PAGE 1
Prospectus for the T. Rowe Price Tax-Efficient Balanced Fund,
Inc., dated July 1, 1997.
<PAGE>
PROSPECTUS
July 1, 1997
Tax-Efficient
Balanced Fund
A fund seeking attractive after-tax total returns from a portfolio of stocks
and tax-exempt bonds.
(T. ROWE PRICE RAM LOGO)
<PAGE>
FACTS AT A GLANCE
Tax-Efficient Balanced Fund
Investment Goal
To provide an attractive level of after-tax total returns over the long term
through capital appreciation and tax-exempt current income while keeping
taxable distributions relatively low.
As with any mutual fund, there is no guarantee the fund will achieve its goals.
Strategy
To invest in a balanced portfolio consisting of at least 50% in tax-exempt
municipal securities and the balance in common stocks.
Risk/Reward
The potential to balance over time the capital appreciation offered by stocks
with the tax-exempt income and lesser volatility of municipal bonds. However,
the fund's share price will fluctuate as stock and bond market conditions
change and could cause a loss.
Investor Profile
Relatively high-income investors seeking a balanced approach to tax-advantaged
total returns who can accept the possibility of share price declines. Not
appropriate for tax-deferred retirement accounts, such as IRAs.
Fees and Charges
100% no load. Shares purchased and held for less than one year are subject to a
1% redemption fee, paid to the fund. No fees or charges to buy shares or to
reinvest dividends; no 12b-1 marketing fees; free telephone exchange among T.
Rowe Price funds.
Investment Manager
Founded in 1937 by the late Thomas Rowe Price, Jr., T. Rowe Price Associates,
Inc. ("T. Rowe Price") and its affiliates managed over $103 billion for more
than five million individual and institutional investor accounts as of March
31, 1997.
<PAGE>
T. Rowe Price Tax-Efficient Balanced Fund, Inc.
Prospectus
July 1, 1997
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
<PAGE>
T. ROWE PRICE 2
CONTENTS
1
ABOUT THE FUND
Transaction and Fund Expenses 2
Fund, Market, and Risk Characteristics 3
2
ABOUT YOUR ACCOUNT
Pricing Shares and Receiving Sale Proceeds 7
Distributions and Taxes 9
Transaction Procedures andSpecial Requirements 11
3
MORE ABOUT THE FUND
Organization and Management 15
Understanding Performance Information 17
Investment Policies and Practices 18
4
INVESTING WITH T. ROWE PRICE
Account Requirements and Transaction Information 27
Opening a New Account 27
Purchasing Additional Shares 29
Exchanging and Redeeming 29
Shareholder Services 31
Discount Brokerage 33
Investment Information 34
This prospectus contains information you should know before investing. Please
keep it for future reference. A Statement of Additional Information about the
fund, dated July 1, 1997, has been filed with the Securities and Exchange
Commission and is incorporated by reference in this prospectus. To obtain a free
copy, call 1-800-638-5660.
<PAGE>
3
ABOUT THE FUND
1
TRANSACTION AND FUND EXPENSES
----------------------------------------------------------
. Like all T. Rowe Price funds, this fund is 100% no load.
These tables should help you understand the kinds of expenses you will bear
directly or indirectly as a fund shareholder.
Shareholder Transaction Expenses in Table 1 shows that you pay no sales
charges. All the money you invest in the fund goes to work for you, subject
to the fees explained below. Annual Fund Expenses shows how much it will cost
to operate the fund for a year, based on estimated fiscal year expenses.
These are costs you pay indirectly, because they are deducted from the fund's
total assets before the daily share price is calculated and before dividends
and other distributions are made. In other words, you will not see these
expenses on your account statement.
<TABLE>
Table 1
<CAPTION>
<S> <C> <C> <C> <C>
Shareholder Transaction Annual Fund Expenses Percentage of
Expenses (after reduction) Average Net
Assets
Sales charge "load" on purchases None Management fee 0.06%/a/
Sales charge "load" on reinvested Marketing fees (12b-1)
distributions None None
Redemption fees (for shares held Total other (shareholder servicing,
less than one year) 1% custodial, auditing, etc.) 0.94%/a/
Exchange fees None Total fund expenses 1.00%/a/
- ----------------------------------------------------------------------------------------------------
</TABLE>
/a/In the interest of limiting the expenses of the fund during its initial
period of operations, T. Rowe Price has agreed to waive fees and bear any
expenses through February 28, 1999, which would cause the fund's ratio of
expenses to average net assets to exceed 1.00%. Fees waived or expenses paid
or assumed under this agreement are subject to reimbursement to T. Rowe Price
by the fund whenever the fund's expense ratio is below 1.00%; however, no
reimbursement will be made after February 28, 2001, or if it would result in
the expense ratio exceeding 1.00%. Any amounts reimbursed will have the
effect of increasing fees otherwise paid by the fund. Without this expense
limitation, it is estimated that the fund's management fee, other expenses,
and total expense ratio would be 0.53%, 0.94%, and 1.47%, respectively.
Organizational expenses will be charged to the fund over a period not to
exceed 60 months.
Note:A $5 fee is charged for wire redemptions under $5,000, subject to change
without notice, and a $10 fee is charged for small accounts, when applicable
(see Small Account Fee under Transaction Procedures and Special Requirements).
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T. ROWE PRICE 4
The main types of expenses, which all mutual funds may charge against fund
assets, are:
. A management fee The percent of fund assets paid to the fund's investment
manager. The fund's fee comprises a group fee, 0.33% as of March 31, 1997,
and an individual fund fee of 0.20%.
. "Other" administrative expenses Primarily the servicing of shareholder
accounts, such as providing statements and reports, disbursing dividends, and
providing custodial services.
. Marketing or distribution fees An annual charge ("12b-1") to existing
shareholders to defray the cost of selling shares to new shareholders. T.
Rowe Price funds do not levy 12b-1 fees.
For further details on fund expenses, please see Organization and Management.
. Hypothetical example Assume you invest $1,000, the fund returns 5% annually,
expense ratios remain as listed previously, and you close your account at the
end of the time periods shown. Your expenses would be:
<TABLE>
Table 2
<CAPTION>
<S> <C> <C> <C>
Hypothetical Fund Expenses
1 year 3 years
$10 $32
- ------------------------------------------------------------
</TABLE>
. Table 2 is just an example; actual expenses can be higher or lower than
those shown.
FUND, MARKET, AND RISK CHARACTERISTICS: WHAT TO EXPECT
----------------------------------------------------------
To help you decide whether this fund is appropriate for you, this section
takes a closer look at its investment objective and approach.
What is the fund's objective?
The fund's objective is to provide attractive long-term total returns on an
after-tax basis with a balanced portfolio of stocks and municipal bonds.
What is the fund's investment program?
The fund will invest a minimum of 50% of total assets in municipal bonds and
the balance in stocks. The stock portion will be invested primarily in mid-
to large-capitalization stocks selected mainly from the largest 1,000 U.S.
companies. It will also focus on lower-yielding stocks with relatively low
<PAGE>
ABOUT THE FUND 5
taxable dividend income. The bond portion will be invested primarily in
long-term municipal bonds, with maturities generally exceeding 10 years and
investment-grade ratings of BBB or higher. A maximum of 10% of the bond
component may be invested in below investment-grade ("junk") bonds to take
advantage of their relatively high tax-exempt income and potential for price
appreciation.
To accomplish the fund's goal of minimizing taxes, the portfolio managers
will strive to avoid realizing taxable capital gains. However, the managers
will lock in gains when they believe the risk of remaining in a security
outweighs the tax benefit of continuing to hold it.
The fund may purchase convertible securities, warrants, and other securities
when consistent with the fund's investment objective and program, and may
engage in a variety of investment management practices, such as buying and
selling futures and options.
. For details about the fund's investment program and practices, please see
the Investment Policies and Practices section.
What other measures will be taken to enhance the tax efficiency of the fund?
When gains are taken, the managers will attempt to offset them with losses
from other securities whenever possible. This may be accomplished by selling
bonds or stocks at losses and investing the proceeds in similar securities.
The fund is required to invest a minimum of 50% of its assets in municipal
securities (measured at the end of each fiscal quarter) to maintain the
tax-advantaged status of the bond income. The managers will also strive to
keep income from taxable dividends relatively low. In addition, the fund will
not purchase bonds subject to the alternative minimum tax.
What is a "balanced" investment approach?
This approach attempts to "balance" the potential for growth and greater
volatility of stocks with the stable income and normally more moderate price
fluctuations of fixed income securities. It is widely regarded as a
conservative strategy designed to cushion an investment from the volatility
associated with funds composed exclusively of common stocks.
How does the fund select stocks for the portfolio?
Stock selection is based on fundamental, "bottom-up" analysis that seeks to
identify companies with good appreciation prospects. The fund managers may
use both growth and value approaches to stock selection. In the growth area,
the managers will try to identify companies with capable management,
attractive business niches, sound financial and accounting practices, and a
demonstrated ability to increase revenues, earnings, and cash flow
consistently. In looking for
<PAGE>
T. ROWE PRICE 6
value stocks, the managers will seek companies whose current stock prices
appear undervalued in terms of earnings, projected cash flow, or asset value
per share, and whose growth potential is temporarily unrecognized by the
market.
. Growth investors look for companies with above-average earnings gains. Value
investors look for undervalued assets.
What distinguishes the fund from many other balanced funds?
The stock portion of the portfolio in this fund will be balanced with
tax-exempt income from municipal bonds rather than taxable income in an
effort to achieve the fund's investment objective of generating high
after-tax returns. Investors in the higher tax brackets, in particular, are
increasingly aware of the negative impact of taxes on their overall
investment returns. To meet the growing demand for tax-efficient investing,
the fund's balanced approach is specifically designed to combine the growth
potential of equities with steady tax-free income and a minimum of taxable
distributions.
In addition, while turnover is expected to be low in rising markets, it may
increase in falling markets to the extent that previous gains from the sale
of securities are offset by losses in a further attempt to meet the fund's
investment objective.
. The fund's share price will fluctuate; when you sell your shares, you may
lose money.
What are some potential risks and rewards of investing in this fund?
The fund hopes to provide investors with attractive after-tax total returns
over time with less risk than that of the Standard & Poor's 500 Stock Index
by balancing the potential for capital appreciation with the tax-free income
and lesser volatility of municipal bonds. While stocks and municipal bonds
have individual risks discussed below, they also have a low historical
performance correlation, which means they do not always move in the same
direction at the same time. This could help cushion the fund's share price
decline when either the stock or bond market falls. It is important for
investors to view the fund as a long-term investment (minimum five years).
Common stocks in general offer a way to invest for long-term growth of
capital. As the U.S. economy has expanded, corporate profits have grown and
share prices have risen. Nevertheless, economic growth has been punctuated by
periods of stagnation and recession. Share prices of all companies, even the
best-managed and most profitable, can fall for any number of reasons, ranging
from lower-than-expected earnings to changes in investor psychology.
Significant trading by large institutional investors also can lead to price
declines. In addition, if our assessment of company prospects proves
incorrect, companies that our managers and analysts expect to do well may
perform poorly. Since
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ABOUT THE FUND 7
1950, the U.S. stock market has experienced 10 negative years as well as
steep drops of shorter duration. Its worst calendar quarter in recent years
was -22.5% in 1987's fourth quarter.
. Investors should have a long-term investment horizon and be willing to wait
out bear markets.
There are also risks associated with municipal bond investing, particularly
interest rate risk and credit risk. Bond prices and interest rates move in
opposite directions, so prices of the fund's bonds will fall when interest
rates rise, and vice versa. The longer the average maturity of the fund's
bond holdings, the greater the price movement. Credit risk is the chance that
any of the fund's holdings will have its credit rating downgraded or will
default, causing a loss of principal value and perhaps of income. Although
the large majority of holdings will be investment grade, the lowest
investment-grade rating of BBB has speculative elements, and any holdings of
noninvestment-grade (junk) bonds would increase the bond portfolio's overall
credit risk. While these are risks common to all bonds, municipal bonds also
face political and geographic risk. Political risk is the possibility of a
significant change in the federal tax structure or even serious discussion of
the topic in Congress. Either could reduce the advantages of municipal bonds
and cause their prices to fall. Geographic risk is the chance of price
declines in the fund resulting from developments in a single state.
How can I decide if the fund is appropriate for me?
Consider your investment goals, your time horizon for achieving them, your
tolerance for risk, and your tax situation. If you can accept the possibility
of share price decline in an effort to achieve attractive after-tax total
returns over the long term, the fund could be an appropriate part of your
overall investment strategy.
. The fund should not represent your complete investment program nor be used
for short-term trading purposes.
Is there other information I need to review before making a decision?
Be sure to read Investment Policies and Practices in Section 3, which
discusses the principal types of portfolio securities that the fund may
purchase, as well as the types of management practices that the fund may use.
<PAGE>
T. ROWE PRICE 8
ABOUT YOUR ACCOUNT
2
PRICING SHARES AND RECEIVING SALE PROCEEDS
----------------------------------------------------------
Here are some procedures you should know when investing in a T. Rowe Price
fund.
How and when shares are priced
The share price (also called "net asset value" or NAV per share) for the fund
is calculated at 4 p.m. ET each day the New York Stock Exchange is open for
business. To calculate the NAV, the fund's assets are valued and totaled,
liabilities are subtracted, and the balance, called net assets, is divided by
the number of shares outstanding.
. The various ways you can buy, sell, and exchange shares are explained at the
end of this prospectus and on the New Account Form. These procedures may
differ for institutional and employer-sponsored retirement accounts.
How your purchase, sale, or exchange price is determined
If we receive your request in correct form by 4 p.m. ET, your transaction
will be priced at that day's NAV. If we receive it after 4 p.m., it will be
priced at the next business day's NAV.
We cannot accept orders that request a particular day or price for your
transaction or any other special conditions.
Note: The time at which transactions and shares are priced and the time until
which orders are accepted may be changed in case of an emergency or if the
New York Stock Exchange closes at a time other than 4 p.m. ET.
How you can receive the proceeds from a sale
. When filling out the New Account Form, you may wish to give yourself the
widest range of options for receiving proceeds from a sale.
If your request is received by 4 p.m. ET in correct form, proceeds are
usually sent on the next business day. Proceeds can be sent to you by mail or
to your bank account by Automated Clearing House (ACH) transfer or bank wire.
Proceeds sent by ACH transfer should be credited the second day after the
sale. ACH is an automated method of initiating payments from and receiving
payments in your financial institution account. ACH is a payment system
supported by over 20,000
<PAGE>
ABOUT YOUR ACCOUNT 9
banks, savings banks, and credit unions, which electronically exchanges the
transactions primarily through the Federal Reserve Banks. Proceeds sent by
bank wire should be credited to your account the next business day.
. Exception: Under certain circumstances and when deemed to be in the fund's
best interests, your proceeds may not be sent for up to five business days
after receiving your sale or exchange request. If you were exchanging into a
bond or money fund, your new investment would not begin to earn dividends
until the sixth business day.
. If for some reason we cannot accept your request to sell shares, we will
contact you.
Contingent Redemption Fee
The fund can experience substantial price fluctuations and is intended for
long-term investors. The fund is not designed for short-term traders, whose
frequent purchases, redemptions, and exchanges unnecessarily can disrupt the
fund's investment program and drive up the fund's transaction costs. For
these reasons, the fund assesses a 1% fee on redemptions (including
exchanges) of fund shares held for less than one year.
Redemption fees will be paid to the fund to help offset transaction costs.
The fund will use the "first-in, first-out" (FIFO) method to determine the
one-year holding period. Under this method, the date of the redemption or
exchange will be compared with the earliest purchase date of shares held in
the account. If this holding period is less than one year, the redemption fee
will be assessed.
The fee does not apply to any shares purchased through reinvested
distributions (dividends and capital gains) or to shares held in retirement
plans such as 401(k), 403(b),457, Keogh, profit sharing, SIMPLE IRA,
SEP-IRA, and money purchase pension accounts. These exceptions may not apply
to shares held in broker omnibus accounts. The fee does apply to shares held
in IRA accounts and to shares purchased through automatic investment plans
(described under Shareholder Services).
In determining "one year," the fund will use the anniversary date of the
transaction. Thus, shares purchased on July 1, 1997, for example, will be
subject to the fee if they are redeemed on or prior to June 30, 1998. If they
are redeemed on or after July 1, 1998, they will not be subject to the fee.
<PAGE>
T. ROWE PRICE 10
USEFUL INFORMATION ON DISTRIBUTIONS AND TAXES
----------------------------------------------------------
. All net investment income and realized capital gains are distributed to
shareholders.
Dividends and Other Distributions
Dividend and capital gain distributions are reinvested in additional fund
shares in your account unless you select another option on your New Account
Form. The advantage of reinvesting distributions arises from compounding;
that is, you receive income dividends and capital gain distributions on a
rising number of shares.
Distributions not reinvested are paid by check or transmitted to your bank
account via ACH. If the Post Office cannot deliver your check, or if your
check remains uncashed for six months, the fund reserves the right to
reinvest your distribution check in your account at the NAV on the business
day of the reinvestment and to reinvest all subsequent distributions in
shares of the fund.
Income dividends
. A dividend on the tax-exempt portion of the fund's portfolio will be
declared daily at 4 p.m. ET to shareholders of record at that time provided
payment has been received on the previous business day, and these dividends
will be paid quarterly.
. A dividend (if any) on the taxable portion of the fund's portfolio will be
declared and paid annually.
. A portion of the fund's dividends may be eligible for the 70% deduction for
dividends received by corporations.
Capital gains
. A capital gain or loss is the difference between the purchase and sale price
of a security.
. If the fund has net capital gains for the year (after subtracting any
capital losses), they are usually declared and paid in December to
shareholders of record on a specified date that month. If a second
distribution is necessary, it is usually declared and paid during the first
quarter of the following year.
Tax Information
. You will be sent timely information for your tax filing needs.
A significant portion of the fund's dividend is expected to be exempt from
federal income taxes. However, you need to be aware of the possible tax
consequences when:
. You sell fund shares, including an exchange from one fund to another.
. The fund makes a distribution to your account.
<PAGE>
ABOUT YOUR ACCOUNT 11
Due to 1993 tax legislation, a portion of the capital gains realized on the
sale of market discount bonds with maturities beyond one year may be treated
as ordinary income and cannot be offset by other capital losses. Therefore,
to the extent the fund invests in these securities, the likelihood of a
taxable gain distribution will be increased.
Note: You must report your total tax-exempt income on IRS Form 1040. The IRS
uses this information to help determine the tax status of any Social Security
payments you may have received during the year. For shareholders who receive
Social Security benefits, the receipt of tax-exempt interest may increase the
portion of benefits that are subject to tax.
Taxes on fund redemptions
When you sell shares in any fund, you may realize a gain or loss. An exchange
from one fund to another is still a sale for tax purposes. If you realize a
loss on the sale or exchange of fund shares held six months or less, your
capital loss is reduced by the tax-exempt dividends received on those shares.
In January, you will be sent Form 1099-B, indicating the date and amount of
each sale you made in the fund during the prior year. This information will
also be reported to the IRS. For accounts opened new or by exchange in 1983
or later, we will provide you with the gain or loss of the shares you sold
during the year, based on the "average cost" method. This information is not
reported to the IRS, and you do not have to use it. You may calculate the
cost basis using other methods acceptable to the IRS, such as "specific
identification."
To help you maintain accurate records, we send you a confirmation immediately
following each transaction you make (except for systematic purchases and
redemptions) and a year-end statement detailing all your transactions in each
fund account during the year.
Taxes on fund distributions
The fund intends to invest a sufficient portion of its assets in municipal
bonds and notes so that it will qualify to pay tax-exempt dividends. The
portion of your income dividend derived from investment in tax-exempt
securities, will be exempt from federal income tax. The amount of such
dividends will be reported to you on your calendar year-end statement.
In January, you will also be sent Form 1099-DIV indicating the tax status of
any taxable dividend and capital gain distribution made to you. This
information will also be reported to the IRS. Such distributions are taxable
to you for the year in which they were paid. The only exception is that
distributions declared during the last three months of a calendar year and
paid in January are taxed as though they were paid by December 31. You will
be sent any additional information you need to determine your taxes on fund
distributions, such as the portion of your dividend, if any, that may be
exempt from state income taxes.
<PAGE>
T. ROWE PRICE 12
Short-term capital gain distributions are taxable as ordinary income and
long-term gain distributions are taxable at the applicable long-term gain
rate. The gain is long- or short-term depending on how long the fund held the
securities, not how long you held shares in the fund. If you realize a loss
on the sale or exchange of fund shares held six months or less, your
short-term loss recognized is reclassified to long-term to the extent of any
long-term capital gain distribution received.
Gains and losses from the sale of foreign currencies and the foreign currency
gain or loss resulting from the sale of a foreign debt security can increase
or decrease the fund's ordinary income dividend. Net foreign currency losses
may result in the fund's dividend being classified as a return of capital.
. Capital gain distributions or taxable income dividends are taxable whether
reinvested in additional shares or received in cash.
Tax effect of buying shares before a capital gain or dividend distribution
If you buy shares shortly before or on the "record date"- the date that
establishes you as the person to receive the upcoming distribution-you may
receive, in the form of a taxable distribution, a portion of the money you
just invested. Therefore, you may also wish to find out the fund's record
date before investing. Of course, the fund's share price may, at any time,
reflect undistributed capital gains, taxable income and unrealized
appreciation. To the extent these amounts are eventually distributed, they
will be taxable.
TRANSACTION PROCEDURES AND SPECIAL REQUIREMENTS
----------------------------------------------------------
. Following these procedures helps assure timely and accurate transactions.
Purchase Conditions
Nonpayment
If your payment is not received or you pay with a check or ACH transfer that
does not clear, your purchase will be canceled. You will be responsible for
any losses or expenses incurred by the fund or transfer agent, and the fund
can redeem shares you own in this or another identically registered T. Rowe
Price fund as reimbursement. The fund and its agents have the right to reject
or cancel any purchase, exchange, or redemption due to nonpayment.
U.S. dollars
All purchases must be paid for in U.S. dollars; checks must be drawn on U.S.
banks.
<PAGE>
ABOUT YOUR ACCOUNT 13
Sale (Redemption) Conditions
10-day hold
If you sell shares that you just purchased and paid for by check or ACH
transfer, the fund will process your redemption but will generally delay
sending you the proceeds for up to 10 calendar days to allow the check or
transfer to clear. If your redemption request was sent by mail or mailgram,
proceeds will be mailed no later than the seventh calendar day following
receipt unless the check or ACH transfer has not cleared. (The 10-day hold
does not apply to the following: purchases paid for by bank wire; cashier's,
certified, or treasurer's checks; or automatic purchases through your
paycheck.)
Telephone, Tele*Access/(R)/, and personal computer transactions
Exchange and redemption services through telephone and Tele*Access are
established automatically when you sign the New Account Form unless you check
the box which states that you do not want these services. Personal computer
transactions must be authorized separately. Each fund uses reasonable
procedures (including shareholder identity verification) to confirm that
instructions given by telephone are genuine and is not liable for acting on
these instructions. If these procedures are not followed, it is the opinion
of certain regulatory agencies that a fund may be liable for any losses that
may result from acting on the instructions given. A confirmation is sent
promptly after the telephone transaction. All conversations are recorded.
Redemptions over $250,000
Large sales can adversely affect a portfolio manager's ability to implement a
fund's investment strategy by causing the premature sale of securities that
would otherwise be held. If, in any 90-day period, you redeem (sell) more
than $250,000, or your sale amounts to more than 1% of the fund's net assets,
the fund has the right to delay sending your proceeds for up to five business
days after receiving your request, or to pay the difference between the
redemption amount and the lesser of the two previously mentioned figures with
securities from the fund.
Excessive Trading
. T. Rowe Price may bar excessive traders from purchasing shares.
Frequent trades, involving either substantial fund assets or a substantial
portion of your account or accounts controlled by you, can disrupt management
of the fund and raise its expenses. We define "excessive trading" as
exceeding one purchase and sale involving the same fund within any 120-day
period.
For example, you are in fund A. You can move substantial assets from fund A
to fund B and, within the next 120 days, sell your shares in fund B to return
to fund A or move to fund C.
<PAGE>
T. ROWE PRICE 14
If you exceed the number of trades described above, you may be barred
indefinitely from further purchases of T. Rowe Price funds.
Three types of transactions are exempt from excessive trading guidelines: 1)
trades solely between money market funds; 2) redemptions that are not part of
exchanges; and 3) systematic purchases or redemptions (see Shareholder
Services).
Keeping Your Account Open
Due to the relatively high cost to the fund of maintaining small accounts, we
ask you to maintain an account balance of at least $1,000. If your balance is
below $1,000 for three months or longer, we have the right to close your
account after giving you 60 days in which to increase your balance.
Small Account Fee
Because of the disproportionately high costs of servicing accounts with low
balances, a $10 fee, paid to T. Rowe Price Services, the fund's transfer
agent, will automatically be deducted from nonretirement accounts with
balances falling below a minimum level. The valuation of accounts and the
deduction are expected to take place during the last five business days of
September. The fee will be deducted from accounts with balances below $2,000,
except for UGMA/ UTMA accounts, for which the limit is $500. The fee will be
waived for any investor whose aggregate T. Rowe Price mutual fund investments
total $25,000 or more. Accounts employing automatic investing (e.g., payroll
deduction, automatic purchase from a bank account, etc.) are also exempt from
the charge. The fee will not apply to IRAs and other retirement plan
accounts. (A separate custodial fee may apply to IRAs and other retirement
plan accounts.)
Signature Guarantees
. A signature guarantee is designed to protect you and the T. Rowe Price funds
from fraud by verifying your signature.
You may need to have your signature guaranteed in certain situations, such
as:
. Written requests 1) to redeem over $100,000, or 2) to wire redemption
proceeds.
. Remitting redemption proceeds to any person, address, or bank account not on
record.
. Transferring redemption proceeds to a T. Rowe Price fund account with a
different registration (name or ownership) from yours.
. Establishing certain services after the account is opened.
<PAGE>
ABOUT YOUR ACCOUNT 15
You can obtain a signature guarantee from most banks, savings institutions,
broker-dealers, and other guarantors acceptable to T. Rowe Price. We cannot
accept guarantees from notaries public or organizations that do not provide
reimbursement in the case of fraud.
<PAGE>
T. ROWE PRICE 16
MORE ABOUT THE FUND
3
ORGANIZATION AND MANAGEMENT
----------------------------------------------------------
How is the fund organized?
The fund was incorporated in Maryland in 1997 and is a "diversified, open-end
investment company," or mutual fund. Mutual funds pool money received from
shareholders and invest it to try to achieve specified objectives.
. Shareholders benefit from T. Rowe Price's 60 years of investment management
experience.
What is meant by "shares"?
As with all mutual funds, investors purchase shares when they put money in a
fund. These shares are part of a fund's authorized capital stock, but share
certificates are not issued.
Each share and fractional share entitles the shareholder to:
. Receive a proportional interest in a fund's income and capital gain
distributions.
. Cast one vote per share on certain fund matters, including the election of
fund directors, changes in fundamental policies, or approval of changes in
the fund's management contract.
Do T. Rowe Price funds have annual shareholder meetings?
The funds are not required to hold annual meetings and, in order to avoid
unnecessary costs to fund shareholders, do not intend to do so except when
certain matters, such as a change in a fund's fundamental policies, are to be
decided. In addition, shareholders representing at least 10% of all eligible
votes may call a special meeting, if they wish, for the purpose of voting on
the removal of any fund director or trustee. If a meeting is held and you
cannot attend, you can vote by proxy. Before the meeting, the fund will send
you proxy materials that explain the issues to be decided and include a
voting card for you to mail back.
<PAGE>
ABOUT YOUR ACCOUNT 17
Who runs the fund?
General Oversight
The fund is governed by a Board of Directors that elects the fund's officers
and meets regularly to review the fund's investments, performance, expenses,
and other business affairs. The policy of the fund is that a majority of
Board members will be independent of T. Rowe Price.
. All decisions regarding the purchase and sale of fund investments are made
by T. Rowe Price-specifically by the fund's portfolio managers.
Portfolio Management
The fund has an Investment Advisory Committee composed of the following
members: Mary J. Miller and Donald J. Peters, Co-chairpersons, Stephen W.
Boesel, William T. Reynolds, William F. Snider, William J. Stromberg, and
Arthur S. Varnado. The committee co-chairpersons have day-to-day
responsibility for managing the fund and work with the committee in
developing and executing the fund's investment program. Ms. Miller joined T.
Rowe Price in 1983 and has been managing investments since 1987. Mr. Peters
has been managing investments since joining T. Rowe Price in 1993.
Marketing
T. Rowe Price Investment Services, Inc., a wholly owned subsidiary of T. Rowe
Price, distributes (sells) shares of this and all other T. Rowe Price funds.
Shareholder Services
T. Rowe Price Services, Inc., another wholly owned subsidiary, acts as the
funds' transfer and dividend disbursing agent and provides shareholder and
administrative services. The address for T. Rowe Price Investment Services,
Inc., and T. Rowe Price Services, Inc., is 100 East Pratt St., Baltimore, MD
21202.
