1933 Act Registration No. 333-37625
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-14AE
REGISTRATION STATEMENT UNDER THE
SECURITIES ACT OF 1933
[ ] Pre-Effective [X] Post-Effective
Amendment No. Amendment No. 1
EVERGREEN FIXED INCOME TRUST
[Exact Name of Registrant as Specified in Charter)
Area Code and Telephone Number: (617) 210-3200
200 Berkeley Street
Boston, Massachusetts 02116
-----------------------------------
(Address of Principal Executive Offices)
Rosemary D. Van Antwerp, Esq.
Keystone Investment Management Company
200 Berkeley Street
Boston, Massachusetts 02116
-----------------------------------------
(Name and Address of Agent for Service)
Copies of All Correspondence to:
Robert N. Hickey, Esq.
Sullivan & Worcester LLP 1025
Connecticut Avenue, N.W.
Washington, D.C. 20036
The Registrant has registered an indefinite amount of securities under
the Securities Act of 1933 pursuant to Section 24(f) under the Investment
Company Act of 1940 (File No. 333-37433); accordingly, no fee is payable
herewith. Registrant is filing as an exhibit to this Registration Statement a
copy of an earlier declaration under Rule 24f-2. Pursuant to Rule 429, this
Registration Statement relates to the aforementioned registration on Form N-1A.
A Rule 24f-2 Notice for the Registrant's fiscal year ending April 30, 1998 will
be filed with the Commission on or about June 29, 1998.
<PAGE>
It is proposed that this filing will become effective :
X immediately upon filing pursuant to paragraph (b)
on ____________ pursuant to paragraph (b)
60 days after filing pursuant to paragraph (a)(1)
on ____________ pursuant to paragraph (a)(1)
75 days after filing pursuant to paragraph (a)(1)
on ____________ pursuant to paragraph (a)(2) of Rule 485
This post-effective amendment designates a new effective
date for a previously filed post-effective amendment.
<PAGE>
EVERGREEN FIXED INCOME TRUST
CROSS REFERENCE SHEET
Pursuant to Rule 481(a) under the Securities Act of 1933
Location in Prospectus/Proxy
Item of Part A of Form N-14 Statement
1. Beginning of Registration Cross Reference Sheet; Cover
Statement and Outside Page
Front Cover Page of
Prospectus
2. Beginning and Outside Table of Contents
Back Cover Page of
Prospectus
3. Fee Table, Synopsis and Comparison of Fees and
Risk Factors Expenses; Summary; Comparison
of Investment Objectives and
Policies; Risks
4. Information About the Summary; Reasons for the
Transaction Reorganizations; Comparative
Information on Shareholders'
Rights; Exhibits A-1 and A-2
(Agreements and Plans of
Reorganization)
5. Information about the Cover Page; Summary; Risks;
Registrant Comparison of Investment
Objectives and Policies;
Comparative Information on
Shareholders' Rights;
Additional Information
6. Information about the Cover Page; Summary; Risks;
Company Being Acquired Comparison of Investment
Objective and Policies;
Comparative Information on
Shareholders' Rights;
Additional Information
<PAGE>
Location in Prospectus/Proxy
Item of Part A of Form N-14 Statement
7. Voting Information Cover Page; Summary; Voting
Information Concerning the
Meeting
8. Interest of Certain Financial Statements and
Persons and Experts Experts; Legal Matters
9. Additional Information Inapplicable
Required for Reoffering
by Persons Deemed to be
Underwriters
Item of Part B of Form N-14
10. Cover Page Cover Page
11. Table of Contents Omitted
12. Additional Information Statement of Additional
About the Registrant Information of the Evergreen
Fixed Income Trust - Evergreen
Diversified Bond Fund dated
November 10, 1997
13. Additional Information Statement of Additional
about the Company Being Information of Keystone
Acquired Quality Bond Fund (B-1) dated
February 28, 1997;
Statement of
Additional
Information of
Keystone Diversified
Bond Fund (B-2) dated
December 10, 1996, as
supplemented
14. Financial Statements Financial Statements dated
October 31, 1996 and April 30,
1997 of Keystone Quality Bond
Fund (B-1); Financial
Statements of Keystone
Diversified Bond Fund (B-2)
dated August 31,
1997; Pro Forma
Financial Statements
<PAGE>
Location in Prospectus/Proxy
Statement
Item of Part C of Form N-14
15. Indemnification Incorporated by Reference to
Part A Caption - "Comparative
Information on Shareholders'
Rights - Liability and
Indemnification of Trustees"
16. Exhibits Item 16. Exhibits
17. Undertakings Item 17. Undertakings
<PAGE>
KEYSTONE QUALITY BOND FUND (B-1)
KEYSTONE DIVERSIFIED BOND FUND (B-2)
200 BERKELEY STREET
BOSTON, MASSACHUSETTS 02116
November 14, 1997
Dear Shareholder,
I am writing to shareholders of the Keystone Quality Bond Fund (B-1) and the
Keystone Diversified Bond Fund (B-2) to inform you of a Special Shareholders'
meeting to be held on January 6, 1998. Before that meeting, I would like your
vote on the important issues affecting your fund as described in the attached
Prospectus/Proxy Statement.
The Prospectus/Proxy Statement includes the proposed reorganization of the
Keystone Quality Bond Fund (B-1) and the Keystone Diversified Bond Fund (B-2).
All of the assets of both funds would be acquired by a new fund, the Evergreen
Diversified Bond Fund. Details about the new fund's investment objective,
portfolio management team, performance, etc. are contained in the attached
Prospectus/Proxy Statement.
The Boards of Trustees have unanimously approved the proposal and recommend that
you vote FOR this proposal.
You will receive shares of the new fund in the same class, with the same letter
designation, the same fees and the same contingent deferred sales charges as the
shares you held prior to the reorganization. This is a non-taxable event for
shareholders.
I realize that this Prospectus/Proxy Statement will take time to review, but
your vote is very important. Please take the time to familiarize yourself with
the proposal presented and sign and return your proxy card(s) in the enclosed
postage-paid envelope today. You may receive more than one proxy card if you own
shares in more than one fund. Please sign and return each card you receive.
If we do not receive your completed proxy card(s) after several weeks, you may
be contacted by our proxy solicitor, Shareholder Communications Corporation.
