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 UltraSmall-Cap
ProFund, the UltraMid-Cap ProFund, and the UltraJapan ProFund (collectively, the
"ProFunds"). Each ProFund offers two classes of shares: Service Shares and
Investor Shares. The ProFunds 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
seeks investment results that correspond each day to a specified benchmark. The
ProFunds may be used independently or in combination with each other as part of
an overall investment strategy.
The ProFunds 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 to determine whether an investment in
a particular ProFund is appropriate. None of the ProFunds alone constitutes a
balanced investment plan. Each ProFund 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 will be achieved.
This Statement of Additional Information is not a prospectus. It should be
read in conjunction with the ProFunds' Prospectus, dated February 1, 2000, 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 February 1, 2000.
<PAGE>
TABLE OF CONTENTS
PAGE
----
ProFunds................................................................ 3
Investment Policies and Techniques ..................................... 3
Investment Restrictions.................................................15
Determination of Net Asset Value........................................16
Portfolio Transactions and Brokerage....................................17
Management of ProFunds..................................................18
Costs and Expenses......................................................21
Organization and Description of Shares of Beneficial Interest...........21
Taxation ...............................................................22
Performance Information ................................................26
Financial Statements....................................................28
Appendix Description of Securities Ratings ............................29
2
<PAGE>
PROFUNDS
ProFunds (the "Trust") is an open-end management investment company, and
currently comprises twenty-three separate series. Three of the series are
discussed herein. All of the ProFunds 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. In addition, set forth below is further
information relating to the ProFunds. The discussion below supplements and
should be read in conjunction with the Prospectus.
Certain investment restrictions of a ProFund 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, as defined in the
Investment Company Act of 1940, as amended (the "1940 Act"). All other
investment policies of the ProFunds not specified as fundamental (including the
benchmarks of the ProFunds) may be changed by the Trustees of the Trust without
the approval of shareholders.
A ProFund may consider changing its benchmark if, for example, the current
benchmark becomes unavailable, the ProFund 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 investment results to correspond
sufficiently to its current benchmark. If believed appropriate, a ProFund may
specify a benchmark for itself that is "leveraged" or proprietary. Of course,
there can be no assurance that a ProFund will achieve its objective.
Fundamental securities analysis is not generally used by ProFund Advisors
LLC (the "Advisor"), the ProFunds' investment adviser, in seeking to correlate
with the respective benchmarks. Rather, the Advisor primarily uses statistical
and quantitative analysis to determine the investments a ProFund 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 and the performance of its benchmark), certain factors
will tend to cause a ProFunds' investment results to vary from a perfect
correlation to its benchmark. The ProFunds, 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 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 discussed below, and as discussed
in the Prospectus, may be used by a ProFund if, in the opinion of the Advisor,
these strategies will be advantageous to the ProFunds. The ProFunds are free to
reduce or eliminate the ProFunds' activity in any of those areas without
changing the ProFunds fundamental investment policies. There is no assurance
that any of these strategies or any other strategies and methods of investment
available to a ProFund will result in the achievement of its objective.
3
<PAGE>
ULTRASMALL-CAP PROFUND
The investment objective of the UltraSmall-Cap ProFund is to provide daily
investment results that correspond to twice (200%) the performance of the
Russell 2000(R) Index.
The UltraSmall-Cap ProFund does not intend to hold the 2,000 securities
included in the Russell 2000(R) Index. Instead, the UltraSmall-Cap ProFund
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, the UltraSmall-Cap ProFund 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.
ULTRAMID-CAP PROFUND
The investment objective of the UltraMid-Cap ProFund is to provide daily
investment results that correspond to twice (200%) the performance of the S&P
MidCap 400 Index(R).
The UltraMid-Cap ProFund does not intend to hold the 400 securities
included in the S&P Mid-Cap 400 Index(R). Instead, the UltraMid-Cap ProFund
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, the UltraMid-Cap ProFund will invest, under
normal conditions, at least 65% of its total assets in the securities comprising
the S&P Mid-Cap 400 Index(R) and instruments with values that are representative
of such securities, such as futures and option contracts on such securities or
such index.
