What Are Basis Points, And How Do They Work?

Shawn Plummer

CEO, The Annuity Expert

Have you ever heard of basis points and wondered what they are? Whether you are a financial professional or an average individual, understanding essential points can be helpful in many ways. Basis points measure the percentage difference in interest rates, investment returns, and other financial metrics. This guide will explore the essential points, how they work, and why they matter.

What are the essential points?

Basis points are a unit of measurement commonly used in the financial industry to express changes in interest rates, bond yields, and other financial metrics. One basis point is equal to one-hundredth of a percent or 0.01%. Therefore, if an interest rate increases by 25 basis points, the interest rate increases by 0.25%.

What Are Basis Points

How are basis points used in finance?

Basis points express the difference between two interest rates or bond yields. For example, if the yield on a ten-year treasury bond is 2.50% and the yield on a two-year treasury bond is 1.50%, the difference is 100 basis points. This difference is commonly referred to as the yield curve, and it is an essential indicator of the economy’s health.

Why are basis points important?

Basis points are essential because they allow financial professionals to express changes in interest rates and bond yields in a standardized manner. This makes comparing different financial products and communicating interest rate changes to clients easier. For example, if a financial advisor tells a client that interest rates have increased by 50 basis points, the client knows that the interest rate has increased by 0.50%.

How do basis points work?

Basis points work by expressing changes in financial metrics as a percentage of the original value. For example, if the interest rate on a loan is 5.00% and increases by 25 basis points, the new interest rate is 5.25% (5.00% + 0.25%). Similarly, if the yield on a bond is 3.50% and decreases by 50 basis points, the new yield is 3.00% (3.50% – 0.50%).

How are basis points calculated?

Basis points are calculated by taking the difference between two percentages and multiplying by 100. For example, if the interest rate on a loan is 5.00% and increases by 25 basis points, the calculation is as follows: 0.25% x 100 = 25 basis points.

How are basis points used in financial products?

Basis points are used in various financial products, including loans, bonds, and mortgages. For example, a mortgage lender may offer a mortgage with an interest rate of 4.25% plus 50 basis points. This means that the interest rate on the mortgage is 4.75% (4.25% + 0.50%). Similarly, a bond may yield 5.00% minus 25 basis points. This means that the yield on the bond is 4.75% (5.00% – 0.25%).

Next Steps

In conclusion, basis points are a basic unit of measurement in the financial industry. They are used to express changes in interest rates, bond yields, and other financial metrics in a standardized manner. In addition, basis points allow financial professionals to compare different financial products and communicate interest rate changes to clients. Therefore, understanding basis points are essential for anyone working in finance or investing in financial products.

Basis Points

Request A Quote

Get help from a licensed financial professional. This service is free of charge.

Contact Us

Frequently Asked Questions

What are some common uses of basis points in financial markets?

Basis points are commonly used in financial markets to measure interest rate changes, bond yield, stock performance, and foreign exchange rate changes. They are also used in financial contracts, such as loans and derivatives, to calculate payments and determine prices.

What is the significance of basis points in the stock market?

In the stock market, basis points are used to measure changes in the value of stocks and other securities. They are also used to calculate returns and performance. A slight difference in basis points can significantly impact investment returns over time.

Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

Scroll to Top