They will remind you to vote your shares or will record your vote over the phone
if you choose to vote in that manner. You may also call Shareholder
Communications Corporation directly at 1-800-733- 8481 ext.404 and vote by
phone.
Thank you for taking this matter seriously and participating in this important
process.
<PAGE>
Sincerely,
William M. Ennis
Managing Director
Evergreen Funds
<PAGE>
November 1997
IMPORTANT NEWS
FOR EVERGREEN SHAREHOLDERS
We encourage you to read the attached Prospectus/Proxy Statement in full;
however, the following questions and answers represent some typical concerns
that shareholders might have regarding this document.
Q: WHY IS EVERGREEN SENDING ME THIS PROSPECTUS/PROXY
STATEMENT?
Mutual funds are required to get shareholders' votes for certain types of
changes. As a shareholder, you have a right to vote on major policy decisions,
such as those included here.
Q: WHAT ARE THE ISSUES CONTAINED IN THIS PROSPECTUS/PROXY
STATEMENT?
You are being asked to vote to approve a proposal to reorganize the Keystone
Quality Bond Fund (B-1) and the Keystone Diversified Bond Fund (B-2) into a new
fund, called Evergreen Diversified Bond Fund. The new fund's investment
objective is substantially the same as that of the former funds.
Q: HOW WILL THIS CHANGE AFFECT ME AS A FUND SHAREHOLDER?
The reorganization of these funds into the Evergreen Diversified Bond Fund means
that the Keystone Quality Bond Fund (B-1) and the Keystone Diversified Bond Fund
(B-2) would no longer exist after January 23, 1998. Shareholders would receive
shares of the new fund in the same class, with the same letter designation, the
same fees and the same contingent deferred sales charges as the shares held
prior to the reorganization. This is a non-taxable event for shareholders.
Q: WHY IS EVERGREEN PROPOSING THIS CHANGE?
This proposal represents one of the final steps we are undertaking to unify the
Evergreen and Keystone fund families. Shareholders can anticipate the following
benefits:
A comprehensive fund family with a common risk/reward spectrum
The elimination of any overlap or gaps in fund offerings
<PAGE>
Reduced confusion surrounding privileges associated with each fund,
specifically regarding exchangeability, letter of intent, and rights of
accumulation
A user-friendly product line for both shareholders and investment
professionals
A single location for fund information, whether you're looking up funds
in the newspaper or locating a Morningstar report on the Internet.
Q: HOW DO THE BOARD MEMBERS OF MY FUND RECOMMEND THAT I VOTE?
The Board members of each fund recommend that you vote in favor of or FOR the
proposal on the enclosed proxy card.
Q: WHOM DO I CALL FOR MORE INFORMATION OR
TO PLACE MY VOTE?
Please call Shareholder Communications Corporation at 1-800-
733-8481 ext. 404 for additional information. You can vote one
of three ways:
Use the enclosed proxy card to record your vote either FOR, AGAINST or
ABSTAIN, then return the card in the postpaid envelope provided.
or
Complete the enclosed proxy card and FAX to 1-800-733- 1885.
or
Call 1-800-733-8481 ext. 404 and record your vote by
telephone.
Q: WHY ARE MULTIPLE CARDS ENCLOSED?
If you own shares of more than one fund, you will receive a proxy card for each
fund you own. Please sign, date and return each proxy card you receive.
<PAGE>
KEYSTONE QUALITY BOND FUND (B-1)
KEYSTONE DIVERSIFIED BOND FUND (B-2)
200 BERKELEY STREET
BOSTON, MASSACHUSETTS 02116
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON JANUARY 6, 1998
Notice is hereby given that a Special Meeting (the "Meeting") of
Shareholders of each of Keystone Quality Bond Fund (B-1) and Keystone
Diversified Bond Fund (B-2) (each a "Fund") will be held at the offices of the
Evergreen Keystone Funds, 200 Berkeley Street, Boston, Massachusetts 02116, on
January 6, 1998 at 3:00 p.m. for the following purposes:
1. To consider and act upon the Agreement and Plan of Reorganization
(the "Plan") dated as of September 30, 1997, providing for the acquisition of
all of the assets of the Fund by Evergreen Diversified Bond Fund, a series of
Evergreen Fixed Income Trust, ("Evergreen Diversified Bond") in exchange for
shares of Evergreen Diversified Bond and the assumption by Evergreen Diversified
Bond of certain identified liabilities of the Fund. The Plan also provides for
distribution of such shares of Evergreen Diversified Bond to shareholders of the
Fund in liquidation and subsequent termination of the Fund. A vote in favor of
the Plan is a vote in favor of the liquidation and dissolution of the Fund.
2. To transact any other business which may properly come before the
Meeting or any adjournment or adjournments thereof.
The Trustees of Keystone Quality Bond Fund (B-1) and the Trustees of
Keystone Diversified Bond Fund (B-2) have fixed the close of business on
November 10, 1997 as the record date for the determination of shareholders of
each respective Fund entitled to notice of and to vote at the Meeting or any
adjournment thereof.
IT IS IMPORTANT THAT PROXIES BE RETURNED PROMPTLY. SHAREHOLDERS WHO DO
NOT EXPECT TO ATTEND IN PERSON ARE URGED WITHOUT DELAY TO SIGN AND RETURN THE
ENCLOSED PROXY IN THE ENCLOSED ENVELOPE, WHICH REQUIRES NO POSTAGE, SO THAT
THEIR SHARES MAY BE REPRESENTED AT THE MEETING. YOUR PROMPT ATTENTION TO THE
ENCLOSED PROXY WILL HELP TO AVOID THE EXPENSE OF FURTHER SOLICITATION.
By Order of the Boards of Trustees
George O. Martinez
<PAGE>
Secretary
November 14, 1997
<PAGE>
INSTRUCTIONS FOR EXECUTING PROXY CARDS
The following general rules for signing proxy cards may be of
assistance to you and may help to avoid the time and expense involved in
validating your vote if you fail to sign your proxy card(s) properly.
1. INDIVIDUAL ACCOUNTS: Sign your name exactly as
it appears in the Registration on the proxy card(s).
2. JOINT ACCOUNTS: Either party may sign, but the name
of the party signing should conform exactly to a name shown in
the Registration on the proxy card(s).
