PROFUNDS
STATEMENT OF ADDITIONAL INFORMATION
7900 WISCONSIN AVENUE, SUITE 300
BETHESDA, MARYLAND 20814
(888) 776-3637 RETAIL SHAREHOLDERS
(888) 776-5717 (FINANCIAL PROFESSIONALS ONLY)
This Statement of Additional Information describes the Pro Fund VP UltraOTC
("UltraOTC VP"), ProFund VP Small Cap ("Small Cap VP") and ProFund VP Europe 30
("Europe 30 VP") (collectively, the "ProFunds VP"); three series of the
ProFunds. The ProFunds VP may be used by professional money managers and
investors as part of an asset-allocation or market-timing investment strategy or
to create specified investment exposure to a particular segment of the
securities market or to hedge an existing investment portfolio. Each ProFund VP
seeks investment results that correspond each day to a specified benchmark. The
ProFunds VP may be used independently or in combination with each other as part
of an overall investment strategy.
Shares of the ProFunds VP are available for purchase by insurance company
separate accounts to serve as an investment medium for variable insurance
contracts, and by qualified pension and retirement plans, certain insurance
companies, and ProFund Advisors LLC (the "Advisor").
The ProFunds VP involve special risks, some not traditionally associated
with mutual funds. Investors should carefully review and evaluate these risks in
considering an investment in the ProFunds VP to determine whether an investment
in a particular ProFund VP is appropriate. None of the ProFunds VP alone
constitutes a balanced investment plan. Each ProFund VP is not intended for
investors whose principal objective is current income or preservation of
capital. Because of the inherent risks in any investment, there can be no
assurance that the investment objectives of the ProFunds VP will be achieved.
This Statement of Additional Information is not a prospectus. It should be
read in conjunction with the Prospectus, dated October 18, 1999, as supplemented
from time to time, which incorporates this Statement of Additional Information
by reference. Words or phrases used in the Statement of Additional Information
without definition have the same meaning as ascribed to them in the Prospectus.
A copy of the Prospectus is available, without charge, upon request to the
address above or by telephoning at the telephone numbers above.
The date of this Statement of Additional Information is
October 18, 1999.
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TABLE OF CONTENTS
PAGE
ProFunds................................................................ 3
Investment Policies and Techniques ..................................... 3
Investment Restrictions................................................ 16
Determination of Net Asset Value....................................... 17
Portfolio Transactions and Brokerage................................... 18
Management of ProFunds................................................. 19
Costs and Expenses..................................................... 22
Organization and Description of Shares of Beneficial Interest.......... 22
Taxation .............................................................. 23
Performance Information ............................................... 26
Financial Statements................................................... 28
Appendix A -- Europe 30 Index ......................................... 29
Appendix B-- Description of Securities Ratings ....................... 30
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PROFUNDS
ProFunds (the "Trust") is an open-end management investment company, and
currently comprises twenty separate series. The three series described in this
Statement of Additional Information are offered to insurance company separate
accounts and qualified pension and retirement plans and are discussed herein.
All of the ProFunds VP are classified as non-diversified, although they
currently intend to operate in a diversified manner.
INVESTMENT POLICIES AND TECHNIQUES
GENERAL
Reference is made to the Prospectus for a discussion of the investment
objectives and policies of the ProFunds VP. In addition, set forth below is
further information relating to the ProFunds VP. The discussion below
supplements and should be read in conjunction with the Prospectus.
The investment objectives (except the specific benchmarks which are tracked
by the ProFunds VP) and certain investment restrictions of the ProFunds VP
specifically identified as fundamental policies may not be changed without the
affirmative vote of at least the majority of the outstanding shares of that
ProFund VP, as defined in the Investment Company Act of 1940, as amended (the
"1940 Act"). All other investment policies of the ProFunds VP not specified as
fundamental (including the benchmarks of the ProFunds VP) may be changed by the
trustees of the ProFunds VP without the approval of shareholders.
A ProFund VP may consider changing its benchmark if, for example, the
current benchmark becomes unavailable, the ProFund VP believes the current
benchmark no longer serves the investment needs of a majority of shareholders or
another benchmark better serves their needs, or the financial or economic
environment makes it difficult for the ProFunds VP investment results to
correspond sufficiently to its current benchmark. If believed appropriate, a
ProFund VP may specify a benchmark for itself that is "leveraged" or
proprietary. Of course, there can be no assurance that a ProFund VP will achieve
its objective.
Fundamental securities analysis is not generally used by the Advisor in
seeking to correlate with the respective benchmarks. Rather, the Advisor
primarily uses statistical and quantitative analysis to determine the
investments a ProFund VP makes and techniques it employs. While the Advisor
attempts to minimize any "tracking error" (that statistical measure of the
difference between the investment results of a ProFunds VP and the performance
of its benchmark), certain factors will tend to cause a ProFunds VP's investment
results to vary from a perfect correlation to its benchmark. The ProFunds VP,
however, do not expect that their total returns will vary adversely from their
respective current benchmarks by more than ten percent over the course of a
year. See "Special Considerations."
It is the policy of the ProFunds VP to pursue their investment objectives
of correlating with their benchmarks regardless of market conditions, to remain
nearly fully invested and not to take defensive positions.
The investment strategies of the ProFunds VP discussed below, and as
discussed in the Prospectus, may be used by a ProFund VP if, in the opinion of
the Advisor, these strategies will be advantageous to the ProFunds VP. The
ProFunds VP are free to reduce or eliminate the ProFunds VP's activity in any of
those areas without changing the ProFunds VP fundamental investment policies.
There is no assurance that any of these strategies or any other strategies and
methods of investment available to a ProFund VP will result in the achievement
of the its objectives.
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ULTRAOTC VP
The investment objective of UltraOTC VP is to provide daily investment
results that correspond to twice (200%), the performance of the NASDAQ 100
Index(TM).
UltraOTC VP does not intend to hold the 100 securities included in the
NASDAQ 100 Index(TM). Instead, UltraOTC VP intends to engage in transactions on
stock index futures contracts, options on stock index futures contracts, and
options on securities and stock indexes. As a nonfundamental policy, UltraOTC VP
will invest, under normal conditions, at least 65% of its total assets in
securities traded on the over-the-counter markets and instruments with values
that are representative of such securities such as futures and option contracts
in such securities or indices.
If the ProFund VP achieved a perfect correlation for any single trading
day, the net asset value of the shares of UltraOTC VP would increase for that
day proportional to twice any increase in the level of the NASDAQ 100 Index(TM).
Conversely, the net asset value of the shares of UltraOTC VP would decrease for
that day proportional to twice any decrease in the level of the NASDAQ 100
Index(TM) for that day.
For example, if the NASDAQ 100 Index(TM) were to increase by 1% on a
particular day, investors in UltraOTC VP should experience a gain in net asset
value of approximately 2% for that day. Conversely, if the NASDAQ 100 Index(TM)
were to decrease by 1% by the close of business on a particular trading day,
investors in UltraOTC VP would experience a loss in net asset value of
approximately 2%.
In pursuing its investment objective, UltraOTC VP generally does not invest
in traditional securities, such as common stock of operating companies. Rather,
UltraOTC VP employs certain investment techniques, including engaging in certain
transactions in stock index futures contracts, options on stock index futures
contracts, and options on securities and stock indexes.
Under these techniques, UltraOTC VP will generally realize a gain if the
price of the underlying security or index increases between the date of the
employment of the technique and the date on which UltraOTC VP terminates the
position. UltraOTC VP will generally incur a loss if the underlying security or
index decreases in price between those dates. The amount of any gain or loss on
an investment technique may be affected by any premium or amounts in lieu of
dividends or interest that Ultra OTC VP pays or receives as the result of the
transaction.
Companies whose securities are traded on the over-the-counter ("OTC")
markets generally have smaller market capitalization or are newer companies than
those listed on the NYSE or the American Stock Exchange (the "AMEX"). OTC
companies often have limited product lines, or relatively new products or
services, and may lack established markets, depth of experienced management, or
financial resources and the ability to generate funds. The securities of these
companies may have limited marketability and may be more volatile in price than
securities of larger capitalized or more well-known companies. Among the reasons
for the greater price volatility of securities of certain smaller OTC companies
are the less certain growth prospects of comparably smaller firms, the lower
degree of liquidity in the OTC markets for such securities, and the greater
sensitivity of smaller capitalization companies to changing economic conditions
than larger capitalization, exchange-traded securities. Conversely, because many
of these OTC securities may be overlooked by investors and undervalued in the
marketplace, there is potential for significant capital appreciation.
SMALL CAP VP
The investment objective of Small Cap VP is to provide daily investment
results that correspond to the performance of the Russell 2000(R) Index.
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Small Cap VP does not intend to hold the 2,000 securities included in the
Russell 2000(R) Index. Instead, Small Cap VP intends to engage in transactions
in equities, stock index futures contracts, options on stock index futures
contracts, and options on securities and stock indexes. As a nonfundamental
policy, Small Cap VP will invest, under normal conditions, at least 65% of its
total assets in the securities comprising the Russell 2000(R) Index and
instruments with values that are representative of such securities, such as
futures and option contracts on such securities or such index.
The Russell 2000(R) Index is a capitalization-weighted index of domestic
equities traded on the NYSE, AMEX and NASDAQ. The index represents the bottom
2,000 companies of the 3,000 U.S. stocks with the largest market
capitalizations. As of June 30, 1999, the market capitalization of these 2,000
companies represented about 8% of the total market capitalization of the 3,000
companies. Companies whose stock comprises the Russell 2000(R) Index often have
limited product lines, or relatively new products or services, and may lack
established markets, depth of experienced management, or financial resources and
the ability to generate funds. The securities of these companies may have
limited marketability and may be more volatile in price than securities of
larger capitalized or more well-known companies. Among the reasons for the
greater price volatility of securities of smaller companies whose stock
comprises the Russell 2000(R) Index are the less certain growth prospects of
smaller firms, the lower degree of liquidity in the markets for such securities,
and the greater sensitivity of smaller capitalization companies to changing
economic conditions than larger capitalization companies. Conversely, because
many of these securities may be overlooked by investors and undervalued in the
marketplace, there is potential for significant capital appreciation.
EUROPE 30 VP
The investment objective of Europe 30 VP is to provide daily investment
results that correspond to the performance of the ProFunds Europe 30 Index
("PEI").
If Europe 30 VP achieved a perfect correlation for any single trading day,
the net asset value of the shares of this ProFund VP would increase for that day
proportional to any increase in the level of the PEI. Conversely, the net asset
value of the shares of Europe 30 VP would decrease for that day proportional to
any decrease in the level of the PEI for that day.
Investing in foreign companies or financial instruments by this ProFund VP
may involve risks not typically associated with investing in U.S. companies. The
value of securities denominated in foreign currencies, and of dividends from
such securities, can change significantly when foreign currencies strengthen or
weaken relative to the U.S. Dollar. Foreign securities markets generally have
less trading volume and less liquidity than U.S. markets, and prices in some
foreign markets can be extremely volatile. Many foreign countries lack uniform
accounting and disclosure standards. Because this ProFund VP will invest
indirectly in foreign markets, it will be subject to certain of the market,
economic and political risks prevalent in these foreign markets.
Changes in foreign exchange rates will affect the value of securities of
financial instruments denominated or quoted in currencies other than the U.S.
Dollar, and this ProFund VP will not engage in activities designed to hedge
against foreign currency exchange rate fluctuations. Foreign currency exchange
rates may fluctuate significantly over short periods of time. They generally are
determined by forces of supply and demand in the foreign exchange markets and
the relative merits of investments in different countries, actual or perceived
changes in interest rates and other complex factors, as seen from an
international perspective. Currency exchange rates also can be affected
unpredictably by intervention (or failure to intervene) by U.S. or foreign
governments or central banks, by currency controls or by political developments
in the U.S. or abroad.
By investing in American Depository Receipts ("ADRs") under normal market
conditions, Europe 30 VP may reduce some of the risks of investing in foreign
securities. ADRs are denominated in the U.S. Dollar, which reduces the risk of
currency fluctuations during the settlement period for either purchase or sales.
Further, the information available for ADRs is subject to the accounting,
auditing and financial reporting standards of the domestic market or exchange on
which they are traded, which standards are more uniform and more exacting than
those to which many foreign issuers may be subject. However, ADRs do not
eliminate all the risk inherent in investing in the securities of foreign
issuers.
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On January 1, 1999, the European Monetary Union (EMU) began to implement a
new currency unit, the Euro, which is expected to reshape financial markets,
banking systems and monetary policy in Europe and other parts of the world.
Although it is not possible to predict the impact of the Euro implementation
plan on Europe 30 VP, the transition to the Euro may change the economic
environment and behavior of investors, particularly in European markets.
