Which of the following is a method to manage interest rate risk?

Employing financial derivatives is an effective method to manage interest rate risk because these instruments can be specifically designed to hedge against fluctuations in interest rates. By utilizing derivatives such as interest rate swaps, options, or futures, institutions can lock in interest rates or offset the potential impact of interest rate changes on their cash flows.

For instance, a company expecting to borrow funds in the future may use an interest rate swap to exchange a variable interest rate for a fixed rate, thereby securing predictable interest expenses regardless of future market conditions. This trade-off allows organizations to stabilize their financing costs and reduce uncertainty associated with interest rate movements.

In contrast, other options such as real estate investments, holding cash reserves, and investing in mutual funds may not effectively address the specific risk associated with changing interest rates. Real estate investments, while potentially offering appreciation and rental income, are subject to market risks beyond just interest rates. Holding cash reserves provides liquidity but does not protect against interest rate changes affecting borrowing costs or investment yields. Mutual funds may offer diversification but do not specifically target interest rate risk and can be influenced by interest rate changes based on their underlying asset compositions.