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When it comes to bonds, mortgages, and other interest-rate-sensitive instruments, most people refer to the change in interest rates as basis points or bps for short. For example, you might hear someone say that a bond yield increased by 12 bps. The actual meaning is that the new yield is 0.12% higher than the old one. BPS is used to describe changes in interest rates on fixed income instruments because it is the decimal form of the change.
In this article, we are going to look at what is Basis Point and how to calculate it.
What is a Basis Point
A basis point is a unit in measurement used to quantify change. To calculate the basis points from any given percent change, you simply need to multiply the change by 100 to obtain the value in basis points.
Now when it comes to bonds and mortgages, most people refer to the change in the interest rate as basis points or bps for short. So, bps is used to describe changes in interest rates on fixed income instruments because it is the decimal form of the change.
Example of Basis Points
Question: What is the change in yield in basis point of a bond trading at par that has a yield increase from 6% to 6.10%?
Answer: Using the calculation method mentioned above, we multiply the change (0.10%) by 100 and obtain 10 BPS.
Another Example
Question: What is the change in yield of a bond trading at 103 that has a yield decrease from 5.02% to 4.98%?
Answer: -0.04 multiplied by 100 = -4 BPS
So, as you can see it simply requires multiplying the change by 100 to get your answer.
Why use basis points
BPS is widely used for quoting changes in financial assets, especially bonds and interest rates. This is because the basic point is a decimal form of change that makes it easy to understand the relative change in numbers, compared to percentages, which can be confusing and misleading in certain cases.
It gives you a better idea of a security’s or an instrument’s volatility. BPS is a unit that is used to measure the change in various fixed-income instruments which have different values for each one, just like interest rates. It does not matter if you are dealing with bonds, mortgages, or other interest-rate-sensitive instruments, BPS measures the increase or decrease from the previous value.
How to Calculate Basis Point Value of a Bond or Mortgage
In order to calculate the basis point value of a bond or mortgage, you need to know how much they are worth currently. Then you have to find out how much their value changes after the shift in interest rates. Once you have done this you divide the change in the instrument’s value by the basis points and you’ll get the basis point value
Benefits of using basis points and basis point values
- It is beneficial because it makes transaction costs easier to understand.
- It makes it easy to compare bonds with different prices and yields
- It is easier to compare bond yields with those on other securities such as mortgages.
Conclusion
BASIS POINT is a unit of measurement used to quantify change. It is widely used for quoting changes in financial assets, especially bonds and interest rates. It gives you a better idea of a security’s or an instrument’s volatility. It is very easy to calculate the basis point. All you have to do is to multiple the change in percent by 100.
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