What is Basis Point (BPS)?

Meaning of Basis Points (BPS)

A basis point (BPS), often referred to as "bps," is a unit used to measure small changes in financial percentages or rates. One basis point is equal to 0.01%, or 1/100th of 1%, which is written as 0.0001 in decimal form. The term "basis" refers to the difference between two percentages or interest rates. These small changes can have a significant impact; basis points offer a precise way to describe them. They are frequently used to quantify small variations in areas like mutual fund expenses, returns, and interest rates.

Basis Points Impact

In mutual funds, even a difference of 10 to 20 basis points can make a measurable impact over time. Since returns and costs compound, a 25 bps variation in the Total Expense Ratio (TER) can reduce long-term gains. Basis points provide a clear way to communicate small percentage changes. This clarity makes it easier to compare critical financial metrics such as fund performance, fees, and yields. By accurately showing changes in returns or interest rates, basis points help investors track market trends, evaluate fund efficiency, and make more informed decisions.

How Basis Points are Used in Mutual Funds

In mutual funds, basis points are widely used to present small changes in costs, returns, and yields in a clear and consistent manner. They make it easier for investors to understand fund data and compare performance between schemes. Fund documents and fact sheets commonly use basis points in the following ways:

• Total Expense Ratio (TER): Represents the fund’s annual cost. For example, 100 basis points equal 1% per year.

• Loads and Fee Changes: Any change in entry or exit load, or revision in management fees, is expressed in basis points for accuracy.

• Performance Differences: Metrics such as alpha and tracking error are stated in basis points to show small variations precisely.

• Yield Movements in Debt Funds: A 10 basis point fall in bond yield can affect NAV and overall returns.

Converting Basis Points to Percentages

Basis points represent very small percentage changes and are often used for precise financial calculations. One basis point equals 0.01%, or 0.0001 in decimal form. To convert basis points to a percentage, divide by 100; to convert a percentage to basis points, multiply by 100.

Formula to Convert Basis Points to Percentage

Use the simple formula below to convert basis points into percentage values:

Basis Points ÷ 100 = Percentage (%)

The table below shows how different basis point values translate into percentage terms:

Example to Calculate Basis Points (BPS)

To understand how basis points work in real life, let’s look at a few simple examples that show how small changes can make a big difference in mutual funds and other financial areas.

• Mutual Fund TER Adjustments: If a fund’s Total Expense Ratio (TER) increases from 1.55% to 1.60%, the difference is 0.05%, which equals 5 basis points (bps). Even small increases, such as 5 basis points, can slightly reduce long-term returns for investors.

• RBI Policy Rate Changes: The repo rate is the rate at which commercial banks borrow money from the Reserve Bank of India. When the RBI changes this rate, the adjustment is expressed in basis points. For example, if the RBI reduces the repo rate from 6.50% to 6.25%, it represents a decrease of 25 basis points. A rate cut like this typically signals an easing of monetary policy, making borrowing cheaper and stimulating economic activity.

• Bond Yields and Credit Spreads: If the yield on a government security widens from 6.80% to 7.00%, that’s a 20 bps rise. Such changes often reflect inflation trends or shifts in credit risk.

• Home Loan Interest Rates: Banks often communicate changes in lending rates in basis points. For instance, a 50 bps hike in interest rates may increase monthly EMIs for borrowers, especially in a high-debt environment.

Other Financial Instruments Measured in Basis Points

Basis points are used across various financial instruments, not just in mutual funds. They are widely used across various financial instruments to express small rate or yield changes with accuracy. Below are some common examples where basis points play an important role.

• Treasury Bonds: Treasury bonds, issued by the central or state governments, use basis points to represent interest rate movements. Even a small change in yield, such as 10 or 25 bps, can affect bond prices and investor returns significantly.

• Corporate Bonds: Corporate bonds are debt securities issued by companies to raise capital. Basis points are used to measure variations in coupon rates or yield spreads, helping investors understand credit risk and market sentiment.

• Credit Card Instruments: Banks and financial institutions often communicate interest rate changes on credit cards in basis points. For instance, a 50 bps hike means the interest rate has increased by 0.50%, directly affecting borrowing costs for customers.

• Futures and Options: In derivative markets, such as futures and options, basis points measure small changes in return rates or premium values. This allows traders and analysts to assess market volatility and price movements more precisely.

• Bank Lending and Deposit Rates: Banks frequently use basis points to describe adjustments in lending (MCLR/RLLR) and deposit rates. A 25 bps change can influence both the interest earned by depositors and the borrowing cost for loan customers.

Common Misconceptions Regarding Basis Point

Many people often confuse basis points with other financial terms or underestimate their importance. Understanding these misconceptions can help you read and interpret financial information more accurately.

• Confusing Basis Points with Percentage Points: One of the most common mistakes is mixing up basis points and percentage points. A basis point (BPS) represents a change of 0.01%, while a percentage point represents a full 1% change. For example, if the interest rate increases from 5% to 6%, it’s a 1 percentage point increase. In terms of basis points, this is equivalent to 100 basis points (bps). A 1% increase is 100 basis points, not just 1 bps. This distinction is important because small percentage changes can be much clearer when expressed in basis points.

• Thinking Basis Points Are Only for Interest Rates: Basis points are not limited to interest rates. They are also used to show small changes in mutual fund fees, bond yields, investment spreads, and expense ratios. This helps maintain accuracy across various financial products.

• Believing Basis Points Are Complicated: Many assume that basis points are difficult to understand, but they are actually quite simple. Once you know that 1 bps equals 0.01%, it becomes easy to convert and compare changes in rates or fees.

• Ignoring Their Real Impact on Money: Some people think that basis points represent insignificant changes. In reality, even a few bps can make a noticeable difference in returns or borrowing costs over time. For example, a 25 bps change in fund expenses can affect long-term earnings.

• Underestimating Their Role in Communication: Using basis points helps avoid confusion and ensures clarity when discussing financial changes. It allows investors, analysts, and institutions to communicate precise figures without misunderstanding.

Key Takeaways

Basis points (BPS) offer a simple and precise way to measure small percentage changes in finance. For example, a change of 10 basis points (0.10%) in a mutual fund’s return can significantly impact long-term gains. BPS help investors understand tiny variations in mutual fund costs, returns, and interest rates. Understanding how to read and convert basis points helps avoid confusion with percentage points, improving financial clarity. Even a small change in BPS can make a big difference in long-term investment outcomes.