<PAGE>
DEM, Inc.
- ------------------------------------------------------------------------------
DEM, INC.
ANNUAL REPORT
DECEMBER 31, 1997
- ------------------------------------------------------------------------------
<PAGE>
ARTHUR ANDERSEN LLP
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
DEM, Inc.:
We have audited the accompanying statement of assets and liabilities,
including the statement of portfolio investments, of DEM, Inc. (a Maryland
corporation), as of December 31, 1997, and the related statement of
operations for the year then ended, the statement of changes in net assets
for each of the two years in the period then ended, and financial
highlights for each of the three years in the period then ended. These
financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements
based on our audit.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above presents fairly, in all material respects, the financial position
of DEM, Inc. as of December 31, 1997, the results of its operations for the
year then ended, the changes in its net assets for each of the two years in
the period then ended, and financial highlights for each of the three years
in the period then ended, in conformity with generally accepted accounting
principles.
/s/ ARTHUR ANDERSEN LLP
Baltimore, Maryland,
February 10, 1998
<PAGE>
DEM, INC.
STATEMENT OF ASSETS AND LIABILITIES
AS OF DECEMBER 31, 1997
<TABLE>
<S> <C>
ASSETS:
Common stock investments (cost $14,746,243) $17,204,656
Cash and cash equivalents 781,551
Interest receivable 166
Prepaid expenses 10,386
Deferred organizational costs, net (Note 2) 29,809
-------------
Total assets 18,026,568
-------------
LIABILITIES:
Payable for investments purchased 46,350
Accounts payable and accrued expenses 30,461
-------------
Total liabilities 76,811
-------------
NET ASSETS - equivalent $15.63 per share on 1,148,776 shares
of common stock outstanding $17,949,757
-------------
SUMMARY OF SHAREHOLDERS' EQUITY (Note 4):
Common stock, $.00001 par value, 500,000,000 shares
authorized, 1,148,776 shares issued and outstanding $ 11
Additional paid-in capital 16,526,177
Accumulated net realized loss on investments (274,238)
Unrealized gain on investments 2,458,413
Undistributed investment income, net (760,606)
-------------
Net assets applicable to outstanding common stock $17,949,757
-------------
</TABLE>
The accompanying notes are an integral part of this statement.
<PAGE>
DEM, INC.
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<S> <C>
INVESTMENT INCOME:
Dividend income (net of withholding tax of $1,276) $ 28,468
Interest income (Note 2) 10,076
-------------
Total investment income 38,544
-------------
EXPENSES:
Advisory fees (Note 3) 117,473
Transfer agent fees 30,899
Legal and auditing fees 65,429
Directors' fees and expenses 18,429
Organizational expenses 9,933
Administrative fees (Note 3) 19,579
Custodian fees 7,907
Insurance expenses 8,422
Marketing expenses 8,602
Other expenses 46,691
-------------
Total expenses 333,364
-------------
Net investment loss (294,820)
-------------
REALIZED LOSS AND UNREALIZED GAIN ON
INVESTMENTS:
Net realized loss on investments (687,578)
Unrealized gain on investments 2,469,085
-------------
Net gain on investments 1,781,507
-------------
Net increase in net assets resulting from operations $ 1,486,687
-------------
</TABLE>
The accompanying notes are an integral part of this statement.
<PAGE>
DEM, INC.
STATEMENTS OF CHANGES IN NET ASSETS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
INCREASE IN NET ASSETS RESULTING FROM OPERATIONS:
Net investment loss $ (294,820) $ (148,428)
Net realized (loss) gain on investments (687,578) 413,340
Unrealized gain (loss) on investments 2,469,085 (10,672)
------------ ------------
Net increase in net assets resulting from operations 1,486,687 254,240
------------ ------------
DISTRIBUTION TO SHAREHOLDERS FROM:
Net investment income (302,021) (17,222)
------------ ------------
Net decrease in net assets resulting from distribution
to shareholders (302,021) (17,222)
------------ ------------
CAPITAL SHARE TRANSACTIONS (Note 4):
Common shares issued, net of issuance costs 5,739,892 6,044,996
Common shares issued in reinvestment of dividends 47 338
------------ ------------
Net increase in net assets resulting from capital
shares transactions 5,739,939 6,045,334
------------ ------------
TOTAL INCREASE IN NET ASSETS 6,924,605 6,282,352
NET ASSETS, beginning of year 11,025,152 4,742,800
------------ ------------
NET ASSETS, end of year $17,949,757 $11,025,152
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE>
DEM, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. ORGANIZATION:
DEM, Inc. (the Company) was incorporated on October 20, 1995, in the State of
Maryland and is registered as a nondiversified closed-end management
investment company under the Investment Company Act of 1940, as amended.
