CORPORATE HIGH YEILD FUND III INC, 497, 1997-12-09

CORPORATE HIGH YEILD FUND III INC
497, 1997-12-09

Previous: GBCI CAPITAL TRUST, SB-2/A, 1997-12-09

Next: ESG RE LTD, F-1/A, 1997-12-09

<PAGE>

INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.

SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED DECEMBER 9, 1997

PROSPECTUS
SHARES
CORPORATE HIGH YIELD FUND III, INC.
COMMON STOCK

------------------------

Corporate High Yield Fund III, Inc. (the 'Fund') is a newly organized,
diversified, closed-end management investment company. The primary investment
objective of the Fund is to seek current income by investing primarily in a
diversified portfolio of fixed-income securities which are rated in the lower
rating categories of the established rating services (Baa or lower by Moody's
Investors Service, Inc. ('Moody's') or BBB or lower by Standard & Poor's Ratings
Service ('S&P')) or are unrated securities of comparable quality. Such
securities generally involve greater volatility of price and risks to principal
and income than securities in the higher rating categories. As a secondary
objective, the Fund will seek capital appreciation. The Fund may invest without
limitation in financial instruments of issuers domiciled outside the United
States or that are denominated in various foreign currencies and multinational
foreign currency units. The Fund does not currently intend to hedge its non-U.S.
dollar denominated investments. For these reasons, an investment in the Fund may
be speculative in that it involves a high degree of risk and should not
constitute a complete investment program. Investors should carefully consider
the risks before investing. In addition, the Fund should be considered a
long-term investment and not a vehicle for trading purposes. See 'Risk Factors
and Special Considerations.' The Fund also may engage in various portfolio
strategies to enhance income and to hedge its portfolio against investment and
interest rate risks, including the utilization of leverage and the use of
interest rate and options and futures transactions. There can be no assurance
that the investment objectives of the Fund will be realized.

At times, the Fund expects to utilize leverage through borrowings, including
the issuance of short-term debt securities, or the issuance of shares of
preferred stock. The Fund intends to utilize leverage in an initial amount equal
to approximately 15% of its total assets (including the amount obtained from
leverage). The Fund generally will not utilize leverage if it anticipates that
the Fund's leveraged capital structure would result in a lower return to holders

of the Common Stock than that obtainable if the Common Stock were unleveraged
for any significant amount of time. Use of leverage creates an opportunity for
increased income and capital appreciation, but, at the same time, creates
special risks. See 'Risk Factors and Special Considerations' and 'Other
Investment Policies--Leverage.'

This Prospectus sets forth in concise form information about the Fund that a
prospective investor should know before investing in the Fund. Investors should
read and retain this Prospectus for future reference. Fund Asset Management,
L.P. is the Fund's Investment Adviser (the 'Investment Adviser'). The address of
the Fund is 800 Scudders Mill Road, Plainsboro, New Jersey 08536, and its
telephone number is (609) 282-2800.

The Underwriter may engage in transactions that stabilize, maintain or
otherwise affect the price of the Fund's Common Stock. Such transactions may
include stabilizing, the purchase of the Fund's Common Stock to cover short
positions and the imposition of penalty bids. For a description of these
activities, see 'Underwriting.'

Prior to this offering, there has been no public market for the Fund's
shares of Common Stock. Application has been made to list the Fund's Common
Stock on the New York Stock Exchange. However, during an initial period which is
not expected to exceed one week from the date of this Prospectus, the Fund's
Common Stock will not be listed on any securities exchange. During such period,
the Underwriter does not intend to make a market in the Fund's Common Stock.
Consequently, it is anticipated that an investment in the Fund will be illiquid
during such period.

Because the Fund is newly organized, its shares have no history of public
trading. Shares of closed-end investment companies frequently trade at a
discount from their net asset value. This risk may be greater for initial
investors expecting to sell their shares in a relatively short period after
completion of the public offering. See 'Risk Factors and Special
Considerations.'
------------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION, NOR HAS THE COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
PRICE TO PUBLIC(1) SALES LOAD(1)(2) PROCEEDS TO THE FUND(3)
<S> <C> <C> <C>
Per Share....................... $15.00 None $15.00
Total(4)........................ $ None $
</TABLE>

(1) The Investment Adviser or an affiliate will pay the Underwriter a commission
in the amount of % of the Price to Public per share in connection with
the sale of shares of Common Stock offered hereby. See 'Underwriting.'

(2) The Fund and the Investment Adviser have agreed to indemnify the Underwriter
against certain liabilities, including liabilities under the Securities Act
of 1933. See 'Underwriting.'

(3) Before deducting organizational and offering costs payable by the Fund
estimated at $ .

(4) The Fund has granted the Underwriter an option exercisable for 45 days after
the date hereof to purchase up to an additional shares to cover
over-allotments. If all such shares are purchased, the total Price to Public
and Proceeds to the Fund will be $ and $ , respectively. See
'Underwriting.'

---------------------------

The shares are offered by the Underwriter subject to prior sale, when, as and
if issued by the Fund and accepted by the Underwriter, subject to approval of
certain legal matters by counsel for the Underwriter and certain other
conditions. The Underwriter reserves the right to withdraw, cancel or modify
such offer and to reject orders in whole or in part. It is expected that
delivery of the shares will be made in New York, New York on or about January ,
1998.

------------------------

MERRILL LYNCH & CO.

------------------------

The Date of this Prospectus is January , 1998.

<PAGE>
PROSPECTUS SUMMARY

The following summary should be read in conjunction with the detailed
information appearing elsewhere in this Prospectus.

<TABLE>
<S> <C>
THE FUND Corporate High Yield Fund III, Inc. (the 'Fund') is a newly organized, diversified,
closed-end management investment company. See 'The Fund.'

THE OFFERING The Fund is offering shares of Common Stock at an initial offering price of
$15.00 per share. The Common Stock is being offered by Merrill Lynch, Pierce, Fenner &
Smith Incorporated ('Merrill Lynch' or the 'Underwriter'). The Underwriter has been
granted an option, exercisable for 45 days from the date of this Prospectus, to purchase
up to additional shares of Common Stock to cover over-allotments. See
'Underwriting.'

INVESTMENT The Fund's primary investment objective is to seek current income by investing principally
OBJECTIVES AND in fixed-income securities which are rated in the lower rating categories of the
POLICIES established rating services (Baa or lower by Moody's or BBB or lower by S&P) or are
unrated securities of comparable quality. Such investments generally involve greater

volatility of price and risks to principal and income than securities in the higher rating
categories. As a secondary objective, the Fund will seek capital appreciation. There can
be no assurance that the investment objectives of the Fund will be realized. See
'Investment Objectives and Policies.'

Under normal circumstances, at least 65% of the total assets of the Fund will be invested
in high-yield corporate debt instruments which are rated in the lower rating categories of
the established rating services (Baa or lower by Moody's and BBB or lower by S&P), or in
unrated securities considered by the Investment Adviser to be of comparable quality.
Securities rated below Baa by Moody's or below BBB by S&P, and unrated securities of
comparable quality, are commonly known as 'junk bonds.' The Fund may invest without
limitation in financial instruments of issuers domiciled outside the United States or that
are denominated in various foreign currencies and multinational currency units. The Fund
does not currently intend to hedge its non-U.S. dollar denominated investments. The Fund
may invest up to 15% of its total assets in loans extended to corporate borrowers by
commercial banks or other financial institutions ('Corporate Loans'). The Fund also may
invest up to 10% of its total assets in securities which are the subject of bankruptcy
proceedings or otherwise in default or in significant risk of being in default
('Distressed Securities'). For these reasons, an investment in the Fund may be speculative
in that it involves a high degree of risk and should not constitute a complete investment
program. See 'Risk Factors and Special Considerations.'

At times, the Fund expects to utilize leverage through borrowings, including the issuance of
short-term debt securities or the issuance of shares of preferred stock. Although the Fund
has the ability to utilize leverage in an amount up to 33 1/3% of its total assets
(including the amount obtained from leverage), it intends to utilize leverage in an initial
amount equal to approximately 15% of its total assets (including the amount obtained from
leverage). The Fund intends to utilize leverage to provide the holders of Common Stock with
a potentially higher return. The Fund generally will not utilize leverage if it anticipates
that the Fund's leveraged capital structure would result in a lower return to holders of the
Common Stock than that obtainable if the Common Stock were unleveraged for any significant
amount of time. Use of leverage creates an opportunity for increased income and capital
appreciation, but, at the same time, creates special risks.
</TABLE>
2
<PAGE>
<TABLE>
<S> <C>
See 'Risk Factors and Special Considerations-- Leverage' and 'Other Investment
Policies--Leverage.'

The Fund may engage in various portfolio strategies to seek to increase its return and to
hedge its portfolio against movements in interest rates through the use of interest rate
transactions, the purchase of call and put options on securities, the sale of covered call
and put options on its portfolio securities and transactions in financial futures and
related options on such futures. See 'Other Investment Policies.'

Investment in shares of Common Stock of the Fund offers several benefits. The Fund offers
investors the opportunity to receive current income by investing in a professionally
managed portfolio comprised primarily of high-yield corporate debt securities. In managing
such portfolio, the Investment Adviser provides the Fund and its shareholders with
professional credit analysis. The Fund also relieves the investor of the burdensome
administrative details involved in managing a portfolio of such investments. Additionally,
the Investment Adviser may seek to enhance the return on the Common Stock by leveraging
the Fund's capital structure through the borrowing of money or the issuance of short-term

debt securities or shares of preferred stock. The benefits are at least partially offset
by the expenses involved in operating an investment company. Such expenses primarily
consist of the advisory fee and operational costs. Additionally, the use of leverage
involves certain expenses and risk considerations. See 'Risk Factors and Special
Considerations' and 'Other Investment Policies--Leverage.'

LISTING Prior to this offering, there has been no public market for the shares of Common Stock of
the Fund. Application has been made to list the Fund's shares of Common Stock on the New
York Stock Exchange (the 'NYSE'). However, during an initial period which is not expected to
exceed one week from the date of this Prospectus, the Fund's shares of Common Stock will not
be listed on any securities exchange. During such period, the Underwriter does not intend to
make a market in the Fund's shares of Common Stock. Consequently, it is anticipated that an
investment in the Fund will be illiquid during such period. See 'Underwriting.'

INVESTMENT Fund Asset Management, L.P. is the Fund's investment adviser (the 'Investment Adviser')
ADVISER and is responsible for the management of the Fund's investment portfolio and for providing
administrative services to the Fund. For its services, the Fund pays the Investment
Adviser a monthly fee at the annual rate of 0.60% of 1% of the Fund's average weekly net
assets plus the proceeds of any outstanding borrowings used for leverage. The Investment
Adviser is an affiliate of Merrill Lynch Asset Management, L.P. ('MLAM'), which is owned
and controlled by Merrill Lynch & Co., Inc. ('ML & Co.'). The Investment Adviser, or MLAM,
acts as the investment adviser for over 140 other registered management investment
companies. The Investment Adviser also offers portfolio management and portfolio analysis
services to individuals and institutions. As of October 31, 1997, the Investment Adviser
and MLAM had a total of approximately $271.9 billion in investment company and other
portfolio assets under management, including accounts of certain affiliates of the
Investment Adviser. See 'Investment Advisory and Management Arrangements.'

DIVIDENDS The Fund intends to distribute dividends of substantially all of its net investment income
AND monthly to holders of Common Stock. All net realized capital gains, if any, will be
DISTRIBUTIONS distributed to the Fund's shareholders at least annually. See 'Dividends and
Distributions.'

</TABLE>
3

<PAGE>
<TABLE>
<S> <C>
The Fund expects that it will commence paying dividends within 90 days of the date of this
Prospectus.

AUTOMATIC All dividends and capital gains distributions will be automatically reinvested in
DIVIDEND additional shares of Common Stock of the Fund unless a shareholder elects to receive cash.
REINVESTMENT Shareholders whose shares are held in the name of a broker or nominee should contact
PLAN such broker or nominee to confirm that they may participate in the Fund's dividend
reinvestment plan. See 'Automatic Dividend Reinvestment Plan.'

MUTUAL FUND Purchasers of shares of Common Stock of the Fund through Merrill Lynch in this offering
INVESTMENT will have an investment option consisting of the right to reinvest the net proceeds from a
OPTION sale of such shares (the 'Original Shares') in Class D initial sales charge shares of
certain Merrill Lynch-sponsored open-end mutual funds ('Eligible Class D Shares') at their
net asset value, without the imposition of the initial sales charge, if the conditions set
forth below are satisfied. First, the sale of the Original Shares must be made through
Merrill Lynch, and the net proceeds therefrom must be reinvested immediately in Eligible
Class D Shares. Second, the Original Shares must have either been acquired in this
offering or be shares representing reinvested dividends from shares of Common Stock
acquired in this offering. Third, the Original Shares must have been continuously
maintained in a Merrill Lynch securities account. Fourth, there must be a minimum purchase
of $250 to be eligible for the investment option. Class D shares of certain of the mutual
funds are subject to an account maintenance fee at an annual rate of up to 0.25% of the
average daily net asset value of such mutual fund. See 'Mutual Fund Investment Option.'
</TABLE>
4

<PAGE>
RISK FACTORS AND SPECIAL CONSIDERATIONS

GENERAL

The Fund is a newly organized, diversified, closed-end management
investment company and has no operating history. As described under 'Prospectus
Summary--Listing,' it is anticipated that an investment in the Fund will be
illiquid prior to listing of the Fund's shares of Common Stock on the New York
Stock Exchange. See 'Underwriting.' Shares of closed-end investment companies
frequently trade at a discount from their net asset value. This risk may be
greater for investors expecting to sell their shares in a relatively short
period after completion of the public offering. Accordingly, the Common Stock of
the Fund is designed primarily for long-term investors and should not be
considered a vehicle for trading purposes. The net asset value of the Fund's
shares of Common Stock will fluctuate with interest rate changes as well as with
price changes of the Fund's portfolio securities and these fluctuations are
likely to be greater in the case of a fund having a leveraged capital structure,
as contemplated for the Fund. See 'Other Investment Policies--Leverage.'

LOWER-RATED SECURITIES

Junk bonds are regarded as being predominantly speculative as to the
issuer's ability to make payments of principal and interest. Investment in such
securities involves substantial risk. Issuers of junk bonds may be highly
leveraged and may not have available to them more traditional methods of
financing. Therefore, the risks associated with acquiring the securities of such
issuers generally are greater than is the case with higher-rated securities. For
example, during an economic downturn or a sustained period of rising interest
rates, issuers of junk bonds may be more likely to experience financial stress,
especially if such issuers are highly leveraged. During periods of economic
downturn, such issuers may not have sufficient revenues to meet their interest
payment obligations. The issuer's ability to service its debt obligations also
may be adversely affected by specific issuer developments, or the issuer's
inability to meet specific projected business forecasts or the unavailability of
additional financing. The risk of loss due to default by the issuer is
significantly greater for the holders of junk bonds because such securities may
be unsecured and may be subordinate to other creditors of the issuer. Other than
with respect to Distressed Securities, discussed below, the junk bonds in which
the Fund may invest do not include instruments which, at the time of investment,
are in default or the issuers of which are in bankruptcy. However, there can be
no assurance that such events will not occur after the Fund purchases a
particular security, in which case the Fund may experience losses and incur
costs.

Junk bonds frequently have call or redemption features that would permit an
issuer to repurchase the security from the Fund. If a call were exercised by the
issuer during a period of declining interest rates, the Fund is likely to have
to replace such called security with a lower yielding security, thus decreasing
the net investment income to the Fund and dividends to shareholders.

adversely affecting the market value of such securities are likely to affect
adversely the Fund's net asset value. Like higher-rated fixed-income securities,
junk bonds generally are purchased and sold through dealers who make a market in
such securities for their own accounts. However, there are fewer dealers in the
junk bond market, which market may be less liquid than the market for
higher-rated fixed-income securities, even under normal economic conditions.
Also, there may be significant disparities in the prices quoted for junk bonds
by various dealers. Adverse economic conditions and investor perceptions thereof
(whether or not based on economic reality) may impair the liquidity of this
market and may cause the prices the Fund receives for its junk

<PAGE>

bonds to be reduced. In addition, the Fund may experience difficulty in
liquidating a portion of its portfolio when necessary to meet the Fund's
liquidity needs or in response to a specific economic event such as
deterioration in the creditworthiness of the issuers. Under such conditions,
judgment may play a greater role in valuing certain of the Fund's portfolio
instruments than in the case of instruments trading in a more liquid market. In
addition, the Fund may incur additional expense to the extent that it is
required to seek recovery upon a default on a portfolio holding or to
participate in the restructuring of the obligation. See 'Investment Objectives
and Policies--Description of High-Yield Debt Securities.'