The S&P MidCap 400 Index(R) is a widely used measure of medium capitalized
U.S. company stock performance. It consists of the common stocks of 400 major
corporations selected for their size and the frequency and ease which their
stocks trade. Standard & Poor's also attempts to assure that the Index reflects
the full range and diversity of the American economy. The securities of medium
capitalization companies, while typically not as volatile as the securities of
small capitalization companies, may be more volatile than securities of larger
or more well-known companies.
ULTRAJAPAN PROFUND
The investment objective of the UltraJapan ProFund is to provide daily
investment results that correspond to twice (200%) the performance of the Nikkei
225 Stock Average.
4
<PAGE>
The UltraJapan ProFund does not intend to hold the 225 securities included
in the Nikkei 225 Stock Average. Instead, the UltraJapan ProFund 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, the UltraJapan ProFund will invest, under normal
conditions, at least 65% of its total assets in the securities comprising the
Nikkei 225 Stock Average and instruments with values that are representative of
such securities, such as futures and option contracts on such securities or such
index.
The Nikkei 225 Stock Average is a price-weighted index of 225 large,
actively traded Japanese stocks traded on the Tokyo Stock Exchange. The index is
computed and distributed by the Nihon Keizai Shimbun ("NKS")
Investing in foreign companies or financial instruments by this ProFund 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 will invest directly
or indirectly, in foreign markets, it will be subject to certain of the market,
economic and political risks prevalent in these foreign markets, and
particularly the Japanese 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 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, the UltraJapan ProFund 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 purchases
or sales. Further, the information available for ADRs is subject to 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.
FUTURES CONTRACTS AND RELATED OPTIONS
The ProFunds 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 purchases a put or call option on a futures contract, the
ProFund 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 receives a premium in return for granting to the purchaser of the option
the right to sell to or buy from the ProFund the underlying futures contract for
a specified price upon exercise at any time during the option period.
5
<PAGE>
Whether a ProFund realizes a gain or loss from futures activities depends
generally upon movements in the underlying commodity. The extent of the
ProFund's loss from an unhedged short position in futures contracts or from
writing options on futures contracts is potentially unlimited. The ProFunds 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, or selling an option of the same series as an
option previously purchased by a ProFund. The ProFunds 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 purchases or sells a stock index futures contract, or sells
an option thereon, the ProFund "covers" its position. To cover its position, a
ProFund 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 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 would be excluded from the definition of
a "commodity pool operator." Under Section 4.5 of the CFTC Regulations, a
ProFund 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'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.
The ProFunds will cover their positions when they write a futures contract
or option on a futures contract. A ProFund 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 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 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 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 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 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 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 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 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 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 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
6
<PAGE>
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 to substantial losses. If trading is not possible, or if a ProFund
determines not to close a futures position in anticipation of adverse price
movements, the ProFund will be required to make daily cash payments of variation
margin. The risk that the ProFund 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 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.
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 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 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 will not enter into an
option position that exposes the ProFund to an obligation to another party,
unless the ProFund either (i) owns an offsetting position in securities or other
options and/or (ii) maintains with the ProFund'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 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. 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
7
<PAGE>
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
may buy or sell; however, the Advisor intends to comply with all limitations.
OPTIONS ON SECURITIES
Each ProFund may buy and write (sell) options on securities for the purpose
of realizing its investment objectives. By buying a call option, a ProFund 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 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 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 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 may cover its position by owning
the underlying security on which the option is written. Alternatively, the
ProFund 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 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 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. When a ProFund writes a put option, the ProFund 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 to write call options on stocks held by the ProFund 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 that writes an option wishes to terminate the ProFund's
obligation, the ProFund may effect a "closing purchase transaction." The ProFund
accomplishes this by buying an option of the same series as the option
previously written by the ProFund. 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 which is the holder of an option may
liquidate its position by effecting a "closing sale transaction." The ProFund
accomplishes this by selling an option of the same series as the option
previously purchased by the ProFund. 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 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 if the premium, plus commission costs, paid by the ProFund 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 on the sale of the call
or the put option. The ProFund also will realize a gain if a call or put option
which the ProFund has written lapses unexercised, because the ProFund would
retain the premium.
