What is a Basis Point?
A basis point, often abbreviated as "bps," is a unit of measurement used to describe small changes in financial percentages or rates. One basis point equals 0.01% or 1/100th of a percentage point. This unit is crucial in finance for measuring variations in interest rates, bond yields, and other financial metrics where precise changes matter.
Basis points are particularly useful for tracking minute adjustments in rates that, while seemingly small, can have significant implications for investments and financial decisions.
Basis Points Percentage Terms:
|
Point |
Percentage |
|---|---|
|
1 |
0.01% |
|
5 |
0.05% |
|
10 |
0.10% |
|
50 |
0.50% |
|
100 |
1% |
Importance of Basis Points
Understanding the meaning of basis points is crucial for several reasons:
- Precision in Financial Terms: Basis points allow for clear communication of minute changes in rates, such as interest rates or fees, which are critical in financial analysis.
- Rate Comparisons: They provide a standardised way to compare changes in rates across different financial products or periods.
- Cost Implications: Small changes in basis points can significantly impact costs and returns over time, making it essential for evaluating financial products and investments.
- Benchmarking Performance: Basis points help in measuring and comparing the performance of financial instruments or portfolios against benchmarks.
Steps to Calculate Basis Points
Calculating basis points involves the following steps:1. Determine the Rate Change: Identify the change in interest rates or other percentages. For example, if the rate changes by 30 basis points, this equates to 0.30%.
2. Convert Basis Points to Percentage: To convert basis points to a percentage, divide the number of basis points by 100. For instance, 50 basis points equals 0.50% (50 ÷ 100).
3. Apply Changes: Add or subtract the percentage value obtained from the basis points to or from the original rate to determine the new rate.
Example of Basis Points
Consider a fixed deposit account with an annual interest rate of 1.20%. If the bank raises the rate by 15 basis points, follow these steps to find the new rate:- Convert Current Rate: Convert the existing rate of 1.20% to basis points: 1.20%*100 = 120 basis points
- Add Basis Points: Add the 15 basis points increase: 120+15 = 135 basis points
- Convert to Percentage: Convert the new basis points back to a percentage: 135 basis points / 100 =1.35%
Thus, the new interest rate on the fixed deposit account is 1.35%.
