Information:

Your team has been asked to provide analysis for and adviceto an Australian-based, high net worth (HNW) client, who is considering the purchase of a structured financial product (SFP) issued by a US-based investment bank. Your client wishes to be advised on the financial risks to which they would be exposed in association with investment in this SFP.

You have the following information on this SFP,

The face value of the SFP is USD25,000

The payoff is due in two years

Payoff at maturity is max{USD25,000, [(SP500_T/SP500₀)x USD25,000]}

SP500_Trepresents thevalue of the S&P 500 Indexat maturity of the investment product and SP500₀thevalue of the S&P 500 Indexat inception of the SFP (i.e., the end of June 2019)

Discount rate (% p.a.) = 2-yr spot + 2-yr spread - 120 bp

2-yr spot is the 2-year spot rate on US Government liabilities, 2-yr spread is the difference between the yield on 2-year US Treasury Bonds and US BBB-rated corporate bonds

The 2-yr spread at the end of June 2020 was 1.1 per cent, while the historical default rate on BBB-rated corporate bonds is 0.9 per cent

You also have other information on key financial variables (as of the end of June 2020, the date you will assume as 'now/today' for undertaking your calculations):

You have been provided with time series data in the form of the yield on U.S. government bonds (% p.a.), the USD/AUD exchange rate, and the value of the S&P 500 Index (see the spreadsheet provided with the AssignmentBANK 3003 Risk Management Case 1 Data.xlsx). USD/AUD represents the US dollar/Australian dollar exchange rate (price of AUD 1 in USD).

Note: Not all information given above can be used in this your calculations. Some are not appropriate to use and/or incomplete. A part of the assessment is to identify which pieces of information/data should be used.

The Task

brief report in which your team:

(a)Identifies the financial risks to which your HNW client would have exposure if invested in this SFP.(Hint:you should tabulate the different financial risks to which an investor would be exposed if they bought the SFP and the sources of each financial risk.)

(b)Quantitatively analyse the risk factors for which you are given data. Analyse individual risk factors and the relationship between these risk factors. (Hint: For quantitative analyses, you should focus on the characteristics of the risk factors. Quantitatively establish how a risk factor affects the SFP is not strictly required. At minimum, you should calculate the mean, standard deviation and correlations of the risk factors.)

(c)Discuss how each risk factor may impact the return of the SFP, including the risk factors you have not quantitatively analysed. Given your analysis of the data available to you, which financial risks do you think are likely to be of most concern to the client? Provide a brief justification/support for your answer.