What are Basis Points? Do They Have Any Impact on Investors?

When the Reserve Bank of India (RBI) conducts its monetary policy meeting, market participants, including investors, await announcements consisting of two words - basis points (BPS). What is a basis point and does it impact investors? Let’s find out.

What is BPS?

Basis points (BPS) are units representing 1/100th of a point. One BPS equals 0.01%, and they are used to describe changes in interest rates, bond yields, etc. BPS originated in bond markets and has become a standard metric for calculating changes in interest rates of various financial instruments.

Basis points help provide clarity during discussions on changes in interest rates. Instead of saying 0.25%, professionals say 25 BPS to avoid confusion.

Basis point to percentage

For common investors, basis point to percentage conversion can help better understand the meaning of BPS. To convert basis point to percentage, divide BPS by 100. For example, 75 BPS would come to 0.75%. Similarly, to convert percentage to basis points multiply by 100. For instance, 1.5% would be 150 BPS.

BPS impact on investors

While BPS may seem minor, in reality, they have a big impact on investments and investors. Here’s how:

• Impact on interest rates

The RBI uses BPS to announce changes in policy rates. If the RBI raises the repo rate, the rate at which it lends money to commercial banks, by 25 BPS, it directly affects rates on loans and deposits. A rise in BPS can increase borrowing costs, make loans expensive and increase your monthly EMIs. Similarly, a decrease in BPS can make loans cheaper.

• Effect on bond yield and prices

Yields and bond prices share an inverse relationship. If a bond's yield increases by any bps, its price falls. This can impact you as a bond investor as the value of your bond holdings decreases.

• Impact on mutual fund returns

Changes in BPS can impact returns from mutual fund investments. For instance, if a fund's expense ratio is 1.5% and it increases by 10 BPS, the new ratio is 1.6%. This may look small but can significantly impact returns in the long term.

• Effect on stock prices

Changes in BPS can impact stock prices. If the RBI increases the repo rate by a certain bps, say 50, it becomes expensive for companies to borrow funds. Higher borrowing costs may reduce overall profitability, thus impacting investors’ confidence and stock prices.

In conclusion

As evident, even a small change in basis points can significantly impact your investments. It can significantly impact their value. A holistic understanding of basis points can help you gain deep insights into market trends and make sound investment decisions.