FUTURES CONTRACTS AND RELATED OPTIONS
The ProFunds VP may purchase or sell stock index futures contracts and
options thereon as a substitute for a comparable market position in the
underlying securities or to satisfy regulation requirements. A futures contract
obligates the seller to deliver (and the purchaser to take delivery of) the
specified commodity on the expiration date of the contract. A stock index
futures contract obligates the seller to deliver (and the purchaser to take) an
amount of cash equal to a specific dollar amount multiplied by the difference
between the value of a specific stock index at the close of the last trading day
of the contract and the price at which the agreement is made. No physical
delivery of the underlying stocks in the index is made.
When a ProFund VP purchases a put or call option on a futures contract, the
ProFund VP pays a premium for the right to sell or purchase the underlying
futures contract for a specified price upon exercise at any time during the
option period. By writing (selling) a put or call option on a futures contract,
a ProFund VP receives a premium in return for granting to the purchaser of the
option the right to sell to or buy from the ProFund VP the underlying futures
contract for a specified price upon exercise at any time during the option
period.
Whether a ProFund VP realizes a gain or loss from futures activities
depends generally upon movements in the underlying commodity. The extent of the
ProFund VP's loss from an unhedged short position in futures contracts or from
writing options on futures contracts is potentially unlimited. The ProFunds VP
may engage in related closing purchase or sale transactions with respect to
options on futures contracts by buying an option of the same series as an option
previously written by a ProFund VP, or selling an option of the same series as
an option previously purchased by a ProFund VP. The ProFunds VP will engage in
transactions in futures contracts and related options that are traded on a U.S.
exchange or board of trade or that have been approved for sale in the U.S. by
the Commodity Futures Trading Commission.
When a ProFund VP purchases or sells a stock index futures contract, or
sells an option thereon, the ProFund VP "covers" its position. To cover its
position, a ProFund VP may enter into an offsetting position or maintain with
its custodian bank (and mark-to-market on a daily basis) a segregated account
consisting of liquid instruments that, when added to any amounts deposited with
a futures commission merchant as margin, are equal to the market value of the
futures contract or otherwise "cover" its position.
The ProFunds VP may purchase and sell futures contracts and options thereon
only to the extent that such activities would be consistent with the
requirements of Section 4.5 of the regulations promulgated by the Commodity
Futures Trading Commission (the "CFTC Regulations") under the Commodity Exchange
Act under which each of these ProFunds VP would be excluded from the definition
of a "commodity pool operator." Under Section 4.5 of the CFTC Regulations, a
ProFund VP may engage in futures transactions, either for "bona fide hedging"
purposes, as this term is defined in the CFTC Regulations, or for non- bona fide
hedging purposes to the extent that the aggregate initial margins and option
premiums required to establish such non- bona fide hedging positions do not
exceed 5% of the liquidation value of the ProFund VP's portfolio. In the case of
an option on futures contracts that is "in-the-money" at the time of purchase
(i.e., the amount by which the exercise price of the put option exceeds the
current market value of the underlying security or the amount by which the
current market value of the underlying security exceeds the exercise price of
the call option), the in-the-money amount may be excluded in calculating this 5%
limitation.
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The ProFunds VP will cover their positions when they write a futures
contract or option on a futures contract. A ProFund VP may "cover" its long
position in a futures contract by purchasing a put option on the same futures
contract with a strike price (i.e., an exercise price) as high or higher than
the price of the futures contract, or, if the strike price of the put is less
than the price of the futures contract, the ProFund VP will maintain in a
segregated account cash or liquid instruments equal in value to the difference
between the strike price of the put and the price of the futures contract. A
ProFund VP may also cover its long position in a futures contract by taking a
short position in the instruments underlying the futures contract, or by taking
positions in instruments the prices of which are expected to move relatively
consistently with the futures contract. A ProFund VP may cover its short
position in a futures contract by taking a long position in the instruments
underlying the futures contract, or by taking positions in instruments the
prices of which are expected to move relatively consistently with the futures
contract.
A ProFund VP may cover its sale of a call option on a futures contract by
taking a long position in the underlying futures contract at a price less than
or equal to the strike price of the call option, or, if the long position in the
underlying futures contract is established at a price greater than the strike
price of the written (sold) call, the ProFund VP will maintain in a segregated
account liquid instruments equal in value to the difference between the strike
price of the call and the price of the futures contract. A ProFund VP may also
cover its sale of a call option by taking positions in instruments the prices of
which are expected to move relatively consistently with the call option. A
ProFund VP may cover its sale of a put option on a futures contract by taking a
short position in the underlying futures contract at a price greater than or
equal to the strike price of the put option, or, if the short position in the
underlying futures contract is established at a price less than the strike price
of the written put, the ProFund VP will maintain in a segregated account cash or
high-grade liquid debt securities equal in value to the difference between the
strike price of the put and the price of the future. A ProFund VP may also cover
its sale of a put option by taking positions in instruments the prices of which
are expected to move relatively consistently with the put option.
Although the ProFunds VP intend to sell futures contracts only if there is
an active market for such contracts, no assurance can be given that a liquid
market will exist for any particular contract at any particular time. Many
futures exchanges and boards of trade limit the amount of fluctuation permitted
in futures contract prices during a single trading day. Once the daily limit has
been reached in a particular contract, no trades may be made that day at a price
beyond that limit or trading may be suspended for specified periods during the
day. Futures contract prices could move to the limit for several consecutive
trading days with little or no trading, thereby preventing prompt liquidation of
futures positions and potentially subjecting a ProFund VP to substantial losses.
If trading is not possible, or if a ProFund VP determines not to close a futures
position in anticipation of adverse price movements, the ProFund VP will be
required to make daily cash payments of variation margin. The risk that the
ProFund VP will be unable to close out a futures position will be minimized by
entering into such transactions on a national exchange with an active and liquid
secondary market.
INDEX OPTIONS
The ProFunds VP may purchase and write options on stock indexes to create
investment exposure consistent with their investment objectives, to hedge or
limit the exposure of their positions and to create synthetic money market
positions. See "Taxation" herein.
A stock index fluctuates with changes in the market values of the stocks
included in the index. Options on stock indexes give the holder the right to
receive an amount of cash upon exercise of the option. Receipt of this cash
amount will depend upon the closing level of the stock index upon which the
option is based being greater than (in the case of a call) or less than (in the
case of a put) the exercise price of the option. The amount of cash received, if
any, will be the difference between the closing price of the index and the
exercise price of the option, multiplied by a specified dollar multiple. The
writer (seller) of the option is obligated, in return for the premiums received
from the purchaser of the option, to make delivery of this amount to the
purchaser. All settlements of index options transactions are in cash.
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Index options are subject to substantial risks, including the risk of
imperfect correlation between the option price and the value of the underlying
securities composing the stock index selected and the risk that there might not
be a liquid secondary market for the option. Because the value of an index
option depends upon movements in the level of the index rather than the price of
a particular stock, whether a ProFund VP will realize a gain or loss from the
purchase or writing (sale) of options on an index depends upon movements in the
level of stock prices in the stock market generally or, in the case of certain
indexes, in an industry or market segment, rather than upon movements in the
price of a particular stock. Whether a ProFund VP will realize a profit or loss
by the use of options on stock indexes will depend on movements in the direction
of the stock market generally or of a particular industry or market segment.
This requires different skills and techniques than are required for predicting
changes in the price of individual stocks. A ProFund VP will not enter into an
option position that exposes the ProFund VP to an obligation to another party,
unless the ProFund VP either (i) owns an offsetting position in securities or
other options and/or (ii) maintains with the ProFund VP's custodian bank liquid
instruments that, when added to the premiums deposited with respect to the
option, are equal to the market value of the underlying stock index not
otherwise covered.
The ProFunds VP may engage in transactions in stock index options listed on
national securities exchanges or traded in the over-the-counter market as an
investment vehicle for the purpose of realizing their investment objectives.
Options on indexes are settled in cash, not by delivery of securities. The
exercising holder of an index option receives, instead of a security, cash equal
to the difference between the closing price of the securities index and the
exercise price of the option.
Some stock index options are based on a broad market index such as the S&P
500 Index, the NYSE Composite Index, or the AMEX Major Market Index, or on a
narrower index such as the Philadelphia Stock Exchange Over-the-Counter Index.
Options currently are traded on the Chicago Board Options Exchange (the "CBOE"),
the AMEX, and other exchanges ("Exchanges"). Purchased over-the-counter options
and the cover for written over-the-counter options will be subject to the 15%
limitation on investment in illiquid securities by the ProFunds VP. See
"Illiquid Securities."
Each of the Exchanges has established limitations governing the maximum
number of call or put options on the same index which may be bought or written
(sold) by a single investor, whether acting alone or in concert with others
(regardless of whether such options are written on the same or different
Exchanges or are held or written on one or more accounts or through one or more
brokers). Under these limitations, option positions of all investment companies
advised by the same investment adviser are combined for purposes of these
limits. Pursuant to these limitations, an Exchange may order the liquidation of
positions and may impose other sanctions or restrictions. These position limits
may restrict the number of listed options which a ProFund VP may buy or sell;
however, the Advisor intends to comply with all limitations.
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OPTIONS ON SECURITIES
Each ProFund VP may buy and write (sell) options on securities for the
purpose of realizing its investment objectives. By buying a call option, a
ProFund VP has the right, in return for a premium paid during the term of the
option, to buy the securities underlying the option at the exercise price. By
writing a call option on securities, a ProFund VP becomes obligated during the
term of the option to sell the securities underlying the option at the exercise
price if the option is exercised. By buying a put option, a ProFund VP has the
right, in return for a premium paid during the term of the option, to sell the
securities underlying the option at the exercise price. By writing a put option,
a ProFund VP becomes obligated during the term of the option to purchase the
securities underlying the option at the exercise price if the option is
exercised. During the term of the option, the writer may be assigned an exercise
notice by the broker-dealer through whom the option was sold. The exercise
notice would require the writer to deliver, in the case of a call, or take
delivery of, in the case of a put, the underlying security against payment of
the exercise price. This obligation terminates upon expiration of the option, or
at such earlier time that the writer effects a closing purchase transaction by
purchasing an option covering the same underlying security and having the same
exercise price and expiration date as the one previously sold. Once an option
has been exercised, the writer may not execute a closing purchase transaction.
To secure the obligation to deliver the underlying security in the case of a
call option, the writer of a call option is required to deposit in escrow the
underlying security or other assets in accordance with the rules of the Options
Clearing Corporation (the "OCC"), an institution created to interpose itself
between buyers and sellers of options. The OCC assumes the other side of every
purchase and sale transaction on an exchange and, by doing so, gives its
guarantee to the transaction. When writing call options on securities, a ProFund
VP may cover its position by owning the underlying security on which the option
is written. Alternatively, the ProFund VP may cover its position by owning a
call option on the underlying security, on a share for share basis, which is
deliverable under the option contract at a price no higher than the exercise
price of the call option written by the ProFund VP or, if higher, by owning such
call option and depositing and maintaining in a segregated account cash or
liquid instruments equal in value to the difference between the two exercise
prices. In addition, a ProFund VP may cover its position by depositing and
maintaining in a segregated account cash or liquid instruments equal in value to
the exercise price of the call option written by the ProFund VP. When a ProFund
VP writes a put option, the ProFund VP will have and maintain on deposit with
its custodian bank cash or liquid instruments having a value equal to the
exercise value of the option. The principal reason for a ProFund VP to write
call options on stocks held by the ProFund VP is to attempt to realize, through
the receipt of premiums, a greater return than would be realized on the
underlying securities alone.
If a ProFund VP that writes an option wishes to terminate the ProFund VP's
obligation, the ProFund VP may effect a "closing purchase transaction." The
ProFund VP accomplishes this by buying an option of the same series as the
option previously written by the ProFund VP. The effect of the purchase is that
the writer's position will be canceled by the OCC. However, a writer may not
effect a closing purchase transaction after the writer has been notified of the
exercise of an option. Likewise, a ProFund VP which is the holder of an option
may liquidate its position by effecting a "closing sale transaction." The
ProFund VP accomplishes this by selling an option of the same series as the
option previously purchased by the ProFund VP. There is no guarantee that either
a closing purchase or a closing sale transaction can be effected. If any call or
put option is not exercised or sold, the option will become worthless on its
expiration date. A ProFund VP will realize a gain (or a loss) on a closing
purchase transaction with respect to a call or a put option previously written
by the ProFund VP if the premium, plus commission costs, paid by the ProFund VP
to purchase the call or put option to close the transaction is less (or greater)
than the premium, less commission costs, received by the ProFund VP on the sale
of the call or the put option. The ProFund VP also will realize a gain if a call
or put option which the ProFund VP has written lapses unexercised, because the
ProFund VP would retain the premium.
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Although certain securities exchanges attempt to provide continuously
liquid markets in which holders and writers of options can close out their
positions at any time prior to the expiration of the option, no assurance can be
given that a market will exist at all times for all outstanding options
purchased or sold by a ProFund VP. If an options market were to become
unavailable, the ProFund VP would be unable to realize its profits or limit its
losses until the ProFund VP could exercise options it holds, and the ProFund VP
would remain obligated until options it wrote were exercised or expired. 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 or closing
transactions or both; (iii) trading halts, suspensions or other restrictions may
be imposed with respect to particular classes or series of options; (iv) unusual
or unforeseen circumstances may interrupt normal operations on an exchange; (v)
the facilities of an exchange or the OCC 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) would cease to
exist, although outstanding options on that exchange that had been issued by the
OCC as a result of trades on that exchange would continue to be exercisable in
accordance with their terms.