The principal investment objective of the Company is long-term growth through
capital appreciation. Both capital appreciation and income will be considered
in the selection of investments, but primary emphasis is on capital
appreciation. The Company retains maximum flexibility as to the types of
investments it may make and it is permitted to invest in portfolio companies
with large and small market capitalizations. The Company, however, seeks to
invest a substantial portion of its assets in securities of domestic emerging
companies with smaller market capitalizations. There can be no assurance that
the Company's objectives will be achieved. The Company's investment
objectives and policies may be changed by the Board of Directors without the
approval of shareholders. Most of the Company's investments are expected to
be in marketable common stocks or marketable securities convertible into
common stock traded on an exchange or in the over-the-counter markets.
While the primary objective of the Company is to seek long-term growth through
capital appreciation, the Company may invest its assets in income producing
securities such as non-convertible preferred stock, bonds, debentures, notes
and other similar securities, if the Investment Adviser deems such investments
advisable.
2. SIGNIFICANT ACCOUNTING POLICIES:
Security Valuation
Investments in securities traded on a national securities exchange (or
reported on the NASDAQ national market) are stated at the last reported sales
price on the day of valuation; other securities traded in the over-the-counter
market and listed securities for which no sale was reported on that date are
stated at the last quoted bid price.
Cash and Cash Equivalents
Cash and cash equivalents as of December 31, 1997, consist of funds invested
in the money market funds stated at cost which is market.
<PAGE>
-2-
Deferred Organizational Costs
Costs incurred to organize the Company have been deferred and are amortized on
a straight-line basis over a five-year period starting in 1996. Accumulated
amortization cost as of December 31, 1997, was $9,933.
Income Taxes
The Company elected to be treated as a regulated investment company (a RIC)
for Federal income tax purposes in accordance with Subchapter M of the
Internal Revenue Code of 1986, as amended. In order to so qualify, the
Company must satisfy certain tests regarding the source of its income,
diversification of its assets and distribution of its income. If the Company
otherwise qualifies as a regulated investment company and distributes to its
stockholders at least 90% of its investment company taxable income, then the
Company will not be subject to Federal income tax on the income so
distributed. However, the Company would be subject to corporate income tax on
any undistributed income. In addition, the Company will be subject to a
nondeductible 4% excise tax on the amount by which the amount it distributes
in any calendar year is less than a statutorily-designated, required amount of
its regulated investment company income and its capital gain net income
(generally 98%).
Other
The Company follows industry practice and records security transactions on the
trade date. Dividend income is recognized on the ex-dividend date, and
interest income is recognized on an accrual basis. Discounts and premiums on
securities purchased are amortized over the life of the respective securities.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, revenues and expenses
in the financial statements and the disclosure of contingent assets and
liabilities. While actual results could differ from those estimates,
management believes that actual results will not be materially different from
amounts provided in the accompanying financial statements.
3. INVESTMENT ADVISORY AGREEMENT:
The investment adviser to the Company is Chapman Capital Management, Inc. (the
Investment Advisor and CCM). The President of the Company is also the
President and a Board Member of CCM. Pursuant to an Investment Advisory
Agreement, the Investment Advisor receives an advisory fee from the Company at
an annual rate of .90% of the average weekly net assets of the Company. CCM
also serves as the Company's administrator and is compensated for those
services at an annual rate of .15% of the average weekly net assets of the
Company.
4. CAPITAL SHARE TRANSACTIONS:
As of December 31, 1997, there were 500,000,000 shares of $.00001 par value
capital stock authorized and additional paid-in capital aggregated
$16,526,177.
<PAGE>
-3-
Transactions in capital stock for the year ended December 31, were as follows:
<TABLE>
<CAPTION>
Shares Dollar Value
---------------------- ---------------------------
1997 1996 1997 1996
---------- --------- ------------ -----------
<S> <C> <C> <C> <C>
Shares sold 370,960 433,333 $ 5,739,892 $ 6,044,996
Shares issued as reinvestment
of dividends 3 23 47 338
---------- --------- ------------ -----------
Net increase 370,963 433,356 $ 5,739,939 $ 6,045,334
---------- --------- ------------ -----------
---------- --------- ------------ -----------
</TABLE>
The dollar amounts in the above table are net of sales commissions and fees of
$432,008 paid to The Chapman Co. (Chapman) for underwriting management fees
and broker commissions.
