Definition of Basis Point
A basis point (bps) is a unit of measure commonly used in finance to describe the percentage change in value or rate, such as interest rates. One basis point is equivalent to 0.01%, or 1/100th of a percent. This term is especially useful for discussing interest rates, bond yields, and other financial indices where even slight changes are significant.
Examples
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Interest Rate Change: If the Federal Reserve lowers the benchmark interest rate by 25 basis points, it means the rate has been reduced by 0.25%.
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Bond Yield: If a bond’s yield increases from 3.00% to 3.50%, this is an increase of 50 basis points.
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Loan Rates: If a mortgage rate increases from 4.00% to 4.25%, it has increased by 25 basis points.
Frequently Asked Questions (FAQs)
What is meant by “100 basis points”?
- Answer: 100 basis points is equivalent to 1%. Therefore, if an interest rate increases by 100 basis points, it means the rate has increased by 1%.
How do basis points affect investments?
- Answer: Basis points are crucial in investments as they indicate small yet significant changes in rates and yields. For instance, a change of 10 basis points can have substantial impacts on the returns from bonds or loans.
Are basis points only used for interest rates?
- Answer: No, basis points can apply to any financial percentage measurement where fine margins matter, like bond yields, loan interest rates, and even fee structures.
How do you convert basis points to percentages?
- Answer: To convert basis points to percentages, simply divide the number of basis points by 100. For example, 50 basis points is 50/100 = 0.50%.
Can basis points be negative?
- Answer: Yes, basis points can be negative when indicating a decrease in rates or yields. For instance, a decrease from 5.00% to 4.75% would be -25 basis points.
Related Terms
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Percentage Point: A unit for the arithmetic difference between two percentages. For example, an increase from 5% to 6% is an increase of 1 percentage point.
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Yield Spread: The difference between the yields of two different debt instruments, calculated in basis points.
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Interest Rate Swap: A financial derivative instrument often measured in basis points, used to swap interest rate cash flows between parties.
Online Resources
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Investopedia: Great articles on the use of basis points in different financial contexts Investopedia
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The Balance: Provides insights and examples related to basis points The Balance
Suggested Books for Further Studies
- “Financial Management: Theory & Practice” by Eugene F. Brigham and Michael C. Ehrhardt
- “Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen
- “Fixed Income Securities: Tools for Today’s Markets” by Bruce Tuckman and Angel Serrat
Accounting Basics: “Basis Point” Fundamentals Quiz
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