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Foreign Exchange Option Pricing
Feb 1, 1989
Currency options are useful tools for taking one-sided currency bets and can be replicated to produce multi-currency option coverage such as the currency exposure implicit in an EAFE fund. European FX options are priced like Black-Scholes stock options where the stock pays a continuous proportional dividend. Option replication is complicated and requires a good understanding of the sources of risk including exchange rates, interest rates, time decay, volatility, and counterparty.