Understanding Basis Points

In finance, basis points (bps) is another unit of measurement and it is used to describe the percentage change in the rate of a security or financial instrument.

In our last post, we explained the meaning of what stock market points are and how they are used to analyse the short term increases or decreases of stocks and indexes in the stock market.

Another important term used that could be confused with stock market points is basis points. In finance, basis points (bps) is another unit of measurement and it is used to describe the percentage change in the rate of a security or financial instrument.

While stock market points are used to assess naira gains or losses, basis points are used to determine changes in interest rates and bond yields. In other words, it tells you how much bond is paid to the investor.

Also, while stock market points have one point as one naira, one basis point is 1/100th of a percent. This can also be put forward as 0.01% or 0.0001 in decimal form.

In order to convert basis points into a percent form, therefore, you simply multiply the number of basis points you want by 0.0001. 10 basis points is 0.1%, 50 basis points is 0.5%, 1000 basis points is 10% and so on.

For fractional figures as well, the same applies. For example, 1.8 basis point is the same as 0.018% or 0.00018 in decimal.

Where it is used

As mentioned, the commonest way basis point is used is when you are talking about the yields on bonds or interest rates that the investor stands to enjoy. For example, if the yield of a bond which was 0.75% is increased by 25 basis points, it means that it was increased to 1%.

However, there are situations where it can also be used to explain the percentage change in the value of an asset like a stock. For example, if a stock index is said to have moved up 192 basis points in the trading for a period, it means there has been a 1.92% increase in the value of such index.

Why it is used?

The simple reason why the term basis point is used is to avoid ambiguity from either relative or absolute terms. A good example of this is a situation where there is said to have been a "1% increase" from an interest rate of 10%.

This 10% could mean an increase from 10% to 10.1% which is the relative term showing 1% of 10%, or it could have meant a growth to 11% which represents the absolute of 1% plus 10%. Basis point makes it very clear to determine what is being said as an increase of 1 basis point means 10.1%.

Written by Lawretta Egba.