Which of the following scenarios would encourage a company to use short-term loans to retire its 10-year bonds that have 5 years until maturity?

Answer (C) is correct. If interest rates have declined, refunding with short-term debt may be appropriate. The bonds pay a higher interest rate than the new short-term debt. Assuming that rates continue to fall, the short-term debt can itself be refunded with debt having a still lower interest charge. The obvious risk is that interest rates may rise, thereby compelling the company to choose between paying off the debt or refunding it at higher rates.