SWAP AGREEMENTS
The ProFunds VP may enter into equity index or interest rate swap
agreements for purposes of attempting to gain exposure to the stocks making up
an index of securities in a market without actually purchasing those stocks, or
to hedge a position. Swap agreements are two-party contracts entered into
primarily by institutional investors for periods ranging from a day to more than
one year. In a standard "swap" transaction, two parties agree to exchange the
returns (or differentials in rates of return) earned or realized on particular
predetermined investments or instruments. The gross returns to be exchanged or
"swapped" between the parties are calculated with respect to a "notional
amount," i.e., the return on or increase in value of a particular dollar amount
invested in a "basket" of securities representing a particular index. Forms of
swap agreements include interest rate caps, under which, in return for a
premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or "cap"; interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall below a specified level, or "floor"; and
interest rate collars, under which a party sells a cap and purchases a floor or
vice versa in an attempt to protect itself against interest rate movements
exceeding given minimum or maximum levels.
Most swap agreements entered into by the ProFunds VP calculate the
obligations of the parties to the agreement on a "net basis." Consequently, a
ProFund VP's current obligations (or rights) under a swap agreement will
generally be equal only to the net amount to be paid or received under the
agreement based on the relative values of the positions held by each party to
the agreement (the "net amount").
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A ProFund VP's current obligations under a swap agreement will be accrued
daily (offset against any amounts owing to the ProFund VP) and any accrued but
unpaid net amounts owed to a swap counterparty will be covered by segregating
assets determined to be liquid. Obligations under swap agreements so covered
will not be construed to be "senior securities" for purposes of a ProFund VP's
investment restriction concerning senior securities. Because they are two party
contracts and because they may have terms of greater than seven days, swap
agreements may be considered to be illiquid for the ProFund VP illiquid
investment limitations. A ProFund VP will not enter into any swap agreement
unless the Advisor believes that the other party to the transaction is
creditworthy. A ProFund VP bears the risk of loss of the amount expected to be
received under a swap agreement in the event of the default or bankruptcy of a
swap agreement counterparty.
Each ProFund VP may enter into swap agreements to invest in a market
without owning or taking physical custody of securities in circumstances in
which direct investment is restricted for legal reasons or is otherwise
impracticable. The counterparty to any swap agreement will typically be a bank,
investment banking firm or broker/dealer. The counterparty will generally agree
to pay the ProFund VP the amount, if any, by which the notional amount of the
swap agreement would have increased in value had it been invested in the
particular stocks, plus the dividends that would have been received on those
stocks. The ProFund VP will agree to pay to the counterparty a floating rate of
interest on the notional amount of the swap agreement plus the amount, if any,
by which the notional amount would have decreased in value had it been invested
in such stocks. Therefore, the return to the ProFund VP on any swap agreement
should be the gain or loss on the notional amount plus dividends on the stocks
less the interest paid by the ProFund VP on the notional amount.
Swap agreements typically are settled on a net basis, which means that the
two payment streams are netted out, with the ProFund VP receiving or paying, as
the case may be, only the net amount of the two payments. Payments may be made
at the conclusion of a swap agreement or periodically during its term. Swap
agreements do not involve the delivery of securities or other underlying assets.
Accordingly, the risk of loss with respect to swap agreements is limited to the
net amount of payments that a ProFund VP is contractually obligated to make. If
the other party to a swap agreement defaults, a ProFund VP's risk of loss
consists of the net amount of payments that such ProFund VP is contractually
entitled to receive, if any. The net amount of the excess, if any, of a ProFund
VP's obligations over its entitlements with respect to each equity swap will be
accrued on a daily basis and an amount of cash or liquid assets, having an
aggregate net asset value at least equal to such accrued excess will be
maintained in a segregated account by a ProFund VP's custodian. Inasmuch as
these transactions are entered into for hedging purposes or are offset by
segregated cash of liquid assets, as permitted by applicable law, the ProFunds
VP and their Advisor believe that transactions do not constitute senior
securities under the 1940 Act and, accordingly, will not treat them as being
subject to a ProFund VP's borrowing restrictions.
The swap market has grown substantially in recent years with a large number
of banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. As a result, the swap market has
become relatively liquid in comparison with the markets for other similar
instruments which are traded in the over-the-counter market. The Advisor, under
the supervision of the Board of Trustees, are responsible for determining and
monitoring the liquidity of the ProFund VP transactions in swap agreements.
<PAGE>
The use of equity swaps is a highly specialized activity which involves
investment techniques and risks different from those associated with ordinary
portfolio securities transactions.
AMERICAN DEPOSITORY RECEIPTS
For many foreign securities, U.S. Dollar denominated ADRs, which are traded
in the United States on exchanges or over-the-counter, are issued by domestic
banks. ADRs represent the right to receive securities of foreign issuers
deposited in a domestic bank or a correspondent bank. ADRs do not eliminate all
the risk inherent in investing in the securities of foreign issuers. However, by
investing in ADRs rather than directly in foreign issuers' stock, Europe 30 VP
can avoid currency risks during the settlement period for either purchase or
sales.
In general, there is a large, liquid market in the United States for many
ADRs. The information available for ADRs is subject to the accounting, auditing
and financial reporting standards of the domestic market or exchange on which
they are traded, which standards are more uniform and more exacting than those
to which many foreign issuers may be subject. Certain ADRs, typically those
denominated as unsponsored, require the holders thereof to bear most of the
costs of such facilities, while issuers of sponsored facilities normally pay
more of the costs thereof. The depository of an unsponsored facility frequently
is under no obligation to distribute shareholder communications received from
the issuer of the deposited securities or to pass through the voting rights to
facility holders with respect to the deposited securities, whereas the
depository of a sponsored facility typically distributes shareholder
communications and passes through the voting rights.
Europe 30 VP may invest in both sponsored and unsponsored ADRs. Unsponsored
ADR programs are organized independently and without the cooperation of the
issuer of the underlying securities. As a result, available information
concerning the issuers may not be as current as for sponsored ADRs, and the
prices of unsponsored depository receipts may be more volatile than if such
instruments were sponsored by the issuer.
U.S. GOVERNMENT SECURITIES
Each ProFund VP also may invest in U.S. government securities in pursuit of
its investment objectives, as "cover" for the investment techniques these
ProFunds VP employ, or for liquidity purposes.
Yields on U.S. government securities are dependent on a variety of factors,
including the general conditions of the money and bond markets, the size of a
particular offering, and the maturity of the obligation. Debt 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 value of U.S. government
securities generally varies inversely with changes in market interest rates. An
increase in interest rates, therefore, would generally reduce the market value
of a ProFund VP's portfolio investments in U.S. government securities, while a
decline in interest rates would generally increase the market value of a ProFund
VP's portfolio investments in these securities.
U.S. government securities include U.S. Treasury securities, which are
backed by the full faith and credit of the U.S. Treasury and which differ only
in their interest rates, maturities, and times of issuance. U.S. Treasury bills
have initial maturities of one year or less; U.S. Treasury notes have initial
maturities of one to ten years; and U.S. Treasury bonds generally have initial
maturities of greater than ten years. Certain U.S. government securities are
issued or guaranteed by agencies or instrumentalities of the U.S. government
including, but not limited to, obligations of U.S. government agencies or
instrumentalities, such as the Federal National Mortgage Association, the
Government National Mortgage Association, the Small Business Administration, the
Federal Farm Credit Administration, the Federal Home Loan Banks, Banks for
Cooperatives (including the Central Bank for Cooperatives), the Federal Land
Banks, the Federal Intermediate Credit Banks, the Tennessee Valley Authority,
the Export-Import Bank of the United States, the Commodity Credit Corporation,
the Federal Financing Bank, the Student Loan Marketing Association, and the
National Credit Union Administration. Some obligations issued or guaranteed by
U.S. government agencies and instrumentalities, including, for example,
Government National Mortgage Association pass-through certificates, are
supported by the full faith and credit of the U.S. Treasury. Other obligations
issued by or guaranteed by Federal agencies, such as those securities issued by
the Federal National Mortgage Association, are supported by the discretionary
authority of the U.S. government to purchase certain obligations of the federal
agency, while other obligations issued by or guaranteed by federal agencies,
such as those of the Federal Home Loan Banks, are supported by the right of the
issuer to borrow from the U.S. Treasury. While the U.S. government provides
financial support to such U.S. government-sponsored Federal agencies, no
assurance can be given that the U.S. government will always do so, since the
U.S. Government is not so obligated by law. U.S. Treasury notes and bonds
typically pay coupon interest semi-annually and repay the principal at maturity.
<PAGE>
REPURCHASE AGREEMENTS
Each of the ProFunds VP may enter into repurchase agreements with financial
institutions. Under a repurchase agreement, a ProFund VP purchases a debt
security and simultaneously agrees to sell the security back to the seller at a
mutually agreed-upon future price and date, normally one day or a few days
later. The resale price is greater than the purchase price, reflecting an
agreed-upon market interest rate during the purchaser's holding period. While
the maturities of the underlying securities in repurchase transactions may be
more than one year, the term of each repurchase agreement will always be less
than one year. The ProFunds VP follow certain procedures designed to minimize
the risks inherent in such agreements. These procedures include effecting
repurchase transactions only with large, well-capitalized and well-established
financial institutions whose condition will be continually monitored by the
Advisor. In addition, the value of the collateral underlying the repurchase
agreement will always be at least equal to the repurchase price, including any
accrued interest earned on the repurchase agreement. In the event of a default
or bankruptcy by a selling financial institution, a ProFund VP will seek to
liquidate such collateral which could involve certain costs or delays and, to
the extent that proceeds from any sale upon a default of the obligation to
repurchase were less than the repurchase price, the ProFund VP could suffer a
loss. A ProFund VP also may experience difficulties and incur certain costs in
exercising its rights to the collateral and may lose the interest the ProFund VP
expected to receive under the repurchase agreement. Repurchase agreements
usually are for short periods, such as one week or less, but may be longer. It
is the current policy of the ProFunds VP not to invest in repurchase agreements
that do not mature within seven days if any such investment, together with any
other liquid assets held by the ProFund VP, amounts to more than 15% of its
total net assets. The investments of each of the ProFunds VP in repurchase
agreements at times may be substantial when, in the view of the Advisor,
liquidity, investment, regulatory, or other considerations so warrant.
CASH RESERVES
To seek its investment objective as a cash reserve, for liquidity purposes,
or as "cover" for positions it has taken, each ProFund VP may temporarily invest
all or part of the ProFund VP's assets in cash or cash equivalents, which
include, but are not limited to, short-term money market instruments, U.S.
government securities, certificates of deposit, bankers acceptances, or
repurchase agreements secured by U.S. government securities.
REVERSE REPURCHASE AGREEMENTS
The ProFunds VP may use reverse repurchase agreements as part of their
investment strategies. Reverse repurchase agreements involve sales by a ProFund
VP of portfolio assets concurrently with an agreement by the ProFund VP to
repurchase the same assets at a later date at a fixed price. Generally, the
effect of such a transaction is that the ProFund VP can recover all or most of
the cash invested in the portfolio securities involved during the term of the
reverse repurchase agreement, while the ProFund VP will be able to keep the
interest income associated with those portfolio securities. Such transactions
are advantageous only if the interest cost to the ProFund VP of the reverse
repurchase transaction is less than the cost of obtaining the cash otherwise.
Opportunities to achieve this advantage may not always be available, and the
ProFund VP intend to use the reverse repurchase technique only when it will be
to the ProFund VP's advantage to do so. The ProFund VP will establish a
segregated account with its custodian bank in which the ProFund VP will maintain
cash or liquid instruments equal in value to the ProFund VP's obligations in
respect of reverse repurchase agreements.
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BORROWING
The ProFunds VP may borrow money for cash management purposes or investment
purposes. Each of the ProFunds VP may also enter into reverse repurchase
agreements, which may be viewed as a form of borrowing, with financial
institutions. However, to the extent a ProFund VP "covers" its repurchase
obligations as described above in "Reverse Repurchase Agreements," such
agreement will not be considered to be a "senior security" and, therefore, will
not be subject to the 300% asset coverage requirement otherwise applicable to
borrowings by the ProFunds VP. Borrowing for investment is known as leveraging.
Leveraging investments, by purchasing securities with borrowed money, is a
speculative technique which increases investment risk, but also increases
investment opportunity. Since substantially all of a ProFund VP's assets will
fluctuate in value, whereas the interest obligations on borrowings may be fixed,
the net asset value per share of the ProFund VP will increase more when the
ProFund VP's portfolio assets increase in value and decrease more when the
ProFund VP's portfolio assets decrease in value than would otherwise be the
case. Moreover, interest costs on borrowings may fluctuate with changing market
rates of interest and may partially offset or exceed the returns on the borrowed
funds. Under adverse conditions, a ProFund VP might have to sell portfolio
securities to meet interest or principal payments at a time when investment
considerations would not favor such sales.
