Pointing to a girl in a photograph, a man says to his friend, “She is the granddaughter of the elder…

The correct choice is: “Niece”

The elder brother of the man’s father is the man’s uncle. The uncle’s granddaughter is the daughter of the uncle’s child, that is, the daughter of the man’s cousin. In reasoning tests a cousin’s daughter is treated as a niece (strictly, a first cousin once removed), so the girl is the man’s niece.

She cannot be his sister (she is two generations below his uncle, one below the man), his aunt (that would be a generation above him), or his sister-in-law (no marriage is involved).