(b) The requirement is to identify the appropriate hedging
strategy. Answer (b) is correct because by selling Treasury
notes for delivery in the future, the company can hedge increases
in short-term interest rates. If interest rates increase, the value of
the Treasury notes will decline, resulting in a gain to the company.
If the hedge is effective, the gain will offset the increase in
the company’s interest costs. Answer (a) is incorrect because
buying Treasury notes would put the company at greater risk
with respect to increases in interest rates. Answer (c) is incorrect
because buying an option on Treasury bonds would hedge a
decline in interest rates. Answer (d) is incorrect because an option
allows the purchaser the option, but not the obligation, to
purchase Treasury bonds. Therefore, selling options would not
be effective at hedging increases in interest rates.