Basis Point Value
Basis points represent a unit employed to measure interest rates and other financial percentages. A basis point equals 1/100th of a single percentage point. It can be denoted as 0.01% or 0.0001 in decimal form.
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What is Basis Point Value?
Basis Point value denotes the changes in the price of a bond given a basis point change in the bond yield. A measure of price volatility of bond prices to 0.01% or 1 basis point change in its yield is called as BPV of a bond. It is a change in the price of a bond that can be attributed to one unit change in the yield of a given bond.
How it is calculated?
Basis Point Value is calculated as follows:
BPV = FV * (Days /360) * 0.0001
For example:
- The FV of the Euro futures contract is $200000. The futures track a 6-month rate; hence we are using 180 days in the equation and 0.01% in decimal form.
BPV = 200000 * (180/360) * 0.0001
= $10
Assume that there is an increase in the rate of interest from 3 percent to 3.5 percent, which means that interest rates have raised by 50 basis points.
- Suppose you want to calculate the BPV of a $100000, 5 year bond with a coupon rate of 5% when the interest rate is 5% using a financial calculator
Solution:
We input the following:
N= 5
I = 5
PMT=5000
FV = 100000
Press PV and we get 100000
Suppose the rate changes to 5.01%, the calculator gives 99956.71
The difference is BPV 43.28
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Calculation of the Basis Point Value
The Eurodollar futures contract has a face value of $1,000,000 and has a duration of one year. The futures follow three-month Eurodollar rates (three-month ICE LIBOR), therefore we use 90 days in the calculation to account for the lag time. 01 percent is represented in decimal form as.0001.
Basis Point Value (BPV) is Face Value multiplied by (#days 360) multiplied by.01 percent.
BPV = 1,000,000 multiplied by (90 360) multiplied by.0001
The BPV is equal to $25.00.
Example
Eurodollars are represented in this example in terms of the IMM Price Index. Suppose Eurodollar interest rates increased from 1.00 percent to 1.05 percent. This would indicate a 0.5% increase in Eurodollar interest rates, or a five basis point increase in Eurodollar interest rates. However, you should recall from the previous modules that Eurodollar futures are priced based on the IMM price index.
The IMM price index is equal to 100 minus the Eurodollar rate (or three month ICE LIBOR)
Eurodollars were trading at 1.00 percent in the previous case. As a result, the IMM price index would be equal to 100 – 1.00 = 99.00. Interest rates increased to 1.05 percent as a result of this increase. This would result in a price index of 100 – 1.05 = 98.95 for the IMM at that time.
As you can see, the price of interest rates moves in the opposite direction of the yield on interest rates. In response to the increase in interest rates by five basis points, the Eurodollar IMM price index fell from 99.00 to 98.95.
In order to determine how big of a difference this represents in terms of dollar worth, we must translate basis point movement into dollar movement. This requires knowledge of the DV01 (dollar Value of a .01 move)
We calculated that the basis point value in Eurodollar futures is $25.00 using the formula above. As a result, a five basis point change is equal to $125.00 in value.
5 basis points multiplied by $25.00 per basis point is $125.00.
Uses of Basis Point Value in financial markets:
- It describes interest rate changes for securities and interest rate reporting.
- It helps in avoiding ambiguity and confusion while discussing relative and absolute interest rates when the rate of difference is less than 1%.
- It helps in managing interest rate exposure.
- It helps firms in restricting the traders by giving them a maximum BPV that they are permitted to run.
- It is useful in calculating BPV for money market products & swaps.
- It helps the dealer in calculating simple hedge ratios.
Conclusion:
BPV is used as a tool to measure interest rates risk especially those associated with bond trading books, portfolios, or money market books. It determines the difference of gain or loss on an investment position due to a minute change in the yield. Basis Point Value is also known as Delta or DV01.
Author: Urvi Surti
About the Author: Urvi is a commerce graduate and has a keen interest in Finance. She has completed her Chartered Wealth Management (CWM) from the American Academy of Financial Management and is currently pursuing a career in Financial Risk Management (FRM).
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