Basis Point (BPS)
Candlefocus EditorThe term ‘Basis Point’ originated from the usage of basis in the context of comparing two different dollar amounts. It is the smallest difference in percentage which can be used to denote larger ranges between two given numbers. For example, if one bond rate is 5.01% and the next bond rate is 5.03%, then the spread between the two is two basis points.
When talking about equity indices or fixed-income securities, the basis point helps recognise rate changes when the movement and fluctuations of rates are compared. For instance, a jump in the 30-year treasury yield from 3.63% to 3.65% is equivalent to two basis points. Similarly, a fall in the S&P 500 index from 3,000 to 2,999 signifies a one basis-point drop.
Another widespread use of basis points can be seen in the unit pricing structure of mutual funds and exchange-traded funds – which consists of a ‘3’ or a ‘4’ preceding basis points. So, for example, a mutual fund with a unit price of $123 is equal to 12.3 basis points.
Basis points are also used in several other quantitative measures such as loan money adjustments and changes to return on investment percentages. As such, it can be concluded that basis points are a critical part of financial analysis and its associated terminology.