8
<PAGE>
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. If an options market were to become unavailable,
the ProFund would be unable to realize its profits or limit its losses until the
ProFund could exercise options it holds, and the ProFund 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 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 calculate the obligations
of the parties to the agreement on a "net basis." Consequently, a ProFund'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").
A ProFund's current obligations under a swap agreement will be accrued
daily (offset against any amounts owing to the ProFund) 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'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 illiquid investment
limitations. A ProFund will not enter into any swap agreement unless the Advisor
believes that the other party to the transaction is creditworthy. A ProFund
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 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
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 will agree
to pay to the counterparty a floating rate of interest on the notional amount of
the swap
9
<PAGE>
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 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 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 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 is contractually obligated to make. If the
other party to a swap agreement defaults, a ProFund's risk of loss consists of
the net amount of payments that such ProFund is contractually entitled to
receive, if any. The net amount of the excess, if any, of a ProFund'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'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 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'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 transactions in swap agreements.
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, the UltraJapan
ProFund 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.
The UltraJapan ProFund may invest in both sponsored and unsponsored ADRs.
Unsponsored ADRs programs are organized independently and without the
cooperation of the issuer of the underlying securities. As result, available
information concerning the issuers may not be as current for sponsored ADRs, and
the prices of unsponsored depository receipts may be more volatile than if such
instruments were sponsored by the issuer.
10
<PAGE>
U.S. GOVERNMENT SECURITIES
Each ProFund also may invest in U.S. government securities in pursuit of
its investment objectives, as "cover" for the investment techniques these
ProFunds 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's portfolio investments in U.S. government securities, while a
decline in interest rates would generally increase the market value of a
ProFund'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.
REPURCHASE AGREEMENTS
Each of the ProFunds may enter into repurchase agreements with financial
institutions. Under a repurchase agreement, a ProFund 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 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 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 could suffer a loss. A ProFund also may experience
difficulties and incur certain costs in exercising its rights to the collateral
and may lose the interest the ProFund 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
11
<PAGE>
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,
amounts to more than 15% of its total net assets. The investments of each of the
ProFunds 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 may temporarily
invest all or part of the ProFund'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 may use reverse repurchase agreements as part of their
investment strategies. Reverse repurchase agreements involve sales by a ProFund
of portfolio assets concurrently with an agreement by the ProFund to repurchase
the same assets at a later date at a fixed price. Generally, the effect of such
a transaction is that the ProFund 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 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 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 ProFunds intend to use the
reverse repurchase technique only when it will be to the ProFund's advantage to
do so. The ProFund will establish a segregated account with its custodian bank
in which the ProFund will maintain cash or liquid instruments equal in value to
the ProFund's obligations in respect of reverse repurchase agreements.
BORROWING
The ProFunds may borrow money for cash management purposes or investment
purposes. Each of the ProFunds 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 "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. 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's assets will
fluctuate in value, whereas the interest obligations on borrowings may be fixed,
the net asset value per share of the ProFund will increase more when the
ProFund's portfolio assets increase in value and decrease more when the
ProFund'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 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 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's assets should fail to meet this 300% coverage
test, the ProFund, within three days (not including Sundays and holidays), will
reduce the amount of the ProFund'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 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's total assets. This borrowing is not
subject to
12
<PAGE>
the foregoing 300% asset coverage requirement. The ProFunds are authorized to
pledge portfolio securities as the Advisor deems appropriate in connection with
any borrowings.
LENDING OF PORTFOLIO SECURITIES
Each of the ProFunds 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 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 any income accruing thereon, and the ProFund may invest the
cash collateral in portfolio securities, thereby earning additional income. A
ProFund will not lend more than 33 1/3% of the value of the ProFund's total
assets. Loans would be subject to termination by the lending ProFund 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. 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 may pay reasonable finders, borrowers,
administrative, and custodial fees in connection with a loan.
