A basis point is considered the smallest measurement of quoting changes to interest rates or yields on bonds. It is a way to describe one-hundredth of a percentage point (0.01%). Basis points are often used instead of percentage points when differences of less than 1% are meaningful and have a tangible effect.
Learn more about basis points, how they work, and their role in investing.
What Is a Basis Point?
A basis point—which is commonly heard from financial media and experienced investors—represents 0.01%. For example, if someone says the yield on a 10-year Treasury bond fell 10 basis points, they mean it dropped by 0.1% (0.01 * 10). If someone says a bond yield fell 100 basis points, it means it decreased by 1% (0.01 * 100). The term is common in discussions about bonds, other fixed-income investments, and loans.
People use the terms "basis points" and "percentage points" to avoid confusion when discussing the difference between the two rates. For example, let's say that a news report said the yield on a bond rose 0.5% from 7.5%. It might be difficult to discern what the new yield is. It could be 8% (7.5% + 0.5%) or it could be 7.875% (7.5% + 0.375%, which is 5% of 7.5%). However, if the news reported a 0.5 percentage point increase—or a 50 basis point increase—you would know the new yield is 8%.
If someone references basis points and you can’t remember what that means, you can convert to a percentage by placing the decimal point before the final two numbers. So 1,050 basis points is 10.50%, and 236 basis points is 2.36%.
How Basis Points Work
Basis points are commonly used to express changes in the yields on corporate or government bonds bought and sold by investors. Yields fluctuate, in part because of prevailing interest rates, which are set by the Federal Reserve’s Open Market Committee. If the Fed lowers its fed funds target rate, interest rates on newly issued bonds will decline, and vice versa. Those changes affect the prices investors are willing to pay for older bonds, which affects the expected return on the bonds.
Let’s say you have $10,000 to invest, and decide to buy a bond with an interest rate, usually called a coupon rate, of 3%. A year later, prevailing rates have dropped 50 basis points, so new bonds with the same face value are now paying 2.5%. Your bond is now worth more because it pays out $300 a year rather than $250. Generally, investors want to see yields rising, and you’ll often hear the changes expressed in basis points.
Interest rates are sometimes explained in relation to an index or benchmark rate. One common comparison is to the London Interbank Offer Rate (LIBOR). A bond with a floating rather than a fixed interest rate may have a rate of 25 basis points above LIBOR. If LIBOR stands at 2%, then the rate is 2.25%.
Suppose you’re an investor in mutual funds or exchange-traded funds. In that case, you may encounter an annual fee called an expense ratio, which is the portion of assets deducted each year by your fund manager for fund expenses. If your expense ratio is 145 basis points, that means your fund manager is charging you 1.45% of your total assets in the fund—which equals to $14.50 per $1,000 invested.
Basis points are also common in discussions about borrowing as well as investing. The Fed’s benchmark rate, which influences rates on mortgages, credit cards, and other loans, is usually changed 25 basis points at a time. However, the Fed last changed the benchmark in March 2020, decreasing it by 100 basis points.
- Using basis points can avoid confusion when discussing changes in yields or interest rates.
- Basis points are most commonly used when differences of less than 1% are meaningful.
- A basis point refers to one-hundredth of a percentage point. For example, the difference between 1.25% and 1.30% is five basis points.
- When the Fed benchmark interest rates are changed, they usually go up or down by 25 basis points.
- Basis points are also commonly used when referring to the cost of mutual funds and exchange-traded funds.