1.

4 Bangko Sentral
ng Pilipinas,
monetary policy, and
interest rates
Bangko Sentral ng Pilipinas,
monetary policy, and interest rates
•  1.4.1 Structure of the Bangko Sentral
ng Pilipinas
•  1.4.2 Tools of monetary policy
•  1.4.3 BSP reserves, money supply and
interest rates
•  1.4.4 Updates on cryptocurrency per
BSP
Bangko Sentral ng Pilipinas
(BSP)
•  central bank of the Republic of the
Philippines
•  established on 3 July 1993 pursuant to
the provisions of the 1987 Philippine
Constitution and the New Central
Bank Act of 1993
•  enjoys fiscal and administrative
autonomy from the National
Government in the pursuit of its
mandated responsibilities
 BSP Objectives
•  The BSP’s primary objective is to
maintain price stability conducive to a
balanced and sustainable economic
growth (Republic Act 7653).

•  The BSP also aims to promote and

preserve monetary stability and the
convertibility of the national currency.
Why do we want Price Stability?
•  supports economic growth
•  allows households and businesses to plan
ahead and arrive at better informed
decisions about their consumption,
investment, savings and production needs
•  promotes income equality by protecting the
purchasing power of the poor who often do
not have assets to hedge against inflation
 BSP Functions
1.  Liquidity Management- formulates and
implements monetary policy aimed at
influencing money supply
2.  Currency issue- exclusive power to issue
the national currency
3.  Lender of last resort- extends discounts,
loans and advances to banking institutions
4.  Financial supervision- supervises banks
and exercises regulatory powers over non-
bank institutions performing quasi-banking
functions
 BSP Functions
5.  Management of foreign currency reserves-
maintain sufficient international reserves to
meet any foreseeable net demands for
foreign currencies
6.  Determination of exchange rate policy-
determines the exchange rate policy of the
Philippines
7.  Other activities- functions as the banker,
financial advisor and official depository of
the Government, its political subdivisions
and instrumentalities and government-
owned and -controlled corporations
Structure of the BSP
Inflation Targeting Framework
•  focused mainly on achieving a low and
stable inflation
•  entails the announcement of an explicit
inflation target that the BSP promises to
achieve over a given time period
•  current target at 3 percent ± 1 percentage
point for 2020-2022
•  target serves as a guide for the public's
expectations about future inflation,
allowing them to plan ahead with greater
certainty
 Money Supply Targe/ng vs. Interest Rate
Targe/ng

Interest Interest MS’ MS

Rate Rate

MS
i’=8% iT = 6%
MD’
i*=6%
i’’= 5% MD
i’’=4% MD’
MD MD’’
MD’’
MS Quantity of Money Quantity of Money
 Monetary Policy
•  a set of measures or actions implemented by the
central bank to affect the supply of money and
credit in the economy
1.  Contractionary – to reduce liquidity in financial system
2.  Expansionary – to increase liquidity / funds in market
•  The adoption of inflation targeting framework of
monetary policy in January 2002 is aimed at
achieving this objective.
•  Other countries using inflation targeting are
Australia, Canada, Finland, Sweden, New
Zealand, the United Kingdom, Israel, Brazil, Chile
and Thailand
Monetary Policy Instruments
•  Primary: overnight reverse repurchase
(RRP) or borrowing rate
•  RRP rate is the rate at which the BSP
borrows money from commercial banks
within the country
•  raises or reduces its overnight RRP rate
depending on the BSP’s assessment of
the outlook for inflation and GDP growth
(e.g. perceives inflation forecast to
exceed target, increase RRP to reduce
supply)
Monetary Policy Instruments
•  Other monetary policy instruments
–  encouraging/discouraging deposits under the
term deposit auction facility (TDF);
–  standing liquidity facilities, namely, the overnight
lending facility (OLF) and the overnight deposit
facility (ODF);
–  adjusting the rediscount rate on loans extended
to banking institutions on a short-term basis
against eligible collateral of banks' borrowers;
–  outright sales/purchases of the BSP's holding of
government securities
–  increasing/decreasing the reserve requirement;
Reserve requirement (RR)
•  refer to the percentage of bank deposits and deposit
substitute liabilities that banks must set aside in
deposits with the BSP which they cannot lend out, or
where available through reserve-eligible government
securities
•  vary across bank types and liabilities
•  Series of reduction in RR was made in 2019 in line with
the BSP’s broad financial sector reform agenda to
promote a more efficient financial system by lowering
financial intermediation costs.
•  Effective April 2020, the reserve requirement is 12%
BSP Balance Sheet
As of December 31
 Tools Monetary Policy
Contrac(onary Expansionary
Overnight reverse Increase Reduce
repurchase rate
(RRP)
Overnight deposit Encourage deposit Discourage deposit
facility (ODF)
Rediscount rate on Increase Decrease
loans
Reserve Increase Decrease
requirement
BSP holdings of Outright sales Outright purchase
government
securi/es
 Changes of Money Supply to Interest Rate
and Infla/on rate