As required by the 1940 Act, a ProFund VP must maintain continuous asset
coverage (total assets, including assets acquired with borrowed funds, less
liabilities exclusive of borrowings) of 300% of all amounts borrowed. If at any
time the value of the ProFund VP's assets should fail to meet this 300% coverage
test, the ProFund VP, within three days (not including Sundays and holidays),
will reduce the amount of the ProFund VP's borrowings to the extent necessary to
meet this 300% coverage. Maintenance of this percentage limitation may result in
the sale of portfolio securities at a time when investment considerations
otherwise indicate that it would be disadvantageous to do so. In addition to the
foregoing, the ProFunds VP are authorized to borrow money from a bank as a
temporary measure for extraordinary or emergency purposes in amounts not in
excess of 5% of the value of the ProFund VP's total assets. This borrowing is
not subject to the foregoing 300% asset coverage requirement. The ProFunds VP
are authorized to pledge portfolio securities as the Advisor deems appropriate
in connection with any borrowings.
LENDING OF PORTFOLIO SECURITIES
Each of the ProFunds VP may lend its portfolio securities to brokers,
dealers, and financial institutions, provided that cash equal to at least 100%
of the market value of the securities loaned is deposited by the borrower with
the ProFund VP and is maintained each business day in a segregated account
pursuant to applicable regulations. While such securities are on loan, the
borrower will pay the lending ProFund VP any income accruing thereon, and the
ProFund VP may invest the cash collateral in portfolio securities, thereby
earning additional income. A ProFund VP will not lend more than 33 1/3% of the
value of the ProFund VP's total assets. Loans would be subject to termination by
the lending ProFund VP on four business days' notice, or by the borrower on one
day's notice. Borrowed securities must be returned when the loan is terminated.
Any gain or loss in the market price of the borrowed securities which occurs
during the term of the loan inures to the lending ProFund VP. There may be risks
of delay in receiving additional collateral or risks of delay in recovery of the
securities or even loss of rights in the securities lent should the borrower of
the securities fail financially. A lending ProFund VP may pay reasonable
finders, borrowers, administrative, and custodial fees in connection with a
loan.
WHEN-ISSUED AND DELAYED-DELIVERY SECURITIES
Each ProFund VP, from time to time, in the ordinary course of business, may
purchase securities on a when-issued or delayed-delivery basis (i.e., delivery
and payment can take place between a month and 120 days after the date of the
transaction). These securities are subject to market fluctuation and no interest
accrues to the purchaser during this period. At the time a ProFund VP makes the
commitment to purchase securities on a when-issued or delayed-delivery basis,
the ProFund VP will record the transaction and thereafter reflect the value of
the securities, each day, in determining the ProFund VP's net asset value. Each
ProFund VP will not purchase securities on a when-issued or delayed-delivery
basis if, as a result, more than 15% of the ProFund VP's net assets would be so
invested. At the time of delivery of the securities, the value of the securities
may be more or less than the purchase price.
<PAGE>
The Trust will also establish a segregated account with the Trust's
custodian bank in which the ProFunds VP will maintain liquid instruments equal
to or greater in value than the ProFund VP's purchase commitments for such
when-issued or delayed-delivery securities, or the Trust does not believe that a
ProFund VP's net asset value or income will be adversely affected by the ProFund
VP's purchase of securities on a when-issued or delayed delivery basis.
INVESTMENTS IN OTHER INVESTMENT COMPANIES
The ProFunds VP may invest in the securities of other investment companies
to the extent that such an investment would be consistent with the requirements
of the 1940 Act. If a ProFund VP invests in, and, thus, is a shareholder of,
another investment company, the ProFund VP's shareholders will indirectly bear
the ProFund VP's proportionate share of the fees and expenses paid by such other
investment company, including advisory fees, in addition to both the management
fees payable directly by the ProFund VP to the ProFund VP's own investment
adviser and the other expenses that the ProFund VP bears directly in connection
with the ProFund VP's own operations.
ILLIQUID SECURITIES
While none of the ProFunds VP anticipates doing so, each of the ProFunds VP
may purchase illiquid securities, including securities that are not readily
marketable and securities that are not registered ("restricted securities")
under the Securities Act of 1933, as amended (the "1933 Act"), but which can be
sold to qualified institutional buyers under Rule 144A of the 1933 Act. A
ProFund VP will not invest more than 15% of the ProFund VP's net assets in
illiquid securities. The term "illiquid securities" for this purpose means
securities that cannot be disposed of within seven days in the ordinary course
of business at approximately the amount at which the ProFund VP has valued the
securities. Under the current guidelines of the staff of the Securities and
Exchange Commission (the "Commission"), illiquid securities also are considered
to include, among other securities, purchased over-the-counter options, certain
cover for over-the-counter options, repurchase agreements with maturities in
excess of seven days, and certain securities whose disposition is restricted
under the Federal securities laws. The ProFund VP may not be able to sell
illiquid securities when the Advisor considers it desirable to do so or may have
to sell such securities at a price that is lower than the price that could be
obtained if the securities were more liquid. In addition, the sale of illiquid
securities also may require more time and may result in higher dealer discounts
and other selling expenses than does the sale of securities that are not
illiquid. Illiquid securities also may be more difficult to value due to the
unavailability of reliable market quotations for such securities, and
investments in illiquid securities may have an adverse impact on net asset
value.
Institutional markets for restricted securities have developed as a result
of the promulgation of Rule 144A under the 1933 Act, which provides a safe
harbor from 1933 Act registration requirements for qualifying sales to
institutional investors. When Rule 144A restricted securities present an
attractive investment opportunity and otherwise meet selection criteria, a
ProFund VP may make such investments. Whether or not such securities are
illiquid depends on the market that exists for the particular security. The
Commission staff has taken the position that the liquidity of Rule 144A
restricted securities is a question of fact for a board of trustees to
determine, such determination to be based on a consideration of the
readily-available trading markets and the review of any contractual
restrictions. The staff also has acknowledged that, while a board of trustees
retains ultimate responsibility, trustees may delegate this function to an
investment adviser. Trustees of ProFunds VP have delegated this responsibility
for determining the liquidity of Rule 144A restricted securities which may be
invested in by a ProFund VP to the Advisor. It is not possible to predict with
assurance exactly how the market for Rule 144A restricted securities or any
other security will develop. A security which when purchased enjoyed a fair
degree of marketability may subsequently become illiquid and, accordingly, a
security which was deemed to be liquid at the time of acquisition may
subsequently become illiquid. In such event, appropriate remedies will be
considered to minimize the effect on the ProFund VP's liquidity.
<PAGE>
PORTFOLIO TURNOVER
The nature of the ProFunds VP will cause the ProFunds VP to experience
substantial portfolio turnover. A higher portfolio turnover rate would likely
involve correspondingly greater brokerage commissions and transaction and other
expenses which would be borne by the ProFunds VP. In addition, a ProFund VP's
portfolio turnover level may adversely affect the ability of the ProFund VP to
achieve its investment objective. Because each ProFund VP's portfolio turnover
rate to a great extent will depend on the purchase, redemption, and exchange
activity of the ProFund VP's investors, it is difficult to estimate what the
ProFund VP's actual turnover rate will be in the future. "Portfolio Turnover
Rate" is defined under the rules of the Commission as the value of the
securities purchased or securities sold, excluding all securities whose
maturities at time of acquisition were one year or less, divided by the average
monthly value of such securities owned during the year. Based on this
definition, instruments with remaining maturities of less than one year are
excluded from the calculation of portfolio turnover rate. Instruments excluded
from the calculation of portfolio turnover generally would include the futures
contracts and option contracts in which the ProFunds VP invest since such
contracts generally have a remaining maturity of less than one year. Pursuant to
the formula prescribed by the Commission, the portfolio turnover rate for each
ProFund VP is calculated without regard to instruments, including options and
futures contracts, having a maturity of less than one year. Small Cap VP
typically holds most of its investments in short-term options and futures
contracts, which, therefore, are excluded for purposes of computing portfolio
turnover. Therefore, based on the Commission's portfolio turnover formula, Small
Cap VP expects a portfolio turnover rate of approximately 0%.
SPECIAL CONSIDERATIONS
To the extent discussed above and in the prospectus, the ProFunds VP
present certain risks, some of which are further described below.
TRACKING ERROR. While the ProFunds VP do not expect that their returns over
a year will deviate adversely from their respective benchmarks by more than ten
percent, several factors may affect their ability to achieve this correlation.
Among these factors are: (1) ProFund VP expenses, including brokerage (which may
be increased by high portfolio turnover) and the cost of the investment
techniques employed by the ProFunds VP; (2) less than all of the securities in
the benchmark being held by a ProFund VP and securities not included in the
benchmark being held by a ProFund VP; (3) an imperfect correlation between the
performance of instruments held by a ProFund VP, such as futures contracts and
options, and the performance of the underlying securities in the cash market;
(4) bid-ask spreads (the effect of which may be increased by portfolio
turnover); (5) holding instruments traded in a market that has become illiquid
or disrupted; (6) a ProFund VP share prices being rounded to the nearest cent;
(7) changes to the benchmark index that are not disseminated in advance; (8) the
need to conform a ProFund VP's portfolio holdings to comply with investment
restrictions or policies or regulatory or tax law requirements, and (9) early
and unanticipated closings of the markets on which the holdings of a ProFund VP
trade, resulting in the inability of the ProFund VP to execute intended
portfolio transactions. While a close correlation of any ProFund VP to its
benchmark may be achieved on any single trading day, over time the cumulative
percentage increase or decrease in the net asset value of the shares of a
ProFund VP may diverge significantly from the cumulative percentage decrease or
increase in the benchmark due to a compounding effect.
LEVERAGE. UltraOTC VP intends to use leveraged investment techniques in
pursuing their investment objectives. Utilization of leveraging involves special
risks and should be considered to be speculative. Leverage exists when a ProFund
VP achieves the right to a return on a capital base that exceeds the amount the
ProFund VP has invested. Leverage creates the potential for greater gains to
shareholders of these ProFund VP during favorable market conditions and the risk
of magnified losses during adverse market conditions. Leverage should cause
higher volatility of the net asset values of these ProFund VP's shares. Leverage
may involve the creation of a liability that does not entail any interest costs
or the creation of a liability that requires the ProFund VP to pay interest
which would decrease the ProFund VP's total return to shareholders. If these
ProFunds VP achieve their investment objectives, during adverse market
conditions, shareholders should experience a loss of approximately twice the
amount they would have incurred had these ProFunds VP not been leveraged.
<PAGE>
NON-DIVERSIFIED STATUS. Each ProFund VP is a "non-diversified" series. Each
ProFund VP is considered "non-diversified" because a relatively high percentage
of the ProFund VP's assets may be invested in the securities of a limited number
of issuers, primarily within the same economic sector. That ProFund VP's
portfolio securities, therefore, may be more susceptible to any single economic,
political, or regulatory occurrence than the portfolio securities of a more
diversified investment company. A ProFund VP's classification as a
"non-diversified" investment company means that the proportion of the ProFund
VP's assets that may be invested in the securities of a single issuer is not
limited by the 1940 Act. Each ProFund VP, however, intends to seek to qualify as
a "regulated investment company" for purposes of the Internal Revenue Code,
which imposes diversification requirements on these ProFund VP that are less
restrictive than the requirements applicable to the "diversified" investment
companies under the 1940 Act.
INVESTMENT RESTRICTIONS
The ProFunds VP have adopted certain investment restrictions as fundamental
policies which cannot be changed without the approval of the holders of a
"majority" of the outstanding shares of a ProFund VP, as that term is defined in
the 1940 Act. The term "majority" is defined in the 1940 Act as the lesser of:
(i) 67% or more of the shares of the series present at a meeting of
shareholders, if the holders of more than 50% of the outstanding shares of the
ProFund VP are present or represented by proxy; or (ii) more than 50% of the
outstanding shares of the series. (All policies of a ProFund VP not specifically
identified in this Statement of Additional Information or the Prospectus as
fundamental may be changed without a vote of the shareholders of the ProFund
VP.) For purposes of the following limitations, all percentage limitations apply
immediately after a purchase or initial investment.
A ProFund VP may not:
1. Invest more than 25% of its total assets, taken at market value at the time
of each investment, in the securities of issuers in any particular industry
(excluding the U.S. government and its agencies and instrumentalities or
repurchase agreements with respect thereto).
2. Make investments for the purpose of exercising control or management.
3. Purchase or sell real estate, except that, to the extent permitted by
applicable law, the ProFund VP may invest in securities directly or indirectly
secured by real estate or interests therein or issued by companies that invest
in real estate or interests therein.
