The answer is correct.
C. a system-assigned managed identity in Azure AD should be created first to implement the principle of least privilege when creating a SQL Server Agent job that will rebuild indexes of the databases hosted on VM1.
With a system-assigned managed identity, Azure automatically creates an identity in Azure AD that is tied to the Azure VM instance. This allows you to grant the identity permissions to the specific resources that it requires, without having to manage credentials or rotate passwords.
Using a managed identity ensures that only the necessary permissions are granted to the job, which is in line with the principle of least privilege. The job can then use this managed identity to perform the required actions, such as rebuilding indexes.