Final answer:
A forward contract can lock in the purchase price and sale price of a specified currency for future exchange, allowing firms to mitigate currency risk from exchange rate fluctuations and achieve stable financial planning.
Step-by-step explanation:
A forward contract can be used to lock in both the purchase price and sale price of a specified currency at a future point in time. In a business context, this is particularly relevant for firms engaging in international trade who want to protect themselves against the volatility of exchange rates. For example, a U.S. firm exporting to France and receiving payment in euros may not want to risk the potential devaluation of the euro against the dollar. By entering into a forward contract, the firm can agree upon a specified exchange rate for the future, mitigating this currency risk. Financial institutions typically facilitate these contracts, often for a fee or by creating a spread in the exchange rate.
Such contracts are vital for businesses aiming to maintain stable financial planning in the midst of future uncertainties due to exchange rate fluctuations. This financial tool effectively hedges against potential losses from adverse currency movements, providing businesses with a more predictable cash flow and valuation of future revenues or costs.