What are Basis Points?
Basis Points (bps) represent a unit of measurement for interest rates in finance and are equal to 1/100th of 1.0%. The term “basis points” is most often used when discussing the interest rate environment such as the Fed or in reference to bonds and fixed-income securities.
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How to Calculate Basis Points (bps)
One basis point equals one-hundredth of a percentage point, or expressed numerically, 1/100th of 1.0%.
Within the finance industry, it is the norm to discuss interest rates in terms of basis points rather than percentages, especially regarding smaller figures. Using bps can be more convenient and reduce the chance of misinterpretations, as the expression is an absolute figure and is thus easier to understand than a small percentage.
Describing interest rates, spreads, and yields in terms of basis points tends to be more precise, as the implications of such minor changes can often be significant on the economy or instrument in question.
Basis points, or “bps”, are pronounced as “bips” and are relevant when speaking about a wide variety of financial instruments, such as government bonds (e.g. treasury bonds, treasury bills), corporate bonds, and mortgage loans.
While 1/100th of 1.0% might initially sound like a minuscule difference, the economic implications and impact on yields can be substantial.
For example, interest rate adjustments by the central government (i.e. the Fed in the U.S.), even by one mere basis point, could have a substantial wave of effects on the bond and equities market, contrary to what some might anticipate.
Hence, using bps ensures clarity in speech.