Have you heard the term basis point before and been confused? Don’t worry, most people who hear the term and don’t work in finance don’t fully understand what it means. Yet, it’s an easy concept. The term basis point is used in most industries dealing with money. For example, accounting, personal finance, banking, investing, and various economic markets use the term.
A basis point is simply one one-hundredth of a percentage point. In the mutual funds industry, for example, it’s commonly used to describe the mutual fund’s annual fee. To say that a mutual fund has an annual fee of 10 basis points means that the fund has an annual fee of 0.1%. In the fixed income, or bond market, the basis point is the smallest measure used for quoting bond yields, which then determines prices. Banks might quote various fees for loans or services that you use in terms of basis points.
Calculating the financial value of a basis point is straightforward. Since it’s just one one-hundredth of a percentage point, you just need to multiply the dollar value in question by 0.0001. Decimals can sometimes get confusing, so for some examples of basis point calculations, consider the following.
A bond valued at $100,000 increased in price by 5 basis points. The increase in price is calculated as $100,000 times 0.0005, or $50. As another example, imagine your business has $1 million invested in a mutual fund that charges 20 basis points annually as their fee. The annual fee is calculated as $1 million times 0.0020, or $2,000.
A basis point is a simple breakdown of a percentage point that is used across most areas of finance and accounting. Now that you know what it is, you can easily analyze business deals in the future and make better business decisions.