3. ALL OTHER ACCOUNTS: The capacity of the individual signing the proxy
card(s) should be indicated unless it is reflected in the form of Registration.
For example:
REGISTRATION VALID SIGNATURE
CORPORATE
ACCOUNTS
(1) ABC Corp. ABC Corp.
(2) ABC Corp. John Doe, Treasurer
(3) ABC Corp.
c/o John Doe, Treasurer John Doe, Treasurer
(4) ABC Corp. Profit Sharing Plan John Doe, Trustee
TRUST ACCOUNTS
(1) ABC Trust Jane B. Doe, Trustee
(2) Jane B. Doe, Trustee Jane B. Doe
u/t/d 12/28/78
CUSTODIAL OR ESTATE ACCOUNTS
(1) John B. Smith, Cust. John B. Smith
f/b/o John B. Smith, Jr. UGMA
(2) John B. Smith, Jr. John B. Smith, Jr.,
Executor
<PAGE>
PROSPECTUS/PROXY STATEMENT DATED NOVEMBER 14, 1997
Acquisition of Assets of
KEYSTONE QUALITY BOND FUND (B-1)
200 Berkeley Street
Boston, Massachusetts 02116
and
KEYSTONE DIVERSIFIED BOND FUND (B-2)
200 Berkeley Street
Boston, Massachusetts 02116
By and in Exchange for Shares of
EVERGREEN DIVERSIFIED BOND FUND
a series of
Evergreen Fixed Income Trust
200 Berkeley Street
Boston, Massachusetts 02116
This Prospectus/Proxy Statement is being furnished to shareholders of
Keystone Quality Bond Fund (B-1) ("Keystone Quality") and Keystone Diversified
Bond Fund (B-2) ("Keystone Diversified") in connection with a proposed Agreement
and Plan of Reorganization (the "Plan") to be submitted to shareholders of each
of Keystone Quality and Keystone Diversified for consideration at a Special
Meeting of Shareholders to be held on January 6, 1998 at 3:00 p.m. at the
offices of the Evergreen Keystone Funds, 200 Berkeley Street, Boston,
Massachusetts 02116, and any adjournments thereof (the "Meeting"). Each Plan
provides for all of the assets of Keystone Quality and Keystone Diversified,
respectively, to be acquired by Evergreen Diversified Bond Fund ("Evergreen
Diversified Bond") in exchange for shares of Evergreen Diversified Bond and the
assumption by Evergreen Diversified Bond of certain identified liabilities of
Keystone Quality and Keystone Diversified, respectively (hereinafter referred to
individually as the "Reorganization" or collectively as the "Reorganizations").
Evergreen Diversified Bond, Keystone Quality and Keystone Diversified are
sometimes hereinafter referred to individually as the "Fund" and collectively as
the "Funds." Following the Reorganizations, shares of Evergreen Diversified Bond
will be distributed to shareholders of Keystone Quality and Keystone Diversified
in liquidation of Keystone Quality and Keystone Diversified and such Funds will
be terminated. Holders of shares of Keystone Quality and Keystone Diversified
will receive shares of Evergreen Diversified Bond having the same
distribution-related fees, shareholder servicing-related fees and contingent
deferred sales charges ("CDSCs"), if any, as the shares of Keystone Quality and
Keystone Diversified held by them prior to the Reorganizations. As a result of
the proposed Reorganizations, shareholders of Keystone Quality and Keystone
Diversified will
<PAGE>
receive that number of full and fractional shares of Evergreen Diversified Bond
having an aggregate net asset value equal to the aggregate net asset value of
such shareholder's shares of Keystone Quality or Keystone Diversified. Each
Reorganization is being structured as a tax-free reorganization for federal
income tax purposes.
Evergreen Diversified Bond is a separate series of Evergreen Fixed
Income Trust, an open-end management investment company registered under the
Investment Company Act of 1940, as amended (the "1940 Act"). The investment
objective of Evergreen Diversified Bond is to seek maximum income without undue
risk of principal . Such investment objective is substantially similar to those
of Keystone Quality and Keystone Diversified.
This Prospectus/Proxy Statement, which should be retained for future
reference, sets forth concisely the information about Evergreen Diversified Bond
that shareholders of Keystone Quality and Keystone Diversified should know
before voting on the Reorganizations. Certain relevant documents listed below,
which have been filed with the Securities and Exchange Commission ("SEC"), are
incorporated in whole or in part by reference. A Statement of Additional
Information dated November 14, 1997 relating to this Prospectus/Proxy Statement
and the Reorganizations incorporating by reference the financial statements of
Keystone Quality dated October 31, 1996 and April 30, 1997 and Keystone
Diversified dated August 31, 1997 has been filed with the SEC and is
incorporated by reference in its entirety into this Prospectus/Proxy Statement.
Evergreen Diversified Bond is a newly created series of Evergreen Fixed Income
Trust and has had no operations to date. Consequently, there are no current
financial statements of Evergreen Diversified Bond. A copy of such Statement of
Additional Information is available upon request and without charge by writing
to Evergreen Diversified Bond at 200 Berkeley Street, Boston, Massachusetts
02116, or by calling toll-free 1-800-343-2898.
The Prospectus of Evergreen Diversified Bond dated November 10, 1997 is
incorporated herein by reference in its entirety. The Prospectus, which pertains
to Class A, Class B and Class C shares, describes the separate distribution and
shareholder servicing arrangements applicable to the classes. Shareholders of
Keystone Quality and Keystone Diversified will receive, with this
Prospectus/Proxy Statement, copies of the Prospectus which describes the Class B
shares of Evergreen Diversified Bond that they will receive as a result of the
consummation of each Reorganization. Additional information about Evergreen
Diversified Bond is contained in its Statement of Additional Information of the
same date which has been
<PAGE>
filed with the SEC and which is available upon request and without charge by
writing to or calling Evergreen Diversified Bond at the address or telephone
number listed in the preceding paragraph.
The Prospectus of Keystone Quality dated February 28, 1997, as
supplemented, and the Prospectus of Keystone Diversified dated December 10,
1996, as supplemented, are incorporated herein in their entirety by reference.
Copies of the Prospectuses and related Statements of Additional Information
dated the same respective dates are available upon request without charge by
writing or calling the Fund of which you are a shareholder at the address listed
in the second preceding paragraph.
