Optimum portfolio construction of IT sector using capital asset pricing model

Capital Asset Pricing Model (CAPM) is based on the rational behavior of investors. Rational behavior implies that investors are risk averse by nature and always prefer extra returns known as risk premium for the risk assumed by them as compared to the returns expected from risk-free avenues. Therefore an optimum portfolio for an investor is the one which provides optimum level of return for the assumed by the investor. CAPM provides a framework for establishing a relationship between risk and expected returns for different investment avenues. CAPM follows that investors have the freedom either to make the investment in risk-free avenues or in risky avenues or a mix of these two avenues. CAPM model identifies the portfolios as undervalued, efficient or overvalued with the help of efficient frontier. Undervalued security/portfolio is the one which generates returns more than the expected return for the given level of risk.