4. Make loans to other persons, except that the acquisition of bonds, debentures
or other corporate debt securities and investment in government obligations,
commercial paper, pass-through instruments, certificates of deposit, bankers'
acceptances and repurchase agreements and purchase and sale contracts and any
similar instruments shall not be deemed to be the making of a loan, and except
further that the ProFund VP may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with applicable
law and the guidelines set forth in the Prospectus and this Statement of
Additional Information, as they may be amended from time to time.
5. Issue senior securities to the extent such issuance would violate applicable
law.
<PAGE>
6. Borrow money, except that the ProFund VP (i) may borrow from banks (as
defined in the Investment Company Act of 1940) in amounts up to 33 1/3% of its
total assets (including the amount borrowed), (ii) may, to the extent permitted
by applicable law, borrow up to an additional 5% of its total assets for
temporary purposes, (iii) may obtain such short-term credit as may be necessary
for the clearance of purchases and sales of portfolio securities, (iv) may
purchase securities on margin to the extent permitted by applicable law and (v)
may enter into reverse repurchase agreements. The ProFund VP may not pledge its
assets other than to secure such borrowings or, to the extent permitted by the
ProFund VP's investment policies as set forth in the Prospectus and this
Statement of Additional Information, as they may be amended from time to time,
in connection with hedging transactions, short sales, when-issued and forward
commitment transactions and similar investment strategies.
7. Underwrite securities of other issuers, except insofar as the ProFund VP
technically may be deemed an underwriter under the Securities Act of 1933, as
amended, in selling portfolio securities.
8. Purchase or sell commodities or contracts on commodities, except to the
extent the ProFund VP may do so in accordance with applicable law and the
ProFund VP's Prospectus and Statement of Additional Information, as they may be
amended from time to time.
DETERMINATION OF NET ASSET VALUE
The net asset values of the shares of the ProFunds VP are determined as of
the close of business of the NYSE (ordinarily, 4:00 p.m. Eastern Time) on each
day the NYSE and the Chicago Mercantile Exchange ("CME") are open for business.
To the extent that portfolio securities of a ProFund VP are traded in other
markets on days when the ProFund VP's principal trading market(s) is closed, the
ProFund VP's net asset value may be affected on days when investors do not have
access to the ProFund VP to purchase or redeem shares. Although the ProFunds VP
expect the same holiday schedules to be observed in the future, the exchanges
may modify their holiday schedules at any time.
The net asset value of shares of a ProFund VP serves as the basis for the
purchase and redemption price of that class of shares. The net asset value per
share of a ProFund VP is calculated by dividing the market value of the ProFund
VP's assets, less all liabilities attributed to the ProFund VP, by the number of
outstanding shares of the ProFund VP. If market quotations are not readily
available, a security will be valued at fair value by the Trustees of the Trust
or by the Advisor using methods established or ratified by the Trustees of the
Trust.
The securities in the portfolio of a ProFund VP, except as otherwise noted,
that are listed or traded on a stock exchange, are valued on the basis of the
last sale on that day or, lacking any sales, at a price that is the mean between
the closing bid and asked prices. Other securities that are traded on the OTC
markets are priced using NASDAQ, which provides information on bid and asked
prices quoted by major dealers in such stocks. Bonds, other than convertible
bonds, are valued using a third-party pricing system. Convertible bonds are
valued using this pricing system only on days when there is no sale reported.
Short-term debt securities are valued using this pricing system only on days
when there is no sale reported. Short-term debt securities are valued at
amortized cost, which approximates market value. When market quotations are not
readily available, securities and other assets are valued at fair value as
determined in good faith under procedures established by and under the general
supervision and responsibility of the ProFunds' Board of Trustees.
Futures contracts maintained by ProFunds VP are valued at their last sale
price prior to the valuation time. Options on futures contracts generally are
valued at fair value as determined with reference to established futures
exchanges. Options on securities and indices purchased by a ProFund VP are
valued at their last sale price prior to the valuation time or at fair value. In
the event of a trading halt that closes the NYSE early, futures contracts will
be valued on the basis of settlement prices on futures exchanges, options on
futures will be valued at fair value as determined with reference to such
settlement prices, and options on securities and indices will be valued at their
last sale price prior to the trading halt or at fair value.
<PAGE>
In the event a trading halt closes a futures exchange for a given day and
that closure occurs prior to the close of the NYSE on that day, futures
positions traded on such exchange and held by a ProFund VP will be valued on the
basis of the day's settlement prices on the futures exchange or fair value.
Options on futures contracts generally are valued at fair value as
determined with reference to established futures exchanges. Options on
securities and indices purchased by these ProFunds VP are valued at their last
sale price immediately prior to the close of the underlying stock exchange.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the general supervision by the Trustees, the Advisor is
responsible for decisions to buy and sell securities for each of the ProFunds
VP, the selection of brokers and dealers to effect the transactions, and the
negotiation of brokerage commissions, if any. The Advisor expects that the
ProFunds VP may execute brokerage or other agency transactions through
registered broker-dealers, for a commission, in conformity with the 1940 Act,
the Securities Exchange Act of 1934, as amended, and the rules and regulations
thereunder. The Advisor may serve as an investment manager to a number of
clients, including other investment companies. It is the practice of the Advisor
to cause purchase and sale transactions to be allocated among the ProFunds VP
and others whose assets the Advisor manages in such manner as the Advisor deems
equitable. The main factors considered by the Advisor in making such allocations
among the ProFunds VP and other client accounts of the Advisor are the
respective investment objectives, the relative size of portfolio holdings of the
same or comparable securities, the availability of cash for investment, the size
of investment commitments generally held, and the opinions of the person(s)
responsible, if any, for managing the portfolios of the ProFunds VP and the
other client accounts.
The policy of each ProFund VP regarding purchases and sales of securities
for a ProFund VP's portfolio is that primary consideration will be given to
obtaining the most favorable prices and efficient executions of transactions.
Consistent with this policy, when securities transactions are effected on a
stock exchange, each ProFund VP's policy is to pay commissions which are
considered fair and reasonable without necessarily determining that the lowest
possible commissions are paid in all circumstances. Each ProFund VP believes
that a requirement always to seek the lowest possible commission cost could
impede effective portfolio management and preclude the ProFund VP and the
Advisor from obtaining a high quality of brokerage and research services. In
seeking to determine the reasonableness of brokerage commissions paid in any
transaction, the Advisor relies upon its experience and knowledge regarding
commissions generally charged by various brokers and on its judgment in
evaluating the brokerage and research services received from the broker
effecting the transaction. Such determinations are necessarily subjective and
imprecise, as in most cases an exact dollar value for those services is not
ascertainable.
Purchases and sales of U.S. government securities are normally transacted
through issuers, underwriters or major dealers in U.S. government securities
acting as principals. Such transactions are made on a net basis and do not
involve payment of brokerage commissions. The cost of securities purchased from
an underwriter usually includes a commission paid by the issuer to the
underwriters; transactions with dealers normally reflect the spread between bid
and asked prices.
In seeking to implement a ProFund VP's policies, the Advisor effects
transactions with those brokers and dealers who the Advisor believes provide the
most favorable prices and are capable of providing efficient executions. If the
Advisor believes such prices and executions are obtainable from more than one
broker or dealer, the Advisor may give consideration to placing portfolio
transactions with those brokers and dealers who also furnish research and other
services to the ProFund VP or the Advisor. Such services may include, but are
not limited to, any one or more of the following: information as to the
availability of securities for purchase or sale; statistical or factual
information or opinions pertaining to investment; wire services; and appraisals
or evaluations of portfolio securities. If the broker-dealer providing these
additional services is acting as a principal for its own account, no commissions
would be payable. If the broker-dealer is not a principal, a higher commission
may be justified, at the determination of the Advisor, for the additional
services.
<PAGE>
The information and services received by the Advisor from brokers and
dealers may be of benefit to the Advisor in the management of accounts of some
of the Advisor's other clients and may not in all cases benefit a ProFund VP
directly. While the receipt of such information and services is useful in
varying degrees and would generally reduce the amount of research or services
otherwise performed by the Advisor and thereby reduce the Advisor's expenses,
this information and these services are of indeterminable value and the
management fee paid to the Advisor is not reduced by any amount that may be
attributable to the value of such information and services.
MANAGEMENT OF PROFUNDS
The Board of Trustees is responsible for the general supervision of the
Trust's business. The day-to-day operations of the ProFunds are the
responsibilities of ProFunds' officers. The names and addresses (and ages) of
the Trustees of the Trust, the officers of the Trust, and the officers of the
Advisor, together with information as to their principal business occupations
during the past five years, are set forth below. Fees and expenses for
non-interested Trustees will be paid by the Trust; Trustee expenses for
interested Trustees will be paid by the Advisor.
TRUSTEES AND OFFICERS OF PROFUNDS
MICHAEL L. SAPIR* (birthdate: May 19, 1958). Currently: Trustee, Chairman
and Chief Executive Officer of ProFunds; Chairman and Chief Executive Officer of
the Advisor. Formerly: Principal, Law Offices of Michael L. Sapir; President,
Rydex Distributors, Inc.; Senior Vice President, General Counsel, Padco
Advisors, Inc.; Partner, Jorden Burt Berenson & Klingensmith. His address is
7900 Wisconsin Avenue, Suite 300, Bethesda, Maryland 20814.
LOUIS M. MAYBERG* (birthdate: August 9, 1962). Currently: Trustee and
Secretary of ProFunds; President, the Advisor. Formerly: President, Potomac
Securities, Inc.; Managing Director, National Capital Companies, LLC. His
address is 7900 Wisconsin Avenue, Suite 300, Bethesda, Maryland 20814.
NIMISH BHATT (birthdate: June 6, 1963). Currently: Treasurer of ProFunds;
Vice President, Tax and Financial Services, BISYS Fund Services. Formerly:
Assistant Vice President, Evergreen ProFunds VP/First Union Bank; Senior Tax
Consultant, Price Waterhouse LLP. His address is 3435 Stelzer Road, Columbus,
Ohio 43219.
MICHAEL C. WACHS (birthdate: October 21, 1961). Currently: Trustee of
ProFunds; Vice President, Delancy Investment Group, Inc. Formerly: Vice
President/Senior Underwriter, First Union National Bank; Vice President, Vice
President/Senior Credit Officer and Vice President/Team Leader, First Union
Capital Markets Corp. His address is 1528 Powder Mill Lane, Wynnewood,
Pennsylvania 19096.
RUSSELL S. REYNOLDS, III (birthdate: July 21, 1957). Currently: Trustee of
ProFunds; Managing Director, Chief Financial Officer and Secretary,
Directorship, Inc. Formerly: President, Quadcom Services, Inc. His address is 7
Stag Lane, Greenwich, Connecticut 06831.
*This Trustee is deemed to be an "interested person" within the meaning of
Section 2(a)(19) of the 1940 Act, inasmuch as this person is affiliated with the
Advisor, as described herein.
<PAGE>
PROFUNDS TRUSTEE COMPENSATION TABLE
The following table reflect fees paid to the Trustees for the year ended
December 31, 1998.
NAME OF
PERSON: POSITION COMPENSATION
Michael L. Sapir, Chairman and Chief Executive Officer None
Louis M. Mayberg, Trustee, President, Secretary None
Russell S. Reynolds, III, Trustee $5,000
Michael C. Wachs, Trustee $3,750
PROFUND ADVISORS LLC
Under an investment advisory agreement between the ProFunds VP and the
Advisor, dated October 18, 1999, each of the ProFunds VP pays the Advisor a fee
at an annualized rate, based on its average daily net assets, of 0.75%. The
Advisor manages the investment and the reinvestment of the assets of each of the
ProFunds VP, in accordance with the investment objectives, policies, and
limitations of each ProFund VP, subject to the general supervision and control
of Trustees and the officers of ProFunds VP. The Advisor bears all costs
associated with providing these advisory services. The Advisor, from its own
resources, including profits from advisory fees received from the ProFunds VP,
provided such fees are legitimate and not excessive, also may make payments to
broker-dealers and other financial institutions for their expenses in connection
with the distribution of ProFund VP shares. The Advisor's address is 7900
Wisconsin Avenue, Suite 300, Bethesda, Maryland 20814.
ADMINISTRATION, TRANSFER AGENT, FUND ACCOUNTING AGENT AND CUSTODIAN
BISYS Fund Services Limited Partnership d/b/a BISYS Fund Services ("BISYS")
acts as Administrator to the ProFunds VP. The Administrator provides the
ProFunds VP with all required general administrative services, including,
without limitation, office space, equipment, and personnel; clerical and general
back office services; bookkeeping, internal accounting, and secretarial
services; the determination of net asset values; and the preparation and filing
of all reports, registration statements, proxy statements, and all other
materials required to be filed or furnished by the ProFunds VP under Federal and
state securities laws. The Administrator also maintains the shareholder account
records for the ProFunds VP, distributes dividends and distributions payable by
the ProFunds VP, and produces statements with respect to account activity for
the ProFunds VP and their shareholders. The Administrator pays all fees and
expenses that are directly related to the services provided by the Administrator
to the ProFunds VP; each ProFund VP reimburses the Administrator for all fees
and expenses incurred by the Administrator which are not directly related to the
services the Administrator provides to the ProFunds VP under the service
agreement.
