Basis Point

Basis Points (BPS) | Definition & Calculation of BPS in Finance

Basis Point

Basis points (bps) in finance is the smallest unit to measure return on bonds, note, other fixed income securities, and interest rate quotes. A basis point is also used to show a minor percentage change in interest rate, the yield of bonds, etc.

From the viewpoint of investors, traders, and analysts, 1 BPS is equal to a variation of 0.01%, and 100 BPS is equal to a variation of  1 percent.

1 BP = (1/100th)*1%= 0.01 %

In the financial market, the use of BPS is preferred over a percentage to avoid any confusion. For e.g., if an analyst states that an instrument that was yielding  15% of the rate of interest and there is an increase of 10% in rate. As an investor, there will be confusion whether this 10% increase in the rate is absolute that means 15% + 10%= 25% or relative 15%(1+10%)= 16.5%.

The use of BPS avoids such ambiguity. If an instrument that was yielding 15% of the rate of interest and there is an increase of 50 BPS, this clearly means the new rate of interest is 15% +0.5%= 15.5%.

Understanding of BPS

The following are some points to understand basis points (bps) in finance better.

#1 – For Inter-Bank Lending Rate

In the newspaper, we generally read the news the Federal Open Market Committee has lowered its benchmark fund rate by 25 basis points. This means that now the bank will cut the overnight lending charge to other banks by 0.25 %.

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#2 – For Mutual Funds

As an investor, when we look for mutual fund and exchange-traded funds, we look into a very important parameter called Expense Ratio – which is a kind of annual fee which is deducted by the fund manager from the asset. Generally, the expense ratio is measured in BPS as if the expense ratio is 175 BPS, and then the fund manager will deduct 1.75% of the total asset as fund expense every year.

#3 – For loans

When we hear news a bank has reduced the home loan lending rate by ten basis points, then this states that now Home loan has become cheaper by 0.1 %.

BPS also used to measure whether banks are passing the benefits of the rate cuts by the central bank to the consumers or not.

if the Federal Open Market Committee (FOMC) cut the rate, then the bank should also reduce the prime lending rate, and the interest rate on loans should come down.

If rates are not coming down, then the banks are not passing the benefit of the rate cut to consumers, So the consumer can switch their loan to other banks with lower interest rates.

#4 – For Change in Yield on Bond

Suppose Adams has invested $10,000 in a bond that usually yields an interest of 4%. A year later, rates have dropped by 100 basis points (reduced by 1%), which means now the same bond after a year yields 3%. So the value of bond purchase a year back yields a higher return that is $400 as compared to the same bond purchased after a year that yields are $300.

#5 – For Calculation of Floating Interest Rate

The yield of some of the bonds are linked to some other offer rates and are not fixed. For e.g., the interest rate of some of the bonds are linked to the London Interbank Offer Rate (LIBOR) “30 basis point above LIBOR”, so if LIBOR is 2.5%, then the Interest rate on the bond will be 2.5% + 0.3% = 2.8%

Calculation of Basis Point in Finance

Below are the examples to explain bps calculation.

Example #1

A Bank has cutdown Home loan lending rate by 25 basis point from 8.75%, so in this case, the new lending rate will be as follows:

Given:

So, Rate Cut in percentage will be –

  • Rate Cut = 0.01%*25
  • Rate Cut = 0.25%

New Lending Rate will be –

  • New Lending Rate = 8.75% – 0.25%
  • New Lending Rate = 8.50 %.

Example #2

Adams purchased a short term fund that gave a return of 10% in a year on which the expense ratio is quoted as a 25 basis point. So, in this case, the net return on investment will be:

  • Return from Fund = 10%
  • Expense Ratio = 25 BPS = 25*0.01%= 0.25%
  • Net Return from Fund= 10% -0.25% = 9.75%

Basis Point Value Calculation

Basis point value also is known as DV01, represents the change in the value of the asset when the yield on asset change by 1 BPS. Instead of using a basis point change, the price value of a one basis point is used to represent changes.

Basis Point Value (BPV)  =  Face Value x (days ÷ 360) x 1 BP

For Example, there is a Eurodollar future contract with the face value of is $100000 that tracks 3 months LIBOR. So its BPV will be:

So,

  • BPV =  $100000 x (90 ÷ 360) x 0.0001
  • BPV = $ 25

(1 BP = 0.01%= 0.0001)

Advantages of Basis Point

Some of the advantages of BPS are as follows –

  • Clarity – The main importance of Basis Point is that it brings clarity while discussing the changes in interest rates or other financial parameters. Un in percentage where change denoted in percentage always confuse the stakeholders whether the change is absolute or relative one.
  • In Explaining Spread – A basis point is most commonly used in the financial world to explain the ‘Spread.’ Spread generally refers to a change in the price of an asset after a time duration or change in the return on a percentage. So, if Spread is expressed in terms of Basis Point, then it will represent a clear picture of variation.

