What are Basis Points (BPS)?
Basis points (BPS) are the smallest measurement of fixed income securities and interest rate quotes and are used to measure changes and differentials in interest rates and margins.
A basis point (often abbreviated as bp, often pronounced as “bip” or “beep”) is (a difference of) one hundredth of a percent or equivalently one percent of one percent or one ten thousandth. A very rarely used term, permyriad, means parts per ten thousand, differing in meaning only in that basis points are normally used to express differences in parts per ten thousand. Figures are commonly quoted in basis points in finance, especially in fixed income markets.
Basis points (BPS) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%, or 0.0001, and is used to denote the percentage change in a financial instrument. The relationship between percentage changes and basis points can be summarized as follows: 1% change = 100 basis points and 0.01% = 1 basis point.
|Basis Points||Percentage Terms|
Basis points are typically expressed in the abbreviations “bp,” “bps,” or “bips.”
What instruments does BPS apply to?
The usage of basis points is primarily applied to yields and interest rates, but they may also apply to the change in the value of an asset, such as the percentage changes of stock values. Common examples include the following:
- Treasury bonds
- Corporate bonds
- Interest rate derivatives
- Credit derivatives
- Equity securities, such as common stock
- Debt securities, such as mortgage loans
- Options, futures
How Basis Points Work
Basis points are commonly used to express changes in the yields on corporate or government bonds bought and sold by investors. Yields fluctuate, in part because of prevailing interest rates, which are set by the Federal Reserve’s Open Market Committee. If the Fed lowers its fed funds target rate, interest rates on newly issued bonds will decline, and vice versa. Those changes affect the prices investors are willing to pay for older bonds, which affects the expected return on the bonds.
Let’s say you have $10,000 to invest, and decide to buy a bond with an interest rate, usually called a coupon rate, of 3%. A year later, prevailing rates have dropped 50 basis points, so new bonds with the same face value are now paying 2.5%. Your bond is now worth more because it pays out $300 a year rather than $250. Generally, investors want to see yields rising, and you’ll often hear the changes expressed in basis points.
Suppose you’re an investor in mutual funds or exchange-traded funds. In that case, you may encounter an annual fee called an expense ratio, which is the portion of assets deducted each year by your fund manager for fund expenses. If your expense ratio is 145 basis points, that means your fund manager is charging you 1.45% of your total assets in the fund—which equals to $14.50 per $1,000 invested.
Basis points are also common in discussions about borrowing as well as investing. The Fed’s benchmark rate, which influences rates on mortgages, credit cards, and other loans, is usually changed 25 basis points at a time. However, the Fed last changed the benchmark in March 2020, decreasing it by 100 basis points.
- The difference between bond interest rates of 9.85 percent and 9.35 percent is 0.5 percent, equivalent to 50 basis points.
- The Federal Reserve boosts interest rates by 100 BPS, signaling an increase from 10 percent to 11 percent.
- Due to the growth of iPhone sales, Apple Inc. reported high earnings, more than what was estimated; the stock increased 330 BPS, or 3.3 percent, in one day.
Conversion between basis points and percentage
To convert the number of basis points to a percentage and, in turn, a percentage to basis points, without using a conversion template or chart, review the following:
- Basis points to percentage – Divide the points by 100
- Percentage to basis points – Multiply the percentage by 100
The easiest way to convert basis points into a percent form is to simply take the number of basis points and multiply by 0.0001, which will convey the percent in decimal form. For example, if you wish to convert 384 basis points into a percent, simply multiply 384 by 0.0001. This will give you 0.0384, which is 3.84% (0.0384 x 100).
Why do investors and analysts use BPS?
The main reasons investors use BPS points are:
- To describe incremental interest rate changes for securities and interest rate reporting.
- To avoid ambiguity and confusion when discussing relative and absolute interest rates, especially when the rate difference is less than 1 percent, but the amount has material importance. For example, when discussing an interest rate that has increased from 11% to 12%, some may use the absolute method stating there is a 1% increase in the interest rate, while some may use the relative method stating a 9.09% increase in in the interest rate. Using basis points eliminates this confusion by stating that there is an increase in the interest rate of 100 basis points.
- Using basis points can avoid confusion when discussing changes in yields or interest rates.
- Basis points are most commonly used when differences of less than 1% are meaningful.
- A basis point refers to one-hundredth of a percentage point. For example, the difference between 1.25% and 1.30% is five basis points.
- When the Fed benchmark interest rates are changed, they usually go up or down by 25 basis points.
- Basis points are also commonly used when referring to the cost of mutual funds and exchange-traded funds.