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MODULE 2 PACKET
AE 18 – FINANCIAL MARKETS & INSTITUTIONS

MODULE 2 OVERVIEW:

Welcome to Module 2 – The Philippine Stock Exchange and the Bangko Sentral ng
Pilipinas

The module will let students appreciate the roles of the PSE and BSP in the country.
Understanding how and why exchange rates and interest rates change will be discussed as well
as the regulatory actions done by the aforementioned institutions. This module contains in-
lesson activity/quiz/assignment.

CONSULTATION HOURS:
Phone or Messenger: 3-4 PM Mondays | Thursdays
Virtual time: 6-7 PM Tuesdays I Fridays

MODULE 2 LEARNING OBJECTIVES:

By the end of this module, the students will be able to:

1. Familiarize the roles and functions of PSE and BSP.

2. Understand what foreign exchange and interest rates are.
3. Appreciate why financial institutions are regulated.

COURSE CONTENT FOR MODULE 2:

The Philippine Stock Exchange and the Bangko Sentral ng Pilipinas
ACTIVITY DESCRIPTION TIME TO
COMPLETE
Lecture discussion The Philippine Stock Exchange, Inc. 30 minutes
Lecture discussion Bangko Sentral ng Pilipinas 1 hour
Lecture discussion Exchange Rates 30 minutes
Lecture discussion Interest Rates 30 minutes
Activity ACTIVITY 2 30 minutes
Quiz Summative quiz for module 1 30 minutes
Deadline for module 2 output: 21 November 2020, at strictly 5:00 in the afternoon

LECTURE DISCUSSIONS

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Module 2 – The Philippine Stock Exchange and the Bangko Sentral ng Pilipinas

The Philippine Stock Exchange, Inc.

1. What is the Philippine Stock Exchange, Inc.?

The Philippine Stock Exchange, Inc. (PSE or Exchange) is a private non-profit and non-stock
organization created to provide and maintain a fair, efficient, transparent and orderly market for
the purchase and sale of securities such as stocks, warrants, bonds, options and others.

2. What is the role of the PSE?

The PSE bring together companies which aim to raise capital through the issue of new securities.
Through the listing of their share in the stock exchange, companies can have easier access to
funds. Raising new capital through an additional public offering is easier and less expensive
when the company is already listed in the Exchange. Therefore, the PSE plays a vital role in the
financing of productive enterprises that use the funds for growth and expansion of new jobs. It
is therefore essential to the growth of the Philippine economy.

Furthermore, the PSE facilitates the selling and buying of the issued stocks and warrants. It
provides a suitable market for the trading of securities to individuals and organizations seeking
to invest their saving or excess funds through the purchase of securities.

Apart from these functions, the PSE has committed itself to (a) protecting the interest of the
investing public; and (b) developing and maintaining an efficient, fair, orderly and transparent
market.

Efficient. This means that orders are executed and transactions are settled in the fastest
possible way. Some reforms have been instituted or are being carried out by the PSE to make
the market more efficient, such as:

· Installation of fully automated trading system;

· Installation of computer trading terminals in cities outside Metro Manila to encourage the entry
of provincial investors; and creation of a central cleaning and depository system to mobilized
stock certificates and allow transfer of shares and funds by book entry.

Fair. This means that the PSE assures that no investor will have an undue advantage over
another, market player in trading by manipulating prices and engaging into insider trading.
Insider trading is the act of buying or selling a particular stock based on certain privileged
information which is not available to the public. As such it is considered as illegal and prohibited
by the PSE.
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Market Transparency. Transparency proceeds from the assumption that the investor can only
make informed and intelligent information about the particular sock he wants to buy. The PSE
requires listed companies to disclose timely, complete and accurate material information to the
Exchange and the public on a regular basis. Such information would include stock price
information, corporate conditions and developments which tend to affect stock prices like
dividend, mergers and joint ventures, and the like.

3. How did the PSE begin?

The Philippine Stock Exchange began 70 years ago, on August 8, 1927. Five Manila based
businessmen, namely W. Eric Little, Gordon W. Mackay, John J. Russell, Frank W. Wakefield
and W.P.G. Elliot felt that increasing trading activity would stimulate the business atmosphere.
They got together, put their plan into action and founded the Manila Stock Exchange, the first
Stock Exchange in the Philippines and one of the oldest in the Far East. It was originally located
in downtown Manila, transferred in1970 to its own three-story building in Binondo, and then
moved to Pasig in 1992.

On May 27, 1963, the Makati Stock Exchange was organized by five other businessmen.
These were Hermenegildo B. Reyes, Bernard Gaberman, Eduardo Ortigas, Aristeo Lat and
Miguel Campos. It started it operations on November 16, 1965 and was located in Makati, then
emerging center for finance.

