Abdul, FaridaMuturi, J.Nzuki, V. G.2011-08-182011-08-182011-08-18http://ir-library.ku.ac.ke/handle/123456789/961Department of Business Administration,59p.The HD 9490.N9 2009Disruptions and supply insecurity in the world oil markets as a result of growth in demand, shrinking buffers, speculation and underinvestment in exploration and refining have important implications in the use of financial tools in the management of oil price risk in Kenya. The study surveyed the use of futures contracts as means to mitigate price volatility by oil companies registered in Kenya. Daily data on the WTI crude oil futures and spot prices were used to work out the hedge ratios and the measures of hedging effectiveness resulting from using the six-month contract for the period 1997-2006. The study also sought to establish the derivatives used by Kenyan registered oil companies and the extent to which the oil companies in Kenya apply Futures to hedge price volatility and the ratio they hedge when they use the futures as a return balancing portfolio. Exploratory survey design involving both descriptive qualitative and quantitative analysis was adopted in conducting the study. The target population for this study was all the 364 registered oil companies in Kenya. A representative sample of 36 cases was selected using systematic sampling method. Semi-structured questionnaires were utilized to collect primary data while secondary data was sourced from the U.S. official energy website. The descriptive and OLS methods were used to analyses the data. Statistical data analysis was done using excel, SPSS and STATA. The results show that oil companies in Kenya seem to give due consideration to crude oil price volatility and as a consequence, they use a hybrid of derivatives, mainly futures market and forward contracts. Further, oil spot and futures prices don't seem to vary significantly as the two prices move together. The results also indicate that majority of the oil companies in Kenya hedge about thirty one to sixty percent of their oil volumes using futures market and this compares unfavorably to the optimal hedge ratio of 93%. The results imply that oil companies in Kenya are currently under-hedging their futures markets and are therefore exposed to high price risks resulting from the underlying price volatility. The companies are therefore recommended to scale up the value of the hedged oil volumes in line with optimal hedge ratio. Majority of the oil companies indicated that their use of futures contracts impacted positively on their profit margins. However, the oil firms indicated that they usually review their petrol pump prices whenever international crude oil prices go up. This implies that that even as the oil companies sustain their earnings as a result of hedging, they continue to pass the prices hikes to their customers. The findings of this study suggest that in terms of risk reduction, the MV method is an appropriate method for estimating optimal hedge ratio. The empirical results in this paper reveal that NYMEX crude oil futures contract is an effective tool for hedging risk. In conclusion, under the assumption that the hedger's objective is to minimize risk regardless of the risk-reduction trade off, that is the hedger is highly risk-averse, an OHR of 93% for Oil is recommended. By applying the optimal hedge ratio, a company may reduce their risk exposure up to 81.03% compared to an unhedged position. This means that the optimal proportion of future contracts that oil companies in Kenya should hold to offset the spot prices position is 93%. This implies that futures contract deserves consideration as a possible hedging instrument for international oil market price risks by oil firms in the countryenOil Industries-KenyaThesis