Basis Point

A Basis Point (often abbreviated as "bp" or "bps") is a unit of measurement equal to 1/100th of 1 percent (0.01%). This measurement is widely used in finance to express small percentage changes in financial instruments, particularly interest rates, yields, and spreads.

How Basis Points Work

The concept of basis points simplifies the communication of small changes in percentages:

  • 1 basis point = 0.01%

  • 100 basis points = 1%

  • 50 basis points = 0.5%

  • 25 basis points = 0.25%

  • 10 basis points = 0.1%

Using basis points helps avoid confusion when discussing percentage changes versus absolute changes in rates that are already expressed as percentages.

Examples of Basis Points in Action

Let's consider some practical examples:

Example 1: Interest Rate Changes

  • A mortgage rate increases from 4.25% to 4.75%

  • The change is 0.50% or 50 basis points

  • Financial professionals would say: "The mortgage rate increased by 50 basis points"

Example 2: Bond Yield Spreads

  • Treasury bond yield: 3.15%

  • Corporate bond yield: 3.85%

  • The spread is 0.70% or 70 basis points

  • Financial professionals would say: "The corporate bond trades at a 70-basis-point spread over Treasuries"

Example 3: Investment Management Fees

  • A mutual fund charges a management fee of 0.75%

  • An exchange-traded fund (ETF) charges 0.15%

  • The difference is 0.60% or 60 basis points

  • Financial professionals would say: "The mutual fund is 60 basis points more expensive than the ETF"

Example 4: Central Bank Decisions

  • A central bank raises its policy rate from 2.25% to 2.50%

  • The change is 0.25% or 25 basis points

  • Financial news would report: "The central bank implemented a 25-basis-point rate hike"

Common Uses of Basis Points

Basis points are used in numerous financial contexts:

  • Central Bank Policy: Rate decisions by the Federal Reserve and other central banks

  • Bond Markets: Yield changes, credit spreads, and price movements

  • Money Markets: Changes in short-term interest rates and financial instrument yields

  • Loan Pricing: Adjustments to interest rates on variable loans and credit facilities

  • Investment Performance: Measuring excess returns or underperformance

  • Fee Structures: Expressing management fees, expense ratios, and transaction costs

  • Credit Default Swaps: Pricing default insurance premiums

Calculating with Basis Points

Converting between basis points and percentages:

  • To convert basis points to percentage: Divide the basis points by 100

    • Example: 75 basis points = 75/100 = 0.75%

  • To convert percentage to basis points: Multiply the percentage by 100

    • Example: 0.32% = 0.32 × 100 = 32 basis points

Calculating monetary impact:

  • To calculate dollar impact of basis point changes: Principal × (Basis Points ÷ 10,000)

    • Example: For a $1,000,000 bond, a 25 basis point increase equals:

    • $1,000,000 × (25 ÷ 10,000) = $1,000,000 × 0.0025 = $2,500

Significance of Basis Points

The use of basis points is significant for several reasons:

  • Precision: Allows for precise expression of small changes that have significant impacts

  • Clarity: Eliminates confusion between relative and absolute percentage changes

  • Standardization: Provides a consistent unit of measurement across financial markets

  • Impact Assessment: Helps quantify the financial impact of seemingly minor rate movements

  • Market Sensitivity: Reflects the high sensitivity of financial markets to small rate changes