Private Wealth Management, Institutional Investors

Question 1

What are the two major sources of earnings risk?

Answer 1

Loss of employment
Serious illness or disability

Question 2

How can serious illness or disability risk be managed?

Answer 2

Disability insurance

Question 3

How can longevity risk be managed?

Answer 3

Annuity

Question 4

How can premature death risk be managed?

Answer 4

Life insurance

Question 5

How can property risk be managed?

Answer 5

Property insurance

Question 6

What are the key factors driving human capital?

Answer 6

Survival probabilities (usually proxied by mortality tables)
Current employment income
Expected annual wage growth
The risk-free rate
A risk adjustment based on occupational income volatility
The expected number of working years

Question 7

What is the difference between the human life value method and the needs requirement capital method?

Question 8

What is risk avoidance?

Answer 8

Risk avoidance involves avoiding a risk altogether. For example, one way to avoid the risk to human and financial capital from riding a motorcycle is to simply not own or ride one.

Question 9

What is risk retention?

Answer 9

Risk retention involves retaining a risk and thus maintaining the ability to finance the cost of losses; when funds are set aside to meet potential losses, the individual is said to self-insure.

Question 10

What is risk transfer?

Answer 10

Risk transfer involves transferring the risk: The use of insurance and annuities to transfer risk to insurers.

Question 11

What is risk reduction?

Answer 11

Risk reduction involves mitigating a risk by reducing its impact on an individual’s welfare, either by lowering the likelihood that it will occur or by decreasing the magnitude of loss (for example, by wearing a helmet when riding a motorcycle)

Question 12

How should a risk with high frequency of occurrence and low severity of loss be handled?

Answer 12

Risk reduction

i.e. dental cavities, is best managed through risk reduction—for example, through proper dental hygiene.

Question 13

How should a risk with high frequency of occurrence and high severity of loss be handled?

Answer 13

Risk avoidance

Question 14

How should a risk with low frequency of occurrence and high severity of loss be handled?

Answer 14

Risk transfer

Question 15

How should a risk with low frequency of occurrence and low severity of loss be handled?

Answer 15

Risk retention

Question 16

What is an economic/holistic balance sheet?

Answer 16

An economic balance sheet allows an individual to anticipate how available resources can be used to fund consumption over the remaining lifetime. It includes the present value of non-marketable assets (e.g., human capital and pensions) and liabilities (e.g., consumption needs and bequests) provides a much more accurate baseline from which to maximize the expected utility of future consumption.

Question 17

How do you calculate the net payment cost index?

Answer 17

• Steps:
  1. Calculate the future value of an annuity due of an amount equal to the premium, compounded at a discount rate for number of life insurance years.
  2. Calculate the future value of an ordinary annuity of an amount equal to the projected annual dividend (if any), compounded at the discount rate for the number of life insurance years.
  3. Subtract step 2 from step 1 to get the 20-year insurance cost.
  4. Calculate the payments for a annuity due with a future value equal to step 3. This amount is the interest-adjusted cost per year.
  5. Divide by the number of thousand dollars of face value.

Question 18

How do you calculate the surrender cost index?

Answer 18

• Steps:
  1. Calculate the future value of an annuity due of an amount equal to the premium, compounded at the discount rate for life insurance years.
  2. Calculate the future value of an ordinary annuity of an amount equal to the projected annual dividend (if any), compounded at the discount rate for life insurance years.
  3. Subtract step 2 and the projected cash value from step 1 to get the total insurance cost.
  4. Calculate the payments for a annuity due with a future value equal to step 3.
  5. Divide by the number of thousand dollars of face value.

Question 19

What factors influence immediate fixed annuity income yields?

Answer 19

Age
Gender
Expected return of the insurance company on premiums

Question 20

What are the key technical skills of a wealth manager?

Answer 20

Capital markets proficiency - but not experts
Portfolio construction ability - experts
Financial planning knowledge - working knowledge
Quantitative skills - experts
Technology skills - experts
Language fluency - experts/critical

Question 21

What are the key soft skills of a wealth manager?

Answer 21

Communication skills - critical
Social skills - critical
Education and coaching skills - important
Business development and sales skills - working knowledge

Question 22

Which of the following can be shaped by a wealth manager? Risk tolerance, risk capacity, or risk perception?

Answer 22

Risk perception can be shaped through client education. Risk tolerance and capacity cannot be shaped.

Question 23

What is deterministic forecasting and what is its drawback in evaluating capital sufficiency?

Answer 23

Portfolio growth in a deterministic model occurs in a “straight-line” manner. For example, suppose a client’s investment horizon is 15 years and the wealth manager has determined that the portfolio’s likely compound annual return is 6%. In deterministic forecasting, the client is expected to achieve a 6% return in each of the 15 years in the analysis. While simple to understand, the deterministic method is typically unrealistic with respect to the variability in potential future outcomes.

Question 24

What is Monte Carlo simulation and what is it’s advantage in evaluating capital sufficiency?

Answer 24

Monte Carlo simulation generates random outcomes according to assumed probability distributions for these key variables. Monte Carlo models can incorporate customized input data, such as life expectancy, taxes, inflation, and investment management fees.