CORPORATE LOANS

In furtherance of its primary investment objective, the Fund may also
invest up to 15% of its total assets in secondary market purchases of loans
extended to corporate borrowers by commercial banks and other financial
institutions ('Corporate Loans'). As in the case of junk bonds, the Corporate
Loans in which the Fund may invest may be rated in the lower rating categories
of the established rating services (Baa or lower by Moody's and BBB or lower by
S&P), or may be unrated investments of comparable quality. As in the case of
junk bonds, such Corporate Loans can be expected to provide higher yields than
lower-yielding, higher-rated fixed income securities but may be subject to
greater risk of loss of principal and income. There are, however, some
significant differences between Corporate Loans and junk bonds. Corporate Loan
obligations are frequently secured by pledges of liens and security interests in
the assets of the borrower, and the holders of Corporate Loans are frequently
the beneficiaries of debt service subordination provisions imposed on the
borrower's bondholders. These arrangements are designed to give Corporate Loan
investors preferential treatment over junk bond investors in the event of a
deterioration in the credit quality of the issuer. Even when these arrangements
exist, however, there can be no assurance that the principal and interest owed
on the Corporate Loans will be repaid in full. Corporate Loans generally bear
interest at rates set at a margin above a generally recognized base lending rate
that may fluctuate on a day to day basis, in the case of the Prime Rate of a
U.S. bank, or which may be adjusted on set dates, typically 30 days but
generally not more than one year, in the case of the London Interbank Offered
Rate ('LIBOR'). Consequently, the value of Corporate Loans held by the Fund may
be expected to fluctuate significantly less than the value of fixed rate junk
bond instruments as a result of changes in the interest rate environment. On the

other hand, the secondary dealer market for Corporate Loans is not as well
developed as the secondary dealer market for junk bonds, and therefore presents
increased market risk relating to liquidity and pricing concerns. See
'Investment Objectives and Policies--Description of Corporate Loans.'

DISTRESSED SECURITIES

The Fund may invest up to 10% of its total assets in high-yield/high-risk
securities, including Corporate Loans purchased in the secondary market, which
are the subject of bankruptcy proceedings or otherwise in default as to the
repayment of principal and/or payment of interest at the time of acquisition by
the Fund or are rated in the lower rating categories (Ca or lower by Moody's and
CC or lower by S&P) or which, if unrated, are in the judgment of the Investment
Adviser of equivalent quality ('Distressed Securities'). Investment in
Distressed Securities is speculative and involves significant risk. Distressed
Securities frequently do not produce income while they are outstanding and may
require the Fund to bear certain extraordinary expenses in order to protect and
recover its investment. Therefore, to the extent the Fund pursues its secondary
objective of capital appreciation through investment in Distressed Securities,
the Fund's ability to achieve current income for its shareholders may be
diminished. See 'Investment Objectives and Policies--Description of Distressed
Securities.'

6
<PAGE>

FOREIGN SECURITIES

The Fund may invest without limitation in financial instruments of issuers
domiciled outside of the United States or that are denominated in various
foreign currencies and multinational foreign currency units. Investing in
securities of foreign entities and securities denominated in foreign currencies
involves certain risks not involved in domestic investments, including, but not
limited to, fluctuations in foreign exchange rates, future foreign political and
economic developments, different legal systems and the possible imposition of
exchange controls or other foreign governmental laws or restrictions. Securities
prices in different countries are subject to different economic, financial,
political and social factors. Since the Fund may invest in securities
denominated or quoted in currencies other than the U.S. dollar, changes in
foreign currency exchange rates may affect the value of securities in the Fund
and the unrealized appreciation or depreciation of investments. Currencies of
certain countries may be volatile and therefore may affect the value of
securities denominated in such currencies. In addition, with respect to certain
foreign countries, there is the possibility of expropriation of assets,
confiscatory taxation, difficulty in obtaining or enforcing a court judgment,
economic, political or social instability or diplomatic developments that could
affect investments in those countries. Moreover, individual foreign economies
may differ favorably or unfavorably from the U.S. economy in such respects as
growth of gross domestic product, rates of inflation, capital reinvestment,
resources, self-sufficiency and balance of payments position. Certain foreign
investments also may be subject to foreign withholding taxes. These risks often
are heightened for investments in smaller, emerging capital markets. See
'Investment Objectives and Policies--Other Investment Policies--Foreign
Securities.'

As a result of these potential risks, the Investment Adviser may determine
that, notwithstanding otherwise favorable investment criteria, it may not be
practicable or appropriate to invest in a particular country. The Fund may
invest in countries in which foreign investors, including the Investment
Adviser, have had no or limited prior experience.

LEVERAGE

The use of leverage by the Fund creates an opportunity for increased net
income and capital appreciation for the Common Stock, but, at the same time,
creates special risks. The Fund intends to utilize leverage to provide the
holders of Common Stock with a potentially higher return. Leverage creates risks
for holders of Common Stock, including the likelihood of greater volatility of
net asset value and market price of shares of the Common Stock, and the risk
that fluctuations in interest rates on borrowings and short-term debt or in the
dividend rates on any preferred stock may affect the return to the holders of
Common Stock. To the extent the income or capital appreciation derived from
securities purchased with funds received from leverage exceeds the cost of
leverage, the Fund's return will be greater than if leverage had not been used.
Conversely, if the income or capital appreciation from the securities purchased
with such funds is not sufficient to cover the cost of leverage, the return to
the Fund will be less than if leverage had not been used, and therefore the
amount available for distribution to shareholders as dividends and other
distributions will be reduced. In the latter case, the Investment Adviser in its
best judgment nevertheless may determine to maintain the Fund's leveraged
position if it expects that the benefits to the Fund's shareholders of
maintaining the leveraged position will outweigh the current reduced return.
Certain types of borrowings by the Fund may result in the Fund being subject to
covenants in credit agreements relating to asset coverage and portfolio
composition requirements. The Fund may be subject to certain restrictions on
investments imposed by guidelines of one or more nationally recognized
statistical ratings organizations which may issue ratings for the short-term
corporate debt securities or preferred stock issued by the Fund. These
guidelines may impose asset coverage or portfolio composition requirements that
are more stringent
7

<PAGE>

than those imposed by the Investment Company Act of 1940, as amended (the
'Investment Company Act'). It is not anticipated that these covenants or
guidelines will impede the Investment Adviser from managing the Fund's portfolio
in accordance with the Fund's investment objectives and policies. The Fund at
times may borrow from affiliates of the Investment Adviser, provided that the
terms of such borrowings are no less favorable than those available from
comparable sources of funds in the marketplace. As discussed under 'Investment
Advisory and Management Arrangements,' the fee paid to the Investment Adviser
will be calculated on the basis of the Fund's assets including proceeds from
borrowings for leverage and the issuance of preferred stock. See 'Other
Investment Policies--Leverage.'

OTHER INVESTMENT MANAGEMENT TECHNIQUES

The Fund may use various other investment management techniques that also
involve special considerations, including engaging in interest rate
transactions, utilization of options and futures transactions, making forward
commitments and lending its portfolio securities. For further discussion of
these practices and the associated risks and special considerations, see 'Other
Investment Policies.'

ILLIQUID SECURITIES

The Fund may invest in securities that lack an established secondary
trading market or are otherwise considered illiquid. Liquidity of a security
relates to the ability to easily dispose of the security and the price to be
obtained and does not generally relate to the credit risk or likelihood of
receipt of cash at maturity. Illiquid corporate bonds and notes may trade at a
discount from comparable, more liquid investments.

ANTITAKEOVER PROVISIONS

The Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of an opportunity to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund. See 'Description of Capital
Stock--Certain Provisions of the Articles of Incorporation.'

For these reasons, an investment in Common Stock of the Fund may be
speculative in that it involves a high degree of risk and should not constitute
a complete investment program.

8
<PAGE>
FEE TABLE

<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES:
Maximum Sales Load (as a percentage of offering price).............................................. None
Dividend Reinvestment Plan Fees..................................................................... None
ANNUAL EXPENSES (as a percentage of net assets attributable to Common Stock):
Management Fees (a)(b).............................................................................. 0.60%
Interest Payments on Borrowed Funds (b)............................................................. None
Other Expenses (b).................................................................................. 0.14%
----------
Total Annual Expenses (b)........................................................................ 0.74%
----------
----------
<CAPTION>
1 3 5 10
EXAMPLE: YEAR YEARS YEARS YEARS
------ ------ ------ -------
<S> <C> <C> <C> <C>
An investor would pay the following expenses on a $1,000
investment, assuming (1) total annual expenses of 0.74%

(assuming no leverage) and 1.89% (assuming leverage of 15%
of the Fund's total assets) and (2) a 5% annual return
throughout the periods:
Assuming No Leverage...................................... $ 62 $ 77 $ 94 $ 142
Assuming 15% Leverage..................................... $ 73 $ 111 $ 152 $ 264
</TABLE>
- ------------
(a) See 'Investment Advisory and Management Arrangements'--page .
(b) In the event the Fund utilizes leverage by borrowing in an amount equal
to approximately 15% of the Fund's total assets (including the amount
obtained from leverage), it is estimated that, as a percentage of net
assets attributable to Common Stock, the Management Fees would be 0.71%,
Interest Payments on Borrowed Funds would be 1.01%, Other Expenses would
be 0.17%, and Total Annual Expenses would be 1.89%. The Fund may utilize
leverage up to 33 1/3% of the Fund's total assets (including the amount
obtained from leverage), depending on economic conditions. See 'Risk
Factors and Special Considerations--Leverage' and 'Other Investment
Policies--Leverage.'

The foregoing Fee Table is intended to assist investors in understanding
the costs and expenses that a shareholder in the Fund will bear directly or
indirectly. The expenses set forth under 'Other Expenses' are based on estimated
amounts through the end of the Fund's first fiscal year on an annualized basis.
The Example set forth above assumes reinvestment of all dividends and
distributions and utilizes a 5% annual rate of return as mandated by Securities
and Exchange Commission ("Commission") regulations. THE EXAMPLE SHOULD NOT BE
CONSIDERED A REPRESENTATION OF FUTURE EXPENSES OR ANNUAL RATE OF RETURN, AND
ACTUAL EXPENSES, LEVERAGE AMOUNT OR ANNUAL RATE OF RETURN MAY BE MORE OR LESS
THAN THOSE ASSUMED FOR PURPOSES OF THE EXAMPLE.

<PAGE>
THE FUND

Corporate High Yield Fund III, Inc. (the 'Fund') is a newly organized,
diversified, closed-end management investment company. The Fund was incorporated
under the laws of the State of Maryland on October 31, 1997, and has registered
under the Investment Company Act. See 'Description of Capital Stock.' The Fund's
principal office is located at 800 Scudders Mill Road, Plainsboro, New Jersey
08536, and its telephone number is (609) 282-2800.

The Fund has been organized as a closed-end investment company. Closed-end
investment companies differ from open-end investment companies (commonly
referred to as mutual funds) in that closed-end investment companies do not
redeem their securities at the option of the shareholder, whereas open-end
investment companies issue securities redeemable at net asset value at any time
at the option of the shareholder and typically engage in a continuous offering
of their shares. Accordingly, open-end investment companies are subject to
continuous asset in-flows and out-flows that can complicate portfolio
management. However, shares of closed-end investment companies frequently trade
at a discount from net asset value. This risk may be greater for investors
expecting to sell their shares in a relatively short period after completion of
the public offering.

USE OF PROCEEDS

The net proceeds of this offering will be approximately $ (or
approximately $ assuming the Underwriter exercises the over-allotment
option in full) after payment of organizational and offering costs.

The net proceeds of the offering will be invested in accordance with the
Fund's investment objectives and policies within approximately three months
after completion of the offering of the shares of Common Stock, depending on
market conditions and the availability of appropriate securities. Pending such
investment, it is anticipated that the proceeds will be invested in U.S.
Government securities or high grade, short-term money market instruments. See
'Investment Objectives and Policies.'

INVESTMENT OBJECTIVES AND POLICIES

The Fund's primary investment objective is to seek current income by
investing primarily in a diversified portfolio of fixed-income securities which
are rated in the lower rating categories of the established rating services (Baa
or lower by Moody's or BBB or lower by S&P) or unrated securities of comparable
quality. Under normal market conditions, at least 65% of the Fund's total assets
will be invested in high-yield corporate debt instruments. Such investments
generally involve greater volatility of price and risks to principal and income
than securities in the higher rating categories. As a secondary objective, the
Fund will seek capital appreciation. The Fund may invest without limit in
financial instruments of issuers domiciled outside the United States or that are
denominated in various foreign currencies and multinational foreign currency
units. The Fund does not currently intend to hedge its non-U.S. dollar
denominated portfolio investments. Up to 15% of the Fund's total assets may be
invested in Corporate Loans. Up to 10% of the Fund's total assets may be
invested in Distressed Securities, which includes publicly offered or privately
placed debt securities and Corporate Loans which, at the time of investment, are
the subject of bankruptcy proceedings or otherwise in default as to the
repayment of principal or payment of interest or are rated in the lowest rating
categories (Ca or lower by Moody's and CC or lower by S&P) or which, if unrated,
are in the judgment of the Investment Adviser of equivalent quality. For these
reasons, an investment in the Fund may be speculative in that it involves a high
degree of risk and should not constitute a complete investment program. See
'Risk Factors and Special Considerations.' The investment objectives are
fundamental policies of the Fund and may not be changed without the approval of
a majority of the

<PAGE>
outstanding voting securities of the Fund (as defined in the Investment Company
Act). There can be no assurance that the investment objectives of the Fund will
be realized.

When changing economic conditions and other factors cause the yield
difference between lower-rated and higher-rated securities to narrow, the Fund
may purchase higher-rated securities if the Investment Adviser believes that the

risk of loss of income and principal may be reduced substantially with only a
relatively small reduction in yield. In addition, under unusual market or
economic conditions or for temporary or defensive or liquidity purposes, the
Fund may invest up to 100% of its total assets in securities issued or
guaranteed by the U.S. Government or its instrumentalities or agencies,
certificates of deposit, bankers' acceptances and other bank obligations,
commercial paper rated in the highest category by a nationally recognized
statistical rating organization or other fixed-income securities deemed by the
Investment Adviser to be consistent with a defensive posture, or may hold it in
cash. The yield on such securities may be lower than the yield on lower-rated
fixed-income securities.

Although the Fund will invest primarily in lower-rated securities, other
than with respect to Distressed Securities (which are discussed below), it will
not invest in securities in the lowest rating categories (Ca or below by Moody's
and CC or below by S&P) unless the Investment Adviser believes that the
financial condition of the issuer or the protection afforded to the particular
securities is stronger than would otherwise be indicated by such low ratings.

Investment in the Common Stock of the Fund offers the individual investor
several potential benefits. In managing a portfolio of high-yield corporate debt
instruments, the Investment Adviser provides professional management which
includes the extensive credit analysis needed to invest in foreign securities,
junk bonds, Corporate Loans and Distressed Securities. The Fund also relieves
the investor of the burdensome administrative details involved in managing a
portfolio of such investments. Additionally, the Investment Adviser may seek to
enhance the yield or capital appreciation of the Fund's Common Stock by
leveraging the Fund's capital structure through the borrowing of money or the
issuance of short-term debt securities or shares of preferred stock. The
benefits are at least partially offset by the expenses involved in running an
investment company. Such expenses primarily consist of advisory fees and
operational costs. The use of leverage also involves certain expenses and risk
considerations. See 'Risk Factors and Special Considerations' and 'Other
Investment Policies--Leverage.'

The Fund may engage in various portfolio strategies to seek to increase its
return and to hedge its portfolio against movements in interest rates through
the use of interest rate transactions, the purchase of call and put options on
securities, the sale of covered call and put options on its portfolio securities
and transactions in financial futures and related options on such futures. Each
of these portfolio strategies is described below. There can be no assurance that
the Fund will employ these strategies or that, if employed, they will be
effective.

The Fund may invest in, among other things, the types of instruments
described below:

DESCRIPTION OF HIGH-YIELD DEBT SECURITIES

Moody's or below BBB by S&P, and unrated securities of comparable quality, are
commonly known as 'junk bonds.' See Appendix A--'Description of Corporate Bond
Ratings' for additional information concerning rating categories.

