A Basis Point (BPS) is a unit of measure used in finance to describe changes in interest rates, bond yields, and other financial percentages. One basis point is equal to 1/100th of 1%, or 0.01%. This means that 100 basis points equal 1%.
Key Points About Basis Points:
- Measurement of Percentage Changes: Basis points are commonly used to express changes in interest rates, yields, and other percentages where precision is important. For example, if an interest rate increases from 2.00% to 2.25%, it has increased by 25 basis points.
- Avoiding Ambiguity: Using basis points helps avoid confusion when discussing changes in percentages. For example, saying that an interest rate has increased by 1% could be unclear—does it mean the rate went from 5% to 6% (a 1 percentage point increase) or by 1% of the original rate (which would be a smaller absolute increase)? Saying that the rate increased by 100 basis points (from 5% to 6%) provides clarity.
- Common Usage:
- Interest Rates: Basis points are frequently used in the context of interest rates. For example, central banks might raise or lower interest rates by a certain number of basis points.
- Bond Yields: Bond yields are also often quoted in basis points. A change in a bond yield from 3.00% to 3.50% represents a 50 basis point increase.
- Spreads: The spread between different interest rates or yields is often expressed in basis points.
Examples:
- Interest Rate Increase: If the Federal Reserve raises interest rates by 25 basis points, this means the rate has increased by 0.25%. For example, if the rate was previously 2.00%, a 25 basis point increase would bring it to 2.25%.
- Bond Yield Movement: If a bond’s yield rises from 4.75% to 5.00%, this is a 25 basis point increase in the yield.
Conversion:
- 1 basis point = 0.01%
- 10 basis points = 0.10%
- 100 basis points = 1.00%
In summary, a basis point is a small unit of measure used to describe changes in financial percentages with precision. It helps to communicate changes in interest rates, bond yields, and other financial metrics clearly and accurately.
