Basis point definition: How to measure change in the value of assets or interest rates
Basis points represent a fraction of the percentage of changes in financial instruments’ value
What is a basis point?
A basis point, or basis points – also known as ‘bps’, ‘bips’ or ‘points’ – are used to measure the change in the value of assets or a change in interest rates. The basis point represents changes expressed as a percentage of the value. It signifies a fraction of the percentage, meaning that one basis point change would indicate a change of 0.01%, while a 100% change in terms of bps would be a 10,000-basis point change. Accordingly, a basis point denotes one-hundredth of 1% (1/100 of 1%).
Translating basis points to percentage is done by dividing the basis points by 100. Translating a percentage change to basis points is done by multiplying the percentage by 100. Assume that the change on an instrument is stated to be 70 basis points (bps), while the change for another instrument is 3%. The conversion is as follows:
70bps to percentage = 70/100 = 0.7%
3% to bps = 3x100 = 300bps.
Basis point meaning
The need for this type of measure comes from the confusion that may arise when changes are stated only in percentages. For instance, stating that the rate of 10 % has a positive change of 3% is difficult to understand – so is the change from the current 10%to 13%, or the increased rate is 10.3%.
Avoiding this kind of misinterpretation is possible when changes are stated in basis points. When something changes by 25bps, it is clear that the change is 0.25%. The basis points could indicate a change in the interest rates, bond yields, stock prices and other financial assets.
Let's go through an example with interest-rate change. It is stated that the current interest rate of 3% will increase by 50bps. This would mean that the new interest rate would be 3% plus 0.5% (50bps) or 3.5%. An announcement by the Central Bank that it will cut interest rates by 30bps indicates that new interest rates will be lower by 0.3%.