Basis Points

The speaker covers the basics of a basis point.  A basis point is the smallest unit of measure to account for changes in rates of a financial instrument.  1 basis point equals 1/100th of a percent.  If the Fed lowers the rates from 3 to 2.5%, it can be said that they made a 50 basis point drop.

What is a Basis Point?

The term Basis Point (bp) was created to account for fractional changes in bond yields. Since large institutional bond traders can make or lose hundreds of thousands of dollars on fractional moves in interest rates, they divide each percentage point by 100 to gain a more granular level of analysis. A basis point represents one hundredths of a percentage point, or basically .01%. For example, if interest rates moved from 4% to 4.25%, this would represent a change of 25 basis points.

The term is also used to compare many bond instruments to each other. A bond trader may compare a 3 year bond yielding 4.52% and a 5 year bond yielding 4.73% and describe the difference between to the two of them to be 21 basis points. A general rule of thumb is that a daily move of over 10 basis points in any bond instrument is a more substantial move.

You may also hear the term basis points used frequently by the Federal Reserve when they discuss monetary policy on interest rates. When the fed decides to move interest rates up or down, they will publish that change in basis points. If the Fed changes interest rates, it will usually be by 25 basis points; however, if market conditions require, a 50 basis point move may be required.

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