Basis Points (BPS)

Basis point (bps) is a measuring unit to represent percentage variation in the value of financial instruments. It is generally used to calculate changes in bond yields, interest rates, and different percentages in finance. Concerning percentage point vs basis point, both terms differ in definition and calculation.

One bps (bips) is equivalent to 0.0001 (1/100^th of one percent) or 0.01%, and therefore, 100 bps is equal to 0.01 or 1%. Successively, it rises to 10000 bps, amounting to 100%. Moreover, the benefits of bps incorporate precise calculation and a better explanation of spread.

• The basis point definition renders the smallest metric to signify a percentage change in the price or value of financial parameters, namely treasury bonds, corporate bonds, and debt securities.
• One bps is equal to 0.01% or 0.0001, and a hundred bps is equivalent to 1% or 0.01.
• Its merits include a detailed estimation of pricing movement below 1% and a better spread explanation.
• The investor must divide the bps by 100 for percentage conversion and multiply the percentage by 100 for conversion to bps.

Basis point or bps assist the Federal Reserve (Fed) in exercising good control on the interest rates influenced to manage the US economy. The Fed utilizes bps while loaning out cash or modifying interest rates. Additionally, investors and portfolio directors use this to trade in mutual funds, US treasury bonds, and exchange-traded funds (ETFs).

Please note that the return on some bonds is fluctuating and connected with different offer rates like 30 bps above London Interbank Offer Rate (LIBOR). Alternately labeled as DV01, the basis point value indicates the price movement (in dollars) of fixed-income security following the change of one bps in its yield.

So, 2.5% LIBOR reports an interest rate of,

= 2.5% +30 bps

= 2.5% + 0.3%

Thus, the interest rate = 2.8%

The principal difference considering percentage point vs basis point in finance lies in their interpretation. The former implies a distinction between two percentages, while the latter denotes a percentage change in the value of financial instruments. In terms of percentage point vs basis point, bps helps express smaller numeric changes more adequately than the percentage point.

Which Financial Instruments Utilize Basis Point?

Although essentially pertained to interest rates and bond yields in the financial market, bps are also applicable to the change in an asset’s value. Here are a few common examples:

1. Corporate bonds
2. Treasury bonds
3. Credit derivatives
4. Interest rate derivatives
5. Debt securities
6. Futures and options
7. Equity securities

For conversion from basis point to percentage and vice-versa:

• Bps to percentage – Divide the bps by 100

Consequently, 5 bps = 5/100 = 0.05%

• Percentage to bps – Multiply the percentage by 100

Hence, 50% = 50 * 100 = 5000 bps

Here are a few examples of a basis point calculations in finance.

Example #1

Let’s assume that a commercial bank reduces the home loan lending rate by 25 bps from 8.75%. Thus, the rate cut (in percentage) is as demonstrated,

Rate Cut = 0.01% * 25

               = (0.01/100) * 25

               = 0.25%

Now, the current lending rate is determined like this,

New lending rate = 8.75% – 0.25%

                             = 8.50 %

Example #2

Say, Penny invests in a fixed income security with 20% return on investment (ROI) annually and an expense ratio of 25 bps. Accordingly, the gross rate of return is,

Total ROI = 10% - 25 bps

                  = 10% - (25/100) %

                  = 10% - 0.25%

            Hence, ROI = 9.75%

Example #3

The Fed has raised the benchmark interest rate to the biggest amount in two decades (half a percentage point) to counter inflation. According to its chairperson Jerome Powell, this insinuates numerous 50-bips price hikes (maximum). This step will aid in reinstating price stabilization.

Additionally, the Federal Reserve has indicated the starting of cutback on its $9 trillion asset holdings. Notwithstanding the leaning of market pricing to the Fed increment by ¾ of the percentage point, the panel is still not considering 75 bips.

The plan beginning on June 1, will watch the fall off of Treasurys ($30 billion) and mortgage-backed securities ($17.5). Furthermore, the cap will surge to $35 billion after three months and $60 million for mortgages and treasuries, respectively.

To clarify, let’s examine some benefits of basis point:

Detailed Calculation

The basis point value confirms error-free estimation of financial parameters such as interest rates. Moreover, it is convenient when the rate variation is below 1% and the quantity is relevant. That is to say, it prevents doubtfulness and skepticism while analyzing absolute and relative interest rates.

Determining The Spread

Typically, bps is used to describe spread, which signifies the deviation between the bid (buy) and ask (sell) prices of an asset or security. It also conveys the difference in the yields or ROI of financial vehicles. Expressing spread in terms of bps aids in a decent explanation of the price variation.

This has been a guide to Basis Points (BPS) & its definition. We explain its calculations, how to convert it into percentages, along with finance examples You can learn more from the following articles -

• Cost Basis Examples
• Bullet Points in Excel
• Types of Bond ETFs
• Cost of Debt Calculation