Answer the following concept questions. Explain your answers briefly.

(a) Imagine that the yield curve is currently flat. The Treasury announces that they will no longer issue securities with maturities longer than two years. As a result, long-term government bonds will be refinanced using only relatively short-term debt. If the "market segmentation theory" of the yield curve is correct, what will happen to the slope of the yield curve as a result of this policy change? If the "preferred habitat" theory holds, what will happen? Explain briefly.

(b) True, False, or Uncertain and Explain. According to the "liquidity preference theory" of the yield curve, if the yield curve is flat, rates investors expect to be available in the future are the same as current rates

(c) IO/PO: As a portfolio manager responsible for the assets of a medium sized municipality, you get the following sales pitchfrom a broker you recently met: "Take a look at these inverse floater IOs (Interest Only mortgage-backed securities)that just came in! The yield looks good,and with the inverse floater, the rate you receive increases when interest rates decline, so your normal prepayment risk is hedged." Do you agree that you would be hedged? Briefly explain why or why not.

*this is fixed income&derivatives analysis term project