Selection and supervision of high-yield debt securities by the Investment
Advisor involves continuous analysis of individual issuers, general business
conditions and other factors which may be too time-consuming or

11
<PAGE>

too costly for the average investor. The furnishing of these services does not,
of course, guarantee successful results. The Investment Adviser's analysis of
issuers includes, among other things, historic and current financial conditions,
current and anticipated cash flow and borrowing requirements, value of assets in
relation to historical costs, strength of management, responsiveness to business
conditions, credit standing, and current and anticipated results of operations.
Analysis of general conditions and other factors may include anticipated change
in economic activity and interest rates, the availability of new investment
opportunities and the economic outlook for specific industries. While the
Investment Adviser considers as one factor in its credit analysis the ratings
assigned by the rating services, the Investment Adviser performs its own
independent credit analysis of issuers and, consequently, the Fund may invest,
without limit, in unrated securities. As a result, the Fund's ability to achieve
its investment objectives may depend to a greater extent on the Investment
Adviser's own credit analysis than investment companies which invest in
higher-rated securities. Although the Fund will invest primarily in lower-rated
securities, other than with respect to Distressed Securities (which are
discussed below) it will not invest in securities in the lowest rating
categories (Ca or below for Moody's and CC or below for S&P) unless the
Investment Adviser believes that the financial condition of the issuer or the
protection afforded to the particular securities is stronger than would
otherwise be indicated by such ratings. Securities which subsequently are
downgraded may continue to be held and will be sold only if, in the judgment of
the Investment Adviser, it is advantageous to do so.

Junk bonds are regarded as being predominantly speculative as to the
issuer's ability to make repayments of principal and payments of interest.
Investment in such securities involves substantial risk. Issuers of junk bonds
may be highly leveraged and may not have available to them more traditional
methods of financing. Therefore, the risks associated with acquiring the
securities of such issuers generally are greater than is the case with higher-
rated securities. For example, during an economic downturn or a sustained period
of rising interest rates, issuers of junk bonds may be more likely to experience
financial stress, especially if such issuers are highly leveraged. During
periods of economic downturn, such issuers may not have sufficient revenues to
meet their interest payment obligations. The issuer's ability to service its
debt obligations also may be adversely affected by specific issuer developments,
or the issuer's inability to meet specific projected business forecasts or the
unavailability of additional financing. The risk of loss due to default by the
issuer is significantly greater for the holders of junk bonds because such
securities may be unsecured and may be subordinate to other creditors of the
issuer. Other than with respect to Distressed Securities, the junk bonds in
which the Fund may invest do not include securities which, at the time of

investment, are in default or the issuers of which are in bankruptcy. However,
there can be no assurance that such events will not occur after the Fund
purchases a particular security, in which case the Fund may experience losses
and incur costs.

Junk bonds tend to be more volatile than higher-rated fixed-income
securities, so that adverse economic events may have a greater impact on the
prices of junk bonds than on higher-rated fixed-income securities. Factors
adversely affecting the market value of such securities are likely to affect
adversely the Fund's net asset value. Like higher-rated fixed-income securities,
junk bonds generally are purchased and sold through dealers who make a market in
such securities for their own accounts. However, there are fewer dealers in the
junk bond market, which market may be less liquid than the market for
higher-rated fixed-income securities, even under normal economic conditions.
Also, there may be significant disparities in the prices quoted for junk bonds
by various dealers. Adverse economic conditions and investor perceptions thereof
(whether or not based on economic fundamentals) may impair the liquidity of this
market and may cause the prices the Fund receives for

<PAGE>

its junk bonds to be reduced. In addition, the Fund may experience difficulty in
liquidating a portion of its portfolio when necessary to meet the Fund's
liquidity needs or in response to a specific economic event such as a
deterioration in the creditworthiness of the issuer. Under such conditions,
judgment may play a greater role in valuing certain of the Fund's portfolio
securities than in the case of securities trading in a more liquid market. In
addition, the Fund may incur additional expense to the extent that it is
required to seek recovery upon a default on a portfolio holding or to
participate in the restructuring of the obligation.

In connection with its investments in corporate debt securities, or
restructuring of investments owned by the Fund, the Fund may receive warrants or
other non-income producing equity securities. The Fund may retain such
securities until the Investment Adviser determines it is appropriate in light of
current market conditions to effect a disposition of such securities.

DESCRIPTION OF CORPORATE LOANS

In furtherance of its primary investment objective, the Fund may also
invest up to 15% of its total assets in secondary market purchases of Corporate
Loans. As in the case of junk bonds, the Corporate Loans in which the Fund may
invest may be rated in the lower rating categories of the established rating
services (Baa or lower by Moody's and BBB or lower by S&P), or may be unrated
investments of comparable quality. As in the case of junk bonds, such Corporate
Loans can be expected to provide higher yields than lower-yielding, higher-rated

fixed income securities but may be subject to greater risk of loss of principal
and income. There are, however, some significant differences between Corporate
Loans and junk bonds. Corporate Loan obligations are frequently secured by
pledges of liens and security interests in the assets of the borrower, and the
holders of Corporate Loans are frequently the beneficiaries of debt service
subordination provisions imposed on the borrower's bondholders. These
arrangements are designed to give Corporate Loan investors preferential
treatment over junk bond investors in the event of a deterioration in the credit
quality of the issuer. Even when these arrangements exist, however, there can be
no assurance that the principal and interest owed on the Corporate Loans will be
repaid in full. Corporate Loans generally bear interest at rates set at a margin
above a generally recognized base lending rate that may fluctuate on a day to
day basis, in the case of the Prime Rate of a U.S. bank, or which may be
adjusted on set dates, typically 30 days but generally not more than one year,
in the case of the London Interbank Offered Rate ('LIBOR'). Consequently, the
value of Corporate Loans held by the Fund may be expected to fluctuate
significantly less than the value of fixed rate junk bond instruments as a
result of changes in the interest rate environment. On the other hand, the
secondary dealer market for Corporate Loans is not as well developed as the
secondary dealer market for junk bonds, and therefore presents increased market
risk relating to liquidity and pricing concerns.

DESCRIPTION OF DISTRESSED SECURITIES

The Fund may invest up to 10% of its total assets in high-yield/high-risk
securities ('Distressed Securities'), including Corporate Loans purchased in the
secondary market, which are the subject of bankruptcy proceedings or otherwise
in default as to the repayment of principal and/or payment of interest at the
time of acquisition by the Fund or are rated in the lower rating categories (Ca
or lower by Moody's and CC or lower by S&P) or which, if unrated, are in the
judgment of the Investment Adviser of equivalent quality. Investment in
Distressed Securities is speculative and involves significant risk. Distressed
Securities frequently do not produce income while they are outstanding and may
require the Fund to bear certain extraordinary expenses in order to protect and
recover its investment. Therefore, to the extent the Fund pursues its secondary
objective of capital appreciation through investment in Distressed Securities,
the Fund's ability to achieve current income for its shareholders may be
diminished. The Fund also will be subject to significant uncertainty as to when
and in what manner and for what value the obligations evidenced by the
Distressed Securities will eventually be satisfied

<PAGE>

(e.g., through a liquidation of the obligor's assets, an exchange offer or plan
of reorganization involving the Distressed Securities or a payment of some
amount in satisfaction of the obligation). In addition, even if an exchange
offer is made or plan of reorganization is adopted with respect to Distressed
Securities held by the Fund, there can be no assurance that the securities or
other assets received by the Fund in connection with such exchange offer or plan
of reorganization will not have a lower value or income potential than may have
been anticipated when the investment was made. Moreover, any securities received
by the Fund upon completion of an exchange offer or plan of reorganization may

be restricted as to resale. As a result of the Fund's participation in
negotiations with respect to any exchange offer or plan of reorganization with
respect to an issuer of Distressed Securities, the Fund may be restricted from
disposing of such securities. See 'Risk Factors and Special Considerations.'

ILLIQUID SECURITIES

The Fund may invest in junk bonds, Corporate Loans and other securities
that lack a secondary trading market or are otherwise considered illiquid.
Liquidity of a security relates to the ability to easily dispose of the security
and the price to be obtained upon disposition of the security, which may be less
than would be obtained for a comparable more liquid security. The Fund has no
limitation on the amount of its investments which are not readily marketable or
are subject to restrictions on resale.

OTHER INVESTMENT POLICIES

The Fund has adopted certain other investment policies as set forth below:

LEVERAGE

At times, the Fund expects to utilize leverage through borrowings or
issuance of short-term debt securities or shares of preferred stock. The Fund
intends to utilize leverage in an initial amount equal to approximately 15% of
its total assets (including the amount obtained from leverage); however,the Fund
has the ability to utilize leverage in an amount up to 33 1/3% of its total
assets (including the amount obtained from leverage). The Fund generally will
not utilize leverage if it anticipates that the Fund's leveraged capital
structure would result in a lower return to holders of the Common Stock than
that obtainable if the Common Stock were unleveraged for any significant amount
of time. The Fund also may borrow money as a temporary measure for extraordinary
or emergency purposes, including the payment of dividends and the settlement of
securities transactions which otherwise may require untimely dispositions of
Fund securities. The Fund at times may borrow from affiliates of the Investment
Adviser, provided that the terms of such borrowings are no less favorable than
those available from comparable sources of funds in the marketplace. As
discussed under 'Investment Advisory and Management Arrangements,' the fee paid
to the Investment Adviser will be calculated on the basis of the Fund's assets
including proceeds from borrowings for leverage and the issuance of preferred
stock.

The concept of leveraging is based on the premise that the cost of the
assets to be obtained from leverage will be based on short-term rates which
normally will be lower than the return earned by the Fund on its longer term
portfolio investments. Since the total assets of the Fund (including the assets
obtained from leverage) will be invested in the higher yielding portfolio
investments or portfolio investments with the potential for capital
appreciation, the holders of Common Stock will be the beneficiaries of the
incremental return. Should the differential between the underlying assets and
cost of leverage narrow, the incremental return 'pick up' will be reduced.
Furthermore, if long-term rates rise, the Common Stock net asset value will
reflect the decline in the value of portfolio holdings resulting therefrom.

<PAGE>

Leverage creates risks for holders of Common Stock, including the
likelihood of greater volatility of net asset value and market price of shares
of Common Stock, and the risk that fluctuations in interest rates on borrowings
and short-term debt or in the dividend rates on any preferred stock may affect
the return to the holders of Common Stock. To the extent the income or capital
appreciation derived from securities purchased with funds received from leverage
exceeds the cost of leverage, the Fund's return will be greater than if leverage
had not been used. Conversely, if the income or capital appreciation from the
securities purchased with such funds is not sufficient to cover the cost of
leverage, the return of the Fund will be less than if leverage had not been
used, and therefore the amount available for distribution to shareholders as
dividends and other distributions will be reduced. In the latter case, the
Investment Adviser in its best judgment nevertheless may determine to maintain
the Fund's leveraged position if it expects that the benefits to the Fund's
shareholders of maintaining the leveraged position will outweigh the current
reduced return.

Capital raised through leverage will be subject to interest costs or
dividend payments which may or may not exceed the income and appreciation on the
assets purchased. The Fund also may be required to maintain minimum average
balances in connection with borrowings or to pay a commitment or other fee to
maintain a line of credit; either of these requirements will increase the cost
of borrowing over the stated interest rate. The issuance of additional classes
of preferred stock involves offering expenses and other costs and may limit the
Fund's freedom to pay dividends on shares of Common Stock or to engage in other
activities. Borrowings and the issuance of a class of preferred stock having
priority over the Fund's Common Stock create an opportunity for greater return
per share of Common Stock, but at the same time such borrowing is a speculative
technique in that it will increase the Fund's exposure to capital risk. Unless
the income and appreciation, if any, on assets acquired with borrowed funds or
offering proceeds exceed the cost of borrowing or issuing additional classes of
securities, the use of leverage will diminish the investment performance of the
Fund compared with what it would have been without leverage.

Certain types of borrowings may result in the Fund being subject to
covenants in credit agreements relating to asset coverage and portfolio
composition requirements. The Fund may be subject to certain restrictions on
investments imposed by guidelines of one or more nationally recognized rating
organizations which may issue ratings for the short-term corporate debt
securities or preferred stock issued by the Fund. These guidelines may impose
asset coverage or portfolio composition requirements that are more stringent
than those imposed by the Investment Company Act. It is not anticipated that
these covenants or guidelines will impede the Investment Adviser from managing
the Fund's portfolio in accordance with the Fund's investment objectives and
policies.

Under the Investment Company Act, the Fund is not permitted to incur
indebtedness unless immediately after such incurrence the Fund has an asset
coverage of at least 300% of the aggregate outstanding principal balance of
indebtedness (i.e., such indebtedness may not exceed 33 1/3% of the Fund's total
assets). Additionally, under the Investment Company Act, the Fund may not
declare any dividend or other distribution upon any class of its capital stock,

or purchase any such capital stock, unless the aggregate indebtedness of the
Fund has, at the time of the declaration of any such dividend or distribution or
at the time of any such purchase, an asset coverage of at least 300% after
deducting the amount of such dividend, distribution, or purchase price, as the
case may be. Under the Investment Company Act, the Fund is not permitted to
issue shares of preferred stock unless immediately after such issuance the net
asset value of the Fund's portfolio is at least 200% of the liquidation value of
the outstanding preferred stock (i.e., such liquidation value may not exceed 50%
of the Fund's total assets). In addition, the Fund is not permitted to declare
any cash dividend or other distribution on its Common Stock unless, at the time
of such declaration, the net asset value of the Fund's portfolio (determined
after deducting the amount of such dividend or distribution) is at least 200% of
such liquidation value. In the event shares of preferred stock are issued, the
Fund intends, to the extent possible, to purchase or redeem shares of preferred
stock from time to time to maintain coverage of any preferred stock of at least
200%.

15
<PAGE>

The Fund's willingness to borrow money and issue new securities for
investment purposes, and the amount it will borrow or issue, will depend on many
factors, the most important of which are investment outlook, market conditions
and interest rates. Successful use of a leveraging strategy depends on the
Investment Adviser's ability to predict correctly interest rates and market
movements, and there is no assurance that a leveraging strategy will be
successful during any period in which it is employed.

Assuming the utilization of leverage by borrowings in the amount of
approximately 15% of the Fund's total assets, and an annual interest rate of
5.75% payable on such leverage based on market rates as of the date of this
Prospectus, the annual return that the Fund's portfolio must experience (net of
expenses) in order to cover such interest payments would be 0.86%.

The following table is designed to illustrate the effect on the return to a
holder of the Fund's Common Stock of the leverage obtained by borrowings in the
amount of approximately 15% of the Fund's total assets, assuming hypothetical
annual returns of the Fund's portfolio of minus 10% to plus 10%. As the table
shows, leverage generally increases the return to stockholders when portfolio
return is positive and greater than the cost of leverage and decreases the
return when the portfolio return is negative or less than the cost of leverage.
The figures appearing in the table are hypothetical and actual returns may be
greater or less than those appearing in the table.

Assumed Portfolio Return
(net of expenses).......... (10)% (5)% 0 % 5 % 10%
Corresponding Common
Stock Return............... (13)% (7)% (1)% 5 % 11%

Until the Fund borrows or issues shares of preferred stock, the Fund's
Common Stock will not be leveraged, and the risks and special considerations
related to leverage described in this Prospectus will not apply. Such leveraging
of the Common Stock cannot be fully achieved until the proceeds resulting from
the use of leverage have been invested in longer-term debt instruments in

accordance with the Fund's investment objectives and policies.

INTEREST RATE TRANSACTIONS

In order to hedge the value of the Fund's portfolio against interest rate
fluctuations or to enhance the Fund's income, the Fund may enter into various
interest rate transactions such as interest rate swaps and the purchase or sale
of interest rate caps and floors. The Fund expects to enter into these
transactions primarily to preserve a return or spread on a particular investment
or portion of its portfolio or to protect against any increase in the price of
securities the Fund anticipates purchasing at a later date. The Fund intends to
use these transactions primarily as a hedge and not as a speculative investment.
However, the Fund also may invest in interest rate swaps to enhance income or to
increase the Fund's yield, for example, during periods of steep interest rate
yield curves (i.e., wide differences between short-term and long-term interest
rates).

In an interest rate swap, the Fund exchanges with another party their
respective commitments to pay or receive interest (e.g., an exchange of fixed
rate payments for floating rate payments). For example, if the Fund holds a debt
instrument with an interest rate that is reset only once each year, it may swap
the right to receive interest at this fixed rate for the right to receive
interest at a rate that is reset every week. This would enable the Fund to
offset a decline in the value of the debt instrument due to rising interest
rates but would also limit its ability to benefit from falling interest rates.
Conversely, if the Fund holds a debt instrument with an interest rate that is
reset every week and it would like to lock in what it believes to be a high
interest rate for one year, it may swap the right to receive interest at this
variable weekly rate for the right to receive interest at a rate that is fixed
for one year. Such a swap would protect the Fund from a reduction in yield due
to falling interest rates and may permit the Fund to enhance its income through
the positive differential between one week and one year interest rates, but
would preclude it from taking full advantage of rising interest rates.