How are fund expenses determined?
The management agreement spells out the expenses to be paid by the fund. In
addition to the management fee, the fund pays for the following: shareholder
service expenses; custodial, accounting, legal, and audit fees; costs of
preparing and printing prospectuses and reports sent to shareholders;
registration fees and expenses; proxy and annual meeting expenses (if any);
and director/trustee fees and expenses.
. For the fiscal period ending February 28, 1998, the fund is expected to pay
the following: $260,000 to T. Rowe Price Services, Inc., for transfer and
dividend disbursing functions and shareholder services; and $60,000 to T.
Rowe Price for accounting services.
<PAGE>
T. ROWE PRICE 18
The Management Fee
This fee has two parts- an "individual fund fee" (discussed under Transaction
and Fund Expenses), which reflects a fund's particular investment management
costs, and a "group fee." The group fee, which is designed to reflect the
benefits of the shared resources of the T. Rowe Price investment management
complex, is calculated daily based on the combined net assets of all T. Rowe
Price funds (except Equity Index and the Spectrum Funds and any institutional
or private label mutual funds). The group fee schedule (shown below) is
graduated, declining as the asset total rises, so shareholders benefit from
the overall growth in mutual fund assets.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
0.480% First $1 billion 0.360% Next $2 billion 0.310% Next $16 billion
--------------------------
0.450% Next $1 billion 0.350% Next $2 billion 0.305% Next $30 billion
----------------------------------------------------
0.420% Next $1 billion 0.340% Next $5 billion 0.300% Thereafter
----------------------------------------------------
0.390% Next $1 billion 0.330% Next $10 billion
------------------------------------------------------------------------------
0.370% Next $1 billion 0.320% Next $10 billion
</TABLE>
The fund's portion of the group fee is determined by the ratio of its daily
net assets to the daily net assets of all the T. Rowe Price funds described
previously. Based on combined T. Rowe Price funds' assets of approximately
$63 billion at March 31, 1997, the group fee was 0.33%.
UNDERSTANDING PERFORMANCE INFORMATION
----------------------------------------------------------
This section should help you understand the terms used to describe fund
performance. You will come across them in shareholder reports you receive
from us, in our newsletter, The Price Report, in Insights articles, in T.
Rowe Price advertisements, and in the media.
Total Return
This tells you how much an investment in the fund has changed in value over a
given time period. It reflects any net increase or decrease in the share
price and assumes that all dividends and capital gains (if any) paid during
the period were reinvested in additional shares. Including reinvested
distributions means that total return numbers include the effect of
compounding, i.e., you receive income and capital gain distributions on a
rising number of shares.
Advertisements for the fund may include cumulative or compound average annual
total return figures, which may be compared with various indices, other
performance measures, or other mutual funds.
<PAGE>
ABOUT YOUR ACCOUNT 19
. Total return is the most widely used performance measure. Detailed
performance information is included in the fund's annual and semiannual
shareholder reports and in the quarterly Performance Update, which are all
available without charge.
Cumulative Total Return
This is the actual rate of return on an investment for a specified period. A
cumulative return does not indicate how much the value of the investment may
have fluctuated between the beginning and the end of the period specified.
Average Annual Total Return
This is always hypothetical. Working backward from the actual cumulative
return, it tells you what constant year-by-year return would have produced
the actual cumulative return. By smoothing out all the variations in annual
performance, it gives you an idea of the investment's annual contribution to
your portfolio provided you held it for the entire period in question.
INVESTMENT POLICIES AND PRACTICES
----------------------------------------------------------
This section takes a detailed look at some of the types of securities the
fund may hold in its portfolio and the various kinds of investment practices
that may be used in day-to-day portfolio management. The fund's investment
program is subject to further restrictions and risks described in the
Statement of Additional Information.
Shareholder approval is required to substantively change the fund's objective
and certain investment restrictions noted in the following section as
"fundamental policies." The managers also follow certain "operating
policies," which can be changed without shareholder approval. However,
significant changes are discussed with shareholders in fund reports. The fund
adheres to applicable investment restrictions and policies at the time it
makes an investment. A later change in circumstances will not require the
sale of an investment if it was proper at the time it was made.
The fund's holdings of certain kinds of investments cannot exceed maximum
percentages of total assets, which are set forth herein. For instance, this
fund is not permitted to invest more than 10% of total equity assets in
hybrid instruments. While these restrictions provide a useful level of detail
about the fund's investment program, investors should not view them as an
accurate gauge of the potential risk of such investments. For example, in a
given period, a 5% investment in hybrid instruments could have significantly
more of an
<PAGE>
T. ROWE PRICE 20
impact on the fund's share price than its weighting in the portfolio. The net
effect of a particular investment depends on its volatility and the size of
its overall return in relation to the performance of all the fund's other
investments.
Changes in the fund's holdings, the fund's performance, and the contribution
of various investments are discussed in the shareholder reports sent to you.
. Fund managers have considerable leeway in choosing investment strategies and
selecting securities they believe will help the fund achieve its objective.
Types of Portfolio Securities
In seeking to meet its investment objective, the fund may invest in any type
of security or instrument (including certain potentially high-risk
derivatives described in this section) whose investment characteristics are
consistent with the fund's investment program. The following pages describe
the principal types of portfolio securities and investment management
practices of the fund.
Fundamental policy The fund will not purchase a security if, as a result,
with respect to 75% of its total assets, more than 5% of its total assets
would be invested in securities of a single issuer or if more than 10% of the
voting securities of the issuer would be held by the fund; provided that
these limitations do not apply to the fund's purchase of securities issued or
guaranteed by the U.S. government, its agencies, or instrumentalities.
The municipal portion of the fund's portfolio can include the following types
of securities:
Municipal Securities
The fund's municipal assets are invested primarily in various tax-free
municipal debt securities. The issuers have a contractual obligation to pay
interest at a stated rate on specific dates and to repay principal (the
bond's face value) on a specified date or dates. An issuer may have the right
to redeem or "call" a bond before maturity, and the investor may have to
reinvest the proceeds at lower rates.
There are two broad categories of municipal bonds. General obligation bonds
are backed by the issuer's "full faith and credit," that is, its full taxing
and revenue raising power. Revenue bonds usually rely exclusively on a
specific revenue source, such as charges for water and sewer service, to
generate money for debt service.
. In purchasing municipals, the fund relies on the opinion of the issuer's
bond counsel regarding the tax-exempt status of the investment.
In addition to general obligation and revenue bonds, the fund's municipal
investments may include, but are not limited to, the following types of
securities:
<PAGE>
MORE ABOUT THE FUND 21
Municipal Lease Obligations
A lease is not a full faith and credit obligation of the issuer and is
usually backed only by the borrowing government's unsecured pledge to make
annual appropriation for lease payments. There have been challenges to the
legality of lease financing in numerous states and, from time to time,
certain municipalities have considered not appropriating money for lease
payments. In deciding whether to purchase a lease obligation, the fund would
assess the financial condition of the borrower, the merits of the project,
the level of public support for the project, and the legislative history of
lease financing in the state. These securities may be less readily marketable
than other municipals. The fund may also purchase unrated lease obligations.
Municipal Warrants
Municipal warrants are essentially call options on municipal bonds. In
exchange for a premium, they give the purchaser the right, but not the
obligation, to purchase a municipal bond in the future. The fund might
purchase a warrant to lock in forward supply in an environment where the
current issuance of bonds is sharply reduced. Like options, warrants may
expire worthless and they may have reduced liquidity.
Operating policy The fund will not invest more than 2% of its total municipal
assets in municipal warrants.
Securities With "Puts" or Other Demand Features
Some longer-term municipals give the investor the right to "put" or sell the
security at par (face value) within a specified number of days following the
investor's request-usually one to seven days. This demand feature enhances a
security's liquidity by dramatically shortening its effective maturity and
enables it to trade at a price equal to or very close to par. If a demand
feature terminates prior to being exercised, the fund would hold the
longer-term security, which could experience substantially more volatility.
Securities With Credit Enhancements
. Letters of credit Letters of credit are issued by a third party, usually a
bank, to enhance liquidity and ensure repayment of principal and any accrued
interest if the underlying municipal security should default.
. T. Rowe Price periodically reviews the credit quality of the insurer.
. Municipal Bond Insurance This insurance, which is usually purchased by the
bond issuer from a private, nongovernmental insurance company, provides an
unconditional and irrevocable guarantee that the insured bond's principal and
interest will be paid when due. Insurance does not guarantee the price of the
bond or the share price of any fund. The credit rating of an insured bond
reflects the credit rating of the insurer, based on its claims-paying
ability.
<PAGE>
T. ROWE PRICE 22
The obligation of a municipal bond insurance company to pay a claim extends
over the life of each insured bond. Although defaults on insured municipal
bonds have been low to date and municipal bond insurers have met their
claims, there is no assurance this will continue. A higher than expected
default rate could strain the insurer's loss reserves and adversely affect
its ability to pay claims to bondholders, such as the fund. The number of
municipal bond insurers is relatively small, and not all of them have the
highest rating.
. Standby Purchase Agreements A Standby Bond Purchase Agreement (SBPA) is a
liquidity facility provided to pay the purchase price of bonds that cannot be
remarketed. The obligation of the liquidity provider (usually a bank) is only
to advance funds to purchase tendered bonds that cannot be remarketed and
does not cover principal or interest under any other circumstances. The
liquidity provider's obligations under the SBPA are usually subject to
numerous conditions, including the continued creditworthiness of the
underlying borrower.
Synthetic or Derivative Securities
These securities are created from existing municipal bonds:
. Residual Interest Bonds (These are a type of potentially high-risk
derivative.) The income stream provided by an underlying bond is divided to
create two securities, one short term and one long term. The interest rate on
the short-term component is reset by an index or auction process normally
every seven to 35 days. After income is paid on the short-term securities at
current rates, the residual income goes to the long-term securities.
Therefore, rising short-term interest rates result in lower income for the
longer-term portion, and vice versa. The longer-term bonds can be very
volatile and may be less liquid than other municipals of comparable maturity.
Operating policy The fund will not invest more than 10% of its total
municipal assets in residual interest bonds.
. Participation Interests This term covers various types of securities created
by converting fixed rate bonds into short-term, variable rate certificates.
These securities have been developed in the secondary market to meet the
demand for short-term, tax-exempt securities. The fund will invest only in
securities deemed tax-exempt by a nationally recognized bond counsel, but
there is no guarantee the interest will be exempt because the IRS has not
issued a definitive ruling on the matter.
. Embedded Interest Rate Swaps and Caps In a fixed rate, long-term municipal
bond with an interest rate swap attached to it, the bondholder usually
receives the bond's fixed coupon payment as well as a variable rate payment
that represents the difference between a fixed rate for the term of the swap
(which is typically shorter than the bond it is attached to) and a variable
rate short-term municipal index. The bondholder receives excess income when
short-term rates remain below the fixed interest rate swap rate. If
short-term rates rise above the
<PAGE>
MORE ABOUT THE FUND 23
fixed income swap rate, the bondholder's income is reduced. At the end of the
interest rate swap term, the bond reverts to a single fixed coupon payment.
An embedded interest rate cap allows the bondholder to receive payments
whenever short-term rates rise above a level established at the time of
purchase. They normally are used to hedge against rising short-term interest
rates.
Both instruments may be volatile and of limited liquidity, and their use may
adversely affect the fund's total return.
Operating policy The fund will not invest more than 10% of its total
municipal assets in embedded interest rate swaps and caps.
High-Yield/High-Risk Investing
The total return and yield of lower-quality (high-yield/high-risk) bonds,
commonly referred to as "junk", can be expected to fluctuate more than the
total return and yield of higher-quality bonds. Junk bonds (those rated below
BBB or in default) are regarded as predominantly speculative with respect to
the issuer's ability to meet principal and interest payments. Successful
investment in lower-medium- and low-quality bonds involves greater investment
risk and is highly dependent on T. Rowe Price's credit analysis. A real or
perceived economic downturn or rising interest rates could cause a decline in
high-yield bond prices, by lessening the ability of issuers to make principal
and interest payments. These bonds are often thinly traded and can be more
difficult to sell and value accurately than high-quality bonds. Because
objective pricing data may be less available, judgment may play a greater
role in the valuation process.
Operating policy The fund will not purchase a noninvestment-grade debt
security (or junk bond) if immediately after such purchase the fund would
have more than 10% of its total municipal assets invested in such securities.
The fund's investments in convertible securities are not subject to this
limit.
Credit-Quality Considerations
The credit quality of most bond issues is evaluated by rating agencies such
as Moody's and Standard & Poor's. Credit quality refers to the issuer's
ability to meet all required interest and principal payments. The highest
ratings are assigned to issuers perceived to be the best credit risks. T.
Rowe Price research analysts also evaluate all portfolio holdings of each
fund, including those rated by outside agencies. The lower the rating on a
bond, the higher the yield, other things being equal.
<PAGE>
T. ROWE PRICE 24
The equity portion of the fund's portfolio can include the following types of
securities:
Common and Preferred Stocks
Stocks represent shares of ownership in a company. Generally, preferred stock
has a specified dividend and ranks after bonds and before common stocks in
its claim on income for dividend payments and on assets should the company be
liquidated. After other claims are satisfied, common stockholders participate
in company profits on a pro-rata basis; profits may be paid out in dividends
or reinvested in the company to help it grow. Increases and decreases in
earnings are usually reflected in a company's stock price, so common stocks
generally have the greatest appreciation and depreciation potential of all
corporate securities. While most preferred stocks pay a dividend, the fund
may purchase preferred stock where the issuer has omitted, or is in danger of
omitting, payment of its dividend. Such investments would be made primarily
for their capital appreciation potential.
Convertible Securities and Warrants
The fund may invest in debt or preferred equity securities convertible into
or exchangeable for equity securities. Traditionally, convertible securities
have paid dividends or interest at rates higher than common stocks but lower
than nonconvertible securities. They generally participate in the
appreciation or depreciation of the underlying stock into which they are
convertible, but to a lesser degree. In recent years, convertibles have been
developed which combine higher or lower current income with options and other
features. Warrants are options to buy a stated number of shares of common
stock at a specified price anytime during the life of the warrants
(generally, two or more years).
Foreign Securities
The fund may invest a portion of its equity portfolio in foreign securities.
These include nondollar-denominated securities traded outside of the U.S. and
dollar-denominated securities of foreign issuers traded in the U.S. (such as
ADRs). Such investments increase a portfolio's diversification and may
enhance return, but they also involve some special risks, such as exposure to
potentially adverse local political and economic developments;
nationalization and exchange controls; potentially lower liquidity and higher
volatility; possible problems arising from accounting, disclosure,
settlement, and regulatory practices that differ from U.S. standards; and the
chance that fluctuations in foreign exchange rates will decrease the
investment's value (favorable changes can increase its value). These risks
are heightened for investments in developing countries, and there is no limit
on the amount of the fund's foreign investments that may be made in such
countries.
Operating policy The fund may invest up to 25% of its total equity assets
(excluding reserves) in foreign securities.
<PAGE>
MORE ABOUT THE FUND 25
Hybrid Instruments
These instruments (a type of potentially high-risk derivative) can combine
the characteristics of securities, futures, and options. For example, the
principal amount, redemption, or conversion terms of a security could be
related to the market price of some commodity, currency, or securities index.
Such securities may bear interest or pay dividends at below market (or even
relatively nominal) rates. Under certain conditions, the redemption value of
such an investment could be zero.
. Hybrids can have volatile prices and limited liquidity, and their use by the
fund may not be successful.
Operating policy The fund may invest up to 10% of its total equity assets in
hybrid instruments.
The municipal and equity portions of the fund's portfolio may contain the
following:
Private Placements
These securities are sold directly to a small number of investors, usually
institutions. Although certain of these securities may be readily sold, for
example, under Rule 144A, others may be illiquid, and their sale may involve
substantial delays and additional costs.
Operating policy The fund will not invest more than 15% of its net assets in
illiquid securities.
Types of Management Practices
Cash Position
The fund expects that its cash position will be invested primarily in
short-term tax-exempt money market securities although it may hold U.S. and
foreign dollar-denominated taxable money market securities, including
repurchase agreements as well. All such securities will be in the two highest
rating categories, maturing in one year or less. Some of the tax-exempt
securities may have adjustable, variable, or floating rates. For temporary,
defensive purposes, the fund may invest without limitation in money market
securities. This reserve position provides flexibility in meeting
redemptions, expenses, and the timing of new investments; helps in
structuring the fund's weighted average maturity; and serves as a short-term
defense during periods of unusual market volatility.
Borrowing Money and Transferring Assets
The fund can borrow money from banks as a temporary measure for emergency
purposes, to facilitate redemption requests, or for other purposes consistent
with the fund's investment objective and program. Such borrowings may be
collateralized with fund assets, subject to restrictions.
<PAGE>
T. ROWE PRICE 26
Fundamental policy Borrowings may not exceed 33/1//\\/3/\\% of total fund
assets.
Operating policies The fund may not transfer as collateral any portfolio
securities except as necessary in connection with permissible borrowings or
investments, and then such transfers may not exceed 33/1//\\/3/\\% of the
fund's total assets. The fund may not purchase additional securities when
borrowings exceed 5% of total assets.
When-Issued Securities and Forwards
New issues of municipals are often sold on a "when-issued" basis, that is,
delivery and payment take place 15-45 days after the buyer has agreed to the
purchase. Some bonds, called "forwards," have longer than standard settlement
dates, typically six to 24 months. When buying these securities, the fund
will maintain cash or high-grade marketable securities held by its custodian
equal in value to its commitment for these securities. The fund does not earn
interest on when-issued and forward securities until settlement, and the
value of the securities may fluctuate between purchase and settlement.
Municipal "forwards" typically carry a substantial yield premium to
compensate the buyer for their greater interest rate, credit, and liquidity
risks.
Futures and Options
Futures (a type of potentially high-risk derivative) are often used to manage
or hedge risk because they enable the investor to buy or sell an asset in the
future at an agreed upon price. Options (another type of potentially
high-risk derivative) give the investor the right, but not the obligation, to
buy or sell an asset at a predetermined price in the future. The fund may buy
and sell futures and options contracts for any number of reasons, including:
to hedge against a potentially unfavorable change in interest rates; to
adjust portfolio duration; to manage its exposure to changes in securities
prices and foreign currencies; as an efficient means of adjusting its overall
exposure to certain markets; in an effort to enhance income; and to protect
the value of portfolio securities. The fund may purchase, sell, or write call
and put options on securities, financial indices, and foreign currencies.
Futures contracts and options may not always be successful hedges; their
prices can be highly volatile. Using them could lower the fund's total
return, and the potential loss from the use of futures can exceed the fund's
initial exposure to such contracts.
Operating policies Futures: Initial margin deposits and premiums on options
used for non-hedging purposes will not equal more than 5% of the fund's net
asset value. Options on securities: The total market value of securities
against which the fund has written call or put options may not exceed 25% of
its total assets. The fund will not commit more than 5% of its total assets
to premiums when purchasing call or put options.
<PAGE>
MORE ABOUT THE FUND 27
Managing Foreign Currency Risk
Investors in foreign securities may "hedge" their exposure to potentially
unfavorable currency changes by purchasing a contract to exchange one
currency for another on some future date at a specified exchange rate. In
certain circumstances, a "proxy currency" may be substituted for the currency
in which the investment is denominated, a strategy known as "proxy hedging."
Although foreign currency transactions will be used primarily to protect the
fund's foreign securities from adverse currency movements relative to the
dollar, they involve the risk that anticipated currency movements will not
occur and the fund's total return could be reduced.
Lending of Portfolio Securities
Like other mutual funds, the fund may lend securities to broker-dealers,
other institutions, or other persons to earn additional income. The principal
risk is the potential insolvency of the broker-dealer or other borrower. In
this event, the fund could experience delays in recovering its securities and
possibly capital losses.
Fundamental policy The value of loaned securities may not exceed
33/1//\\/3/\\% of total fund assets.
Portfolio Turnover
The fund will not generally trade in securities for short-term profits, but,
when circumstances warrant, securities may be purchased and sold without
regard to the length of time held. A high turnover rate may increase
transaction costs resulting in additional taxable gains paid by shareholders.
The fund's portfolio turnover rate is expected to be lower in rising markets
and higher in declining markets. The portfolio turnover rate for the portion
of the fund invested in stocks during fund's initial period of operations is
not expected to exceed 100%, but could if deemed prudent by the portfolio
managers in order to carry out the fund's objective of minimizing taxable
income.
<PAGE>
T. ROWE PRICE 28
INVESTING WITH T. ROWE PRICE
4
ACCOUNT REQUIREMENTS AND TRANSACTION INFORMATION
----------------------------------------------------------
Tax Identification Number
We must have your correct Social Security or corporate tax identification number
on a signed New Account Form or W-9 Form. Otherwise, federal law requires the
funds to withhold a percentage (currently 31%) of your dividends, capital gain
distributions, and redemptions, and may subject you to an IRS fine. If this
information is not received within 60 days after your account is established,
your account may be redeemed, priced at the NAV on the date of redemption.
Always verify your transactions by carefully reviewing the confirmation we send
you. Please report any discrepancies to Shareholder Services promptly.
Institutional Accounts
Transaction procedures in the following sections may not apply to institutional
accounts. For procedures regarding institutional accounts, please call your
designated account manager or service representative.
OPENING A NEW ACCOUNT
----------------------------------------------------------
$2,500 minimum initial investment; $1,000 for gifts or transfers to minors
(UGMA/UTMA) accounts
Account Registration
If you own other T. Rowe Price funds, be sure to register any new account just
like your existing accounts so you can exchange among them easily. (The name and
account type would have to be identical.)
By Mail
Please make your check payable to T. Rowe Price Funds (otherwise it will be
returned) and send your check together with the New Account Form to the
appropriate address on the next page. We do not accept third party checks to
open new accounts.
<PAGE>
MORE ABOUT THE FUND 29
Regular Mail
T. Rowe Price Account Services P.O. Box 17300 Baltimore, MD 21298-9353
Mailgram, Express, Registered, or Certified Mail
T. Rowe Price Account Services 10090 Red Run Blvd. Owings Mills, MD 21117
By Wire
Call Investor Services for an account number and give the following wire
information to your bank:
PNC Bank, N.A. (Pittsburgh) ABA# 043000096 T. Rowe Price [fund name] Account#
1004397951 account name and account number
Complete a New Account Form and mail it to one of the appropriate addresses
listed above.
Note: No services will be established and IRS penalty withholding may occur
until a signed New Account Form is received.
By Exchange
Call Shareholder Services or use Tele*Access or your personal computer (see
Automated Services under Shareholder Services). The new account will have the
same registration as the account from which you are exchanging. Services for the
new account may be carried over by telephone request if preauthorized on the
existing account. For limitations on exchanging, see explanation of Excessive
Trading under Transaction Procedures and Special Requirements.
In Person
Drop off your New Account Form at any location listed on the cover and obtain a
receipt.
<PAGE>
T. ROWE PRICE 30
PURCHASING ADDITIONAL SHARES
----------------------------------------------------------
$100 minimum purchase; $50 minimum for Automatic Asset Builder, and gifts or
transfers to minors (UGMA/ UTMA) accounts
By ACH Transfer
Use Tele*Access, your personal computer, or call Investor Services if you have
established electronic transfers using the ACH network.
By Wire
Call Shareholder Services or use the wire address in Opening a New Account.
By Mail
1. Make your check payable to T. Rowe Price Funds (otherwise it may be
returned).
2. Mail the check to us at the address shown below with either a fund
reinvestment slip or a note indicating the fund you want to buy and your fund
account number.
3. Remember to provide your account number and the fund name on the memo line of
your check.
Regular Mail
T. Rowe Price Funds Account Services P.O. Box 89000 Baltimore, MD 21289-1500
/(For mailgrams, express, registered, or certified mail, see / /previous
section.)/
By Automatic Asset Builder
Fill out the Automatic Asset Builder section on the New Account or Shareholder
Services Form.
EXCHANGING AND REDEEMING SHARES
----------------------------------------------------------
By Phone
Call Shareholder Services
If you find our phones busy during unusually volatile markets, please consider
placing your order by your personal computer, Tele*Access (if you have
previously authorized telephone services), mailgram, or express mail. For
exchange policies, please see Transaction Procedures and Special Requirements
- -Excessive Trading.
<PAGE>
INVESTING WITH T. ROWE PRICE 31
Redemption proceeds can be mailed to your account address, sent by ACH transfer,
or wired to your bank (provided your bank information is already on file). For
charges, see Electronic Transfers -By Wire under Shareholder Services.
By Mail
For each account involved, provide the account name, number, fund name, and
exchange or redemption amount. For exchanges, be sure to indicate any fund you
are exchanging out of and the fund or funds you are exchanging into. Please mail
to the appropriate address below. T. Rowe Price requires the signatures of all
owners exactly as registered, and possibly a signature guarantee (see
Transaction Procedures and Special Requirements-Signature Guarantees).
Regular Mail
T. Rowe Price Account Services P.O. Box 89000 Baltimore, MD 21289-0220
Mailgram, Express, Registered, or Certified Mail
T. Rowe Price Account Services 10090 Red Run Boulevard Owings Mills, MD 21117
Rights Reserved by the Fund
The fund and its agents reserve the right to waive or lower investment minimums;
to accept initial purchases by telephone or mailgram; to refuse any purchase
order; to cancel or rescind any purchase or exchange (for example, if an account
has been restricted due to excessive trading or fraud) upon notice to the
shareholder within five business days of the trade or if the written
confirmation has not been received by the shareholder, whichever is sooner; to
freeze any account and suspend account services when notice has been received of
a dispute between the registered or beneficial account owners or there is reason
to believe a fraudulent transaction may occur; to otherwise modify the
conditions of purchase and any services at any time; or to act on instructions
believed to be genuine.
<PAGE>
T. ROWE PRICE 32
SHAREHOLDER SERVICES
----------------------------------------------------------
Shareholder Services 1-800-225-5132 1-410-625-6500 Investor Services
1-800-638-5660 1-410-547-2308
Many services are available to you as a T. Rowe Price shareholder; some you
receive automatically, and others you must authorize on the New Account Form. By
signing up for services on the New Account Form rather than later on, you avoid
having to complete a separate form and obtain a signature guarantee. This
section reviews some of the principal services currently offered. Our Services
Guide contains detailed descriptions of these and other services.
If you are a new T. Rowe Price investor, you will receive a Services Guide with
our Welcome Kit.
Note: Corporate and other institutional accounts require an original or
certified resolution to establish services and to redeem by mail. For more
information, call Investor Services.
Retirement Plans
We offer a wide range of plans for individuals, institutions, and large and
small businesses: IRAs, SIMPLE IRAs, SEP-IRAs, Keoghs (profit sharing, money
purchase pension), 401(k), and 403(b)(7). For information on IRAs, call Investor
Services. For information on all other retirement plans, including our no-load
variable annuity, please call our Trust Company at 1-800-492-7670.
Exchange Service
You can move money from one account to an existing identically registered
account, or open a new identically registered account. Remember, exchanges are
purchases and sales for tax purposes. (Exchanges into a state tax-free fund are
limited to investors living in states where the funds are registered.) Some of
the T. Rowe Price funds may impose a redemption fee of 0.5% to 2% on shares held
for less than six months or one year, as specified in the prospectus. The fee is
paid to the fund.
Automated Services Tele*Access 1-800-638-2587 24 hours, 7 days
Tele*Access
24-hour service via toll-free number enables you to (1) access information on
fund yields, prices, distributions, account balances, and your latest
transaction; (2) request checks, prospectuses, services forms, dupli-
<PAGE>
INVESTING WITH T. ROWE PRICE 33
cate statements, and tax forms; and (3) initiate purchase, redemption, and
exchange transactions in your accounts (see Electronic Transfers on the next
page).
T. Rowe Price OnLine
24-hour service via dial-up modem provides the same services as Tele*Access but
on a personal computer. Please call Investor Services for an information guide.
After obtaining proper authorization, account transactions may also be conducted
on the Internet.
Plan Account Line 1-800-401-3279
Plan Account Line
This 24-hour service is similar to Tele*Access, but is designed specifically to
meet the needs of retirement plan investors.
Telephone and Walk-In Services
Buy, sell, or exchange shares by calling one of our service representatives or
by visiting one of our investor center locations whose addresses are listed on
the cover.
Electronic Transfers
By ACH
With no charges to pay, you can initiate a purchase or redemption for as little
as $100 or as much as $100,000 between your bank account and fund account using
the ACH network. Enter instructions via Tele*Access or your personal computer,
or call Shareholder Services.
By Wire
Electronic transfers can be conducted via bank wire. There is currently a $5 fee
for wire redemptions under $5,000, and your bank may charge for incoming or
outgoing wire transfers regardless of size.
Checkwriting
(Not available for equity funds, or the High Yield or Emerging Markets Bond
Funds) You may write an unlimited number of free checks on any money market
fund, and most bond funds, with a minimum of $500 per check. Keep in mind,
however, that a check results in a redemption; a check written on a bond fund
will create a taxable event which you and we must report to the IRS.