So, for about thirty years the Philippines had toe stock exchanges, the Manila Stock
Exchange (MSE) and the Makita Stock Exchange (MKSE). Although the two exchanges
remained as separate entities, they basically were trading the same listed issues.

The existence of two stock exchanges in one country caused confusion among (prospective)
investors because the two bourses had different policies, different members and, last but not the
least, different stock prices for the same listed stocks.

The idea to unite the two exchanges and have it managed by a professional group emerged
and was attained when the Philippine Stock Exchange, Inc. was incorporated on July 14, 1992.
To further consolidate logistics and to hasten the development of a more efficient capital market,
the leaders of both bourses agreed to unify on December 23, 1993 under the PSE.

On March 4, 1994 the Securities and Exchange Commission granted the Philippine Stock
Exchange, Inc. its license to operate as a securities exchange in the country stating that “a
unified Stock Exchange is vital in developing a strong capital market and a sustainable economic
growth.” It simultaneously canceled the licenses of the MSE and the MKSE.

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The Philippine Stock Exchange is currently the only organized exchange in the Philippines
licensed for trading stocks and warrants.

4. How is the PSE managed?

One of the non-broker members heads the Exchange, appointed by the Board as the
President and Chief Executive Officer (CEO). The President, along with the professional
management of the PSE, executes the policy determinations of the Board and ensures that the
Exchange is operating efficiently. It carries out for the members, listed companies and exchange
system to ensure that stock market operation in the Philippines is kept within the standards of
fairness, transparency, professionalism, trust and integrity. Additionally, it sets the rules and
regulations of the Exchange, monitors its implementation and ensures that the investing public
is given protection in the transaction of their investments. The Exchange also ensures that all
legal requirements under the Corporation Code and the Revised Securities Act are met.

5. How is the PSE organized?

The PSE”S organizational structure holds five (5) groups, namely: Listings & Disclosure Group,
Compliance & Surveillance Group, Operations/Automated Trading Group, Finance and
Investment Group and Business Development & Information Group along with the Office of the
General Counsel, Membership Department and Human Resources Management Department,
which reports directly to the Office of the President.

BSP: OVERVIEW OF FUNCTIONS AND OPERATIONS

In the Philippines, the banking sector is pretty wide and many banking and non-banking
institutions offer a whole gamut of services.

There are 36 commercial banks, 492 rural banks, 57 thrift banks, 40 credit unions, and around
6000 plus non-banking institutions in the Philippines.To control and direct these banks, the
Bangko Sentral ng Philipinas was established. In the month of July 1993, this central authority
was founded. It was created as per the Philippine Constitution, 1987 and also as per the New
Central Bank Act, 1993. The Bangko Sentral ng Philipinas was established to regulate all the
banks and also help these banks informing the right policies.

As per Moody’s Analytics, the Philippines’ banking sector is looking quite positive. The most
important factor for which Moody’s Analytics has been very positive about the banking sector of
the Philippines is the way the central bank of Philippines has curbed the effect of inflation over
the years.

The Bangko Sentral ng Pilipinas (BSP) is the central bank (bank of all banks) of the Republic of
the Philippines. It was established on 3 July 1993 pursuant to the provisions of the 1987
Philippine Constitution and the New Central Bank Act of 1993.
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OBJECTIVES

The BSP’s primary objective is to maintain price stability conducive to a balanced and
sustainable economic growth. The BSP also aims to promote and preserve monetary stability
and the convertibility of the national currency.

RESPONSIBILITIES

The BSP provides policy directions in the areas of money, banking and credit. It supervises
operations of banks and exercises regulatory powers over non-bank financial institutions with
quasi-banking functions.
Under the New Central Bank Act, the BSP performs the following functions, all of which relate
to its status as the Republic’s central monetary authority.

•Liquidity Management. The BSP formulates and implements monetary policy aimed at
influencing money supply consistent with its primary objective to maintain price stability.

•Currency issue. The BSP has the exclusive power to issue the national currency. All notes
and coins issued by the BSP are fully guaranteed by the Government and are considered legal
tender for all private and public debts.

•Lender of last resort. The BSP extends discounts, loans and advances to banking institutions
for liquidity purposes.

•Financial Supervision. The BSP supervises banks and exercises regulatory powers over non-
bank institutions performing quasi-banking functions.

•Management of foreign currency reserves. The BSP seeks to maintain sufficient

international reserves to meet any foreseeable net demands for foreign currencies in order to
preserve the international stability and convertibility of the Philippine peso.

