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CFA3 > SS04 > Flashcards

SS04 Flashcards

1
Q

What are the 3 parts in the Situational Profiling?

A

Source of wealth, perceived wealth x needs, stage of life

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2
Q

Why do the Situational Profiling?

A

Can provide insights to risk tolerance and return objectives.

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3
Q

Two types of source of wealth

A

Created actively or passively

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4
Q

Examples of wealth created actively

A

Entrepreneurial activities

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5
Q

How do people who created wealth actively tolerate risk?

A

Have taken business risk before, they might take investment risk. Above-average willingness to tolerate risk.

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6
Q

How can willingness to take risk be measured?

A

Willingness can be indicated by both statements and actions.

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7
Q

Examples of wealth created passively

A

Inheritance, windfall, or through long, secure, employment and conservative investing

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8
Q

How do people who created wealth passively tolerate risk?

A

Below average willingness to take risk. Heirs have little faith of regaining the money should they experience significant losses. Employment and conservative investing means delayed consumption and low-risk investments.

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9
Q

How does the Measure of Wealth relates to risk?

A

Positive correlation between a clients perceived wealth and his willingness to take investment risk.

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10
Q

How can investors in the early stages of life manage market market downturns?

A

Investors in the early stages of life can add to their portfolio through employment-related income and therefore can manage short-term market downturns.

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11
Q

What are the Life Stages

A

Foundation, Accumulation, Maintenance, Distribution

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12
Q

Explain the Foundation Life Stage

A

Seeking to accumulate wealth, long time horizon. Little ability to take risk. Those who inherit have a long time horizon AND ability to take risk.

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13
Q

Explain the Accumulation Life Stage

A

Maximum savings and wealth accumulation, with a higher ability to take risk.

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14
Q

How is risk assessed at the Maintenance (Retirement) Life Stage

A

Ability to take risk will be declining but is probably not low (life expectancy is high!). Being too conservative can lead to a decline in standard of living.

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15
Q

Explain the Distribution Life Stage

A

assets exceed any level of need for the individual and a process of distributing assets to others can begin. For the wealthy, financial objectives can extend beyond their death, so that time horizon remains long and ability to take risk can remain high.

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16
Q

How does Tradicional Finance sees Risk Aversion?

A

Minimize risk for a given level of return, or maximize return for a given level of risk. Measure risk as volatility.

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17
Q

How does Tradicional Finance sees Rational expectations?

A

Investor’s forecasts are unbiased and accurately reflect all relevant information pertaining to asset valuation.

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18
Q

How does Tradicional Finance sees Asset Integration?

A

Investor’s consider the correlation of a potential investment with their existing portfolios.

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19
Q

What can be expected when constructing a portfolio, according to Asset Integration?

A

Asset prices will reflect economic factors, and portfolios can be constructed using weighted average returns, covariance and correlation.

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20
Q

How does Behavioral Finance sees Loss aversion?

A

Phrased as a gain, they take certainty, which is consistent with traditional finance. Phrased as a loss, they take uncertainty, hoping to avoid the loss.

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21
Q

Meaning of Biased Expectations, according to Behavioral Finance

A

Overconfidence in predicting the future.

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22
Q

What are the 3 types of Biased Expectations?

A

Assuming returns of the average manager will be those of a particular manager, excessively focusing on outlier events, mistakenly letting one asset represent another asset

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23
Q

How does Behavioral Finance sees Asset Segregation?

A

Do not consider the effect of correlation with other assets

24
Q

How do investors tend to construct portfolios?

A

One asset at a time, instead of using asset integration.

25
Q

How is Wealth creation determined?

A

Making investment decisions that relate to specific goals (e.g. pyramiding)

26
Q

How can Personality Types be broadly assessed?

A

Questionnaires that focus on non-investment-related questions concerning personal attitudes and decision making.

27
Q

What are the four Personality Types?

A

Cautious, Methodical, Individualistic, Spontaneous

28
Q

Explain the Cautious Personality Type

A

Risk averse and base decisions on feelings, difficult to advise.

29
Q

Explain the Methodical Personality Type

A

Risk averse and base decisions on thinking, constantly on the lookout for better information.

