edging foreign exchange risk by means of forward or futures contracts in H foreign exchange is a manifestly central feature of treasury management in international corporations and banks. The extraordinary volume of activity in the spot, forward, and futures markets in foreign currencies is testimony to their use in the daily course of international finance. A seldom-mentioned fact, however, is that forward and futures contracts are imperfect instruments for the hedging of certain common exchange risks faced by multinational firms. The reason is simply that a forward contract is a fixed and inviolable agreement, yet in many practical instances the hedger is uncertain whether the hedged foreign currency cash inflow or outflow will materialize. When an overseas deal falls through, for example, or when a bid on a foreign currency contract is accepted, or when a foreign subsidiary's dividend payments exceed (or fall short of) the expected amount, then the international corporate treasurer will find himself partially exposed.In such cases what is needed is the right, but not the obligation, to buy or sell a designated quantity of a foreign currency at a specific price (exchange rate). This is precisely what a foreign exchange option provides.Puts and calls in foreign exchange have drawn little attention in the literature on international finance. One finds mention of them in Shapiro and Rutenberg (1976), Feiger andJacquillat (1979), and Dufey and Giddy (1Wl). Feiger and Jacquillat did find a theoretical link between call option prices and interest rates on single-currency and currency-option bonds. The failure of such a market to develop, however, has meant that there is little raw material to write about. Nevertheless, even before a full-fledged market emerges, it may be possible to say some things about foreign currency options-about pricing, about arbitrage links to forward markets, and about applications.Currency options were in fact sold in an unorganized fashion in the United States a few years ago, until they were declared illegal in suits brought by the Commodity Futures Trading Commission. These options, as Babbel(1980) showed, were priced so high as to render the probability of the option buyer's breaking even almost nil. In addition, a contract which is mistakenly called a forward option is sometimes offered by international banks; this is a forward exchange contract where the date of execution of the contract is at the customer's choice within a specified period. In a true option, the buyer always has the right not to execute