Basis Points | B2B Finance Glossary
What Are Basis Points?
Basis points – also known as BPS or “bips” – are a way to measure specific aspects of finance. One basis point is one hundredth (1/100th) of one percentage point, or 0.01%. This means that a change of 100 basis points equals a change of 1%. In decimal form, one basis point appears as 0.0001. A fractional basis point such as 1.5 basis points is equivalent to 0.015%. In decimal form, a fractional basis point is 0.00015.
Basis points make it possible to identify the percentage change in the value of financial instruments or the rate change in an index or other benchmark. Typically, they refer to changes in bond yields and interest rates, but they also may refer to the percentage change in the value of an asset such as a stock. In the bond market, a basis point refers to the yield a bond pays the investor.
Why Are Basis Points Used Instead of Percentages?
Basis points are used instead of percentages because they are less ambiguous – they represent an absolute, set figure instead of a ratio. Basis points are also helpful when discussing measurement changes because it is much more convenient to say 50 “bips” instead of 0.05%. On top of this, the smaller the number being discussed, the more convenient it is to use basis points to communicate: for example, it’s much simpler to say two basis points as opposed to 0.02%.
Additionally, basis points can help you track changes to the stock index in a very clear way. Many analysts find it easier to use basis points to report changes in asset value as opposed to percentages since percentages can get mixed up with other rate increases.
How Are Basis Points Used?
Basis points are usually employed to measure small expressions of change in interest rates or yields. However, it’s important to note that they can also be applied to asset value changes. For example, when stock values change by percentages lower than 1%, basis points are typically used to describe this change since they represent one-hundredth of a percentage point.
Basis points are usually used to measure the following financial instruments:
- Treasury bonds
- Equity securities
- Debt securities
- Options and futures
- Credit derivatives
- Interest rates
- Corporate bonds
- Equity securities, such as common stock
- Debt securities, such as mortgage loans
What Are the Benefits of Basis Points?
Basis points are essential because they can help investors track changes in value regarding minimal percentages. Essentially, they offer an incredibly accurate way to pinpoint these small changes. Using basis points can also help mitigate ambiguity when recording the differences between relative and absolute interest rates.
If, for example, you’re looking at an interest rate that has increased from 5% to 6%, you would report a 1% increase under the absolute method. But, on the other hand, you may have a completely different figure. As a result, basis points are used to avoid any confusion that might appear. In this example, you can say there was an increase of 100 basis points. Since one basis point is equivalent to 0.01%, it’s a form of measurement that ensures no confusion will occur: basis points are a universal measurement with many different use cases.
How Can Basis Points be Converted to Percentages?
Two simple formulas help you convert basis points into percentages and percentages into basis points. Here’s what they look like:
- Percentage X 100 = basis points
- Basis points/100 = percentage
How Do Investors Use Basis Points?
Basis points are beneficial when measuring returns and yields since they express small changes over time that add to a significant change over a long period.
Investors use basis points to measure change across many different financial instruments. These include corporate bonds, common stock, treasury bonds, and mortgage loans. Basis points can also be used to compare expenses and certain funds’ fees since they express an asset’s value change. Adjusting interest rates by even one basis point can have a devastating impact on investments. At the same time, changing an asset’s value to just one or two basis points can create a massive shift for institutions and individual investors.