Theories of Interest: Caiib Paper 1 (Module A), Unit 4

Theories of Interest: Caiib Paper 1 (Module A), Unit 4

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We all know that CAIIB exams are conducted by the Indian Institute of Banking and Finance (IIBF).  CAIIB is said to be one of the difficult courses to be cleared for the bankers. But we assure you that with the help of our “CAIIB study material”, you will definitely clear the CAIIB exam.
CAIIB exams are conducted twice in a year. Candidates should have completed JAIIB before appearing for CAIIB Exam. Here, we will provide detailed notes of every unit of the CAIIB Exam on the latest pattern of IIBF.
So, here we are providing “Unit 4: Theories of Interest” of “Module A: Economic Analysis” from “Paper 1: Advanced Bank Management (ABM)”.

The Article is Caiib Unit 4: Theories of Interest


Interest is a payment made by a borrower for the use of a sum of money for a period of time.
Three elements can be distinguished in interest:

  • Payment for the risk involved in making the loan
  • Payment for the trouble involved
  • Pure interest, i.e. a payment for the use of money.
Keynes’ Liquidity Preference Theory of Rate of Interest

The position of money demand curve depends upon two factors:

  1. The level of nominal income and
  2. The expectation about the changes in bond prices in the future which implies change in rate of interest in future.
IS and LM curves Theory promulgated by Sir Hon Richard Hicks and Alvin Hansen

Renowned Economists, Sir John Richard Hicks and Alvin Hansen, have brought about a synthesis be-tween the classical and Keynes’ theories of interest and have thereby succeeded in propounding an adequate and determinate theory of interest. This involves 3 steps:

 The IS curve and the LM curve relate the two variables

  • Income and
  • the rate of interest

LMLiquidity preference and Money supply equilibrium. LM curve is derived from Kenes Liquidity preference theory of interest.

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