Certified Management Accountant 2025 – 400 Free Practice Questions to Pass the Exam

Forward contracts are primarily used to hedge against risk in future transactions. These contracts are customized agreements between two parties to buy or sell an asset at a predetermined price at a specified future date. This makes them particularly valuable for businesses and investors who want to secure prices and manage the uncertainty of future market fluctuations.

For example, a company that expects to purchase raw materials in six months can lock in a price today using a forward contract. This protection against price increases allows the company to budget effectively and reduces the volatility associated with market prices. By hedging, entities can stabilize their cash flows and mitigate the financial risk posed by fluctuating prices in the market.

Other choices focus on different aspects of financial activities. Speculating on stock price fluctuations involves taking on risk with the hope of capitalizing on price changes, which is a different objective than hedging. Gaining access to capital markets pertains to financing activities, not the risk management focus of forward contracts. Diversifying investment portfolios involves spreading investments across various assets to reduce risk, which does not align with the specific function of forward contracts. Overall, the use of forward contracts is critical for effective risk management in financial planning and operations.