In Finance, a basis point is a unit that is equal to 1/100th of 1% and is used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indexes and the yield of a fixed-income security.
100 Basis points = 1 percentage point.
Why Basis Points are important:
It is typically used to:
- Express differences in interest rates of less than 1% per year.
- Avoid ambiguities between relative and absolute changes in interest rates.
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 Central Bank of Nigeria cut interest rates by 25 basis points,” this means that the CBN lowered rates by 0.25%. In finance, basis points are often written as “bps” and pronounced “beeps” or simply “points.”
For example, if a report says there has been a “1% increase” from a 10% interest rate, this could refer to an increase either from 10% to 10.1% (relative, 1% of 10%), or from 10% to 11% (absolute, 1% plus 10%). If, however, the report says there has been a “10 basis point increase” from a 10% interest rate, then we know that the interest rate of 10% has increased by 0.10% (the absolute change) to a 10.1% rate.
*This article was first published on Nairametrics on June 18, 2016.