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Points in Finance: Definition, Uses, and Examples

Last updated 03/14/2024 by

Alessandra Nicole

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Points in finance represent a versatile measurement in various financial contexts, indicating percentages, values, or fees. From bond prices to stock movements, and even mortgage interest rates, understanding points is vital for sound financial decision-making. This article delves into the multifaceted world of points, clarifying their meanings and applications in different financial instruments.

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Understanding points

In finance, the term “point” always signifies a quantity of one, but its interpretation and utilization vary across different financial instruments. Points can represent percentages, values, or price changes.

Points in bonds and debentures

In the realm of bonds and debentures, a single point equates to a 1% change in the face value of the investment. For instance, if a bond is sold at two points under par, it means it was sold at a 2% discount compared to its face value.

Points in stocks and stock indexes

When it comes to stocks and stock indexes, movements are often expressed in points, where one point is equivalent to $1. For example, if a stock opens a trading session at $23 and closes the day at $25, it’s said to have risen by two points.

Points in futures contracts

In futures contracts, a point signifies a price change of one one-hundredth of one cent. It’s a minute unit of measurement used to track price fluctuations in commodities, currencies, and other assets.

Points in mortgages and loans

Points in banking refer to the percentage difference between a loan’s interest rate and the prevailing prime interest rate. For instance, a credit card may offer an initial rate that converts to an interest rate of 12.99 points over the prime lending rate, meaning it’s 12.99% above the prime rate.
Additionally, in mortgages, a point can indicate the size of the loan origination fee charged by the lender. Each point represents 1% of the loan amount. For example, a $200,000 mortgage with a three-point origination fee means a $6,000 fee.
Weigh the risks and benefits
Here is a list of the benefits and drawbacks of using points in financial transactions.
  • Effective way to measure and compare financial instruments.
  • Allows for precise tracking of price movements in stocks and bonds.
  • Enables borrowers to reduce their interest rates in mortgages through point buydowns.
  • Can be confusing due to varying definitions in different financial contexts.
  • Misunderstanding or miscalculation of points may lead to financial losses.
  • Origination fees in mortgages can add to the overall cost of a loan.

Frequently asked questions

What is a basis point?

A basis point, often denoted as “bps,” is a unit of measurement used to describe very small changes in interest rates or financial indicators. One basis point is equal to one one-hundredth of a percentage point.

How can I calculate points in a mortgage?

To calculate points in a mortgage, multiply the loan amount by the point value (e.g., 1 point equals 1% of the loan amount). This provides the origination fee. To calculate points regarding interest rates, it’s the percentage difference between the loan rate and the prime rate.

Are points always expressed as percentages?

No, points can represent values, percentages, or price changes, depending on the financial context in which they are used.

Key takeaways

  • Points in finance are versatile, representing quantities of one in various ways.
  • They can signify percentages in bonds, values in stocks, and small price changes in futures contracts.
  • In mortgages, points indicate either loan origination fees or interest rate premiums over the prime rate.
  • Understanding the specific meaning of points in different contexts is crucial for informed financial decision-making.

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