Included as Exhibits A-1 and A-2 to this Prospectus/Proxy Statement are
copies of each Plan.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS/PROXY STATEMENT. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
The shares offered by this Prospectus/Proxy Statement are not deposits
or obligations of any bank and are not insured or otherwise protected by the
U.S. government, the Federal Deposit Insurance Corporation, the Federal Reserve
Board or any other government agency and involve investment risk,
including possible loss of capital.
<PAGE>
TABLE OF CONTENTS
Page
COMPARISON OF FEES AND EXPENSES........................................ 5
SUMMARY................................................................ 10
Proposed Plans of Reorganization.............................. 10
Tax Consequences.............................................. 12
Investment Objectives and Policies
of the Funds ............................................... 12
Comparative Performance Information
for each Fund...................................... 13
Management of the Funds....................................... 13
Investment Adviser ........................................... 14
Portfolio Management.......................................... 14
Distribution of Shares........................................ 15
Purchase and Redemption Procedures............................ 18
Exchange Privileges........................................... 18
Dividend Policy............................................... 19
Risks......................................................... 20
REASONS FOR THE REORGANIZATIONS........................................ 22
Agreements and Plans of Reorganization........................ 25
Federal Income Tax Consequences............................... 28
Pro-forma Capitalization...................................... 29
Shareholder Information....................................... 30
COMPARISON OF INVESTMENT OBJECTIVES AND POLICIES....................... 32
COMPARATIVE INFORMATION ON SHAREHOLDERS' RIGHTS........................ 34
Forms of Organization......................................... 34
Capitalization................................................ 35
Shareholder Liability......................................... 35
Shareholder Meetings and Voting Rights........................ 36
Liquidation or Dissolution.................................... 37
Liability and Indemnification of Trustees..................... 37
ADDITIONAL INFORMATION................................................. 39
VOTING INFORMATION CONCERNING THE MEETINGS............................. 39
FINANCIAL STATEMENTS AND EXPERTS....................................... 42
LEGAL MATTERS.......................................................... 43
OTHER BUSINESS......................................................... 43
<PAGE>
COMPARISON OF FEES AND EXPENSES
It is anticipated that on or about January 9, 1998 Keystone Quality and
Keystone Diversified will each become a multiple class fund. As of that date
each Fund will offer Class A, Class B and Class C shares, each of which Class of
shares will be similar in all respects to the Class A, Class B and Class C
shares of Evergreen Diversified Bond. It is further anticipated that at that
time current outstanding shares of Keystone Quality and Keystone Diversified
will become Class B shares of each Fund. On or about January 16, 1998, it is
anticipated that any Class B shares of Keystone Quality and Keystone Diversified
purchased prior to January 1, 1995 will be converted to Class A shares of each
Fund. Should these events occur, shareholders of Keystone Quality and Keystone
Diversified will receive on the date of the Reorganizations the same Class of
shares of Evergreen Diversified Bond held by them in each Fund after January 16,
1998. See "Reasons for the Reorganizations - Pro forma Capitalization."
The amounts for shares of Keystone Quality and Keystone Diversified set
forth in the following tables and in the examples are based on the expenses for
the fiscal year ended October 31, 1996 and August 31, 1997, respectively. The
pro forma amounts for Class A, Class B and Class C shares of Evergreen
Diversified Bond are based on the estimated expenses of Evergreen Diversified
Bond for the fiscal year ending April 30, 1998.
The following tables show for Keystone Quality, Keystone Diversified
and Evergreen Diversified Bond pro forma the shareholder transaction expenses
and annual fund operating expenses associated with an investment in the shares
of each Fund. The pro forma numbers reflect the events described in the first
paragraph of this section.
Comparison of Shares of Evergreen Diversified
Bond With Shares of Keystone Quality
and Keystone Diversified
Keystone Quality
----------------
Shareholder
Transaction Expenses
<PAGE>
Contingent Deferred 4.00% in the
Sales Charge (as a first year,
percentage of original declining to
purchase price or 1.00% in the
redemption proceeds, fourth year and
whichever is lower) 0.00%
thereafter
Exchange Fee None
Annual Fund Operating
Expenses (as a
percentage of average
daily net assets)
Management Fee 0.60%
12b-1 Fees (1) 1.00%
Other Expenses 0.35%
--------
Annual Fund Operating
Expenses(3) 1.95%
--------
--------
Keystone Diversified
--------------------
Shareholder
Transaction Expenses
Contingent Deferred 4.00% in the
Sales Charge (as a first year,
percentage of original declining to
purchase price or 1.00% in the
redemption proceeds, fourth year and
whichever is lower) 0.00%
thereafter
Exchange Fee None
Annual Fund Operating
Expenses (as a
percentage of average
daily net assets)
Management Fee 0.55%
12b-1 Fees (1) 1.00%
<PAGE>
Other Expenses
0.33%
--------
Annual Fund Operating 1.88%
Expenses(3) --------
--------
<TABLE>
<CAPTION>
Evergreen Diversified Bond Pro Forma
Shareholder Class A Class B Class C
Transaction Expenses ------- ------- -------
<S> <C> <C> <C>
Maximum Sales Load 4.75% None None
Imposed on Purchases
(as a percentage of
offering price)
Maximum Sales Load None None None
Imposed on Reinvested
Dividends (as a
percentage of offering
price)
Contingent Deferred None 5.00% in the 1.00% in
Sales Charge (as a first year, the first
percentage of original declining to year; 0.00%
purchase price or 1.00% in the thereafter
redemption proceeds, sixth year
whichever is lower) and 0.00%
thereafter
(2)
Exchange Fee None None None
Annual Fund Operating
Expenses (as a
percentage of average
daily net assets)
0.52% 0.52% 0.52%
Management Fee
12b-1 Fees (1) 0.25% 1.00% 1.00%
Other Expenses 0.33% 0.33% 0.33%
----- ------- -----
Annual Fund Operating 1.10% 1.85% 1.85%
Expenses ----- ------- -----
----- ------- -----
- ---------------
</TABLE>
<PAGE>
(1) For shares of Keystone Quality and Keystone Diversified and for Class B
shares of Evergreen Diversified Bond, a portion of the 12b-1 fees
equivalent to 0.25% of average daily net assets will be shareholder
servicing-related. Distribution-related 12b-1 fees will be limited to 0.75%
of average daily net assets as permitted under the rules of the National
Association of Securities Dealers, Inc.
