Definition
Basis Points (BPS) refer to a unit of measure used in finance to describe the percentage change in the value or rate of a financial instrument. One basis point is equivalent to 0.01% or 0.0001 in decimal form. For example, if a loan’s interest rate increases from 2% to 2.5%, it has increased by 50 basis points.
Key Takeaways
- A basis point (BPS) refers to a common unit of measure for interest rates and other percentages in finance. One basis point equals one-hundredth of a percentage point (0.01%).
- Basis points are generally used in the financial industry to indicate the change in financial instruments like interest rates, equity indices, and fixed income securities.
- Despite their small size, changes in rates and other financial benchmarks measured in basis points can lead to significant profits or losses due to the large amount of money typically involved in financial transactions.
Importance
Basis Points (BPS) is a crucial term in finance due to its broad application in quantifying and expressing changes in financial rates and values. By measuring changes in interests rates, yields, and equity indices among others on a standardized scale, investors and analysts can better understand subtle fluctuations that might otherwise be overlooked.
BPS, being one-hundredth of a percent, makes it possible to articulate small percentage changes with greater precision. Its uniformity across all markets and financial instruments aids in making clear and accurate comparisons, all of which can influence critical financial decisions in lending, investing and pricing of securities.
Thus, the use of basis points is fundamental in financial discussions and analyses.
Explanation
Basis Points, often referred to as bps, serve an essential purpose in the financial world, predominantly employed for calculating changes in interest rates, equity indexes, and the yield of a fixed-income security. The most generating use is in the bond market, where the cost of bond yields and interest rates are extremely impactful.
Because these changes often transpire in fractions, basis points give these changes a whole number that is easier to handle and understand. For example, if the Federal Reserve raises interest rates by 0.25%, that would be stated as a rise of 25 basis points.
Similarly, if the yield on a bond escalates from 2.20% to 2.45%, it has moved by 25 basis points. This usage generally helps to omit the ambiguity that can occur with percentages and offers a more precise measure of these delicate and minuscule changes.
This precision is critically important to financial analysts and investors in making sound financial decisions.
Examples of Basis Points (BPS)
Mortgage Rates: If you’re looking at mortgage rates from various banks and one bank offers a rate that is 50 basis points less than another, it means there’s a5% difference in interest rates. For example, if Bank A offers a
5% rate and Bank B offers a0% rate, Bank B’s rate is 50 basis points lower than Bank A’s.
Investment Performance: In the world of investment, basis points are often used to denote changes in the value of a portfolio. For example, if a fund manager states that their fund has increased by 125 basis points over the last quarter, this means that the fund has increased in value by25%.
Central Bank Policy Rates: The central banks, such as the Federal Reserve in the U.S., often use basis points when changing the official interest rates. For instance, if the Federal Reserve raises its benchmark interest rate by 25 basis points, it means the interest rate has increased by25%. This can affect other interest rates, like those for mortgages and bonds.
Basis Points (BPS) FAQ
1. What are Basis Points (BPS)?
Basis Points, commonly abbreviated as BPS, is a unit of measure used in finance to describe the percentage change in financial instruments. One basis point is equivalent to 0.01% or 0.0001 decimal.
2. Where are Basis Points (BPS) commonly used?
BPS are predominantly used in finance sectors to denote changes in interest rates, equity indexes, and the yield of a fixed-income security.
3. How are Basis Points (BPS) calculated?
Basis points are calculated by taking the change in a percentage and multiplying it by 100. For example, a change from 5% to 5.5% would represent a change of 50 basis points.
4. Why are Basis Points (BPS) important?
Basis points provide an easier way of describing small changes in yields and interest rates. Using basis points in finance makes calculations simpler and reduces the chances of errors.
5. Can you give an example of how Basis Points (BPS) are used?
If a report states that the interest rates have risen by 100 basis points, that means it has increased by 1%. Simply put, if your credit card APR increases from 14.9% to 15.9%, it has gone up by 100 basis points.
Related Entrepreneurship Terms
- Interest Rate
- Yield Spread
- Foreign Exchange (Forex) Rate
- Percentage Change
- Fixed Income Securities
Sources for More Information
- Investopedia: This is a leading global source of financial content on the web, ranging from market news to retirement strategies, investing education to insights.
- Bloomberg: A global leader in business and financial news delivering data, analysis and top tier reporting on international news and world markets.
- Reuters: An international news organization, well respected for their coverage on financial markets and economic concepts.
- CNBC: CNBC is a recognized world leader in business news who provides real-time financial market coverage and business content.