The Company has a dividend reinvestment plan (the Plan). Shockholders of
record, whose shares are registered in his or her name, will automatically be
a participant in the Plan, unless the shockholder specifically elects to
receive dividends and capital gains in cash paid by check. The Company
instructs the stock transfer agent to buy shares in the open market or to
issue new shares. When the Company issues new shares, the price is equal to
the last sale price at the close of the previous trading day. If there is no
sale on that date, then the mean between the closing bid and asked quotations
for such common stock on such date is used.
5. DISTRIBUTIONS TO SHAREHOLDERS:
Dividends to shareholders are recorded on the ex-dividend date.
On January 31, 1997, and April 18, 1997, a distribution of $.19, aggregating
$147,784 and $154,237, respectively, was declared from net investment income
during 1997. The dividends were paid on February 28, 1997, and May 23, 1997,
respectively, to shareholders of record on February 14, 1997, and May 9, 1997,
respectively.
6. RELATED PARTY TRANSACTIONS:
Included in the accompanying statement of operations for the year ended
December 31, 1997, is $137,052 of investment advisory and administrative fees
related to the Investment Advisory Agreement discussed in Note 3, of which
$16,008 are included in accounts payable and accrued expenses in the
accompanying statement of assets and liabilities as of December 31, 1997.
Also included in accounts payable and accrued expenses as of December 31,
1997, is $19 payable to Chapman and $1,300 payable to CCM for costs paid on
behalf of the Company. Commissions on trading activity of $22,872 were paid
to Chapman for the year ended December 31, 1997.
<PAGE>
Page 1 of 3
DEM, INC.
STATEMENT OF PORTFOLIO INVESTMENTS
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
Shares Value
- ----------- -------------
<S> <C> <C>
CASH AND MONEY MARKETS - 4.3%:
Cash - 4.1% $ 744,268
Fidelity U.S. Treasury Portfolio II - .2% 37,283
-------------
Total money markets 781,551
-------------
COMMON STOCK - 95.7%:
Apparel - 1.0%
15,000 Supreme International Corp.* 187,500
-------------
187,500
-------------
Banking - 11.5%
11,000 Capital Bancorp FLA 635,937
5,500 Carver Bancorp, Inc. 89,375
1,000 GBC Bancorp* 63,750
1,000 Jeffbanks Inc. 46,000
25,000 Popular Inc. 1,237,500
-------------
2,072,562
-------------
Communications - 3.7%
7,000 Digital Link Corp.* 67,375
26,000 Mastec, Inc.* 594,750
-------------
662,125
-------------
Consumer Products - 3.8%
30,000 Movado Group 690,000
-------------
Consumer Services - 3.1%
5,000 Complete Business Solutions, Inc.* 217,500
1,000 M/A/R/C Inc. 18,000
12,000 Vincam Group, Inc.* 319,500
-------------
555,000
-------------
Environmental Services - 1.4%
12,500 Tetra Tech, Inc.* 250,000
-------------
Financial Services - 1.3%
10,000 Capital Factor Holdings, Inc.* 190,000
1,250 Oriental Financial Group, Inc.* 36,953
-------------
226,953
-------------
</TABLE>
The accompanying notes are an integral part of this statement.
<PAGE>
Page 2 of 3
DEM, INC.
STATEMENT OF PORTFOLIO INVESTMENTS
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
Shares Value
- ----------- -------------
<S> <C> <C>
COMMON STOCK (Continued):
Furniture - 5.6%
10,000 Ethan Allen Interiors, Inc. $ 1,002,625
-------------
Healthcare - 1.7%
7,000 Pediatrix Medical Group 299,250
-------------
Media/Publishing - 8.2%
18,000 BET Holdings* 983,250
7,000 Univision Communications, Inc.* 488,688
-------------
1,471,938
-------------
Pharmaceutical - 6.7%
10,000 Theragenics Corp.* 360,000
26,000 Watson Pharmaceuticals Inc.* 843,375
-------------
1,203,375
-------------
Retail - 6.3%
32,000 CHS Electronics, Inc. * 548,000
20,000 Wet Seal, Inc.* 590,000
-------------
1,138,000
-------------
Software and Technology Service - 18.7%
2,000 Ace Communications Corp.* 23,625
20,000 Autodesk Inc. 740,000
24,000 Computer Associate International 1,272,000
10,000 I2 Technologies, Inc.* 527,500
8,000 Information Management Resources, Inc.* 300,000
10,000 Integrated Systems, Inc.* 137,500
10,000 Quickresponse Services, Inc.* 370,000
-------------
3,370,625
-------------
</TABLE>
* Non-income producing for the year ended December 31, 1997.