Conclusion

Basis Points (BPS) is the smallest unit of measuring yield on the bond, note, and other fixed-income Security. One basis point is equal to 1/100 of one percentage point or 0.01. BPS is commonly used by the stakeholders in the financial market because it brings clarity to the discussion.

This has been a guide to what is Basis Points (BPS) and its definition. Here we discuss the examples for the calculation of basis point value in finance along with its advantages. You can learn more from the following articles –

Источник: https://www.wallstreetmojo.com/basis-points-bps/

Basis Points (BPS) — Finance Unit of Measurement 1/100th of 1%

Basis Point

In finance, Basis Points (BPS) are a unit of measurement equal to 1/100th of 1 percent.

  BPS are used for measuring interest rates, the yield of a fixed-income securityFixed Income Bond TermsDefinitions for the most common bond and fixed income terms.

Annuity, perpetuity, coupon rate, covariance, current yield, par value, yield to maturity. etc., and other percentages or rates used in finance.

This metric is commonly used for loans and bonds to signify percentage changes or yield spreads in financial instruments, especially when the difference in material interest rates is less than one percent.

One basis point is equal to .01 percent or 1/100th of 1 percent. The succeeding points move up gradually to 100%, which equals 10000 basis points, as illustrated in the diagram below.

PercentageBasis Points
0.01%1
0.1%10
0.5%50
1%100
10%1000
100%10000

Examples:

  • The difference between bond interest rates of 9.85 percent and 9.35 percent is 0.5 percent, equivalent to 50 basis points.
  • The Federal Reserve boosts interest rates by 100 BPS, signaling an increase from 10 percent to 11 percent.
  • Due to the growth of iPhone sales, Apple Inc. reported high earnings, more than what was estimated; the stockStockWhat is a stock? An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved). The terms «stock», «shares», and «equity» are used interchangeably. increased 330 BPS, or 3.3 percent, in one day.

Conversion between basis points and percentage

To convert the number of basis points to a percentage and, in turn, a percentage to basis points, without using a conversion template or chart, review the following:

  • Basis points to percentage – Divide the points by 100
  • Percentage to basis points – Multiply the percentage by 100

Why do investors and analysts use BPS?

The main reasons investors use BPS points are:

  • To describe incremental interest rate changes for securities and interest rate reporting.
  • To avoid ambiguity and confusion when discussing relative and absolute interest rates, especially when the rate difference is less than 1 percent, but the amount has material importance. For example, when discussing an interest rate that has increased from 11% to 12%, some may use the absolute method stating there is a 1% increase in the interest rate, while some may use the relative method stating a 9.09% increase in in the interest rate. Using basis points eliminates this confusion by stating that there is an increase in the interest rate of 100 basis points.

What instruments does BPS apply to?

The usage of basis points is primarily applied to yields and interest ratesSimple InterestSimple interest formula, definition and example. Simple interest is a calculation of interest that doesn't take into account the effect of compounding.

  In many cases, interest compounds with each designated period of a loan, but in the case of simple interest, it does not.  The calculation of simple interest is equal to the principal amount multiplied by the interest rate, multiplied by the number of periods.

, but they may also apply to the change in the value of an asset, such as the percentage changes of stock values. Common examples include the following:

  • Treasury bonds
  • Corporate bonds
  • Interest rate derivatives
  • Credit derivatives
  • Equity securities, such as common stock
  • Debt securities, such as mortgage loans
  • Options, futures

Additional resources

Thanks for reading this guide!  At CFI our mission is to help you advance your career.  With that in mind, we’ve developed these additional CFI resources to help you take your analyst career to the next level.  Please check out:

  • Simple interestBuy Side AnalystA buy side analyst is an analyst who works with fund managers in mutual fund companies, financial advisory firms, and other firms, such as hedge funds, trusts, and proprietary traders. These firms buy large portions of securities for fund management. Recommendations made by buy side analysts are confidential
  • Hurdle ratesEBITDAEBITDA or Earnings Before Interest, Tax, Depreciation, Amortization is a company's profits before any of these net deductions are made. EBITDA focuses on the operating decisions of a business because it looks at the business’ profitability from core operations before the impact of capital structure. Formula, examples
  • Line of creditBank LineA bank line or a line of credit (LOC) is a kind of financing that is extended to an individual, corporation, or government entity, by a bank or other
  • Investment BankingInvestment BankingInvestment banking is the division of a bank or financial institution that serves governments, corporations, and institutions by providing underwriting (capital raising) and mergers and acquisitions (M&A) advisory services. Investment banks act as intermediaries
  • Financial ModelingWhat is Financial ModelingFinancial modeling is performed in Excel to forecast a company's financial performance. Overview of what is financial modeling, how & why to build a model.

Источник: https://corporatefinanceinstitute.com/resources/knowledge/finance/basis-points-bps-definition/

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