Definition and Example of a Basis Point
A basis point is considered the smallest unit of measure for changes in interest rates or bond yields. It is a way to describe one hundredth of a percentage point (0.01%).
How Basis Points Work
Basis points are commonly used to express changes in yields on government or corporate bonds that investors buy and sell. Yields fluctuate, in part due to prevailing interest rates set by the Federal Open Market Committee of the Federal Reserve. If the Federal Reserve lowers the target federal funds rate, interest rates on newly issued bonds will decrease, and vice versa. These changes affect the prices that investors are willing to pay for older bonds, which in turn impacts the expected yield on those bonds.
What This Means for Individual Investors
Suppose you are an investor in mutual funds or exchange-traded funds (ETFs). In this case, you may encounter an annual fee called the “expense ratio,” which is the portion deducted from assets annually by your fund manager for the fund’s costs. If your expense ratio is 145 basis points for every $1,000, your fund manager charges 1.45%, or $14.50 for every $1,000 invested.
Basis points are also used in discussions about borrowing and investing. The reference interest rate set by the Federal Reserve, which affects mortgage rates, credit cards, and other loans, is typically adjusted in increments of 25 basis points.
The Federal Reserve’s reference interest rate is the effective interest rate at which banks borrow from each other overnight. This rate is controlled within a target range for the effective federal funds rate set by the Federal Reserve.
Source: https://www.thebalancemoney.com/the-basis-point-and-what-it-means-to-investors-4691621
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