What is a Basis Point? Definition & Examples
A basis point is a unit of measurement in finance for small percentages. One basis point is equivalent to 0.01% or 1/100 of a percent.
What is a Basis Point?
A basis point, also known as BP or BPS for plural, is a unit of measurement in finance for small percentages. It is commonly used for interest rate changes of less than one percent.
One basis point is equivalent to 0.01% or 1/100 of a percent. Expressed as a decimal, one basis point is 0.0001.
Why are Basis Points Used?
Finance professionals use basis points to avoid confusion when discussing percentages.
For example, if interest rates increased from 15% to 16%, some may say the interest rate increased by 1%, while others may say the interest rate grew by 7.1%. This can often lead to confusion as the former is using absolute terms, while the latter is using relative terms.
Although a change of 0.1% or 10 basis points may seem like a small figure, when applied to a large fund managing $100 billion, that’s a $10 million difference. As a result, finance professionals have developed basis points to eliminate confusion.
Basis Point Calculation
To convert a percentage into a basis point, multiply the percentage rate by 100. For example, a 5% converted into a basis point would be 5 * 100 = 500 basis points
Basis Points (bps) = Percentage (%) * 100
To convert a basis point into a percentage, divide the basis point by 100. For example, 500 basis points converted into percentage would be 500 / 100 = 5%
Percentage (%) = Basis Point (bps) / 100
Basis Points Table Converter
As you can see in the basis points table converter below:
- 1 basis point is equivalent to 0.01%, or 0.0001
- 10,000 basis points are equivalent to 10% or 0.1
Basis Point Examples
- Bond A has an interest rate of 5.45% while Bond B has an interest rate of 6.15%. The difference is 0.7% or 70 basis points.
- Company A surpassed shareholder expectations and its shares are up 2.5%, or 25bps.
Basis Points Real-World Examples
Basis Points are often used in financial news. For example, you may hear:
- The “FED (Federal Reserve) announces interest rate hike of 25 basis points”. This means that the interest rates have risen 0.25% or 25 basis points. The FED, which is the US central bank, raised rates by 25bps to increase the cost of borrowing. With this action, it hopes to decrease inflation to a more stable level. As of mid-2023, inflation is at 6%, which is much higher than the FED target of 2%.
- Mutual fund A has an annual management fee of 25bps. This means it has an annual fee of 0.25%. So if you invest $1,000, the mutual fund will charge an annual fee of $2.5 for managing that money.
When are basis points used?
Basis points are primarily used for percentages such as interest rates and yields in financial instruments such as:
- Treasury and corporate bonds
- Options, futures, and credit derivatives
- Common and preferred stock
- Mortgages
They are most common in the fixed-income world with securities such as bonds, swamps, and options, especially when the changes are less than 1% or 100 basis points.
Basis Points in Mortgages
There are broadly two types of mortgages; fixed and variable. For fixed-rate mortgages, the interest payments stay the same throughout the life of the mortgage. For variable-rate mortgages (also known as adjustable-rate mortgages), interest payments may fluctuate depending on a benchmark such as the federal funds rate.
For example, with a variable-rate mortgage, if the mortgage interest rate rises from 2.5% to 3.0%, your interest rate rises by 50 basis points (0.50%). Depending on your mortgage size, this can have a significant effect on your monthly payments.
That said, the opposite is also true. If interest rates dropped, that would decrease your mortgage payments. Depending on your risk profile, you may prefer a fixed-rate mortgage to avoid fluctuating mortgage payments.
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