Final answer:
The market segmentation theory asserts that the yield curve is shaped by the specific maturity preferences of investors and financial institutions, rather than purely by interest rate expectations or demand for long-term funds. Elasticity of savings affects the supply curve, while other factors can shift the demand curve in financial markets.
Step-by-step explanation:
The market segmentation theory posits that the yield curve reflects the maturity preferences of different investors and financial institutions, rather than being solely dependent on expectations of future interest rates or demand for long-term borrowing. As such, option 3) 'the yield curve reflects the maturity preferences of financial institutions and investors' is the correct description of the market segmentation theory. In financial markets, the concept of elasticity of savings illustrates how sensitive the quantity of savings is to changes in interest rates, affecting the supply curve for financial capital. An increase or decrease in savings will not necessarily lead to a specific shape of the yield curve; instead, it will cause a movement along the supply curve.
Conversely, factors such as changes in economic confidence or needs for borrowing can shift the entire demand for financial capital, influencing the overall market rates. The yield curve itself can exhibit different shapes - normal (upward sloping), inverted (downward sloping), or flat - depending on the collective maturity preferences and expectations of the market participants at any given time.