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CFA Level III > Private Wealth Management > Flashcards

Private Wealth Management Flashcards

1
Q

Traditional Finance

A

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

REM - risk averse, rational expectations, asset integration

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2
Q

Behavioral Finance

A

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
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3
Q

Source of Wealth

A

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

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

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4
Q

Measure of Wealth

A

how much wealth client preceives themself to have

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

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5
Q

Stage of Life

A
  • 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
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6
Q

Personality Types

A
  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
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7
Q

Client Benefits of IPS

A
  1. identify objectives and constraints
  2. dynamic (can change)
  3. easily understood, transferable
  4. educational about themself/ investment process
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8
Q

Manager Benefits of IPS

A
  1. know client
  2. guidance for decisions
  3. guidance for resolving disputes
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9
Q

IPS Objectives

A
  1. return
  2. risk
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10
Q

IPS Constraints

A
  1. time horizon
  2. taxes
  3. liquidity
  4. legal
  5. unique
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11
Q

Ability to Take Risk

A

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)
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12
Q

Willingness to Take Risk

A

psychological profile

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13
Q

Return Objective

A
  1. list objectives
  2. determine asset base
  3. determine distribution
  4. calc [real] return (distribution/ base)
  5. calc nominal return (real + inflation)
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14
Q

Process of Elimination

A

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)
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15
Q

Deterministic Approach

A

traditional approach

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

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16
Q

Monte Carlo Simulation

A

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

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17
Q

Tax Drag

A

money lost to taxes

tax drag$ = gainPT - gainAT

gain = FV - BV

tax drag% = TD$/ gainPT

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18
Q

RAE

A

accrual equivalent return; hypothetical tax rate if taxed every period

  • RAE = (FVAT / PV)1/n - 1
  • RAE = r * ( 1 - TAE )

** might not be on exam

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19
Q

Tax Regimes

A
  • Progress: favorable for int, div, cap gains
  • Heavy: favorable for int
  • Light: favorable for div, cap gains
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20
Q

Accrual Taxation

A

taxes paid periodically

FVAT = PV [1 + r * ( 1 - t )]n

TD% > t

TD positively correlated with n and r

21
Q

Capital Gains Taxation

A

tax on gains from sale

capital gain = sale proceeds - tax basis

FVAT = PV [( 1 + r )n ( 1 - tcg ) + tcg*B]

B = tax basis/ MV

  • B < 1, unrealized gain, TD% > t
  • B > 1, unrealized loss, TD% < t
22
Q

Wealth Taxation

A

periodic tax on total value (property tax)

FVAT = PV [(1 + r) * (1 - tw)]n

  • inc n = inc TD$, inc TD%
  • inc r = inc TD$, dec TD%
23
Q

Blended Taxation

A

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

weighted avg realized tax rate (wartr) = piti +pdtd + pcgtcg

deferred cg tax rate (T*) = tcg [pdeferred cg / (1 - wartr)]

FVAT = PV [(1 + r*)n ( 1 - T* ) + T* - ( 1 - B )tcg ]

24
Q

TDA

A

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

FVAT = PV ( 1 + r )n ( 1 - tn )

25
Q

TEA

A

tax exempt account; contributions are taxed, no tax on withdrawals

FVAT = PVAT ( 1 + r )n

26
Q

TEA vs TDA

A

t0 < tn : prefer TEA

t0 > tn : prefer TDA

t0 = tn : indifferent between TEA an TDA

contribution limits: TEA better b/c tax adv on more savings (if cont limits are equal)

27
Q

Adjusting for Unrealized Gain/ Loss

A
  1. asset sold today: +/- = MV - value of cg tax
  2. asset sold in future: +/- = MV - value of cg tax discounted by AT rasset
  3. asset sold in future: +/- = MV - value of cg tax discounted by AT rf
28
Q

After Tax Risk and Return

A

σAT = σPT ( 1 - t )

rAT = rPT ( 1 - t )

corrAT = corrPT

29
Q

Tax Alpha

A

value created by tax management

  • TDA for heavily taxed items (bonds)
  • TEA for lightly taxed items (equity)

GOALS: dec tax drag, dec TEA, trade less often, utilize TEA and TDA

30
Q

Trading Behavior

A
  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
31
Q

HIFO

A

highest in/ first out

designate highest tax lots to each sale

minimize gain, maximize loss

32
Q

LIFO

A

lowest in/ first out

designate highest tax lots to each sale

when you expect higher taxes in future

33
Q

Holding Period Management

A

usually tax advanatage to holding inv b/c tLT < tST

tLT = tST, still better to hold b/c pretax compounding return

year end: realize loss, defer gain = dec current taxes

34
Q

Mean - Variance Optimization

A
  • max after-tax return to after-tax risk
  • optimize asset location
  • structure allocations to pref tax locations
35
Q

Probate

A

legal process, courts determine validity of will, inventories, and resolves disputes

AVOID WITH: joint ownership w/ survivorship, trust, retirement plans, life insurance

36
Q

Wealth Transfer Taxes

A
  1. gift - gift tax
  2. bequest/ testamentary gratuitous transfers
  • estate tax: paid by transferor
  • inheritance tax: paid by recipient
37
Q

Limitations on Distribution of Assest

A
  • 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
38
Q

Estate Planning

A

objectives

  1. minimize taxes
  2. transfer assets to heirs and others
39
Q

Individual’s Balance Sheet

A
  • A: human capital, net employment capital > assets + PV future net income
  • L: PV all current and future costs
  • E: excess capital
40
Q

Probability of Ruin

A

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

41
Q

RVtax free gift

A

RV > 1 = gift

RV < 1 = bequest after death

42
Q

RVtaxable gift

(paid by receiver)

A

RV > 1 = gift

RV < 1 = bequest after death

43
Q

RVtaxable gift

(paid by giver)

A

RV > 1 = gift

RV < 1 = bequest after death

44
Q

RVtax exempt charity

A

RV > 1 = gift

RV < 1 = bequest after death

Tio = tax rate on ordinary income

45
Q

Relief from Double Taxation

A
  • 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
46
Q

Value of Generationg Skipping

A

skipping generations while passing down inheritences

value to 3rd gen increased by a factor of 1 / ( 1 - t )

(assuming r is same for all generations)

47
Q

Valuation Discounts

A

reduce taxable value for difficult to value assets (takes liquidity and minority interest into consideration)

Value = MV*(1 - discountliquidity)*(1 - discountminority int)

48
Q

Trusts

A
  • 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
49
Q

Nominal Pre-Tax Return

A

*100% of nominal after-tax return is taxable

nominal pre-tax return = ( nominal after-tax return )/( 1 - t )

CFA Level III (12 decks)

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