Final answer:
The 'Efficient Market hypothesis' is a cornerstone of modern finance theory, suggesting that stock prices always reflect all relevant information. Other key concepts include the Random Walk Theory and the Capital Asset Pricing Model, which relate to the unpredictable movement of stock prices and the relationship between investment return and risk, respectively. Capital markets play an essential role in allocating financial resources between firms seeking capital and households looking for investment opportunities. The correct option is a.
Step-by-step explanation:
The correct answer to the question "The ______ hypothesis remains one of the cornerstones of modern finance theory." is a) Efficient Market hypothesis. This theory suggests that it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the Efficient Market Hypothesis, stocks always trade at their fair value, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices.
As for the various theories in modern finance, the Random Walk Theory asserts that the prices of securities in financial markets move randomly, which means that the past movement or trend of a stock price or market cannot be used to predict its future movement. Similarly, the Capital Asset Pricing Model (CAPM) offers an equation that quantifies the relationship between expected return on investment and risk.
Understanding how capital markets transform financial capital involves recognizing that firms raise financial capital to fund their operations and growth, while households invest in search of a desirable blend of return, risk, and liquidity. These capital markets are crucial as they are the platform where supply meets demand for financial resources.