(2) The contingent deferred sales charge, if any, applicable to shares of
Keystone Quality and Keystone Diversified prior to the date of the
Reorganizations will carry over to the shares of Evergreen Diversified
Bond received in the Reorganizations.
(3) Expense ratios include indirectly paid expenses, which represent offset
arrangements with the Fund's custodian.
Examples. The following tables show for Keystone Quality and Keystone
Diversified, and for Evergreen Diversified Bond pro forma, assuming consummation
of the Reorganizations, examples of the cumulative effect of shareholder
transaction expenses and annual fund operating expenses indicated above on a
$1,000 investment in each class of shares for the periods specified, assuming
(i) a 5% annual return, and (ii) redemption at the end of such period, and
additionally for Class B and Class C shares of Evergreen Diversified Bond and
shares of Keystone Quality and Keystone Diversified, no redemption at the end of
each period.
<TABLE>
<CAPTION>
Keystone Quality
----------------
One Three Five Ten
Year Years Years Years
---- ----- ----- -----
<S> <C> <C> <C> <C>
(Assuming $60 $81 $105 $227
redemption at end
of period)
(Assuming no $20 $61 $105 $227
redemption at end
of period)
</TABLE>
<TABLE>
<CAPTION>
Keystone Diversified
--------------------
One Three Five Ten
Year Years Years Years
---- ----- ----- -----
<PAGE>
<S> <C> <C> <C> <C>
(Assuming
redemption at end $59 $79 $220
of period) $102
(Assuming no $19 $59 $220
redemption at end $102
of period)
</TABLE>
<TABLE>
<CAPTION>
Evergreen Diversified Bond Pro Forma
------------------------------------
One Three Five Ten
Year Years Years Years
----- ----- ----- -----
<S> <C> <C> <C> <C>
Class A $58 $81 $105 $175
Class B $69 $88 $120 $188
(Assuming
redemption at end
of period)
Class B $19 $58 $100 $188
(Assuming no
redemption at end
of period)
Class C $29 $58 $100 $217
(Assuming
redemption at end
of period)
Class C $19 $58 $100 $217
(Assuming no
redemption at end
of period)
</TABLE>
The purpose of the foregoing examples is to assist Keystone Quality and
Keystone Diversified shareholders in understanding the various costs and
expenses that an investor in Evergreen Diversified Bond as a result of the
Reorganizations would bear directly and indirectly, as compared with the various
direct and indirect expenses currently borne by a shareholder in each Fund.
These examples should not be considered a representation of past or future
expenses or annual return. Actual expenses may be greater or less than those
shown.
<PAGE>
SUMMARY
This summary is qualified in its entirety by reference to the
additional information contained elsewhere in this Prospectus/Proxy Statement
and, to the extent not inconsistent with such additional information, the
Prospectus of Evergreen Diversified Bond dated November 10, 1997 and the
Prospectuses of Keystone Quality and Keystone Diversified dated February 28,
1997, as supplemented, and December 10, 1996, as supplemented, respectively,
(which are incorporated herein by reference), and the Plans, forms of which are
attached to this Prospectus/Proxy Statement as Exhibits A-1 and A-2.
Proposed Plans of Reorganization
The Plans provide for the transfer of all of the assets of Keystone
Quality and Keystone Diversified, as applicable, in exchange for shares of
Evergreen Diversified Bond and the assumption by Evergreen Diversified Bond of
certain identified liabilities of each Fund. The identified liabilities consist
only of those liabilities reflected on each Fund's statement of assets and
liabilities determined immediately preceding the Reorganizations. The Plans also
call for the distribution of shares of Evergreen Diversified Bond to Keystone
Quality and Keystone Diversified shareholders in liquidation of those Funds as
part of the Reorganizations. As a result of the Reorganizations, the
shareholders of Keystone Quality and Keystone Diversified will become the owners
of that number of full and fractional shares of Evergreen Diversified Bond
having an aggregate net asset value equal to the aggregate net asset value of
the shareholder's respective class of shares of Keystone Quality and Keystone
Diversified as of the close of business immediately prior to the date that such
Fund's assets are exchanged for shares of Evergreen Diversified Bond. See
"Reasons for the Reorganizations - Agreements and Plans of Reorganization."
The Trustees of Keystone Quality and the Trustees of Keystone
Diversified, including the Trustees who are not "interested persons," (the
"Trustees") as such term is defined in the 1940 Act (the "Independent
Trustees"), have concluded that the Reorganizations would be in the best
interests of shareholders of Keystone Quality and Keystone Diversified,
respectively, and that the interests of the shareholders of Keystone Quality and
Keystone Diversified, respectively, will not be diluted as a result of the
transactions contemplated by the Reorganizations. Accordingly, the Trustees have
submitted the Plans for the approval of Keystone Quality's and Keystone
Diversified's shareholders.
THE BOARD OF TRUSTEES OF KEYSTONE QUALITY
RECOMMENDS APPROVAL BY SHAREHOLDERS OF KEYSTONE
<PAGE>
QUALITY OF THE PLAN EFFECTING THE REORGANIZATION.
THE BOARD OF TRUSTEES OF KEYSTONE DIVERSIFIED
RECOMMENDS APPROVAL BY SHAREHOLDERS OF KEYSTONE
DIVERSIFIED OF THE PLAN EFFECTING THE REORGANIZATION.
The Trustees of Evergreen Fixed Income Trust have also
approved the Plans, and accordingly, Evergreen Diversified
Bond's participation in the Reorganizations.
Approval of a Reorganization on the part of Keystone Quality and
Keystone Diversified will require the affirmative vote of a majority of each
Fund's shares present and entitled to vote at Meetings at which a quorum of each
Fund's shares is present. A majority of the outstanding shares entitled to vote
of each Fund, represented in person or by proxy, is required to constitute a
quorum at the Meetings. See "Voting Information Concerning the Meetings."
The Reorganizations are scheduled to take place on or about January 23,
1998.
If the shareholders of Keystone Quality or Keystone Diversified do not
vote to approve the Reorganizations, the Trustees will consider other possible
courses of action in the best interests of shareholders.
