9/12/2020 Basis Points (BPS)

BONDS FIXED INCOME ESSENTIALS

Basis Points (BPS)

By JAMES CHEN | Reviewed By GORDON SCOTT | Updated Feb 22, 2020

What Are Basis Points (BPS)?

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.

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Basis Points Percentage Terms

1 0.01%

5 0.05%

10 0.1%

50 0.5%

100 1%

1000 10%

10000 100%

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Basis points are typically expressed in the abbreviations "bp," "bps," or "bips."

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Understanding Basis Points

Understanding Basis Points (BPS)

The "basis" in basis point comes from the base move between two percentages, or the spread
between two interest rates. Because the changes recorded are usually narrow, and because
small changes can have outsized outcomes, the "basis" is a fraction of a percent.

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The basis point is commonly used for calculating changes in interest rates, equity indices, and
the yield of a fixed-income security. It is common for bonds and loans to be quoted in basis
point terms. For example, it could be said that the interest rate offered by your bank is 50 basis
points higher than the London Interbank Offered Rate (LIBOR). A bond whose yield increases
from 5% to 5.5% is said to increase by 50 basis points, or interest rates that have risen 1% are
said to have increased by 100 basis points. If the Federal Reserve Board raises the target interest
rate by 25 basis points, it means that rates have risen by 0.25% percentage points. [1] If rates
were at 2.50%, and the Fed raised them by 0.25%, or 25 basis points, the new interest rate
would be 2.75%.

Important: Using basis points in conversation instead of talking in percentages

instantly clarifies whether that "10% increase" in a financial instrument priced at
10% means that it's now at 11% [0.10 x (1 + 0.10) = 11% ] or 20% [10% + 10% = 20%].

By using basis points in conversation, traders and analysts remove some of the ambiguity that
can arise when talking about things in percentage moves. For example, if a financial instrument
is priced at a 10% rate of interest and the rate experiences a 10% increase, it could conceivably
mean that it is now 0.10 x (1 + 0.10) = 11% or it could also mean 10% + 10% = 20%. The intent of
the statement is unclear. The use of basis points, in this case, makes the meaning obvious: If the
instrument is priced at a 10% rate of interest and experiences a 100 bp move up, it is now 11%.
The 20% result would occur if there were instead a move of 1,000 bps.

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Basis point refers to a common unit of measure for interest rates and other percentages
in finance. 
The "basis" in basis point comes from the base move between two percentages, or the
spread between two interest rates.
Because the changes recorded are usually narrow, and because small changes can
have outsized outcomes, the "basis" is a fraction of a percent.
The basis point is commonly used for calculating changes in interest rates, equity
indices, and fixed-income security yields.
Basis points are also used when referring to the cost of mutual funds and exchange-
traded funds.

Price Value of a Basis Point

The Price Value of a Basis Point (PVBP) is a measure of the absolute value of the change in the
price of a bond for a one basis point change in yield. It is another way to measure interest-rate
risk, similar to duration, which measures the percent change in a bond price given a 1% change
in rates.
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PVBP is just a special case of dollar duration. Instead of using a 100 basis point change, the price
value of a basis point simply uses a 1 basis point change. It does not matter if there is an
increase or decrease in rates because such a small move in rates will be about the same in
either direction. This may also be referred to as DV01, or the dollar value change for a 1 bp
move.

BPS and Investments

Basis points are also used when referring to the cost of mutual funds and exchange-traded
funds (ETFs). A mutual fund with an annual management expense ratio (MER) of 0.15% will be
quoted as having 15 bps. When funds are compared, basis points are used to provide a clearer
understanding of the difference between the cost of investment funds. For example, an analyst
may state that a fund with 0.35% in expenses is 10 basis points lower than another with an
annual expenseAdvertisement
of 0.45%.

Since interest rates don't apply to equity, basis points are less commonly used as a terminology
for price quotes in the stock market. (For related reading, see "Calculating the Value of Basis
Points in Excel")

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A yield spread is the net difference between two interest bearing instruments, expressed in terms of
percent or bps. more

Effective Duration
Effective duration is a calculation for bonds with embedded options that takes into account that expected
cash flows fluctuate as interest rates change. more

Bond
A bond is a fixed income investment in which an investor loans money to an entity (corporate or
governmental) that borrows the funds for a defined period of time at a fixed interest rate. more

Understanding Convexity Adjustments

A convexity adjustment is a change required to be made to a forward interest rate or yield to get the
expected future interest rate or yield. more

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Related Terms
Price Value of a Basis Point (PVBP)
Price value of a basis point (PVBP) is a measure used to describe how a basis point change in yield affects
the price of a bond. more

What Are Points?

A point is a measurement of a change in value or a degree of difference in value. Its precise meaning
differs for mortgage rates, stocks, and bonds. more

Yield Spread Definition

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