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Glossary
Basis point
Definition
A basis point is one one-hundredth of a percentage point. Basis points are a unit of measurement used to describe very small movements in an asset’s value. Also known as bps or bips, basis points are most commonly used when discussing changes in interest rates or bond yields.
A closer look at basis points
Basis points (also known as bps or bips) help traders and analysts make more precise judgements about the rate of change in an asset’s value. Every 0.01% (0.0001) equals one basis point, so if a country’s interest rate has been cut by 50 basis points, that means the interest rate fell 0.5%.
With some financial instruments, even the smallest change in a value can make a substantial difference. A basis point is the smallest unit of measurement that can be used when looking at the rate of change for certain instruments.
Why are basis points used by traders/investors rather than percentages?
Using basis points instead of percentages removes ambiguity when discussing or reporting on rates of change. When using percentages, the actual meaning can be uncertain.
For example, if a country’s central bank increases its rate of interest by 15%, this could be interpreted in two ways. If the previous base rate was 3%, you might think the interest rate has risen to 3.45%, or you might think it has risen to 18%.
To avoid any confusion when trying to understand changes in a financial instrument’s value, basis points help make things clear. Using the same scenario as above, if the base rate went from 3% to 3.45%, that would be an increase of 45 basis points. If the base rate went from 3% to 18%, that would be a staggering rise of 1,500 basis points.
Basis points are also more precise, as they can define even the most minor price movements in the markets to provide more clarity to traders and help avoid trading errors.