The accompanying notes are an integral part of this statement.
<PAGE>
Page 3 of 3
DEM, INC.
STATEMENT OF PORTFOLIO INVESTMENTS
AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
Shares Value
- ----------- -------------
<S> <C> <C>
COMMON STOCK (Continued):
Technology - 18.1%
25,000 ESS Tech, Inc.* 189,844
12,000 Gemstar International Group Ltd.* 292,500
25,000 Lattice Semiconductor Corp.* 1,184,375
35,000 Osicom Technologies, Inc.* 75,469
22,000 Solectron Corp.* 914,375
17,050 Trident Microsystems, Inc.* 154,515
22,000 Yurie Systems, Inc.* 444,125
-------------
3,255,203
-------------
Textile - 3.5%
20,000 Warnaco Group, Inc., Class A 627,500
-------------
Transportation - 1.1%
8,000 Atlas Air Inc.* 192,000
-------------
Total common stock 17,204,656
-------------
Total investments $17,986,207
-------------
</TABLE>
* Non-income producing for the year ended December 31, 1997.
The accompanying notes are an integral part of this statement.
<PAGE>
DEM, INC.
FINANCIAL HIGHLIGHTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
---------- ----------- ----------
<S> <C> <C> <C>
PER SHARE DATA:
Net asset value on issuance of shares $ - $ - $ 13.97
---------- ----------- ----------
Dilutive effect from shares-
Organizational costs - - (.21)
---------- ----------- ----------
Investment income .04 .30 .01
Expenses (.38) (.72) -
---------- ----------- ----------
Net investment (loss) income (.34) (.42) .01
Distributions from net investment income (.35) (.05) -
Net realized and unrealized gain on securities 2.15 .87 -
---------- ----------- ----------
Net increase in net asset value 1.46 .40 .01
Net asset value-
Beginning of year 14.17 13.77 -
---------- ----------- ----------
End of year $ 15.63 $ 14.17 $ 13.77
---------- ----------- ----------
Weighted average shares outstanding during the year 867,122 349,219 344,457
---------- ----------- ----------
Per share market value, end of period $ 16.13 $ 15.50 $ 15.00
---------- ----------- ----------
Total investment return 9.89% 3.68% - %
---------- ----------- ----------
RATIOS TO AVERAGE NET ASSETS:
Expenses 2.30% 3.21% .04%
Net investment (loss) income (2.04)% (1.89)% 1.45%
Average commission rate paid 5.00% 4.38% - %
Portfolio turnover rate 18.50% 332.60% - %
SUPPLEMENTAL DATA:
Net assets, end of the period $17,949,757 $11,025,152 $4,742,800
----------- ----------- ----------
</TABLE>
The accompanying notes are an integral part of this statement.
<PAGE>
RESULTS OF THE ANNUAL SHAREHOLDERS MEETING
DEM, Inc.'s Annual meeting of shareholders was held on June 6, 1997. At that
meeting the following directors were nominated and elected to serve on the
board until their respective terms expire. Each director received 736,306
votes for, 0 votes against, 75,469 votes withheld, 0 votes abstained and 0
broker non-votes.
<TABLE>
<S> <C>
Nathan A. Chapman, Jr. 2000
Lottie L. Shackelford 1999
James B. Lewis 1998
Robert L. Wallace 1999
Ronald A. White 2000
</TABLE>
Arthur Andersen LLP shall serve as independent auditors for the Company with
736,306 votes for, 0 votes against, 75,469 votes withheld, 0 votes abstained
and 0 broker non-votes.
RISK FACTORS
Investors should consider the following risk factors associated
with an investment in the Company.