16
<PAGE>

The Fund usually will enter into interest rate swaps on a net basis (i.e.,
the two payment streams are netted out with the Fund receiving or paying, as the
case may be, only the net amount of the two payments). The net amount of the
excess, if any, of the Fund's obligations over its entitlements with respect to
each interest rate swap will be accrued on a daily basis, and an amount of cash
or liquid instruments having an aggregate net asset value at least equal to the
accrued excess will be maintained in a segregated account by the Fund's
custodian. If the interest rate swap transaction is entered into on other than a
net basis, the full amount of the Fund's obligations will be accrued on a daily
basis, and the full amount of the Fund's obligations will be maintained in a
segregated account by the Fund's custodian.

The Fund may also engage in interest rate transactions in the form of
purchasing or selling interest rate caps or floors. The Fund will not sell
interest rate caps or floors that it does not own. The purchase of an interest
rate cap entitles the purchaser, to the extent that a specified index exceeds a
predetermined interest rate, to receive payments of interest equal to the

difference of the index and the predetermined rate on a notional principal
amount (i.e., the reference amount with respect to which interest obligations
are determined although no actual exchange of principal occurs) from the party
selling such interest rate cap. The purchase of an interest rate floor entitles
the purchaser, to the extent that a specified index falls below a predetermined
interest rate, to receive payments of interest at the difference of the index
and the predetermined rate on a notional principal amount from the party selling
such interest rate floor. The Fund will not enter into caps or floors if, on a
net basis, the aggregate notional principal amount with respect to such
agreements exceeds the net assets of the Fund.

Typically, the parties with which the Fund will enter into interest rate
transactions will be broker-dealers and other financial institutions. The Fund
will not enter into any interest rate swap, cap or floor transaction unless the
unsecured senior debt or the claims-paying ability of the other party thereto is
rated investment grade quality by at least one nationally recognized statistical
rating organization at the time of entering into such transaction or whose
creditworthiness is believed by the Investment Adviser to be equivalent to such
rating. If there is a default by the other party to such a transaction, the Fund
will have contractual remedies pursuant to the agreements related to the
transaction. 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 other similar instruments
traded in the interbank market. Caps and floors, however, are more recent
innovations and are less liquid than swaps. Certain Federal income tax
requirements may limit the Fund's ability to engage in certain interest rate
transactions. Gains from transactions in interest rate swaps distributed to
shareholders will be taxable as ordinary income or, in certain circumstances, as
long-term capital gains to shareholders. See 'Taxes.'

INVESTMENTS IN FOREIGN SECURITIES

The Fund may invest without limitation in financial instruments of issuers
domiciled outside of the United States or that are denominated in various
foreign currencies and multinational foreign currency units. Investment in such
securities involves certain risks not involved in domestic investments, as
discussed above under 'Risk Factors and Special Considerations--Foreign
Securities' and in more detail below.

Public Information. Many of the foreign securities held by the Fund will
not be registered with the Commission nor will the issuers thereof be subject to
the reporting requirements of such agency. Accordingly, there may be less
publicly available information about the foreign issuer of such securities than
about a U.S. issuer, and such foreign issuers may not be subject to accounting,
auditing and financial reporting standards and requirements comparable to those
of U.S. issuers. Traditional investment measurements, such as price/earnings
ratios, as used in the United States, may not be applicable to such securities,
particularly those issued in certain smaller, emerging foreign capital markets.
Foreign issuers, and issuers in smaller, emerging capital markets in

17
<PAGE>

particular, generally are not subject to uniform accounting, auditing and
financial reporting standards or to practices and requirements comparable to
those applicable to domestic issuers.

Trading Volume, Clearance and Settlement. Foreign financial markets, while
often growing in trading volume, have, for the most part, substantially less
volume than U.S. markets, and securities of many foreign companies are less
liquid and their prices may be more volatile than securities of comparable
domestic companies. Foreign markets also have different clearance and settlement
procedures, and in certain markets there have been times when settlements have
failed to keep pace with the volume of securities transactions, making it
difficult to conduct such transactions. Further, satisfactory custodial services
for investment securities may not be available in some countries having smaller,
emerging capital markets, which may result in the Fund incurring additional
costs and delays in transporting and custodying such securities outside such
countries. Delays in settlement could result in periods when assets of the Fund
are uninvested and no return is earned thereon. The inability of the Fund to
make intended security purchases due to settlement problems or the risk of
intermediary counterparty failures could cause the Fund to miss attractive
investment opportunities. The inability to dispose of a portfolio security due
to settlement problems could result either in losses to the Fund due to
subsequent declines in the value of such portfolio security or, if the Fund has
entered into a contract to sell the security, could result in possible liability
to the purchaser.

Government Supervision and Regulation. There generally is less
governmental supervision and regulation of exchanges, brokers and issuers in
foreign countries than there is in the United States. For example, there may be
no comparable provisions under certain foreign laws to insider trading and
similar investor protection securities laws that apply with respect to
securities transactions consummated in the United States. Further, brokerage
commissions and other transaction costs on foreign securities exchanges
generally are higher than in the United States.

Restrictions on Foreign Investment. Some countries prohibit or impose
substantial restrictions on investments in their capital markets, particularly
their equity markets, by foreign entities such as the Fund. As illustrations,
certain countries require governmental approval prior to investments by foreign
persons, or limit the amount of investment by foreign persons in a particular
company, or limit the investment by foreign persons in a company to only a
specific class of securities that may have less advantageous terms than
securities of the company available for purchase by nationals. Certain countries
may restrict investment opportunities in issuers or industries deemed important
to national interests.

A number of countries have authorized the formation of closed-end
investment companies to facilitate indirect foreign investment in their capital
markets. In accordance with the Investment Company Act, the Fund may invest up
to 10% of its total assets in securities of closed-end investment companies, not
more than 5% of which may be invested in any one such company. This restriction
on investments in securities of closed-end investment companies may limit
opportunities for the Fund to invest indirectly in certain smaller capital
markets. Shares of certain closed-end investment companies may at times be
acquired only at market prices representing premiums to their net asset values.

If the Fund acquires shares in closed-end investment companies, shareholders
would bear both their proportionate share of expenses in the Fund (including
investment advisory fees) and, indirectly, the expenses of such closed-end
investment companies. The Fund also may seek, at its own cost, to create its own
investment entities under the laws of certain countries.

In some countries, banks or other financial institutions may constitute a
substantial number of the leading companies or companies with the most actively
traded securities. The Investment Company Act limits the Fund's ability to
invest in any equity security of an issuer which, in its most recent fiscal
year, derived more than 15% of

18
<PAGE>

its revenues from 'securities related activities,' as defined by the rules
thereunder. These provisions may also restrict the Fund's investments in certain
foreign banks and other financial institutions.

Foreign Sub-Custodians and Securities Depositories. Rules adopted under
the Investment Company Act permit the Fund to maintain its foreign securities
and cash in the custody of certain eligible non-U.S. banks and securities
depositories. Certain banks in foreign countries may not be eligible
sub-custodians for the Fund, in which event the Fund may be precluded from
purchasing securities in certain foreign countries in which it otherwise would
invest or the Fund may incur additional costs and delays in providing
transportation and custody services for such securities outside of such
countries. The Fund may encounter difficulties in effecting on a timely basis
portfolio transactions with respect to any securities of issuers held outside
their countries. Other banks that are eligible foreign sub-custodians may be
recently organized or otherwise lack extensive operating experience. In
addition, in certain countries there may be legal restrictions or limitations on
the ability of the Fund to recover assets held in custody by foreign
sub-custodians in the event of the bankruptcy of the sub-custodian.

OPTIONS ON PORTFOLIO SECURITIES

Call Options on Portfolio Securities. The Fund may purchase call options
on any of the types of securities in which it may invest. A purchased call
option gives the Fund the right to buy, and obligates the seller to sell, the
underlying security at the exercise price at any time during the option period.
The Fund also is authorized to write (i.e., sell) covered call options on the
securities in which it may invest and to enter into closing purchase
transactions with respect to certain of such options. A covered call option is
an option where the Fund, in return for a premium, gives another party a right
to buy specified securities owned by the Fund at a specified future date and
price set at the time of the contract. The principal reason for writing call
options is attempt to realize, through the receipt of premiums, a greater return
than would be realized on the securities alone. By writing covered call options,
the Fund gives up the opportunity, while the option is in effect, to profit from
any price increase in the underlying security above the option exercise price.
In addition, the Fund's ability to sell the underlying security will be limited
while the option is in effect unless the Fund effects a closing purchase
transaction. A closing purchase transaction cancels out the Fund's position as

the writer of an option by means of an offsetting purchase of an identical
option prior to the expiration of the option it has written. Covered call
options also serve as a partial hedge against the price of the underlying
security declining. The Fund may also purchase and sell call options on indices.
Index options are similar to options on securities except that, rather than
taking or making delivery of securities underlying the option at a specified
price upon exercise, an index option gives the holder the right to receive cash
upon exercise of the option if the level of the index upon which the option is
based is greater than the exercise price of the option.

Put Options on Portfolio Securities. The Fund is authorized to purchase
put options to hedge against a decline in the value of its securities. By buying
a put option, the Fund has a right to sell the underlying security at the
exercise price, thus limiting the Fund's risk of loss through a decline in the
market value of the security until the put option expires. The amount of any
appreciation in the value of the underlying security will be partially offset by
the amount of the premium paid for the put option and any related transaction
costs. Prior to its expiration, a put option may be sold in a closing sale
transaction and profit or loss from the sale will depend on whether the amount
received is more or less than the premium paid for the put option plus the
related transaction costs. A closing sale transaction cancels out the Fund's
position as the purchaser of an option by means of an offsetting sale of an
identical option prior to the expiration of the option it has purchased. The
Fund also has authority to write (i.e., sell) put options on the types of
securities which may be held by the Fund, provided that such put options are
covered, meaning that such options are secured by segregated, liquid
instruments. In certain

19
<PAGE>

circumstances, the Fund may purchase call options on securities held in its
portfolio on which it has written call options or which it intends to purchase.
The Fund will receive a premium for writing a put option, which increases the
Fund's return. The Fund will not sell puts if, as a result, more than 50% of the
Fund's assets would be required to cover its potential obligations under its
hedging and other investment transactions. The Fund may purchase and sell put
options on indices. Index options are similar to options on securities except
that, rather than taking or making delivery of securities underlying the option
at a specified price upon exercise, an index option gives the holder the right
to receive cash upon exercise of the option if the level of the index upon which
the option is based is less than the exercise price of the option.

FINANCIAL FUTURES AND OPTIONS THEREON

The Fund is authorized to engage in transactions in financial futures
contracts ('futures contracts') and related options on such futures contracts
either as a hedge against adverse changes in the market value of its portfolio
securities or to enhance the Fund's income. A futures contract is an agreement
between two parties which obligates the purchaser of the futures contract, to
buy and the seller of a futures contract to sell a security for a set price on a
future date or, in the case of an index futures contract, to make and accept a
cash settlement based upon the difference in value of the index between the time
the contract was entered into and the time of its settlement. A majority of

transactions in futures contracts, however, do not result in the actual delivery
of the underlying instrument or cash settlement, but are settled through
liquidation (i.e., by entering into an offsetting transaction). Futures
contracts have been designed by boards of trade which have been designated
'contract markets' by the Commodities Futures Trading Commission (the 'CFTC').
Transactions by the Fund in futures contracts and financial futures are subject
to limitations as described below under '--Restrictions on the Use of Futures
Transactions.'

The Fund may sell financial futures contracts in anticipation of an
increase in the general level of interest rates. Generally, as interest rates
rise, the market values of securities which may be held by the Fund will fall,
thus reducing the net asset value of the Fund. However, as interest rates rise,
the value of the Fund's short position in the futures contract will also tend to
increase, thus offsetting all or a portion of the depreciation in the market
value of the Fund's investments which are being hedged. While the Fund will
incur commission expenses in selling and closing out futures positions, these
commissions are generally less than the transaction expenses which the Fund
would have incurred had the Fund sold portfolio securities in order to reduce
its exposure to increases in interest rates. The Fund also may purchase
financial futures contracts in anticipation of a decline in interest rates when
it is not fully invested in a particular market in which it intends to make
investments to gain market exposure that may in part or entirely offset an
increase in the cost of securities it intends to purchase. It is anticipated
that, in a substantial majority of these transactions, the Fund will purchase
securities upon termination of the futures contract.

The Fund also has authority to purchase and write call and put options on
futures contracts. Generally, these strategies are utilized under the same
market and market sector conditions (i.e., conditions relating to specific types
of investments) in which the Fund enters into futures transactions. The Fund may
purchase put options or write call options on futures contracts rather than
selling the underlying futures contract in anticipation of a decrease in the
market value of securities or an increase in interest rates. Similarly, the Fund
may purchase call options, or write put options on futures contracts, as a
substitute for the purchase of such futures to hedge against the increased cost
resulting from an increase in the market value or a decline in interest rates of
securities which the Fund intends to purchase.

The Fund may engage in options and futures transactions on exchanges and
options in the over-the-counter markets ('OTC options'). In general,
exchange-traded contracts are third-party contracts (i.e.,performance of

20
<PAGE>

the parties' obligation is guaranteed by an exchange or clearing corporation)
with standardized strike prices and expiration dates. OTC options transactions
are two-party contracts with price and terms negotiated by the buyer and seller.
See 'Restrictions on OTC Options' below for information as to restrictions on
the use of OTC options.

Restrictions on the Use of Futures Transactions. Under regulations of the
CFTC, the futures trading activity described herein will not result in the Fund

being deemed a 'commodity pool,' as defined under such regulations, provided
that the Fund adheres to certain restrictions. In particular, the Fund may
purchase and sell futures contracts and options thereon (i) for bona fide
hedging purposes and (ii) for non-hedging purposes, if the aggregate initial
margin and premiums required to establish positions in such contracts and
options does not exceed 5% of the liquidation value of the Fund's portfolio,
after taking into account unrealized profits and unrealized losses on any such
contracts and options. Margin deposits may consist of cash or securities
acceptable to the broker and the relevant contract market.

When the Fund purchases a futures contract or writes a put option or
purchases a call option thereon, an amount of cash or liquid instruments will be
deposited in a segregated account with the Fund's custodian so that the amount
so segregated, plus the amount of variation margin held in the account of its
broker, equals the market value of the futures contract, thereby ensuring that
the use of such futures is unleveraged.

An order has been obtained from the Securities and Exchange Commission (the
'Commission') which exempts the Fund from certain provisions of the Investment
Company Act in connection with transactions involving futures contracts and
options thereon.

Restrictions on OTC Options. The Fund will engage in transactions in OTC
options only with banks or dealers which have capital of at least $50 million or
whose obligations are guaranteed by an entity having capital of at least $50
million. OTC options and assets used to cover OTC options written by the Fund
are considered by the staff of the Commission to be illiquid. The illiquidity of
such options or assets may prevent a successful sale of such options or assets,
result in a delay of sale, or reduce the amount of proceeds that might otherwise
be realized.

RISK FACTORS IN INTEREST RATE TRANSACTIONS AND OPTIONS AND FUTURES TRANSACTIONS

The use of interest rate transactions is a highly specialized activity
which involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. Interest rate transactions
involve the risk of an imperfect correlation between the index used in the
hedging transaction and that pertaining to the securities which are the subject
of such transaction. If the Investment Adviser is incorrect in its forecasts of
market values, interest rates and other applicable factors, the investment
performance of the Fund would diminish compared with what it would have been if
these investment techniques were not used. In addition, interest rate
transactions that may be entered into by the Fund do not involve the delivery of
securities or other underlying assets or principal. Accordingly, the risk of
loss with respect to interest rate swaps is limited to the net amount of
interest payments that the Fund is contractually obligated to make. If the
security underlying an interest rate swap is prepaid and the Fund continues to
be obligated to make payments to the other party to the swap, the Fund would
have to make such payments from another source. If the other party to an
interest rate swap defaults, the Fund's risk of loss consists of the net amount
of interest payments that the Fund contractually is entitled to receive. In the
case of a purchase by the Fund of an interest rate cap or floor, the amount of
loss is limited to the fee paid. Since interest rate transactions are
individually negotiated, the Investment Adviser expects to achieve an acceptable

degree of correlation between the Fund's rights to receive interest on
securities and its rights and obligations to receive and pay interest pursuant
to interest rate swaps.

21
<PAGE>

Utilization of options and futures transactions to hedge the portfolio
involves the risk of imperfect correlation in movements in the price of options
and futures and movements in the prices of the securities which are the subject
of the hedge. If the price of the options or futures moves more or less than the
price of the subject of the hedge, the Fund will experience a gain or loss which
will not be completely offset by movements in the price of the subject of the
hedge. The risk particularly applies to the Fund's use of futures and options
thereon since it will generally use such instruments as a so-called
'cross-hedge,' which means that the security that is the subject of the futures
contract is different from the security being hedged by the contract.

