The correct answer is C. When short-term rates are negative, the financial analyst sets the rate to zero. This is because negative short-term interest rates can arise in models where the terminal distribution of interest rates follows a normal distribution. However, the existence of negative interest rates does not make much economic sense, as market participants would not lend cash at negative rates when they can hold cash and earn a zero return. To address this, one can set all negative interest rates to zero, which localizes the change in assumptions to points in the distribution corresponding to negative rates and preserves the original rate tree for all other observations. Adjusting the risk-neutral probabilities or increasing the volatility would alter the dynamics across the entire range of interest rates and is not an optimal approach. Despite the potential for negative rates, the model can still be useful in certain situations, particularly when the valuation depends more on the average path of the interest rate, such as in valuing coupon bonds.