An Exploration of the possible impact of commodity futures trading for tea farmers in Limuru to mitigate the price volatility of tea

A Research project submitted in partial fulfillment of the requirements for the degree of Bachelor of Business Science in Actuarial Science at Strathmore UniversityThe research project aimed to show how the volatility of tea prices experienced by the farmer could be mitigated through the introduction of a tea commodity futures. The researched aimed at determining the significance of the volatility of the tea prices in Kenya and ho the tea futures would smooth out the volatility of the tea prices for farmers in Kenya. This involved determining the feasibility of the futures market in the Kenyan economy. The feasibility of tea as a commodity tradable in the futures market was also investigated with the help of different literatures. A mix of descriptive and quantitative research design was used in this research project. The Risk Premium Model was used to formulate the future price of the fuures contract. The population under investigation was Kenyan tea farmers and the sample under investigation were small scale farmers in the Kambaa Area of Limuru. This is because small scale farmers have the experienced highest growth over the past 10 years and have similar characteristics of small scale farmers throughout the country. The local and primary data was obtained from the farmers in Kambaa region and secondary data from the Index Mundi website for international market prices for auctioned Kenyan tea. The results and analysis show that the volatility of prices in the international market would not be reduced by introducing the future, in the short term. However, the future would reduce the effect of volatility of the prices on the farmer. Further studies showed that the volatility will be reduced with increased activity in the futures market. The analysis also shows that the farmer and the investor have a high probability of getting higher returns by trading through the futures market than the actual market. The effect of volatility will be transferred from the farmer to eh investor who sold the contract to the farmer. From the discussions, the volatility of tea prices is observed to influence the extent of gains or losses the investor experiences from the sale of the futures contract to the farmer. Information asymmetry will also be reduced between the farmer and the intermediary company that sells the tea. This is because the farmer will be able to monitor the returns the intermediary receives from the sale of tea and therefore encourage transparency in the formulation of the final bonus rate announced at the end of the financial year. It is recommended that the government should educate the farmers on the futures market and its advantages and disadvantages as this has a direct effect on the performance of the futures contract. It is recommended that further research be done on the effect the introduction of tea commodity futures in other countries will have on the volatility of the international tea prices