WHEN-ISSUED AND DELAYED-DELIVERY SECURITIES
Each ProFund, 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 makes the
commitment to purchase securities on a when-issued or delayed-delivery basis,
the ProFund will record the transaction and thereafter reflect the value of the
securities, each day, in determining the ProFund's net asset value. Each ProFund
will not purchase securities on a when-issued or delayed-delivery basis if, as a
result, more than 15% of the ProFund'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.
The Trust will also establish a segregated account with the Trust's
custodian bank in which the ProFunds will maintain liquid instruments equal to
or greater in value than the ProFund's purchase commitments for such when-issued
or delayed-delivery securities, or the Trust does not believe that a ProFund's
net asset value or income will be adversely affected by the ProFund's purchase
of securities on a when-issued or delayed delivery basis.
INVESTMENTS IN OTHER INVESTMENT COMPANIES
The ProFunds 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 invests in, and, thus, is a shareholder of, another
investment company, the ProFund's shareholders will indirectly bear the
ProFund'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 to the ProFund's own investment adviser and
the other expenses that the ProFund bears directly in connection with the
ProFund's own operations.
ILLIQUID SECURITIES
While none of the ProFunds anticipates doing so, each of the ProFunds 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 will not invest more than 15% of the ProFund'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
13
<PAGE>
approximately the amount at which the ProFund 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 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 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 have delegated this responsibility for determining the liquidity of
Rule 144A restricted securities which may be invested in by a ProFund 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's
liquidity.
PORTFOLIO TURNOVER
The nature of the ProFunds will cause the ProFunds 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. In addition, a ProFund's
portfolio turnover level may adversely affect the ability of the ProFund to
achieve its investment objective. Because each ProFund's portfolio turnover rate
to a great extent will depend on the purchase, redemption, and exchange activity
of the ProFund's investors, it is difficult to estimate what the ProFund'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 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 is calculated without
regard to instruments, including options and futures contracts, having a
maturity of less than one year. Each ProFund expects to typically hold 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, the ProFunds expect a portfolio
turnover rate of approximately 0%.
SPECIAL CONSIDERATIONS
To the extent discussed above and in the Prospectus, the ProFunds present
certain risks, some of which are further described below.
14
<PAGE>
TRACKING ERROR. While the ProFunds 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 expenses, including brokerage (which may be
increased by high portfolio turnover) and the cost of the investment techniques
employed by the ProFunds; (2) less than all of the securities in the benchmark
being held by a ProFund and securities not included in the benchmark being held
by a ProFund; (3) an imperfect correlation between the performance of
instruments held by a ProFund, 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 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'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 trade, resulting in the
inability of the ProFund to execute intended portfolio transactions. While a
close correlation of any ProFund 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 may diverge significantly from the
cumulative percentage decrease or increase in the benchmark due to a compounding
effect.
LEVERAGE. Each ProFund 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
achieves the right to a return on a capital base that exceeds the amount the
ProFund has invested. Leverage creates the potential for greater gains to
shareholders of these ProFund 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'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 to pay interest which
would decrease the ProFund's total return to shareholders. If these ProFunds
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 not been leveraged.
NON-DIVERSIFIED STATUS. Each ProFund is a "non-diversified" series. Each
ProFund is considered "non-diversified" because a relatively high percentage of
the ProFund's assets may be invested in the securities of a limited number of
issuers, primarily within the same economic sector. That ProFund'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's classification as a
"non-diversified" investment company means that the proportion of the ProFund's
assets that may be invested in the securities of a single issuer is not limited
by the 1940 Act. Each ProFund, 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 that are less restrictive
than the requirements applicable to the "diversified" investment companies under
the 1940 Act.
INVESTMENT RESTRICTIONS
The ProFunds 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, 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 are present or represented by proxy; or (ii) more than 50% of the
outstanding shares of the series. (All policies of a ProFund 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.)
For purposes of the following limitations, all percentage limitations apply
immediately after a purchase or initial investment.
A ProFund may not:
15
<PAGE>
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 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 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.
6. Borrow money, except that the ProFund (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 may not pledge its assets other
than to secure such borrowings or, to the extent permitted by the ProFund'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
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 may do so in accordance with applicable law and the ProFund'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 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 are traded in other
markets on days when the ProFund's principal trading market(s) is closed, the
ProFund's net asset value may be affected on days when investors do not have
access to the ProFund to purchase or redeem shares.
