A basis point is a common unit of measure for interest rates and other percentages in finance. Basis points are typically expressed with the abbreviations bp, bps, or bips.
One basis point is equal to 1/100th of 1%, or 0.01%. In decimal form, one basis point appears as 0.0001 (0.01/100). Basis points (BPS) are used to show the change in the value or rate of a financial instrument, such as 1% change equals a change of 100 basis points and 0.01% change equals one basis point.
- A basis point is a standard measure for interest rates and other percentages in finance.
- One basis point equals 1/100th of 1%, or 0.01% (and .0001 in decimal form).
- The word basis comes from the base move between two percentages, or the spread between two interest rates.
- The basis point is commonly used for calculating changes in interest rates, equity indices, and fixed-income security yields.
- Basis points are also used when referring to the cost of mutual funds and exchange-traded funds.
Understanding Basis Points
Understanding Basis Points (BPS)
The word basis in the term basis point comes from the base move between two percentages, or the spread between two interest rates. Since the changes recorded are usually narrow, and because small changes can have outsized outcomes, the basis is a fraction of a percent.
The basis point is commonly used for calculating changes in interest rates, equity indices, and the yield of a fixed-income security. It is common for bonds and loans to be quoted in terms of basis points.
For example, it could be said that the interest rate offered by your bank is 50 basis points higher than the Secured Overnight Financing Rate (SOFR). A bond whose yield increases from 5% to 5.5% is said to increase by 50 basis points. Interest rates that have risen by 1% are said to have increased by 100 basis points.
If the Federal Reserve Board raises the target interest rate by 25 basis points, it means that rates have risen by 0.25% percentage points. If rates were at 2.50%, and the Fed raised them by 25 basis points, the new interest rate would be 2.75%.
If you start with a decimal and want the figure in percentage form, multiply by 100. If you start with a percentage and want the figure in decimal form, divide by 100.
By using basis points in the conversation, traders and analysts remove some of the ambiguity or confusion that can arise when talking about percentage moves. For example, if a financial instrument is priced at a 10% rate of interest and the rate experiences a 10% increase, it could conceivably mean that the financial instrument is now 11% (0.10 x (1 + 0.10) or it could mean that it is now 20% (10% + 10% = 20%).
The use of basis points, in this case, makes the meaning clear. If the instrument is priced at a 10% rate of interest and experiences a 100 bp move up, its rate would then be 11%. If the instrument experiences a 1,000 bp move up, it would be 20%.
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Price Value of a Basis Point
The price value of a basis point (PVBP) is a measure of the change in the absolute value of the price of a bond for a one basis point change in yield. This may also be referred to as DV01, or the dollar value change for a one bp move. It is another way to measure interest rate risk and is similar to duration, which measures the percent change in a bond price given a 1% change in rates.
PVBP is just a special case of dollar duration. Instead of using a 100 basis point change, the price value of a basis point simply uses a one basis point change. It does not matter if there is an increase or decrease in rates because such a small move in rates will be about the same in either direction.
Basis Points and Investments
Basis points are also used when referring to the cost of mutual funds and exchange-traded funds (ETFs). For example, a mutual fund's annual management expense ratio (MER) of 0.15% will be quoted as 15 bps.
When funds are compared, basis points are used to provide a clearer understanding of the difference in their costs. For example, an analyst may state that a fund with 0.35% in expenses is 10 basis points lower in cost than another with an annual expense of 0.45%.
Since interest rates don't apply to equities, basis points are less commonly used as terminology for price quotes in the stock market. Instead, stock prices are quoted in dollars and cents.
What Is a Basis Point?
Basis point is a term used in finance to refer to changes in values or interest rates. One basis point equals 0.01%. Put differently, 1/100th of 1%, 0.01%, and 0.0001 all express the same thing: one basis point. For example, five basis points could be expressed as 0.05%. Likewise, if an interest rate increased from 5.00% to 5.25%, it moved up by 25 basis points.
Why Use Basis Points Versus Percentages?
The reason that traders use basis points to express changes in value or rate is because it can be clearer and prevent any ambiguity. This can help expedite communications and avoid trading mistakes. Since the values of financial instruments are often highly sensitive to even small changes in underlying interest rates, ensuring clarity can be very important for traders.
Where Does the Term Basis Point Come From?
The term basis point originates from the term basis, which refers to the difference (or spread) between two interest rates.
How Are Basis Points Used?
Oftentimes, traders will use basis points to refer to the change in value of a security or when comparing the rates on different securities. For example, you may hear the term used when yields on corporate bonds and treasury securities are compared.