An investment in the Company's shares does not constitute a
complete investment program since it involves the greater market risks
inherent in seeking higher returns and is not recommended for short-term or
risk averse investors. No assurance can be given that securities of small
emerging companies will appreciate, that a sufficient number of appropriate
investments will be available or that the Company's particular investment
choices will be successful. The prices of securities in which the Company
may invest may also be more volatile than securities of issuers with larger
market capitalizations and the Company's net asset value may therefore be
subject to greater fluctuation than other investment companies that invest in
equity securities.
Investment in Small Companies
Because the Company intends to invest substantially all of its
assets in securities of emerging companies with small market capitalizations,
an investor should be aware of certain special considerations and risk
factors relating to investments in such companies. No assurance can be given
that securities of small emerging companies will appreciate, that a
sufficient number of appropriate investments will be available or that the
Company's particular investment choices will be successful. Investors should
also be aware of considerations and risks relating to the Company's
investment practices. An investment in the Company should not itself be
considered a balanced investment program and is intended to provide
diversification as part of a more complete investment program. The Company
is intended for long-term investors not seeking current income, who have the
financial ability to accept greater investment risk in exchange for the
potential of higher than average, long-term capital appreciation.
Investing in small capitalization stocks can involve greater risk
than is customarily associated with investing in securities of larger, more
established companies. Small emerging companies may be subject to greater
earnings fluctuation, lack of established markets for products or services,
more limited financial resources and less depth of experienced management.
Securities of small emerging companies generally have more limited
marketability and may be subject to greater price volatility than securities
of larger companies. They may be dependent for management on one or a few
key persons, and can be more susceptible to losses and risks of bankruptcy.
Transaction and trading costs in smaller capitalization stocks may be higher
than those of larger capitalization companies, primarily because of more
limited volumes
<PAGE>
and fewer active market markers. These risks are in addition to the risks
normally associated with any strategy seeking capital appreciation by
investing in a portfolio of equity securities. Furthermore, such companies
are often traded on markets such as the OTC Bulletin Board-SM- and the Pink
Sheets-SM- where the trading market is thinner and the spread between bid and
offer prices is often larger than on the major exchanges or Nasdaq system.
The nature of these trading markets may limit the flexibility of the Company
to divest of portfolio securities quickly and at a reasonable price in
response to market conditions.
Limited Experience of the Investment Adviser
The Investment Adviser has acted as investment manager for various
balanced and equity portfolios. Further, the Investment Adviser has acted
and is currently acting as an investment adviser and manager for The Chapman
Funds, Inc., an open-end, diversified management investment company which
currently offers one money market fund. However, prior to advising the
Company, the Investment Adviser had not acted as an adviser to a closed-end
management investment company.
Non-Diversified Status
The Company is classified as a non-diversified management
investment company under the 1940 Act, which means that the Company is not
limited by that Act in the proportion of its assets that may be invested in
the securities of a single issuer. However, the Company complies and intends
to continue to comply with the diversification requirements imposed by the
U.S. Internal Revenue Code of 1986, as amended (the "Code"), for
qualification as a regulated investment company. See "TAXATION" in the
Company's Statement of Additional Information. As a non-diversified
investment company, the Company may invest a greater proportion of its assets
in the obligations of a smaller number of issuers and, as a result, may be
subject to greater risk with respect to its portfolio securities.
Lower Rated Securities
The Company may invest in fixed-income securities rated in the
lower rating categories of recognized statistical rating agencies, such as
securities rated "CCC or lower by S&P or "Caa" or lower by Moody's or
non-rated securities of comparable quality. These debt securities are
predominantly speculative, involve major risk exposure to adverse conditions
and are often referred to in the financial press as "junk bonds." See
Appendix A.
Special Factors Relating to Closed-End Companies
The Company is a non-diversified, closed-end management investment
company designed for long-term investment and investors should not consider
it as a trading vehicle. Shares of closed-end investment companies
frequently trade at a discount from net asset value. See "INVESTMENT
OBJECTIVES AND POLICIES."
Potential Conflict of Interest
The Company may utilize The Chapman Co., a broker-dealer registered
under the Securities and Exchange Act of 1934 and a member of the National
Association of Securities Dealers, in connection with the purchase or sale of
portfolio securities in certain circumstances. As of February 26, 1998, the
Investment Adviser is a wholly-owned subsidiary of Chapman Capital Holdings,
Inc. Mr. Nathan A. Chapman, Jr., the President and Chairman of the Board of
Directors of the Company, is also the President and Chairman of the Board of
Directors of the Investment Adviser and Chapman Capital Holdings, Inc. The
Chapman Co. is a wholly-owned subsidiary of Chapman Holdings, Inc. Mr.