Prior to exercise or expiration, an exchange-traded option position can
only be terminated by entering into a closing purchase or sale transaction. This
requires a secondary market on an exchange for call or put options of the same
series. The Fund intends to enter into options and futures transactions, on an
exchange or in the over-the-counter market, only if there appears to be a liquid
secondary market for such options and futures. However, there can be no
assurance that a liquid secondary market will exist at any specific time. Thus,
it may not be possible to close an options or futures position. The inability to
close options and futures positions also could have an adverse impact on the
Fund's ability to effectively hedge its portfolio. There is also the risk of
loss by the Fund of margin deposits or collateral in the event of bankruptcy of
a broker with whom the Fund has an open position in an option, a futures
contract or an option related to a futures contract.

OTHER INVESTMENT STRATEGIES

Repurchase Agreements and Purchase and Sale Contracts. The Fund may invest
in securities pursuant to repurchase agreements and purchase and sale contracts.
Repurchase agreements and purchase and sale contracts may be entered into only
with a member bank of the Federal Reserve System or primary dealer in U.S.
Government securities. Under such agreements, the bank or primary dealer agrees,
upon entering into the contract, to repurchase the security at a mutually agreed
upon time and price, thereby determining the yield during the term of the
agreement. This results in a fixed rate of return insulated from market
fluctuations during such period. In the case of repurchase agreements, the
prices at which the trades are conducted do not reflect accrued interest on the
underlying obligations; whereas, in the case of purchase and sale contracts, the
prices take into account accrued interest. Such agreements usually cover short
periods, such as under one week. Repurchase agreements may be construed to be
collateralized loans by the purchaser to the seller secured by the securities
transferred to the purchaser. In the case of a repurchase agreement, the Fund
will require the seller to provide additional collateral if the market value of
the securities falls below the repurchase price at any time during the term of
the repurchase agreement; the Fund does not have the right to seek additional
collateral in the case of purchase and sale contracts. In the event of default
by the seller under a repurchase agreement construed to be a collateralized

loan, the underlying securities are not owned by the Fund but only constitute
collateral for the seller's obligation to pay the repurchase price. Therefore,
the Fund may suffer time delays and incur costs or possible losses in connection
with the disposition of the collateral. A purchase and sale contract differs
from a repurchase agreement in that the contract arrangements stipulate that the
securities are owned by the Fund. In the event of a default under such a
repurchase agreement or a purchase and sale contract, instead of the contractual
fixed rate of return, the rate of return to the Fund shall be dependent upon
intervening fluctuations of the market value of such security and the accrued
interest on the security. In such event, the Fund would have rights against the
seller for breach of contract with respect to any losses arising from market
fluctuations following the failure of the seller to perform.

Reverse Repurchase Agreements. The Fund may enter into reverse repurchase
agreements with respect to its portfolio investments subject to the investment
restrictions set forth herein. Reverse repurchase agreements involve the sale of
securities held by the Fund with an agreement by the Fund to repurchase the
securities at an

22
<PAGE>

agreed upon price, date and interest payment. The use by the Fund of reverse
repurchase agreements involves many of the same risks of leverage described
under 'Risk Factors and Special Considerations' and '--Leverage' since the
proceeds derived from such reverse repurchase agreements may be invested in
additional securities. At the time the Fund enters into a reverse repurchase
agreement, it may establish and maintain a segregated account with the custodian
containing liquid instruments having a value not less than the repurchase price
(including accrued interest). If the Fund establishes and maintains such a
segregated account, a reverse repurchase agreement will not be considered a
borrowing by the Fund; however, under circumstances in which the Fund does not
establish and maintain such a segregated account, such reverse repurchase
agreement will be considered a borrowing for the purpose of the Fund's
limitation on borrowings. Reverse repurchase agreements involve the risk that
the market value of the securities acquired in connection with the reverse
repurchase agreement may decline below the price of the securities the Fund has
sold but is obligated to repurchase. Also, reverse repurchase agreements involve
the risk that the market value of the securities retained in lieu of sale by the
Fund in connection with the reverse repurchase agreement may decline in price.
In the event the buyer of securities under a reverse repurchase agreement files
for bankruptcy or becomes insolvent, such buyer or its trustee or receiver may
receive an extension of time to determine whether to enforce the Fund's
obligation to repurchase the securities, and the Fund's use of the proceeds of
the reverse repurchase agreement may effectively be restricted pending such
decision. Also, the Fund would bear the risk of loss to the extent that the
proceeds of the reverse repurchase agreement are less than the value of the
securities subject to such agreement.

Lending of Portfolio Securities The Fund from time to time may lend
securities from its portfolio, with a value not exceeding 33 1/3% of its total
assets, to banks, brokers and other financial institutions and receive
collateral in cash or securities issued or guaranteed by the U.S. Government,
its agencies or instrumentalities which will be maintained at all times in an

amount equal to at least 100% of the current market value of the loaned
securities. The purpose of such loans is to permit the borrower to use such
securities for delivery to purchasers when such borrower has sold short. If cash
collateral is received by the Fund, it is invested in short-term money market
securities, and a portion of the yield received in respect of such investment is
retained by the Fund. Alternatively, if securities are delivered to the Fund as
collateral, the Fund and the borrower negotiate a rate for the loan premium to
be received by the Fund for lending its portfolio securities. In either event,
the total yield on the Fund's portfolio is increased by loans of its portfolio
securities. The Fund will have the right to regain record ownership of loaned
securities to exercise beneficial rights such as voting rights, subscription
rights and rights to dividends, interest or other distributions. Such loans are
terminable at any time. The Fund may pay reasonable finder's, administrative and
custodial fees in connection with such loans.

When-Issued and Forward Commitment Securities. The Fund may purchase
securities on a 'when-issued' basis and may purchase or sell securities on a
'forward commitment' basis in order to hedge against anticipated changes in
interest rates and prices. When such transactions are negotiated, the price,
which generally is expressed in yield terms, is fixed at the time the commitment
is made, but delivery and payment for the securities take place at a later date.
When-issued securities and forward commitments may be sold prior to the
settlement date, but the Fund will enter into when-issued and forward commitment
transactions only with the intention of actually receiving or delivering the
securities, as the case may be. If the Fund disposes of the right to acquire a
when-issued security prior to its acquisition or disposes of its right to
deliver or receive against a forward commitment, it can incur a gain or loss. At
the time the Fund enters into a transaction on a when-issued or forward
commitment basis, it will segregate with the custodian cash or other liquid
instruments with a value not less than the value of the when-issued or forward
commitment securities. The value of these assets will be monitored daily to
ensure that their marked to market value at all times will exceed the
corresponding obligations of the Fund. There is always a risk that the
securities may not be delivered, and the Fund may incur a loss.

23
<PAGE>

Settlements in the ordinary course, which may take substantially more than five
business days for mortgage-related securities, are not treated by the Fund as
when-issued or forward commitment transactions and accordingly are not subject
to the foregoing restrictions.

Standby Commitment Agreements. The Fund from time to time may enter into
standby commitment agreements. Such agreements commit the Fund, for a stated
period of time, to purchase a stated amount of a fixed-income security which may
be issued and sold to the Fund at the option of the issuer. The price and coupon
of the security is fixed at the time of the commitment. At the time of entering
into the agreement the Fund may be paid a commitment fee, regardless of whether
or not the security ultimately is issued. The Fund will enter into such
agreements only for the purpose of investing in the security underlying the
commitment at a yield and price which is considered advantageous to the Fund.
The Fund at all times will segregate with the custodian cash or other liquid
instruments with a value equal to the purchase price of the securities

underlying the commitment.

There can be no assurance that the securities subject to a standby
commitment will be issued and the value of the security, if issued, on the
delivery date may be more or less than its purchase price. Since the issuance of
the security underlying the commitment is at the option of the issuer, the Fund
may bear the risk of decline in the value of such security and may not benefit
from an appreciation in the value of the security during the commitment period.

The purchase of a security subject to a standby commitment agreement and
the related commitment fee will be recorded on the date on which the security
reasonably can be expected to be issued and the value of the security thereafter
will be reflected in the calculation of the Fund's net asset value. The cost
basis of the security will be adjusted by the amount of the commitment fee. In
the event the security is not issued, the commitment fee will be recorded as
income on the expiration date of the standby commitment.

INVESTMENT RESTRICTIONS

The following are fundamental investment restrictions of the Fund and,
prior to the issuance of any preferred stock, may not be changed without the
approval of the holders of a majority of the Fund's outstanding shares of Common
Stock (which for this purpose and under the Investment Company Act means the
lesser of (i) 67% of the shares of Common Stock represented at a meeting at
which more than 50% of the outstanding shares of Common Stock are represented or
(ii) more than 50% of the outstanding shares). Subsequent to the issuance of a
class of preferred stock, the following investment restrictions may not be
changed without the approval of a majority of the outstanding shares of Common
Stock and of preferred stock, voting together as a class, and the approval of a
majority of the outstanding shares of preferred stock, voting separately by
class. The Fund may not:

1. Make any investment inconsistent with the Fund's classification as
a diversified company under the Investment Company Act.

2. Make investments for the purpose of exercising control or
management.

3. Purchase or sell real estate, commodities or commodity contracts,
provided that the Fund may invest in securities secured by real estate or
interests therein or issued by companies that invest in real estate or
interests therein, and the Fund may purchase and sell financial futures
contracts and options thereon.

4. Issue senior securities or borrow money except as permitted by
Section 18 of the Investment Company Act.

5. Underwrite securities of other issuers, except insofar as the Fund
may be deemed an underwriter under the Securities Act of 1933, as amended,
in selling portfolio securities.

<PAGE>

6. Make loans to other persons, except (i) to the extent that the Fund
may be deemed to be making loans by purchasing Corporate Loans or other
corporate debt securities and entering into repurchase agreements in
accordance with its investment objectives, policies and limitations and
(ii) the Fund may lend its portfolio securities in an amount not in
excess of 33 1/3% of its total assets, taken at market value, provided
that such loans shall be made in accordance with the guidelines set forth
in this Prospectus.

7. Invest more than 25% of its total assets in the securities of
issuers in any one industry; provided that this limitation shall not apply
with respect to obligations issued or guaranteed by the U.S. Government or
by its agencies or instrumentalities.

Additional investment restrictions adopted by the Fund, which may be
changed by the Board of Directors, provide that the Fund may not:

a. Purchase securities of other investment companies, except to the
extent that such purchases are permitted by applicable law. Applicable law
currently prohibits the Fund from purchasing the securities of other
investment companies except if immediately thereafter not more than (i) 3%
of the total outstanding voting stock of such company is owned by the Fund,
(ii) 5% of the Fund's total assets, taken at market value, would be
invested in any one such company, (iii) 10% of the Fund's total assets,
taken at market value, would be invested in such securities, and (iv) the
Fund, together with other investment companies having the same investment
adviser and companies controlled by such companies, owns not more than 10%
of the total outstanding stock of any one closed-end investment company.

b. Mortgage, pledge, hypothecate or in any manner transfer, as
security for indebtedness, any securities owned or held by the Fund except
as may be necessary in connection with borrowings mentioned in investment
restriction (4) above or except as may be necessary in connection with
transactions in financial futures contracts and options thereon.

c. Purchase any securities on margin, except that the Fund may obtain
such short-term credit as may be necessary for the clearance of purchases
and sales of portfolio securities (the deposit or payment by the Fund of
initial or variation margin in connection with financial futures contracts
and options thereon is not considered the purchase of a security on
margin).

d. Make short sales of securities or maintain a short position or
invest in put, call, straddle or spread options, except that the Fund may
write, purchase and sell options and futures on portfolio securities and
related indices or otherwise in connection with bona fide hedging
activities.

If a percentage restriction on investment policies or the investment or use
of assets set forth above is adhered to at the time a transaction is effected,
later changes in percentage resulting from changing values will not be
considered a violation.

Because of the affiliation of Merrill Lynch with the Fund, the Fund is
prohibited from engaging in certain transactions involving Merrill Lynch except
pursuant to an exemptive order or otherwise in compliance with the provisions of
the Investment Company Act and the rules and regulations thereunder. Included
among such restricted transactions will be purchases from or sales to Merrill
Lynch of securities in transactions in which it acts as principal. See
'Portfolio Transactions.'

<PAGE>

DIRECTORS AND OFFICERS

Information about the Directors, executive officers and the portfolio
managers of the Fund including their ages and principal occupations during the
last five years is set forth below. Unless otherwise noted, the address of each
Director, executive officer and the portfolio managers is 800 Scudders Mill
Road, Plainsboro, New Jersey 08536.

ARTHUR ZEIKEL (65)--President and Director (1)(2)--President of the
Investment Adviser (which term as used herein includes its corporate
predecessors) since 1977; President of MLAM (which term as used herein
includes its corporate predecessors) since 1977; President and Director of
Princeton Services, Inc. ('Princeton Services') since 1993; Executive Vice
President of Merrill Lynch & Co., Inc. ('ML & Co.') since 1990.

JOE GRILLS (62)--Director (2)--P.O. Box 98, Rapidan, Virginia 22733. Member
of the Committee of Investment of Employee Benefit Assets of the Financial
Executives Institute ('CIEBA') since 1986; member of CIEBA's Executive Committee
since 1988 and its Chairman from 1991 to 1992; Assistant Treasurer of
International Business Machines Incorporated ('IBM') and Chief Investment
Officer of IBM Retirement Funds from 1986 until 1993; Member of the Investment
Advisory Commitee of the State of New York Common Retirement Fund and the Howard
Hughes Medical Institute; Director, Duke Management Company since 1992;
Director, La Salle Street Fund since 1995; Director, Kimco Realty Corporation
since January 1997.

WALTER MINTZ (68)--Director (2)--1114 Avenue of the Americas, New York, New
York 10036. Special Limited Partner of Cumberland Associates (investment
partnership) since 1982.

ROBERT S. SALOMON, JR. (61)--Director (2)--106 Dolphin Cove Quay, Stamford,
Connecticut 06902. Principal of STI Management (investment adviser); Director,
Common Fund; Chairman and CEO of Salomon Brothers Asset Management from 1992
until 1995; Chairman of Salomon Brothers equity mutual funds from 1992 until
1995; Director of Stock Research and U.S. Equity Strategist at Salomon Brothers
from 1975 until 1991.

MELVIN R. SEIDEN (67)--Director (2)--780 Third Avenue, Suite 2502, New
York, New York 10017. Director of Silbanc Properties, Ltd. (real estate,
investments and consulting) since 1987; Chairman and President of Seiden & de
Cuevas, Inc. (private investment firm) from 1964 to 1987.

STEPHEN B. SWENSRUD (64)--Director (2)--24 Federal Street, Suite 400,
Boston, Massachusetts 02110. Chairman of Fernwood Advisers (investment
advisers) since 1975.

TERRY K. GLENN (57)--Executive Vice President (1)(2)--Executive Vice
President of the Investment Adviser and MLAM since 1983; Executive Vice
President and Director of Princeton Services since 1993; President of Merrill
Lynch Funds Distributor, Inc. ('MLFD' or the 'Distributor') since 1986 and
Director thereof since 1991; President of Princeton Administrators, L.P. since
1988.

JOSEPH T. MONAGLE, JR. (49)--Senior Vice President (2)--Senior Vice
President of the Investment Adviser and MLAM since 1990 and Vice President of
the Investment Adviser and MLAM prior thereto.

VINCENT T. LATHBURY, III (57)--Vice President and Portfolio Manager
(1)(2)--First Vice President of the Investment Adviser since 1997; Vice
President of the Investment Adviser since 1982; Portfolio Manager of the
Investment Adviser and MLAM since 1982.

ELIZABETH M. PHILLIPS (47)--Vice President and Portfolio Manager
(1)(2)--Vice President of MLAM since 1990; Portfolio Manager of the Investment
Adviser and MLAM since 1993.
26
<PAGE>

GERALD M. RICHARD (48)--Treasurer (1)(2)--Senior Vice President and
Treasurer of the Investment Adviser and MLAM since 1984; Senior Vice President
and Treasurer of Princeton Services since 1993; Treasurer of MLFD since 1984 and
Vice President thereof since 1981.

DONALD C. BURKE (37)--Vice President (1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1990 to 1997; Director of Taxation of
MLAM since 1990.

PATRICK D. SWEENEY (43)--Secretary (1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1990 to 1997.

- ------------
(1) Interested person, as defined in the Investment Company Act, of the Fund.

(2) Such Director or officer is a director, trustee or officer of one or more
other investment companies for which the Investment Adviser, MLAM or their
affiliates act as investment adviser.