For its services as Administrator, each ProFund VP pays BISYS an annual fee
equal to .05% of average daily net assets. BISYS Funds Services, Inc. ("BFSI"),
an affiliate of BISYS, acts as transfer agent and fund accounting agent for the
ProFunds VP, for which it receives additional fees. Additionally, ProFunds VP
and BISYS and BFSI have entered into an Omnibus Fee Agreement in which the
amount of compensation due and payable to BISYS shall be the greater of (i) the
aggregate fee amount due and payable for services pursuant to the
Administration, Fund Accounting and Transfer Agency Agreements and (ii) the
minimum relationship fee described as specific dollar amounts payable over a
period of ten calendar quarters. The address for BISYS and BFSI is 3435 Stelzer
Road, Suite 1000, Columbus, Ohio 43219.
<PAGE>
The Advisor, pursuant to a separate Management Services Agreement, performs
certain client support and other administrative services on behalf of the
ProFunds VP. For these services, each ProFund VP will pay to the Advisor a fee
at the annual rate of .15% of its average daily net assets for all ProFunds VP.
UMB Bank, N.A. acts as custodian to the ProFunds VP. UMB Bank, N.A.'s
address is 928 Grand Avenue, Kansas City, Missouri.
ADMINISTRATIVE SERVICES
The Trust, on behalf of the ProFunds VP, has entered into an administrative
services agreement with American Skandia Life Assurance Corporation ("American
Skandia") pursuant to which American Skandia will provide administrative
services with respect to these ProFunds VP. These services may include, but are
not limited to: coordinating matters relating to the operation of American
Skandia's separate account with these ProFunds VP, including necessary
coordination with other service providers; coordinating the preparation of
necessary documents to be submitted to regulatory authorities; providing
assistance to variable contract powers who use or intend to use the ProFunds VP
as funding vehicles for their variable contracts; coordinating with the Advisor
regarding investment limitations and parameters to which these ProFunds VP are
subject; and generally assisting with compliance with applicable regulatory
requirements. For these services, the Trust pays American Skandia a quarterly
fee equal on an annual basis to 0.25% of the average daily net assets of each
ProFund VP that were invested in such ProFund VP through American Skandia's
separate account.
From time to time the ProFunds VP and/or the Advisor may enter into
arrangements under which certain administrative services may be performed by
other insurance companies that purchase shares of the ProFunds VP. These
administrative services may include, among other things, the services set forth
above, as well as responding to ministerial inquiries concerning the ProFunds VP
investment objectives, investment programs, policies and performance,
transmitting, on behalf of the ProFunds VP, proxy statements, annual reports,
updated prospectuses, and other communications regarding the ProFunds VP, and
providing any related services as the ProFunds VP or their investors may
reasonably request. Depending on the arrangements, the ProFunds VP and/or the
Advisor may compensate such insurance companies or their agents directly or
indirectly for the administrative services. To the extent the ProFunds VP
compensate the insurance company for these services, the ProFunds VP will pay
the insurance company an annual fee that will vary depending upon the number of
investors that utilize the ProFunds VP as the funding medium for their
contracts. The insurance company may impose other account or service charges.
See the prospectus for the separate account of the insurance company for
additional information regarding such charges.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP serves as independent auditors to the ProFunds
VP. PricewaterhouseCoopers LLP provides audit services, tax return preparation
and assistance and consultation in connection with certain SEC filings.
PricewaterhouseCoopers LLP is located at 100 East Broad Street, Columbus, Ohio
43215.
LEGAL COUNSEL
Dechert Price & Rhoads serves as counsel to the ProFunds VP. The firm's
address is 1775 Eye Street, N.W., Washington, DC 20006-2401.
DISTRIBUTION PLAN
Pursuant to a Distribution Plan, the ProFunds VP may reimburse or
compensate financial intermediaries from their assets for services rendered and
expenses borne in connection with activities primarily intended to result in the
sale of ProFunds VP's shares. It is anticipated that a portion of the amounts
paid by ProFunds VP will be used to defray various costs incurred in connection
with the printing and mailing of prospectuses, statements of additional
information, and any supplements thereto and shareholder reports, and holding
seminars and sales meetings with wholesale and retail sales personnel designed
to promote the distribution of the Funds' shares. The ProFunds VP also may
reimburse or compensate financial intermediaries and third-party broker-dealers
for their services in connection with the distribution of the shares of the
ProFunds VP.
<PAGE>
The Distribution Plan provides that the Trust, on behalf of each ProFund
VP, will pay annually up to 0.25% of the average daily net assets of a ProFund
VP in respect of activities primarily intended to result in the sale of its
shares. Under the terms of the Distribution Plan and related agreements, each
ProFund VP is authorized to make quarterly payments that may be used to
reimburse or compensate entities providing distribution and shareholder
servicing with respect to the shares of the ProFund VP for such entities' fees
or expenses incurred or paid in that regard.
The Distribution Plan is of a type known as a "compensation" plan because
payments may be made for services rendered to the ProFunds VP regardless of the
level of expenditures by the financial intermediaries. The Trustees will,
however, take into account such expenditures for purposes of reviewing
operations under the Distribution Plan in connection with their annual
consideration of the Distribution Plan's renewal. Expenditures under the
Distribution Plan may include, without limitation: (a) the printing and mailing
of ProFunds VP prospectuses, statements of additional information, any
supplements thereto and shareholder reports for prospective investors; (b) those
relating to the development, preparation, printing and mailing of
advertisements, sales literature and other promotional materials describing
and/or relating to the ProFunds VP; (c) holding seminars and sales meetings
designed to promote the distribution of the ProFunds VP shares; (d) obtaining
information and providing explanations to wholesale and retail distributors of
contracts regarding the investment objectives and policies and other information
about the ProFunds VP, including the performance of the ProFunds VP; (e)
training sales personnel regarding the ProFunds VP; and (f) financing any other
activity that is primarily intended to result in the sale of shares of the
ProFunds VP. In addition, a financial intermediary may enter into an agreement
with the Trust under which it would be entitled to receive compensation for,
among other things, making the ProFunds VP available to its contract owners as
funding vehicles for variable insurance contracts.
The Distribution Plan and any related agreement that is entered into by the
Trust in connection with the Distribution Plan will continue in effect for a
period of more than one year only so long as continuance is specifically
approved at least annually by a vote of a majority of the Trust's Board of
Trustees, and of a majority of the Trustees who are not "interested persons" of
the Trust and who have no financial interest in the operation of the
Distribution Plan (the "Independent Trustees"), cast in person at a meeting
called for the purpose of voting on the Distribution Plan or any related
agreement, as applicable. In addition, the Distribution Plan and any related
agreement may be terminated as to a ProFund VP at any time, without penalty, by
vote of a majority of the outstanding shares of the ProFund VP or by vote of a
majority of the Independent Trustees. The Distribution Plan also provides that
it may not be amended to increase materially the amount (up to 0.25% of average
daily net assets annually) that may be spent for distribution of shares of any
ProFund VP without the approval of shareholders of that ProFund VP.
COSTS AND EXPENSES
Each ProFund VP bears all expenses of its operations other than those
assumed by the Advisor or the Administrator. ProFund VP expenses include: the
management fee; administrative and transfer agent fees; custodian and accounting
fees and expenses, legal and auditing fees; securities valuation expenses;
fidelity bonds and other insurance premiums; expenses of preparing and printing
prospectuses, confirmations, proxy statements, and shareholder reports and
notices; registration fees and expenses; proxy and annual meeting expenses, if
any; all Federal, state, and local taxes (including, without limitation, stamp,
excise, income, and franchise taxes); organizational costs; and non-interested
Trustees' fees and expenses.
ORGANIZATION AND DESCRIPTION OF SHARES OF BENEFICIAL INTEREST
ProFunds is a registered open-end investment company under the 1940 Act.
The Trust was organized as a Delaware business trust on April 17, 1997, and has
authorized capital of unlimited shares of beneficial interest of no par value
which may be issued in more than one class or series. Currently, the Trust
consists of twenty separately managed series, three of which are described
herein.
<PAGE>
All shares of the ProFunds VP are freely transferable. The Trust shares do
not have preemptive rights or cumulative voting rights, and none of the shares
have any preference to conversion, exchange, dividends, retirements,
liquidation, redemption, or any other feature. Trust shares have equal voting
rights, except that, in a matter affecting only a particular series or class of
shares, only shares of that series or class may be entitled to vote on the
matter.
Under Delaware law, the Trust is not required to hold an annual
shareholders meeting if the 1940 Act does not require such a meeting. Generally,
there will not be annual meetings of Trust shareholders. Trust shareholders may
remove Trustees from office by votes cast at a meeting of Trust shareholders or
by written consent of such Trustees. If requested by shareholders of at least
10% of the outstanding shares of the Trust, the Trust will call a meeting of
shareholders for the purpose of voting upon the question of removal of a Trustee
of the Trust and will assist in communications with other Trust shareholders.
The Declaration of Trust of the Trust disclaims liability of the
shareholders or the officers of the Trust for acts or obligations of the Trust
which are binding only on the assets and property of the Trust. The Declaration
of Trust provides for indemnification of the Trust's property for all loss and
expense of any shareholder held personally liable for the obligations of the
Trust. The risk of a Trust shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which the Trust itself
would not be able to meet the Trust's obligations. This risk should be
considered remote.
TAXATION
Set forth below is a discussion of certain U.S. federal income tax issues
concerning the ProFunds VP and the purchase, ownership, and disposition of
ProFund VP shares. This discussion does not purport to be complete or to deal
with all aspects of federal income taxation that may be relevant to shareholders
in light of their particular circumstances, nor to certain types of shareholders
subject to special treatment under the federal income tax laws (for example,
banks and life insurance companies). This discussion is based upon present
provisions of the Internal Revenue Code of 1986, as amended (the "Code"), the
regulations promulgated thereunder, and judicial and administrative ruling
authorities, all of which are subject to change, which change may be
retroactive. Prospective investors should consult their own tax advisors with
regard to the federal tax consequences of the purchase, ownership, or
disposition of ProFund VP shares, as well as the tax consequences arising under
the laws of any state, foreign country, or other taxing jurisdiction.
Each of the ProFunds VP intends to qualify and elect to be treated each
year as a regulated investment company (a "RIC") under Subchapter M of the Code.
A RIC generally is not subject to federal income tax on income and gains
distributed in a timely manner to its shareholders. Accordingly, each ProFund VP
generally must, among other things, (a) derive in each taxable year at least 90%
of its gross income from dividends, interest, payments with respect to certain
securities loans, and gains from the sale or other disposition of stock,
securities or foreign currencies, or other income derived with respect to its
business of investing in such stock, securities or currencies; and (b) diversify
its holdings so that, at the end of each fiscal quarter, (i) at least 50% of the
market value of the ProFund VP's assets is represented by cash, U.S. government
securities, the securities of other regulated investment companies and other
securities, with such other securities limited, in respect of any one issuer, to
an amount not greater than 5% of the value of the ProFund VP's total assets and
10% of the outstanding voting securities of such issuer, and (ii) not more than
25% of the value of its total assets is invested in the securities of any one
issuer (other than U.S. government securities and the securities of other
regulated investment companies).
As a RIC, a ProFund VP generally will not be subject to U.S. federal income
tax on income and gains that it distributes to shareholders, if at least 90% of
the ProFund VP's investment company taxable income (which includes, among other
items, dividends, interest and the excess of any net short-term capital gains
over net long-term capital losses) for the taxable year is distributed.
Each ProFund VP intends to distribute substantially all of such income.
<PAGE>
Amounts not distributed on a timely basis in accordance with a calendar
year distribution requirement are subject to a nondeductible 4% excise tax at
the ProFund VP level. To avoid the tax, each ProFund VP must distribute during
each calendar year an amount equal to the sum of (1) at least 98% of its
ordinary income (not taking into account any capital gains or losses) for the
calendar year, (2) at least 98% of its capital gains in excess of its capital
losses (adjusted for certain ordinary losses) for a one-year period generally
ending on October 31 of the calendar year, and (3) all ordinary income and
capital gains for previous years that were not distributed during such years. To
avoid application of the excise tax, the ProFunds VP intend to make
distributions in accordance with the calendar year distribution requirement. A
distribution will be treated as paid on December 31 of a calendar year if it is
declared by the ProFund VP in October, November or December of that year with a
record date in such a month and paid by the ProFund VP during January of the
following year. Such distributions will be taxable to shareholders in the
calendar year in which the distributions are declared, rather than the calendar
year in which the distributions are received.
