CFA III SS 4 Private Wealth Management

  1. Fixed vs Variable Annuity
    • Opposite of Life Insurance - hedge longevity risk
    • Fixed: usually no inflation adjustment; can't withdraw, rate is locked
    • Variable: payments based on mixed assets selected by client; receive fixed number of units, value fluctuates with value of assets
  2. Retirement Risks and Hedges
    • 1. Financial Market
    • 2. Longevity
    • 3. Savings
    • 1. Loss due to decline in value; hedge with diversification
    • 2. Outliving assets; annuity
    • 3. Not saving enough for planned longevity; employ savings program, consume less
  3. Relationship between human and financial capital
    • HC decreases over time, FC increases, total wealth should slowly increase
    • If HC is steady and risk free, FC can be more risky. HC includes social security, steady job, pension
  4. How do the following affect the demand for life insurance:
    • 1. Risk tolerance
    • 2. Wealth
    • 3. Probability of death
    • 4. Age
    • 5. Bequest desire
    • 1. high RT = low demand bc more willing to accept loss of HC
    • 2. high wealth = low demand
    • 3. high probability = high demand
    • 4. high age = low demand bc less HC to lose
    • 5. high bequest desire = high demand
  5. Three ways to deal with concentrated position in real estate
    • 1. Loan: use RE as collateral, non-recourse is analogous to protective put
    • 2. Sale and Lease: sell RE and buyer leases back. lease payments are tax deductible
    • 3. Donor advised fund or charitable trust: take tax deduction on full market value; charity can sell with no tax liability; can retain some influence on use of RE
  6. Seven ways to deal with concentrated position in a private business
    • 1. Sale: sell to strategic buyer; strategic generally offers higher price
    • 2. Recapitalization:owner retains around 30% of stock and control, sells 70% back to company
    • 3. Management buy-out or sale to employees: purchaser usually lacks money, which may hurt price. could also hurt firm if negotiation fails
    • 4. Sell non-core assets: sell assets and use cash to diversify
    • 5. Line of credit: open line of credit with firm as collateral
    • 6. Sell to family: retains ownership, gift would provide no cash but may still be taxed
    • 7. Employee Stock Ownership Plan, IPO: transfer ownership to employees, tax advantage
  7. 1. Perfect Hedge
    • 2. Cross Hedge
    • 3. Exchange Fund
    • 1. Perfect hedge eliminates all systematic and nonsystematic risk - may be taxable event
    • 2. Cross hedges with "like" product - different but similar stock, related index. still hold nonsystematic risk
    • 3. Several investors pool concentrated positions and receive pro rata shares of fund diversification without sale 
  8. Five ways to manage concentrated stock position risk with derivatives:
    • 1. protective put: most expensive, buy at the money (ATM) put
    • 2. knock-out put: if stock rises to X, put terminates. cheaper than number one
    • 3. ATM and OTM puts: offset ATM put cost by selling OTM at lower strike. will be protected against small declines
    • 4. put and call: buy put and sell call, protects at no cost but lose upside
    • 5. prepaid variable forward (PVF): ex. receive 90 shares now, repay shares, but number owed decreases as price rises. retains some upside.
  9. Four ways to monetize concentration position
    • 1. Short against the box: short shares owned - proceeds create liquidity 
    • 2. Forward sale: sell forward contract on stock
    • 3. Forward with options: buy put and sell call with same strike
    • 4. Total equity swap: pay return on stock for LIBOR + X
  10. Gain liquidity from business owned using limited partnership
    • 1. establish LP to hold concentrated position, retain control
    • 2. gift some shares, will be discounted due to lack of marketability and liquidity
  11. Three investment objectives for concentrated positions
    • 1. Reduce risk caused by position - hedge
    • 2. Generate liquidity to meet diversification or spending needs
    • 3. Optimize tax efficiency 