Automatic Investing
($50 minimum) You can invest automatically in several different ways, including:
<PAGE>
T. ROWE PRICE 34
Automatic Asset Builder
You instruct us to move $50 or more from your bank account, or you can instruct
your employer to send all or a portion of your paycheck to the fund or funds you
designate.
Automatic Exchange
You can set up systematic investments from one fund account into another, such
as from a money fund into a stock fund.
DISCOUNT BROKERAGE
----------------------------------------------------------
This additional service gives you the opportunity to easily consolidate all of
your investments with one company. Through our discount brokerage, you can buy
and sell individual securities-stocks, bonds, options, and others - at
commission savings over full-service brokers. We also provide a wide range of
services, including:
To open an account 1-800-638-5660 For existing discount brokerage investors
1-800-225-7720
Automated telephone and on-line services
You can enter trades, access quotes, and review account information 24 hours a
day, seven days a week. Any trades executed through these programs save you an
additional 10% on commissions.
Note: Discount applies to our current commission schedule, subject to our $35
minimum commission.
Investor information
A variety of informative reports, such as our Brokerage Insights series, S&P
Market Month Newsletter, and select stock reports can help you better evaluate
economic trends and investment opportunities.
Dividend Reinvestment Service
Virtually all stocks held in customer accounts are eligible for this
service-free of charge.
/Discount Brokerage is a division of //T. Rowe Price// Investment Services, /
/Inc., Member NASD/SIPC./
<PAGE>
INVESTING WITH T. ROWE PRICE 35
INVESTMENT INFORMATION
----------------------------------------------------------
To help shareholders monitor their current investments and make decisions that
accurately reflect their financial goals, T. Rowe Price offers a wide variety of
information in addition to account statements.
Shareholder Reports
Fund managers' reviews of their strategies and results. If several members of a
household own the same fund, only one fund report is mailed to that address. To
receive additional copies, please call Shareholder Services or write to us at
100 East Pratt Street, Baltimore, Maryland 21202.
The T. Rowe Price Report
A quarterly investment newsletter discussing markets and financial strategies.
Performance Update
Quarterly review of all T. Rowe Price fund results.
Insights
Educational reports on investment strategies and financial markets.
Investment Guides
Asset Mix Worksheet, College Planning Kit, Diversifying Overseas: A T. Rowe
Price Guide to International Investing, How to Choose a Bond Fund, Personal
Strategy Planner, Retirees Financial Guide, Retirement Planning Kit, and Tax
Considerations for Investors.
<PAGE>
T. ROWE PRICE 36
To help you achieve your financial goals, T. Rowe Price offers a wide range of
stock, bond, and money market investments, as well as convenient services and
timely, informative reports.
To Open a Mutual Fund Account
Investor Services
1-800-638-5660 1-410-547-2308
For Existing Accounts
Shareholder Services
1-800-225-5132
1-410-625-6500
For Yields, Prices, Account Information, or to Conduct Transactions
Tele*Access/(R)/
1-800-638-2587 24 hours, 7 days
To Open a Discount Brokerage Account
1-800-638-5660
Internet Address
www.troweprice.com
Investor Centers
101 East Lombard St. Baltimore, MD 21202
T. Rowe Price
Financial Center
10090 Red Run Blvd.
Owings Mills, MD 21117
Farragut Square
900 17th Street, N.W.
<PAGE>
INVESTING WITH T. ROWE PRICE 37
Washington, D.C. 20006
ARCO Tower
31st Floor
515 South Flower St.
Los Angeles, CA 90071
4200 West Cypress St.
10th Floor
Tampa, FL 33607
F19-040 7/1/97
(LOGO)
<PAGE>
PAGE 2
The Statement of Additional Information for the T. Rowe Price
Tax-Efficient Balanced Fund, Inc., dated July 1, 1997.
PAGE 1
STATEMENT OF ADDITIONAL INFORMATION
T. Rowe Price Tax-Exempt Money Fund, Inc.
T. Rowe Price Tax-Free Short-Intermediate Fund, Inc.
T. Rowe Price Tax-Free Insured Intermediate Bond Fund, Inc.
T. Rowe Price Tax-Free Income Fund, Inc.
T. Rowe Price Tax-Free High Yield Fund, Inc.
T. Rowe Price Tax-Efficient Balanced Fund, Inc.
(the "Funds")
This Statement of Additional Information is not a
prospectus but should be read in conjunction with the Funds'
prospectuses dated July 1, 1997, which may be obtained from
T. Rowe Price Investment Services, Inc., 100 East Pratt Street,
Baltimore, Maryland 21202.
If you would like a prospectus for a Fund of which you
are not a shareholder, please call 1-800-638-5660. A prospectus
with more complete information, including management fees and
expenses will be sent to you. Please read it carefully.
The date of this Statement of Additional Information is
July 1, 1997.
C03-043 7/1/97
<PAGE>
PAGE 2
TABLE OF CONTENTS
Page Page
Capital Stock. . . . . . 64 Management of Funds. . . . . 41
Code of Ethics . . . . . 52 Net Asset Value Per Share. . 59
Custodian. . . . . . . . 51 Options. . . . . . . . . . . 29
Determination of Maturity Portfolio Management
of Money Market Practices . . . . . . . . . 18
Securities. . . . . . . 15 Portfolio Transactions . . . 52
Distributor for Funds. . 51 Pricing of Securities. . . . 57
Dividends and Principal Holders of
Distributions . . . . . 59 Securities. . . . . . . . . 48
Federal Registration Ratings of Commercial Paper. 40
of Shares . . . . . . . 65 Ratings of Municipal Debt
Forwards . . . . . . . . 15 Securities. . . . . . . . . 38
Futures Contracts. . . . 18 Ratings of Municipal Notes
Independent Accountants. 66 and Variable Securities . . 40
Investment Management Residual Interest Bonds. . . 12
Services. . . . . . . . 48 Risk Factors . . . . . . . . 3
Investment in Taxable Money Risk Factors of Foreign
Market Securities . . . 15 Investing . . . . . . . . . 6
Investment Objectives Shareholder Services . . . . 52
and Policies. . . . . . 2 Tax-Exempt vs. Taxable
Investment Performance . 62 Yields. . . . . . . . . . . 62
Investment Programs. . . 9 Tax Status . . . . . . . . . 59
Investment Restrictions. 35 When-Issued Securities . . . 14
Legal Counsel. . . . . . 66 Yield Information. . . . . . 61
INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the discussion of
each Fund's investment objectives and policies discussed in each
Fund's prospectus. The Funds will not make a material change in
their investment objectives without obtaining shareholder
approval. Unless otherwise specified, the investment programs
and restrictions of the Funds are not fundamental policies. Each
Fund's operating policies are subject to change by its Board of
Directors without shareholder approval. However, shareholders
will be notified of a material change in an operating policy.
Each Fund's fundamental policies may not be changed without the
approval of at least a majority of the outstanding shares of the
Fund or, if it is less, 67% of the shares represented at a
meeting of shareholders at which the holders of 50% or more of
the shares are represented.
Throughout this Statement of Additional Information,
the "Fund" is intended to refer to each Fund listed on the cover
page, unless otherwise indicated.
PAGE 3
RISK FACTORS
General
The Fund is designed for investors who, because of
their tax bracket, can benefit from investment in municipal bonds
whose income is exempt from federal taxes. The Fund is not
appropriate for qualified retirement plans where income is
already tax deferred.
Because of their investment policies, the Funds may or
may not be suitable or appropriate for all investors. The Funds
(except for the Money Fund) are not an appropriate investment for
those whose primary objective is principal stability. The value
of the portfolio securities of the Fund will fluctuate based upon
market conditions. The Tax-Efficient Balanced Fund will normally
have 40-50% of its assets in equity securities. This portion of
the Tax-Efficient Balanced Fund's assets will be subject to all
of the risks of investing in the stock market.
There can, of course, be no assurance that the Fund
will achieve its investment objective. Reference is also made to
the sections entitled "Types of Securities" and "Portfolio
Management Practices" for discussions of the risks associated
with the investments and practices described therein as they
apply to the Fund.
Municipal Securities
There can be no assurance that the Fund will achieve
its investment objectives. Yields on municipal securities are
dependent on a variety of factors, including the general
conditions of the money market and the municipal bond market, the
size of a particular offering, the maturity of the obligation,
and the rating of the issue. Municipal securities with longer
maturities tend to produce higher yields and are generally
subject to potentially greater capital appreciation and
depreciation than obligations with shorter maturities and lower
yields. The market prices of municipal securities usually vary,
depending upon available yields. An increase in interest rates
will generally reduce the value of portfolio investments, and a
decline in interest rates will generally increase the value of
portfolio investments. The ability of all the Funds to achieve
their investment objectives is also dependent on the continuing
ability of the issuers of municipal securities in which the Funds
invest to meet their obligations for the payment of interest and
principal when due. The ratings of Moody's, S&P, and Fitch
represent their opinions as to the quality of municipal
securities which they undertake to rate. Ratings are not
PAGE 4
absolute standards of quality; consequently, municipal securities
with the same maturity, coupon, and rating may have different
yields. There are variations in municipal securities, both
within a particular classification and between classifications,
depending on numerous factors. It should also be pointed out
that, unlike other types of investments, municipal securities
have traditionally not been subject to regulation by, or
registration with, the SEC, although there have been proposals
which would provide for regulation in the future.
The federal bankruptcy statutes relating to the debts
of political subdivisions and authorities of states of the United
States provide that, in certain circumstances, such subdivisions
or authorities may be authorized to initiate bankruptcy
proceedings without prior notice to or consent of creditors,
which proceedings could result in material and adverse changes in
the rights of holders of their obligations.
Proposals have been introduced in Congress to restrict
or eliminate the federal income tax exemption for interest on
municipal securities, and similar proposals may be introduced in
the future. Proposed "Flat Tax" and "Valued Added Tax" proposals
would also have the effect of eliminating the tax preference for
municipal securities. Some of the past proposals would have
applied to interest on municipal securities issued before the
date of enactment, which would have adversely affected their
value to a material degree. If such a proposal were enacted, the
availability of municipal securities for investment by the Fund
and the value of a Fund's portfolio would be affected and, in
such an event, a Fund would reevaluate its investment objectives
and policies.
Although the banks and securities dealers with which
the Fund will transact business will be banks and securities
dealers that T. Rowe Price believes to be financially sound,
there can be no assurance that they will be able to honor their
obligations to the Fund with respect to such securities.
After purchase by the Fund, a security may cease to be
rated or its rating may be reduced below the minimum required for
purchase by the Fund. For the Money Fund, the procedures set
forth in Rule 2a-7, under the Investment Company Act of 1940, may
require the prompt sale of any such security. For the other
Funds, neither event would require a sale of such security by the
Fund. However, T. Rowe Price Associates, Inc. ("T. Rowe Price")
will consider such event in its determination of whether the Fund
should continue to hold the security. To the extent that the
ratings given by Moody's Investors Service, Inc. ("Moody's"),
Standard & Poor's Corporation ("S&P"), or Fitch Investors
PAGE 5
Service, Inc. ("Fitch") may change as a result of changes in such
organizations or their rating systems, the Fund will attempt to
use comparable ratings as standards for investments in accordance
with the investment policies contained in the prospectus. When
purchasing unrated securities, T. Rowe Price, under the
supervision of the Fund's Board of Directors, determines whether
the unrated security is of a qualify comparable to that which the
Fund is allowed to purchase.
Municipal Bond Insurance. The Fund may purchase
insured bonds from time to time. The Tax-Free Insured
Intermediate Fund must purchase such bonds. Municipal bond
insurance provides an unconditional and irrevocable guarantee
that the insured bond's principal and interest will be paid when
due. The guarantee is purchased from a private, non-governmental
insurance company.
There are two types of insured securities that may be
purchased by the Fund, bonds carrying either (1) new issue
insurance or (2) secondary insurance. New issue insurance is
purchased by the issuer of a bond in order to improve the bond's
credit rating. By meeting the insurer's standards and paying an
insurance premium based on the bond's total debt service, the
issuer is able to obtain a higher credit rating for the bond.
Once purchased, municipal bond insurance cannot be cancelled, and
the protection it affords continues as long as the bonds are
outstanding and the insurer remains solvent.
The Fund may also purchase bonds which carry secondary
insurance purchased by an investor after a bond's original
issuance. Such policies insure a security for the remainder of
its term. Generally, the Fund expects that portfolio bonds
carrying secondary insurance will have been insured by a prior
investor. However, the Fund may, on occasion, purchase secondary
insurance on its own behalf.
Each of the municipal bond insurance companies has
established reserves to cover estimated losses. Both the method
of establishing these reserves and the amount of the reserves
vary from company to company. The obligation a municipal bond
insurance company may have to pay a claim extends over the life
of each insured bond. Municipal bond insurance companies are
obligated to pay a bond's interest and principal when due if the
issuing entity defaults on the insured bond. Although defaults
on insured municipal bonds have been low to date and municipal
insurers have met these claims, there is no assurance this low
rate will continue in the future. A higher than expected default
rate could deplete loss reserves and adversely affect the ability
of a municipal bond insurer to pay claims to holders of insured
bonds, such as the Fund.
PAGE 6
Money Fund
The Fund will limit its purchases of portfolio
instruments to those U.S. dollar-denominated securities which the
Fund's Board of Directors determines present minimal credit risk,
and which are Eligible Securities as defined in Rule 2a-7 under
the Investment Company Act of 1940 (1940 Act). Eligible
Securities are generally securities which have been rated (or
whose issuer has been rated or whose issuer has comparable
securities rated) in one of the two highest short-term rating
categories by nationally recognized statistical rating
organizations or, in the case of any instrument that is not so
rated, is of comparable high quality as determined by T. Rowe
Price pursuant to written guidelines established in accordance
with Rule 2a-7 under the Investment Company Act of 1940 under the
supervision of the Fund's Board of Directors. In addition, the
Funds may treat variable and floating rate instruments with
demand features as short-term securities pursuant to Rule 2a-7
under the 1940 Act.
There can be no assurance that the Money Fund will
achieve its investment objectives or be able to maintain its net
asset value per share at $1.00. The price stability and
liquidity of the Money Fund may not be equal to that of a taxable
money market fund which exclusively invests in short-term taxable
money market securities. The taxable money market is a broader
and more liquid market with a greater number of investors,
issuers, and market makers than the short-term municipal
securities market. The weighted average maturity of the Fund
varies (subject to a 90 day maximum under Rule 2a-7): the
shorter the average maturity of a portfolio, the less its price
will be impacted by interest rate fluctuations.
Bond and Balanced Funds
Because of their investment policies, the Bond and
Balanced Funds may not be suitable or appropriate for all
investors. The Funds are designed for investors who wish to
invest in non-money market funds for income, and who would
benefit, because of their tax bracket, from receiving income that
is exempt from federal income taxes. The Funds' investment
programs permit the purchase of investment grade securities that
do not meet the high quality standards of the Money Fund. Since
investors generally perceive that there are greater risks
associated with investment in lower quality securities, the
yields from such securities normally exceed those obtainable from
higher quality securities. In addition, the principal value of
long term lower-rated securities generally will fluctuate more
widely than higher quality securities. Lower quality investments
entail a higher risk of default--that is, the nonpayment of
PAGE 7
interest and principal by the issuer than higher quality
investments. The value of the portfolio securities of the Bond
Funds will fluctuate based upon market conditions. Although
these Funds seek to reduce credit risk by investing in a
diversified portfolio, such diversification does not eliminate
all risk. The Funds are also not intended to provide a vehicle
for short-term trading purposes.
Special Risks of High Yield Investing. Junk bonds are
regarded as predominantly speculative with respect to the
issuer's continuing ability to meet principal and interest
payments. Because investment in low and lower-medium quality
bonds involves greater investment risk, to the extent the Funds
invest in such bonds, achievement of their investment objectives
will be more dependent on T. Rowe Price's credit analysis than
would be the case if the Funds were investing in higher quality
bonds. High yield bonds may be more susceptible to real or
perceived adverse economic conditions than investment grade
bonds. A projection of an economic downturn, or higher interest
rates, for example, could cause a decline in high yield bond
prices because the advent of such events could lessen the ability
of highly leverage issuers to make principal and interest
payments on their debt securities. In addition, the secondary
trading market for high yield bonds may be less liquid than the
market for higher grade bonds, which can adversely affect the
ability of a Fund to dispose of its portfolio securities. Bonds
for which there is only a "thin" market can be more difficult to
value inasmuch as objective pricing data may be less available
and judgment may play a greater role in the valuation process.
Tax-Efficient Balanced Fund
Foreign Securities
The Fund may invest in U.S. dollar-denominated and non-
U.S. dollar-denominated securities of foreign issuers.
Risk Factors of Foreign Investing
There are special risks in foreign investing. Many of
the risks are more pronounced for investments in developing or
emerging countries, such as many of the countries of Southeast
Asia, Latin America, Eastern Europe and the Middle East.
Although there is no universally accepted definition, a
developing country is generally considered to be a country which
is in the initial stages of its industrialization cycle with a
per capita gross national product of less than $8,000.
Political and Economic Factors. Individual foreign
economies of certain countries may differ favorably or
PAGE 8
unfavorably from the United States' economy in such respects as
growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments
position. The internal politics of certain foreign countries are
not as stable as in the United States. For example, in 1991, the
existing government in Thailand was overthrown in a military
coup. In 1992, there were two military coup attempts in
Venezuela and in 1992 the President of Brazil was impeached. In
addition, significant external political risks currently affect
some foreign countries. Both Taiwan and China still claim
sovereignty of one another and there is a demilitarized border
between North and South Korea.
Governments in certain foreign countries continue to
participate to a significant degree, through ownership interest
or regulation, in their respective economies. Action by these
governments could have a significant effect on market prices of
securities and payment of dividends. The economies of many
foreign countries are heavily dependent upon international trade
and are accordingly affected by protective trade barriers and
economic conditions of their trading partners. The enactment by
these trading partners of protectionist trade legislation could
have a significant adverse effect upon the securities markets of
such countries.
Currency Fluctuations. The Fund may invest in
securities denominated in various currencies. Accordingly, a
change in the value of any such currency against the U.S. dollar
will result in a corresponding change in the U.S. dollar value of
the Fund's assets denominated in that currency. Such changes
will also affect the Fund's income. Generally, when a given
currency appreciates against the dollar (the dollar weakens) the
value of the Fund's securities denominated in that currency will
rise. When a given currency depreciates against the dollar (the
dollar strengthens) the value of the Funds' securities
denominated in that currency would be expected to decline.
Investment and Repatriation of Restrictions. Foreign
investment in the securities markets of certain foreign countries
is restricted or controlled in varying degrees. These
restrictions may limit at times and preclude investment in
certain of such countries and may increase the cost and expenses
of the Fund. Investments by foreign investors are subject to a
variety of restrictions in many developing countries. These
restrictions may take the form of prior governmental approval,
limits on the amount or type of securities held by foreigners,
and limits on the types of companies in which foreigners may
invest. Additional or different restrictions may be imposed at
any time by these or other countries in which the Funds invest.
In addition, the repatriation of both investment income and
PAGE 9
capital from several foreign countries is restricted and
controlled under certain regulations, including in some cases the
need for certain government consents. For example, capital
invested in Chile normally cannot be repatriated for one year.
Market Characteristics. It is contemplated that most
foreign securities will be purchased in over-the-counter markets
or on stock exchanges located in the countries in which the
respective principal offices of the issuers of the various
securities are located, if that is the best available market.
Investments in certain markets may be made through ADRs traded in
the United States. Foreign stock markets are generally not as
developed or efficient as, and may be more volatile than, those
in the United States. While growing in volume, they usually have
substantially less volume than U.S. markets and the Fund's
portfolio securities may be less liquid and subject to more rapid
and erratic price movements than securities of comparable U.S.
companies. Equity securities may trade at price/earnings
multiples higher than comparable United States securities and
such levels may not be sustainable. Fixed commissions on foreign
stock exchanges are generally higher than negotiated commissions
on United States exchanges, although the Funds will endeavor to
achieve the most favorable net results on their portfolio
transactions. There is generally less government supervision and
regulation of foreign stock exchanges, brokers and listed
companies than in the United States. Moreover, settlement
practices for transactions in foreign markets may differ from
those in United States markets. Such differences may include
delays beyond periods customary in the United States and
practices, such as delivery of securities prior to receipt of
payment, which increase the likelihood of a "failed settlement."
Failed settlements can result in losses to a Fund.
Investment Funds. The Fund may invest in investment
funds which have been authorized by the governments of certain
countries specifically to permit foreign investment in securities
of companies listed and traded on the stock exchanges in these
respective countries. If the Fund invests in such investment
funds, the Fund's shareholders will bear not only their
proportionate share of the expenses of the Fund (including
operating expenses and the fees of the investment manager), but
also will bear indirectly similar expenses of the underlying
investment funds. In addition, the securities of these
investment funds may trade at a premium over their net asset
value.
Information and Supervision. There is generally less
publicly available information about foreign companies comparable
to reports and ratings that are published about companies in the
United States. Foreign companies are also generally not subject
PAGE 10
to uniform accounting, auditing and financial reporting
standards, practices and requirements comparable to those
applicable to United States companies. It also may be more
difficult to keep currently informed of corporate actions which
affect the prices of portfolio securities.
Taxes. The dividends and interest payable on certain
of the Fund's foreign portfolio securities may be subject to
foreign withholding taxes, thus reducing the net amount of income
available for distribution to the Fund's shareholders.
Other. With respect to certain foreign countries,
especially developing and emerging ones, there is the possibility
of adverse changes in investment or exchange control regulations,
expropriation or confiscatory taxation, limitations on the
removal of funds or other assets of the Funds, political or
social instability, or diplomatic developments which could affect
investments by U.S. persons in those countries.
Eastern Europe and Russia. Changes occurring in
Eastern Europe and Russia today could have long-term potential
consequences. As restrictions fall, this could result in rising
standards of living, lower manufacturing costs, growing consumer
spending, and substantial economic growth. However, investment
in the countries of Eastern Europe and Russia is highly
speculative at this time. Political and economic reforms are too
recent to establish a definite trend away from centrally-planned
economies and state owned industries. In many of the countries
of Eastern Europe and Russia, there is no stock exchange or
formal market for securities. Such countries may also have
government exchange controls, currencies with no recognizable
market value relative to the established currencies of western
market economies, little or no experience in trading in
securities, no financial reporting standards, a lack of a banking
and securities infrastructure to handle such trading, and a legal
tradition which does not recognize rights in private property.
In addition, these countries may have national policies which
restrict investments in companies deemed sensitive to the
country's national interest. Further, the governments in such
countries may require governmental or quasi-governmental
authorities to act as custodian of the Fund's assets invested in
such countries and these authorities may not qualify as a foreign
custodian under the Investment Company Act of 1940 and exemptive
relief from such Act may be required. All of these
considerations are among the factors which could cause
significant risks and uncertainties to investment in Eastern
Europe and Russia. The Fund will only invest in a company
located in, or a government of, Eastern Europe and Russia, if it
believes the potential return justifies the risk. To the extent
<PAGE>
PAGE 11
any securities issued by companies in Eastern Europe and Russia
are considered illiquid, the Fund will be required to include
such securities within its 15% restriction on investing in
illiquid securities.
Latin America
Inflation. Most Latin American countries have
experienced, at one time or another, severe and persistent levels
of inflation, including, in some cases, hyperinflation. This
has, in turn, led to high interest rates, extreme measures by
governments to keep inflation in check and a generally
debilitating effect on economic growth. Although inflation in
many countries has lessened, there is no guarantee it will remain
at lower levels.
Political Instability. The political history of
certain Latin American countries has been characterized by
political uncertainty, intervention by the military in civilian
and economic spheres, and political corruption. Such
developments, if they were to reoccur, could reverse favorable
trends toward market and economic reform, privatization and
removal of trade barriers and result in significant disruption in
securities markets.
Foreign Currency. Certain Latin American countries may
have managed currencies which are maintained at artificial levels
to the U.S. dollar rather than at levels determined by the
market. This type of system can lead to sudden and large
adjustments in the currency which, in turn, can have a disruptive
and negative effect on foreign investors. For example, in late
1994 the value of the Mexican peso lost more than one-third of
its value relative to the dollar. Certain Latin American
countries also may restrict the free conversion of their currency
into foreign currencies, including the U.S. dollar. There is no
significant foreign exchange market for certain currencies and
it would, as a result, be difficult for the Fund to engage in
foreign currency transactions designed to protect the value of
the Fund's interests in securities denominated in such
currencies.
Sovereign Debt. A number of Latin American countries
are among the largest debtors of developing countries. There
have been moratoria on, and reschedulings of, repayment with
respect to these debts. Such events can restrict the flexibility
of these debtor nations in the international markets and result
in the imposition of onerous conditions on their economies.
PAGE 12
INVESTMENT PROGRAMS
Type of Securities
Set forth below is additional information about certain
of the investments described in the Fund's prospectus.
Municipal Securities
Subject to the investment objectives and programs
described in the prospectus and the additional investment
restrictions described in this Statement of Additional
Information, the Fund's portfolio may consist of any combination
of the various types of municipal securities described below or
other types of municipal securities that may be developed. The
amount of the Fund's assets invested in any particular type of
municipal security can be expected to vary.
The term "municipal securities" means obligations
issued by or on behalf of states, territories, and possessions of
the United States and the District of Columbia and their
political subdivisions, agencies and instrumentalities, as well
as certain other persons and entities, the interest from which is
exempt from federal income tax. In determining the tax-exempt
status of a municipal security, the Fund relies on the opinion of
the issuer's bond counsel at the time of the issuance of the
security. However, it is possible this opinion could be
overturned, and as a result, the interest received by the Fund
from such a security might not be exempt from federal income tax.
Municipal securities are classified by maturity as notes, bonds,
or adjustable rate securities.
Municipal Notes. Municipal notes generally are used to
provide for short-term operating or capital needs and generally
have maturities of one year or less. Municipal notes include the
following:
Tax Anticipation Notes. Tax anticipation notes are
issued to finance working capital needs of
municipalities. Generally, they are issued in
anticipation of various seasonal tax revenue, such as
income, property, use and business taxes, and are
payable from these specific future taxes.
Revenue Anticipation Notes. Revenue anticipation notes
are issued in expectation of receipt of other types of
revenue, such as federal or state revenues available
under the revenue sharing or grant programs.
PAGE 13
Bond Anticipation Notes. Bond anticipation notes are
issued to provide interim financing until long-term
financing can be arranged. In most cases, the
long-term bonds then provide the money for the
repayment of the notes.
Tax-Exempt Commercial Paper. Tax-exempt commercial
paper is a short-term obligation with a stated maturity
of 270 days or less. It is issued by state and local
governments or their agencies to finance seasonal
working capital needs or as short-term financing in
anticipation of longer term financing.
Municipal Bonds. Municipal bonds, which meet longer
term capital needs and generally have maturities of
more than one year when issued, have two principal
classifications: general obligation bonds and revenue
bonds. Two additional categories of potential
purchases are lease revenue bonds and pre-
refunded/escrowed to maturity bonds. Another type of
municipal bond is referred to as an Industrial
Development Bond.
General Obligation Bonds. Issuers of general
obligation bonds include states, counties, cities,
towns, and special districts. The proceeds of these
obligations are used to fund a wide range of public
projects, including construction or improvement of
schools, public buildings, highways and roads, and
general projects not supported by user fees or
specifically identified revenues. The basic security
behind general obligation bonds is the issuer's pledge
of its full faith and credit and taxing power for the
payment of principal and interest. The taxes that can
be levied for the payment of debt service may be
limited or unlimited as to the rate or amount of
special assessments. In many cases voter approval is
required before an issuer may sell this type of bond.
Revenue Bonds. The principal security for a revenue
bond is generally the net revenues derived from a
particular facility, or enterprise, or in some cases,
the proceeds of a special charge or other pledged
revenue source. Revenue bonds are issued to finance a
wide variety of capital projects including: electric,
gas, water and sewer systems; highways, bridges, and
tunnels; port and airport facilities; colleges and
universities; and hospitals. Revenue bonds are
sometimes used to finance various privately operated
PAGE 14
facilities provided they meet certain tests established
for tax-exempt status.
Although the principal security behind these bonds
may vary, many provide additional security in the form
of a mortgage or debt service reserve fund. Some
authorities provide further security in the form of the
state's ability (without obligation) to make up
deficiencies in the debt service reserve fund. Revenue
bonds usually do not require prior voter approval
before they may be issued.
Lease Revenue Bonds. Municipal borrowers may also
finance capital improvements or purchases with
tax-exempt leases. The security for a lease is
generally the borrower's pledge to make annual
appropriations for lease payments. The lease payment
is treated as an operating expense subject to
appropriation risk and not a full faith and credit
obligation of the issuer. Lease revenue bonds are
generally considered less secure than a general
obligation or revenue bond and often do not include a
debt service reserve fund. To the extent the Fund's
Board determines such securities are illiquid, they
will be subject to the Fund's 15% limit on illiquid
securities (10% limit for the Money Fund). There have
also been certain legal challenges to the use of lease
revenue bonds in various states.