Tax Consequences
Prior to or at the completion of a Reorganization, Keystone Quality and
Keystone Diversified will each have received an opinion of counsel that the
Reorganization has been structured so that no gain or loss will be recognized by
the Fund or its shareholders for federal income tax purposes as a result of the
receipt of shares of Evergreen Diversified Bond in the Reorganization. The
holding period and aggregate tax basis of shares of Evergreen Diversified Bond
that are received by each Fund's shareholders will be the same as the holding
period and aggregate tax basis of shares of the Fund previously held by such
shareholders, provided that shares of the Fund are held as capital assets. In
addition, the holding period and tax basis of the assets of each Fund in the
hands of Evergreen Diversified Bond as a result of the Reorganization will be
the same as in the hands of each Fund immediately prior to the Reorganization,
and no gain or loss will be recognized by Evergreen Diversified Bond upon the
receipt of the assets of each Fund in exchange for shares of Evergreen
Diversified Bond and the assumption by Evergreen Diversified Bond of certain
identified liabilities.
Investment Objectives and Policies of the Funds
<PAGE>
The investment objective of Evergreen Diversified Bond is to seek
maximum income without undue risk of principal. Evergreen Diversified Bond will
invest at least 65% of its total assets in bonds, which are debt instruments
used by issuers to borrow money from investors. The Fund invests in debt
instruments that are normally characterized by relatively liberal returns and
moderate price fluctuations. Such debt instruments will be rated within the four
highest categories by a nationally recognized statistical ratings organization
("NRSRO").
Evergreen Diversified Bond may also invest in limited partnerships,
including master limited partnerships, up to 50% of its assets in foreign
securities and up to 35% of its assets in high yield, high risk bonds and
similar securities in the lower rating categories of a NRSRO. The Fund may also
invest in high grade money market instruments, fixed and adjustable rate or
stripped bonds and certain derivative securities, including futures and options.
The investment objective and policies of Keystone Diversified are identical to
those of Evergreen Diversified Bond.
The investment objective and policies of Keystone Quality are
substantially similar to those of Evergreen Diversified Bond except that
Keystone Quality invests at least 65% of its total assets in debt securities
rated within the three highest categories by a NRSRO and may not invest any of
its assets in high yield, high risk bonds and similar securities. See
"Comparison of Investment Objectives and Policies" below.
Comparative Performance Information for each Fund
Discussions of the manner of calculation of total return are contained
in the respective Prospectuses and Statements of Additional Information of the
Funds. Evergreen Diversified Bond, as of the date of this Prospectus/Proxy
Statement, had not commenced operations. The total return of Keystone Quality
and Keystone Diversified for the one, five and ten year periods ended August 31,
1997 and for the periods from inception through August 31, 1997 is set forth in
the table below. The calculations of total return assume the reinvestment of all
dividends and capital gains distributions on the reinvestment date and the
deduction of all recurring expenses (including sales charges) that were charged
to shareholders' accounts.
<TABLE>
<CAPTION>
Average Annual Total Return
<PAGE>
1 Year 5 Years 10 Years From
Ended Ended Ended Inception
August 31, August August To August Inception
1997 31, 1997 31, 1997 31, 1997 Date
-------- ------- -------- --------- ---------
<S> <C> <C> <C> <C>
Keystone 4.74% 6.97% 5.15% 9/11/35
Quality 6.08%
Keystone 9.25% 6.55% 7.16% 6.95% 9/11/35
Diversified
</TABLE>
- --------------
Management of the Funds
The overall management of Evergreen Diversified Bond, of Keystone
Quality and of Keystone Diversified is the responsibility of, and is supervised
by, the Board of Trustees of Evergreen Fixed Income Trust, Keystone Quality and
Keystone
Diversified, respectively.
Investment Adviser
The investment adviser to Evergreen Diversified Bond, Keystone Quality
and Keystone Diversified is Keystone Investment Management Company ("Keystone").
Keystone has provided investment advisory and management services to investment
companies and private accounts since 1932. Keystone is an indirect wholly-owned
subsidiary of First Union National Bank ("FUNB"). Keystone is located at 200
Berkeley Street, Boston, Massachusetts 02116-5034.
FUNB is a subsidiary of First Union Corporation, the sixth largest bank
holding company in the U.S. based on total assets as of June 30, 1997.
Evergreen Diversified Bond, Keystone Quality and Keystone Diversified
each pay Keystone a fee for its services at the annual rate below:
Aggregate Net Asset
Value of the Shares
Management Fee Income of the Fund
2.00% of Gross Dividend
and Interest Income
Plus
0.50% of the first $100,000,000, plus
0.45% of the next $100,000,000, plus
0.40% of the next $100,000,000, plus
0.35% of the next $100,000,000, plus
0.30% of the next $100,000,000, plus
<PAGE>
0.25% of amounts
over $500,000,000.
Keystone's fee is computed as of the close of business each business day and
payable monthly.
Keystone may, at its discretion, also reduce or waive its fee or
reimburse a Fund for certain of its other expenses in order to reduce its
expense ratios. Keystone may reduce or cease these voluntary waivers and
reimbursements at any time.
Portfolio Management
The portfolio manager of both Evergreen Diversified Bond and Keystone
Diversified is Christopher C. Conkey. Mr. Conkey has served as the Chief
Investment Officer of Fixed Income for the past nine months and as Head of the
High Grade Bond Team for Keystone for the last three years. During the past five
years at Keystone, Mr. Conkey has also served as portfolio manager of several
high grade fixed income funds, several high grade-high yield fixed income funds
and several off-shore closed-end fixed income funds. Mr. Conkey joined Keystone
as a fixed income manager in 1988 and has managed Keystone Diversified's
portfolio since January, 1995.
Distribution of Shares
Evergreen Distributor, Inc. ("EDI"), an affiliate of BISYS Fund
Services, acts as underwriter of Evergreen Diversified Bond's, Keystone
Quality's and Keystone Diversified's shares. EDI distributes each Fund's shares
directly or through broker-dealers, banks (including FUNB), or other financial
intermediaries. Evergreen Diversified Bond offers three classes of shares: Class
A, Class B and Class C. Keystone Quality and Keystone Diversified currently
offer only one class of shares. However, it is anticipated that on or about
January 9, 1998, Keystone Quality and Keystone Diversified will each offer three
classes of shares, Class A, Class B and Class C. Each class has separate
distribution arrangements. (See "Distribution-Related and Shareholder
Servicing-Related Expenses" below.) No class bears the distribution expenses
relating to the shares of any other class.
