We have often heard that the Repo Rate is either cut or increased by RBI. The Repo rate is the rate at which RBI lends money to the commercial banks of India.
The unit of Repo rate is Basis Points. For example, RBI might announce a repo rate cut of 25 basis points. This means that Reserve bank has lowered the rates by 0.25%. In the financial sector, Basis Points are often written as "bps" and pronounced "beeps" or simply "points". One basis point is equivalent to 0.01% (1/100th of a percent) or 0.0001 in decimal form. In most cases, it refers to changes in interest rates and bond yields. Expressed another way, one percentage point is equal to 100 basis points. This means that if an interest rate drops by 1 percentage point, such as from 10% to 9%, the drop is 100 basis points. If an interest rate increases from 9.75% to 10.00%, the increase is 25 basis points.
Investors or investment professionals regularly refer to basis points while discussing subjects like bond yields and mutual funds. The term basis points avoids the indefiniteness in discussions about rates. Confusion could arise in a statement such as, ‘a 1% increase from a 10% interest rate’. The 1% increase could be interpreted as either a relative increase from 10% to 10.1% or an absolute increase from 10% to 11%.
The table given below is an example of the basis points in terms of percentage.
**Basis Points - Percentage Terms**
1 Basis Point – 0.01%
10 Basis Points – 0.10%
50 Basis Points – 0.50%
100 Basis Points – 1%
1000 Basis Points – 10%
10,000 Basis Points – 100%
Basis points is mostly used to indicate the changes in Interest Rates and Bond Yields. In the bond market if the yield of a bond rises to 2.05% from 2% it is said to have increased by 5 Basis Points. So even the small movements in existing interest rates can have a big dollar or rupee impact. There is an inverse relationship between bond price and yield. As bond prices decrease, their yields increase and vice versa. The degree of change in bond price for each basis point change in yield is determined by a number of other factors, such as the bond's coupon rate, time to maturity and credit rating. When people compare fund expenses, they measure the difference in basis points. A fund with expenses of 0.45% is said to be five basis points more expensive than one with a 0.40% ratio. That difference in expenses might seem small, but on Rs. 1,00,000 invested over 20 years, it can add up to thousands of rupees saved, depending on returns.
If we refer to future market considering basis points the difference between the cash price of the commodity and futures price is referred as basis. As an example, assume the spot price for a crude oil is Rs.5000 per barrel and the futures price for crude oil deliverable in three months' time is Rs.5400. The basis is Rs.400, or Rs.5400 minus Rs.5000.
Stock Market index also has an indication tool in terms of Basis Points. For example, if the stock market index has gone up by 150 bps; this means there is an increase of 1.5%in the value of stock index.
Hope this helps you to understand the increase or decrease in the rates or yields the next time RBI announces a change in repo rate.