Nathan A. Chapman, Jr. is also the President and Chairman of the Board of
Directors of The Chapman Co. and the controlling shareholder,
<PAGE>
President and Chairman of the Board of Directors of Chapman Holdings, Inc.
See "MANAGEMENT OF THE COMPANY--Investment Adviser" below and "OFFICERS AND
DIRECTORS" in the Company's Statement of Additional Information. Mr. Chapman
owns approximately 92% of the equity and has the right to cast approximately
92% of the votes entitled to be cast by stockholders of Chapman Capital
Holdings, Inc. Accordingly, these relationships represent a potential
conflict of interest with respect to commissions and other fees on brokerage
transactions conducted on the Company's behalf by The Chapman Co. A majority
of the Company's board of directors are independent directors and such
directors have adopted procedures in compliance with the Investment Company
Act of 1940 to address such conflict. See INVESTMENT ADVISORY AND OTHER
SERVICES" and "BROKERAGE AND PORTFOLIO TRANSACTIONS" in the Company's
Statement of Additional Information.
DIVIDEND REINVESTMENT PLAN
1. Each holder of shares (a "Shareholder") of common stock, par value
.00001 per share (the "Common Stock"), in DEM, Inc. (the "Fund") whose Fund
shares are registered in his or her own name will automatically be a
participant ("Participant") in the Dividend Reinvestment Plan (the "Plan"),
unless any such Shareholder specifically elects to receive all dividends and
capital gains in cash paid by check mailed directly to the Shareholder. A
Shareholder whose shares are registered in the name of a broker-dealer or any
nominee (the "Nominee") will be a Participant if (a) such a service is
provided by the Nominee and (b) the Nominee makes an election on behalf of
the Shareholder to participate in the Plan. The Chapman Co. intends to make
such an election on behalf of Shareholders whose shares are registered in its
name, as Nominee, unless a Shareholder specifically instructs his or her
broker to pay dividends and capital gains in cash. FPS Services, Inc. (the
"Agent") will act as agent for Participants and will open an account under
the Plan for each Participant in the same name as such Participant's Common
Stock is registered on the books and records of the transfer agent for the
Common Stock.
2. Whenever the Fund declares a capital gains distribution or an
income dividend payable in shares of Common Stock or cash, Participants will
receive such distribution or dividend in the manner described in paragraph 3
below as determined on the date such distribution or dividend becomes
payable. At the time of these dividends and distributions, income and
capital gains are realized, although cash is not received by the shareholder.
3. Whenever the market price of the Fund's Common Stock is equal to or
exceeds the net asset value per share at the time shares of Common Stock are
valued for the purpose of determining the number of shares equivalent to the
cash dividend or capital gains distribution, Participants will be issued
shares of Common Stock valued at the greater of (i) the net asset value per
share most recently determined or (ii) 95% of the then current market price.
Participants will receive any such distribution or dividend entirely in
shares of Common Stock, and the Agent shall automatically receive such shares
of Common Stock, including fractions, for all Participants' accounts. If the
net asset value per share of the Common Stock at the time of valuation
exceeds the market price of the Common Stock, or if the Fund should declare a
dividend or capital gains distribution payable only in cash, a broker-dealer
not affiliated with The Chapman Co. will, as purchasing agent (the
"Purchasing Agent") for the Participants, buy shares of Common Stock in the
open market, on the NASDAQ Smallcap Market (the "NASDAQ") or elsewhere, for
each Participant's account. If, following the commencement of such purchases
and before the Purchasing Agent has completed its purchases, the market price
exceeds the net asset value per share, the average per share purchase price
paid by the Purchasing Agent may exceed the net asset value of the Common
Stock, resulting in the acquisition of fewer shares of Common Stock than if
the dividend or capital gains distribution had been paid in Common Stock
issued by the Fund at net asset value per share.
<PAGE>
Additionally, if the market price exceeds the net asset value of shares
before the Purchasing Agent has completed its purchases, the Purchasing Agent
is permitted to cease purchasing shares and the Fund may issue the remaining
shares at a price equal to the greater of (a) net asset value or (b) 95% of
the then current market price. In a case where the Purchasing Agent has
terminated open market purchases and the Fund has issued the remaining
shares, the number of shares received by the Participant in respect of the
cash dividend or distribution will be based on the weighted average of prices
paid for shares purchased in the open market and the price at which the Fund
issues remaining shares.
