The risk with fixed nominal rate contracts is that inflation may be lower than expected and the real value of payments correspondingly higher. So, if short rates move closely in line with price inflation and future prices are uncertain, the real net present value of total interest and capital payments is likely to be more volatile on fixed-rate debt than on variable-rate debt. By contrast, the time-profile of servicing payments is likely to be more volatile with adjustable-rate debt. If inflation is high when a variable-rate debt contract is written, but is expected to fall, the real value of debt repayments is initially high and tails off in the future. A more rapid decline in inflation than anticipated, and a corresponding fall in short-term nominal interest rates, would unexpectedly delay real repayments. The opposite phenomenon-in which unexpected increases in inflation and nominal interest rates bring forward the burden of debt payments-is known as front-end loading.
Fixed and floating-rate finance in the UK and abroad