Definition: 1/100th of a percent. Decimally, it is .0001.
Example: Based on yesterday’s price, a bond offers an investor the chance to earn 2.80% or 280 basis points. There is higher than normal demand for the bond today so the price goes up a little. If an investor wants to buy it today, he or will pay more than yesterday’s price. By paying a higher price, the investor will earn 2.75%, or 275 basis points. We can say that the yield (ie: rate of return in bond-speak) dropped 280 – 275, or 5 basis points today.
Investeach explains: One might wonder why we have to measure bond yields to such incredible precision. After all, a percent is already 1/100th. Now we’re taking 1/100th of that! The answer is that if investors are working with enormous sums of money, every basis point counts. One such instance is the federal government bond market. Because the U.S. is in such enormous debt, it has issued trillions of dollars in bonds.
For example, there have been times where countries such as China and Japan owned $1 trillion of U.S. government bonds. Earning just one more basis point per year on this amount equals .0001 * 1,000,000,000,000, or $100,000,000 ($100 million)!
Riddle me this:
1. What is the decimal equivalent of a basis point?
2. Why do we need such precision when measuring bond yields?
3. Identify one market where the basis point change in yield from day to day is reported by the financial press.
Also known as: Beep.