The markets plunged by so-and-so points! The markets zoomed by ‘x’ points!
You might have come across these stories while investing. Buy what are these points? Points or basis points (BPS) are a unit of measurement used in finance to describe the percentage change in the value of financial instruments or interest rates. One basis point is equal to one-hundredth of a percentage point, or 0.01%. This means:
- 1 basis point = 0.01%
- 100 basis points = 1%
Importance of Basis Points
Understanding basis points is essential for investors, financial professionals, and anyone involved in financial markets.
1. Precision in Communication
Financial markets often deal with very small percentage changes. Using basis points allows for greater precision and avoids confusion when discussing changes that may be less than one percent. In complex instruments like derivatives, fixed-income securities and loans, even slight changes can have significant impacts. BPS offers a way to articulate these changes clearly.
2. Standardisation:
Basis points provide a standardized unit of measurement that is universally understood in the financial industry. This consistency facilitates better communication among financial professionals, investors, and analysts.
Where are Basis Points Used?
1. Interest Rates
Basis points are commonly used to discuss changes in central bank interest rates, mortgage rates and other borrowing costs. For example, if a central bank raises rates by 50 basis points, it indicates a 0.50% increase or if a bank offers an interest rate on a savings account of 2.00% and then increases it to 2.50%, this is a change of 50 basis points.
2. Bond Markets
In the bond market, yields and spreads (the difference between yields on different securities) are often expressed in basis points. For instance, if a bond’s yield increases from 3.00% to 3.50%, it has risen by 50 basis points.
3. Investment Management
Fund management fees, performance metrics and expense ratios are frequently expressed in basis points. A mutual fund with a fee of 100 basis points charges 1% of assets annually.
4. Foreign Exchange (Forex)
Changes in currency exchange rates may also be discussed in basis points, especially when evaluating the relative strength of currencies.
5. Risk and Credit Spreads
Basis points are used to describe risk premiums in credit spreads, helping investors assess the additional yield required for taking on extra risk compared to a benchmark (like government bonds).
6. Economic Reports
Economic indicators, such as changes in inflation or unemployment rates, may sometimes use basis points to express shifts in related metrics.
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Historical Journey of Nifty and SENSEX
The Nifty 50 and SENSEX are two of the primary stock market indices in India, representing the performance of the largest companies listed on the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) respectively. Their journeys reflect significant economic developments and market trends over the years and basis points (BPS) can be used to describe changes in their values, particularly in the context of interest rates, economic indicators and market fluctuations.
1. Launch and Early Years
- SENSEX: Launched in 1986, the SENSEX began with a base value of 1,000. It tracks 30 of the largest and most actively traded stocks on the BSE.
- Nifty 50: Introduced in 1996, the Nifty 50 started with a base value of 1,000 as well and consists of 50 major stocks listed on the NSE.
- The RBI frequently adjusted the repo rate (the rate at which it lends to commercial banks). A change of 100 BPS (1%) was common, affecting borrowing costs and, subsequently, corporate earnings and stock prices.
2. 2000s Bull Market
- The 2000s were marked by a significant bull run, with both indices reaching new highs. The SENSEX crossed the 10,000-mark in 2005 and Nifty followed suit, reflecting growing investor confidence and economic growth.
- In 2002, the RBI cut rates by 50 BPS, signalling a shift to support economic growth which led to increased borrowing and spending. This move likely contributed to rising corporate profits and consequently, stock prices. Sustained low interest rates (e.g., a steady 25 BPS reduction) were crucial for encouraging investments.
3. Global Financial Crisis (2008)
- Market Decline: The SENSEX dropped from over 21,000 in January 2008 to around 8,000 by December 2008—a decline of nearly 62%.
- RBI’s Response: To combat the economic slowdown, the RBI implemented aggressive rate cuts, reducing rates by as much as 400 BPS (4%) during 2008-2009. These cuts aimed to inject liquidity into the economy, stabilizing financial markets and fostering recovery.
- Impact on Indices: As interest rates fell, borrowing costs decreased, helping companies stabilize. The SENSEX began to recover in early 2009 as investor sentiment improved.
4. Recovery and New Highs (2010s)
- Sustained growth: Following the crisis, both indices recovered and reached new heights. The market recovered with SENSEX reaching 30,000 by 2015. This growth was driven by both domestic and global factors.
- Interest rate adjustments: In 2014, the RBI initiated a series of rate cuts, reducing the repo rate by 125 BPS over several months to stimulate economic growth. This encouraged lending and investments, leading to stock market gains. The market’s response was robust, for instance, after a 50 BPS cut, the SENSEX often rallied, reflecting investor optimism about economic prospects.
5. Recent Developments (2020 – Present)
- COVID-19 Impact: In March 2020, both indices plunged as the pandemic hit. The SENSEX fell dramatically, touching lows around 25,000.
- Rapid Recovery: The RBI slashed rates significantly (by 75 BPS in March 2020 alone) to counteract the economic impact of COVID-19. This led to a surge in liquidity, supporting recovery efforts. By mid-2021, as the economy rebounded, the SENSEX crossed 50,000. The Nifty followed suit, reflecting broader market confidence.
- Current Status (2024): As of Sep-2024, SENSEX had reached over 85,000, while Nifty hovered around 25000, reflecting significant growth over the years.
- The ongoing adjustments in interest rates in response to inflation have continued to affect investor sentiment. A hike of even 25 BPS can lead to shifts in market dynamics, influencing decisions on investments and borrowing.
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Wrapping Up
The journeys of Nifty and SENSEX illustrate the evolution of the Indian stock market over several decades. Basis points play a crucial role in understanding the impact of monetary policy, market fluctuations and economic indicators on these indices. Monitoring these changes helps investors gauge market sentiment and make informed decisions.
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