MARKET DISCOUNT
If a ProFund VP purchases a debt security at a price lower than the stated
redemption price of such debt security, the excess of the stated redemption
price over the purchase price is "market discount". If the amount of market
discount is more than a de minimis amount, a portion of such market discount
must be included as ordinary income (not capital gain) by the ProFund VP in each
taxable year in which the ProFund VP owns an interest in such debt security and
receives a principal payment on it. In particular, the ProFund VP will be
required to allocate that principal payment first to the portion of the market
discount on the debt security that has accrued but has not previously been
includable in income. In general, the amount of market discount that must be
included for each period is equal to the lesser of (i) the amount of market
discount accruing during such period (plus any accrued market discount for prior
periods not previously taken into account) or (ii) the amount of the principal
payment with respect to such period. Generally, market discount accrues on a
daily basis for each day the debt security is held by a ProFund VP at a constant
rate over the time remaining to the debt security's maturity or, at the election
of the ProFund VP, at a constant yield to maturity which takes into account the
semi-annual compounding of interest. Gain realized on the disposition of a
market discount obligation must be recognized as ordinary interest income (not
capital gain) to the extent of the "accrued market discount."
ORIGINAL ISSUE DISCOUNT
Certain debt securities acquired by the ProFunds VP may be treated as debt
securities that were originally issued at a discount. Original issue discount
can generally be defined as the difference between the price at which a security
was issued and its stated redemption price at maturity. Although no cash income
is actually received by a ProFund VP, original issue discount that accrues on a
debt security in a given year generally is treated for federal income tax
purposes as interest and, therefore, such income would be subject to the
distribution requirements applicable to regulated investment companies.
Some debt securities may be purchased by the ProFunds VP at a discount that
exceeds the original issue discount on such debt securities, if any. This
additional discount represents market discount for federal income tax purposes
(see above).
OPTIONS, FUTURES AND FOREIGN CURRENCY FORWARD CONTRACTS
Any regulated futures contracts and certain options (namely, nonequity
options and dealer equity options) in which a ProFund VP may invest may be
"section 1256 contracts." Gains (or losses) on these contracts generally are
considered to be 60% long-term and 40% short-term capital gains or losses;
however foreign currency gains or losses arising from certain section 1256
contracts are ordinary in character. Also, section 1256 contracts held by a
ProFund VP at the end of each taxable year (and on certain other dates
prescribed in the Code) are "marked to market" with the result that unrealized
gains or losses are treated as though they were realized.
<PAGE>
Transactions in options, futures and forward contracts undertaken by the
ProFunds VP may result in "straddles" for federal income tax purposes. The
straddle rules may affect the character of gains (or losses) realized by a
ProFund VP, and losses realized by the ProFund VP on positions that are part of
a straddle may be deferred under the straddle rules, rather than being taken
into account in calculating the taxable income for the taxable year in which the
losses are realized. In addition, certain carrying charges (including interest
expense) associated with positions in a straddle may be required to be
capitalized rather than deducted currently. Certain elections that a ProFund VP
may make with respect to its straddle positions may also affect the amount,
character and timing of the recognition of gains or losses from the affected
positions.
Because only a few regulations implementing the straddle rules have been
promulgated, the consequences of such transactions to the ProFunds VP are not
entirely clear. The straddle rules may increase the amount of short-term capital
gain realized by a ProFund VP, which is taxed as ordinary income when
distributed to shareholders. Because application of the straddles rules may
affect the character of gains or losses, defer losses and/or accelerate the
recognition of gains or losses from the affected straddle positions, the amount
which must be distributed to shareholders as ordinary income or long-term
capital gain may be increased or decreased substantially as compared to a fund
that did not engage in such transactions.
CONSTRUCTIVE SALES
Recently enacted rules may affect the timing and character of gain if a
ProFund VP engages in transactions that reduce or eliminate its risk of loss
with respect to appreciated financial positions. If the ProFund VP enters into
certain transactions in property while holding substantially identical property,
the ProFund VP would be treated as if it had sold and immediately repurchased
the property and would be taxed on any gain (but not loss) from the constructive
sale. The character of gain from a constructive sale would depend upon the
ProFund VP's holding period in the property. Loss from a constructive sale would
be recognized when the property was subsequently disposed of, and its character
would depend on the ProFund VP's holding period and the application of various
loss deferral provisions of the Code.
PASSIVE FOREIGN INVESTMENT COMPANIES
The ProFunds VP may invest in shares of foreign corporations that may be
classified under the Code as passive foreign investment companies ("PFICs"). In
general, a foreign corporation is classified as a PFIC if at least one-half of
its assets constitute investment-type assets, or 75% or more of its gross income
is investment-type income. If a ProFund VP receives a so-called "excess
distribution" with respect to PFIC stock, the ProFund VP itself may be subject
to a tax on a portion of the excess distribution, whether or not the
corresponding income is distributed by the ProFund VP to shareholders. In
general, under the PFIC rules, an excess distribution is treated as having been
realized ratably over the period during which the ProFund VP held the PFIC
shares. Each ProFund VP will itself be subject to tax on the portion, if any, of
an excess distribution that is so allocated to prior ProFund VP taxable years
and an interest factor will be added to the tax, as if the tax had been payable
in such prior taxable years. Certain distributions from a PFIC as well as gain
from the sale of PFIC shares are treated as excess distributions. Excess
distributions are characterized as ordinary income even though, absent
application of the PFIC rules, certain excess distributions might have been
classified as capital gains.
The ProFunds VP may be eligible to elect alternative tax treatment with
respect to PFIC shares. Under an election that currently is available in some
circumstances, a ProFund VP generally would be required to include in its gross
income its share of the earnings of a PFIC on a current basis, regardless of
whether distributions were received from the PFIC in a given year. If this
election were made, the special rules, discussed above, relating to the taxation
of excess distributions, would not apply. In addition, another election would
involve marking to market the ProFund VP's PFIC shares at the end of each
taxable year, with the result that unrealized gains would be treated as though
they were realized and reported as ordinary income. Any mark-to-market losses
and any loss from an actual disposition of ProFund VP shares would be deductible
as ordinary losses to the extent of any net mark-to-market gains included in
income in prior years.
<PAGE>
BACKUP WITHHOLDING
Each ProFund VP generally will be required to withhold federal income tax
at a rate of 31% ("backup withholding") from dividends paid, capital gain
distributions, and redemption proceeds to shareholders if (1) the shareholder
fails to furnish the ProFund VP with the shareholder's correct taxpayer
identification number or social security number, (2) the IRS notifies the
shareholder or the ProFund VP that the shareholder has failed to report properly
certain interest and dividend income to the IRS and to respond to notices to
that effect, or (3) when required to do so, the shareholder fails to certify
that he or she is not subject to backup withholding. Any amounts withheld may be
credited against the shareholder's federal income tax liability.
OTHER TAXATION
Distributions may be subject to additional state, local and foreign taxes,
depending on each shareholder's particular situation. Non-U.S. shareholders and
certain types of U.S. shareholders subject to special treatment under the U.S.
federal income tax laws (e.g. banks and life insurance companies) may be subject
to U.S. tax rules that differ significantly from those summarized above.
EQUALIZATION ACCOUNTING
Each ProFund VP distributes its net investment income and capital gains to
shareholders as dividends annually to the extent required to qualify as a
regulated investment company under the Code and generally to avoid federal
income or excise tax. Under current law, each ProFund VP may on its tax return
treat as a distribution of investment company taxable income and net capital
gain the portion of redemption proceeds paid to redeeming shareholders that
represents the redeeming shareholders' portion of the ProFund VP's undistributed
investment company taxable income and net capital gain. This practice, which
involves the use of equalization accounting, will have the effect of reducing
the amount of income and gains that the ProFund VP is required to distribute as
dividends to shareholders in order for the ProFund VP to avoid federal income
tax and excise tax. This practice may also reduce the amount of distributions
required to be made to nonredeeming shareholders and the amount of any
undistributed income will be reflected in the value of the ProFund VP's shares;
the total return on a shareholder's investment will not be reduced as a result
of the ProFund VP's distribution policy. Investors who purchase shares shortly
before the record date of a distribution will pay the full price for the shares
and then receive some portion of the price back as a taxable distribution.
PERFORMANCE INFORMATION
TOTAL RETURN CALCULATIONS
From time to time, each of the ProFunds VP may advertise the total return
of the ProFund VP for prior periods. Any such advertisement would include at
least average annual total return quotations for one, five, and ten-year
periods, or for the life of the ProFund VP. Other total return quotations,
aggregate or average, over other time periods for the ProFund VP also may be
included.
The total return of a ProFund VP for a particular period represents the
increase (or decrease) in the value of a hypothetical investment in the ProFund
VP from the beginning to the end of the period. Total return is calculated by
subtracting the value of the initial investment from the ending value and
showing the difference as a percentage of the initial investment; this
calculation assumes that the initial investment is made at the current net asset
value and that all income dividends or capital gains distributions during the
period are reinvested in shares of the ProFund VP at net asset value. Total
return is based on historical earnings and asset value fluctuations and is not
intended to indicate future performance. No adjustments are made to reflect any
income taxes payable by shareholders on dividends and distributions paid by the
ProFund VP.
<PAGE>
Average annual total return quotations for periods of two or more years are
computed by finding the average annual compounded rate of return over the period
that would equal the initial amount invested to the ending redeemable value.
COMPARISONS OF INVESTMENT PERFORMANCE
In conjunction with performance reports, promotional literature, and/or
analyses of shareholder service for a ProFund VP, comparisons of the performance
information of the ProFund VP for a given period to the performance of
recognized, unmanaged indexes for the same period may be made. Such indexes
include, but are not limited to, ones provided by Dow Jones & Company, Standard
& Poor's Corporation, Lipper Analytical Services, Inc., Shearson Lehman
Brothers, the National Association of Securities Dealers, Inc., The Frank
Russell Company, Value Line Investment Survey, the American Stock Exchange, the
Philadelphia Stock Exchange, Morgan Stanley Capital International, Wilshire
Associates, the Financial Times-Stock Exchange, and the Nikkei Stock Average and
Deutche Aktienindex, all of which are unmanaged market indicators. Such
comparisons can be a useful measure of the quality of a ProFund VP's investment
performance. In particular, performance information for UltraOTC VP may be
compared to various unmanaged indexes, including, but not limited to its current
benchmark, the NASDAQ 100 Index(TM); and performance information for Small Cap
may be compared to various unmanaged indexes, including, but not limited to, its
current benchmark, the Russell 2000(R) Index.
In addition, rankings, ratings, and comparisons of investment performance
and/or assessments of the quality of shareholder service appearing in
publications such as Money, Forbes, Kiplinger's Magazine, Personal Investor,
Morningstar, Inc., and similar sources which utilize information compiled (i)
internally, (ii) by Lipper Analytical Services, Inc. ("Lipper"), or (iii) by
other recognized analytical services, may be used in sales literature. The total
return of each ProFund VP also may be compared to the performances of broad
groups of comparable mutual funds with similar investment goals, as such
performance is tracked and published by such independent organizations as Lipper
and CDA Investment Technologies, Inc., among others. The Lipper ranking and
comparison, which may be used by the ProFunds VP in performance reports, will be
drawn from the "Small Company Growth Funds" grouping for UltraOTC VP and Small
Cap VP. In addition, the broad-based Lipper groupings may be used for comparison
to any of the ProFunds VP. Further information about the performance of the
ProFunds VP will be contained in the ProFunds VP annual reports to shareholders,
which may be obtained without charge by writing to the ProFunds VP at the
address or telephoning the ProFunds VP at the telephone number set forth on the
cover page of this SAI. However, because the ProFunds VP have no history of
investment operations, they have not yet prepared any shareholder reports.
RATING SERVICES
The ratings of Moody's Investors Service, Inc. and Standard & Poor's
Ratings Group represent their opinions as to the quality of the securities that
they undertake to rate. It should be emphasized, however, that ratings are
relative and subjective and are not absolute standards of quality. Although
these ratings are an initial criterion for selection of portfolio investments,
the Advisor also makes its own evaluation of these securities, subject to review
by the Board of Trustees. A description of the ratings used herein and in the
Prospectus is set forth in the Appendix to this SAI.
Other Information
The ProFunds are not sponsored, endorsed, sold or promoted by Standard &
Poor's, a division of The McGraw-Hill Companies, Inc. ("S&P"), the NASDAQ Stock
Markets, Inc. ("NASDAQ") or the Frank Russell Company. S&P, NASDAQ or the Frank
Russell Company make no representation or warranty, express or implied, to the
owners of shares of the ProFunds VP or any member of the public regarding the
advisability of investing in securities generally or in the ProFunds VP
particularly or the ability of the S&P 500 Index, the NASDAQ 100 Index(TM) or
the Russell(R)2000 Index, respectively, to track general stock market
performance. S&P's, NASDAQ's and the Frank Russell Company's only relationship
to the Licensee is the licensing of certain trademarks and trade names of S&P,
NASDAQ, and the Frank Russell Company, respectively, and of the S&P 500 Index,
the NASDAQ 100 Index(TM) and the Russell(R)2000 Index, respectively. S&P, NASDAQ
and the Frank Russell Company have no obligation to take the needs of the
Licensee or the owners of shares of the ProFunds VP into consideration in
determining, composing or calculating the S&P 500 Index, the NASDAQ 100
Index(TM) and the Russell(R)2000 Index, respectively. S&P, NASDAQ and the Frank
Russell Company are not responsible for and have not participated in the
determination or calculation of the equation by which the shares of the ProFunds
VP are to be converted into cash. S&P, NASDAQ and the Frank Russell Company have
no obligation or liability in connection with the administration, marketing or
trading of the ProFunds VP.
