity in order to diversify and satisfy spending needs
  • Optimize tax efficiency
88
Q

Key non-tax considerations for concentrated positions strategies

A
  • Counterparty Credit Risk
  • Ability to Close Out Transaction Prior to Stated Expiration
  • Price Discovery
  • Transparency of Fees
  • Flexibility of Terms
  • Minimum Size Constraints
89
Q

Yield enhancement techniques

A
  • Writing covered calls
90
Q

US types of medical insurance

A
  • Indemnity plan
  • Preferred provider organization (PPO)
  • Health maintenance organization (HMO)
91
Q

The 2 most popular life insurance cost index calculation method

A
  • Net payment cost index calculation
  • Surrender cost index calculation
92
Q

Cost index calculation method (steps)

A
  1. Find the total insurance cost:
    1. Compute the FV of premiums (beginning of period)
    2. Substract the FV of dividends (end of period)
    3. Substract the projected cash value at the end of the policy (surrender method only)
  2. Find the annuity payment require for the total insurance cost (beginning of period)
  3. Divide by the number of thousand dollars of face value
93
Q

Net wealth

A

Net worth from the traditional balance sheet + (Present value of future earnings + Present value of unvested pension benefits) – (Present value of consumption goals + Present value of bequests)

94
Q

Advanced life deferred annuity (ALDA)

A

A deferred annuity with payments starting late in life in order to protect against longevity risk

95
Q
  • Needs analysis
  • Human life value analysis
A
  • Needs analysis estimates the present value of future consumption that would need to be replaced if the income of a primary earner were lost
  • Human life value analysis seeks to replace the loss in human capital
96
Q

Recourse versus non-recourse mortgages

A
  • With recourse mortgages, the lender has the right to recover any amount due on the loan from the borrower
  • With non-recourse mortgages, the lender’s collateral is limited to the property being mortgaged
97
Q

Suitability assessment

A

Is more complex for private client investors than for institutional investors because of emotional considerations and the possibility of shifting time horizons should an investment not perform

98
Q

Flat heavy tax regimes exemptions

A

Flat heavy tax regimes often include exemptions of some types of bond interest

99
Q

Net wealth versus net worth

A
  • Net wealth is for the economic (holistic) balance sheet
  • Net worth is for the traditionnal balance sheet

CFA Level 3 (19 decks)

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