    Sell, Hedge, Monetize
  12. Source jurisdiction
    • Resident jurisdiction
    • Credit method
    • Exemption method
    • Deduction method
    • Source: taxes paid where income generated
    • Resident: taxes paid by citizens regardless of location
    • Credit: reduce tax owed by taxes paid in source (tax rate to reduce cannot exceed domestic tax rate) - full relief
    • Exemption: reduce taxable income by income taxes paid in source
    • Deduction: deduct foreign taxes from income - partial relief
  13. Define and uses:
    • 1. Generation skipping
    • 2. Revocable vs irrevocable trust
    • 3. Fixed vs discretionary trust
    • 4. Spendthrift trust
    • 5. Life insurance advantages
    • Gen skip: bequest directly to second generation to avoid double taxation
    • Revocable: donor remains in control, can contribute and withdraw
    • Irrevocable: can't be attacked by creditors, donor can't withdraw, no control
    • Fixed trust: distributions set by settlor (donor)
    • Discretionary trust: distributions determined by trustee, settlor can provide wishes
    • Spendthrift: for children or anyone otherwise unable to manage money, how the distributions are spent is determined by the trustee
    • Life insurance advantages: no tax, transfers outside of probate process
  14. List objectives and constraints
    • Objectives: return, risk
    • Constraints: time, tax, legal, liquidity, unique
  15. Estate tax freeze
    Transfer future appreciation and tax liability to future generations

    Create voting preferred (owner/donor) and common stock (gift) - structure so growth accrues to common over time
  16. Investor personality types for IPS
    • Cautious: Emotional, overanalyze out of fear, tend to do nothing
    • Methodical: Thinking, high risk aversion, always researching
    • Individualistic: Thinking, lower risk aversion, similar to methodical other than risk aversion
    • Spontaneous: Emotional, lower risk aversion, constantly changing portfolio
  17. Choices/Definitions for
    • 1. Source of wealth
    • 2. Measure of wealth
    • 3. Stage of life
    • 1. Source: active vs passive - Barnewell two way model
    • 2. Measure: subjective perception of wealth
    • 3. Stage of Life: 
    • Foundation - education, early career
    • Accumulation - mid-late career, income increasing
    • Maintenance - retirement
    • Distribution - death
  18. Calculate wealth using annual tax effect
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  19. Calculate effective capital gains tax rate and explain how to apply it
    • Image Upload 2
    • Calculate total before taxing unrealized CG, then subract (CG effective rate calculated above)*(total before taxing unrealized - cost basis)
  20. Define:
    • 1. testament
    • 2. probate
    • 3. intestate
    • 4. gift and bequest and applicable taxes
    • 5. forced heirship
    • 6. commodity property rights
    • 7. separate property rights
    • 8. clawback
    • 1. testament: will
    • 2. probate: process where court examines will and distributes property
    • 3. intestate: no or invalid will - "died intestate"
    • 4. gift: alive, gift taxes; bequest: dead, estate and/or inheritance tax
    • 5. forced heirship: children have right to parents estate
    • 6. comm prop: spouse has right to 1/2 of other's estate
    • 7. sep prop: each spouse has own estate
    • 8. clawback: may return gifts given back to estate for proper distribution
  21. Relative Value formula:
    • 1. Basic gift with gift and estate tax
    • 2. Gift with gift and estate tax, but donor pays tax

    Image Upload 3
  22. r = return on stock
    • tig = tax rate on receiver 
    • tie = tax rate on estate
    • Tg = gift tax rate
    • Te = estate tax rate
  23. Image Upload 4
  24. Image Upload 5 - additional is partial gift tax benefit from lowering estate value
  25. Define core capital and ways to determine it
    Amount of assets necessary to meet all future liabilities - amount needed through retierment

    a) Mortality table - Find probability of survival for a least one of investor or spouse; multiply by spending per year; discount to present; add safety reserve

    b) Monte Carlo
  26. Deterministic vs Monte Carlo
    • Deterministic: single point estimate; no path dependence - if value lowers, distributions are a higher proportion of portfolio, so lowers future returns
    • Monte Carlo: Much more flexible, handle many inputs, reflects path effect
Card Set
CFA III SS 4 Private Wealth Management