Basis Point

Basis Point

A basis point is a unit of measurement in finance, equal to one-hundredth of a percentage point, or 0.01%. This means that 100 basis points equal 1%. Basis points are commonly used to describe small changes in interest rates, bond yields, and other financial percentages.

Understanding Basis Points

Basis points provide a clear and precise way to discuss changes in financial metrics, particularly when those changes are less than one percent. For example, an interest rate increase from 2.00% to 2.25% is a change of 25 basis points.

Importance of Basis Points

• Precision: They allow for accurate communication of small changes in financial rates, which can have significant impacts on investments and loans.
• Clarity: Using basis points helps avoid ambiguity when discussing percentage changes. For instance, stating that an interest rate increased by 1% could be interpreted in different ways, but saying it increased by 100 basis points is specific and unambiguous.
• Standardisation: Basis points are a standard unit of measurement in finance, facilitating clear comparisons across different financial instruments and markets.

Examples of Basis Points in Use

• Interest Rates: If the Reserve Bank of Australia raises the cash rate from 4.35% to 4.60%, this is an increase of 25 basis points.
• Bond Yields: A bond yield that decreases from 5.00% to 4.75% has fallen by 25 basis points.
• Loan Interest Rates: A mortgage rate reduction from 3.50% to 3.25% represents a decrease of 25 basis points.

Understanding basis points is essential for professionals and investors in the financial sector, as even small changes can have significant implications for borrowing costs, investment returns, and overall financial planning.