The liquidity of such securities will be determined
based on a variety of factors which may include, among
others: (1) the frequency of trades and quotes for the
obligation; (2) the number of dealers willing to
purchase or sell the security and the number of other
potential buyers; (3) the willingness of dealers to
undertake to make a market in the security; (4) the
nature of the marketplace trades, including, the time
needed to dispose of the security, the method of
soliciting offers, and the mechanics of transfer; and
(5) the rating assigned to the obligation by an
established rating agency or T. Rowe Price.
Pre-refunded/Escrowed to Maturity Bonds. Certain
municipal bonds have been refunded with a later bond
issue from the same issuer. The proceeds from the
later issue are used to defease the original issue. In
many cases the original issue cannot be redeemed or
repaid until the first call date or original maturity
date. In these cases, the refunding bond proceeds
PAGE 15
typically are used to buy U.S. Treasury securities that
are held in an escrow account until the original call
date or maturity date. The original bonds then become
"pre-refunded" or "escrowed to maturity" and are
considered as high quality investments. While still
tax-exempt, the security is the proceeds of the escrow
account. To the extent permitted by the Securities and
Exchange Commission and the Internal Revenue Service, a
Fund's investment in such securities refunded with U.S.
Treasury securities will, for purposes of
diversification rules applicable to the Fund, be
considered as an investment in the U.S. Treasury
securities.
Private Activity Bonds. Under current tax law all
municipal debt is divided broadly into two groups:
governmental purpose bonds and private activity bonds.
Governmental purpose bonds are issued to finance
traditional public purpose projects such as public
buildings and roads. Private activity bonds may be
issued by a state or local government or public
authority but principally benefit private users and are
considered taxable unless a specific exemption is
provided.
The tax code currently provides exemptions for
certain private activity bonds such as not-for-profit
hospital bonds, small-issue industrial development
revenue bonds and mortgage subsidy bonds, which may
still be issued as tax-exempt bonds. Some, but not
all, private activity bonds are subject to alternative
minimum tax.
Industrial Development Bonds. Industrial development
bonds are considered Municipal Bonds if the interest
paid is exempt from federal income tax. They are
issued by or on behalf of public authorities to raise
money to finance various privately operated facilities
for business and manufacturing, housing, sports, and
pollution control. These bonds are also used to
finance public facilities such as airports, mass
transit systems, ports, and parking. The payment of the
principal and interest on such bonds is dependent
solely on the ability of the facility's user to meet
its financial obligations and the pledge, if any, of
real and personal property so financed as security for
such payment.
<PAGE>
PAGE 16
Adjustable Rate Securities. Municipal securities may
be issued with adjustable interest rates that are rest
eriodically by pre-determined formulas or indexes in an
effort to minimize movements in the principal value of
the investment. For example, the interest rate on a
bond could be indexed to the consumer price index.
Such securities may have long-term maturities, but may
be treated as a short-term investment under certain
conditions. Generally, as interest rates decrease or
increase, the potential for capital appreciation or
depreciation on these securities is less than for
fixed-rate obligations.
These securities may take a variety of forms, including
the following:
Variable Rate Securities. Variable rate securities are
those whose terms provide for the adjustment of their
interest rates on set dates and which, upon each
adjustment until the final maturity of the instrument
or the period remaining until the principal amount can
be recovered through demand, can reasonably be expected
to have a market value that approximates its amortized
cost. Subject to the provisions of Rule 2a-7 under the
Investment Company Act of 1940 (1940 Act): (1) a
variable rate security, the principal amount of which
is scheduled to be paid in 397 calendar days or less,
is deemed to have a maturity equal to the earlier of
the period remaining until the next readjustment of the
interest rate or the period remaining until the
principal amount can be recovered through demand; (2) a
variable rate security, the principal amount of which
is scheduled to be paid in more than 397 calendar days,
which is subject to a demand feature, as defined in
Rule 2a-7, is deemed to have a maturity equal to the
longer of the period remaining until the next
readjustment of the interest rate or the period
remaining until the principal amount can be recovered
through demand; and (3) a security that is issued or
guaranteed by the U.S. Government or any agency thereof
which has a variable rate of interest readjusted no
less frequently than every 762 calendar days may be
deemed to have a maturity equal to the period remaining
until the next readjustment of the interest rate.
Should the provisions of Rule 2a-7 change, the Fund
will determine the maturity of these securities in
accordance with the amended provisions of such Rule.
<PAGE>
PAGE 17
Floating Rate Securities. Floating rate securities are
those whose terms provide for the adjustment of their
interest rates whenever a specified interest rate
changes and which, at any time until the final maturity
of the instrument or the period remaining until the
principal amount can be recovered through demand, can
reasonably be expected to have a market value that
approximates its amortized cost. Subject to the
provisions of Rule 2a-7 under the 1940 Act: (1) the
maturity of a floating rate security, the principal
amount of which must be unconditionally paid in 397
calendar days or less, is deemed to be one day; and (2)
a floating rate security, the principal amount of which
is scheduled to be paid in more than 397 calendar days,
that is subject to a demand feature, is deemed to have
a maturity equal to the period remaining until the
principal amount can be recovered through demand.
Should the provisions of Rule 2a-7 change, the Fund
will determine the maturity of these securities in
accordance with the amended provisions of such Rule.
Put Option Bonds. Long-term obligations with
maturities longer than one year may provide purchasers
an optional or mandatory tender of the security at par
value at predetermined intervals, often ranging from
one month to several years (e.g., a 30-year bond with a
five-year tender period). These instruments are deemed
to have a maturity equal to the period remaining to the
put date.
Residual Interest Bonds (Bond and Balanced Funds)
(These are a type of high-risk derivative). The Funds
may purchase municipal bond issues that are structured
as two-part, residual interest bond and variable rate
security offerings. The issuer is obligated only to
pay a fixed amount of tax-free income that is to be
divided among the holders of the two securities. The
interest rate for the holders of the variable rate
securities will be determined by an index or auction
process held approximately every 7 to 35 days while the
bond holders will receive all interest paid by the
issuer minus the amount given to the variable rate
security holders and a nominal auction fee. Therefore,
the coupon of the residual interest bonds, and thus the
income received, will move inversely with respect to
short-term, 7 to 35 day tax-exempt interest rates.
There is no assurance that the auction will be
successful and that the variable rate security will
provide short-term liquidity. The issuer is not
PAGE 18
obligated to provide such liquidity. In general, these
securities offer a significant yield advantage over
standard municipal securities, due to the uncertainty
of the shape of the yield curve (i.e., short term
versus long term rates) and consequent income flows.
Unlike many adjustable rate securities, residual
interest bonds are not necessarily expected to trade at
par and in fact present significant market risks. In
certain market environments, residual interest bonds
may carry substantial premiums or be at deep discounts.
This is a relatively new product in the municipal
market with limited liquidity to date.
Participation Interests. The Fund may purchase from
third parties participation interests in all or part of
specific holdings of municipal securities. The
purchase may take different forms: in the case of
short-term securities, the participation may be backed
by a liquidity facility that allows the interest to be
sold back to the third party (such as a trust, broker
or bank) for a predetermined price of par at stated
intervals. The seller may receive a fee from the Fund
in connection with the arrangement.
In the case of longer term bonds, the Intermediate
and Income Funds may purchase interests in a pool of
municipal bonds or a single municipal bond or lease
without the right to sell the interest back to the
third party.
The Fund will not purchase participation interests
unless a satisfactory opinion of counsel or ruling of
the Internal Revenue Service has been issued that the
interest earned from the municipal securities on which
the Fund holds participation interests is exempt from
federal income tax to the Fund. However, there is no
guarantee the IRS would treat such interest income as
tax-exempt.
Embedded Interest Rate Swaps and Caps (Bond and
Balanced Funds). In a fixed-rate, long-term municipal
bond with an interest rate swap attached to it, the
bondholder usually receives the bond's fixed-coupon
payment as well as a variable rate payment that
represents the difference between a fixed rate for the
term of the swap (which is typically shorter than the
bond it is attached to) and a variable rate short-term
municipal index. The bondholder receives excess income
when short-term rates remain below the fixed interest
PAGE 19
rate swap rate. If short-term rates rise above the
fixed-income swap rate, the bondholder's income is
reduced. At the end of the interest rate swap term, the
bond reverts to a single fixed-coupon payment.
Embedded interest rate swaps enhance yields, but also
increase interest rate risk.
An embedded interest rate cap allows the bondholder
to receive payments whenever short-term rates rise
above a level established at the time of purchase.
They normally are used to hedge against rising short-
term interest rates.
Both instruments may be volatile and of limited
liquidity and their use may adversely affect a fund's
total return.
The Funds may invest in other types of derivative
instruments as they become available.
There are, of course, other types of municipal
securities that are, or may become, available, and the Funds
reserve the right to invest in them.
For the purpose of the Fund's investment restrictions,
the identification of the "issuer" of municipal securities which
are not general obligation bonds is made by the Fund's investment
manager, T. Rowe Price, on the basis of the characteristics of
the obligation as described above, the most significant of which
is the source of funds for the payment of principal and interest
on such securities.
When-Issued Securities
New issues of municipal securities are often offered on
a when-issued basis; that is, delivery and payment for the
securities normally takes place 15 to 45 days or more after the
date of the commitment to purchase. The payment obligation and
the interest rate that will be received on the securities are
each fixed at the time the buyer enters into the commitment. A
Fund will only make a commitment to purchase such securities with
the intention of actually acquiring the securities. However, a
Fund may sell these securities before the settlement date if it
is deemed advisable as a matter of investment strategy. Each
Fund will maintain cash and/or high-grade marketable debt
securities with its custodian bank equal in value to commitments
for when-issued securities. Such securities either will mature
or, if necessary, be sold on or before the settlement date.
Securities purchased on a when-issued basis and the securities
PAGE 20
held in a Fund's portfolio are subject to changes in market value
based upon the public perception of the creditworthiness of the
issuer and changes in the level of interest rates (which will
generally result in similar changes in value; i.e., both
experiencing appreciation when interest rates decline and
depreciation when interest rates rise). Therefore, to the extent
a Fund remains fully invested or almost fully invested at the
same time that it has purchased securities on a when-issued
basis, there will be greater fluctuations in its net asset value
than if it solely set aside cash to pay for when-issued
securities. In the case of the Money Fund, this could increase
the possibility that the market value of the Fund's assets could
vary from $1.00 per share. In addition, there will be a greater
potential for the realization of capital gains, which are not
exempt from federal income tax. When the time comes to pay for
when-issued securities, a Fund will meet its obligations from
then-available cash flow, sale of securities or, although it
would not normally expect to do so, from sale of the when-issued
securities themselves (which may have a value greater or less
than the payment obligation). The policies described in this
paragraph are not fundamental and may be changed by a Fund upon
notice to its shareholders.
Forwards
Bond and Balanced Funds
The Fund may purchase bonds on a when-issued basis with
longer than standard settlement dates, in some cases exceeding
one to two years. In such cases, the Fund must execute a receipt
evidencing the obligation to purchase the bond on the specified
issue date, and must segregate cash internally to meet that
forward commitment. Municipal "forwards" typically carry a
substantial yield premium to compensate the buyer for the risks
associated with a long when-issued period, including: shifts in
market interest rates that could materially impact the principal
value of the bond, deterioration in the credit quality of the
issuer, loss of alternative investment options during the when-
issued period, changes in tax law or issuer actions that would
affect the exempt interest status of the bonds and prevent
delivery, failure of the issuer to complete various steps
required to issue the bonds, and limited liquidity for the buyer
to sell the escrow receipts during the when-issued period.
Investment in Taxable Money Market Securities
Although the Funds expect to be solely invested in
municipal securities (except for the Tax-Efficient Balanced
Fund), for temporary defensive purposes they may elect to invest
in the taxable money market securities listed below (without
PAGE 21
limitation) when such action is deemed to be in the best
interests of shareholders. The Tax-Efficient Balanced Fund may
invest in such securities as part of its reserve position. The
interest earned on these money market securities is not exempt
from federal income tax and may be taxable to shareholders as
ordinary income.
U.S. Government Obligations - direct obligations of
the government and its agencies and instrumentalities;
U.S. Government Agency Securities - obligations
issued or guaranteed by U.S. government sponsored enterprises,
federal agencies, and international institutions. Some of these
securities are supported by the full faith and credit of the U.S.
Treasury; others are supported by the right of the issuer; and
the remainder are supported only by the credit of the
instrumentality;
Bank Obligations - certificates of deposit,
bankers' acceptances, and other short-term obligations of U.S.
and Canadian banks and their foreign branches;
Commercial Paper - paper rated A-2 or better by
S&P, Prime-2 or better by Moody's, or F-2 or better by Fitch, or,
if not rated, is issued by a corporation having an outstanding
debt issue rated A or better by Moody's, S&P or Fitch and, with
respect to the Money Fund, is of equivalent investment quality as
determined by the Board of Directors; and
Short-Term Corporate Debt Securities - short-term
corporate debt securities rated at least AA by S&P, Moody's or
Fitch.
Determination of Maturity of Money Market Securities
The Money Fund may only purchase securities which at
the time of investment have remaining maturities of 397 calendar
days or less. The other Funds may also purchase money-market
securities. In determining the maturity of money market
securities, the Funds will follow the provisions of Rule 2a-7
under the Investment Company Act of 1940.
Tax-Efficient Balanced Fund
Illiquid or Restricted Securities
Restricted securities may be sold only in privately
negotiated transactions or in a public offering with respect to
which a registration statement is in effect under the Securities
Act of 1933 (the "1933 Act"). Where registration is required,
PAGE 22
the Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of
the decision to sell and the time the Fund may be permitted to
sell a security under an effective registration statement. If,
during such a period, adverse market conditions were to develop,
the Fund might obtain a less favorable price than prevailed when
it decided to sell. Restricted securities will be priced at fair
value as determined in accordance with procedures prescribed by
the Fund's Board of Directors/Trustees. If through the
appreciation of illiquid securities or the depreciation of liquid
securities, the Fund should be in a position where more than 15%
of the value of its net assets is invested in illiquid assets,
including restricted securities, the Fund will take appropriate
steps to protect liquidity.
Notwithstanding the above, the Fund may purchase
securities which, while privately placed, are eligible for
purchase and sale under Rule 144A under the 1933 Act. This rule
permits certain qualified institutional buyers, such as the Fund,
to trade in privately placed securities even though such
securities are not registered under the 1933 Act. T. Rowe Price
under the supervision of the Fund's Board of Directors/Trustees,
will consider whether securities purchased under Rule 144A are
illiquid and thus subject to the Fund's restriction of investing
no more than 15% of its net assets in illiquid securities. A
determination of whether a Rule 144A security is liquid or not is
a question of fact. In making this determination, T. Rowe Price
will consider the trading markets for the specific security
taking into account the unregistered nature of a Rule 144A
security. In addition, T. Rowe Price could consider the (1)
frequency of trades and quotes, (2) number of dealers and
potential purchases, (3) dealer undertakings to make a market,
and (4) the nature of the security and of marketplace trades
(e.g., the time needed to dispose of the security, the method of
soliciting offers and the mechanics of transfer). The liquidity
of Rule 144A securities would be monitored, and if as a result of
changed conditions it is determined that a Rule 144A security is
no longer liquid, the Fund's holdings of illiquid securities
would be reviewed to determine what, if any, steps are required
to assure that the Fund does not invest more than 15% of its net
assets in illiquid securities. Investing in Rule 144A securities
could have the effect of increasing the amount of the Fund's
assets invested in illiquid securities if qualified institutional
buyers are unwilling to purchase such securities.
Hybrid Instruments
Hybrid Instruments (a type of potentially high-risk
derivative) have been developed and combine the elements of
PAGE 23
futures contracts or options with those of debt, preferred equity
or a depository instrument (hereinafter "Hybrid Instruments").
Generally, a Hybrid Instrument will be a debt security, preferred
stock, depository share, trust certificate, certificate of
deposit or other evidence of indebtedness on which a portion of
or all interest payments, and/or the principal or stated amount
payable at maturity, redemption or retirement, is determined by
reference to prices, changes in prices, or differences between
prices, of securities, currencies, intangibles, goods, articles
or commodities (collectively "Underlying Assets") or by another
objective index, economic factor or other measure, such as
interest rates, currency exchange rates, commodity indices, and
securities indices (collectively "Benchmarks"). Thus, Hybrid
Instruments may take a variety of forms, including, but not
limited to, debt instruments with interest or principal payments
or redemption terms determined by reference to the value of a
currency or commodity or securities index at a future point in
time, preferred stock with dividend rates determined by reference
to the value of a currency, or convertible securities with the
conversion terms related to a particular commodity.
Hybrid Instruments can be an efficient means of
creating exposure to a particular market, or segment of a market,
with the objective of enhancing total return. For example, a
Fund may wish to take advantage of expected declines in interest
rates in several European countries, but avoid the transactions
costs associated with buying and currency-hedging the foreign
bond positions. One solution would be to purchase a U.S. dollar-
denominated Hybrid Instrument whose redemption price is linked to
the average three year interest rate in a designated group of
countries. The redemption price formula would provide for
payoffs of greater than par if the average interest rate was
lower than a specified level, and payoffs of less than par if
rates were above the specified level. Furthermore, the Fund
could limit the downside risk of the security by establishing a
minimum redemption price so that the principal paid at maturity
could not be below a predetermined minimum level if interest
rates were to rise significantly. The purpose of this
arrangement, known as a structured security with an embedded put
option, would be to give the Fund the desired European bond
exposure while avoiding currency risk, limiting downside market
risk, and lowering transactions costs. Of course, there is no
guarantee that the strategy will be successful and the Fund could
lose money if, for example, interest rates do not move as
anticipated or credit problems develop with the issuer of the
Hybrid.
The risks of investing in Hybrid Instruments reflect a
combination of the risks of investing in securities, options,
futures and currencies. Thus, an investment in a Hybrid
PAGE 24
Instrument may entail significant risks that are not associated
with a similar investment in a traditional debt instrument that
has a fixed principal amount, is denominated in U.S. dollars or
bears interest either at a fixed rate or a floating rate
determined by reference to a common, nationally published
Benchmark. The risks of a particular Hybrid Instrument will, of
course, depend upon the terms of the instrument, but may include,
without limitation, the possibility of significant changes in the
Benchmarks or the prices of Underlying Assets to which the
instrument is linked. Such risks generally depend upon factors
which are unrelated to the operations or credit quality of the
issuer of the Hybrid Instrument and which may not be readily
foreseen by the purchaser, such as economic and political events,
the supply and demand for the Underlying Assets and interest rate
movements. In recent years, various Benchmarks and prices for
Underlying Assets have been highly volatile, and such volatility
may be expected in the future. Reference is also made to the
discussion of futures, options, and forward contracts herein for
a discussion of the risks associated with such investments.
Hybrid Instruments are potentially more volatile and
carry greater market risks than traditional debt instruments.
Depending on the structure of the particular Hybrid Instrument,
changes in a Benchmark may be magnified by the terms of the
Hybrid Instrument and have an even more dramatic and substantial
effect upon the value of the Hybrid Instrument. Also, the prices
of the Hybrid Instrument and the Benchmark or Underlying Asset
may not move in the same direction or at the same time.
Hybrid Instruments may bear interest or pay preferred
dividends at below market (or even relatively nominal) rates.
Alternatively, Hybrid Instruments may bear interest at above
market rates but bear an increased risk of principal loss (or
gain). The latter scenario may result if "leverage" is used to
structure the Hybrid Instrument. Leverage risk occurs when the
Hybrid Instrument is structured so that a given change in a
Benchmark or Underlying Asset is multiplied to produce a greater
value change in the Hybrid Instrument, thereby magnifying the
risk of loss as well as the potential for gain.
Hybrid Instruments may also carry liquidity risk since
the instruments are often "customized" to meet the portfolio
needs of a particular investor, and therefore, the number of
investors that are willing and able to buy such instruments in
the secondary market may be smaller than that for more
traditional debt securities. In addition, because the purchase
and sale of Hybrid Instruments could take place in an over-the-
counter market without the guarantee of a central clearing
organization or in a transaction between the Fund and the issuer
of the Hybrid Instrument, the creditworthiness of the counter
PAGE 25
party or issuer of the Hybrid Instrument would be an additional
risk factor which the Fund would have to consider and monitor.
Hybrid Instruments also may not be subject to regulation of the
Commodities Futures Trading Commission ("CFTC"), which generally
regulates the trading of commodity futures by U.S. persons, the
SEC, which regulates the offer and sale of securities by and to
U.S. persons, or any other governmental regulatory authority.
The various risks discussed above, particularly the
market risk of such instruments, may in turn cause significant
fluctuations in the net asset value of the Fund. Accordingly,
the Fund will limit its investments in Hybrid Instruments to 10%
of total assets. However, because of their volatility, it is
possible that the Fund's investment in Hybrid Instruments will
account for more than 10% of the Fund's return (positive or
negative).
Warrants
The Fund may acquire warrants. Warrants are pure
speculation in that they have no voting rights, pay no dividends
and have no rights with respect to the assets of the corporation
issuing them. Warrants basically are options to purchase equity
securities at a specific price valid for a specific period of
time. They do not represent ownership of the securities, but
only the right to buy them. Warrants differ from call options in
that warrants are issued by the issuer of the security which may
be purchased on their exercise, whereas call options may be
written or issued by anyone. The prices of warrants do not
necessarily move parallel to the prices of the underlying
securities.
PORTFOLIO MANAGEMENT PRACTICES
Futures Contracts (Bond and Balanced Funds only)
Futures are a type of potentially high-risk derivative.
Transactions in Futures
The Fund may enter into interest rate futures contracts
("futures" or "futures contracts"). Interest rate futures
contracts may be used as a hedge against changes in prevailing
levels of interest rates in order to establish more definitely
the effective return on securities held or intended to be
acquired by the Fund. The Fund could sell interest rate futures
as an offset against the effect of expected increases in interest
rates and purchase such futures as an offset against the effect
PAGE 26
of expected declines in interest rates. Futures can also be used
as an efficient means of regulating a Fund's exposure to the
market.
Tax-Efficient Balanced Fund
The Tax-Efficient Balanced Fund may enter into futures
contracts including stock index, interest rate and currency
futures ("futures or futures contracts"). The nature of such
futures and the regulatory limitations and risks to which they
are subject are the same as those described below.
Stock index futures contracts may be used to provide a
hedge for a portion of the Fund's portfolio, as a cash management
tool, or as an efficient way for T. Rowe Price to implement
either an increase or decrease in portfolio market exposure in
response to changing market conditions. The Fund may purchase or
sell futures contracts with respect to any stock index.
Nevertheless, to hedge the Fund's portfolio successfully, the
Fund must sell futures contacts with respect to indices or
subindices whose movements will have a significant correlation
with movements in the prices of the Fund's portfolio securities.
Interest rate or currency futures contracts may be used
as a hedge against changes in prevailing levels of interest rates
or currency exchange rates in order to establish more definitely
the effective return on securities or currencies held or intended
to be acquired by the Fund. In this regard, the Fund could sell
interest rate or currency futures as an offset against the effect
of expected increases in interest rates or currency exchange
rates and purchase such futures as an offset against the effect
of expected declines in interest rates or currency exchange
rates.
All Funds
The Fund will enter into futures contracts which are
traded on national (and for the Tax-Efficient Balanced Fund,
foreign) futures exchanges and are standardized as to maturity
date and underlying financial instrument. A public market exists
in futures contracts covering various taxable fixed income
securities as well as municipal bonds. Futures exchanges and
trading in the United States are regulated under the Commodity
Exchange Act by the Commodity Futures Trading Commission
("CFTC"). Futures for the Tax-Efficient Balanced Fund may also
be traded in London at the London International Financial Futures
Exchange; in Paris at the MATIF; and in Tokyo at the Tokyo Stock
Exchange. Although techniques other than the sale and purchase
of futures contracts could be used for the above-referenced
PAGE 27
purposes, futures contracts offer an effective and relatively low
cost means of implementing the Fund's objectives in these areas.
Regulatory Limitations
The Fund will invest in futures contracts and options
thereon only for bona fide hedging, yield enhancement, and risk
management purposes, in each case in accordance with rules and
regulations of the CFTC.
The Fund may not purchase or sell futures contracts or
related options if, with respect to positions which do not
qualify as bona fide hedging under applicable CFTC rules, the sum
of the amounts of initial margin deposits and premiums paid on
those positions would exceed 5% of the net asset value of the
Fund after taking into account unrealized profits and unrealized
losses on any such contracts it has entered into; provided,
however, that in the case of an option that is in-the-money at
the time of purchase, the in-the-money amount may be excluded in
calculating the 5% limitation. For purposes of this policy,
options on futures contracts traded on a commodities exchange
will be considered "related options." This policy may be
modified by the Board of Directors without a shareholder vote and
does not limit the percentage of the Fund's assets at risk to 5%.
In instances involving the purchase of futures
contracts or the writing of calls or put options thereon by the
Fund, an amount of cash, U.S. government securities or other
liquid, high-grade debt obligations, equal to the market value of
the futures contracts and options thereon (less any related
margin deposits), will be identified in an account with the
Fund's custodian to cover the position, or alternative cover
(such as owning an offsetting position) will be employed. Assets
used as cover or held in an identified account cannot be sold
while the position in the corresponding option or future is open,
unless they are replaced with similar assets. As a result, the
commitment of a large portion of a Fund's assets to cover or
identified accounts could impede portfolio management or the
Fund's ability to meet redemption requests or other current
obligations.
If the CFTC or other regulatory authorities adopt
different (including less stringent) or additional restrictions,
the Fund would comply with such new restrictions.
Trading in Futures Contracts
A futures contract provides for the future sale by one
party and purchase by another party of a specified amount of a
specific financial instrument (e.g., units of a debt security)
PAGE 28
for a specified price, date, time and place designated at the
time the contract is made. Brokerage fees are incurred when a
futures contract is bought or sold and margin deposits must be
maintained. Entering into a contract to buy is commonly referred
to as buying or purchasing a contract or holding a long position.
Entering into a contract to sell is commonly referred to as
selling a contract or holding a short position.
It is possible that the Fund's hedging activities will
occur primarily through the use of municipal bond index futures
contracts since the uniqueness of that index contract should
better correlate with the Fund's portfolio and thereby be more
effective. However, there may be times when it is deemed in the
best interest of shareholders to engage in the use of Treasury
bond futures, and the Fund reserves the right to use Treasury
bond futures at any time. Use of these futures could occur, as
an example, when both the Treasury bond contract and municipal
bond index futures contract are correlating well with municipal
bond prices, but the Treasury bond contract is trading at a more
advantageous price making the hedge less expensive with the
Treasury bond contract than would be obtained with the municipal
bond index futures contract. The Fund's activity in futures
contracts generally will be limited to municipal bond index
futures contracts and Treasury bond and note contracts.
Unlike when the Fund purchases or sells a security, no
price would be paid or received by the Fund upon the purchase or
sale of a futures contract. Upon entering into a futures
contract, and to maintain the Fund's open positions in futures
contracts, the Fund would be required to deposit with its
custodian in a segregated account in the name of the futures
broker an amount of cash, U.S. government securities, suitable
money market instruments, or liquid, high-grade debt securities,
known as "initial margin." The margin required for a particular
futures contract is set by the exchange on which the contract is
traded, and may be significantly modified from time to time by
the exchange during the term of the contract. Futures contracts
are customarily purchased and sold on margins that may range
upward from less than 5% of the value of the contract being
traded.
If the price of an open futures contract changes (by
increase in the case of a sale or by decrease in the case of a
purchase) so that the loss on the futures contract reaches a
point at which the margin on deposit does not satisfy margin
requirements, the broker will require an increase in the margin.
However, if the value of a position increases because of
favorable price changes in the futures contract so that the
margin deposit exceeds the required margin, the broker will pay
the excess to the Fund.
PAGE 29
These subsequent payments, called "variation margin,"
to and from the futures broker, are made on a daily basis as the
price of the underlying assets fluctuate making the long and
short positions in the futures contract more or less valuable, a
process known as "marking to the market." The Fund expects to
earn interest income on its margin deposits.
Although certain futures contracts, by their terms,
require actual future delivery of and payment for the underlying
instruments, in practice most futures contracts are usually
closed out before the delivery date. Closing out an open futures
contract purchase or sale is effected by entering into an
offsetting futures contract sale or purchase, respectively, for
the same aggregate amount of the identical securities and the
same delivery date. If the offsetting purchase price is less
than the original sale price, the Fund realizes a gain; if it is
more, the Fund realizes a loss. Conversely, if the offsetting
sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The
transaction costs must also be included in these calculations.
There can be no assurance, however, that the Fund will be able to
enter into an offsetting transaction with respect to a particular
futures contract at a particular time. If the Fund is not able
to enter into an offsetting transaction, the Fund will continue
to be required to maintain the margin deposits on the futures
contract.