The Agent will apply all cash received as a dividend or capital gains
distribution to purchase shares of Common Stock on the open market as soon as
practicable after the payment date of such dividend or capital gains
distribution, but in no event later than 30 days after such date, except
where necessary to comply with applicable provisions of the Federal
securities laws.
4. For all purposes of the Plan: (a) the market price of the Fund's
Common Stock on a particular date shall be the last sale price on the NASDAQ
at the close of the previous trading day or, if there is no sale on the
NASDAQ on that date, then the mean between the closing bid and asked
quotations for such Common Stock on the NASDAQ on such date and (b) net asset
value per share of Common Stock on a particular date shall be as determined
by or on behalf of the Fund.
5. The open market purchases provided for above may be made on any
securities exchange where the shares of Common Stock of the Fund are traded
in the over-the-counter market or in negotiated transactions, and may be on
such terms as to price, delivery and otherwise as the Purchasing Agent shall
determine. Funds held by the Purchasing Agent uninvested will not bear
interest, and it is understood that, in any event, the Purchasing Agent shall
have no liability in connection with any inability to purchase shares of
Common Stock within 30 days after the initial date of such purchase as herein
provided, or with the timing of any purchases effected. The Purchasing Agent
shall have no responsibility as to the value of the shares of Common Stock of
the Fund acquired for any Participant's account.
6. The Agent will hold shares of Common Stock acquired pursuant to the
Plan in noncertificated form in the Participant's name. The Agent will
forward to each Participant any proxy solicitation material and will vote any
shares of Common Stock so held for each Participant only in accordance with
the proxy returned by any such Participant to the Fund. Upon any
Participant's written request, the Agent will deliver to her or him, without
charge, a certificate or certificates for the full shares of Common Stock.
7. The Agent will confirm to each Participant acquisitions made for
his or her account as soon as practicable but not later than 60 days after
the date thereof. Although a Participant may from time to time have an
undivided fractional interest (computed to three decimal places) in a share
of Common Stock of the Fund, no certificates for fractional shares will be
issued. However, dividends and distributions on fractional shares of Common
Stock will be credited to Participants' accounts. In the event of
termination of a Participant account under the Plan, the Agent will adjust
for any such undivided fractional interest in cash at the market value of the
shares of Common Stock at the time of termination.
8. Any stock dividends or split shares distributed by the Fund on
shares of Common Stock held by the Agent for any Participant will be credited
to such Participant's account. In the event that the Fund makes available to
Participants rights to purchase additional shares of Common Stock or other
securities, the Agent will sell such rights and apply the proceeds of the
sale to the purchase of additional shares of Common Stock of the Fund for the
account of Participants.
<PAGE>
9. The Agent's service fee for handling capital gains distributions or
income dividends will be paid by the Fund. Participants will be charged a
pro rata share of brokerage commissions on all open market purchases.
10. Any Participant may withdraw shares from such Participant's account
or terminate such Participant's account under the Plan by notifying the Agent
in writing. Such withdrawal or termination will be effective immediately if
notice is received by the Agent not less than 10 days prior to any dividend
or distribution record date; otherwise such withdrawal or termination will be
effective, with respect to any subsequent dividend or distribution, on the
first trading day after the dividends paid for such record date have been
credited to the Participant's account. The Plan may be terminated by the
Agent or the Fund upon notice in writing mailed to each Participant at least
30 days prior to any record date for the payment of any dividend or
distribution by the Fund. Upon any withdrawal or termination, the Agent will
cause to be delivered to each Participant a certificate or certificates for
the appropriate number of full shares and a cash adjustment for any
fractional share (valued at the market value of the shares at the time of
withdrawal or termination); provided, however, that any Participant may elect
by notice to the Agent in writing in advance of such termination to have the
Agent sell part or all of the shares in question and remit the proceeds to
such Participant, net of any brokerage commissions. A $5.00 fee will be
charged by the Agent upon any cash withdrawal or termination, and the Agent
is authorized to sell a sufficient number of the Participant's shares to
cover such fee and any brokerage commissions on such sale.