In the proposed Reorganizations, shareholders of Keystone Quality and
Keystone Diversified will receive Class A and/or Class B shares of Evergreen
Diversified Bond. As of January 9, 1998, it is anticipated that each class of
shares of Evergreen Diversified Bond, Keystone Quality and Keystone Diversified
will have identical arrangements with respect to CDSCs and distribution and
service fees. Because the Reorganizations will be effected at net asset value
without the imposition of a sales charge, Evergreen Diversified Bond
<PAGE>
shares acquired by shareholders of Keystone Quality and Keystone Diversified
pursuant to the proposed Reorganizations would not be subject to any initial
sales charge or CDSC as a result of the Reorganizations. However, shares
acquired as a result of the Reorganizations would continue to be subject to a
CDSC upon subsequent redemption to the same extent as if shareholders had
continued to hold their shares of Keystone Quality and Keystone Diversified. The
CDSC applicable to a class of shares received in the Reorganizations will be the
CDSC schedule in effect at the time shares of Keystone Quality or Keystone
Diversified were originally purchased.
The following is a summary description of charges and fees for each of
the different classes of shares. More detailed descriptions of the distribution
arrangements applicable to the classes of shares are contained in the respective
Evergreen Diversified Bond Prospectus, the Keystone Quality Prospectus, the
Keystone Diversified Prospectus and in each Fund's respective Statement of
Additional Information.
Currently, Keystone Quality and Keystone Diversified offer only one
class of shares. Shares are sold without any front-end sales charges, but are
subject to a CDSC which ranges from 4% to 1% if shares are redeemed during the
first four calendar years after purchase. In addition, shares are subject to
distribution-related and shareholder servicing- related fees as described below.
It is anticipated that Keystone Quality and Keystone Diversified will each
become a multiple class fund on or about January 9, 1998. Should this occur,
each Fund will offer three classes of shares identical to the Class A, Class B
and Class C shares of Evergreen Diversified Bond and hereafter described,
including identical distribution-related and shareholder servicing-related
expenses.
Class A Shares. Class A Evergreen Diversified Bond shares are sold at
net asset value plus an initial sales charge and, as indicated below, are
subject to distribution- related fees.
Class B Shares. Class B Evergreen Diversified Bond shares are sold
without an initial sales charge but are subject to a CDSC, which ranges from 5%
to 1%, if shares are redeemed during the first six years after the month of
purchase. In addition, Class B shares are subject to distribution-related fees
and shareholder servicing-related fees as described below. Class B shares issued
in the Reorganizations will automatically convert to Class A shares in
accordance with the conversion schedule of Evergreen Diversified Bond in effect
at the time of the Reorganizations. For purposes of determining when Class B
shares issued in the Reorganizations to shareholders of Keystone Quality and
Keystone Diversified will convert to Class A shares, such
<PAGE>
shares will be deemed to have been purchased as of the date the shares of
Keystone Quality and Keystone Diversified were originally purchased.
Class B shares are subject to higher distribution-related fees than the
corresponding Class A shares on which a front-end sales charge is imposed (until
they convert to Class A shares). The higher fees mean a higher expense ratio, so
Class B shares pay correspondingly lower dividends and may have a lower net
asset value than Class A shares of the Fund.
Class C Shares. Class C Evergreen Diversified Bond shares are sold
without an initial sales charge but, as indicated below, are subject to
distribution and shareholder servicing-related fees. Class C shares are subject
to a 1% CDSC if such shares are redeemed during the month of purchase and the
12-month period following the month of purchase. No CDSC is imposed on amounts
redeemed thereafter. Class C shares incur higher distribution and shareholder
servicing- related fees than Class A shares but, unlike Class B shares, do not
convert to any other class of shares.
The amount of the CDSC applicable to redemptions of shares of Keystone
Quality, Keystone Diversified and Evergreen Diversified Bond is charged as a
percentage of the lesser of the then current net asset value or original cost.
The CDSC is deducted from the amount of the redemption and is paid to the Fund's
distributor or its predecessor, as the case may be. Shares of each Fund acquired
through dividend or distribution reinvestment are not subject to a CDSC. For
purposes of determining the schedule of CDSCs, and the time of conversion to
Class A shares, applicable to shares of Evergreen Diversified Bond received by
Keystone Quality's or Keystone Diversified's shareholders in the
Reorganizations, Evergreen Diversified Bond will treat such shares as having
been sold on the date the shares of Keystone Quality or Keystone Diversified
were originally purchased by such Fund's shareholder. Additional information
regarding the Classes of shares of each Fund is included in its respective
Prospectus and Statement of Additional Information.
Distribution-Related and Shareholder Servicing-Related Expenses.
Evergreen Diversified Bond has adopted a Rule 12b-1 plan with respect to its
Class A shares under which the Class may pay for distribution-related expenses
at an annual rate which may not exceed 0.75% of average daily net assets
attributable to the Class. Payments with respect to Class A shares of Evergreen
Diversified Bond are currently limited to 0.25% of average daily net assets
attributable to the Class, which amount may be increased to the full plan rate
for the Fund by the Trustees without shareholder approval.
<PAGE>
Evergreen Diversified Bond has also adopted a Rule 12b-1 plan with
respect to its Class B and Class C shares under which each Class may pay for
distribution-related and shareholder servicing-related expenses at an annual
rate which may not exceed 1.00% of average daily net assets attributable to the
Class.
The Class B and Class C Rule 12b-1 plans provide that of the total
1.00% 12b-1 fees, up to 0.25% may be for payment in respect of "shareholder
services." Consistent with the requirements of Rule 12b-1 and the applicable
rules of the National Association of Securities Dealers, Inc. ("NASD"),
following the Reorganizations Evergreen Diversified Bond may make
distribution-related and shareholder servicing-related payments with respect to
Keystone Quality and Keystone Diversified shares sold prior to the
Reorganizations, including payments to Keystone Quality's and Keystone
Diversified's former underwriter.
