FRAs and Forward Rates - simple/compounding?

CFA Level II
#1

Pricing an FRA is effectively calculating a forward rate from two spot rates. I am confused as to why the forward rate calculation differs from what was done, for example, in fixed income.

Typically, the formula for calculating forward rates includes raising (1+spot rate) to an exponent in the formula i.e. compounding.

In the FRA calculation it looks like simple interest is being used since there is no exponents in the formula.

Why is there no exponents (compounding) in the FRA calculation?

#2

FRAs usually pay LIBOR.

LIBOR is a nominal rate, not an effective rate. It doesn’t compound.

#3

Thanks a lot!

#4

You’re welcome.

#5

@S2000magician

Say we are asked to calculate an FRA that extends beyond one year. I understand that FRAs are money market instruments and therefore should not be considered beyond one year. However, I have seen examples where they ask for say a 12 x 18 FRA. In this case, surely compounding would need to be considered?

#6

LIBOR is quoted as a nominal rate.