a) Your bank is especially concerned about extreme adverse movements associated with the payoff of this SFP. Provide estimates on the potential exposure(s) associated with the payoff at maturity of the SFP.

Information: Your employer, an Australian-based investment bank, has issued a Structured Financial Product (SFP) to high net worth investors. You have been requested to determine the risk exposure to the bank and to hedge the market financial risks associated with the payoff at maturity on the SFP. You have the following information on this SFP, as well as other information on key financial variables: The face value of the SFP is USD25,000 The payoff is due in one year Payoff at maturity is max{USD25,000, [(SP500_T/SP500₀ )x USD25,000]} SP500_T represents the value of the S&P 500 Index at maturity of the investment product and SP500₀ the value of the S&P 500 Index at inception of the SFP (i.e., the end of June 2020) USD/AUD represents the US dollar/Australian dollar exchange rate (price of AUD 1 in USD) The discount rate for this SFP is the yield on the comparable U.S. government bond plus 200 basis points You have been provided with time series data (as of the end of June 2020, the date you will assume as now/today for undertaking your calculations) 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

(Hint 1: the exposure must relate to any amount in excess of USD25,000 in AUD that the investment bank may be required to pay out at maturity and should consider both likely payoffs and the probabilities of these payoffs.) (Hint 2: you should consider measures such as value-at-risk (VaR) to assist you in determining the exposure(s). You can ignore the time value of money for this part since we are exclusively talking about the payoffs at umaturity. Any proper attempts to further assess the extreme risk will be rewarded.)