As an example of an offsetting transaction in which the
underlying instrument is not delivered, the contractual
obligations arising from the sale of one contract of September
municipal bond index futures on an exchange may be fulfilled at
any time before delivery of the contract is required (i.e., on a
specified date in September, the "delivery month") by the
purchase of one contract of September municipal bond index
futures on the same exchange. In such instance, the difference
between the price at which the futures contract was sold and the
price paid for the offsetting purchase, after allowance for
transaction costs, represents the profit or loss to the Fund.
Tax-Efficient Balanced Fund
For example, the Standard & Poor's 500 Stock Index is
composed of 500 selected common stocks, most of which are listed
on the New York Stock Exchange. The S&P 500 Index assigns
relative weightings to the common stocks included in the Index,
and the Index fluctuates with changes in the market values of
those common stocks. In the case of the S&P 500 Index, contracts
are to buy or sell 500 units. Thus, if the value of the S&P 500
Index were $150, one contract would be worth $75,000 (500 units x
$150). The stock index futures contract specifies that no
PAGE 30
delivery of the actual stock making up the index will take place.
Instead, settlement in cash occurs. Over the life of the
contract, the gain or loss realized by the Fund will equal the
difference between the purchase (or sale) price of the contract
and the price at which the contract is terminated. For example,
if the Fund enters into a futures contract to buy 500 units of
the S&P 500 Index at a specified future date at a contract price
of $150 and the S&P 500 Index is at $154 on that future date, the
Fund will gain $2,000 (500 units x gain of $4). If the Fund
enters into a futures contract to sell 500 units of the stock
index at a specified future date at a contract price of $150 and
the S&P 500 Index is at $152 on that future date, the Fund will
lose $1,000 (500 units x loss of $2).
Special Risks of Transactions in Futures Contracts
Volatility and Leverage. The prices of futures
contracts are volatile and are influenced, among other things, by
actual and anticipated changes in the market and interest rates,
which in turn are affected by fiscal and monetary policies and
national and international political and economic events.
Most United States futures exchanges limit the amount
of fluctuation permitted in futures contract prices during a
single trading day. The daily limit establishes the maximum
amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a
particular type of futures contract, no trades may be made on
that day at a price beyond that limit. The daily limit governs
only price movement during a particular trading day and therefore
does not limit potential losses, because the limit may prevent
the liquidation of unfavorable positions. Futures contract
prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby
preventing prompt liquidation of futures positions and subjecting
some futures traders to substantial losses.
Margin deposits required on futures trading are low.
As a result, a relatively small price movement in a futures
contract may result in immediate and substantial loss, as well as
gain, to the investor. For example, if at the time of purchase,
10% of the value of the futures contract is deposited as margin,
a subsequent 10% decrease in the value of the futures contract
would result in a total loss of the margin deposit, before any
deduction for the transaction costs, if the account were then
closed out. A 15% decrease would result in a loss equal to 150%
of the original margin deposit, if the contract were closed out.
Thus, a purchase or sale of a futures contract may result in
PAGE 31
losses in excess of the amount invested in the futures contract.
However, the Fund would presumably have sustained comparable
losses if, instead of the futures contract, it had invested in
the underlying financial instrument and sold it after the
decline. Furthermore, in the case of a futures contract
purchase, in order to be certain that the Fund has sufficient
assets to satisfy its obligations under a futures contract, the
Fund earmarks to the futures contract money market instruments
equal in value to the current value of the underlying instrument
less the margin deposit.
Liquidity. The Fund may elect to close some or all of
its futures positions at any time prior to their expiration. The
Fund would do so to reduce exposure represented by long futures
positions or short futures positions. The Fund may close its
positions by taking opposite positions which would operate to
terminate the Fund's position in the futures contracts. Final
determinations of variation margin would then be made, additional
cash would be required to be paid by or released to the Fund, and
the Fund would realize a loss or a gain.
Futures contracts may be closed out only on the
exchange or board of trade where the contracts were initially
traded. Although the Fund intends to purchase or sell futures
contracts only on exchanges or boards of trade where there
appears to be an active market, there is no assurance that a
liquid market on an exchange or board of trade will exist for any
particular contract at any particular time. In such event, it
might not be possible to close a futures contract, and in the
event of adverse price movements, the Fund would continue to be
required to make daily cash payments of variation margin.
However, in the event futures contracts have been used to hedge
the underlying instruments, the Fund would continue to hold the
underlying instruments subject to the hedge until the futures
contracts could be terminated. In such circumstances, an
increase in the price of underlying instruments, if any, might
partially or completely offset losses on the futures contract.
However, as described below, there is no guarantee that the price
of the underlying instruments will, in fact, correlate with the
price movements in the futures contract and thus provide an
offset to losses on a futures contract.
Hedging Risk. A decision of whether, when, and how to
hedge involves skill and judgment, and even a well-conceived
hedge may be unsuccessful to some degree because of unexpected
market behavior, market or interest rate trends. There are
several risks in connection with the use by the Fund of futures
contracts as a hedging device. One risk arises because of the
imperfect correlation between movements in the prices of the
futures contracts and movements in the prices of the underlying
PAGE 32
instruments which are the subject of the hedge. T. Rowe Price
will, however, attempt to reduce this risk by entering into
futures contracts whose movements, in its judgment, will have a
significant correlation with movements in the prices of the
Fund's underlying instruments sought to be hedged.
Successful use of futures contracts by the Fund for
hedging purposes is also subject to T. Rowe Price's ability to
correctly predict movements in the direction of the market. It
is possible that, when the Fund has sold futures to hedge its
portfolio against a decline in the market, the index, indices, or
instruments underlying futures are written might advance and the
value of the underlying instruments held in the Fund's portfolio
might decline. If this were to occur, the Fund would lose money
on the futures and also would experience a decline in value in
its underlying instruments. However, while this might occur to a
certain degree, T. Rowe Price believes that over time the value
of the Fund's portfolio will tend to move in the same direction
as the market indices used to hedge the portfolio. It is also
possible that if the Fund were to hedge against the possibility
of a decline in the market (adversely affecting the underlying
instruments held in its portfolio) and prices instead increased,
the Fund would lose part or all of the benefit of increased value
of those underlying instruments that it has hedged, because it
would have offsetting losses in its futures positions. In
addition, in such situations, if the Fund had insufficient cash,
it might have to sell underlying instruments to meet daily
variation margin requirements. Such sales of underlying
instruments might be, but would not necessarily be, at increased
prices (which would reflect the rising market). The Fund might
have to sell underlying instruments at a time when it would be
disadvantageous to do so.
In addition to the possibility that there might be an
imperfect correlation, or no correlation at all, between price
movements in the futures contracts and the portion of the
portfolio being hedged, the price movements of futures contracts
might not correlate perfectly with price movements in the
underlying instruments due to certain market distortions. First,
all participants in the futures market are subject to margin
deposit and maintenance requirements. Rather than meeting
additional margin deposit requirements, investors might close
futures contracts through offsetting transactions, which could
distort the normal relationship between the underlying
instruments and futures markets. Second, the margin requirements
in the futures market are less onerous than margin requirements
in the securities markets, and as a result the futures market
might attract more speculators than the securities markets do.
Increased participation by speculators in the futures market
might also cause temporary price distortions. Due to the
PAGE 33
possibility of price distortion in the futures market and also
because of the imperfect correlation between price movements in
the underlying instruments and movements in the prices of futures
contracts, even a correct forecast of general market trends by
T. Rowe Price might not result in a successful hedging
transaction over a very short time period.
Options on Futures Contracts
The Fund may purchase and sell options on the same
types of futures in which it may invest. Options are another
type of potentially high risk derivative.
The Fund might trade in municipal bond index option
futures or similar options on futures developed in the future.
In addition, the Fund may also trade in options on futures
contracts on U.S. government securities and any U.S. government
securities futures index contract which might be developed. In
the opinion of T. Rowe Price, there is a high degree of
correlation in the interest rate, and price movements of U.S.
government securities and municipal securities. However, the
U.S. government securities market and municipal securities
markets are independent and may not move in tandem at any point
in time.
The Fund will purchase put options on futures contracts
to hedge its portfolio of municipal securities against the risk
of rising interest rates, and the consequent decline in the
prices of the municipal securities it owns. The Fund will also
write call options on futures contracts as a hedge against a
modest decline in prices of the municipal securities held in the
Fund's portfolio. If the futures price at expiration of a
written call option is below the exercise price, the Fund will
retain the full amount of the option premium, thereby partially
hedging against any decline that may have occurred in the Fund's
holdings of debt securities. If the futures price when the
option is exercised is above the exercise price, however, the
Fund will incur a loss, which may be wholly or partially offset
by the increase of the value of the securities in the Fund's
portfolio which were being hedged.
Writing a put option on a futures contract serves as a
partial hedge against an increase in the value of securities the
Fund intends to acquire. If the futures price at expiration of
the option is above the exercise price, the Fund will retain the
full amount of the option premium which provides a partial hedge
against any increase that may have occurred in the price of the
debt securities the Fund intends to acquire. If the futures
price when the option is exercised is below the exercise price,
however, the Fund will incur a loss, which may be wholly or
PAGE 34
partially offset by the decrease in the price of the securities
the Fund intends to acquire.
Options on futures are similar to options on underlying
instruments except that options on futures give the purchaser the
right, in return for the premium paid, to assume a position in a
futures contract (a long position if the option is a call and a
short position if the option is a put), rather than to purchase
or sell the futures contract, at a specified exercise price at
any time during the period of the option. Upon exercise of the
option, the delivery of the futures position by the writer of the
option to the holder of the option will be accompanied by
delivery of the accumulated balance in the writer's futures
margin account which represents the amount by which the market
price of the futures contract, at exercise, exceeds (in the case
of a call) or is less than (in the case of a put) the exercise
price of the option on the futures contract. Purchasers of
options who fail to exercise their options prior to the exercise
date suffer a loss of the premium paid.
From time to time a single order to purchase or sell
futures contracts (or options thereon) may be made on behalf of
the Fund and other T. Rowe Price Funds. Such aggregated orders
would be allocated among the Fund and the other T. Rowe Price
Funds in a fair and non-discriminatory manner.
Tax-Efficient Balanced Fund
As an alternative to writing or purchasing call and put
options on stock index futures, the Fund may write or purchase
call and put options on stock indices. Such options would be
used in a manner similar to the use of options on futures
contracts.
Special Risks of Transactions in Options on Futures Contracts
The risks described under "Special Risks of
Transactions on Futures Contracts" are substantially the same as
the risks of using options on futures. In addition, where the
Fund seeks to close out an option position by writing or buying
an offsetting option covering the same index, underlying
instrument or contract and having the same exercise price and
expiration date, its ability to establish and close out positions
on such options will be subject to the maintenance of a liquid
secondary market. Reasons for the absence of a liquid secondary
market on an exchange include the following: (i) there may be
insufficient trading interest in certain options; (ii)
restrictions may be imposed by an exchange on opening
transactions or closing transactions or both; (iii) trading
halts, suspensions or other restrictions may be imposed with
PAGE 35
respect to particular classes or series of options, or underlying
instruments; (iv) unusual or unforeseen circumstances may
interrupt normal operations on an exchange; (v) the facilities of
an exchange or a clearing corporation may not at all times be
adequate to handle current trading volume; or (vi) one or more
exchanges could, for economic or other reasons, decide or be
compelled at some future date to discontinue the trading of
options (or a particular class or series of options), in which
event the secondary market on that exchange (or in the class or
series of options) would cease to exist, although outstanding
options on the exchange that had been issued by a clearing
corporation as a result of trades on that exchange would continue
to be exercisable in accordance with their terms. There is no
assurance that higher than anticipated trading activity or other
unforeseen events might not, at times, render certain of the
facilities of any of the clearing corporations inadequate, and
thereby result in the institution by an exchange of special
procedures which may interfere with the timely execution of
customers' orders. In the event no such market exists for a
particular contract in which the Fund maintains a position, in
the case of a written option, the Fund would have to wait to sell
the underlying securities or futures positions until the option
expires or is exercised. The Fund would be required to maintain
margin deposits on payments until the contract is closed.
Options on futures are treated for accounting purposes in the
same way as the analogous option on securities are treated.
In addition, the correlation between movements in the
price of options on futures contracts and movements in the price
of the securities hedged can only be approximate. This risk is
significantly increased when an option on a U.S. government
securities future or an option on a municipal securities index
future is used to hedge a municipal bond portfolio. Another risk
is that the movements in the price of options on futures
contracts may not move inversely with changes in interest rates.
If the Fund has written a call option on a futures contract and
the value of the call increases by more than the increase in the
value of the securities held as cover, the Fund may realize a
loss on the call which is not completely offset by the
appreciation in the price of the securities held as cover and the
premium received for writing the call.
The successful use of options on futures contracts
requires special expertise and techniques different from those
involved in portfolio securities transactions. A decision of
whether, when and how to hedge involves skill and judgment, and
even a well-conceived hedge may be unsuccessful to some degree
because of unexpected market behavior or interest rate trends.
During periods when municipal securities market prices are
PAGE 36
appreciating, the Fund may experience poorer overall performance
than if it had not entered into any options on futures contracts.
General Considerations
Transactions by the Fund in options on futures will be
subject to limitations established by each of the exchanges,
boards of trade or other trading facilities governing the maximum
number of options in each class which may be written or purchased
by a single investor or group of investors acting in concert,
regardless of whether the options are written on the same or
different exchanges, boards of trade or other trading facilities
or are held or written in one or more accounts or through one or
more brokers. Thus, the number of contracts which the Fund may
write or purchase may be affected by contracts written or
purchased by other investment advisory clients of T. Rowe Price.
An exchange, board of trade or other trading facility may order
the liquidations of positions found to be in excess of these
limits, and it may impose certain other sanctions.
Additional Futures and Options Contracts
Although the Fund has no current intention of engaging
in futures or options transactions other than those described
above, it reserves the right to do so. Such futures and options
trading might involve risks which differ from those involved in
the futures and options described above.
Tax-Efficient Balanced Fund
Foreign Futures and Options
Participation in foreign futures and foreign options
transactions involves the execution and clearing of trades on or
subject to the rules of a foreign board of trade. Neither the
National Futures Association nor any domestic exchange regulates
activities of any foreign boards of trade, including the
execution, delivery and clearing of transactions, or has the
power to compel enforcement of the rules of a foreign board of
trade or any applicable foreign law. This is true even if the
exchange is formally linked to a domestic market so that a
position taken on the market may be liquidated by a transaction
on another market. Moreover, such laws or regulations will vary
depending on the foreign country in which the foreign futures or
foreign options transaction occurs. For these reasons, when the
Fund trades foreign futures or foreign options contracts, it may
not be afforded certain of the protective measures provided by
the Commodity Exchange Act, the CFTC's regulations and the rules
of the National Futures Association and any domestic exchange,
including the right to use reparations proceedings before the
PAGE 37
Commission and arbitration proceedings provided by the National
Futures Association or any domestic futures exchange. In
particular, funds received from the Fund for foreign futures or
foreign options transactions may not be provided the same
protections as funds received in respect of transactions on
United States futures exchanges. In addition, the price of any
foreign futures or foreign options contract and, therefore, the
potential profit and loss thereon may be affected by any variance
in the foreign exchange rate between the time the Fund's order is
placed and the time it is liquidated, offset or exercised.
Foreign Currency Transactions
A forward foreign currency exchange contract involves
an obligation to purchase or sell a specific currency at a future
date, which may be any fixed number of days from the date of the
contract agreed upon by the parties, at a price set at the time
of the contract. These contracts are principally traded in the
interbank market conducted directly between currency traders
(usually large, commercial banks) and their customers. A forward
contract generally has no deposit requirement, and no commissions
are charged at any stage for trades.
The Fund may enter into forward contracts for a variety
of purposes in connection with the management of the foreign
securities portion of its portfolio. The Fund's use of such
contracts would include, but not be limited to, the following:
First, when the Fund enters into a contract for the
purchase or sale of a security denominated in a foreign currency,
it may desire to "lock in" the U.S. dollar price of the security.
By entering into a forward contract for the purchase or sale, for
a fixed amount of dollars, of the amount of foreign currency
involved in the underlying security transactions, the Fund will
be able to protect itself against a possible loss resulting from
an adverse change in the relationship between the U.S. dollar and
the subject foreign currency during the period between the date
the security is purchased or sold and the date on which payment
is made or received.
Second, when T. Rowe Price believes that one currency
may experience a substantial movement against another currency,
including the U.S. dollar, it may enter into a forward contract
to sell or buy the amount of the former foreign currency,
approximating the value of some or all of the Fund's portfolio
securities denominated in such foreign currency. Alternatively,
where appropriate, the Fund may hedge all or part of its foreign
currency exposure through the use of a basket of currencies or a
proxy currency where such currency or currencies act as an
effective proxy for other currencies. In such a case, the Fund
PAGE 38
may enter into a forward contract where the amount of the foreign
currency to be sold exceeds the value of the securities
denominated in such currency. The use of this basket hedging
technique may be more efficient and economical than entering into
separate forward contracts for each currency held in the Fund.
The precise matching of the forward contract amounts and the
value of the securities involved will not generally be possible
since the future value of such securities in foreign currencies
will change as a consequence of market movements in the value of
those securities between the date the forward contract is entered
into and the date it matures. The projection of short-term
currency market movement is extremely difficult, and the
successful execution of a short-term hedging strategy is highly
uncertain. Under normal circumstances, consideration of the
prospect for currency parities will be incorporated into the
longer term investment decisions made with regard to overall
diversification strategies. However, T. Rowe Price believes that
it is important to have the flexibility to enter into such
forward contracts when it determines that the best interests of
the Fund will be served.
The Fund may enter into forward contacts for any other
purpose consistent with the Fund's investment objective and
program. However, the Fund will not enter into a forward
contract, or maintain exposure to any such contract(s), if the
amount of foreign currency required to be delivered thereunder
would exceed the Fund's holdings of liquid, high-grade debt
securities, and currency available for cover of the forward
contract(s) or other suitable cover. In determining the amount
to be delivered under a contract, the Fund may net offsetting
positions.
At the maturity of a forward contract, the Fund may
sell the portfolio security and make delivery of the foreign
currency, or it may retain the security and either extend the
maturity of the forward contract (by "rolling" that contract
forward) or may initiate a new forward contract.
If the Fund retains the portfolio security and engages
in an offsetting transaction, the Fund will incur a gain or a
loss (as described below) to the extent that there has been
movement in forward contract prices. If the Fund engages in an
offsetting transaction, it may subsequently enter into a new
forward contract to sell the foreign currency. Should forward
prices decline during the period between the Fund's entering into
a forward contract for the sale of a foreign currency and the
date it enters into an offsetting contract for the purchase of
the foreign currency, the Fund will realize a gain to the extent
the price of the currency it has agreed to sell exceeds the price
PAGE 39
of the currency it has agreed to purchase. Should forward prices
increase, the Fund will suffer a loss to the extent of the price
of the currency it has agreed to purchase exceeds the price of
the currency it has agreed to sell.
The Fund's dealing in forward foreign currency exchange
contracts will generally be limited to the transactions described
above. However, the Fund reserves the right to enter into
forward foreign currency contracts for different purposes and
under different circumstances. Of course, the Fund is not
required to enter into forward contracts with regard to its
foreign currency-denominated securities and will not do so unless
deemed appropriate by T. Rowe Price. It also should be realized
that this method of hedging against a decline in the value of a
currency does not eliminate fluctuations in the underlying prices
of the securities. It simply establishes a rate of exchange at a
future date. Additionally, although such contracts tend to
minimize the risk of loss due to a decline in the value of the
hedged currency, at the same time, they tend to limit any
potential gain which might result from an increase in the value
of that currency.
Although the Fund values its assets daily in terms of
U.S. dollars, it does not intend to convert its holdings of
foreign currencies into U.S. dollars on a daily basis. It will
do so from time to time, and investors should be aware of the
costs of currency conversion. Although foreign exchange dealers
do not charge a fee for conversion, they do realize a profit
based on the difference (the "spread") between the prices at
which they are buying and selling various currencies. Thus, a
dealer may offer to sell a foreign currency to the Fund at one
rate, while offering a lesser rate of exchange should the Fund
desire to resell that currency to the dealer.
Federal Tax Treatment of Futures Contracts
Although the Fund invests almost exclusively in
securities which generate income which is exempt from federal
income taxes, the instruments described above are not exempt from
such taxes. Therefore, use of the investment techniques
described above could result in taxable income to shareholders of
the Fund.
Generally, the Fund is required, for federal income tax
purposes, to recognize as income for each taxable year its net
unrealized gains and losses on futures contracts as of the end of
the year as well as those actually realized during the year.
Gain or loss recognized with respect to a futures contract will
generally be 60% long-term capital gain or loss and 40% short-
PAGE 40
term capital gain or loss, without regard to the holding period
of the contract.
Futures contracts which are intended to hedge against a
change in the value of securities may be classified as "mixed
straddles," in which case the recognition of losses may be
deferred to a later year. In addition, sales of such futures
contracts on securities may affect the holding period of the
hedged security and, consequently, the nature of the gain or loss
on such security on disposition.
In order for the Fund to continue to qualify for
federal income tax treatment as a regulated investment company,
at least 90% of its gross income for a taxable year must be
derived from qualifying income; i.e., dividends, interest, income
derived from loans of securities, and gains from the sale of
securities. Gains realized on the sale or other disposition of
securities, including futures contracts on securities held for
less than three months, must be limited to less than 30% of the
Fund's annual gross income. In order to avoid realizing
excessive gains on securities held less than three months, the
Fund may be required to defer the closing out of futures
contracts beyond the time when it would otherwise be advantageous
to do so. It is anticipated that unrealized gains on futures
contracts, which have been open for less than three months as of
the end of the Fund's fiscal year and which are recognized for
tax purposes, will not be considered gains on securities held
less than three months for purposes of the 30% test.
The Fund will distribute to shareholders annually any
net gains which have been recognized for federal income tax
purposes from futures transactions (including unrealized gains at
the end of the Fund's fiscal year). Such distributions will be
combined with distributions of ordinary income or capital gains
realized on the Fund's other investments. Shareholders will be
advised of the nature of the payments. The Fund's ability to
enter into transactions in options on futures contracts may be
limited by the Internal Revenue Code's requirements for
qualification as a regulated investment company.
Options on Securities
Options are another type of potentially high-risk
derivative.
Bond and Money Funds
The Funds have no current intention of investing in
options on securities, although they reserve the right to do so.
Appropriate disclosure would be added to the Fund's prospectus
PAGE 41
and Statement of Additional Information when and if the Fund
decides to invest in options.
Tax-Efficient Balanced Fund
Writing Covered Call Options
The Fund may write (sell) American or European style
"covered" call options and purchase options to close out options
previously written by a Fund. In writing covered call options,
the Fund expects to generate additional premium income which
should serve to enhance the Fund's total return and reduce the
effect of any price decline of the security or currency involved
in the option. Covered call options will generally be written on
securities or currencies which, in T. Rowe Price's opinion, are
not expected to have any major price increases or moves in the
near future but which, over the long term, are deemed to be
attractive investments for the Fund.
A call option gives the holder (buyer) the "right to
purchase" a security or currency at a specified price (the
exercise price) at expiration of the option (European style) or
at any time until a certain date (the expiration date) (American
style). So long as the obligation of the writer of a call option
continues, he may be assigned an exercise notice by the broker-
dealer through whom such option was sold, requiring him to
deliver the underlying security or currency against payment of
the exercise price. This obligation terminates upon the
expiration of the call option, or such earlier time at which the
writer effects a closing purchase transaction by repurchasing an
option identical to that previously sold. To secure his
obligation to deliver the underlying security or currency in the
case of a call option, a writer is required to deposit in escrow
the underlying security or currency or other assets in accordance
with the rules of a clearing corporation.
The Fund will write only covered call options. This
means that the Fund will own the security or currency subject to
the option or an option to purchase the same underlying security
or currency, having an exercise price equal to or less than the
exercise price of the "covered" option, or will establish and
maintain with its custodian for the term of the option, an
account consisting of cash, U.S. government securities or other
liquid high-grade debt obligations having a value equal to the
fluctuating market value of the optioned securities or
currencies.
Portfolio securities or currencies on which call
options may be written will be purchased solely on the basis of
investment considerations consistent with the Fund's investment
PAGE 42
objective. The writing of covered call options is a conservative
investment technique believed to involve relatively little risk
(in contrast to the writing of naked or uncovered options, which
the Fund will not do), but capable of enhancing the Fund's total
return. When writing a covered call option, a Fund, in return
for the premium, gives up the opportunity for profit from a price
increase in the underlying security or currency above the
exercise price, but conversely retains the risk of loss should
the price of the security or currency decline. Unlike one who
owns securities or currencies not subject to an option, the Fund
has no control over when it may be required to sell the
underlying securities or currencies, since it may be assigned an
exercise notice at any time prior to the expiration of its
obligation as a writer. If a call option which the Fund has
written expires, the Fund will realize a gain in the amount of
the premium; however, such gain may be offset by a decline in the
market value of the underlying security or currency during the
option period. If the call option is exercised, the Fund will
realize a gain or loss from the sale of the underlying security
or currency. The Fund does not consider a security or currency
covered by a call to be "pledged" as that term is used in the
Fund's policy which limits the pledging or mortgaging of its
assets.
The premium received is the market value of an option.
The premium the Fund will receive from writing a call option will
reflect, among other things, the current market price of the
underlying security or currency, the relationship of the exercise
price to such market price, the historical price volatility of
the underlying security or currency, and the length of the option
period. Once the decision to write a call option has been made,
T. Rowe Price, in determining whether a particular call option
should be written on a particular security or currency, will
consider the reasonableness of the anticipated premium and the
likelihood that a liquid secondary market will exist for those
options. The premium received by the Fund for writing covered
call options will be recorded as a liability of the Fund. This
liability will be adjusted daily to the option's current market
value, which will be the latest sale price at the time at which
the net asset value per share of the Fund is computed (close of
the New York Stock Exchange), or, in the absence of such sale,
the latest asked price. The option will be terminated upon
expiration of the option, the purchase of an identical option in
a closing transaction, or delivery of the underlying security or
currency upon the exercise of the option.
Closing transactions will be effected in order to
realize a profit on an outstanding call option, to prevent an
underlying security or currency from being called, or, to permit
the sale of the underlying security or currency. Furthermore,
PAGE 43
effecting a closing transaction will permit the Fund to write
another call option on the underlying security or currency with
either a different exercise price or expiration date or both. If
the Fund desires to sell a particular security or currency from
its portfolio on which it has written a call option, or purchased
a put option, it will seek to effect a closing transaction prior
to, or concurrently with, the sale of the security or currency.
There is, of course, no assurance that the Fund will be able to
effect such closing transactions at favorable prices. If the
Fund cannot enter into such a transaction, it may be required to
hold a security or currency that it might otherwise have sold.
When the Fund writes a covered call option, it runs the risk of
not being able to participate in the appreciation of the
underlying securities or currencies above the exercise price, as
well as the risk of being required to hold on to securities or
currencies that are depreciating in value. This could result in
higher transaction costs. The Fund will pay transaction costs in
connection with the writing of options to close out previously
written options. Such transaction costs are normally higher than
those applicable to purchases and sales of portfolio securities.
Call options written by the Fund will normally have
expiration dates of less than nine months from the date written.
The exercise price of the options may be below, equal to, or
above the current market values of the underlying securities or
currencies at the time the options are written. From time to
time, the Fund may purchase an underlying security or currency
for delivery in accordance with an exercise notice of a call
option assigned to it, rather than delivering such security or
currency from its portfolio. In such cases, additional costs may
be incurred.
The Fund will realize a profit or loss from a closing
purchase transaction if the cost of the transaction is less or
more than the premium received from the writing of the option.
Because increases in the market price of a call option will
generally reflect increases in the market price of the underlying
security or currency, any loss resulting from the repurchase of a
call option is likely to be offset in whole or in part by
appreciation of the underlying security or currency owned by the
Fund.
The Fund will not write a covered call option if, as a
result, the aggregate market value of all portfolio securities or
currencies covering call or put options exceeds 25% of the market
value of the Fund's net assets. In calculating the 25% limit, the
Fund will offset, against the value of assets covering written
calls and puts, the value of purchased calls and puts on
identical securities or currencies with identical maturity dates.
PAGE 44
Writing Covered Put Options
The Fund may write American or European style covered
put options and purchase options to close out options previously
written by the Fund. A put option gives the purchaser of the
option the right to sell, and the writer (seller) has the
obligation to buy, the underlying security or currency at the
exercise price during the option period (American style) or at
the expiration of the option (European style). So long as the
obligation of the writer continues, he may be assigned an
exercise notice by the broker-dealer through whom such option was
sold, requiring him to make payment of the exercise price against
delivery of the underlying security or currency. The operation
of put options in other respects, including their related risks
and rewards, is substantially identical to that of call options.
The Fund would write put options only on a covered
basis, which means that the Fund would maintain in a segregated
account cash, U.S. government securities or other liquid high-
grade debt obligations in an amount not less than the exercise
price or the Fund will own an option to sell the underlying
security or currency subject to the option having an exercise
price equal to or greater than the exercise price of the
"covered" option at all times while the put option is
outstanding. (The rules of a clearing corporation currently
require that such assets be deposited in escrow to secure payment
of the exercise price.)
