Free CFA Level III: Private Wealth Preserving the Wealth Practice Questions

A is correct. Human capital is the economic concept representing the present value of all expected future earnings from an individual's labor over their remaining working years. For younger workers, human capital is typically their largest asset, often exceeding their financial capital (investment portfolio). As an individual ages and accumulates financial assets while approaching retirement, human capital declines and financial capital grows.

B is incorrect. The market value of an investment portfolio represents financial capital, not human capital. These are complementary concepts — total economic wealth equals human capital plus financial capital.

C is incorrect. While education contributes to human capital by enhancing earning potential, human capital is measured as the present value of future income, not the quantity of education. Two individuals with identical education levels may have very different human capital values due to differences in career choices, earning trajectories, and remaining working years.

B is correct. Career risk threatens human capital — the present value of future earnings. When career risk materializes (job loss, industry decline, or skill obsolescence), the individual's human capital may be permanently impaired, meaning financial capital must compensate for the lost earning capacity. This affects wealth planning in several ways: (1) higher savings rates may be needed; (2) the portfolio may need to be more conservatively managed to preserve the now-essential financial capital; (3) insurance strategies may need revision; and (4) retirement timing may need to change.

Choice A is incorrect because career risk affects workers across all industries. Manufacturing, retail, financial services, healthcare, and other sectors all experience disruption, automation, and structural changes that can impair workers' earning capacity. Technology workers are not uniquely exposed to this risk.

Choice C is incorrect because standard disability insurance covers physical or mental inability to work, not career disruption due to industry changes or skill obsolescence. If a client loses their job because their industry contracts or their skills become obsolete (while they remain physically able to work), disability insurance does not provide coverage for that type of employment loss.

C is correct. An optimal currency hedging policy for a UHNW client should consider multiple factors: (1) hedging costs — currency forwards have a cost based on interest rate differentials, which can be significant for some currency pairs; (2) diversification benefits — some unhedged foreign currency exposure can reduce overall portfolio volatility if currency movements are negatively correlated with domestic asset returns; (3) spending currency — if the client spends in multiple currencies (residences, travel), natural hedging reduces the need for financial hedging; (4) correlation analysis — currencies that are correlated with portfolio risk factors may warrant more hedging than those providing diversification; and (5) tactical considerations — the hedging ratio may be adjusted based on extreme currency dislocations.

Choice B is incorrect because full hedging eliminates the diversification benefit of foreign currency exposure, which can reduce overall portfolio volatility in some market environments. It also generates maximum hedging costs, which may not be justified for all currency pairs. Furthermore, a client who spends in multiple currencies would be over-hedged if all exposure were neutralized to the home currency.

Choice A is incorrect because leaving all currency exposure unhedged ignores the potential for significant currency losses that can materially affect portfolio value. While currency movements may be difficult to predict, the risk management objective is to control the magnitude of potential losses, not to forecast direction.