What is a basis point?
In trading, it is widespread for a financial instrument such as forex, stocks, future, or commodities to change in value. We can also use basis points in interest rates, bonds, and many more. These financial instruments use a unit that tells the percentage fraction of the value changes. We call this a basis point. A basis point is also known as bp that we pronounce as bip or beep. A basis point is equivalent to 0.01% (one-hundredth of one percent).
Let us explain the basis point further.
The basis point is always expressed in percentage. This percentage refers to how much the value has changed or moved.
One basis point is equal to a 0.01 percent change. It takes 10,000 basis points for an asset or an interest to have a 100 percent value change.
Talking about numbers and figures
The concept of one basis point is 1/100 of one percent (one-hundredth of one percent). If we have the basis point and want to know the percentage, we can divide it by 100. If the situation is the other way around, where we have the percentage, and we want to find the basis point, we can multiply the percentage by 100.
Let us cite an example!
Let us assume that an asset had a value change of 50 basis points. If we follow what we have explained earlier, the equation goes something like this:
Basis point to percentage: BP / 100
50/ 100 = 0.5%
In another perspective, let us assume that an asset’s value change is 5%, and you want to know the basis point. We can convert it using this formula:
Percentage to basis point: Percentage * 100
5% * 100 = 500 basis points
It is pretty simple, right?
Another example related to interest rates
Jane currently has an account in X bank where the interest rate is 1.5%. X bank informed their clients, including Jane, that their interest rates would increase by 60 basis points starting next week. So, what will be the new interest rate?
60 basis points to percentage: 60/ 100 = 0.06%
Now, let us add the current interest rate!
1.5% current interest rate + additional 0.06% = 2.1%
The new interest rate will be 2.1% starting next week.
Is it essential to know the basis point?
Now that we have seen how easy the conversion is, we can say that it is still essential to know how to do it because sometimes, we only have the percentage as given. It might be a little challenging to comprehend the changes of value. For example, the statement only goes like 10 percent rate’s positive value change is 5. It might take a long time to understand this because it sounds a little confusing. Not unlike if we make statements using basis points, then the confusion will lessen. If an asset has a ten basis point change, the change is 0.10 percent. If it has a 50 basis point change, then the percentage is 0.50%.