<PAGE>
S&P DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE S&P 500
INDEX OR ANY DATA INCLUDED THEREIN AND S&P SHALL HAVE NO LIABILITY FOR ANY
ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN. S&P MAKES NO WARRANTY, EXPRESS OR
IMPLIED, AS TO RESULTS TO BE OBTAINED BY LICENSEE, OWNERS OF SHARES OF THE
PROFUNDS VP, OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE S&P 500 INDEX OR
ANY DATA INCLUDED THEREIN. S&P MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND
EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A
PARTICULAR PURPOSE OR USE WITH RESPECT TO THE S&P 500 INDEX OR ANY DATA INCLUDED
THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL S&P HAVE ANY
LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES
(INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
FINANCIAL STATEMENTS
Since the ProFunds VP had not commenced operation as of the date of this
Statement of Additional Information, there are no financial statements to
include in the Statement of Additional Information.
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THE PROSPECTUS, OR IN THIS STATEMENT OF
ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR PRESENTATIONS MUST NOT BE RELIED UPON
AS HAVING BEEN AUTHORIZED BY PROFUNDS. THIS STATEMENT OF ADDITIONAL INFORMATION
DOES NOT CONSTITUTE AN OFFERING BY PROFUNDS IN ANY JURISDICTION IN WHICH SUCH AN
OFFERING MAY NOT LAWFULLY BE MADE.
<PAGE>
APPENDIX A
EUROPE 30 INDEX
Company Name
BP Amoco
Vodafone Airtouch
Deutsche Telekom
Royal Dutch Shell
Nokia Corp
Glaxo Wellcome
British Telecom
HSBC Holdings
France Telecom
Astrazeneca
Shell Transport and Trading
Smithkline Beecham
Ericsson (LM) Tel
ING Groep
Aegon
Telefonica
Telcom ITA
ENI
AXA
Barclays
TL Westminster Bank
Banco Santander
Unilever
Total Fina
ABN Amro Holding
Diageo
Phillips Electronics
LVMH
Banco Bilboa Vizcaya
Veba
<PAGE>
APPENDIX B
DESCRIPTION OF SECURITIES RATINGS
DESCRIPTION OF S&P'S CORPORATE RATINGS:
AAA-Bonds rated AAA have the highest rating assigned by S&P to a debt
obligation. Capacity to pay interest and repay principal is extremely strong.
AA-Bonds rated AA have a very strong capacity to pay interest and repay
principal and differ from the highest rated issuers only in small degree.
S&P's letter ratings may be modified by the addition of a plus or a minus
sign, which is used to show relative standing within the major categories,
except in the AAA rating category.
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS:
Aaa-Bonds which are rated Aaa are judged to be the best quality. They carry
the smallest degree of investment risk and are generally referred to as
"gilt-edge". Interest payments are protected by a large or exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa-Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
Moody's applies the numerical modifiers 1, 2 and 3 to each generic rating
classification from Aa through B. The modifier 1 indicates that the security
ranks in the higher end of its generic category; the modifier 2 indicates a
mid-range ranking; and the modifier 3 indicates that the issue ranks in the
lower end of its generic rating category.
DESCRIPTION OF FITCH INVESTORS SERVICE'S CORPORATE BOND RATINGS:
AAA-Securities of this rating are regarded as strictly high-grade, broadly
marketable, suitable for investment by trustees and fiduciary institutions, and
liable to slight market fluctuation other than through changes in the money
rate. The factor last named is of importance varying with the length of
maturity. Such securities are mainly senior issues of strong companies, and are
most numerous in the railway and public utility fields, though some industrial
obligations have this rating. The prime feature of an AAA rating is showing of
earnings several times or many times interest requirements with such stability
of applicable earnings that safety is beyond reasonable question whatever
changes occur in conditions. Other features may enter in, such as a wide margin
of protection through collateral security or direct lien on specific property as
in the case of high class equipment certificates or bonds that are first
mortgages on valuable real estate. Sinking funds or voluntary reduction of the
debt by call or purchase are often factors, while guarantee or assumption by
parties other than the original debtor may also influence the rating.
AA-Securities in this group are of safety virtually beyond question, and as
a class are readily salable while many are highly active. Their merits are not
greatly unlike those of the AAA class, but a security so rated may be of junior
though strong lien in many cases directly following an AAA security or the
margin of safety is less strikingly broad. The issue may be the obligation of a
small company, strongly secure but influenced as the ratings by the lesser
financial power of the enterprise and more local type of market.
<PAGE>
DESCRIPTION OF DUFF & PHELPS' CORPORATE BOND RATINGS:
AAA-Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury ProFunds VP.
AA+, AA-High credit quality. Protection factors are strong. Risk is modest
but may vary slightly from time to time because of economic conditions.
DESCRIPTION OF S&P'S MUNICIPAL BOND RATINGS:
AAA-Prime-These are obligations of the highest quality. They have the
strongest capacity for timely payment of debt service.
General Obligation Bonds-In a period of economic stress, the issuers will
suffer the smallest declines in income and will be least susceptible to
autonomous decline. Debt burden is moderate. A strong revenue structure appears
more than adequate to meet future expenditure requirements. Quality of
management appears superior.
Revenue Bonds-Debt service coverage has been, and is expected to remain,
substantial; stability of the pledged revenues is also exceptionally strong due
to the competitive position of the municipal enterprise or to the nature of the
revenues. Basic security provisions (including rate covenant, earnings test for
issuance of additional bonds and debt service reserve requirements) are
rigorous. There is evidence of superior management.
AA-High Grade-The investment characteristics of bonds in this group are
only slightly less marked than those of the prime quality issues. Bonds rated AA
have the second strongest capacity for payment of debt service.
S&P's letter ratings may be modified by the addition of a plus or a minus
sign, which is used to show relative standing within the major rating
categories, except in the AAA rating category.
DESCRIPTION OF MOODY'S MUNICIPAL BOND RATINGS:
Aaa-Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Aa-Bonds which are rated Aa judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities, or fluctuation of protective elements
may be of greater amplitude, or there may be other elements present which make
the long-term risks appear somewhat larger than in Aaa securities.
Moody's may apply the numerical modifier in each generic rating
classification from Aa through B. The modifier 1 indicates that the security
within its generic rating classification possesses the strongest investment
attributes.
DESCRIPTION OF S&P'S MUNICIPAL NOTE RATINGS:
Municipal notes with maturities of three years or less are usually given
note ratings (designated SP-1 or SP-2) to distinguish more clearly the credit
quality of notes as compared to bonds. Notes rated SP-1 have a very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given the designation of SP-1+.
Notes rated SP-2 have a satisfactory capacity to pay principal and interest.
<PAGE>
DESCRIPTION OF MOODY'S MUNICIPAL NOTE RATINGS:
Moody's ratings for state and municipal notes and other short-term loans
are designated Moody's Investment Grade (MIG) and for variable rate demand
obligations are designated Variable Moody's Investment Grade (VMIG). This
distinction recognizes the differences between short-term credit risk and
long-term risk. Loans bearing the designation MIG-1/VMIG-1 are of the best
quality, enjoying strong protection from established cash flows of funds for
their servicing or from established and broad-based access to the market for
refinancing, or both. Loans the designation MIG-2/VMIG-2 are of high quality,
with ample margins of protection, although not as large as the preceding group.
DESCRIPTION OF S&P COMMERCIAL PAPER RATINGS:
Commercial paper rated A-1 by S&P indicates that the degree of safety
regarding timely payment is either overwhelming or very strong. Those issues
determined to posses overwhelming safety characteristics are denoted A-1+.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS:
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Issuers rated Prime-1 (or related supporting institutions) are
considered to have a superior capacity for repayment of short-term promissory
obligations.
DESCRIPTION OF FITCH INVESTORS SERVICE'S COMMERCIAL PAPER RATINGS:
F-1+-Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
F-1-Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than the strongest
issue.
DESCRIPTION OF DUFF & PHELPS' COMMERCIAL PAPER RATINGS:
Duff 1+-Highest certainly of timely payment. Short term liquidity,
including internal operating factors and/or access to alternative sources of
funds, is outstanding, and safety is just below risk free U.S. Treasury short
term obligations.
Duff 1-Very high certainty of timely +.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS:
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Issuers rated Prime-1 (or relating supporting institutions) are
considered to have a superior capacity for repayment of short-term promissory
obligations.
DESCRIPTION OF FITCH INVESTORS SERVICE'S COMMERCIAL PAPER RATINGS:
F-1+-Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment risk.
Capacity for timely repayment of principal and interest is substantial. Adverse
changes in business economic or financial conditions may increase investment
risk albeit not very significantly.
<PAGE>
A-Obligations for which there is a low expectation of investment risk.
Capacity for timely repayment of principal and interest is strong, although
adverse changes in business, economic or financial conditions may lead to
increased investment risk.
BBB-Capacity for timely repayment of principal and interest is adequate,
although adverse changes in business, economic or financial conditions are more
likely to lead to increased investment risk than for obligations in higher
categories.
BB-Obligations for which there is a possibility of investment risk
developing. Capacity for timely repayment of principal and interest exists, but
is susceptible over time to adverse changes in business, economic or financial
conditions.
B-Obligations for which investment risk exists. Timely repayment of
principal and interest is not sufficiently protected against adverse changes in
business, economic or financial conditions.
CCC-Obligations for which there is a current perceived possibility of
default. Timely repayment of principal and interest is dependent on favorable
business, economic or financial conditions.
CC-Obligations which are highly speculative or which have a high risk of
default.
C-Obligations which are currently in default.
Notes: "+" or "-".
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS:
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Issuers rated Prime-1 (or related supporting institutions) are
considered to have a superior capacity for repayment of short-term promissory
obligations.
DESCRIPTION OF FITCH INVESTORS SERVICE'S COMMERCIAL PAPER RATINGS:
F-1+-Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely business,
economic or financial conditions.
A3-Obligations supported by an adequate capacity for timely repayment. Such
capacity is more susceptible to adverse changes in business, economic or
financial conditions than for obligations in higher categories.
B-Obligations for which the capacity for timely repayment is susceptible to
adverse changes in business, economic or financial conditions.
C-Obligations for which there is an inadequate capacity to ensure timely
repayment.
D-Obligations which have a high risk of default or which are currently in
default
DESCRIPTION OF THOMSON BANK WATCH SHORT-TERM RATINGS:
TBW-1-The highest category; indicates a very high likelihood that principal
and interest will be paid on a timely basis.
TBW-2-The second-highest category; while the degree of safety regarding
timely repayment of principal and interest is strong, the relative degree of
safety is not as high as of issues rated 'TBW-1'.
<PAGE>
TWB-3-The lowest investment-grade category; indicates that while the
obligation is more susceptible to adverse developments (both internal and
external) than those with higher ratings, the capacity to service principal and
interest in a timely fashion is considered adequate.
TWB-4-The lowest rating category; this rating is regarded as non-investment
grade and therefore speculative.
DESCRIPTION OF THOMSON BANKWATCH LONG-TERM RATINGS:
AAA-The highest category; indicates that the ability to repay principal and
interest on a timely basis is extremely high.
AA-The second -highest category; indicates a very strong ability to repay
principal and interest on a timely basis, with limited incremental risk compared
to issues rated in the highs category.
A-The third-highest category; indicates the ability to repay principal and
interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
BBB-The lowest investment-grade category; indicates an acceptable capacity
to repay principal and interest. Issues rated "BBB" are, however, more
vulnerable to adverse developments (both internal and external) than obligations
with higher ratings.
NON-INVESTMENT GRADE (ISSUES REGARDED AS HAVING SPECULATIVE CHARACTERISTICS IN
THE LIKELIHOOD OF TIMELY REPAYMENT OF PRINCIPAL AND INTEREST.)
BB-While not investment grade, the "BB" rating suggests that the likelihood
of default is considerably less than for lower-rated issues. However, there are
significant uncertainties that could affect the ability to adequately service
debt obligations.
B-Issues rated "B" show a higher degree of uncertainty and therefore
greater likelihood of default than higher-rated issues. Adverse development
could well negatively affect the payment of interest and principal on a timely
basis.
CCC-Issues rate "CCC" clearly have a high likelihood of default, with
little capacity to address further adverse changes in financial circumstances.
CC-"CC" is applied to issues that are subordinate to other obligations
rated "CCC" and are afforded less protection in the event of bankruptcy or
reorganization.
D-Default
These long-term debt ratings can also be applied to local currency debt. In
such cases the ratings defined above will be preceded by the designation "local
currency".
RATINGS IN THE LONG-TERM DEBT CATEGORIES MAY INCLUDE A PLUS (+) OR MINUS (-)
DESIGNATION, WHICH INDICATES WHERE WITHIN THE RESPECTIVE CATEGORY THE ISSUE IS
PLACED.