The Fund would generally write covered put options in
circumstances where T. Rowe Price wishes to purchase the
underlying security or currency for the Fund's portfolio at a
price lower than the current market price of the security or
currency. In such event the Fund would write a put option at an
exercise price which, reduced by the premium received on the
option, reflects the lower price it is willing to pay. Since the
Fund would also receive interest on debt securities or currencies
maintained to cover the exercise price of the option, this
technique could be used to enhance current return during periods
of market uncertainty. The risk in such a transaction would be
that the market price of the underlying security or currency
would decline below the exercise price less the premiums
received. Such a decline could be substantial and result in a
significant loss to the Fund. In addition, the Fund, because it
does not own the specific securities or currencies which it may
be required to purchase in exercise of the put, cannot benefit
from appreciation, if any, with respect to such specific
securities or currencies.
PAGE 45
The Fund will not write a covered put option if, as a
result, the aggregate market value of all portfolio securities or
currencies covering put or call options exceeds 25% of the market
value of the Fund's net assets. In calculating the 25% limit, the
Fund will offset, against the value of assets covering written
puts and calls, the value of purchased puts and calls on
identical securities or currencies with identical maturity dates.
Purchasing Put Options
The Fund may purchase American or European style put
options. As the holder of a put option, the Fund has the right
to sell the underlying security or currency at the exercise price
at any time during the option period (American style) or at the
expiration of the option (European style). The Fund may enter
into closing sale transactions with respect to such options,
exercise them or permit them to expire. The Fund may purchase
put options for defensive purposes in order to protect against an
anticipated decline in the value of its securities or currencies.
An example of such use of put options is provided below.
The Fund may purchase a put option on an underlying
security or currency (a "protective put") owned by the Fund as a
defensive technique in order to protect against an anticipated
decline in the value of the security or currency. Such hedge
protection is provided only during the life of the put option
when the Fund, as the holder of the put option, is able to sell
the underlying security or currency at the put exercise price
regardless of any decline in the underlying security's market
price or currency's exchange value. For example, a put option
may be purchased in order to protect unrealized appreciation of a
security or currency where T. Rowe Price deems it desirable to
continue to hold the security or currency because of tax
considerations. The premium paid for the put option and any
transaction costs would reduce any capital gain otherwise
available for distribution when the security or currency is
eventually sold.
The Fund may also purchase put options at a time when
the Fund does not own the underlying security or currency. By
purchasing put options on a security or currency it does not own,
the Fund seeks to benefit from a decline in the market price of
the underlying security or currency. If the put option is not
sold when it has remaining value, and if the market price of the
underlying security or currency remains equal to or greater than
the exercise price during the life of the put option, the Fund
will lose its entire investment in the put option. In order for
the purchase of a put option to be profitable, the market price
of the underlying security or currency must decline sufficiently
below the exercise price to cover the premium and transaction
PAGE 46
costs, unless the put option is sold in a closing sale
transaction.
The Fund will not commit more than 5% of its assets to
premiums when purchasing put and call options. The premium paid
by the Fund when purchasing a put option will be recorded as an
asset of the Fund. This asset will be adjusted daily to the
option's current market value, which will be the latest sale
price at the time at which the net asset value per share of the
Fund is computed (close of New York Stock Exchange), or, in the
absence of such sale, the latest bid price. This asset will be
terminated upon expiration of the option, the selling (writing)
of an identical option in a closing transaction, or the delivery
of the underlying security or currency upon the exercise of the
option.
Purchasing Call Options
The Fund may purchase American or European style call
options. As the holder of a call option, the Fund has the right
to purchase the underlying security or currency at the exercise
price at any time during the option period (American style) or at
the expiration of the option (European style). The Fund may
enter into closing sale transactions with respect to such
options, exercise them or permit them to expire. The Fund may
purchase call options for the purpose of increasing its current
return or avoiding tax consequences which could reduce its
current return. The Fund may also purchase call options in order
to acquire the underlying securities or currencies. Examples of
such uses of call options are provided below.
Call options may be purchased by the Fund for the
purpose of acquiring the underlying securities or currencies for
its portfolio. Utilized in this fashion, the purchase of call
options enables the Fund to acquire the securities or currencies
at the exercise price of the call option plus the premium paid.
At times the net cost of acquiring securities or currencies in
this manner may be less than the cost of acquiring the securities
or currencies directly. This technique may also be useful to the
Fund in purchasing a large block of securities or currencies that
would be more difficult to acquire by direct market purchases.
So long as it holds such a call option rather than the underlying
security or currency itself, the Fund is partially protected from
any unexpected decline in the market price of the underlying
security or currency and in such event could allow the call
option to expire, incurring a loss only to the extent of the
premium paid for the option.
The Fund will not commit more than 5% of its assets to
premiums when purchasing call and put options. The Fund may also
PAGE 47
purchase call options on underlying securities or currencies it
owns in order to protect unrealized gains on call options
previously written by it. A call option would be purchased for
this purpose where tax considerations make it inadvisable to
realize such gains through a closing purchase transaction. Call
options may also be purchased at times to avoid realizing losses.
Dealer (Over-the-Counter) Options
The Fund may engage in transactions involving dealer
options. Certain risks are specific to dealer options. While
the Fund would look to a clearing corporation to exercise
exchange-traded options, if the Fund were to purchase a dealer
option, it would rely on the dealer from whom it purchased the
option to perform if the option were exercised. Failure by the
dealer to do so would result in the loss of the premium paid by
the Fund as well as loss of the expected benefit of the
transaction.
Exchange-traded options generally have a continuous
liquid market while dealer options have none. Consequently, the
Fund will generally be able to realize the value of a dealer
option it has purchased only by exercising it or reselling it to
the dealer who issued it. Similarly, when the Fund writes a
dealer option, it generally will be able to close out the option
prior to its expiration only by entering into a closing purchase
transaction with the dealer to which the Fund originally wrote
the option. While the Fund will seek to enter into dealer
options only with dealers who will agree to and which are
expected to be capable of entering into closing transactions with
the Fund, there can be no assurance that the Fund will be able to
liquidate a dealer option at a favorable price at any time prior
to expiration. Until the Fund, as a covered dealer call option
writer, is able to effect a closing purchase transaction, it will
not be able to liquidate securities (or other assets) or
currencies used as cover until the option expires or is
exercised. In the event of insolvency of the contra party, the
Fund may be unable to liquidate a dealer option. With respect to
options written by the Fund, the inability to enter into a
closing transaction may result in material losses to the Fund.
For example, since the Fund must maintain a secured position with
respect to any call option on a security it writes, the Fund may
not sell the assets which it has segregated to secure the
position while it is obligated under the option. This
requirement may impair a Fund's ability to sell portfolio
securities or currencies at a time when such sale might be
advantageous.
<PAGE>
PAGE 48
The Staff of the SEC has taken the position that
purchased dealer options and the assets used to secure the
written dealer options are illiquid securities. The Fund may
treat the cover used for written OTC options as liquid if the
dealer agrees that the Fund may repurchase the OTC option it has
written for a maximum price to be calculated by a predetermined
formula. In such cases, the OTC option would be considered
illiquid only to the extent the maximum repurchase price under
the formula exceeds the intrinsic value of the option.
Accordingly, the Fund will treat dealer options as subject to the
Fund's limitation on illiquid securities. If the SEC changes its
position on the liquidity of dealer options, the Fund will change
its treatment of such instrument accordingly.
Lending of Portfolio Securities
Securities loans are made to broker-dealers or
institutional investors or other persons, pursuant to agreements
requiring that the loans be continuously secured by collateral at
least equal at all times to the value of the securities lent
marked to market on a daily basis. The collateral received will
consist of cash, U.S. government securities, letters of credit or
such other collateral as may be permitted under its investment
program. While the securities are being lent, the Fund will
continue to receive the equivalent of the interest or dividends
paid by the issuer on the securities, as well as interest on the
investment of the collateral or a fee from the borrower. The
Fund has a right to call each loan and obtain the securities on
five business days' notice or, in connection with securities
trading on foreign markets, within such longer period of time
which coincides with the normal settlement period for purchases
and sales of such securities in such foreign markets. The Fund
will not have the right to vote on securities while they are
being lent, but it will call a loan in anticipation of any
important vote. The risks in lending portfolio securities, as
with other extensions of secured credit, consist of possible
delay in receiving additional collateral or in the recovery of
the securities or possible loss of rights in the collateral
should the borrower fail financially. Loans will only be made to
firms deemed by T. Rowe Price to be of good standing and will not
be made unless, in the judgment of T. Rowe Price, the
consideration to be earned from such loans would justify the
risk.
Repurchase Agreements
The Fund may enter into a repurchase agreement through
which an investor (such as the Fund) purchases a security (known
as the "underlying security") from a well-established securities
PAGE 49
dealer or a bank that is a member of the Federal Reserve System.
Any such dealer or bank will be on T. Rowe Price's approved list
and have a credit rating with respect to its short-term debt of
at least A1 by Standard & Poor's Corporation, P1 by Moody's
Investors Service, Inc., or the equivalent rating by T. Rowe
Price. At that time, the bank or securities dealer agrees to
repurchase the underlying security at the same price, plus
specified interest. Repurchase agreements are generally for a
short period of time, often less than a week. Repurchase
agreements which do not provide for payment within seven days
will be treated as illiquid securities. The Fund will only enter
into repurchase agreements where (i) the underlying securities
are of the type (excluding maturity limitations) which the Fund's
investment guidelines would allow it to purchase directly, (ii)
the market value of the underlying security, including interest
accrued, will be at all times equal to or exceed the value of the
repurchase agreement, and (iii) payment for the underlying
security is made only upon physical delivery or evidence of book-
entry transfer to the account of the custodian or a bank acting
as agent. In the event of a bankruptcy or other default of a
seller of a repurchase agreement, the Fund could experience both
delays in liquidating the underlying security and losses,
including: (a) possible decline in the value of the underlying
security during the period while the Fund seeks to enforce its
rights thereto; (b) possible subnormal levels of income and lack
of access to income during this period; and (c) expenses of
enforcing its rights.
Reverse Repurchase Agreements
Although the Fund has no current intention, in the
foreseeable future, of engaging in reverse repurchase agreements,
the Fund reserves the right to do so. Reverse repurchase
agreements are ordinary repurchase agreements in which a Fund is
the seller of, rather than the investor in, securities, and
agrees to repurchase them at an agreed upon time and price. Use
of a reverse repurchase agreement may be preferable to a regular
sale and later repurchase of the securities because it avoids
certain market risks and transaction costs. A reverse repurchase
agreement may be viewed as a type of borrowing by the Fund,
subject to Investment Restriction (1). (See "Investment
Restrictions," below.)
<PAGE>
PAGE 50
INVESTMENT RESTRICTIONS
All Funds
Fundamental policies may not be changed without the
approval of the lesser of (1) 67% of a Fund's shares present at a
meeting of shareholders if the holders of more than 50% of the
outstanding shares are present in person or by proxy or (2) more
than 50% of a Fund's outstanding shares. Other restrictions in
the form of operating policies are subject to change by a Fund's
Board of Directors without shareholder approval. Any investment
restriction which involves a maximum percentage of securities or
assets shall not be considered to be violated unless an excess
over the percentage occurs immediately after, and is caused by,
an acquisition of securities or assets of, or borrowings by, a
Fund.
Fundamental Policies
As a matter of fundamental policy, the Fund may not:
(1) Borrowing. Borrow money except that the Fund may (i)
borrow for non-leveraging, temporary or emergency
purposes and (ii) engage in reverse repurchase
agreements and make other investments or engage in
other transactions, which may involve a borrowing, in
a manner consistent with the Fund's investment
objective and program, provided that the combination
of (i) and (ii) shall not exceed 33 1/3% of the value
of the Fund's total assets (including the amount
borrowed) less liabilities (other than borrowings) or
such other percentage permitted by law. Any
borrowings which come to exceed this amount will be
reduced in accordance with applicable law. The Fund
may borrow from banks, other Price Funds or other
persons to the extent permitted by applicable law;
(2) Commodities. Purchase or sell physical commodities;
except that the Fund (other than the Money Fund) may
enter into futures contracts and options thereon;
(3) Industry Concentration. Purchase the securities of
any issuer if, as a result, more than 25% of the
value of the Fund's total assets would be invested in
the securities of issuers having their principal
business activities in the same industry;
<PAGE>
PAGE 51
(4) Loans. Make loans, although the Fund may (i) lend
portfolio securities and participate in an interfund
lending program with other Price Funds provided that
no such loan may be made if, as a result, the
aggregate of such loans would exceed 33 1/3% of the
value of the Fund's total assets; (ii) purchase money
market securities and enter into repurchase
agreements; and (iii) acquire publicly-distributed or
privately-placed debt securities and purchase debt;
(5) Percent Limit on Assets Invested in Any One Issuer.
Purchase a security if, as a result, with respect to
75% of the value of its total assets, more than 5% of
the value of the Fund's total assets would be
invested in the securities of a single issuer, except
securities issued or guaranteed by the U.S.
Government or any of its agencies or
instrumentalities;
(6) Percent Limit on Share Ownership of Any One Issuer.
Purchase a security if, as a result, with respect to
75% of the value of the Fund's total assets, more
than 10% of the outstanding voting securities of any
issuer would be held by the Fund (other than
obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities);
(7) Real Estate. Purchase or sell real estate, including
limited partnership interests therein, unless
acquired as a result of ownership of securities or
other instruments (but this shall not prevent the
Fund from investing in securities or other
instruments backed by real estate or in securities of
companies engaged in the real estate business);
(8) Senior Securities. Issue senior securities except in
compliance with the Investment Company Act of 1940;
(9) Taxable Securities (All Funds, except Tax-Efficient
Balanced). During periods of normal market
conditions, purchase any security if, as a result,
less than 80% of the Fund's income would be exempt
from federal income tax. The income included under
the 80% test does not include income from securities
subject to the alternative minimum tax (AMT); or
(10) Underwriting. Underwrite securities issued by other
persons, except to the extent that the Fund may be
deemed to be an underwriter within the meaning of the
Securities Act of 1933 in connection with the
PAGE 52
purchase and sale of its portfolio securities in the
ordinary course of pursuing its investment program.
NOTES
The following Notes should be read in connection with the
above-described fundamental policies. The Notes are not
fundamental policies.
With respect to investment restrictions (1) and (4) the
Fund will not borrow from or lend to any other T. Rowe
Price Fund unless they apply for and receive an exemptive
order from the SEC or the SEC issues rules permitting
such transactions. The Fund has no current intention of
engaging in any such activity and there is no assurance
the SEC would grant any order requested by the Fund or
promulgate any rules allowing the transactions.
With respect to investment restriction (1), the Money
Fund has no current intention of engaging in any
borrowing transactions.
With respect to investment restriction (2), the Fund does
not consider hybrid instruments to be commodities.
For purposes of investment restriction (3), U.S., state
or local governments, or related agencies or
instrumentalities, are not considered an industry.
Industrial development bonds issued by nongovernmental
users are subject to the restriction on concentration.
Operating Policies
As a matter of operating policy, the Fund may not:
(1) Borrowing. The Fund will not purchase additional
securities when money borrowed exceeds 5% of its
total assets;
(2) Control of Portfolio Companies. Invest in companies
for the purpose of exercising management or control;
(3) Equity Securities (All Funds, except Tax-Efficient
Balanced). Purchase any equity security or security
convertible into an equity security provided that the
Fund (other than the Money Fund) may invest up to 10%
of its total assets in equity securities which pay
tax-exempt dividends and which are otherwise
consistent with the Fund's investment objective and,
further provided, that the Money Fund may invest up
PAGE 53
to 10% of its total assets in equity securities of
other tax-free open-end money market funds;
(4) Futures Contracts. Purchase a futures contract or an
option thereon if, with respect to positions in
futures or options on futures which do not represent
bona fide hedging, the aggregate initial margin and
premiums on such positions would exceed 5% of the
Fund's net asset value;
(5) Illiquid Securities. Purchase illiquid securities
if, as a result, more than 15% (10% for the Money
Fund) of its net assets would be invested in such
securities;
(6) Investment Companies. Purchase securities of open-
end or closed-end investment companies except in
compliance with the Investment Company Act of 1940,
provided that, the Money Fund may only purchase the
securities of other tax-free open-end money market
investment companies;
(7) Margin. Purchase securities on margin, except (i)
for use of short-term credit necessary for clearance
of purchases of portfolio securities and (ii) it may
make margin deposits in connection with futures
contracts or other permissible investments;
(8) Mortgaging. Mortgage, pledge, hypothecate or, in any
manner, transfer any security owned by the Fund as
security for indebtedness except as may be necessary
in connection with permissible borrowings or
investments and then such mortgaging, pledging or
hypothecating may not exceed 33 1/3% of the Fund's
total assets at the time of borrowing or investment;
(9) Oil and Gas Programs. Purchase participations in, or
other direct interests or enter into leases with
respect to, oil, gas, or other mineral exploration or
development programs if, as a result thereof, more
than 5% of the value of the total assets of the Fund
would be invested in such programs;
(10) Options, Etc. Invest in puts, calls, straddles,
spreads, or any combination thereof, except to the
extent permitted by the prospectus and Statement of
Additional Information;
(11) Short Sales. Effect short sales of securities; or
PAGE 54
(12) Warrants. Invest in warrants if, as a result
thereof, more than 2% of the value of the net assets
of the Fund would be invested in warrants.
For purposes of investment restriction (6), the Fund has no
current intention of purchasing the securities of other
investment companies. Duplicate fees could result from any
such purchases.
RATINGS OF MUNICIPAL DEBT SECURITIES
Moody's Investors Service, Inc.
Aaa - Bonds 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."
Aa - Bonds 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.
A - Bonds rated A possess many favorable investment
attributes and are to be considered as upper medium grade
obligations.
Baa - Bonds 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 rated Ba are judged to have speculative elements:
their futures 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 characterize
bonds in this class.
B - Bonds rated B generally lack the characteristics of a
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.
Caa - Bonds rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with
respect to principal or interest.
PAGE 55
Ca - Bonds rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default
or have other marked short-comings.
C - Lowest-rated; extremely poor prospects of ever attaining
investment standing.
Standard & Poor's Corporation
AAA - This is the highest rating assigned by Standard &
Poor's to a debt obligation and indicates an extremely strong
capacity to pay principal and interest.
AA - Bonds rated AA also qualify as high-quality debt
obligations. Capacity to pay principal and interest is very
strong.
A - Bonds rated A have a strong capacity to pay principal
and interest, although they are somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions.
BBB - Bonds rated BBB are regarded as having an adequate
capacity to pay principal and interest. Whereas they normally
exhibit adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead to a
weakened capacity to pay principal and interest for bonds in this
category than for bonds in the A category.
BB, C, CCC, CC - Bonds rated BB, B, CCC, and CC are regarded
on balance, as predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal. BB
indicates the lowest degree of speculation and CC the highest
degree of speculation. While such bonds will likely have some
quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse
conditions.
D - In default.
Fitch Investors Service, Inc.
AAA - Bonds rated AAA are considered to be investment grade and
of the highest credit quality. The obligor has an exceptionally
strong ability to pay interest and repay principal, which is
unlikely to be affected by reasonably foreseeable events.
AA - Bonds rated AA are considered to be investment grade and of
very high credit quality. The obligor's ability to pay interest
and repay principal is very strong, although not quite as strong
PAGE 56
as bonds rated AAA. Because bonds rated in the AAA and AA
categories are not significantly vulnerable to foreseeable future
developments, short-term debt of these issuers is generally rate
F-1+.
A - Bonds rated A are considered to be investment grade and of
high credit quality. The obligor's ability to pay interest and
repay principal is considered to be strong, but may be more
vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB - Bonds rated BBB are considered to be investment grade and
of satisfactory credit quality. The obligor's ability to pay
interest and repay principal is considered to be adequate.
Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these bonds,
and therefore impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher
than for bonds with higher ratings.
BB, B, CCC, CC, and C are regarded on balance as predominantly
speculative with respect to the issuer's capacity to repay
interest and repay principal in accordance with the terms of the
obligation for bond issues not in default. BB indicates the
lowest degree of speculation and C the highest degree of
speculation. The rating takes into consideration special
features of the issue, its relationship to other obligations of
the issuer, and the current and prospective financial condition
and operating performance of the issuer.
RATINGS OF MUNICIPAL NOTES AND VARIABLE SECURITIES
Moody's Investors Services, Inc.
VMIG-1/MIG-1: the best quality. VMIG-2/MIG-2: high quality,
with margins of protection ample though not so large as in the
preceding group.
VMIG-3/MIG-3: favorable quality, with all security elements
accounted for, but lacking the undeniable strength of the
preceding grades. Market access for refinancing, in particular,
is likely to be less well established. VMIG-4/MIG-4: adequate
quality but there is specific risk.
Standard & Poor's Corporation
<PAGE>
PAGE 57
SP-1: very strong or strong capacity to pay principal and
interest. Those issues determined to possess overwhelming safety
characteristics will be given a plus (+) designation. SP-2:
satisfactory capacity to pay principal and interest.
SP-3: speculative capacity to pay principal and interest.
Fitch Investors Service, Inc.
F-1+: exceptionally strong credit quality, strongest degree of
assurance for timely payment. F-1: very strong credit quality.
F-2: good credit quality, having a satisfactory degree of
assurance for timely payment. F-3: fair credit quality,
assurance for timely payment is adequate but adverse changes
could cause the securities to be rated below investment grade.
F-S: weak credit quality, having characteristics suggesting a
minimal degree of assurance for timely payment.
RATINGS OF COMMERCIAL PAPER
Moody's Investors Service, Inc.
P-1: Superior capacity for repayment. P-2: strong capacity for
repayment.
P-3: acceptable capacity for repayment of short-term promissory
obligations.
Standard & Poor's Corporation
A-1: highest category, degree of safety regarding timely payment
is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+)
designation. A-2: satisfactory capacity to pay principal and
interest.
A-3: adequate capacity for timely payment, but are vulnerable to
adverse effects of changes in circumstances than higher rated
issues. B, and C: speculative capacity to pay principal and
interest.
Fitch Investors Service, Inc.
F-1+: exceptionally strong credit quality, strongest degree of
assurance for timely payment. F-1: very strong credit quality.
<PAGE>
PAGE 58
F-2: good credit quality, having a satisfactory degree of
assurance for timely payment. F-3: fair credit quality,
assurance for timely payment is adequate but adverse changes
could cause the securities to be rated below investment grade.
F-5: weak credit quality, having characteristics suggesting a
minimal degree of assurance for timely payment.
MANAGEMENT OF FUNDS
The officers and directors of each of the Funds are listed
below. Unless otherwise noted, the address of each is 100 East
Pratt Street, Baltimore, Maryland 21202. Except as indicated,
each has been an employee of T. Rowe Price for more than five
years. In the list below, the Funds' directors who are
considered "interested persons" of T. Rowe Price as defined under
Section 2(a)(19) of the Investment Company Act of 1940 are noted
with an asterisk (*). These directors are referred to as inside
directors by virtue of their officership, directorship, and/or
employment with T. Rowe Price.
All Funds (except Tax-Efficient Balanced)
Independent Directors
ROBERT P. BLACK, Retired; formerly President, Federal Reserve
Bank of Richmond; Address: 10 Dahlgren Road, Richmond, Virginia
23233
CALVIN W. BURNETT, PH.D., President, Coppin State College; Board
of Directors, McDonogh School, Inc. and Provident Bank of
Maryland; Past President, Baltimore Area Council Boy Scouts of
America; Vice President, Board of Directors, The Walters Art
Gallery; Address: 2500 West North Avenue, Baltimore, Maryland
21216
ANTHONY W. DEERING, Director, President and Chief Executive
Officer, The Rouse Company, real estate developers, Columbia,
Maryland; Advisory Director, Kleinwort, Benson (North America)
Corporation, a registered broker-dealer; Address: 10275 Little
Patuxent Parkway, Columbia, Maryland 21044
F. PIERCE LINAWEAVER, President, F. Pierce Linaweaver &
Associates, Inc., Consulting Environmental & Civil Engineer(s);
formerly (1987-1991) Executive Vice President, EA Engineering,
Science, and Technology, Inc.; and (1987-1990) President, EA
Engineering, Inc., Baltimore, Maryland; Address: The Legg Mason
Tower, 111 South Calvert Street, Suite 2700, Baltimore, Maryland
21202
JOHN G. SCHREIBER, President, Schreiber Investments, Inc., a real
estate investment company; Director and formerly (1/80-12/90)
PAGE 59
Executive Vice President, JMB Realty Corporation, a national real
estate investment manager and developer; Address: 1115 East
Illinois Road, Lake Forest, Illinois 60045
All Funds (except Tax-Efficient Balanced)
Officers
*JAMES S. RIEPE, Director and Vice President--Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Services,
Inc., T. Rowe Price Retirement Plan Services, Inc., T. Rowe Price
Trust Company, and T. Rowe Price Investment Services, Inc.;
Director, Rhone-Poulenc Rorer, Inc.
*M. DAVID TESTA, Director--Chairman of the Board, Price-Fleming;
Vice Chairman of the Board, Chief Investment Officer, and
Managing Director, T. Rowe Price; Vice President and Director,
T. Rowe Price Trust Company; Chartered Financial Analyst;
Chartered Investment Counselor
JANET G. ALBRIGHT, Vice President--Vice President, T. Rowe Price
PATRICIA S. DEFORD, Vice President--Vice President, T. Rowe Price
CHARLES O. HOLLAND, Vice President--Vice President, T. Rowe Price
HENRY H. HOPKINS, Vice President--Vice President, Price-Fleming
and T. Rowe Price Retirement Plan Services, Inc.; Director and
Managing Director, T. Rowe Price; Vice President and Director,
T. Rowe Price Investment Services, Inc., T. Rowe Price Services,
Inc. and T. Rowe Price Trust Company
ALAN P. RICHMAN, Vice President--Vice President, T. Rowe Price
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
PATRICIA S. BUTCHER, Assistant Secretary--Assistant Vice
President, T. Rowe Price and T. Rowe Price Investment Services,
Inc.
