What Are Basis Points (Bps)?

What Are Basis Points (Bps)?Understanding Basis Points

1. Definition:Basis points (bps) are a unit of measurement used in finance to express fractional percentage changes, particularly in interest rates, yields, and spreads.
2. Conversion:One basis point is equal to 0.01%, or 1 / 100 of a percentage point. For example, a 100 basis point increase in an interest rate represents an increase of 1%.

Applications of Basis Points

3. Interest Rates:Basis points are commonly used to describe small changes in interest rates. For instance, a 25 basis point hike refers to an increase in the interest rate by 0.25%.
4. Yields:Basis points are also used to measure changes in the yield of bonds and other investments. A bond with a yield of 5.10% has a yield spread of 10 basis points over a benchmark bond with a yield of 5%.
5. Spreads:The difference between two interest rates or yields is often expressed in basis points. For example, if the spread between a government bond and a corporate bond is 50 basis points, it means the corporate bond offers a 50 basis point higher yield than the government bond.
6. Risk Premiums:Basis points can also be used to quantify risk premiums, which are the extra return required by investors for taking on additional risk.

Examples of Basis Point Calculations

7. Interest Rate Increase:If the Federal Reserve raises the interest rate by 50 basis points, it means the rate will increase from 0.50% to 1.00%.
8. Bond Yield Change:If the yield on a 10-year Treasury bond increases from 2.50% to 2.75%, the change in yield is 25 basis points.
9. Spread Calculation:If the yield on a corporate bond is 6.50% and the yield on a comparable government bond is 5.75%, the spread is 75 basis points.

Conclusion

Basis points are a precise and convenient unit of measurement for expressing small changes in financial values. They are widely used in the financial industry to describe interest rates, yields, spreads, and risk premiums. Understanding basis points is essential for interpreting financial news and making informed investment decisions.