What is a Basis Point (BPS)

Steps to Calculate BPS

Basis points represent a percentage of 1%. One basis point equals 0.01% or 0.0001 in decimal form. To change basis points to a percentage or the other way around, you need to multiply or divide it by 100.

Following is the formula to convert basis points to percentage

Basis Points ÷ 100 = Percentage

For example, if an interest rate is set to increase by 129 basis points, you can convert it to a percentage by using the equation:

129 Basis Points ÷ 100 = 1.29%

You can also do this quickly in your head by moving the decimal point two places to the left (from 129.0 to 1.29).

The following table shows the different percentages of different BPS:

Example of Basis Points

To understand BPS meaning more simply, let us take an example.

Suppose you invested in a government bond that has an interest rate of 12.50%. After a few months, the interest rate on that bond falls to 12.25%. You can calculate the change in the interest rate by applying the formula:

Percentage x 100 = Basis Points

0.25% X 100 = 25 Basis Points

Financial Instruments That Use Basis Points

Basis points are used in the following instruments:

• Treasury Bonds

Issued by federal or state governments, Treasury bonds use basis points for purposes such as communicating the rate of interest and analysing the change in the rate of interest.

• Corporate Bonds

Corporate bonds are debt instruments issued by companies to raise funds. Basis points measure changes in interest or coupon rates.

• Credit Card Instruments

Interest rate changes on credit cards can be communicated and analysed using basis points.

• Futures and Options

In stock market derivatives like futures and options, basis points measure the changes in return rates. 

Advantages of Basis Points

Now that you have learnt basis points meaning, let's have a look at some benefits of using the basis points system:

• It prevents confusion when dealing with small percentage changes by providing an accurate number indicating the change. 
• This metric clearly distinguishes between absolute and relative changes in interest rates, removing any ambiguity.
• Basis points help investors track changes in stock indices.
• Using the BPS system makes it easy to understand and communicate the changes in asset values. Clear communication is crucial for effective financial operations.

Importance of Basis Points

The concept of a basis point, as a measurement, plays an important role in finance for several reasons:

• Precision

A basis point offers a precise way to express changes in financial metrics. It allows for accurate measurement of interest rates or yield changes, which significantly affect financial investments.

• Standardisation

A BPS provides a consistent method for comparing financial metrics across various investments. This is essential for investors to evaluate the performance of different investment options.

• Trading

In financial markets, basis points measure the spread between different investments. This helps traders spot profit opportunities by buying low and selling high.

• Cost of Borrowing

Lenders often express interest rates in basis points. This helps borrowers compare loan options to zero in on the most cost-effective option.

• Risk Management

Basis points help measure the risk of various investments. By understanding how interest rate or yield changes might impact them, investors can make better decisions about their portfolio allocations.

The Bottomline

Using BPS is a clear and efficient way to measure changes in interest rates for loans and debt instruments. It helps to clearly communicate the rate changes and their impact.

As an investor or market analyst, you should use basis points instead of percentages to effectively communicate value changes.