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price,
T. Rowe Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price,
and T. Rowe Price Trust Company
EDWARD T. SCHNEIDER, Assistant Vice President--Vice President,
T. Rowe Price
INGRID I. VORDEMBERGE, Assistant Vice President--Employee,
T. Rowe Price
Tax-Exempt Money Fund
*WILLIAM T. REYNOLDS, Chairman of the Board--Director and
Managing Director, T. Rowe Price
PATRICE L. BERCHTENBREITER ELY, President--Vice President,
T. Rowe Price
PAUL W. BOLTZ, Vice President--Vice President and Financial
Economist, T. Rowe Price
JOSEPH K. LYNAGH, Vice President--Assistant Vice President,
T. Rowe Price
PAGE 60
MARY J. MILLER, Vice President--Managing Director, T. Rowe Price
THEODORE E. ROBSON, Vice President--Assistant Vice President,
T. Rowe Price
C. STEPHEN WOLFE, II, Vice President--Vice President, T. Rowe
Price
LAURA L. MCAREE, Vice President--Assistant Vice President,
T. Rowe Price
JEREMY N. BAKER, Assistant Vice President--Employee, T. Rowe
Price
Tax-Free Short-Intermediate Fund
*WILLIAM T. REYNOLDS, Chairman of the Board--Director and
Managing Director, T. Rowe Price
MARY J. MILLER, President--Managing Director, T. Rowe Price
CHARLES B. HILL, Executive Vice President--Vice President,
T. Rowe Price
PATRICE L. BERCHTENBREITER ELY, Vice President--Vice President,
T. Rowe Price
KONSTANTINE B. MALLAS, Vice President-- Vice President, T. Rowe
Price
LAURA L. MCAREE, Vice President--Assistant Vice President,
T. Rowe Price
HUGH D. MCGUIRK, Vice President--Vice President, T. Rowe Price;
(1991-1993) municipal underwriter, Alex. Brown & Sons, Inc.,
Baltimore, Maryland
C. STEPHEN WOLFE, II, Vice President--Vice President, T. Rowe
Price
Tax-Free Insured Intermediate Bond Fund
*WILLIAM T. REYNOLDS, Director--Director and Managing Director,
T. Rowe Price
MARY J. MILLER, Executive Vice President--Managing Director,
T. Rowe Price
CHARLES B. HILL, Vice President--Vice President, T. Rowe Price
KONSTANTINE B. MALLAS, Vice President--Assistant Vice President,
T. Rowe Price
HUGH D. MCGUIRK, Vice President--Vice President, T. Rowe Price;
formerly (1991-1993) municipal underwriter, Alex. Brown & Sons,
Inc., Baltimore, Maryland
LAURA L. MCAREE, Vice President--Assistant Vice President,
T. Rowe Price
WILLIAM F. SNIDER, Vice President--Vice President, T. Rowe Price
Tax-Free Income Fund
*WILLIAM T. REYNOLDS, Chairman of the Board--Director and
Managing Director, T. Rowe Price
MARY J. MILLER, President--Managing Director, T. Rowe Price
PAGE 61
PATRICE L. BERCHTENBREITER ELY, Vice President--Vice President,
T. Rowe Price
A. GENE CAPONI, Vice President--Vice President and Analyst,
T. Rowe Price
CHARLES B. HILL, Vice President--Vice President, T. Rowe Price
KONSTANTINE B. MALLAS, Vice President--Vice President, T. Rowe
Price
HUGH D. MCGUIRK, Vice President--Vice President, T. Rowe Price;
(1991-1993) municipal underwriter, Alex. Brown & Sons, Inc.,
Baltimore, Maryland
WILLIAM F. SNIDER, Vice President--Vice President, T. Rowe Price
C. STEPHEN WOLFE, II, Vice President--Vice President, T. Rowe
Price
Tax-Free High Yield Fund
*WILLIAM T. REYNOLDS, Chairman of the Board--Director and
Managing Director, T. Rowe Price
C. STEPHEN WOLFE, II, President--Vice President, T. Rowe Price
A. GENE CAPONI, Vice President--Vice President and Analyst,
T. Rowe Price
CHARLES B. HILL, Vice President--Vice President, T. Rowe Price
KONSTANTINE B. MALLAS, Vice President--Vice President, T. Rowe
Price
HUGH D. MCGUIRK, Vice President--Vice President, T. Rowe Price;
(1991-1993) municipal underwriter, Alex. Brown & Sons, Inc.,
Baltimore, Maryland
MARY J. MILLER, Vice President--Managing Director, T. Rowe Price
WILLIAM F. SNIDER, Vice President--Vice President, T. Rowe Price
Tax-Efficient Balanced Fund
DONALD W. DICK, JR., Director--Principal, EuroCapital Advisors,
LLC, an acquisition and management advisory firm; formerly (5/89-
6/95) Principal, Overseas Partners, Inc., a financial investment
firm; formerly (6/65-3/89) Director and Vice President-Consumer
Products Division, McCormick & Company, Inc., international food
processors; Director, Waverly, Inc., Baltimore, Maryland;
Address: P.O. Box 491, Chilmark, MA 02535-0491
DAVID F. FAGIN, Director--Chairman, Chief Executive Officer and
Director, Golden Star Resources, Ltd.; formerly (1986-7/91)
President, Chief Operating Officer and Director, Homestake Mining
Company; Address: One Norwest Center, 1700 Lincoln Street, Suite
1950, Denver, Colorado 80203
*JAMES A.C. KENNEDY, III, Director and Vice President--Managing
Director of T. Rowe Price; Chartered Financial Analyst
HANNE M. MERRIMAN, Director--Retail business consultant; formerly
President and Chief Operating Officer (1991-92), Nan Duskin,
Inc., a women's specialty store, Director (1984-1990) and
Chairman (1989-90) Federal Reserve Bank of Richmond, and
PAGE 62
President and Chief Executive Officer (1988-89), Honeybee, Inc.,
a division of Spiegel, Inc.; Director, Central Illinois Public
Service Company, CIPSCO Incorporated, The Rouse Company, State
Farm Mutual Automobile Insurance Company and USAir Group, Inc.;
Address: 3201 New Mexico Avenue, N.W., Suite 350, Washington,
D.C. 20016
*JAMES S. RIEPE, Director and President--Vice Chairman of the
Board and Managing Director, T. Rowe Price; Chairman of the
Board, T. Rowe Price Services, Inc., T. Rowe Price Retirement
Plan Services, Inc., and T. Rowe Price Investment Services, Inc;
President and Trust Officer, T. Rowe Price Trust Company;
Director, Rowe Price-Fleming International, Inc. and Rhone-
Poulenc Rorer, Inc.
*M. DAVID TESTA, Director--Chairman of the Board, Price-Fleming;
Vice Chairman of the Board, Chief Investment Officer, and
Managing Director, T. Rowe Price; Vice President and Director,
T. Rowe Price Trust Company; Chartered Financial Analyst;
Chartered Investment Counselor
HUBERT D. VOS, Director--President, Stonington Capital
Corporation, a private investment company; Address: 1114 State
Street, Suite 247, P.O. Box 90409, Santa Barbara, California
93190-0409
PAUL M. WYTHES, Director--Founding General Partner, Sutter Hill
Ventures, a venture capital limited partnership, providing equity
capital to young high technology companies throughout the United
States; Director, Teltone Corporation, Interventional
Technologies Inc. and Stuart Medical, Inc.; Address: 755 Page
Mill Road, Suite A200, Palo Alto, California 94304-1005
MARY J. MILLER, Executive Vice President--Managing Director,
T. Rowe Price
DONALD J. PETERS, Executive Vice President--Vice President,
T. Rowe Price; formerly portfolio manager, Geewax Terker and
Company
STEPHEN W. BOESEL, Vice President--Vice President, T. Rowe Price
HENRY H. HOPKINS, Vice President--Director and Managing Director,
T. Rowe Price; Vice President and Director, T. Rowe Price
Investment Services, Inc., T. Rowe Price Services, Inc., and
T. Rowe Price Trust Company; Vice President, Rowe Price-Fleming
International, Inc. and T. Rowe Price Retirement Plan Services,
Inc.
HUGH D. MCGUIRK, Vice President--Vice President, T. Rowe Price;
(1991-1993) municipal underwriter, Alex. Brown & Sons, Inc.,
Baltimore, Maryland
WILLIAM T. REYNOLDS, Vice President--Managing Director, T. Rowe
Price; Chartered Financial Analyst
WILLIAM F. SNIDER, Vice President--Vice President, T. Rowe Price
WILLIAM J. STROMBERG, Vice President--Vice President, T. Rowe
Price; Chartered Financial Analyst
ARTHUR S. VARNADO, Vice President--Vice President, T. Rowe Price
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
PAGE 63
PATRICIA S. BUTCHER, Assistant Secretary--Assistant Vice
President, T. Rowe Price and T. Rowe Price Investment Services,
Inc.
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price,
T. Rowe Price Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price,
T. Rowe Price Services, Inc., and T. Rowe Price Trust Company
J. JEFFREY LANG, Assistant Vice President--Assistant Vice
President, T. Rowe Price
INGRID I. VORDEMBERGE, Assistant Vice President--Employee,
T. Rowe Price
The Executive Committee of the Money, Income, High
Yield, and Insured Intermediate Bond Funds is composed of Messrs.
Reynolds, Riepe, and Testa; and the Executive Committee of the
Short-Intermediate Fund, is composed of Mrs. Miller and Messrs.
Reynolds, Riepe, Testa. The Executive Committee of the Tax-
Efficient Balanced Fund is composed of Messrs. Kennedy, Riepe,
and Testa. These Executive Committees have been authorized by
their respective Board of Directors to exercise all powers of the
Board to manage the Fund in the intervals between meetings of the
Board, except the powers prohibited by statute from being
delegated.
COMPENSATION TABLE
The Funds do not pay pension or retirement benefits to
their officers or directors. Also, any director of a Fund who is
an officer or employee of T. Rowe Price does not receive any
remuneration from the Fund.
_________________________________________________________________
Total Compensation
Aggregate from Fund and
Name of Compensation Fund Group
Person, from Paid to
Position Fund(a) Directors(b)
_________________________________________________________________
Tax-Exempt Money Fund
Robert P. Black, $2,409 $56,917
Director
Calvin W. Burnett, Ph.D, 2,409 56,917
Director
Anthony W. Deering, 1,569 70,667
Director
<PAGE>
PAGE 64
F. Pierce Linaweaver, 2,409 56,917
Director
John Schreiber, 2,409 56,917
Director
_________________________________________________________________
Tax-Free Short-Intermediate Fund
Robert P. Black, $1,567 $56,917
Director
Calvin W. Burnett, Ph.D, 1,567 56,917
Director
Anthony W. Deering, 1,224 70,667
Director
F. Pierce Linaweaver, 1,567 56,917
Director
John G. Schreiber, 1,567 56,917
Director
_________________________________________________________________
Tax-Free Insured Intermediate Bond Fund
Robert P. Black, $1,163 $56,917
Director
Calvin W. Burnett, Ph.D, 1,163 56,917
Director
Anthony W. Deering, 1,063 70,667
Director
F. Pierce Linaweaver, 1,163 56,917
Director
John Schreiber, 1,163 56,917
Director
_________________________________________________________________
Tax-Free Income Fund
Robert P. Black, $2,830 $56,917
Director
Calvin W. Burnett, Ph.D, 2,830 56,917
Director
Anthony W. Deering, 1,792 70,667
Director
PAGE 65
F. Pierce Linaweaver, 2,830 56,917
Director
John G. Schreiber, 2,830 56,917
Director
_________________________________________________________________
Tax-Free High Yield Fund
Robert P. Black, $2,969 $56,917
Director
Calvin W. Burnett, Ph.D, 2,969 56,917
Director
Anthony W. Deering, 1,792 70,667
Director
F. Pierce Linaweaver, 2,969 56,917
Director
John G. Schreiber, 2,969 56,917
Director
_________________________________________________________________
Tax-Efficient Balanced Fund (c)
Donald W. Dick, Jr., $503 $72,917
Director
David K. Fagin, 751 59,167
Director
Hanne M. Merriman, 751 59,167
Director
Hubert D. Vos, 751 59,167
Director
Paul M. Wythes, 572 69,667
Director
a Amounts in this Column are based on accrued compensation for
the period March 1, 1996 through February 28, 1997.
b Amounts in this column are based on compensation received
from the T. Rowe Price Funds from January 1, 1996 through
December 31, 1996. The T. Rowe Price Fund complex included
the funds as of December 31, 1996.
c Amounts for the Tax-Efficient Balanced Fund are estimated.
<PAGE>
PAGE 66
PRINCIPAL HOLDERS OF SECURITIES
As of the date of the prospectus, the officers and
directors of the Funds, as a group, owned less than 1% of the
outstanding shares of each Fund.
As of March 31, 1997, no shareholder beneficially owned
more than 5% of the outstanding shares of the Fund.
INVESTMENT MANAGEMENT SERVICES
Services Provided by T. Rowe Price
Under each Fund's Management Agreement, T. Rowe Price
provides each Fund with discretionary investment services.
Specifically, T. Rowe Price is responsible for supervising and
directing the investments of each Fund in accordance with its
investment objectives, programs, and restrictions as provided in
the prospectus and this Statement of Additional Information.
T. Rowe Price is also responsible for effecting all security
transactions on behalf of each Fund, including the allocation of
principal business and portfolio brokerage and the negotiation of
commissions. In addition to these services, T. Rowe Price
provides each Fund with certain corporate administrative
services, including: maintaining the Fund's corporate existence,
corporate records, and registering and qualifying the Fund's
shares under federal and state laws; monitoring the financial,
accounting, and administrative functions of each Fund;
maintaining liaison with the agents employed by each Fund such as
the Fund's custodian and transfer agent; assisting each Fund in
the coordination of such agents' activities; and permitting
T. Rowe Price's employees to serve as officers, directors, and
committee members of each Fund without cost to the Fund.
The Management Agreements also provide that T. Rowe
Price, its directors, officers, employees, and certain other
persons performing specific functions for the Fund will only be
liable to the Fund for losses resulting from willful misfeasance,
bad faith, gross negligence, or reckless disregard of duty.
Management Fee
Each Fund pays T. Rowe Price a fee ("Fee") which
consists of two components: a Group Management Fee ("Group Fee")
and an Individual Fund Fee ("Fund Fee"). The Fee is paid monthly
to the T. Rowe Price on the first business day of the next
succeeding calendar month and is calculated as described below.
PAGE 67
The monthly Group Fee ("Monthly Group Fee") is the sum
of the daily Group Fee accruals ("Daily Group Fee Accruals") for
each month. The Daily Group Fee Accrual for any particular day
is computed by multiplying the Price Funds' group fee accrual as
determined below ("Daily Price Funds' Group Fee Accrual") by the
ratio of the Fund's net assets for that day to the sum of the
aggregate net assets of the Price Funds for that day. The Daily
Price Funds' Group Fee Accrual for any particular day is
calculated by multiplying the fraction of one (1) over the number
of calendar days in the year by the annualized Daily Price Funds'
Group Fee Accrual for that day as determined in accordance with
the following schedule:
Price Funds'
Annual Group Base Fee
Rate for Each Level of Assets
_____________________________
0.480% First $1 billion
0.450% Next $1 billion
0.420% Next $1 billion
0.390% Next $1 billion
0.370% Next $1 billion
0.360% Next $2 billion
0.350% Next $2 billion
0.340% Next $5 billion
0.330% Next $10 billion
0.320% Next $10 billion
0.310% Next $16 billion
0.305% Next $30 billion
0.300% Thereafter
For the purpose of calculating the Group Fee, the Price
Funds include all the mutual funds distributed by T. Rowe Price
Investment Services, Inc. (excluding T. Rowe Price Spectrum Fund,
Inc., T. Rowe Price Equity Index Fund, and any institutional or
any private label mutual funds). For the purpose of calculating
the Daily Price Funds' Group Fee Accrual for any particular day,
the net assets of each Price Fund are determined in accordance
with the Fund's prospectus as of the close of business on the
previous business day on which the Fund was open for business.
The monthly Fund Fee ("Monthly Fund Fee") is the sum of
the daily Fund Fee accruals ("Daily Fund Fee Accruals") for each
month. The Daily Fund Fee Accrual for any particular day is
computed by multiplying the fraction of one (1) over the number
of calendar days in the year by the Individual Fund Fee Rate and
multiplying this product by the net assets of the Fund for that
day, as determined in accordance with the Fund's prospectus as of
the close of business on the previous business day on which the
PAGE 68
Fund was open for business. The individual fund fees for each
Fund are listed in the table below:
Fund Individual Fund Fee
_______ ________________________
Money 0.10%
Short-Intermediate 0.10%
Insured Intermediate Bond 0.05%
Income 0.15%
High Yield 0.30%
Tax-Efficient Balanced 0.20%
The following chart sets forth the total management
fees, if any, paid to T. Rowe Price by the Funds, for each of the
last three fiscal years.
Fund 1997 1996 1995
_______ ______ ______ ______
Money $2,880,000 $2,993,000 $3,346,000
Short-Intermediate 1,884,000 1,975,000 2,171,000
Insured Intermediate
Bond 315,000 274,000 206,000
Income 6,426,000 6,613,000 6,547,000
High Yield 6,309,000 5,968,000 5,561,000
Tax-Efficient Balanced * * *
* Prior to commencement of operations.
Limitation on Fund Expenses
The Management Agreement between each Fund and T. Rowe
Price provides that each Fund will bear all expenses of its
operations not specifically assumed by T. Rowe Price.
For the purpose of determining whether a Fund is
entitled to reimbursement, the expenses of a Fund are calculated
on a monthly basis. If a Fund is entitled to reimbursement, that
month's advisory fee will be reduced or postponed, with any
adjustment made after the end of the year.
Tax-Efficient Fund
In the interest of limiting the expenses of the Fund
during its initial period of operations, T. Rowe Price has agreed
to waive fees and bear any Fund expenses through February 28,
1999 which would cause the Fund's ratio of expenses to average
net assets to exceed 1.00%. Fees waived or expenses paid or
assumed under the Management Agreement are subject to
PAGE 69
reimbursement by the Fund for a period of two years, ending
February 28, 2001; whenever the Fund's expense ratio is below
1.00%. No reimbursement will be made if it would result in the
expense ratio exceeding 1.00%.
This Fund's Management Agreement also provides that one
or more additional expense limitation periods (of the same or
different time periods) may be implemented after the expiration
of the current expense limitation, and that with respect to any
such additional limitation period, the Fund may reimburse T. Rowe
Price, provided the reimbursement does not result in the Fund's
aggregate expenses exceeding the additional expense limitation.
Insured Intermediate Bond Fund
From March 1, 1996, through February 28, 1998, T. Rowe
Price agreed to waive its fees and bear any expenses to the
extent such fees and expenses would cause the Insured
Intermediate Bond Fund's ratio of expenses to average net assets
to exceed 0.65%. Fees waived or expenses paid or assumed under
this agreement are subject to reimbursement to T. Rowe Price
whenever the Fund's expense ratio is below 0.65%; however, no
reimbursement will be made after February 29, 2000, or if it
would result in the expense ratio exceeding 0.65%.
Pursuant to the present expense limitation, $43,000 of
management fees were not accrued by the fund for the year ended
February 28, 1997. Additionally, $209,000 of unaccrued fees and
expenses from the prior period are subject to reimbursement.
DISTRIBUTOR FOR FUNDS
T. Rowe Price Investment Services, Inc. ("Investment
Services"), a Maryland corporation formed in 1980 as a wholly-
owned subsidiary of T. Rowe Price, serves as the distributor of
the Funds. Investment Services is registered as a broker-dealer
under the Securities Exchange Act of 1934 and is a member of the
National Association of Securities Dealers, Inc. The offering of
each Fund's shares is continuous.
Investment Services is located at the same address as
the Funds and T. Rowe T. Rowe Price -- 100 East Pratt Street,
Baltimore, Maryland 21202.
Investment Services serves as distributor to the Funds
pursuant to individual Underwriting Agreements ("Underwriting
Agreements"), which provide that each Fund will pay all fees and
expenses in connection with: necessary state filings, preparing,
setting in type, printing, and mailing its prospectuses and
PAGE 70
reports to shareholders; and issuing its shares, including
expenses of confirming purchase orders.
The Underwriting Agreements provide that Investment
Services will pay all fees and expenses in connection with:
printing and distributing prospectuses and reports for use in
offering and selling shares for each Fund; preparing, setting in
type, printing, and mailing all sales literature and advertising;
Investment Services' federal and state registrations as a
broker-dealer; and offering and selling shares for each Fund,
except for those fees and expenses specifically assumed by the
Funds. Investment Services' expenses are paid by T. Rowe Price.
Investment Services acts as the agent of the Funds in
connection with the sale of their shares in the various states in
which Investment Services is qualified as a broker-dealer. Under
the Underwriting Agreement, Investment Services accepts orders
for Fund shares at net asset value. No sales charges are paid by
investors or the Funds.
CUSTODIAN
State Street Bank and Trust Company is the custodian
for each Fund's securities and cash, but it does not participate
in the Funds' investment decisions. The Funds have authorized
the Bank to deposit certain portfolio securities in central
depository systems as allowed by federal law. In addition, the
Funds are authorized to maintain certain of their securities, in
particular variable rate demand notes in uncertificated form in
the proprietary deposit systems of various dealers in municipal
securities. State Street Bank's main office is 225 Franklin
Street, Boston, Massachusetts 02107.
The Tax-Efficient Balanced Fund has entered into a
Custodian Agreement with The Chase Manhattan Bank, N.A., London,
pursuant to which the fund's equity portfolio securities that are
purchased outside the United States are maintained in the custody
of various foreign branches of The Chase Manhattan Bank and such
other custodians, including foreign banks and foreign securities
depositories as are approved by the fund's Board of Directors in
accordance with regulations under the Investment Company Act of
1940. The address for Chase Manhattan Bank, N.A., London is
Woolgate House, Coleman Street, London, EC2P 2HD, England.
<PAGE>
PAGE 71
SHAREHOLDER SERVICES
The Fund from time to time may enter into agreements
with outside parties through which shareholders hold Fund shares.
The shares would be held by such parties in omnibus accounts. The
agreements would provide for payments by the Fund to the outside
party for shareholder services provided to shareholders in the
omnibus accounts.
CODE OF ETHICS
The Fund's investment adviser (T. Rowe Price) has a
written Code of Ethics which requires all employees to obtain
prior clearance before engaging in personal securities
transactions. Transactions must be executed within three business
days of their clearance. In addition, all employees must report
their personal securities transactions within ten days of their
execution. Employees will not be permitted to effect
transactions in a security: If there are pending client orders in
the security; the security has been purchased or sold by a client
within seven calendar days; the security is being considered for
purchase for a client; a change has occurred in T. Rowe Price's
rating of the security within seven calendar days prior to the
date of the proposed transaction; or the security is subject to
internal trading restrictions. In addition, employees are
prohibited from profiting from short-term trading (e.g.,
purchases and sales involving the same security within 60 days).
Any material violation of the Code of Ethics is reported to the
Board of the Fund. The Board also reviews the administration of
the Code of Ethics on an annual basis.
PORTFOLIO TRANSACTIONS
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of
portfolio securities on behalf of the Fund are made by T. Rowe
Price. T. Rowe Price is also responsible for implementing these
decisions, including the negotiation of commissions and the
allocation of portfolio brokerage and principal business. The
Fund's purchases and sales of municipal securities are normally
done on a principal basis and do not involve the payment of a
commission although they may involve the designation of selling
concessions. That part of the discussion below relating solely
to brokerage commissions would not normally apply to the Fund's
investments in municipal securities. However, it is included
because T. Rowe Price does manage a significant number of common
stock portfolios (including the equity portion of the Tax-
PAGE 72
Efficient Balanced Fund) which do engage in agency transactions
and pay commissions and because some research and services
resulting from the payment of such commissions may benefit the
Funds.
How Brokers and Dealers are Selected
Fixed Income Securities
Fixed income securities are generally purchased from
the issuer or a primary market-maker acting as principal for the
securities on a net basis, with no brokerage commission being
paid by the client although the price usually includes an
undisclosed compensation. Transactions placed through dealers
serving as primary market-makers reflect the spread between the
bid and asked prices. Securities may also be purchased from
underwriters at prices which include underwriting fees.
T. Rowe Price may effect principal transactions on
behalf of the Fund with a broker or dealer who furnishes
brokerage and/or research services, designate any such broker or
dealer to receive selling concessions, discounts or other
allowances, or otherwise deal with any such broker or dealer in
connection with the acquisition of securities in underwritings.
T. Rowe Price may receive brokerage and research services in
connection with such designations in fixed price underwritings.
How Evaluations are Made of the Overall Reasonableness of
Brokerage Commissions Paid
On a continuing basis, T. Rowe Price seeks to determine
what levels of commission rates are reasonable in the marketplace
for transactions executed on behalf of the Fund. In evaluating
the reasonableness of commission rates, T. Rowe Price considers:
(a) historical commission rates, both before and since rates have
been fully negotiable; (b) rates which other institutional
investors are paying, based on available public information; (c)
rates quoted by brokers and dealers; (d) the size of a particular
transaction, in terms of the number of shares, dollar amount, and
number of clients involved; (e) the complexity of a particular
transaction in terms of both execution and settlement; (f) the
level and type of business done with a particular firm over a
period of time; and (g) the extent to which the broker or dealer
has capital at risk in the transaction.
<PAGE>
PAGE 73
Description of Research Services Received from Brokers and
Dealers
T. Rowe Price receives a wide range of research
services from brokers and dealers. These services include
information on the economy, industries, groups of securities,
individual companies, statistical information, accounting and tax
law interpretations, political developments, legal developments
affecting portfolio securities, technical market action, pricing
and appraisal services, credit analysis, risk measurement
analysis, performance analysis and analysis of corporate
responsibility issues. These services provide both domestic and
international perspective. Research services are received
primarily in the form of written reports, computer generated
services, telephone contacts and personal meetings with security
analysts. In addition, such services may be provided in the form
of meetings arranged with corporate and industry spokespersons,
economists, academicians and government representatives. In some
cases, research services are generated by third parties but are
provided to T. Rowe Price by or through broker-dealers.
Research services received from brokers and dealers are
supplemental to T. Rowe Price's own research effort and, when
utilized, are subject to internal analysis before being
incorporated by T. Rowe Price into its investment process. As a
practical matter, it would not be possible for T. Rowe Price to
generate all of the information presently provided by brokers and
dealers. T. Rowe Price pays cash for certain research services
received from external sources. T. Rowe Price also allocates
brokerage for research services which are available for cash.
While receipt of research services from brokerage firms has not
reduced T. Rowe Price's normal research activities, the expenses
of T. Rowe Price could be materially increased if it attempted to
generate such additional information through its own staff. To
the extent that research services of value are provided by
brokers or dealers, T. Rowe Price may be relieved of expenses
which it might otherwise bear.
T. Rowe Price has a policy of not allocating brokerage
business in return for products or services other than brokerage
or research services. In accordance with the provisions of
Section 28(e) of the Securities Exchange Act of 1934, T. Rowe
Price may from time to time receive services and products which
serve both research and non-research functions. In such event,
T. Rowe Price makes a good faith determination of the anticipated
research and non-research use of the product or service and
allocates brokerage only with respect to the research component.
<PAGE>
PAGE 74
Commissions to Brokers who Furnish Research Services
Certain brokers and dealers who provide quality
brokerage and execution services also furnish research services
to T. Rowe Price. With regard to the payment of brokerage
commissions, T. Rowe Price has adopted a brokerage allocation
policy embodying the concepts of Section 28(e) of the Securities
Exchange Act of 1934, which permits an investment adviser to
cause an account to pay commission rates in excess of those
another broker or dealer would have charged for effecting the
same transaction, if the adviser determines in good faith that
the commission paid is reasonable in relation to the value of the
brokerage and research services provided. The determination may
be viewed in terms of either the particular transaction involved
or the overall responsibilities of the adviser with respect to
the accounts over which it exercises investment discretion.
Accordingly, while T. Rowe Price cannot readily determine the
extent to which commission rates or net prices charged by broker-
dealers reflect the value of their research services, T. Rowe
Price would expect to assess the reasonableness of commissions in
light of the total brokerage and research services provided by
each particular broker. T. Rowe Price may receive research, as
defined in Section 28(e), in connection with selling concessions
and designations in fixed price offerings in which the Funds
participate.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a
specific amount of business to any broker or dealer over any
specific time period. Historically, the majority of brokerage
placement has been determined by the needs of a specific
transaction such as market-making, availability of a buyer or
seller of a particular security, or specialized execution skills.
However, T. Rowe Price does have an internal brokerage allocation
procedure for that portion of its discretionary client brokerage
business where special needs do not exist, or where the business
may be allocated among several brokers or dealers which are able
to meet the needs of the transaction.
Each year, T. Rowe Price assesses the contribution of
the brokerage and research services provided by brokers or
dealers, and attempts to allocate a portion of its brokerage
business in response to these assessments. Research analysts,
counselors, various investment committees, and the Trading
Department each seek to evaluate the brokerage and research
services they receive from brokers or dealers and make judgments
as to the level of business which would recognize such services.
In addition, brokers or dealers sometimes suggest a level of
business they would like to receive in return for the various
PAGE 75
brokerage and research services they provide. Actual brokerage
received by any firm may be less than the suggested allocations
but can, and often does, exceed the suggestions, because the
total business is allocated on the basis of all the
considerations described above. In no case is a broker or dealer
excluded from receiving business from T. Rowe Price because it
has not been identified as providing research services.
Miscellaneous
T. Rowe Price's brokerage allocation policy is
consistently applied to all its fully discretionary accounts,
which represent a substantial majority of all assets under
management. Research services furnished by brokers or dealers
through which T. Rowe Price effects securities transactions may
be used in servicing all accounts (including non-Fund accounts)
managed by T. Rowe Price. Conversely, research services received
from brokers or dealers which execute transactions for the Fund
are not necessarily used by T. Rowe Price exclusively in
connection with the management of the Fund.
From time to time, orders for clients may be placed
through a computerized transaction network.
The Fund does not allocate business to any broker-
dealer on the basis of its sales of the Fund's shares. However,
this does not mean that broker-dealers who purchase Fund shares
for their clients will not receive business from the Fund.
Some of T. Rowe Price's other clients have investment
objectives and programs similar to those of the Fund. T. Rowe
Price may occasionally make recommendations to other clients
which result in their purchasing or selling securities
simultaneously with the Fund. As a result, the demand for
securities being purchased or the supply of securities being sold
may increase, and this could have an adverse effect on the price
of those securities. It is T. Rowe Price's policy not to favor
one client over another in making recommendations or in placing
orders. T. Rowe Price frequently follows the practice of
grouping orders of various clients for execution which generally
results in lower commission rates being attained. In certain
cases, where the aggregate order is executed in a series of
transactions at various prices on a given day, each participating
client's proportionate share of such order reflects the average
price paid or received with respect to the total order. T. Rowe
Price has established a general investment policy that it will
ordinarily not make additional purchases of a common stock of a
company for its clients (including the T. Rowe Price Funds) if,
as a result of such purchases, 10% or more of the outstanding
PAGE 76
common stock of such company would be held by its clients in the
aggregate.
To the extent possible, T. Rowe Price intends to
recapture solicitation fees paid in connection with tender offers
through T. Rowe Price Investment Services, Inc., the Fund's
distributor. At the present time, T. Rowe Price does not
recapture commissions or underwriting discounts or selling group
concessions in connection with taxable securities acquired in
underwritten offerings. T. Rowe Price does, however, attempt to
negotiate elimination of all or a portion of the selling-group
concession or underwriting discount when purchasing tax-exempt
municipal securities on behalf of its clients in underwritten
offerings.
