Q1

Different types of investors have their own unique characteristics and needs, which also
determine their behavior and decision-making in the investment market. Understanding
investors' risk appetite is very important for financial institutions and financial advisors as it helps
to provide personalized advice and investment portfolios to meet the needs and goals of different
investors. Types of investors can be classified according to their risk appetite, which determines
their attitude towards the financial risk they take in investment decisions. Based on risk appetite,
investors will categorize the risks associated with an investment in order to find an investment
that fits their preferences.
The first is the "risk-averse investor", who has a very low tolerance for risk. Such investors are
more inclined to choose lower-risk investment products, preferring to accept lower specific
returns than to take high risks. They seek stable returns, usually prefer guaranteed returns, and
stay away from high-risk investments. Such investors are usually retirees or investors who have
higher requirements for capital preservation and steady appreciation.
Then there are "risk-neutral investors," who are indifferent to the gamble or the guaranteed
outcome. They maximize returns regardless of risk, and high returns are desirable to them even
with higher risks. This type of investor places equal weight on potential gains and losses in
wealth, wants a reasonable return, and is willing to try a variety of investments.
Finally, there are "risk-seeking investors," who maximize risk and return, gaining additional utility
from the uncertainty associated with gambling. These investors are willing to take greater risks in
pursuit of higher returns. They may choose high-volatility investments, such as investing in real
estate, start-ups or emerging markets, hoping for higher capital appreciation. Such investors tend
to have a strong risk tolerance and are more interested in opportunities with high risks and high
returns.
For investors themselves, understanding their own risk appetite is also an important prerequisite
for making reasonable investment plans and decisions.
If we use the utility function to describe the utility of investors, then let U=E(r)-1/2*A*σ^2. U is
the utility, E(r) is the expected return, σ^2 is the variance of the expected return, and A is the risk
aversion coefficient. For investors, the A of the risk-averse investor is greater than 0, and the A of
the risk-neutral investor =0, A<0 for risk-seeking investors.
As a result, their indifference curves are also different.
Q2

Modern portfolio theory uses expectation and variance to describe the two key factors of return
and risk. Expectation refers to the security's expected rate of return, and variance is the variance
in the security's expected rate of return. Suppose there are N different assets in the market,
represented by black dots in the figure.

Investment Opportunity Set (indicated by green shading): An investment opportunity set is the
combination of all the different risky assets that an investor can choose from when constructing a
portfolio, with varying expected returns and variances, and a portfolio consisting of these
securities The expected rate of return is the weighted average of the expected rate of return of
individual securities, and the weight is the corresponding investment ratio. The variance of the
investment portfolio is determined by the variance of the security itself and the correlation
coefficient between the securities, which measures the deviation between the actual return rate
and the mean value, and describes the risk of the investment portfolio. The investment
opportunity set represents the range of risk and return combinations available to an investor
when constructing a portfolio using different proportions of risky assets. The investment
opportunity set excludes risk-free assets such as government bonds and instead focuses on risky
assets.

Minimum variance frontier (represented by the black curve): The minimum variance frontier
represents the range of portfolios that offer the lowest possible risk (variance) for a given level of
expected return. From the vertical axis of the coordinate axis, for any given expected return, the
portfolio opportunity concentration will always consist of a portfolio that satisfies the given
expected return and has the smallest variance. These portfolios are combined into a curve, which
shows the portfolio with the lowest risk for different levels of expected return. These portfolios
are achieved by diversifying investments in the most efficient manner, taking into account the
correlations between different assets.

Efficient frontier (indicated by the red curve): The efficient frontier represents the range of
portfolios that provide the greatest possible return for a given level of risk. It includes all
portfolios that are well diversified and achieve the best trade-off between risk and return, and it
is the upper half of the minimum variance frontier. For any given level of risk, there will always be
a portfolio with the highest return in the concentration of investment opportunities, and these
portfolios constitute the efficient frontier. Any portfolio that lies below the efficient frontier is
considered inefficient because investors can earn higher returns without increasing risk. The
efficient frontier is usually a curve that starts at the global minimum variance portfolio and
extends outward to higher levels of expected return.

Global Minimum Variance Portfolio (indicated by a yellow star): The Global Minimum Variance
Portfolio is the portfolio with the lowest risk on the efficient frontier, and it is also the portfolio
with the lowest risk in the investment opportunity set. It does so by assigning weights to different
assets so that the overall portfolio has the lowest overall risk.

Q3
Systematic risk is the risk that affects the securities in the entire market and is caused by factors
outside the company that are not expected and controlled by the company. Factors such as
inflation rate, unemployment rate, exchange rate, natural disasters, and political factors are all
systemic risks, and systemic risks cannot be eliminated through decentralization. Unsystematic
risk is one that affects individual assets. Usually associated with a particular company. For
example, a company's CEO change, patent research and development and other factors.
Unsystematic risk can often be mitigated through diversification.
Investors should not expect to obtain extra returns for taking unsystematic risk because
unsystematic risk can be eliminated by diversification, that is to say, the market will only price
systemic risk, and unsystematic risk will not be priced.

Q4
CAPM (Capital Asset Pricing Model) is a theoretical model used to estimate the relationship
between asset expected return and risk. The formula of the CAPM model is E(r)=rf+β*(rm-rf), E(r)
is the expected rate of return of the security, rf is the risk-free interest rate, rm is the market rate
of return, and β is a measure of market risk . A single asset measures its systematic risk relative to
the market portfolio M (β is 1.0) through the β coefficient. The expected rate of return calculated
by CAPM is the consensus expected rate of return on an asset in the market.
The image representation of CAPM is SML,
The horizontal axis is the beta coefficient, and the vertical axis is the expected return. Assets on
the SML line are reasonably priced. If it is higher than the SML line, it means that the asset is
undervalued and should be bought; if it is lower than the SML line, it should be sold.

The model is based on several assumptions, summarized as follows:

1. Investors' utility is a function of wealth, and they seek to maximize wealth. They can predict
the probability distribution of investment returns and express risk using the variance or standard
deviation of returns.
2. Investors follow Markowitz's theory of asset selection and treat estimates of expected return,
variance, and covariance as exact. They follow the principle of dominance, choosing securities
with higher yields at the same level of risk, and securities with lower risks at the same level of
yield.
3. Investors are free to borrow or lend funds at risk-free rates.
4. Perfect market, no market friction.
These assumptions form the theoretical basis of the CAPM model, which enables investors to
measure and predict an asset's expected return in terms of systematic risk.
However, these strict assumptions of the CAPM create certain limitations, as follows:
1. Assumptions do not match reality:
a. Transaction costs, information costs, and taxes are real in the real world
b. In reality, it is difficult for investors to have homogeneous expectations.
c. Investors Difficult to Borrow at Risk-Free Rates
3. The beta coefficient comes from historical data, and there is no guarantee that the future beta
will still be consistent with the past
4. In reality, risk-free assets and market portfolios may not exist.