Pursuant to the terms of the Fund's investment advisory agreement with the
Investment Adviser (the "Investment Advisory Agreement"), the Investment Adviser
pays all compensation of officers and employees of the Fund as well as the fees
of all Directors of the Fund who are affiliated persons of the Investment
Adviser or any of its affiliates. The Fund pays each Director not affiliated
with the Investment Adviser an annual fee of $ , plus $ for each board
meeting attended and actual out-of-pocket expenses relating to attendance at
such meetings, and each Audit Committee member an annual fee of $ plus $
per audit Committee meeting attended. Fees and expenses paid to the unaffiliated
Directors aggregated $ for the fiscal year ended 199 .

The following table sets forth compensation to be paid by the Fund to the
non-interested Directors projected through the end of the Fund's first full
fiscal year and for the calendar year ended December 31, 1997 the aggregate
compensation paid by all investment companies advised by the Investment Adviser,
MLAM and their affiliates ('FAM/MLAM Advised Funds') to the non-interested
Directors.

<TABLE>

<CAPTION>
TOTAL COMPENSATION
PENSION OR FROM FUND AND
AGGREGATE RETIREMENT BENEFITS FAM/MLAM
COMPENSATION ACCRUED AS PART OF ADVISED FUNDS PAID
NAME OF DIRECTOR FROM FUND FUND EXPENSE TO DIRECTORS
- ---------------------------------------------------------- ------------ ------------------- ------------------
<S> <C> <C> <C>
Joe Grills(1)............................................. $ None $
Walter Mintz(1)........................................... $ None $
Robert S. Salomon, Jr.(1)................................. $ None $
Melvin R. Seiden(1)....................................... $ None $
Stephen B. Swensrud(1).................................... $ None $
</TABLE>

- ------------------

(1) In addtion to the Fund, the Directors serve on the boards of other FAM/MLAM
Advised Funds as follows: Mr. Grills (19 registered investment companies
consisting of 47 portfolios); Mr. Mintz (18 registered investment companies
consisting of 37 portfolios); Mr. Salomon (18 registered investment
companies consisting of 37 portfolios); Mr. Seiden (18 registered investment
companies consisting of 37 portfolios); and Mr. Swensrud (21 registered
investment companies consisting of 52 portfolios).

27
<PAGE>

INVESTMENT ADVISORY AND MANAGEMENT ARRANGEMENTS

The Investment Adviser is an affiliate of MLAM, which is owned and
controlled by ML & Co. The Investment Adviser will provide the Fund with
investment advisory and management services. The Investment Adviser, or MLAM,
acts as the investment adviser for over 140 other registered investment
companies. The Investment Adviser also offers portfolio management and portfolio
analysis services to individuals and institutions. As of October 31, 1997, the
Investment Adviser and MLAM had a total of approximately $271.9 billion in
investment company and other portfolio assets under management, including
accounts of certain affiliates of the Investment Adviser. The principal business
address of the Investment Adviser is 800 Scudders Mill Road, Plainsboro, New
Jersey 08536.

The Investment Advisory Agreement with the Investment Adviser (the
'Investment Advisory Agreement') provides that, subject to the direction of the
Board of Directors of the Fund, the Investment Adviser is responsible for the
actual management of the Fund's portfolio. The responsibility for making
decisions to buy, sell or hold a particular security rests with the Investment
Adviser, subject to review by the Board of Directors.

The Investment Adviser provides the portfolio management for the Fund. Such
portfolio management will consider analyses from various sources (including
brokerage firms with which the Fund does business), make the necessary
investment decisions, and place orders for transactions accordingly. The
Investment Adviser also will be responsible for the performance of certain

administrative and management services for the Fund. The portfolio managers for
the Fund are Vincent T. Lathbury, III and Elizabeth M. Phillips.

For the services provided by the Investment Adviser under the Investment
Advisory Agreement, the Fund will pay a monthly fee at the annual rate of 0.60%
of 1% of the Fund's average weekly net assets plus the proceeds of any
outstanding borrowings used for leverage ('average weekly net assets' means the
average weekly value of the total assets of the Fund, including the amount
obtained from leverage and any proceeds from the issuance of preferred stock,
minus the sum of (i) accrued liabilities of the Fund, (ii) any accrued and
unpaid interest on outstanding borrowings and (iii) accumulated dividends on
shares of preferred stock). For purposes of this calculation, average weekly net
assets is determined at the end of each month on the basis of the average net
assets of the Fund for each week during the month. The assets for each weekly
period are determined by averaging the net assets at the last business day of a
week with the net assets at the last business day of the prior week.

The Investment Advisory Agreement obligates the Investment Adviser to
provide investment advisory services and to pay all compensation of and furnish
office space for officers and employees of the Fund connected with investment
and economic research, trading and investment management of the Fund, as well as
the compensation of all Directors of the Fund who are affiliated persons of the
Investment Adviser or any of its affiliates. The Fund pays all other expenses
incurred in the operation of the Fund, including, among other things, expenses
for legal and auditing services, taxes, costs of printing proxies, stock
certificates and shareholder reports, listing fees, charges of the custodian and
the transfer, dividend disbursing agent and registrar, Commission fees, fees and
expenses of unaffiliated Directors, accounting and pricing costs, insurance,
interest, brokerage costs, litigation and other extraordinary or non-recurring
expenses, mailing and other expenses properly payable by the Fund. Accounting
services are provided to the Fund by the Investment Adviser, and the Fund
reimburses the Investment Adviser for its costs in connection with such
services.

Securities held by the Fund also may be held by or be appropriate
investments for other funds for which the Investment Adviser or MLAM acts as an
adviser or by investment advisory clients of MLAM. Because of different
investment objectives or other factors, a particular security may be bought for
one or more clients when one or more clients are selling the same security. If
purchases or sales of securities for the Fund or other funds for

<PAGE>

which the Investment Adviser or MLAM acts as investment adviser or for their
advisory clients arise for consideration at or about the same time, transactions
in such securities will be made, insofar as feasible, for the respective funds
and clients in a manner deemed equitable to all. To the extent that transactions
on behalf of more than one client of the Investment Adviser or MLAM during the
same period may increase the demand for securities being purchased or the supply
of securities being sold, there may be an adverse effect on price.

Unless earlier terminated as described below, the Investment Advisory

Agreement will remain in effect for period of two years from the date of
execution and will remain in effect from year to year thereafter if approved
annually (a) by the Board of Directors of the Fund or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Directors who are
not parties to such contract or interested persons (as defined in the Investment
Company Act) of any such party. Such contract is not assignable and may be
terminated without penalty on 60 days' written notice at the option of either
party thereto or by the vote of the shareholders of the Fund.

CODE OF ETHICS

The Board of Directors of the Fund has adopted a Code of Ethics pursuant to
Rule 17j-1 under the Investment Company Act that incorporates the Code of Ethics
of the Investment Adviser (together, the 'Codes'). The Codes significantly
restrict the personal investing activities of all employees of the Investment
Adviser and, as described below, impose additional, more onerous, restrictions
on Fund investment personnel.

The Codes require that all employees of the Investment Adviser pre-clear
any personal securities investment (with limited exceptions, such as U.S.
Government securities). The pre-clearance requirement and associated procedures
are designed to identify any substantive prohibition or limitation applicable to
the proposed investment. The substantive restrictions applicable to all
employees of the Investment Adviser include a ban on acquiring any securities in
a 'hot' initial public offering and a prohibition from profiting on short-term
trading securities. In addition, no employee may purchase or sell any security
that at the time is being purchased or sold (as the case may be), or to the
knowledge of the employee is being considered for purchase or sale, by any fund
advised by the Investment Adviser. Furthermore, the Codes provide for trading
'blackout periods' that prohibit trading by investment personnel of the Fund
within periods of trading by the Fund in the same (or equivalent) security (15
or 30 days depending upon the transaction).

PORTFOLIO TRANSACTIONS

Subject to policies established by the Board of Directors of the Fund, the
Investment Adviser is primarily responsible for the execution of the Fund's
portfolio transactions. In executing such transactions, the Investment Adviser
seeks to obtain the best results for the Fund, taking into account such factors
as price (including the applicable fee, commission or spread), size of order,
difficulty of execution and operational facilities of the firm involved, the
firm's risk in positioning a block of securities and the provision of
supplemental investment research by the firm. While the Investment Adviser
generally seeks reasonably competitive fees, commissions or spreads, the Fund
does not necessarily pay the lowest fee, commission or spread available.

The Fund has no obligation to deal with any broker or dealer in execution
of transactions in portfolio securities. Subject to obtaining the best price and
execution, securities firms which provide supplemental investment research to
the Investment Adviser, including Merrill Lynch, may receive orders for
transactions by the Fund. Information so received will be in addition to and not
in lieu of the services required to be performed by the Investment Adviser under
the Investment Advisory Agreement and the expenses of the Investment Adviser
will not necessarily be reduced as a result of the receipt of such supplemental

information.

Securities in which the Fund may invest are traded primarily in the
over-the-counter ('OTC') markets, and the Fund intends to deal directly with the
dealers who make markets in the securities involved, except in those

<PAGE>

circumstances where better prices and execution are available elsewhere. Under
the Investment Company Act, except as permitted by exemptive order, persons
affiliated with the Fund are prohibited from dealing with the Fund as principal
in the purchase and sale of securities. Since transactions in the OTC market
usually involve transactions with dealers acting as principal for their own
account, the Fund will not deal with affiliated persons, including Merrill Lynch
and its affiliates, in connection with such transactions. In addition, the Fund
may not purchase securities for the Fund during the existence of any
underwriting syndicate of which Merrill Lynch is a member except pursuant to
procedures approved by the Board of Directors of the Fund which comply with
rules adopted by the Commission. An affiliated person of the Fund may serve as
its broker in OTC transactions conducted on an agency basis.

PORTFOLIO TURNOVER

Generally, the Fund does not purchase securities for short-term trading
profits. However, the Fund may dispose of securities without regard to the time
they have been held when such actions for defensive or other reasons, appear
advisable to the Investment Adviser. While it is not possible to predict
turnover rates with any certainty, at present it is anticipated that the Fund's
annual portfolio turnover rate, under normal circumstances, will be less than
100%. (The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the particular fiscal year by the
monthly average of the value of the portfolio securities owned by the Fund
during the particular fiscal year. For purposes of determining this rate, all
securities whose maturities at the time of acquisition are one year or less are
excluded.)

DIVIDENDS AND DISTRIBUTIONS

The Fund intends to distribute substantially all of its net investment
income monthly. All net realized capital gains, if any, will be distributed to
the Fund's shareholders at least annually.

Under the Investment Company Act, the Fund is not permitted to incur
indebtedness unless immediately after such incurrence the Fund has an asset
coverage of at least 300% of the aggregate outstanding principal balance of
indebtedness. Additionally, under the Investment Company Act, the Fund may not
declare any dividend or other distribution upon any class of its capital stock,
or purchase any such capital stock, unless the aggregate indebtedness of the
Fund has, at the time of the declaration of any such dividend or distribution or
at the time of any such purchase, an asset coverage of at least 300% after
deducting the amount of such dividend, distribution, or purchase price, as the
case may be. While any shares of preferred stock are outstanding, the Fund may

not declare any cash dividend or other distribution on its Common Stock, unless
at the time of such declaration, (1) all accumulated preferred stock dividends
have been paid and (2) the net asset value of the Fund's portfolio (determined
after deducting the amount of such dividend or other distribution) is at least
200% of the liquidation value of the outstanding preferred stock (expected to be
equal to the original purchase price per share plus any accumulated and unpaid
dividends thereon). In addition to the limitations imposed by the Investment
Company Act described in this paragraph, certain lenders may impose additional
restrictions on the payment of dividends or distributions on the Fund's Common
Stock in the event of a default on the Fund's borrowings. Any limitation on the
Fund's ability to make distributions on its Common Stock could under certain
circumstances impair the ability of the Fund to maintain its qualification for
taxation as a regulated investment company. See 'Other Investment
Policies--Leverage' and 'Taxes.'

See 'Automatic Dividend Reinvestment Plan' for information concerning the
manner in which dividends and distributions to holders of Common Stock may be
automatically reinvested in shares of Common Stock of the Fund. Dividends and
distributions may be taxable to shareholders whether they are reinvested in
shares of the Fund or received in cash.

The Fund expects that it will commence paying dividends within 90 days of
the date of this Prospectus.

30
<PAGE>
TAXES

GENERAL

The Fund intends to elect and to qualify for the special tax treatment
afforded regulated investment companies ('RICs') under the Code. As long as it
so qualifies, in any taxable year in which it distributes at least 90% of its
net income (see below), the Fund (but not its shareholders) will not be subject
to Federal income tax to the extent that it distributes its net investment
income and net realized capital gains. The Funds intends to distribute
substantially all of such income.

Dividends paid by the Fund from its ordinary income or from an excess of
net short-term capital gains over net long-term capital losses (together
referred to hereafter as 'ordinary income dividends') are taxable to
shareholders as ordinary income. Distributions made from an excess of net
long-term capital gains over net short-term capital losses (including gains or
losses from certain transactions in interest rate swaps, futures and options)
('capital gain dividends') are taxable to shareholders as long-term capital
gains, regardless of the length of time the shareholder has owned Fund shares.
Any loss upon the sale or exchange of Fund shares held for six months or less
will be treated as long-term capital loss to the extent of any capital gain
dividends received by the shareholder. Distributions in excess of the Fund's
earnings and profits will first reduce the adjusted tax basis of a holder's
shares and, after such adjusted tax basis is reduced to zero, will constitute
capital gains to such holder (assuming the shares are held as a capital asset).
Not later than 60 days after the close of its taxable year, the Fund will
provide its shareholders with a written notice designating the amounts of any

ordinary income dividends or capital gain dividends (including the amount of
capital gain dividends in the different categories of capital gain referred to
above), as well as any dividends eligible for the dividends received deduction.
Recent legislation creates additional categories of capital gains taxable at
different rates.

Dividends are taxable to shareholders even though they are reinvested in
additional shares of the Fund. Distributions attributable to any dividend income
earned by the Fund will be eligible for the dividends received deduction allowed
to corporations under the Code, if certain requirements are met. If the Fund
pays a dividend in January which was declared in the previous October, November
or December to shareholders of record on a specified date in one of such months,
then such dividend will be treated for tax purposes as being paid by the Fund
and received by its shareholders on December 31 of the year in which the
dividend was declared.

The IRS has taken the position in a revenue ruling that if a RIC has two
classes of shares, it may designate distributions made to each class in any year
as consisting of no more than such class's proportionate share of particular
types of income, including net long-term capital gains and the new categories of
capital gains, discussed above. A class's proportionate share of a particular
type of income is determined according to the percentage of total dividends paid
by the RIC during such year that was paid to such class. Consequently, if both
Common Stock and preferred stock are outstanding, the Fund intends to designate
distributions made to the classes as consisting of particular types of income in
accordance with the classes' proportionate shares of such income. Thus, capital
gain dividends, including the new categories of capital gains will be allocated
between the holders of Common Stock and preferred stock in proportion to the
total dividends paid to each class during the taxable year, or otherwise as
required by applicable law.

If the Fund utilizes leverage through borrowings, it may be restricted by
loan covenants with respect to the declaration and payment of dividends in
certain circumstances. See 'Other Investment Policies--Leverage.' Additionally,
if any time when shares of preferred stock are outstanding the Fund does not
meet the asset coverage requirements of the Investment Company Act, the Fund
will be required to suspend distributions to holders of Common Stock until the
asset coverage is restored. See 'Dividends and Distributions.' Limits on the
Fund's payment of dividends may prevent the Fund from distributing at least 90%
of its net income and may therefore jeopardize the Fund's qualification for
taxation as a RIC and/or may subject the Fund to the 4% excise

31
<PAGE>
tax described below. Upon any failure to meet the asset coverage requirement of
the Investment Company Act, the Fund may, in its sole discretion, redeem shares
of preferred stock in order to maintain or restore the requisite asset coverage
and avoid the adverse consequences to the Fund and its shareholders of failing
to qualify as a RIC. There can be no assurance, however, that any such action
would achieve these objectives. The Fund will endeavor to avoid restriction of
its dividend payments.

As noted above, the Fund must distribute annually at least 90% of its net
investment income. A distribution will only be counted for this purpose if it

qualifies for the dividends paid deduction under the Code. Some types of
preferred stock that the Fund has the authority to issue may raise an issue as
to whether distributions on such preferred stock are 'preferential' under the
Code and therefore not eligible for the dividends paid deduction. In the event
the Fund determines to issue preferred stock, the Fund intends to issue
preferred stock that counsel advises will not result in the payment of a
preferential dividend and may seek a private letter ruling from the IRS to that
effect. If the Fund ultimately relies on a legal opinion in the event it issues
such preferred stock, there is no assurance that the IRS would agree that
dividends on the preferred stock are not preferential. If the IRS successfully
disallowed the dividends paid deduction for dividends on the preferred stock,
the Fund could lose the benefit of the special treatment afforded RICs under the
Code.

