Basis points, otherwise known as “bips” or “bps,” are a unit of measurement that has been simplified, and it represents percentages in finance. A basis point is equivalent to 1/100th of 1%, so it’s able to more accurately measure changes in interest rates. After all, these changes in interest rates may seem insignificant, but in actuality, they usually convert to a significant amount in dollar values. This is why when revealing interest rate spreads or annuity fees, insurance companies usually calculate using basis points.
Basis Points vs. Percentages
One major reason why basis points are used in favor of percentages is that they are more convenient and steadier than the latter. After all, basis points aren’t represented by a ratio. Instead, their stability can be credited to the fact that they are represented by a non-ambiguous set figure. Let’s think of some examples to make this concept easier to grasp: when 1% is increased on a 5% interest rate, this is usually read as either 5.05% or 6%. As you can see, there’s no set figure when you think in percentages. On the other hand, if that same rate is raised by 100 basis points, the result is a set figure, which is 5.01%.
What Is a Basis Point’s Price Value?
Going into specifics, a single basis point is equivalent to 0.01% or 0.0001. If you need further assistance, you can actually employ the help of a calculator, or make use of simple arithmetic to do the conversion. This can be used if you’re trying to convert basis points to percentages and vice versa.
Here’s how you can do the math:
- If you’re trying to convert percent to basis points, multiply the percentage by 100.
- Conversely, if you want to convert basis points to percent, divide the points by 100 instead.
If you use this same calculation, 10,000 basis points are equivalent to 100%. Below you’ll find a quick cheat sheet:
How Investors Use Basis Points
Investors use basis points to relay how much mutual funds cost along with other exchange-traded funds. The use of basis points heavily affects the world of finance and its many instruments, which include mortgage loans, common stocks, treasury bonds, and even corporate bonds.
Basis points are also used by investors to compare and contrast fees and expenses since they’re always consistent. As mentioned, basis points can have a major impact on dollar values, not only for the people but for institutions as well, even though it’s only 1/100th of 1%.
How Annuity Providers Use Basis Points
Asides from investors, annuity providers also make use of basis points to indicate incremental annuity rate changes. Annuity providers, when computing how much the index and the rate spread have changed, use basis points to help them determine these changes in a more consistent way.
Did our explanation help you understand what basis points are and why they’re used so often? We hope so! Using basis points in certain financial situations instead of percentages can significantly make things easier and simpler for you, so try it out next time.