Private Wealth Management

Question 1

Traditional Finance

Answer 1

how individuals should behave; efficient markets; utility theory with diminishing marginal returns (convex indiff curves)

REM - risk averse, rational expectations, asset integration

Question 2

Behavioral Finance

Answer 2

how individuals actually behave and make decisions to realize lifestyle-based objectives - need to consider loss aversion, biased expectations, asset segregation

• micro = decisions of individuals
• macro = why markets deviate from TF expectations

Question 3

Source of Wealth

Answer 3

Active: created through entrepreneurial activity; more willing to take risk

Passive: created through inheritance, windfall, saving; less willing to take risk

Question 4

Measure of Wealth

Answer 4

how much wealth client preceives themself to have

positive correlation between preception of wealth an willingness to take investment risk

Question 5

Stage of Life

Answer 5

• Foundation: generating wealth, long time horizon, risk: higher willingness, lower ability
• Accumulation: accumulated some wealth, long time horizon, higher risk, risk: higher willingness, higher ability
• Maintenance: retirement, lower risk, shorter time horizon
• Distribution: assets > level of need, risk depends on goals

Question 6

Personality Types

Answer 6

1. Cautious investor: risk averse, decisions based on feelings
2. Methodical investor: risk averse, decisions based on facts
3. Individualistic investor: less risk averse, decisions base on facts
4. Spontaneous investor: less risk averse, decisions based on feelings

Question 7

Client Benefits of IPS

Answer 7

1. identify objectives and constraints
2. dynamic (can change)
3. easily understood, transferable
4. educational about themself/ investment process

Question 8

Manager Benefits of IPS

Answer 8

1. know client
2. guidance for decisions
3. guidance for resolving disputes

Question 9

IPS Objectives

Answer 9

1. return
2. risk

Question 10

IPS Constraints

Answer 10

1. time horizon
2. taxes
3. liquidity
4. legal
5. unique

Question 11

Ability to Take Risk

Answer 11

ability to sustain loss without putting goals at risk

1. time horizon
2. goal size in relation to portfolio size
3. liquidity needs
4. goals that cannot be deferred
5. ability to replace losses in value (portfolio = sole income)

Question 12

Willingness to Take Risk

Answer 12

psychological profile

Question 13

Return Objective

Answer 13

1. list objectives
2. determine asset base
3. determine distribution
4. calc [real] return (distribution/ base)
5. calc nominal return (real + inflation)

Question 14

Process of Elimination

Answer 14

eliminate asset allocation models that

1. violate constraints
2. violate risk objective
3. fail to diversify
4. don’t maximize return to risk (efficency, sharpe ratio)

Question 15

Deterministic Approach

Answer 15

traditional approach

linear return analysis; single req return, not representative of actual volatility, no insight into risk

Question 16

Monte Carlo Simulation

Answer 16

calc req return, each variable given prob distribution, thousands of simulations

PROS: considers path dependency, risk/ return trade offs, tax analysis, SR vs LR risk, multiple periods

CONS: GIGO

Question 17

Tax Drag

Answer 17

money lost to taxes

tax drag_$ = gain_PT - gain_AT

gain = FV - BV

tax drag_% = TD_$/ gain_PT

Question 18

R_AE

Answer 18

accrual equivalent return; hypothetical tax rate if taxed every period

• R_AE = (FV_AT / PV)^1/n - 1
• R_AE = r * ( 1 - T_AE )

** might not be on exam

Question 19

Tax Regimes

Answer 19

• Progress: favorable for int, div, cap gains
• Heavy: favorable for int
• Light: favorable for div, cap gains

Question 20

Accrual Taxation

Answer 20

taxes paid periodically

FV_AT = PV [1 + r * ( 1 - t )]ⁿ

TD_% > t

TD positively correlated with n and r

Question 21

Capital Gains Taxation

Answer 21

tax on gains from sale

capital gain = sale proceeds - tax basis

FV_AT = PV [( 1 + r )ⁿ ( 1 - t_cg ) + t_cg*B]

B = tax basis/ MV

• B < 1, unrealized gain, TD_% > t
• B > 1, unrealized loss, TD_% < t

Question 22

Wealth Taxation

Answer 22

periodic tax on total value (property tax)

FV_AT = PV [(1 + r) * (1 - t_w)]ⁿ

• inc n = inc TD_$, inc TD_%
• inc r = inc TD_$, dec TD_%

Question 23

Blended Taxation

Answer 23

over/ understates after tax return b/c unrealized gain/ loss

weighted avg realized tax rate (wartr) = p_it_i +p_dt_d + p_cgt_cg

deferred cg tax rate (T*) = t_cg [p_{deferred cg} / (1 - wartr)]

FV_AT = PV [(1 + r*)ⁿ ( 1 - T* ) + T* - ( 1 - B )t_cg ]

Question 24

TDA

Answer 24

tax deferred account; contributions are pre-tax, tax on withdrawals (best for CBs)

