What are Basis Points (BPS)
Basis point (bps), often referred to by the number 1 bps, can be described as 1/10th of a percentage point or 0.01 percent or 0.0001. It is also known as”pip, “pip,” or a “bip,” or “bp.”
The term is often used when discussing yields and rates in the fixed-income world. The term is popular among those who invest in stocks that pay dividends and are focused on the return of an investment due to a dividend.
In addition, central bank policy announcements usually include interest rate adjustments expressed in base points. e.g., 25, a basis points increase in the Federal Funds rate is an increase of 0.25 percent or a quarter of one percentage point. Basis points are typically used to measure the difference between yields from two instruments of fixed income as it is a more accurate than using percentage points. e.g., the metric the 102 basis points equals 1.02 percent.
Yield Curves and Basis Points
The yield curve is known as a sequence of fixed income maturities coming from traditional sources, e.g., a central bank. Spreads of the basis point between these maturities can be expressed in yields from the more minor maturity, subtracted from that of the higher duration. A broad or steep spread shows a considerable difference in the yields, while a small or flat spread displays only a slight difference in yields.
Inverted spreads have an increased yield of the short maturity than in the longer term, which indicates that the reason for this is that this shorter maturity is more dangerous at the moment. (Yields for longer maturity tend to be higher as more things could be wrong during more extended time frames.)
For instance, if the yield for the two-year Treasury note is at 2.70 percent, or 297 bps, while that of the ten-year Treasury note stands at 2.88 percent or 288 bps and the 2s/10s Treasury spread is 18 bps. If, during the week before, there was a difference of yields was 25bps, the spread of 2s/10s would have widened by seven bps if the yield on the two-year note increased to 2.95 percent while the yield on the 10-year note was unchanged and the spread was inverted to a value of 7 basis points.
Basis Points And Consumer Rates
Basis points are also frequently employed in comparing consumer rates, such as the prime and credit card rates, and mortgage rates. The change in these rates is usually expressed as a change in basis points since it’s usually lower than the percentage point, e.g., 0.5% = 50 bps, or it is an amount that is a fraction of a point, e.g., 3/8 % = 1 3/8 percent = 137.5 bps.
Furthermore, the rates are usually calculated as a function of the risk compared with a standard rate such as the Federal Funds Rate or the 10-year Treasury note yield. From 1994 onward, the base rate has been typically that of the Federal Funds rate plus 3 percent, or 300 bps. The distinction between a 10-year mortgage rate and a ten-year Treasury note yield is usually stated in basis point to provide transparency when comparing one type of instrument against another.