What are Basis Points (bps)?
A basis point is the smallest measure used in quoting yields on fixed income products. Basis points also pertain to interest rates. One basis point is equal to one one-hundredth of one percentage point (0.01%). Therefore, 100 basis points would be equivalent to 1%.
How Do Basis Points (bps) Work?
An interest rate of 5% is 50 basis points greater than an interest rate of 4.5%. The difference between 12.83% and 12.88% is five basis points.
When you read a headline such as 'The Federal Reserve cut interest rates by 25 basis points,' this means that Fed lowered rates by 0.25%. In finance, basis points are often written as 'bps' and pronounced 'beeps' or simply 'points.'
Why Do Basis Points (bps) Matter?
The term basis points avoids the ambiguity in discussions about rates. Confusion could arise in a statement such as, 'a 1% increase from a 10% interest rate.' The 1% increase could be interpreted as either an increase from 10% to 10.1% (relative) or 10% to 11% (absolute).
Using basis points clarifies the amount in question. The statement, '... a 100 basis point increase' would signal that the rate has increased from 10% to 11%.