Basis Points (bps)
What it is:
How it works (Example):
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 prounounced "beeps" or simply "points."
Why it Matters:
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 interpretted 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%.