The net asset value of shares of a ProFund serves as the basis for the
purchase and redemption price of each class of shares. The net asset value per
share of a ProFund is calculated by dividing the market value of the ProFund's
assets, less all liabilities attributed to the ProFund, by the number of
outstanding shares of the ProFund. 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.
16
<PAGE>
The securities in the portfolio of a ProFund, 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
over-the-counter 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 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 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.
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 will be valued on the
basis of the day's settlement prices on the futures exchange or fair value.
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,
the selection of brokers and dealers to effect the transactions, and the
negotiation of brokerage commissions, if any. The Advisor expects that the
ProFunds 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 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 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 and the other
client accounts.
The policy of each ProFund regarding purchases and sales of securities for
a ProFund'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'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 believes that a requirement always
to seek the lowest possible commission cost could impede effective portfolio
management and preclude the ProFund 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
17
<PAGE>
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'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 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.
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
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 Trust's 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; 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.
GARY TENKMAN (birthdate: September 16, 1970). Currently: Treasurer of
ProFunds; Vice President, BISYS Fund Services. Formerly: Audit Manager, Ernst &
Young. 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.
18
<PAGE>
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.
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 Trust and the Advisor
with respect to the ProFunds, dated January 24, 2000, the UltraSmall-Cap ProFund
and UltraMid-Cap ProFund pays the Advisor a fee at an annualized rate, based on
its average daily net assets, of 0.75% and the UltraJapan ProFund pays the
Advisor a fee at an annualized rate, based on its average daily net assets, of
0.90%. The Advisor manages the investment and the reinvestment of the assets of
each of the ProFunds, in accordance with the investment objectives, policies,
and limitations of each ProFund, subject to the general supervision and control
of Trustees and the officers of the Trust. 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,
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 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. The Administrator provides the ProFunds
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 under Federal and state
securities laws. The Administrator also maintains the shareholder account
records for the ProFunds, distributes dividends and distributions payable by the
ProFunds, and produces statements with respect to account activity for the
ProFunds and their shareholders. The Administrator pays all fees and expenses
that are directly related to the services provided by the Administrator to the
ProFunds; each ProFund 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 under the service agreement.
For its services as Administrator, each ProFund 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, for which it receives additional fees. Additionally, ProFunds 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
19
<PAGE>
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.
The Advisor, pursuant to a separate Management Services Agreement, performs
certain client support and other administrative services on behalf of the
ProFunds. For these services, each ProFund will pay to the Advisor a fee at the
annual rate of .15% of its average daily net assets for all ProFunds.
UMB Bank, N.A. acts as custodian to the ProFunds. UMB Bank, N.A.'s address
is 928 Grand Avenue, Kansas City, Missouri.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP serves as independent auditors to the ProFunds.
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. The firm's
address is 1775 Eye Street, N.W., Washington, DC 20006-2401.
DISTRIBUTOR
Concord Financial Group, Inc., 3435 Stelzer Road, Columbus, Ohio 43219,
serves as the distributor and principal underwriter of the ProFunds' shares in
all fifty states and the District of Columbia. Concord Financial Group, Inc.
receives no compensation from the ProFunds for serving as distributor.
SHAREHOLDER SERVICES PLAN
Each ProFund has adopted a Shareholder Services Plan (the "Plan") which
provides that each ProFund will make payments equal to 1.00% (on an annual
basis) of the average daily value of the net assets of such ProFund's Service
Class shares attributable to or held in the name of the investment advisers and
other authorized institutions that sell Service Class shares ("Authorized
Firms") for providing account administration services to their clients who are
beneficial owners of such shares. The Administrator may act as an Authorized
Firm. The Trust will enter into agreements ("Shareholder Services Agreements")
with Authorized Firms that purchase Service Class shares on behalf of their
clients. The Shareholder Services Agreements will provide for compensation to
the Authorized Firms in an amount up to 1.00% (on an annual basis) of the
average daily net assets of the Service Class shares of the applicable ProFund
attributable to or held in the name of the Authorized Firm for its clients. The
ProFunds may pay different service fee amounts to Authorized Firms, which may
provide different levels of services to their clients or customers.
