Foreign currency option values

Foreign exchange options are a recent market innovation. The standard Black-Scholes option-pricing model does not apply well to foreign exchange options, since multiple interest rates are involved in ways differing from the Black-Scholes assumptions. The present paper develops alternative assumptions leading to valuation formulas for foreign exchange options. These valuation formulas have strong connections with the commodity-pricing model of Black (1976) when forward prices are given, and with the proportional-dividend model of Samuelson and Merton (1969) when spot prices are given.