FV_AT = PV ( 1 + r )ⁿ ( 1 - t_n )

Question 25

TEA

Answer 25

tax exempt account; contributions are taxed, no tax on withdrawals FV_AT = PV_AT ( 1 + r )ⁿ

Question 26

TEA vs TDA

Answer 26

t₀ \< t_n : prefer TEA t₀ \> t_n : prefer TDA t₀ = t_n : indifferent between TEA an TDA *contribution limits*: TEA better b/c tax adv on more savings (if cont limits are *equal*)

Question 27

Adjusting for Unrealized Gain/ Loss

Answer 27

1. asset sold today: +/- = MV - value of cg tax 2. asset sold in future: +/- = MV - value of cg tax discounted by AT r_asset 3. asset sold in future: +/- = MV - value of cg tax discounted by AT r_f

Question 28

After Tax Risk and Return

Answer 28

σ_AT = σ_PT ( 1 - t ) r_AT = r_PT ( 1 - t ) corr_AT = corr_PT

Question 29

Tax Alpha

Answer 29

value created by tax management * TDA for heavily taxed items (bonds) * TEA for lightly taxed items (equity) GOALS: dec tax drag, dec T_EA, trade less often, utilize TEA and TDA

Question 30

Trading Behavior

Answer 30

1. Trader: frequent trading, no deferred gains, low alpha 2. Active Investor: less trading, some deferred gains 3. Passive Investor: buy/hold, most gains deferred, high alpha 4. Exempt Investor: no taxes

Question 31

HIFO

Answer 31

highest in/ first out designate highest tax lots to each sale minimize gain, maximize loss

Question 32

LIFO

Answer 32

lowest in/ first out designate highest tax lots to each sale *when you expect higher taxes in future*

Question 33

Holding Period Management

Answer 33

usually tax advanatage to holding inv b/c t_LT \< t_ST t_LT = t_ST, still better to hold b/c pretax compounding return year end: realize loss, defer gain = dec current taxes

Question 34

Mean - Variance Optimization

Answer 34

* max after-tax return to after-tax risk * optimize asset location * structure allocations to pref tax locations

Question 35

Probate

Answer 35

legal process, courts determine validity of will, inventories, and resolves disputes AVOID WITH: joint ownership w/ survivorship, trust, retirement plans, life insurance

Question 36

Wealth Transfer Taxes

Answer 36

1. gift - gift tax 2. bequest/ testamentary gratuitous transfers * estate tax: paid by transferor * inheritance tax: paid by recipient

Question 37

Limitations on Distribution of Assest

Answer 37

* forced heirship: min share to children (+ others) * community property rights: min share to surviving spouse * separate property rights: spouse may own/ dispose of property indenpendently * clawback provisions: force recipients to return gifts if they violate other rights

Question 38

Estate Planning

Answer 38

objectives 1. minimize taxes 2. transfer assets to heirs and others

Question 39

Individual's Balance Sheet

Answer 39

* A: human capital, net employment capital \> assets + PV future net income * L: PV all current and future costs * E: excess capital

Question 40

Probability of Ruin

Answer 40

prob of portfolio = 0 based on different start dates and distribution percentages

Question 41

RV_{tax free gift}

Answer 41

RV \> 1 = gift RV \< 1 = bequest after death

Question 42

RV_{taxable gift} | (paid by receiver)

Answer 42

RV \> 1 = gift RV \< 1 = bequest after death

Question 43

RVtaxable gift | (paid by giver)

Answer 43

RV \> 1 = gift RV \< 1 = bequest after death

Question 44

RV_{tax exempt charity}

Answer 44

RV \> 1 = gift RV \< 1 = bequest after death T_io = tax rate on ordinary income

Question 45

Relief from Double Taxation

Answer 45

* exemption: income taxed by source not taxed by residence country * credit: source tax provides credit against residence tax * deduction: source country tax reduces taxible income in residence

Question 46

Value of Generationg Skipping

Answer 46

skipping generations while passing down inheritences value to 3^rd gen increased by a factor of 1 / ( 1 - t ) (assuming r is same for all generations)

Question 47

Valuation Discounts

Answer 47

reduce taxable value for difficult to value assets (takes liquidity and minority interest into consideration) Value = MV\*(1 - discount_liquidity)\*(1 - discount_{minority int})

Question 48

Trusts

Answer 48

* revocable: settlor can rescind trust, settlor is owner * irrevocable: settlor relinquishes ownership, trustee controls (tax benefits), protext assets from claims against settlor * fixed: settlor determines how assets are distributed * discretionary: trustee determines how assets are distributed * spendthrift: trust b/c beneficiary is young or bad w/ money

Question 49

Nominal Pre-Tax Return

Answer 49

\*100% of nominal after-tax return is taxable nominal pre-tax return = ( nominal after-tax return )/( 1 - t )