30
Q

Explain the Individualistic Personality Type

A

Less risk averse and base decisions on thinking, very confident on their ability to make investment decisions.

31
Q

Explain the Spontaneous Personality Type

A

Less risk averse and base decisions on feelings. Tend to doubt investment advice. High portfolio turnover, chase fads, continually want to do something.

32
Q

For the client, the benefits of the IPS include

A

Identifies and documents investment objective and constraints

33
Q

For the adviser, the benefits of the IPS include

A

Guidance for resolution of disputes (approving or dening client investment requests)

34
Q

RRTTLLU

A

Return, Risk, Time Horizon, Taxes, Liquidity, Legal, Unique

35
Q

Objectives and constraints of the IPS

A

Two objectives: return, then risk. Five constraints TTLLU

36
Q

Where is ownership of a personal residence noted in the IPS

A

Usually under unique. It certainly not part of the investable assets.

37
Q

Definition - Ability to take risk

A

How much volatility the portfolio can withstand and still meet the client’s required expenditures.

38
Q

What affects ability to take risk

A

Significantly affected by the time horizon and size of the expenditures relative to the portfolio.

39
Q

How to separate goals to assess ability to take risk

A

Separate goals under critical (providing for loved ones, future lifestyle) and secondary (lavish vacations).

40
Q

How to assess willingness to take risk

A

Subjetive and determined through an analysis of the psychological profile. Look for statements of evidence in the client’s actions.

41
Q

How should the risk objective be defined?

A

The risk objective should be as specific, relevant to the client, and measurable as possible. Past questions have often specified a maximum shortfall risk, usually defined as E(R) - 2 std deviations.

42
Q

Where should the risk objectives be on the IPS?

A

It has been listed under both willingness and overall risk objectives, so both are acceptable.

43
Q

What are the Individual Investor Constraints?

A

Five constraints - TTLLU - Time Horizon, Taxes, Liquidity, Legal, Unique

44
Q

IPS constraints - Time Horizon

A

number of stages , main objective of each stage, and the number of years in each stage, if identifiable. Look for stages defined by people other than the client (inheritances)

45
Q

Tax Strategies - Tax deferral - Definition

A

Minimize the potentially compounding effect of taxes by paying them at the end of the investment holding period.

46
Q

Tax Strategies - Tax deferral - Applications

A

Strategies that fall under this category focus on long-term capital gains, low turnover, and loss harvesting

47
Q

Tax Strategies - Tax avoidance - Definition

A

Invest in tax-free securities

48
Q

Tax Strategies - Tax reduction - Definition

A

Invest in securities that require less direct tax payment

49
Q

Tax Strategies - Tax reduction - Applications

A

Capital gains may be taxed at a lower rate than income, so securities that generate returns mainly as price appreciation offer the investor a lower effective tax rate

50
Q

Tax Strategies - Wealth transfer taxes - Definition

A

Minimize transfer taxes by transfering wealth to others without utilizing a sale

51
Q

IPS constraints - Liquidity

A

Liquidity can be important in affecting ability to bear risk and in details of the return calculation or SAA.

52
Q

What limits liquidity in a portfolio?

A

The liquidity of assets and of a resulting portfolio is a function of the transaction costs to liquidate and price volatility of the assets.

53
Q

How big should the liquidity be in a portfolio?

A

Holding three months to one year of the annual distribution in cash reserves could be reasonable if agreed in advance.

54
Q

Definition - Personal Trust

A

Legal devices to transfer wealth to future generations

55
Q

Definition - Revocable Trust

A

The grantor retains ownership and control over the trust assets and is responsible for taxes on any income or capital gains. The grantor often remains as trustee and either manages the trust assets or hires a manager.

56
Q

Definition - Irrevocable Trust

A

The grantor confers ownership of the assets to the trust, which is managed by a professional trustee. The assets are considered immediately transferred to future generations and thus can be subject to wealth transfer taxes, such as gift taxes. The individual who originally funded the trust no longer has control of the assets and is not taxed on them.

57
Q

Definition - Family Foundations

A

Similar to the irrevocable trust, used to transfer family assets to future generations. Family members remain as managers of the foundation’s assets.

CFA3 (2 decks)

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