Monetary Money Interest Spending Infla(on

Policy Supply rate rate
Expan/onary Increase Decrease Increase Higher

Contrac/onary Decrease Increase Reduce Lower

Philippine Infla/on rates
Oct 2019-Sep 2020
 Problems in Conducting Monetary
Policy
•  Significant time lags involved between policy
implementation and effect
•  Supplying money to lenders does not guarantee
they will lend
•  Lowering interest rates or supplying money are
attempts to stimulate demand, but they may not
work
–  Problems in consumer confidence
–  High unemployment
–  High debt levels
Differentiating cryptocurrency
•  Cryptocurrency is a type of VC that uses cryptography –
carrying-out transactions in a decentralized manner by a
group of users.
–  A virtual currency (VC) is a type of digital “currency”
created by a community of online users, is stored in
electronic wallets (e-wallets), and generally transacted
online
–  E-money is a digital representation of fiat currency used
to electronically transfer monetary value and is
convertible thru licensed e-money issuers or e-money
agents
•  Hence, its (exponential increase in) value depends on (wide
consent) the number of users willing to accept it as payment
Features and use of VC
Pros Cons
•  Easy to setup •  Vola/lity
•  Pseudo anonymous •  Security
•  Transparent •  Non-repudiable
•  Low transac/on fees •  Poten/al use in illegal
•  Fast ac/vi/es
BSP regulatory approach on
cryptocurrency
•  Cryptocurrencies are not backed by
any central authority; hence, are not
legal tender
•  BSP does not endorse VCs as a
currency or an investment instrument
due to its highly-speculative and risky
nature
•  Rather it aims to address its risks as it
intersects with the financial system
BSP Circular 944 (Feb 6, 2017)
•  Guidelines for Virtual Currency Exchanges
(VCEs)
•  Covers VCEs in the Philippines offering
services or engaging in activities that
provide facility for the conversion or
exchange of fiat currency to VC or vice versa
•  VCEs must register with BSP
•  Large value payout (Php500,000 and above
- any single transaction) shall be via check
payment or direct deposit to bank account
List of Remittance and Transfer Companies (RTC) with Virtual
Currency (VC) Exchange Service
As of 20 June 2020
1.  ABA GLOBAL PHILIPPINES INC
2.  ATOMTRANS TECH CORP.
3.  BETUR INC (DOING BUSINESS UNDER THE NAME AND STYLE
OF COINS.PH)
4.  BEXPRESS INC.
5.  BLOOMSOLUTIONS INC.
6.  COINVILLE PHILS. INC.
7.  ETRANSS REMITTANCE INTERNATIONAL CORP.
8.  FINCHAIN TECHNOLOGY INC.
9.  FYNTEGRATE, INC. [doing business under the name of
Philippine Digital Asset Exchange (PDAX)]
10.  MONEYBEES FOREX CORPORATION
11.  PHILIPPINE DIGITAL FINANCIAL ASSETS EXCHANGE INC.
12.  REBITTANCE INC
13.  TELCOIN CORP.
14.  ZYBI TECH INC. (doing business under the name and style of
JUANCASH)
15.  WIBS PHP INC.
16.  IREMIT INC
1.4 Bangko Sentral ng Pilipinas, monetary policy, and
interest rates

•  1.4.1 Structure of the Bangko Sentral

ng Pilipinas
•  1.4.2 Tools of monetary policy
•  1.4.3 BSP reserves, money supply and
interest rates
•  1.4.4 Updates on cryptocurrency per
BSP
 End of 1.4
•  Questions?
KNOWLEDGE
CHECK
 KC: True or False
1.  As wealth and income increase, funds suppliers are
more willing to supply funds to markets thus
increasing interest rates.
2.  All other things equal (ceteris paribus), households
generally supply more funds to the markets as their
income and wealth increase,. 
3.  Convertible bonds will normally have higher
promised yields than straight bonds of similar terms
and quality. 
4.  The term structure of interest rates is the relationship
between interest rates on bonds similar in terms
except for maturity.
5.  A decrease in reserve requirement leads to a
decrease in the money supply. 
 KC: True or False
6.  A bond with an 11 percent coupon and a 12 percent
required return will sell at a premium to par. 
7.  If interest rates increase, the value of a fixed income
contract decreases and vice versa. 
8.  If you earn 0.5 percent a month in your bank
account, this would be the same as earning a 6
percent annual interest rate with annual
compounding. 
9.  BSP enjoys fiscal and administrative autonomy from
National Government in the pursuit of its mandated
responsibilities.
10. The greater a security's coupon, the lower the
security's price sensitivity to an interest rate change,
ceteris paribus. 
 KC: Multiple Choice
11. The _____ convexity of a security, the ___ interest
rate protection against rate increase and _____
potential gains if interest rate falls.
A. smaller, less, greater
B. smaller, more, greater
C. greater, less, smaller

D. greater, more, greater

 KC: Multiple Choice
12. If the interest rates on all bonds fall from 6 to 5
percent over the course of the year, which bond
would you prefer to hold?