•Determination of exchange rate policy. The BSP determines the exchange rate policy of the
Philippines. Currently, the BSP adheres to a market-oriented foreign exchange rate policy such
that the role of Bangko Sentral is principally to ensure orderly conditions in the market.

•Other activities. The BSP functions as the banker, financial advisor and official depository of
the Government, its political subdivisions and instrumentalities and government-owned and -
controlled corporations.

EXCHANGE RATE

How is the exchange rate defined?

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The exchange rate is the price of a unit of foreign currency in terms of the domestic
currency. In the Philippines, for instance, the exchange rate is conventionally expressed as the
value of one US dollar in peso equivalent. For example, US$1 = P50.00.
In every exchange rate quotation, therefore, there are always two currencies involved.

Why is the exchange rate important?

The exchange rate is important for several reasons:

 It serves as the basic link between the local and the overseas market for various goods,
services and financial assets. Using the exchange rate, we are able to compare prices of
goods, services, and assets quoted in different currencies.

 Exchange rate movements can affect actual inflation as well as expectations about
future price movements. Changes in the exchange rate tend to directly affect domestic
prices of imported goods and services. A stronger peso lowers the peso prices of
imported goods as well as import‐intensive services such as transport, thereby lowering
the rate of inflation. For instance, an increase in the value of the peso from US$1:P50 to
US$1:P40 will lower the price of a $1 per liter gasoline from P50.00 (P50 X $1) to P40.00
(P40X $1).

 Exchange rate movements can affect the country’s external sector through its impact on
foreign trade. An appreciation of the peso, for instance, could lower the price
competitiveness of our exports versus the products of those competitor countries
whose currencies have not changed in value.

 The exchange rate affects the cost of servicing (principal and interest payments) on the
country’s foreign debt. A peso appreciation reduces the amount of pesos needed to buy
foreign exchange to pay interest and maturing obligations.

How is the exchange rate determined?

Under the system of freely floating exchange rates, the value of the dollar in terms of the peso
is determined in the interbank foreign exchange market (by the forces of supply and demand
just like any commodity or service being sold in the market). Under a fixed exchange rate system,
a par value rate is set between the peso and the dollar by the central bank.
The par value may be adjusted from time to time.

(Exchange Rate, March 2020, Department of Economic Research 2, Bangko Sentral ng

Pilipinas)

How does the exchange rate change?

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Under a floating exchange rate system, if more dollars are demanded than are offered, the price
of the dollar in terms of the peso will tend to increase; that is, it will cost more pesos to acquire
one dollar. If, on the other hand, more dollars are offered than are demanded, the value of the
dollar in terms of the peso will tend to decrease; that is, it will cost less pesos to acquire one
dollar. In contrast, under a fixed rate system, a change in the exchange rate is effected through
an official announcement by the central bank.

What is the country’s foreign exchange policy?

At present, the country's exchange rate policy supports a freely floating exchange rate
system whereby the Bangko Sentral ng Pilipinas (BSP) leaves the determination of the
exchange rate to market forces. Under a market‐determined exchange rate framework, the BSP
does not set the foreign exchange rate but instead allows the value of the peso to be determined
by the supply of and demand for foreign exchange.

Thus, the BSP’s participation in the foreign exchange market is limited to tempering sharp
fluctuations in the exchange rate. On such occasions of excessive movements, the BSP enters
the market mainly to maintain order and stability. When warranted, the BSP also stands ready
to provide some liquidity and ensure that legitimate demands for foreign currency are
satisfied.

INTEREST RATES

What are interest rates?

Generally, interest rates are prices. These are the price paid for the use of money for a period
of time and are expressed as a percentage of the total outstanding balance that is either fixed
or variable. There are two ways by which interest rate can be defined: first, from the point of view
of a borrower, it is the cost of borrowing money (borrowing rate); and second, from a
lender’s point of view, it is the fee charged for lending money (lending rate).

How are interest rates classified?

The interest rates charged on borrowed funds are generally classified according to the tenor or
the maturity period: short‐term (less than one year); medium‐term (more than one year
but less than five years); and long‐term (more than five years).

Interest rates differ, depending on the type of instruments (e.g., traditional deposit instruments
like savings deposit, time deposit, and some demand or current accounts, and investment
instruments like bonds, securities) and on the tenor of investment.
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What are real interest rates?

Real interest rates are interest rates adjusted for the expected erosion of purchasing
power resulting from inflation. Real interest rates are what matter to households’ consumption
and firms’ investment decisions, which collectively constitute aggregate demand. Demand for
goods and services cannot be directly controlled by nominal interest rate. Instead, demand is
also affected by expected inflation.

