A basis point is also known as ‘per thousand sign’. A basis point is defined as that numerical figure which represents the one hundredth of a percentage or equivalent to one thousandth. This term is generally used in the finance sector, more specifically in the fixed income market. The basis point is used in finance to denote the change in percentage for a financial instrument’s rate.
In general, one basis point is usually equal to .01% or .0001 in decimal form. A basis point is an important term as it is used to refer to the changes that take place in the interest rates as well as the bond yields. It is that unit of measurement which takes into consideration the differences in the percentage of mostly less than 1%.
Understanding the concept of the basis point
Similar to the percentage points, the basis point too tends to avoid the ambiguity that is there between the relative as well as the absolute discussions when it comes to the interest rates. This is done by dealing only with the absolute change in the numerical value of a rate. To understand this let us consider an example. Suppose that in a report it says that there has been an increase of 1% from an interest rate of 10%. Now here it could refer to either of the two cases. It could refer to either an increase to 10.1% from 10% or it could refer to the increase to 11% from 10%. But if we look at the report further, it says that there has been an increase of “100 basis point” from the interest rate of 10%. In this way the interest rate has increased by 1% from 10% to 11% rate.
An example of the basis point
Let us consider an example of June 2017. At that time the Federal Open Market Committee (FOMC) increased their rate of the benchmark by a basis point of 25 to a range of 1% to 1.25%. This clearly meant that the increase in the rate was done by 0.25% point from the range of 0.75% to 1%.
Now in terms of the bond market, this basis point generally refers to the yield that is paid by a bond to the investor. So in case if the movement of the bond yield is from 7.45% to 7.65%, then one can say that it has risen by a factor of 20 basis points.
In the financial industry, it is a common practice to make use of the