Other
The Funds engaged in portfolio transactions involving
broker-dealers in the following amounts for the fiscal years
ended February 28, 1997, February 29, 1996, and February 28,
1995:
Fund 1997 1996 1995
Money $3,675,043,000 $3,101,344,000$3,476,545,000
Short-Intermediate 1,478,084,000 1,184,341,000 1,879,637,000
Insured Intermediate
Bond 320,231,000 249,376,000 490,025,000
Income 2,284,715,000 2,558,129,000 2,465,423,000
High Yield 1,801,447,000 1,643,296,000 1,961,416,000
The following amounts consisted of principal
transactions as to which the Funds have no knowledge of the
profits or losses realized by the respective broker-dealers for
the fiscal years ended February 28, 1997, February 29, 1996, and
February 28, 1995:
Fund 1997 1996 1995
Money $3,662,460,000 $3,084,964,000$3,476,545,000
Short-Intermediate 1,384,758,000 1,113,118,000 1,849,318,000
Insured Intermediate
Bond 302,633,000 233,485,000 480,566,000
Income 2,034,461,000 2,318,802,000 2,296,647,000
High Yield 1,621,470,000 1,501,879,000 1,855,103,000
The following amounts involved trades with brokers
acting as agents or underwriters for the fiscal years ended
February 28, 1997, February 29, 1996, and February 28, 1995:
PAGE 77
Fund 1997 1996 1995
Money $ 12,583,000 $ 16,380,000 $ 0
Short-Intermediate 93,326,000 71,223,000 30,319,000
Insured Intermediate Bond17,598,000 15,891,000 9,459,000
Income 250,254,000 239,327,000 168,776,000
High Yield 179,977,000 141,417,000 106,313,000
The following amounts involved trades with brokers
acting as agents or underwriters, in which such brokers received
total commissions, including discounts received in connection
with underwritings for the fiscal years ended February 28, 1997,
February 29, 1996, and February 28, 1995:
Fund 1997 1996 1995
Money $ 13,000 $ 70,000 $ 0
Short-Intermediate 370,000 281,000 68,000
Insured Intermediate Bond 108,000 61,000 44,000
Income 1,493,000 1,608,000 932,000
High Yield 1,139,000 970,000 379,000
Of all such portfolio transactions, none were placed
with firms which provided research, statistical, or other
services to T. Rowe Price in connection with the management of
the Funds, or in some cases, to the Funds.
The portfolio turnover rates of the Funds for the
fiscal years ended February 28, 1997, February 29, 1996, and
February 28, 1995:
Fund 1997 1996 1995
Short-Intermediate 84.3% 69.9% 93.1%
Insured Intermediate Bond 76.8% 63.8% 170.8%
Income 40.7% 48.7% 49.3%
High Yield 37.0% 39.3% 59.6%
PRICING OF SECURITIES
Fixed income securities are generally traded in the over-
the-counter market. With the exception of the Money Fund,
investments in securities are stated at fair market value using a
bid-side valuation as furnished by dealers who make markets in
such securities or by an independent pricing service, which
considers yield or price of bonds of comparable quality, coupon,
maturity, and type, as well as prices quoted by dealers who make
markets in such securities. Securities held by the Money Fund
are valued at amortized cost.
PAGE 78
There are a number of pricing services available, and the
Directors of the Funds, on the basis of ongoing evaluation of
these services, may use or may discontinue the use of any pricing
service in whole or in part.
Securities or other assets for which the above valuation
procedures are inappropriate or are deemed not to reflect fair
value will be appraised at prices deemed best to reflect their
fair value. Such determinations will be made in good faith by or
under the supervision of officers of each Fund as authorized by
the Board of Directors.
Maintenance of Money Fund's Net Asset Value Per Share at $1.00
It is the policy of the Fund to attempt to maintain a net
asset value of $1.00 per share by using the amortized cost method
of valuation permitted by Rule 2a-7 under the Investment Company
Act of 1940. Under this method, securities are valued by
reference to the Fund's acquisition cost as adjusted for
amortization of premium or accumulation of discount rather than
by reference to their market value. Under Rule 2a-7:
(a) The Board of Directors must establish written
procedures reasonably designed, taking into account
current market conditions and the fund's investment
objectives, to stabilize the fund's net asset value per
share, as computed for the purpose of distribution,
redemption and repurchase, at a single value;
(b) The Fund must (i) maintain a dollar-weighted
average portfolio maturity appropriate to its objective
of maintaining a stable price per share, (ii) not
purchase any instrument with a remaining maturity
greater than 397 days, and (iii) maintain a
dollar-weighted average portfolio maturity of 90 days
or less;
(c) The Fund must limit its purchase of portfolio
instruments, including repurchase agreements, to those
U.S. dollar-denominated instruments which the Fund's
Board of Directors determines present minimal credit
risks, and which are eligible securities as defined by
Rule 2a-7 (eligible Securities are generally securities
which have been rated or whose issuer has been rated or
whose issuer has comparable securities rated in one of
the two highest rating categories by nationally
recognized statistical rating organizations or, in the
case of any instrument that is not so rated, is of
comparable quality as determined by procedures adopted
by the Fund's Board of Directors); and
PAGE 79
(d) The Board of Directors must determine that (i) it
is in the best interest of the Fund and its
shareholders to maintain a stable net asset value per
share under the amortized cost method; and (ii) the
Fund will continue to use the amortized cost method
only so long as the Board of Directors believes that it
fairly reflects the market based net asset value per
share.
Although the Fund believes that it will be able to
maintain its net asset value at $1.00 per share under most
conditions, there can be no absolute assurance that it will be
able to do so on a continuous basis. If the Fund's net asset
value per share declined, or was expected to decline, below $1.00
(rounded to the nearest one cent), the Board of Directors of the
Fund might temporarily reduce or suspend dividend payments in an
effort to maintain the net asset value at $1.00 per share. As a
result of such reduction or suspension of dividends, an investor
would receive less income during a given period than if such a
reduction or suspension had not taken place. Such action could
result in an investor receiving no dividend for the period during
which he holds his shares and in his receiving, upon redemption,
a price per share lower than that which he paid. On the other
hand, if the Fund's net asset value per share were to increase,
or were anticipated to increase above $1.00 (rounded to the
nearest one cent), the Board of Directors of the Fund might
supplement dividends in an effort to maintain the net asset value
at $1.00 per share.
Tax-Efficient Balanced Fund
The Fund's municipal securities will be priced as
described above. The Fund's equity securities listed or
regularly traded on a securities exchange are valued at the last
quoted sales price at the time the valuations are made. A
security which is listed or traded on more than one exchange is
valued at the quotation on the exchange determined to be the
primary market for such security. Listed securities not traded
on a particular day and securities regularly traded in the over-
the-counter market are valued at the mean of the latest bid and
asked prices. Other equity securities are valued at a price
within the limits of the latest bid and asked prices deemed by
the Board of Directors/Trustees, or by persons delegated by the
Board, best to reflect fair value.
Debt securities are generally traded in the over-the-
counter market and are valued at a price deemed best to reflect
fair value as quoted by dealers who make markets in these
securities or by an independent pricing service. Short-term debt
securities are valued at their amortized cost in local currency
PAGE 80
which, when combined with accrued interest, approximates fair
value.
For purposes of determining the Fund's net asset value
per share, the U.S. dollar value of all assets and liabilities
initially expressed in foreign currencies is determined by using
the mean of the bid and offer prices of such currencies against
U.S. dollars quoted by a major bank.
Assets and liabilities for which the above valuation
procedures are inappropriate or are deemed not to reflect fair
value are stated at fair value as determined in good faith by or
under the supervision of the officers of the Fund, as authorized
by the Board of Directors.
NET ASSET VALUE PER SHARE
The purchase and redemption price of the Funds' shares
is equal to the Funds' net asset value per share or share price.
Each Fund determines its net asset value per share by subtracting
the Funds' liabilities (including accrued expenses and dividends
payable) from its total assets (the market value of the
securities the Fund holds plus cash and other assets, including
income accrued but not yet received) and dividing the result by
the total number of shares outstanding. The net asset value per
share of each Fund is calculated as of the close of trading on
the New York Stock Exchange ("NYSE") every day the NYSE is open
for trading. The net asset value of the Money Fund is also
calculated as of 12:00 noon (Eastern time) every day the NYSE is
open for trading. The NYSE is closed on the following days: New
Year's Day, Washington's Birthday, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
Determination of net asset value (and the offering,
sale redemption and repurchase of shares) for a Fund may be
suspended at times (a) during which the NYSE is closed, other
than customary weekend and holiday closings, (b) during which
trading on the NYSE is restricted, (c) during which an emergency
exists as a result of which disposal by a Fund of securities
owned by it is not reasonably practicable or it is not reasonably
practicable for the Fund fairly to determine the value of its net
assets, or (d) during which a governmental body having
jurisdiction over the Fund may by order permit such a suspension
for the protection of the Fund's shareholders; provided that
applicable rules and regulations of the Securities and Exchange
Commission (or any succeeding governmental authority) shall given
as to whether the conditions prescribed in (b), (c), or (d)
exist.
PAGE 81
DIVIDENDS AND DISTRIBUTIONS
Unless you elect otherwise, the Fund's annual capital
gain distribution and, for the Tax-Efficient Balanced Fund, the
annual dividend, if any, will be reinvested on the reinvestment
date using the NAV per share of that date. The reinvestment date
normally precedes the payment date by about 10 days although the
exact timing is subject to change.
TAX STATUS
Each Fund intends to qualify as a "regulated investment
company" under Subchapter M of the Internal Revenue Code of 1986,
as amended ("Code").
Dividends and distributions paid by the Funds are not
eligible for the dividends-received deduction for corporate
shareholders. For tax purposes, it does not make any difference
whether dividends and capital gain distributions are paid in cash
or in additional shares. Each Fund must declare by its year-end
dividends equal to at least 90% of net tax-exempt income (as of
its year-end) to permit pass-through of tax-exempt income to
shareholders, and declare by December 31 98% of capital gains (as
of October 31) in order to avoid a federal excise tax and
distribute within 12 months 100% of capital gains (as of its tax
year-end) to avoid federal income tax.
At the time of your purchase, a Fund's net asset value
may reflect undistributed capital gains or net unrealized
appreciation of securities held by the Fund. A subsequent
distribution to you of such amounts, although constituting a
return of your investment, would be taxable as a capital gain
distribution. For federal income tax purposes, a Fund is
permitted to carry forward its net realized capital losses, if
any, for eight years and realize net capital gains up to the
amount of such losses without being required to pay taxes on, or
distribute such gains. On May 31, 1997, the books of each Fund
indicated that the Fund's aggregate net assets included:
Realized Unrealized
Capital Appreciation/
Fund Gains/(Losses) Depreciation
____________ ________________ __________________
Money $ (166,074) $ 0
Short-Intermediate (793,113) 4,435,024
Insured Intermediate Bond (336,806) 2,382,853
Income (9,249,864) 79,606,828
High Yield (12,745,251) 61,984,870
PAGE 82
If, in any taxable year, the Funds should not qualify
as regulated investment companies under the Code: (i) each Fund
would be taxed at normal corporate rates on the entire amount of
its taxable income, if any, without deduction for dividends or
other distributions to shareholders; and (ii) each Fund's
distributions to the extent made out of the Fund's current or
accumulated earnings and profits would be taxable to shareholders
as ordinary dividends (regardless of whether they would otherwise
have been considered capital gain or tax-exempt dividends).
The Funds anticipate acquiring bonds after initial
issuance at a price less than the principal amount of such bonds
("market discount bonds"). Gain on the disposition of such bonds
is treated as taxable ordinary income to the extent of accrued
market discount. Such gains cannot be offset by losses on the
sale of other securities but must be distributed to shareholders
annually and taxed as ordinary income.
Each year, the Funds will mail you information on the
tax status of dividends and distributions. The Funds anticipate
that substantially all of the dividends to be paid by each Fund
will be exempt from federal income taxes. If any portion of a
Fund's dividends is not exempt from federal income taxes, you
will receive a Form 1099 stating the taxable portion. The Funds
will also advise you of the percentage of your dividends, if any,
which should be included in the computation of alternative
minimum tax. Social security recipients who receive interest
from tax-exempt securities may have to pay taxes on a portion of
their social security benefit.
Because the interest on municipal securities is tax
exempt, any interest on money you borrow that is directly or
indirectly used to purchase Fund shares is not deductible. (See
Section 265(2) of the Internal Revenue Code.) Further, entities
or persons who are "substantial users" (or persons related to
"substantial users") of facilities financed by industrial
development bonds should consult their tax advisers before
purchasing shares of a Fund. The income from such bonds may not
be tax exempt for such substantial users.
YIELD INFORMATION
Money Fund
The Fund's current and historical yield for a period is
calculated by dividing the net change in value of an account
(including all dividends accrued and dividends reinvested in
additional shares) by the account value at the beginning of the
PAGE 83
period to obtain the base period return. This base period return
is divided by the number of days in the period then multiplied by
365 to arrive at the annualized yield for that period. The
Fund's annualized compound yield for such period is compounded by
dividing the base period return by the number of days in the
period, and compounding that figure over 365 days.
The Money Fund's current yield was 2.98% and the
compound yield was 3.02% for the seven days ended February 28,
1997.
Bond Funds
From time to time, a Fund may advertise a yield figure
calculated in the following manner:
An income factor is calculated for each security in the
portfolio based upon the security's market value at the beginning
of the period and yield as determined in conformity with
regulations of the Securities and Exchange Commission. The
income factors are then totalled for all securities in the
portfolio. Next, expenses of the Fund for the period net of
expected reimbursements are deducted from the income to arrive at
net income, which is then converted to a per-share amount by
dividing net income by the average number of shares outstanding
during the period. The net income per share is divided by the
net asset value on the last day of the period to produce a
monthly yield which is then annualized. A taxable equivalent
yield is calculated by dividing this yield by one minus the
effective federal income tax rate. Quoted yield factors are for
comparison purposes only, and are not intended to indicate future
performance or forecast the dividend per share of the Fund.
The yield of each Fund calculated under the above-
described method for the month ended February 28, 1997 was:
Short-Intermediate 3.76%
Insured Intermediate Bond 4.08%
Income 4.81%
High Yield 5.22%
The tax equivalent yields for these funds for the
same period were 5.45% (Short-Intermediate), 5.91% (Insured
Intermediate), 6.97% (Income), and 7.57% (High Yield). This
assumes a federal tax bracket of 31.0%. Assuming a federal tax
bracket of 28.0%, the tax-equivalent yields for the period would
be 5.22% (Short-Intermediate), 5.67% (Insured Intermediate),
6.68% (Income), and 7.25% (High Yield).
<PAGE>
PAGE 84
TAX-EXEMPT VS. TAXABLE YIELDS
From time to time, a Fund may also illustrate the
effect of tax equivalent yields using information such as that
set forth below:
_________________________________________________________________
Taxable Income (1997)*
Federal
Joint Return Single Return Tax Rates+
_________________________________________________________________
$40,200- $99,600 $24,650- $59,750 28.0%
99,601- 151,750 59,751- 124,650 31.0
151,751- 271,050 124,651- 271,050 36.0
271,051 and above 271,050 and above 39.6
_________________________________________________________________
A Tax-Exempt Yield Of:
3% 4% 5% 6% 7% 8% 9% 10%
Is Equivalent to a Taxable Yield of:
_________________________________________________________________
4.17 5.56 6.94 8.33 9.72 11.11 12.50 13.89
4.35 5.80 7.25 8.70 10.14 11.59 13.04 14.49
4.69 6.25 7.81 9.38 10.94 12.50 14.06 15.63
4.97 6.62 8.28 9.93 11.59 13.25 14.90 16.56
_________________________________________________________________
* Net amount subject to federal income tax after deductions and
exemptions.
+ Federal rates may vary depending on family size and amount and
nature of itemized deductions.
INVESTMENT PERFORMANCE
Total Return Performance
Each Fund's calculation of total return performance includes
the reinvestment of all capital gain distributions and income
dividends for the period or periods indicated, without regard to
tax consequences to a shareholder in the Fund. Total return is
calculated as the percentage change between the beginning value
of a static account in the Fund and the ending value of that
account measured by the then current net asset value, including
all shares acquired through reinvestment of income and capital
gains dividends. The results shown are historical and should not
be considered indicative of the future performance of the Fund.
Each average annual compound rate of return is derived from the
cumulative performance of the Fund over the time period
specified. The annual compound rate of return for the Fund over
any other period of time will vary from the average.
<PAGE>
PAGE 85
Cumulative Performance Percentage Change
Since
1 Yr. 5 Yrs. 10 Yrs. Inception
Ended Ended Ended Ended
2/28/97 2/28/97 2/28/97 2/28/97
Short-Intermediate Fund 4.02 27.28 64.98 113.79%
12/23/83
Insured Intermediate
Bond Fund 4.19 32.04
11/30/92
Income Fund 4.81 42.78 85.89 312.11
10/26/76
High Yield Fund 6.22 45.74 107.99 197.27
3/01/85
Average Annual Compound Rates of Return
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception
2/28/97 2/28/97 2/28/97 2/28/97
Short-Intermediate Fund 4.02 4.94 5.13 5.93%
12/23/83
Insured Intermediate
Bond Fund 4.19 6.76
11/30/92
Income Fund 4.81 7.38 6.40 7.21
10/26/76
High Yield Fund 6.22 7.82 7.60 9.51
3/01/85
All Funds
Outside Sources of Information
From time to time, in reports and promotional
literature: (1) the Fund's total return performance, ranking, or
any other measure of the Fund's performance may be compared to
any one or combination of the following: (i) a broad based
index; (ii) other groups of mutual funds, including T. Rowe Price
Funds, tracked by independent research firms ranking entities, or
financial publications; (iii) indices of stocks comparable to
those in which the Fund invests; (2) the Consumer Price Index (or
any other measure for inflation, government statistics, such as
GNP may be used to illustrate investment attributes of the Fund
or the general economic, business, investment, or financial
environment in which the Fund operates; (3) various financial,
economic and market statistics developed by brokers, dealers and
PAGE 86
other persons may be used to illustrate aspects of the Fund's
performance; (4) the effect of tax-deferred compounding on the
Fund's investment returns, or on returns in general in both
qualified and non-qualified retirement plans or any other tax
advantage product, may be illustrated by graphs, charts, etc.;
and (5) the sectors or industries in which the Fund invests may
be compared to relevant indices or surveys in order to evaluate
the Fund's historical performance or current or potential value
with respect to the particular industry or sector.
Other Publications
From time to time, in newsletters and other
publications issued by T. Rowe Price Investment Services, Inc.,
T. Rowe Price mutual fund portfolio managers may discuss
economic, financial and political developments in the U.S. and
abroad and how these conditions have affected or may affect
securities prices or the Fund; individual securities within the
Fund's portfolio; and their philosophy regarding the selection of
individual stocks, including why specific stocks have been added,
removed or excluded from the Fund's portfolio.
Other Features and Benefits
The Fund is a member of the T. Rowe Price Family of
Funds and may help investors achieve various long-term investment
goals, which include, but are not limited to, investing money for
retirement, saving for a down payment on a home, or paying
college costs. To explain how the Fund could be used to assist
investors in planning for these goals and to illustrate basic
principles of investing, various worksheets and guides prepared
by T. Rowe Price Associates, Inc. and/or T. Rowe Price Investment
Services, Inc. may be made available.
CAPITAL STOCK
Shareholders are entitled to one vote for each full
share held (and fractional votes for fractional shares held) and
will vote in the election of or removal of directors (to the
extent hereinafter provided) and on other matters submitted to
the vote of shareholders. There will normally be no meetings of
shareholders for the purpose of electing directors unless and
until such time as less than a majority of the directors holding
office have been elected by shareholders, at which time the
directors then in office will call a shareholders' meeting for
the election of directors. Except as set forth above, the
directors shall continue to hold office and may appoint successor
directors. Voting rights are not cumulative, so that the holders
of more than 50% of the shares voting in the election of
PAGE 87
directors can, if they choose to do so, elect all the directors
of the Fund, in which event the holders of the remaining shares
will be unable to elect any person as director. The Board of
Directors of each Fund may increase or decrease the aggregate
number of shares of stock or the number of shares of stock of any
class or series authorized to be issued without shareholder
approval.
As set forth in the By-Laws of each Fund, a special
meeting of shareholders of a Fund shall be called by the
Secretary of the Fund on the written request of shareholders
entitled to cast at least 10% of all the votes of the Fund
entitled to be cast at such meeting. Shareholders requesting
such a meeting must pay to the Fund the reasonably estimated
costs of preparing and mailing the notice of the meeting. Each
Fund, however, will otherwise assist the shareholders seeking to
hold the special meeting in communicating to the other
shareholders of the Fund to the extent required by Section 16(c)
of the Investment Company Act of 1940.
Short-Intermediate, Insured Intermediate Bond, Income, High
Yield, and Tax-Efficient Balanced Funds
Each Fund's Charter authorizes the Board of Directors
to classify and reclassify any and all shares which are then
unissued, including unissued shares of capital stock into any
number of classes or series, each class or series consisting of
such number of shares and having such designations, such powers,
preferences, rights, qualifications, limitations, and
restrictions, as shall be determined by the Board subject to the
Investment Company Act and other applicable law. The shares of
any such additional classes or series might therefore differ from
the shares of the present class and series of capital stock and
from each other as to preferences, conversions or other rights,
voting powers, restrictions, limitations as to dividends,
qualifications or terms or conditions of redemption, subject to
applicable law, and might thus be superior or inferior to the
capital stock or to other classes or series in various
characteristics. The Board of Directors may increase or decrease
the aggregate number of shares of stock or the number of shares
of stock of any class or series that the Fund has authorized to
issue without shareholder approval.
Except to the extent that the Boards of Directors of
these Funds might provide by resolution that holders of shares of
a particular class are entitled to vote as a class on specified
matters presented for a vote of the holders of all shares
entitled to vote on such matters, there would be no right of
class vote unless and to the extent that such a right might be
construed to exist under Maryland law. The Funds' Charters
PAGE 88
contain no provision entitling the holders of the present class
of capital stock to a vote as a class on any matter.
Accordingly, the preferences, rights, and other characteristics
attaching to any class of shares, including the present class of
capital stock, might be altered or eliminated, or the class might
be combined with another class or classes, by action approved by
the vote of the holders of a majority of all the shares of all
classes entitled to be voted on the proposal, without any
additional right of vote as a class by the holders of the capital
stock or of another affected class or classes.
Redemptions in Kind
In the unlikely event a shareholder were to receive an
in kind redemption of portfolio securities of the Fund, brokerage
fees could be incurred by the shareholder in a subsequent sale of
such securities.
Issuance of Fund Shares for Securities
Transactions involving issuance of Fund shares for
securities or assets other than cash will be limited to (1) bona
fide reorganizations; (2) statutory mergers; or (3) other
acquisitions of portfolio securities that: (a) meet the
investment objectives and policies of the Funds; (b) are acquired
for investment and not for resale except in accordance with
applicable law; (c) have a value that is readily ascertainable
via listing on or trading in a recognized United States or
international exchange or market; and (d) are not illiquid.
FEDERAL REGISTRATION OF SHARES
The Fund's shares are registered for sale under the
Securities Act of 1933. Registration of the Fund's shares is not
required under any state law, but the Fund is required to make
certain filings with and pay fees to the states in order to sell
its shares in the states.
LEGAL COUNSEL
Shereff, Friedman, Hoffman & Goodman, LLP, whose
address is 919 Third Avenue, New York, New York 10022, is legal
counsel to each of the Funds.
<PAGE>
PAGE 89
INDEPENDENT ACCOUNTANTS
Tax-Efficient Balanced Fund
Coopers & Lybrand L.L.P., 217 East Redwood Street,
Baltimore, Maryland 21202, are independent accountants to the
Fund.
All Funds, except Tax-Efficient Balanced
Coopers & Lybrand L.L.P., 217 East Redwood Street,
Baltimore, Maryland 21202, are independent accountants to the
Funds. The financial statements of the Funds for the fiscal year
ended February 28, 1997 and the report of independent accountants
are included in each Fund's Annual Report on pages 2-20, pages 2-
29, pages 2-15, page 2-17, and page 2-28, respectively. A copy
of each Annual Report accompanies this Statement of Additional
Information. The following financial statements and the report
of independent accountants appearing in each Annual Report for
the fiscal year ended February 28, 1997, are incorporated into
this Statement of Additional Information by reference:
MONEY FUND HIGH YIELD FUND
ANNUAL ANNUAL
REPORT PAGE REPORT PAGE
___________ _______________
Report of Independent Accountants 20 29
Statement of Net Assets,
February 28, 1997 3-15 3-23
Statement of Operations, year ended
February 28, 1997 16 24
Statement of Changes in Net Assets,
years ended February 28, 1997 and
February 29, 1996 17 25
Notes to Financial Statements,
February 28, 1997 18-19 26-28
Financial Highlights 2 2
INSURED
INTERMEDIATE
BOND FUND
ANNUAL REPORT PAGE
_________________
Report of Independent Accountants 15
Statement of Net Assets, February 28, 1997 3-9
Statement of Operations, year ended February 28, 199710
Statement of Changes in Net Assets, years ended
February 28, 1997 and February 29, 1996 11
PAGE 90
Notes to Financial Statements, February 28, 1997 12-14
Financial Highlights 2
SHORT-INTERMEDIATE
FUND ANNUAL
REPORT PAGE
__________________
Report of Independent Accountants 17
Statement of Net Assets, February 28, 1997 3-12
Statement of Operations, year ended February 28, 199713
Statement of Changes in Net Assets, years ended
February 28, 1997 and February 29, 1996 14
Notes to Financial Statements, February 28, 1997 15-16
Financial Highlights 2
INCOME FUND
ANNUAL
REPORT PAGE
_______________
Report of Independent Accountants 28
Statement of Net Assets, February 28, 1997 3-22
Statement of Operations, year ended February 28, 199723
Statement of Changes in Net Assets, years ended
February 28, 1997 and February 29, 1996 24
Notes to Financial Statements, February 28, 1997 25-27
Financial Highlights 2
Effective March 1, 1995, Coopers & Lybrand L.L.P. became the
independent accountants to the Short-Intermediate and Income
Funds.
<PAGE>
PAGE 91
T. ROWE PRICE TAX-EFFICIENT BALANCED FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
JUNE 23, 1997
Assets
Receivable for Fund shares sold $100,000
Deferred organizational expenses 49,045
___________
Total assets 149,045
Liabilities
Amount due Manager 46,395
Accrued expenses 2,650
___________
Total liabilities 49,045
___________
Net Assets - offering and redemption
price of $10.00 per share; 1,000,000,000
shares of $0.0001 par value capital
stock authorized 10,000 shares outstanding $100,000
___________
___________
NOTE TO STATEMENT OF ASSETS AND LIABILITIES
T. Rowe Price Tax-Efficient Balanced Fund, Inc. (the
"Corporation") was organized on April 22, 1997, as a Maryland
corporation and is registered under the Investment Company Act of
1940 as a diversified, open-end management investment company.
The Corporation has had no operations other than those matters
related to organization and registration as an investment
company, the registration of shares for sale under the Securities
Act of 1933, and the sale of 10,000 shares of the T. Rowe Price
Tax-Efficient Balanced Fund at $10.00 per share on June 23, 1997,
to T. Rowe Price Associates, Inc. via share exchange from a
T. Rowe Price money market mutual fund. The exchange was settled
in the ordinary course of business on June 24, 1997, with the
transfer of $100,000 cash. The Corporation has entered into an
investment management agreement with T. Rowe Price Associates,
Inc. (the "Manager") which is described in the Statement of
Additional Information under the heading "Investment Management
Services."
Organizational expenses for the Corporation in the amount of
$49,045 have been accrued at June 23, 1997, and will be amortized
on a straight-line basis over a period not to exceed 60 months.
The Manager has agreed to advance certain organizational expenses
incurred by the Corporation and will be reimbursed for such
PAGE 92
expenses approximately six months after the commencement of the
Corporation's operations.
The Manager has also agreed that in the event any of its
initial shares are redeemed during the 60-month amortization
period of the deferred organizational expenses, proceeds from a
redemption of the shares representing the initial capital will be
reduced by a pro rata portion of any unamortized organizational
expenses.<PAGE>
PAGE 93
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
T. Rowe Price Tax-Efficient Balanced Fund, Inc.
We have audited the accompanying statement of assets and
liabilities of T. Rowe Price Tax-Efficient Balanced Fund, Inc.
(the "Fund") as of June 23, 1997. This financial statement is
the responsibility of the Fund's management. Our responsibility
is to express an opinion on this financial statement based on our
audit.
We conducted our audit 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 statement is free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statement. 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 audit provides a reasonable basis for our opinion.
In our opinion, the statement of assets and liabilities
presents fairly, in all material respects, the financial position
of T. Rowe Price Tax-Efficient Balanced Fund, Inc. as of June 23,
1997, in conformity with generally accepted accounting
principles.
/s/Coopers & Lybrand L.L.P.
COOPERS & LYBRAND L.L.P.
Baltimore, Maryland
June 24, 1997
<PAGE>