Question 25

What are the two methods of evaluating capital sufficiency?

Answer 25

Deterministic forecasting and Monte Carlo simulation

Question 26

What are the three methods of analysing a client’s retirement goals?

Answer 26

Mortality tables, annuities, and Monte Carlo simulation.

Question 27

If the probability of success from a Monte Carlo simulation is below an acceptable range, what are the potential solutions?

Answer 27

Increasing the amount of contributions toward a goal
Reducing the goal amount
Delaying the timing of a goal (e.g., retiring a few years later than originally planned)
Adopting an investment strategy with higher expected returns, albeit within the client’s acceptable risk tolerance and risk capacity

Question 28

What type of insurance should be used to address chronic health problems requiring extended nursing at home?

Answer 28

Long-term care insurance

Question 29

How would loss of employment affect human and financial capital?

Answer 29

Human capital would be reduced by the loss of future earnings and halt accrual of pension benefits at Perrin’s present employer. Financial capital could also be affected because assets may need to be sold to make up for any loss of income.

Question 30

For an individual with specialised skills, what is the best disability insurance?

Answer 30

Inability to perform the important duties of one’s regular occupation. Although this policy would be more expensive, Inability to perform the important duties of any occupation for which one is suited by education and experience, and Inability to perform the duties of any occupation, would likely deem the insurer not the payout.

Question 31

What are the features of a deferred variable annuity?

Answer 31

Menu of potential investment options
May include death benefits

Question 32

What are the features of a deferred fixed annuity?

Answer 32

Locks the annuitant into a portfolio of bond-like assets at whatever rate of return exists at the time of purchase

Question 33

How do you calculate the tax efficiency ratio?

Answer 33

Pre-tax return / post-tax return

Question 34

How should equity and fixed-income assets be split between taxable and tax-exempt accounts?

Answer 34

Taxable bonds should be held in a tax-exempt account and that equities should be held in the taxable account

When there are limits on contributions to TDAs, the most heavily taxed items should go into the TDAs; the more lightly taxed items should go into taxable accounts.

However, investors with a long investment horizon or that have higher turnover equity strategies may find that putting equities in the tax-exempt account results in better after-tax returns because of the accumulation effect.

Question 35

What is a revocable trust?

Answer 35

In a revocable trust arrangement, the settlor (the person whose assets are used to create the trust) retains the right to rescind the trust relationship and regain title to the trust assets. Under these circumstances, the settlor is generally considered to be the owner of the assets for tax purposes in most jurisdictions.

Question 36

What is an irrevocable trust?

Answer 36

Where the settlor has no ability to revoke the trust relationship, the trust is characterized as an irrevocable trust. In an irrevocable trust structure, trustees may be responsible for tax payments and reporting in their capacity as owners of the trust assets for tax purposes.

An irrevocable trust structure generally provides greater asset protection from claims against a settlor than a revocable trust.

Question 37

What is a fixed trust?

Answer 37

Distributions to beneficiaries of a fixed trust are specified in the trust document to occur at certain times or in certain amounts.

Question 38

What is a discretionary trust?

Answer 38

If the trust document enables the trustee to determine whether and how much to distribute based on a beneficiary’s general welfare, the trust would be called a discretionary trust.

Question 39

How do you calculate the return on a tax-deferred account?

Answer 39

Opening value × (1 + return)^years x (1 – tax rate)

Question 40

How do you calculate the return on a taxable account?

Answer 40

Opening value × (1 + return(1 – taxrate))^years

Question 41

What is the difference between tax reduction, tax deferral, tax evasion and tax avoidance?

Answer 41

Tax reduction - tax strategy to reduce amount of taxes paid

Tax deferral - tax strategy to move paying tax to a later date

Tax avoidance - moving tax location (non-taxable account, gifting, etc)

Tax evasion - illegally not paying tax

Question 42

What is unrelated business income tax (UBIT)?

Answer 42

UBIT must be paid by both endowments and foundations if income is produced that is not substantially related to a foundation’s or endowment’s charitable purpose.

Question 43

What is an example of a DB plan investment objective?

Answer 43

For DB pension plans, the primary objective is to achieve a target return over a specified long-term horizon while assuming a level of risk that is consistent with meeting its contractual liabilities. A secondary objective could be to minimize (in present value terms) the cash contributions the sponsor will be required to provide.

Question 44

How do you calculate the leverage multiplier?

Answer 44

Assets / (Assets - liabilities)

Question 45

How do you calculate equity volatility?

Answer 45

Square root of:

Leverage Multiplier^2 x Asset Standard Deviation^2
+
(Leverage Multiplier - 1)^2 x Liability Standard Deviation^2
-
2 x Leverage Multiplier x (Leverage Multiplier - 1) x Asset Standard Deviation x Liability Standard Deviation x Correlation

Question 46

How do you calculate the duration of equity?

Answer 46

Duration of Liabilities x (Leverage Multiplier - 1) x (change in liabilities/change in assets)

Question 47

How do you calculate equity capitalisation?

Answer 47

Equity / Assets

or

1 / Leverage Multiplier