The Trustees of the Trust, including a majority of the Trustees who are not
interested persons of the Trust and who have no direct or indirect financial
interest in the operation of the Plan or the related Shareholder Services
Agreements, have voted to adopt the Plan and Shareholder Services Agreements at
a meeting called for the purposes of voting on such Plan and Shareholder
Services Agreements. The Plan and Shareholder Services Agreements will remain in
effect for a period of one year and will continue in effect thereafter only if
such continuance is specifically approved annually by a vote of the Trustees in
the manner described above. The Plan may be terminated at any time by a majority
of the Trustees as described above or by a vote of a majority of the outstanding
Service Class shares of the affected ProFund. The Shareholder Services
Agreements may be terminated at any time, without payment of any penalty, by
vote of a majority of the Trustees as described above or by a vote of a majority
of the outstanding Service Class shares of the affected ProFund on not more than
60 days' written notice to any other party to the
20
<PAGE>
Shareholder Services Agreements. The Shareholder Services Agreements shall
terminate automatically if assigned. The Trustees have determined that, in their
judgment, there is a reasonable likelihood that the Plan will benefit the
ProFunds and holders of Service Class shares of such ProFunds. In the Trustees'
quarterly review of the Plan and Shareholder Services Agreements, they will
consider their continued appropriateness and the level of compensation provided
therein.
The intent of the Plan and Shareholder Services Agreements is to procure
quality shareholder services on behalf of ProFund shareholders; in adopting the
Plan and Shareholder Services Agreements, the Trustees considered the fact that
such shareholder services may have the effect of enhancing distribution of
ProFund Service Class shares and the growth of the ProFunds. In light of this,
the ProFunds intend to observe the procedural requirements of Rule 12b-1 under
the 1940 Act in considering the continued appropriateness of the Plan and
Shareholder Services Agreements.
COSTS AND EXPENSES
Each ProFund bears all expenses of its operations other than those assumed
by the Advisor or the Administrator. ProFund expenses include: the management
fee; administrative and transfer agent fees; shareholder servicing 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-three separately managed series, three of which are described
herein. Other series may be added in the future. Each ProFund offers two classes
of share: the Service Class shares and the Investor Class shares.
All shares of the ProFunds 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.
21
<PAGE>
If a ProFund does not grow to a size to permit it to be economically
viable, the ProFund may cease operations. In such an event, investors may be
required to liquidate or transfer their investments at an inopportune time.
TAXATION
Set forth below is a discussion of certain U.S. federal income tax issues
concerning the ProFunds and the purchase, ownership, and disposition of ProFund
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 shares, as
well as the tax consequences arising under the laws of any state, foreign
country, or other taxing jurisdiction.
Dividends out of net ordinary income and distribution of net short-term
capital gains are taxable to the recipient U.S. shareholders as ordinary income,
whether received in cash or reinvested in ProFund shares. Dividends from net
ordinary income may be eligible for the corporate dividends-received deduction.
The excess of net long-term capital gains over the net short-term capital
losses realized and distributed by a ProFund to its U.S. shareholders as capital
gains distributions is taxable to the shareholders as gain from the sale of a
capital asset held for more than one year, regardless of the length of time a
shareholder has held the ProFund shares. If a shareholder holds ProFund shares
for six months or less and during that period receives a distribution taxable to
the shareholder as long-term capital gain, any loss realized on the sale of the
ProFund shares will be long-term loss to the extent of such distribution.
The amount of an income dividend or capital gains distribution declared by
a ProFund during October, November or December of a year to shareholder of
record as of a specified date in such a month that is paid during January of the
following year will be deemed to be received by shareholders on December 31 of
the prior year.
Any dividend or distribution paid by a ProFund has the effect of reducing
the ProFund's net asset value per share. Investors should be careful to consider
the tax effect of buying shares shortly before a distribution by a ProFund. The
price of shares purchased at that time will include the amount of the
forthcoming distribution, but the distribution will be taxable to the
shareholder.
