The world of finance and investing, like
many other professions, has its own jargon and glossary of commonly used terms,
and understanding these terms is important for investors. Basis points are a
unit of measurement, typically used to prevent confusion when discussing
numbers otherwise represented as percentages and changes in percentages.
What are
Basis Points?
Basis points are
a commonly-used unit of measurement in finance to express percentages and
changes in percentages. One basis point is equal to one one-hundredth of a
percent or one permyriad (1bp = 0.01%). Basis points are typically abbreviated
as “bp” and are sometimes called a “bip”.
How Basis Points Are Used
Basis points are
most commonly used in discussions of percentages, particularly in cases of
relatively small percentage changes (1% or less), where the numbers to the
right of the decimal point are especially relevant. Investors will encounter
them most often in discussions of the following:
- Fixed income: rates/spreads for bond
- Interest Rates
- Fees
- Expense ratios,
gross or operating margins, and other areas where numbers, or changes in
numbers, are frequently expressed as percentages.
Interest Rate Basis Points
It is common to
quote interest rates in
terms of basis points relative to a benchmark. For instance, a variable rate
loan based upon the London Interbank Offer Rate (or LIBOR), a common short-term
interest rate benchmark, may be quoted as:
LIBOR + 50bp (or LIBOR+50, or L+50)
This means that
the borrower’s interest rate will be 50bp above the LIBOR rate. If the
current LIBOR rate is 0.40%, the borrower will pay 0.90%:
0.40% = 40bp; 40bp + 50bp = 90bp or 0.90%
Fees in Basis Points
It is also
somewhat common to see fees expressed as basis points—an annual expense ratio
of 0.40% of the assets under management would be expressed as “40bp”.
Likewise,
analysts will frequently talk about changes in margins or performance relative
to estimates in basis points—if a company reported a gross margin of 40.0% this
quarter, a gross margin of 39.5% a year ago, and the consensus estimate was
40.4%, an analyst would talk about a 50bp year-over-year increase in the gross
margin and a 40bp miss relative to expectations.
Why Basis Points Matter
Basis points
matter because the use of basis points is commonplace in discussions of
interest rates and yields, as well as other numbers typically expressed as
percentages, including expense ratios and margins.
1. Prevents Ambiguities Caused By Percentages
Basis points are
used to prevent or resolve ambiguities that could arise when talking about
differences in interest rates or other numbers expressed as a percentage. For
instance, if a given interest rate is 10% and someone says that the rate has
increased 10%, that could be interpreted as either 20% (10% + 10%) or 11% (10%
x 1.10). If instead, the increase is referred to as a “100bp” or “1,000bp”
increase, there is no ambiguity.
2. Ease of Reading Multi-Digit Numbers
Basis points can
also be used to make it easier to read numbers with multiple digits on either
side. When looking at lists of numbers it can be easy to mistake 0.15%, 0.015%,
and 0.105%, while “15bp”, “1.5bp”, and “10.5bp” would be less likely to lead to
errors.
How
To Convert Basis Points
For those
comfortable with mental arithmetic, conversion between percentages, basis
points, and decimal values is straightforward and quickly becomes virtually
automatic.
Converting Percentages to Basis Points
One simple way
to convert percentages to basis points is to simply move the decimal point two
places to the right and add the “bp”. For instance, 1.25% becomes 125bp, while
1.255% becomes 125.5bp.
Converting Decimals to Basis Points
To convert from
decimal value to basis points, move the decimal point two extra spaces (four in
total) – 0.0125 becomes 125bp, while 0.0005 becomes 5bp.
Converting Basis Points to Percentages or Decimals
To convert basis
points to percentages, either multiply the number of basis points by 0.0001, or
move the decimal point two places to the left and add a “%” – 125bp becomes
1.25%, 1255bp becomes 12.55%, and so on.
|
Basis points
(bp) |
Percentage |
Decimal |
|
1 |
0.01% |
0.0001 |
|
10 |
0.10% |
0.0010 |
|
50 |
0.50% |
0.0050 |
|
100 |
1.00% |
0.01 |
|
1,000 |
10.00% |
0.10 |
Bottom Line
Basis points are
an important unit of measure used in finance, banking, and investments when
discussing changes in yields, interest rates, or other numbers commonly
expressed as a percentage. With 100bp equal to 1%, it is an easy shorthand for
talking about and avoiding confusion with interest rates, margins, or expense
ratios, and changes in those numbers.
Source: seekingalpha.com