Ordinary income dividends paid to shareholderrs who are nonresident aliens
or foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult their
own tax advisers concerning the applicability of the United States withholding
tax.

Dividends and interest received by the Fund may give rise to withholding
and other taxes imposed by foreign countries. Tax conventions between certain
countries and the United States may reduce or eliminate such taxes. Shareholders
may be able to claim United States foreign tax credits with respect to such
taxes, subject to certain conditions and limitations contained in the Code. For
example, certain retirement accounts cannot claim foreign tax credits on
investments in foreign securities held in the Fund. In addition, recent
legislation permits a foreign tax credit to be claimed with respect to
withholding tax on a dividend only if the shareholder meets certain holding
period requirements. If more than 50% in value of the Fund's total assets at the
close of its taxable year consists of securities of foreign corporations, the
Fund will be eligible, and intends, to file an election with the Internal
Revenue Service pursuant to which shareholders of the Fund will be required to
include their proportionate shares of such withholding taxes in their United
States income tax returns as gross income, treat such proportionate shares as
taxes paid by them, and deduct such proportionate shares in computing their
taxable incomes or, alternatively, use them as foreign tax credits against their
United States income taxes. In the case of foreign taxes passed through by a
RIC, the holding period requirements referred to above must be met by both the
shareholder and the RIC. No deductions for foreign taxes, moreover, may be
claimed by noncorporate shareholders who do not itemize deductions. A
shareholder that is a nonresident alien individual or a foreign corporation may
be subject to United States withholding tax on the income resulting from the
Fund's election described in this paragraph but may not be able to claim a
credit or deduction against such United States tax for the foreign taxes treated
as having been paid by such shareholder. The Fund will report annually to its
shareholders the amount per share of such withholding taxes and other
information needed to claim the foreign tax credit. For this purpose, the Fund
will allocate foreign taxes and foreign source income between Common Stock and
any preferred shares according to a method similar to that described above for
the allocation of capital gains and dividends eligible for the dividends
received deduction.

Under certain Code provisions, some shareholders may be subject to a 31%
withholding tax on ordinary income dividends, capital gain dividends and
redemption payments ('backup withholding'). Generally, shareholders subject to
backup withholding will be those for whom no certified taxpayer identification
number is

32
<PAGE>

on file with the Fund or who, to the Fund's knowledge, have furnished an
incorrect number. When establishing an account, an investor must certify under
penalty of perjury that such number is correct and that such investor is not
otherwise subject to backup withholding.

The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. While the Fund intends to distribute its income and
capital gains in the manner necessary to minimize imposition of the 4% excise
tax, there can be no assurance that sufficient amounts of the Fund's taxable
income and capital gains will be distributed to avoid entirely the imposition of
the tax. In such event, the Fund will be liable for the tax only on the amount
by which it does not meet the foregoing distribution requirements.

The Fund will invest in securities rated in the lower rating categories of
nationally recognized rating organizations in unrated securities (together with
lower rated securities, 'junk bonds') and in high-yield Corporate Loans, as
previously described. Some of these junk bonds and high-yield Corporate Loans
may be purchased at a discount and may therefore cause the Fund to accrue and
distribute income before amounts due under the obligations are paid. In
addition, a portion of the interest payments on such junk bonds and high-yield
Corporate Loans may be treated as dividends for Federal income tax purposes; in
such case, if the issuer of the junk bonds or high-yield Corporate Loans is a
domestic corporation, dividend payments by the Fund will be eligible for the
dividends received deduction to the extent of the deemed dividend portion of
such interest payments.

The Fund may invest up to 10% of its total assets in securities of other
investment companies. If the Fund purchases shares of an investment company (or
similar investment entity) organized under foreign law, the Fund will be treated
as owning shares in a passive foreign investment company ("PFIC") for U.S.
Federal income tax purposes. The Fund may be subject to U.S. Federal income tax,
and an additional tax in the nature of interest (the "interest charge"), on a
portion of the distributions from such a company and on gain from the
disposition of the shares of such a company (collectively referred to as "excess
distributions"), even if such excess distributions are paid by the Fund as a
dividend to its shareholders. The Fund may be eligible to make an election with
respect to certain PFICs in which it owns shares that will allow it to avoid the
taxes on excess distributions. However, such election may cause the Fund to
recognize income in a particular year in excess of the distributions received
from such PFICs. Alternatively, under recent legislation, the Fund could elect
to "mark to market" at the end of each taxable year all shares that it holds in

PFICs. If it made this election, the Fund would recognize as ordinary income
any increase in the value of such shares over their adjusted basis and as
ordinary loss any decrease in such value to the extent it did not exceed prior
increases. By making the mark-to-market election, the Fund could avoid
imposition of the interest charge with respect to its distributions from PFICs,
but in any particular year might be required to recognize income in excess of
the distributions it received from PFICS and its proceeds from dispositions of
PFIC stock.

TAX TREATMENT OF OPTIONS AND FUTURES TRANSACTION

The Fund may engage in interest rate transactions, write (i.e., sell)
covered call and covered put options on its portfolio securities, purchase call
and put options on securities, engage in transactions in financial futures and
related options on such futures and enter into forward foreign exchange
contracts. Such options and futures contracts that are 'Section 1256 contracts'
will be 'marked to market' for Federal income tax purposes at the end of each
taxable year, i.e., each such option or futures contract will be treated as sold
for its fair market value on the last day of the taxable year. Unless such
contract is a forward foreign exchange contract, or is a non-equity option or a
regulated futures contract for a non-U.S. currency for which the Fund elects to
have gain or loss treated as ordinary gain or loss under Code Section 988 (as
described below), gain or loss from Section 1256

33
<PAGE>

contracts will be 60% long-term and 40% short-term capital gain or loss.
Application of these rules to Section 1256 contracts held by the Fund may alter
the timing and character of distributions to shareholders. The mark-to-market
rules outlined above, however, will not apply to certain transactions entered
into by the Fund solely to reduce the risk of changes in price or interest or
currency exchange rate with respect to its investments.

A forward foreign exchange contract that is a Section 1256 will be marked
to market, as described above. However, the character of gain or loss from such
a contract will generally be ordinary under Code Section 988. The Fund may,
nonetheless, elect to treat the gain or loss from certain forward foreign
exchange contracts as capital. In this case, gain or loss realized in connection
with a forward foreign exchange contract that is a Section 1256 contract will be
characterized as 60% long-term and 40% short-term capital gain or loss.

The Federal income tax rules governing the taxation of interest rate swaps
are not entirely clear and may require the Fund to treat payments received under
such arrangements as ordinary income and to amortize such payments under certain
circumstances. The Fund does not anticipate that its activity in this regard
will affect its qualification as a RIC.

Code Section 1092, which applies to certain 'straddles,' may affect the
taxation of the Fund's sales of securities and options, futures and interest
rate transactions. Under Section 1092, the Fund may be required to postpone
recognition for tax purposes of losses incurred in certain sales of securities
and certain closing transactions in options, futures and interest rate
transactions.

SPECIAL RULES FOR CERTAIN FOREIGN CURRENCY TRANSACTIONS

Under Code Section 988, special rules are provided for certain transactions
in a currency other than the taxpayer's functional currency (i.e, unless certain
special rules apply, currencies other than the U.S. dollar). In general, foreign
currency gains and losses in connection with certain debt instruments, from
certain forward contracts, from futures contracts that are not 'regulated
futures contracts' and from unlisted options will be treated as ordinary income
or loss under Code Section 988. In certain circumstances, the Fund may elect
capital gain or loss treatment for such transactions. Regulated futures
contracts, as described above, will be taxed under Code Section 1256 unless
application of Section 988 is elected by the Fund. In general, however, Code
Section 988 gains or losses will increase or decrease the amount of the Fund's
investment company taxable income available to be distributed to shareholders as
ordinary income. Additionally, if Code Section 988 losses exceed other
investment company taxable income during a taxable year, the Fund would not be
able to make any ordinary income dividend distributions, and all or portion of
distributions made before the losses were realized but in the same taxable year
would be recharacterized as a return of capital to shareholders, thereby
reducing the basis of each shareholder's Fund shares, and resulting in a capital
gain for any shareholder who received a distribution greater than the
shareholder's tax basis in Fund shares (assuming the shares were held as a
capital asset). These rules, however, will not apply to certain transactions
entered into by the Fund solely to reduce the risk of currency fluctuations with
respect to its investments.

The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury Regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections and
the Treasury Regulations promulgated thereunder. The Code and the Treasury
Regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.

Ordinary income and capital gain dividends may also be subject to state and
local taxes.

Certain states exempt from state income taxation dividends paid by RICs
which are derived from interest on United States Government obligations. State
law varies as to whether dividend income attributable to United States
Government obligations is exempt from state income tax.

34
<PAGE>

Shareholders are urged to consult their own tax advisers regarding specific
questions as to Federal, foreign, state or local taxes. Foreign investors should
consider applicable foreign taxes in their evaluation of an investment in the
Fund.

AUTOMATIC DIVIDEND REINVESTMENT PLAN

Pursuant to the Fund's Automatic Dividend Reinvestment Plan (the 'Plan'),
unless a shareholder otherwise elects, all dividend and capital gains

distributions will be automatically reinvested by
, as agent for shareholders in administering the Plan (the 'Plan
Agent'), in additional shares of Common Stock of the Fund. Shareholders who
elect not to participate in the Plan will receive all dividends and
distributions in cash paid by check mailed directly to the shareholder of record
(or, if the shares are held in street or other nominee name, then to such
nominee) by , as dividend paying agent.
Such participants may elect not to participate in the Plan and to receive all
distributions of dividends and capital gains in cash by sending written
instructions to , as dividend paying
agent, at the address set forth below. Participation in the Plan is completely
voluntary and may be terminated or resumed at any time without penalty by
written notice if received by the Plan Agent not less than ten days prior to any
dividend record date; otherwise such termination will be effective with respect
to any subsequently declared dividend or distribution.

Whenever the Fund declares an ordinary income dividend or a capital gain
dividend (collectively referred to as 'dividends') payable either in shares or
in cash, non-participants in the Plan will receive cash, and participants in the
Plan will receive the equivalent in shares of Common Stock. The shares will be
acquired by the Plan Agent for the participant's account, depending upon the
circumstances described below, either (i) through receipt of additional unissued
but authorized shares of Common Stock from the Fund ('newly issued shares') or
(ii) by purchase of outstanding shares of Common Stock on the open market
('open-market purchases') on the NYSE or elsewhere. If on the payment date for
the dividend, the net asset value per share of the Common Stock is equal to or
less than the market price per share of the Common Stock plus estimated
brokerage commissions (such condition being referred to herein as 'market
premium'), the Plan Agent will invest the dividend amount in newly issued shares
on behalf of the participant. The number of newly issued shares of Common Stock
to be credited to the participant's account will be determined by dividing the
dollar amount of the dividend by the net asset value per share on the date the
shares are issued, provided that the maximum discount from the then current
market price per share on the date of issuance may not exceed 5%. If on the
dividend payment date the net asset value per share is greater than the market
value (such condition being referred to herein as 'market discount'), the Plan
Agent will invest the dividend amount in shares acquired on behalf of the
participant in open-market purchases. Prior to the time the shares of Common
Stock commence trading on the NYSE, participants in the Plan will receive any
dividends in newly issued shares.

In the event of a market discount on the dividend payment date, the Plan
Agent will have until the last business day before the next date on which the
shares trade on an 'ex-dividend' basis or in no event more than 30 days after
the dividend payment date (the 'last purchase date') to invest the dividend
amount in shares acquired in open-market purchases. It is contemplated that the
Fund will pay monthly income dividends. Therefore, the period during which
open-market purchases can be made will exist only from the payment date on the
dividend through the date before the next 'ex-dividend' date which typically
will be approximately ten days. If, before the Plan Agent has completed its
open-market purchases, the market price of a share of Common Stock exceeds the
net asset value per share, the average per share purchase price paid by the Plan
Agent may exceed the net asset value of the Fund's shares, resulting in the
acquisition of fewer shares than if the dividend had been paid in newly issued

shares on the dividend payment date. Because of the foregoing difficulty with
respect to open-market purchases, the Plan provides that if the Plan Agent is
unable to invest the full dividend amount in open-

35
<PAGE>

market purchases during the purchase period or if the market discount shifts to
a market premium during the purchase period, the Plan Agent will cease making
open-market purchases and will invest the uninvested portion of the dividend
amount in newly issued shares at the close of business on the last purchase
date.

The Plan Agent maintains all shareholders' account in the Plan and
furnishes written confirmation of all transactions in the account, including
information needed by shareholders for tax records. Shares in the account of
each Plan participant will be held by the Plan Agent on behalf of the Plan
participant, and each shareholder's proxy will include those shares purchased or
received pursuant to the Plan. The Plan Agent will forward all proxy
solicitation materials to participants and vote proxies for shares held pursuant
to the Plan in accordance with the instructions of the participants.

In the case of shareholders such as banks, brokers or nominees which hold
shares for others who are the beneficial owners, the Plan Agent will administer
the Plan on the basis of the number of shares certified from time to time by the
record shareholders as representing the total amount registered in the record
shareholder's name and held for the account of beneficial owners who are to
participate in the Plan.

There will be no brokerage charges with respect to shares issued directly
by the Fund as a result of dividends or capital gains distributions payable
either in shares or in cash. However, each participant will pay a pro rata share
of brokerage commissions incurred with respect to the Plan Agent's open-market
purchases in connection with the reinvestment of dividends.

The automatic reinvestment of dividends and distributions will not relieve
participants of any Federal, state or local income tax that may be payable (or
required to be withheld) on such dividends. See 'Taxes.'

Shareholders participating in the Plan may receive benefits not available
to shareholders not participating in the Plan. If the market price plus
commissions of the Fund's shares is above the net asset value, participants in
the Plan will receive shares of the Fund at less than they could otherwise
purchase them and will have shares with a cash value greater than the value of
any cash distribution they would have received on their shares. If the market
price plus commissions is below the net asset value, participants will receive
distributions in shares with a net asset value greater than the value of any
cash distribution they would have received on their shares. However, there may
be insufficient shares available in the market to make distributions in shares
at prices below the net asset value. Also, since the Fund does not redeem its
shares, the price on resale may be more or less than the net asset value. See
'Taxes' for a discussion of tax consequences of the Plan.

Experience under the Plan may indicate that changes are desirable.
Accordingly, the Fund reserves the right to amend or terminate the Plan. There

is no direct service charge to participants in the Plan; however, the Fund
reserves the right to amend the Plan to include a service charge payable by the
participants.

All correspondence concerning the Plan should be directed to the Plan Agent
at .

MUTUAL FUND INVESTMENT OPTION

Purchasers of shares of Common Stock of the Fund through Merrill Lynch in
this offering will have an investment option consisting of the right to reinvest
the net proceeds from a sale of such shares (the 'Original Shares') in Class D
initial sales charge shares of certain Merrill Lynch-sponsored open-end mutual
funds ('Eligible Class D Shares') at their net asset value, without the
imposition of the initial sales charge, if the conditions set forth below are
satisfied. First, the sale of the Original Shares must be made through Merrill
Lynch, and the net proceeds therefrom must be immediately reinvested in Eligible
Class D Shares. Second, the Original Shares must either have been acquired in
this offering or be shares representing reinvested dividends from shares of
Common Stock acquired in this offering. Third, the Original Shares must have
been continuously maintained in a Merrill Lynch securities account. Fourth,
there must be a minimum purchase of $250 to be eligible for the investment
option. Class D shares of certain of the mutual funds are subject to an account

36
<PAGE>

maintenance fee at an annual rate of up to 0.25% of the average daily net asset
value of such mutual fund. The Eligible Class D Shares may be redeemed at any
time at the next determined net asset value, subject in certain cases to a
redemption fee. Prior to the time the shares commence trading on the NYSE, the
distributor for the mutual funds will advise Merrill Lynch Financial Consultants
as to those mutual funds which offer the investment option described above.

NET ASSET VALUE

Net asset value per share is determined as of 15 minutes after the close of
business on the NYSE (generally, 4:00 p.m., New York time), on the last business
day in each week. For purposes of determining the net asset value of a share of
Common Stock, the value of the securities held by the Fund plus any cash or
other assets (including interest accrued but not yet received) minus all
liabilities (including accrued expenses) and the aggregate liquidation value of
any outstanding shares of preferred stock is divided by the total number of
shares of Common Stock outstanding at such time. Expenses, including the fees
payable to the Investment Adviser, are accrued daily.