A dividend or capital gains distribution with respect to shares of a
ProFund held by a tax-deferred or qualified plan, such as an IRA, retirement
plan or corporate pension or profit sharing plan, will not be taxable to the
plan. Distribution from such plans will be taxable to individual participants
under applicable tax rules without regard to the character of the income earned
by the qualified plan.
Shareholders will be advised annually as to the federal tax status of
dividends and capital gains distribution made by the ProFunds for the preceding
year. Distributions by the ProFunds generally will be subject to state and local
taxes.
Each of the ProFunds 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
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's assets is represented by cash, U.S.
22
<PAGE>
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'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 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'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 intends to distribute substantially all of such income.
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 level. To avoid the tax, each ProFund 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 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 in October, November or December of that year with a record date in such
a month and paid by the ProFund 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 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 in each
taxable year in which the ProFund owns an interest in such debt security and
receives a principal payment on it. In particular, the ProFund 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 at a constant rate over the time
remaining to the debt security's maturity or, at the election of the ProFund, 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 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, 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 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).
23
<PAGE>
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 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 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.
Transactions in options, futures and forward contracts undertaken by the
ProFunds may result in "straddles" for federal income tax purposes. The straddle
rules may affect the character of gains (or losses) realized by a ProFund, and
losses realized by the ProFund 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 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 are not
entirely clear. The straddle rules may increase the amount of short-term capital
gain realized by a ProFund, 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 engages in transactions that reduce or eliminate its risk of loss with
respect to appreciated financial positions. If the ProFund enters into certain
transactions in property while holding substantially identical property, the
ProFund 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'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's holding period and the application of various loss
deferral provisions of the Code.
PASSIVE FOREIGN INVESTMENT COMPANIES
The ProFunds 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 receives a so-called "excess
distribution" with respect to PFIC stock, the ProFund 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 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 held the PFIC shares. Each ProFund will
itself be subject to tax on the portion, if any, of an excess distribution that
is so allocated to prior ProFund 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 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 generally would be required to
24
<PAGE>
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'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 shares
would be deductible as ordinary losses to the extent of any net mark-to-market
gains included in income in prior years.
DISTRIBUTIONS
Distributions of investment company taxable income are taxable to a U.S.
shareholder as ordinary income, whether paid in cash or shares. Dividends paid
by a ProFund to a corporate shareholder, to the extent such dividends are
attributable to dividends received from U.S. corporations by the ProFund, may
qualify for the dividends received deduction. However, the revised alternative
minimum tax applicable to corporations may deduct the value of the dividends
received deduction. Distributions of net capital gains (the excess of net
long-term capital gains over net short-term capital losses), if any, designated
by the ProFund as capital gain dividends, whether paid in cash or in shares, are
taxable as gain from the sale or exchange of an asset held for more than one
year, regardless of how long the shareholder has held the ProFund's shares.
Capital gains dividends are not eligible for the dividends received deduction.
Shareholders will be notified annually as to the U.S. federal tax status of
distributions, and shareholders receiving distributions in the form of newly
issued shares will receive a report as to the net asset value of the shares
received.
If the net asset value of shares is reduced below a shareholder's cost as a
result of a distribution by a ProFund, such distribution generally will be
taxable even though it represents a return of invested capital. Investors should
be careful to consider the tax implications of buying shares of a ProFund just
prior to a distribution. The price of shares purchased at this time will include
the amount of the forthcoming distribution, but the distribution will generally
be taxable.
If a shareholder has chosen to receive distributions in cash, and the
postal ( or other delivery ) service is unable to deliver checks to the
shareholder's address of record, the ProFunds will change the distribution
option so that all distributions are automatically reinvested in additional
shares. The ProFunds will not pay interest on uncashed distribution checks.
