The usual definition of basis point is that a basis point is 0.01%, or alternatively, 100 basis points equals 1%. (Note: Canadian and British usage prefers writing “per cent,” whereas Americans prefer “percent.” Although I usually stick with Canadian spelling, this is one case where I bow to American cultural imperialism.)
Basis points is typically abbreviated as “BPs.”, and can either be pronounced as “bips” or “beeps.” (Apparently, Canadians tend to use one, every body else the other, but I heard both.)
The problem with this definition is that it does not properly describe usage in practice: basis points and percent are not swapped out for each other randomly.
I have read a lot and written a lot of fixed income commentary over the years. The rule that I see in practice is: basis points are reserved for differences of percentages (yields). These are either spreads between instruments, or changes in the yield of a single instrument (which is a spread over time). Percentages are used for levels of yields.
- We would write that the 2-year JGB yield is 0.20%, not that it has a yield of 20 basis points.
- If the 2-year yield is 2% and the 5-year yield is 2.3%, the 2-/5-year slope is 30 basis points.
- If a 5-year corporate bond is trading at 3.4%, and the 5-year swap is at 3.2%, the spread versus swaps is 20 basis points.
- If the yield on the 10-year Treasury rises from 4% to 4.04%, we say that the yield rose 4 basis points.
There are some exceptions (see below).
The justification for the use of basis points is two-fold: it is easier for fixed income investors, and it eliminates ambiguity in how percentages are used in every other asset class in finance.
On the ease of use side, most daily yield changes are on the order of 1-10 basis points. It is a lot easier to say “2 beeps” than “0.02 percent.” When you are negotiating pricing over the phone, you need to avoid the risk of mis-speaking.
For written communication, the problem with percent is how other asset classes use it. If the yield on a bond changed from 1% to 2%, the usual interpretation for an equity/commodity/currency price is that “it rose 100%.” This creates an obvious problem: “the rise from 1% to 2% is a rise of 100%” — huh? I have seen things like this over the years from non-fixed income people, and this is an obvious problem for confusing readers.
You can avoid the ambiguity by using very precise phrasing, but the problem in writing about finance is that you are writing about small changes in pricing every business day for every soul-crushing day you are in the work force. After awhile, you want to change up your wording to inject some variety into the monotony of life — which leads to potential ambiguity problems if you use very concise wording.
Exceptions to the Rule
There are some well-established exceptions to the rule I have given. There might be more, but these are the ones I saw frequently.
- Derivatives whose pricing correspond to spreads between cash instruments (e.g., credit default swaps) will use basis points, even though the derivative instrument is a stand-alone instrument.
- Management fees are often quoted in basis points (but not fund documents) — “The index fund charges 8 bips.” Although one might try to argue that management fees are a reduction in fund return percentages (and thus a spread), that is a bit of stretch.
- For large yield changes (e.g., over 1000 basis points), people tend to switch back to percent.
- I have heard equity investors use “basis points” to refer to small returns when they are getting into more technical discussions. Since equities are not quoted in yield terms, this is less ambiguous. Since a lot of equity investing is discussing relative returns, most of the time they are discussing spreads in returns.
- Economic data — such as changes in growth rates — tends to stick to percent, except when fixed income people start writing about them. However, economists face the same ambiguity problem when discussing changes in growth rates when changes are in percent.
My old employer (in Quebec) had a style guide that suggested that people use points centésimaux. (The word centésimaux indicates that something is being is expressed as a fraction with a denominator of 100, and so it makes more sense than “basis points” in English.) Being one of the few anglos working there, I was one of the only people who used that phrasing (until I realised that everyone looked at me funny). In practice, people tended to say “points bases” — which has a lot less syllables. (For people not familiar with French, the “a” in “bases” is soft, and the final “s” is not pronounced — unless the following word starts with a vowel — and so the English transliteration would be “point baz” or “point basz.”)
A non-fiction writer has to know who their audience is, and needs to adapt their writing to that audience. You want to use basis points when your audience is people who are interested in or working in finance, since they are the ones who will be most used to how percentages are used to denote changes to asset prices in other asset classes. This covers the business press.
If you have a slightly wider audience (like myself), you should throw in an reminder of the definition when you first use it. I have gotten lazy, but I still do it (I hope) in articles that are primers.
If you are not writing for the business press, you probably want to avoid the use of basis points — both verbally, and in writing. You write things like “The central bank hiked by a quarter of percent.” That phrasing is very distinct from how equity prices are discussed, so it is exceedingly unlikely that people would interpret that as “the policy rate changed by a factor of 1.0025.” If you have to write about something like a mortgage spread, you might throw in the basis points value as a parenthetical remark just to let the reader that you are not a n00b. You just need to be very careful of your wording so that “percentage changes” are not ambiguous — you can write out the two values, since your readers might not have practice adding differences to yields.
Finally, one piece of fixed income jargon that you can usually avoid (unless you are a trader or writing sell side research) is points. A point is a measure of price: it is 1% of the par value of a bond. That is, under the standard convention of par price of a bond being $100, one point is $1 in price. I have been writing about fixed income since the late 1990s, and I doubt that I ever needed to use the term.