Basis Point
A basis point, often abbreviated as “bp” and pronounced as “bip,” is a unit of measure used in finance to express the change in interest rates, yields, or other percentages. One basis point is equivalent to 0.01% or 0.0001 in decimal form.
Basis points are commonly used in the context of interest rates, bond yields, and other financial instruments where percentage changes are small and precision is required. By expressing changes in basis points, it is easier to communicate and understand these small variations without dealing with decimals or very small percentages.
Example of a Basis Point
Let’s consider an example involving mortgage interest rates to demonstrate the concept of a basis point.
Suppose you are planning to take out a mortgage to buy a house. You’ve been monitoring the interest rates offered by two different banks, Bank A and Bank B. Currently, Bank A offers a 30-year fixed mortgage at an interest rate of 3.25%, while Bank B offers the same mortgage at an interest rate of 3.40%.
A few days later, you notice that both banks have adjusted their interest rates. Bank A has lowered its rate to 3.15%, while Bank B has increased its rate to 3.45%. To express these changes in terms of basis points, we can calculate the difference as follows:
Bank A: Initial interest rate: 3.25% New interest rate: 3.15% Change: -0.10% (a decrease)
In basis points, this change is equivalent to -10 basis points, as -0.10% ÷ 0.01% = -10.
Bank B: Initial interest rate: 3.40% New interest rate: 3.45% Change: +0.05% (an increase)
In basis points, this change is equivalent to +5 basis points, as 0.05% ÷ 0.01% = 5.
Using basis points to express these changes allows for a clearer comparison of the adjustments in interest rates. In this example, Bank A decreased its mortgage interest rate by 10 basis points, while Bank B increased its rate by 5 basis points.
