Final answer:
The statement is (Option a) true; the Capital Asset Pricing Model is the primary theory that links risk with expected rate of return in financial markets.
Step-by-step explanation:
True, the basic theory linking risk and return is indeed the Capital Asset Pricing Model (CAPM). CAPM describes the relationship between the expected rate of return and risk within financial markets. According to this model, investors expect to be compensated with a higher rate of return when they take on higher-risk investments. This expected rate of return includes compensation for the time value of money (represented by the risk-free rate) as well as a risk premium based on the level of market risk associated with the investment. High-risk investments typically have a wide range of potential payoffs, meaning the actual rate of return can vary significantly from the expected rate of return over time.
In practice, if an investment becomes more risky or the expected return decreases, financial capital may flow from that investment to a less risky one. This shift is reflected in the supply curve for financial capital; the supply for the riskier investment A would shift to the left, while the supply for the less risky investment B would shift to the right. This dynamic between rates of return and risk is one of the fundamental principles in finance and investment decision-making.