A. A bond with 1 year to maturity

B. A bond with 5 year to maturity

C. A bond with 10 year to maturity

D. A bond with 20 year to maturity

 KC: Multiple Choice
13. A decrease in reserve requirements could lead to
an
A. increase in bank lending.

B. increase in the money supply.

C. increase in bank lending and an increase in the discount rate.

D. increase in bank lending and an increase in the money

supply.
 KC: Multiple Choice
14. A six-year maturity bond has a five-year duration.
Over the next year maturity will decline by one year
and duration will decline by
A. less than one year.
B. more than one year.

C. one year.

D. N years.
 KC: Multiple Choice
15. A bond that you held to maturity had a realized
return of 8 percent, but when you bought it, it had
an expected return of 6 percent. If no default
occurred, which one of the following must be true?

A. The bond was purchased at a premium to par.

B. The coupons were reinvested at a higher rate than expected

C. The required return was greater than 6 percent.

D. The coupon rate was 8 percent
 KC: Multiple Choice
16. IBM creates and sells additional stock to the
investment banker Morgan Stanley. Morgan Stanley
then resells the issue to the U.S. public. This
transaction is an example of a(n)

A. primary market transaction.

B. asset transformation by Morgan Stanley.

C. money market transaction.

D. foreign exchange transaction.
 KC: Multiple Choice

17. Refer to graph above, inflation causes the demand curve for
loanable funds to shift to the ___ and causes the supply curve
to shift to the ___.
A. Right, left
B. Right, right
C. Left, left
D. Left, right
 KC: Multiple Choice
18. Convexity arises because:

A. bonds pay interest semiannually.

B. present values are a nonlinear function of interest rates.

C. duration is an increasing function of maturity.

D. coupon changes are the opposite sign of interest rate

changes.
 KC: Multiple Choice
19. Due to the pandemic, consumer spending is
expected to drop, generating concerns that inflation
may substantially decrease. If the BSP wishes to
ensure that inflation is within target, the BSP could:

A. Increase reverse repurchase rate

B. Increase rediscount rate on loans

C. Buy treasury securities to government dealers

D. Increase reserve requirement

 KC: Multiple Choice
20. Which of the following bond terms are generally
positively related to bond price volatility?
I. Coupon rate
II. Maturity
III. YTM
IV. Payment frequency
A. II only

B. I and III only

C. II and III only

D. II and IV only
 KC: Problems
21. An investor requires a 2.5% increase in purchasing
power in order to induce her to lend. She expects
inflation to be 2.1% next year. The nominal rate she
must charge is about ___?

22. The spot one-year and two-year zero-coupon

Treasury security rates were 4.90% and 5.35%,
respectively. Using unbiased expectations theory,
calculate the one-year forward rates on zero-coupon
Treasury bonds for year two.
 KC: Problems
23. An annual payment bond with a P1,000 par has a
7% quoted coupon rate, a 7% YTM, and six years
to maturity. What is the bond’s duration?

24. A corporate bond returns 12.44% of its cost (in

PV terms) in the first year, 12.05% in the second
year, 11.60% in the third year and the remainder
in the fourth year. What is the bond’s duration in
years?
 KC: Problems
25. Harlett Company has an issue of P1,000 par value
bonds with a 12% coupon. The issue pays interest
semiannually and has 5 years remaining to its
maturity date. Bonds of similar risk are currently
selling to yield a 10% rate of return. What is the
value of these Harlett Company bonds?

26. An insurance company is analyzing a 7-year P1,000

par value bond with 13% coupon rate that is paid
annually. The company is using duration as its
measure of interest rate risk. Calculate the duration
of this bond if YTM is 15%.
 KC: Problems
27. The Finance section of the newspaper today reports that
the rate on three-year Treasury securities is 6.80% and
the rate on four-year Treasury securities is 7.25%. The
one-year interest rate expected in three years is 6.45%.
According to liquidity premium theory, what is the
liquidity premium on the four-year Treasury security?

28. A particular security’s equilibrium rate of return is 9.50%.

For all securities, the inflation risk premium is 2.3% and
the real risk-free rate is 4%. The security’s liquidity risk
premium is 1.20% and maturity risk premium is 0.90%.
There is no special covenants. Calculate the security’s
default risk premium
 KC: Problems
29. Suppose we observed reported interest rates of
7.25%, 7.5%, 7.75%, and 8% for three-year, four-
year, five-year, and six-year Treasury notes,
respectively. According to the unbiased expectations
theory, what are expected one-year rates for year 6?

30. A bond that pay coupon annually has duration of

8.22 years and convexity of 11.7. Compute for the
predicted percentage price change (using price
prediction equation with convexity adjustment) if
expected return decreases from 9% to 8.4%.