The Fund determines and makes available for publication the net asset value
of its shares of Common Stock weekly. Currently, the net asset values of shares
of publicly traded closed-end investment companies investing in debt securities
are published in Barron's, the Monday edition of The Wall Street Journal and the
Monday and Saturday editions of The New York Times.

Portfolio securities (other than short-term obligations but including
listed issues) may be valued on the basis of prices furnished by one or more

pricing services which determine prices for normal, institutional-size trading
units of such securities using market information, transactions for comparable
securities and various relationships between securities which are generally
recognized by institutional traders. In certain circumstances, portfolio
securities are valued at the last sale price on the exchange that is the primary
market for such securities, or the last quoted bid price for those securities
for which the OTC market is the primary market or for listed securities in which
there were no sales during the day. Corporate Loans for which an active
secondary market exists to a reliable degree in the opinion of the Investment
Adviser and for which the Investment Adviser can obtain at least two quotations
from banks or dealers in Corporate Loans will be valued by the Investment
Adviser by calculating the mean of the last available bid and asked prices in
the market for such Corporate Loans, and then using the mean of those two means.
If only one quote for a particular Corporate Loan is available, such Corporate
Loan will be valued on the basis of the mean of the last available bid and asked
prices in the market. The value of interest rate swaps, caps and floors is
determined in accordance with a formula and then confirmed periodically by
obtaining a bank quotation. Positions in options are valued at the last sale
price on the market where any such option is principally traded. Obligations
with remaining maturities of 60 days or less are valued at amortized cost unless
this method no longer produces fair valuations. Repurchase agreements are valued
at cost plus accrued interest. Rights or warrants to acquire stock, or stock
acquired pursuant to the exercise of a right or warrant, may be valued taking
into account various factors such as original cost to the Fund, earnings and net
worth of the issuer, market prices for securities of similar issuers, assessment
of the issuer's future prosperity, liquidation value or third party transactions
involving the issuer's securities. Securities for which there exist no price
quotations or valuations and all other assets are valued at fair value as
determined in good faith by or on behalf of the Board of Directors of the Fund.

DESCRIPTION OF CAPITAL STOCK

The Fund is authorized to issue 200,000,000 shares of capital stock, par
value $.10 per share, all of which shares initially are classified as Common
Stock. The Board of Directors is authorized, however, to classify and reclassify
any unissued shares of capital stock into one or more additional or other
classes or series as may be

37
<PAGE>

established from time to time by setting or changing in any one or more respects
the designations, preferences, conversion or other rights, voting powers,
restrictions, limitations as to dividends, qualifications or terms or conditions
of redemption of such shares of stock and pursuant to such classification or
reclassification to increase or decrease the number of authorized shares of any
existing class or series. The Fund may reclassify an amount of unissued Common
Stock as preferred stock and at that time offer shares of preferred stock
representing up to approximately 50% of the Fund's total assets immediately
after the issuance of such preferred stock.

COMMON STOCK

Shares of Common Stock, when issued and outstanding, will be fully paid and

non-assessable. Shareholders are entitled to share pro rata in the net assets of
the Fund available for distribution to shareholders upon liquidation of the
Fund. Shareholders are entitled to one vote for each share held.

In the event that the Fund issues preferred stock and so long as any shares
of the Fund's preferred stock are outstanding, holders of Common Stock will not
be entitled to receive any net income of or other distributions from the Fund
unless all accumulated dividends on preferred stock have been paid, and unless
asset coverage (as defined in the Investment Company Act) with respect to
preferred stock would be at least 200% after giving effect to such
distributions. See 'Other Investment Policies--Leverage.'

The Fund will send unaudited reports at least semi-annually and audited
annual financial statements to all of its shareholders of record.

The Investment Adviser provided the initial capital for the Fund by
purchasing 10,000 shares of Common Stock of the Fund for $100,000. As of the
date of this Prospectus, the Investment Adviser owned 100% of the outstanding
shares of Common Stock of the Fund. The Investment Adviser may be deemed to
control the Fund until such time as it owns less than 25% of the outstanding
shares of the Fund.

CERTAIN PROVISIONS OF THE ARTICLES OF INCORPORATION

The Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of an opportunity to sell their shares
at a premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund. A Director may be removed from office
with or without cause but only by vote of the holders of at least 66 2/3% of the
shares entitled to be voted on the matter.

In addition, the Articles of Incorporation require the favorable vote of
the holders of at least 66 2/3% of the Fund's shares to approve, adopt or
authorize the following:

(i) a merger or consolidation or statutory share exchange of the Fund
with any other corporations;

(ii) a sale of all or substantially all of the Fund's assets (other
than in the regular course of the Fund's investment activities); or

(iii) a liquidation or dissolution of the Fund,

unless such action has been approved, adopted or authorized by the affirmative
vote of at least two-thirds of the total number of Directors fixed in accordance
with the by-laws, in which case the affirmative vote of a majority of the Fund's
shares of capital stock is required. Following any issuance of preferred stock
by the Fund, it is anticipated that the approval, adoption or authorization of
the foregoing also would require the favorable vote of a majority of the Fund's
shares of preferred stock then entitled to be voted, voting as a separate class.

In addition, conversion of the Fund to an open-end investment company would

require an amendment to the Fund's Articles of Incorporation. The amendment
would have to be declared advisable by the Board of Directors

38
<PAGE>

prior to its submission to shareholders. Such an amendment would require the
favorable vote of the holders of at least 66 2/3% of the Fund's outstanding
shares (including any preferred stock) entitled to be voted on the matter,
voting as a single class (or a majority of such shares if the amendment
previously was approved, adopted or authorized by at least two-thirds of the
total number of Directors fixed in accordance with the Fund's by-laws), and,
assuming preferred stock is issued, the affirmative vote of a majority of
outstanding shares of preferred stock of the Fund, voting as a separate class.
Such a vote also would satisfy a separate requirement in the Investment Company
Act that the change be approved by the shareholders. Shareholders of an open-end
investment company may require the company to redeem their shares of common
stock at any time (except in certain circumstances as authorized by or under the
Investment Company Act) at their net asset value, less such redemption charge,
if any, as might be in effect at the time of a redemption. All redemptions would
usually be made in cash. If the Fund is converted to an open-end investment
company, it could be required to liquidate portfolio securities to meet requests
for redemption, and the shares would no longer be listed on a stock exchange.
Conversion to an open-end investment company would also require changes in
certain of the Fund's investment policies and restrictions, such as those
relating to the borrowing of money and the purchase of illiquid securities.

The Board of Directors has determined that the 66 2/3% voting requirements
described above, which are greater than the minimum requirements under Maryland
law or the Investment Company Act, are in the best interests of shareholders
generally. Reference should be made to the Articles of Incorporation on file
with the Commission for the full text of these provisions.

CUSTODIAN

The Fund's securities and cash are held under a custodian agreement with
.

<PAGE>
UNDERWRITING

The Underwriter has agreed, subject to the terms and conditions of a
Purchase Agreement with the Fund and the Investment Adviser, to purchase
shares of Common Stock from the Fund. The Underwriter is committed to
purchase all of such shares if any are purchased.

The Underwriter has advised the Fund that it proposes initially to offer
the shares to the public at the public offering price set forth on the cover
page of this Prospectus. There is no sales charge or underwriting discount
charged to investors on purchases of shares of Common Stock in the offering. The
Investment Adviser or an affiliate has agreed to pay the Underwriter from its
own assets a commission in connection with the sale of shares of Common Stock in

the offering in the amount of $____ per share. Such payment is equal to _____%
of the initial public offering price per share. The Underwriter also has advised
the Fund that from this amount the Underwriter may pay a concession to certain
dealers not in excess of $____ per share on sales by such dealers. After the
initial public offering, the public offering price and other selling terms may
be changed. Investors must pay for shares of Common Stock purchased in the
offering on or before January , 1998.

The Fund has granted the Underwriter an option, exercisable for 45 days
after the date hereof, to purchase up to additional shares of Common
Stock to cover over-allotments, if any, at the initial offering price.

The Underwriter may engage in certain transactions that stabilize the price
of the shares of Common Stock. Such transactions consist of bids or purchases
for the purpose of pegging, fixing or maintaining the price of the shares of
Common Stock.

If the Underwriter creates a short position in the shares of Common Stock
in connection with the offering (i.e., if it sells more shares of Common Stock
than are set forth on the cover page of this Prospectus) the Underwriter may
reduce that short position by purchasing shares of Common Stock in the open
market.

The Underwriter may also impose a penalty bid on certain syndicate and
selling group members. This means that if the Underwriter purchases shares of
Common Stock in the open market to reduce the Underwriter's short position or to
stabilize the price of the shares of Common Stock, it may reclaim the amount of
the selling concession from the selling group members who sold those shares of
Common Stock as part of the offering.

In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of such purchases. The imposition of a penalty bid
might also have an effect on the price of a security to the extent that it were
to discourage resales of the security.

Neither the Fund nor the Underwriter makes any representation or prediction
as to the direction or magnitude of any effect that the transactions described
above may have on the price of the shares of Common Stock. In addition, neither
the Fund nor the Underwriter makes any representation that the Underwriter will
engage in such transactions or that such transactions, once commenced, will not
be discontinued without notice.

Prior to this offering, there has been no public market for the shares of
the Fund. Application has been made to list the Fund's shares on the NYSE.
However, during an initial period which is not expected to exceed one week from
the date of this Prospectus, the Fund's shares will not be listed on any
securities exchange. Additionally, during such period, the Underwriter does not
intend to make a market in the Fund's shares, although a limited market may
develop. Consequently, it is anticipated that an investment in the Fund will be
illiquid during such period. In order to meet the requirements for listing,
Merrill Lynch has undertaken to sell lots of 100 or more shares to a minimum of
2,000 beneficial owners.

40
<PAGE>

The Fund anticipates that Merrill Lynch from time to time may act as a
broker in connection with the execution of the Fund's portfolio transactions.

The Underwriter is an affiliate of the Investment Adviser of the Fund.

The Fund and the Investment Adviser have agreed to indemnify the
Underwriter against certain liabilities, including liabilities under the
Securities Act of 1933.

TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR

The transfer agent, dividend disbursing agent and registrar for the shares
of the Fund is

LEGAL OPINIONS

Certain legal matters in connection with the shares offered hereby will be
passed upon for the Fund and the Underwriter by Brown & Wood LLP, New York, New
York.

EXPERTS

The statement of assets, liabilities and capital of the Fund included in
this Prospectus has been so included in reliance on the report of
, independent auditors, and on their authority as experts in auditing and
accounting.

<PAGE>

INDEPENDENT AUDITORS' REPORT

To the Board of Directors and Shareholder,
Corporate High Yield Fund III, Inc.:

We have audited the accompanying statement of assets, liabilities and capital of
Corporate High Yield Fund III, Inc. as of January , 1998. This financial
statement is the responsibility of the Fund's management. Our responsibility is
to express an opinion on this financial statement based on our audit.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statement is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statement. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such statement of assets, liabilities and capital presents
fairly, in all material respects, the financial position of Corporate High Yield
Fund III, Inc. as of January , 1998, in conformity with generally accepted
accounting principles.

January , 1998

<PAGE>

CORPORATE HIGH YIELD FUND III, INC.

STATEMENT OF ASSETS, LIABILITIES AND CAPITAL

JANUARY , 1998

ASSETS

<TABLE>
<S> <C>
Cash................................................................................................ $
Deferred organization expenses (Note 1).............................................................
--------
Total assets...................................................................................

LIABILITIES
Accrued expenses (Note 1)...........................................................................
--------
NET ASSETS............................................................................................ $
--------
--------

CAPITAL
Common Stock, par value $.10 per share; 200,000,000 shares authorized; shares issued and
outstanding (Note 1)............................................................................. $
Paid in Capital in excess of par....................................................................
--------
Total Capital--Equivalent of $15.00 net asset value per share of common stock (Note 1)......... $
--------
--------
</TABLE>

NOTES TO STATEMENT OF ASSETS, LIABILITIES AND CAPITAL

NOTE 1. ORGANIZATION

The Fund was incorporated under the laws of the State of Maryland on
October 31, 1997, as a closed-end, diversified management investment company and
has had no operations other than the sale to Fund Asset Management, L.P. (the
'Investment Adviser') of an aggregate of shares for $ on January ,
1998. The General Partner of the Investment Adviser is an indirect wholly-owned
subsidiary of Merrill Lynch & Co., Inc.

Deferred organization costs will be amortized on a straight-line basis over
a five-year period beginning with the commencement of operations of the Fund.

NOTE 2. MANAGEMENT ARRANGEMENTS

The Fund has engaged the Investment Adviser to provide investment advisory
and management services to the Fund. The Investment Adviser will receive a
monthly fee for advisory services at an annual rate equal to .60% of 1% of the

Fund's average weekly net assets plus the proceeds of any outstanding borrowings
used for leverage.

NOTE 3. FEDERAL INCOME TAXES

The Fund intends to qualify as a 'regulated investment company' and as such
(and by complying with the applicable provisions of the Internal Revenue Code of
1986, as amended) will not be subject to Federal income tax on taxable income
(including realized capital gains) that is distributed to shareholders.

<PAGE>

APPENDIX A: DESCRIPTION OF CORPORATE BOND RATINGS
RATINGS OF CORPORATE BONDS

DESCRIPTION OF CORPORATE BOND RATINGS OF MOODY'S INVESTORS SERVICE, INC.:

Aaa--Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and generally are 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 are judged to be of high quality by all
standards. Together with the Aaa group they comprise what generally are 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.

A--Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium-grade obligations. Factors giving security
to principal and interest are considered adequate but elements may be present
which suggest a susceptibility to impairment sometime in the future.

Baa--Bonds which are rated Baa are considered medium-grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.

Ba--Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.

B--Bonds which are rated B generally lack characteristics of a desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.

Caa--Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.

Ca--Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.

C--Bonds which are rated C are the lowest rated class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing.

The modifier 1 indicates that the bond ranks in the higher end of its
generic rating category; the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates that the issue ranks in the lower end of its rating
category.

A-1

<PAGE>

DESCRIPTION OF CORPORATE BOND RATINGS OF STANDARD & POOR'S RATINGS SERVICES:

AAA--Bonds rated AAA have the highest rating assigned by Standard & Poors
Ratings Services. 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 higher rated issues only in small degree.

A--Bonds rated A have a strong capacity to pay interest and repay principal
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than bonds in higher rated categories.

BBB--Bonds rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
bonds in this category than in higher rated categories.

BB--B--CCC--CC--Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB indicates
the lowest degree of speculation and CC the highest degree of speculation. While
such bonds likely will have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.

C--The C rating is reserved for income bonds on which no interest is being
paid.

D--Bonds rated D are in default, and payment of interest and/or repayment
of principal is in arrears.

NR--Indicates that no rating has been requested, that there is insufficient
information on which to base a rating, or that S&P does not rate a particular
type of bond as a matter of policy.

Plus (+) or Minus (-): The ratings from AA to B may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.

A-2

<PAGE>

------------------------------------------------------
------------------------------------------------------

NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING OF ANY SECURITIES
OTHER THAN THE REGISTERED SECURITIES TO WHICH IT RELATES OR AN OFFER TO ANY
PERSON IN ANY STATE OR JURISDICTION OF THE UNITED STATES OR ANY COUNTRY WHERE
SUCH OFFER WOULD BE UNLAWFUL.

------------------------

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary............................. 2
Risk Factors and Special Considerations........ 5
Fee Table...................................... 9
The Fund....................................... 10
Use of Proceeds................................ 10
Investment Objectives and Policies............. 10
Other Investment Policies...................... 14
Investment Restrictions........................ 24
Directors and Officers......................... 26
Investment Advisory and Management
Arrangements................................. 28
Portfolio Transactions......................... 29
Dividends and Distributions.................... 30
Taxes.......................................... 31
Automatic Dividend Reinvestment Plan........... 35
Mutual Fund Investment Option.................. 36
Net Asset Value................................ 37
Description of Capital Stock................... 37
Custodian...................................... 39
Underwriting................................... 40
Transfer Agent, Dividend Disbursing Agent and
Registrar.................................... 41
Legal Opinions................................. 41
Experts........................................ 41
Independent Auditors' Report................... 42
Statement of Assets, Liabilities and Capital... 43
Appendix A..................................... A-1
</TABLE>

------------------------

UNTIL , 1998 (90 DAYS AFTER THE COMMENCEMENT OF THE

OFFERING), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR
NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER
A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.

------------------------------------------------------
------------------------------------------------------

CORPORATE HIGH YIELD
FUND III, INC.

COMMON STOCK

-------------------------
PROSPECTUS
-------------------------

MERRILL LYNCH & CO.
JANUARY , 1998

Code 16912-0198

------------------------------------------------------
------------------------------------------------------