11. These terms and conditions may be amended or supplemented by the
Agent or the Fund at any time or times but, except when necessary or
appropriate to comply with applicable law or the rules or policies of the
Securities and Exchange Commission or any other regulatory authority, only by
mailing to each Participant appropriate written notice at least 90 days prior
to the effective date thereof. The amendment or supplement shall be deemed to
be accepted by each Participant unless, with respect to any such Participant,
prior to the effective date thereof, the Agent receives written notice of the
termination of that Participant's account under the Plan. Any such amendment
may include an appointment by the Agent in its place and stead of a successor
Agent under these terms and conditions, with full power and authority to
perform all or any of the acts to be performed by the Agent under these terms
and conditions. Upon any such appointment of an Agent for the purpose of
receiving dividends and distributions, the Fund will be authorized to pay to
such successor Agent, for Participants' accounts, all dividends and
distributions payable on the shares of Common Stock held in each
Participant's name or under the Plan for retention or application by such
successor Agent as provided in these terms and conditions.
12. The Agent shall at all times act in good faith and agree to use its
best efforts within reasonable limits to ensure the accuracy of all services
performed under this agreement and to comply with applicable law, but assumes
no responsibility and shall not be liable for loss or damages due to errors
unless such error is caused by its or its employees' gross negligence, bad
faith or willful misconduct.
13. The Participant shall have no right to draw checks or drafts
against such Participant's account or to give instructions to the Plan Agent
in respect of any shares or cash held therein except as expressly provided
herein.
14. The Participant agrees to notify the Plan Agent promptly in writing
of any change of address. Notices to the Participant may be given by the
Plan Agent by letter addressed to the Participant as shown on the records of
the Plan Agent.
15. This Agreement and the account established hereunder for the
Participant shall be governed by and construed in accordance with the laws of
the State of Maryland and the Rules and Regulations of the Securities and
Exchange Commission, as they may be changed or amended from time to time.
<PAGE>
APPENDIX A - CORPORATE BOND RATINGS
Moody's Investors Service, Inc.
Aaa Bonds that are rated Aaa are judged to be of the best quality. they carry
the smallest degree of investment risk and are generally referred to as
"gilt edge." Interest payments are protected by a large or exceptionally
stable margin and principal is secure. While the various protective
elements are likely to change, such changes as can be visualized are most
unlikely to impair the fundamentally strong position of such issues.
Aa Bonds that are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high
grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other
elements present which make the long-term risk appear somewhat larger than
in Aaa Securities.
A Bonds that are rated A possess may favorable investment attributes and are
to be considered as upper-medium-grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment some time in the
future.
Baa Bonds that are rated Baa are considered as medium-grade obligations i.e.,
they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable
over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba Bonds that are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty
of position characterizes bonds in this class.
B Bonds that are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance
of other terms of the contract over any long period of time may be small.
Moody's applies numerical modifiers (l, 2, and 3) with respect to the bonds
rated "Aa" through "B". The modifier 1 indicates that the company ranks in
the higher end of its generic rating category; the modifier 2 indicates a
mid-range ranking; and the modifier 3 indicates that the company ranks in
the lower end of its generic rating category.
Caa Bonds that are rated Caa are of poor standing. These issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca Bonds that are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked
shortcomings.
<PAGE>
C Bonds that are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing.
Standard & Poor's Ratings Group
AAA This is the highest rating assigned by S&P to a debt obligation and
indicates an extremely strong capacity to pay interest and repay principal.
AA Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from AAA issues only in small degree.
A Principal and interest payments on bonds in this category are regarded as
safe. Debt rated A has a strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt in
higher rated categories.
BBB This is the lowest investment grade. Debt rated BBB has an adequate
capacity to pay interest and repay principal. Whereas it normally exhibits
adequate protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than in higher rated
categories.
Speculative Grade
Debt rated BB, CCC, CC and C are regarded, on balance, as predominantly
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligation. BB indicates the lowest
degree of speculation, and C the highest degree of speculation. While such
debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major exposures to adverse
conditions. Debt rated C1 is reserved for income bonds on which no
interest is being paid and debt rated D is in payment default.
In July 1994, S&P initiated an "r" symbol to its ratings. The "r" symbol
is attached to derivatives, hybrids and certain other obligations that S&P
believes may experience high variability in expected returns due to
non-credit risks created by the terms of the obligations.
"AA" to "CCC" may be modified by the addition of a plus or minus sign to show
relative standing within the major categories.
"NR" indicates that no public rating has been requested, that there is
insufficient information on which to base a rating, or that S&P does not rate
a particular type of obligation as a matter of policy.
