What are basis points (bps)?
If you're new to the world of finance, you may have heard the term "basis points" thrown around, but may not be entirely sure what it means. Learn all about it in this article.
Naturally, before buying US shares it’s necessary to have US dollars. The guide below runs you through the ways foreign currencies are priced and the associated fees on Stake.
Key highlights:
- Basis points are a unit of measurement used to express changes in financial metrics such as interest rates or bond yields. One basis point is equal to 0.01% (or one-hundredth of a percentage point).
- Basis points are often used instead of percentages because they allow for more precise measurements of small changes, which can be important in financial markets where even small changes can have a significant impact.
- Price value of a basis point (PVBP) is a commonly used risk measure in fixed income markets. It measures the price change of a bond resulting from a one-basis-point change in yield and is calculated by multiplying the change in price by the bond's modified duration. PVBP can be used to manage interest rate risk and in the pricing and valuation of fixed income securities.
What are basis points?
Basis points (often abbreviated as "bps") are a unit of measurement used to describe the percentage difference between two numbers, usually in the context of finance or economics. One basis point is equal to 0.01% (or one-hundredth of a percentage point).
For example, if a stock price increases by 50 basis points, that means its price has increased by 0.50%. Similarly, if the interest rate on a loan increases by 25 basis points, that means the interest rate has increased by 0.25%.
Basis points are often used when discussing interest rates, bond yields, and other financial metrics that are sensitive to small changes. They are useful because they allow for precise measurement of small changes that might not be easily discernible in percentage terms.
How are basis points calculated?
Basis points are calculated by dividing one percent by 100, resulting in a value equal to 0.01 percent. Thus, one basis point is equivalent to 0.01%. Changes in financial metrics are expressed in terms of the number of basis points by which they increase or decrease. For example, an increase in interest rates from 3.25% to 3.50% is equivalent to a rise of 25 basis points.
For instance, check the table below:
Basis points | Percentage terms |
|---|---|
1 | 0.01% |
7 | 0.07% |
10 | 0.10% |
50 | 0.50% |
100 | 1% |
Why do investors use basis points?
Investors use basis points because they provide a more precise measurement of changes in financial instruments/metrics such as interest rates or bond yields. While percentages are also used to express a change in these metrics, they can be less precise when dealing with smaller changes.
For example, suppose an interest rate increases from 2.00% to 2.25%. In percentage terms, this is a 12.5% increase. However, this percentage increase can be misleading because it implies a larger change than what actually occurred. Using basis points, we can say that the interest rate increased by 25 basis points, which more accurately reflects the size of the change.
Investors also use basis points to measure and manage risk. By using basis points to track changes in interest rates or bond yields, investors can more accurately measure the impact of these changes on their investments. This can help them to make more informed decisions about buying or selling investments, as well as to manage the risks associated with changes in financial markets.
How does Stake use basis points (bps)?
Stake charges a fee of 70 basis points (bps) on FX deposits and withdrawals.
It is essential to note that basis points (bps) are distinct from percentage fees.
Charging 70 bps does not correspond to 0.7% of the entire transfer value. The percentage equivalent of the bps fee varies depending on the direction of the transfer and the exchange rate.
Learn more about how bps is used in Stake pricing.
Example of basis points using Stake's fees
Suppose the official AUD/USD spot rate is 0.7500, and AU$1000 is deposited at this spot rate, resulting in a return of $750.00.
Stake charges a fee of 70 basis points (0.0070), which reduces the rate to 0.7430 (0.7500-0.0070). If AU$1000 is deposited at the AUD/USD spot rate of 0.7500, the return after the 70bp fee is US$743.00.
The fee of 70bps can be computed as US$7.00 ($750.00 – $743.00).
For withdrawals, the rate becomes 0.7570, meaning that customers receive AU$1 for every US$0.7570 withdrawn from their account (0.7500 + 0.0070).
Simply put, the Stake fee is US$0.70 for every AU$100 transferred in or out.
Why use basis points instead of percentages?
Basis points are often used instead of percentages because they allow for more precise measurements of small changes to financial metrics. In many financial markets, even small changes in interest rates, bond yields, equity indices, or other metrics can significantly impact on the profitability of investments or the cost of borrowing.
Using basis points instead of percentages allows for easier comparison of small changes, as well as provides a more accurate measurement of changes over time. For example, if you are tracking the yield on a bond over a period of years, using a basis point calculator allows you to see even small changes in the yield rather than having to rely on percentages, which can make small changes harder to discern.
What is price value of a basis point (PVBP)?
Price value of a basis point (PVBP), also known as "dollar value of a basis point" (DV01), is a measure of the change in the price of a financial instrument (such as a bond) resulting from a one-basis-point change in the yield. It is a commonly used risk measure in fixed income markets.
PVBP is calculated by multiplying the change in the price of the bond resulting from a one-basis-point change in yield by the bond's modified duration. Modified duration measures the sensitivity of a bond's price to changes in yield and takes into account the fact that the relationship between price and yield is not linear.
The PVBP can be thought of as the dollar amount by which the price of a bond will change for a one-basis-point change in yield. For example, if the PVBP of a bond is $10, that means that the price of the bond will change by $10 for every one-basis-point change in yield.
Investors and traders use PVBP to manage interest rate risk by measuring the impact of changes in interest rates on the value of their portfolios. It is also used in the pricing and valuation of fixed income securities.
