What are Basis Points (BPS) In Finance

Consumers and companies use the abbreviation BPS regularly in finance. The term may come up as you apply for a mortgage loan, when you sell a mortgage note, or any other loan for that matter. 

Mortgages and other loans aren’t the only financial instruments where you may encounter the term BPS. It could be used to define yield spreads on bonds or when the Federal Reserve announces that its Fed Funds interest rate increased. 

No matter where you come across the term BPS, it provides crucial information about how much interest you pay on loans or what you can expect from investment returns. 

What Are Basis Points (BPS)?  

BPS is an abbreviation for the term “basis points,” which is a unit of measure finance professionals and consumers alike use to define changes in terms of percentage points. One basis point in percentage is 0.01%, while 50 basis points in percentage is 0.5%. 

For example, you may have read that the Federal Reserve recently held a Federal Open Markets Committee (FOMC) meeting where they increased the Fed Funds Rate target by 75 basis points, which is equal to 0.75%. 

That means if the previous Fed Funds rate was 3%, the new rate is 3.75%. Since the Fed Funds rate is typically the benchmark by which lending institutions set their interest rates, mortgage buyers and other borrowers can expect to pay higher interest following the increase. 

On the investment side of the coin, you may hear that an exchange-traded fund (ETF) increased by 207 basis points over the course of a month. That means the investors in the ETF realized a gain of 2.07% on their investment during the month. 

How Many Basis Points Is 1 Percentage Point?

One basis point is equal to 1/100th of a percentage point, or 0.01%. So, it takes 100 basis points to make up one percentage point, 200 basis points to make up two percentage points, and 300 basis points to make up three percentage points. 

How Do I Calculate BPS?

Converting basis points into percentages is relatively simple. Here’s the formula:

NBPS/100 = PP

Where:

• NBPS is the number of basis points, and
• PP is percentage points. 

For example, if you want to convert 25 basis points into percentage points, your formula would look like this:

25 / 100 = 0.25%

If you want to convert 50 basis points into percentage points, your formula would look like this:

50 / 100 = 0.50%

Based on this chart, if your investment portfolio’s value increased by 100 basis points today, that would mean your portfolio experienced a 1% gain in today’s trading session. 

Why Do Companies Use BPS?

The core reason companies and consumers alike use basis points is to alleviate ambiguity in percentages in finance. No matter how the increase is stated, one basis point is equal to one-hundredth of a percent. 

That comes in handy when someone in finance says something like, “The yield on your investment was 8% before rising 4%.” This statement could be taken two different ways: 

1. Adding the Two Numbers Together. Someone may hear this statement and add 4% to 8%, leading to the belief that the yield on their investments increased from 8% to 12%. 
2. Percentage Increases. Another person may construe the gain as 4% of 8. That would lead to a total gain of 8.32%. 

As you can see, the two end numbers are very different depending on how the statement is interpreted.  When you use percentage points in finance, this is a common issue. Basis points alleviate that issue. 

If the first interpretation of the statement above was true, the ambiguity could be alleviated by saying “The yield on your investment was 8% before rising 400 basis points.” If the second interpretation of the statement above was true, the confusion could be avoided by saying, “The yield on your investment was 8% before rising 32 basis points.”

Final Thoughts

Basis points are an important term in nearly all areas of finance. Basis points help to get rid of ambiguity and define changes more clearly anywhere percentage points are used – alleviating ambiguity and creating a unit of measure that everyone can understand quickly. Next time you see the term basis points, do the math to see how the interest earned or paid has changed.