Q:

How are basis points calculated?

A:

A basis point is simply calculated as one-hundredth of a percentage point, or 0.01 percent, explains Investopedia. For example, if an interest rate rises by 0.2 percent, it rises by 20 basis points since a percentage point consists of 100 basis points.

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Basis points are used in finance and economics to reduce ambiguity when dealing with percentage changes, according to Investopedia. It is not clear whether, for example, an interest rate of 5 percent growing by 10 percent means it has reached 15 percent or 5.5 percent. However, the same analyst stating an interest rate of 5 percent rising by 50 basis points clearly means the interest rate has reached 5.5 percent. While rate changes are also sometimes discussed in terms of percentage point changes, basis points are most commonly used. Financial instruments frequently quoted in terms of basis points include bonds and loans.

One measure of value that relies on basis points is the price value of a basis point, which describes the absolute amount by which a bond’s price changes when its yield changes by one basis point, notes Investopedia. The absolute value is used because the magnitude of very small changes tends to not be affected by whether the change is positive or negative. The price value of a basis point is occasionally also signified as DV01.

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