DISPOSITION OF SHARES
Upon a redemption, sale or exchange of shares of a ProFund, a shareholder
will realize a taxable gain or loss depending upon his or her basis in the
shares. A gain or loss will be treated as capital gain or loss if the shares are
capital assets in the shareholder's hands and generally will be long-term,
mid-term or short-term, depending upon the shareholder's holding period for the
shares. Any loss realized on a redemption, sale or exchange will be disallowed
to the extent the shares disposed of are replaced (including through
reinvestment of dividends) within a period of 61 days, beginning 30 days before
and ending 30 days after the shares are disposed of. In such a case the basis of
the shares acquired will be adjusted to reflect the disallowed loss. Any loss
realized by a shareholder on the disposition of a ProFund's shares held by the
shareholder for six months or less will be treated for tax purposes as a
long-term capital loss to the extent of any distributions of capital gain
dividends received or treated as having been received by the shareholder with
respect to such shares.
BACKUP WITHHOLDING
Each ProFund 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 with the shareholder's correct taxpayer
identification
25
<PAGE>
number or social security number, (2) the IRS notifies the shareholder or the
ProFund 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 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 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'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 is required to distribute as
dividends to shareholders in order for the ProFund 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's shares; the
total return on a shareholder's investment will not be reduced as a result of
the ProFund'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 may advertise the total return of
the ProFund 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. Other total return quotations, aggregate or
average, over other time periods for the ProFund also may be included.
The total return of a ProFund for a particular period represents the
increase (or decrease) in the value of a hypothetical investment in the ProFund
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 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.
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.
26
<PAGE>
COMPARISONS OF INVESTMENT PERFORMANCE
In conjunction with performance reports, promotional literature, and/or
analyses of shareholder service for a ProFund, comparisons of the performance
information of the ProFund 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 Deutsche
Aktienindex, all of which are unmanaged market indicators. Such comparisons can
be useful measures of the quality of a ProFund's investment performance. In
particular, performance information for the UltraSmall-Cap ProFund may be
compared to various unmanaged indexes, including, but not limited to its current
benchmark, the Russell 2000(R) Index; performance information for the
UltraMid-Cap ProFund may be compared to various unmanaged indexes, including,
but not limited to, its current benchmark, the S&P MidCap 400 Index(R); and the
performance information for the UltraJapan ProFund may be compared to various
unmanaged indexes, including, but not limited to, its current benchmark, the
Nikkei 225 Stock Average.
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 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.
Further information about the performance of the ProFunds will be contained
in the ProFunds annual reports to shareholders, which may be obtained without
charge by writing to the ProFunds at the address or telephoning the ProFunds at
the telephone number set forth on the cover page of this SAI. However, because
the ProFunds 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 Frank Russell
Company or NKS. S&P, the Frank Russell Company or NKS make no representation or
warranty, express or implied, to the owners of shares of the ProFunds or any
member of the public regarding the advisability of investing in securities
generally or in the ProFunds particularly or the ability of the S&P MidCap 400
Index(R), the Russell 2000(R) Index or the Nikkei 225 Stock Average,
respectively, to track general stock market performance. S&P's, the Frank
Russell Company's and NKS' only relationship to the Profunds (the "Licensee") is
the licensing of certain trademarks and trade names of S&P, the Frank Russell
Company and NKS, respectively, and of the S&P MidCap 400 Index(R), the Russell
2000(R) Index and the Nikkei 225 Stock Average, respectively. S&P, the Frank
Russell Company and NKS have no obligation to take the needs of the Licensee or
the owners of shares of the ProFunds into consideration in determining,
composing or calculating the S&P MidCap 400 Index(R), the Russell 2000(R) Index
and the Nikkei 225 Stock Average, respectively. S&P, the Frank Russell Company
27
<PAGE>
and NKS are not responsible for and have not participated in the determination
or calculation of the equation by which the shares of the ProFunds are to be
converted into cash. S&P, the Frank Russell Company and NKS have no obligation
or liability in connection with the administration, marketing or trading of the
ProFunds.
S&P DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE S&P
MIDCAP 400 INDEX(R) 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, OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE S&P MIDCAP
400 INDEX(R) 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 MIDCAP 400 INDEX(R) 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 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.
28
<PAGE>
APPENDIX
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.
29
<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.
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
30
<PAGE>
overwhelming safety characteristics are given the designation of SP-1+. Notes
rated SP-2 have a satisfactory capacity to pay principal and interest.
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.
31
<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'.
32
<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.
33