Being the main supplier of bank reserves, a central bank can only set the short‐run
nominal policy rate, which serves as the benchmark for market interest rates. A central bank
cannot set the real interest rates because it cannot set inflation expectations. One may therefore
wonder how an adjustment in short‐run nominal interest rate can affect consumption and
investment decisions, which are carried out over a longer horizon. The answer lies in the fact
that central bank’s policy action can influence not only the market rates but also inflation
expectations.

Thus, by signaling its policy intent through nominal policy rate adjustment, the central bank can
affect the real return on funds faced by households and firms.

For example, a P1,000,000 investment with nominal 10 percent annual return will give
the investor at the end of the year P1,100,000, i.e., 1,000,000(1+.010). With 5 percent
annual inflation, the real value of the investment is P1,047,617, i.e., 1,100,000/(1+0.05).
The real return is therefore 4.8 percent. This is given by r = (i‐π)/(1+π) (where r is real interest
rate, i is nominal interest rate and π is inflation rate). At low rates of inflation, this can be
approximated by r=i‐π.

(Interest Rates, March 2020, Department of Economic Research/Department of Economic

Statistics 2, Bangko Sentral ng Pilipinas)

Can the BSP intervene so that banks will not charge very high lending rates?

The BSP’s past experience with rate‐setting made apparent the limitations of an
administratively fixed interest rate. For this reason, the BSP shifted to a market‐oriented
interest rate policy in 1983. The re‐imposition of rate ceilings or limits on the spread between the
T‐bill rate and lending rate will only introduce distortions in the credit market, including:

a) the pricing of credit outside of the fundamental issue of risk;

b) the exclusion of certain segments of the economy from the market;
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c) the need to also regulate other banking products and services; and
d) the increased burden on bank supervision.

After the Asian crisis, however, the Banker’s Association of the Philippines (BAP) decided
to implement a gentleman’s agreement to maintain a cap on the spread of bank lending rate of
up to a maximum of five (5) percent over the 91‐day T‐bill rate in the secondary market. A review
of the spread between the average monthly bank lending rate charged by commercial
banks (both high‐ and low‐end) and the 91‐day T‐bill rate showed that banks are generally
in compliance with the 500‐basis point cap.

Can the BSP set interest rate levels?

Yes, by law, the BSP can effectively set interest rates. Under the Usury Law (Act No. 2655, as
amended by P.D. 116), the Monetary Board can prescribe the maximum interest rates for loans
made by banks, pawnshops, finance companies and similar credit institutions, and to
change such rates whenever warranted by prevailing economic conditions. Moreover, the BSP
charter (R.A. No. 7653) allows the Monetary Board to take appropriate remedial measures
whenever abnormal movements in monetary aggregates, in credit or in prices endanger the
stability of the Philippine economy. Nevertheless, since 1983, the BSP has followed a market‐
oriented interest rate policy.

(Interest Rates, March 2020, Department of Economic Research/Department of Economic

Statistics 4, Bangko Sentral ng Pilipinas)

What factors influence the rise and fall in interest rates?

Interest rate movements in the Philippines are affected generally by the price level or inflation
rate, fiscal policy stance, and intermediation cost which could impact the demand and supply for
money.

Inflation rate. The BSP’s policy direction to achieve its mandate of maintaining price stability
has a marked influence on the interest rate level. When there is too much liquidity in the
system, there is more pressure for inflation to rise. To curb inflationary pressures arising from
excess liquidity in the system, the BSP will have to increase its key policy rates, i.e., overnight
borrowing rate or reverse repurchase rate (RRP) and overnight lending rate or repurchase
rate (RP). By increasing its key policy rates, the BSP is sending a signal to the market that the
general level of interest rates will be on an uptrend. In mirroring the movement of the BSP’s
policy rates, the benchmark 91‐day T‐bill rate also sets the direction for other rates, specifically,
bank lending rates.

Fiscal policy stance. The fiscal policy stance may also influence the direction of interest rates.
A government that incurs a fiscal deficit needs to finance its existing budgetary requirements by
borrowing from the domestic market or from abroad. The higher is the fiscal deficit, the stronger

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the demand to borrow to finance the gap. This exerts upward pressure on domestic interest
rates, particularly if the government borrows from a relatively less liquid domestic market.

Intermediation cost. Financial institutions incur costs in extending their services. Interest rates
will tend to be high when intermediation cost is high. Included in the intermediation costs
are administrative costs and the BSP’s reserve requirements.

Other factors that could influence the interest rates include the maturity period of the financial
instrument and the perception of risks associated with the instrument. Those with longer‐term
maturity and with higher probability of incurring loss carry higher interest rates. The lack of
intermediation could also affect interest rate movement. For instance, with their larger holdings
of non‐performing assets (NPAs), banks are more cautious in their lending activities. This would
tend to induce an increase in interest rate.

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