Each of Keystone Quality and Keystone Diversified has adopted a Rule
12b-1 plan with respect to its shares pursuant to which each Fund may pay for
distribution-related and shareholder servicing-related expenses at an annual
rate that may not exceed 1.25% of average daily net assets. The NASD limits the
amount that a Fund may pay annually in distribution costs for the sale of its
shares and shareholder service fees. The NASD currently limits such annual
expenditures to 1.00% of the aggregate average daily net asset value of the
Fund's shares, of which 0.75% may be used to pay distribution costs and 0.25%
may be used to pay shareholder service fees.
Additional information regarding the Rule 12b-1 plans adopted by each
Fund is included in its respective Prospectus and Statement of Additional
Information.
Purchase and Redemption Procedures
Information concerning applicable sales charges, distribution-related
fees and shareholder servicing-related fees is described above. Investments in
the Funds are not insured. The minimum initial purchase requirement for each
Fund is $1,000. There is no minimum for subsequent purchases of shares of any
Fund. Each Fund provides for telephone, mail or wire redemption of shares at net
asset value, less any CDSC, as next determined after receipt of a redemption
request on each day the New York Stock Exchange ("NYSE") is open for trading.
Additional information concerning purchases and redemptions of shares, including
how each Fund's net asset value is determined, is contained in the respective
Prospectus for each Fund. Each Fund may involuntarily redeem shareholders'
accounts that have less than $1,000 of invested funds. All funds invested in
each Fund are invested in full
<PAGE>
and fractional shares. The Funds reserve the right to reject any purchase order.
Exchange Privileges
Keystone Quality and Keystone Diversified currently have identical
exchange privileges. Exchanges are limited to the funds in the Keystone Classic
fund family and Class K shares of Evergreen Money Market Fund. Shares of
Evergreen Diversified Bond may be exchanged for shares of a similar class of any
fund in the Evergreen Keystone fund family, other than shares of any fund in the
Keystone Classic fund family. No sales charge is imposed on an exchange. An
exchange which represents an initial investment in another fund must amount to
at least $1,000. The current exchange privileges, and the requirements and
limitations attendant thereto, are described in each Fund's respective
Prospectus and Statement of Additional Information.
Dividend Policy
Each Fund declares income dividends daily and pays such dividends
monthly. Distributions of any net realized gains of a Fund will be made at least
annually. Shareholders begin to earn dividends on the first business day after
shares are purchased unless shares were not paid for, in which case dividends
are not earned until the next business day after payment is received. Dividends
and distributions are reinvested in additional shares of the same class of the
respective Fund, or paid in cash, as a shareholder has elected. See the
respective Prospectus of each Fund for further information concerning dividends
and distributions.
After the Reorganizations, shareholders of Keystone Quality and
Keystone Diversified who have elected to have their dividends and/or
distributions reinvested will have dividends and/or distributions received from
Evergreen Diversified Bond reinvested in shares of Evergreen Diversified Bond.
Shareholders of Keystone Quality and Keystone Diversified who have elected to
receive dividends and/or distributions in cash will receive dividends and/or
distributions from Evergreen Diversified Bond in cash after the Reorganizations,
although they may, after the Reorganizations, elect to have such dividends
and/or distributions reinvested in additional shares of Evergreen Diversified
Bond.
Each of Keystone Quality and Keystone Diversified has qualified and
intends to continue to qualify, and Evergreen Diversified Bond intends to
qualify, to be treated as a regulated investment company under the Internal
Revenue Code of 1986, as amended (the "Code"). While so qualified, so long as
each Fund distributes all of its investment company taxable
<PAGE>
income and any net realized gains to shareholders, it is expected that a Fund
will not be required to pay any federal income taxes on the amounts so
distributed. A 4% nondeductible excise tax will be imposed on amounts not
distributed if a Fund does not meet certain distribution requirements by the end
of each calendar year. Each Fund anticipates meeting such distribution
requirements.
Risks
Since the investment objectives and policies of each Fund are
substantially comparable, the risks involved in investing in each Fund's shares
are similar except that Evergreen Diversified Bond and Keystone Diversified
invest at least 65% of their total assets in debt securities rated within the
four highest categories by a NRSRO and Keystone Quality's purchases of debt
securities are limited, with respect to 65% of its assets, to those debt
securities rated within the three highest categories by a NRSRO. For a
discussion of each Fund's objectives and policies, see "Comparison of Investment
Objectives and Policies." Bonds rated in the fourth highest category, although
considered investment grade, have speculative characteristics. In addition,
Evergreen Diversified Bond and Keystone Diversified may invest in high yield,
high risk bonds. Keystone Quality may not purchase high yield, high risk bonds,
although it may with a portion of its assets purchase debt securities rated in
the fourth highest category by a NRSRO. High yield, high risk bonds generally
involve greater volatility of price and risk of principal and income than bonds
in the higher rating categories and are, on balance, considered predominantly
speculative.
Securities rated below-investment grade are considered predominantly
speculative with respect to the ability of the issuer to meet principal and
interest payments. The lower ratings of certain securities held by the Fund
reflect a greater possibility that adverse changes in the financial condition of
the issuer or in general economic conditions, or both, or an unanticipated rise
in interest rates may impair the ability of the issuer to make payments of
interest and principal, especially if the issuer is highly leveraged. Such
issuer's ability to meet its debt obligations may also be adversely affected by
specific corporate developments, the issuer's inability to meet specific
projected business forecasts, or the unavailability of additional financing.
Also, an economic downturn or an increase in interest rates may increase the
potential for default by the issuers of these securities.
Values of such securities are more sensitive to real or perceived
adverse economic, company or industry conditions and publicity than is the case
for higher quality securities.
<PAGE>
Their values, like those of other fixed income securities, fluctuate in response
to changes in interest rates, generally rising when interest rates decline and
falling when interest rates rise. For example, if interest rates increase after
a fixed income security is purchased, the security, if sold prior to maturity,
may return less than its cost. The prices of below-investment grade bonds,
however, are generally less sensitive to interest rate changes than the prices
of higher- rated bonds.
Shorter term bonds are less sensitive to interest rate changes, but longer term
bonds generally offer higher yields.
In addition, to the extent that investments are made in debt securities
(other than U.S. government securities), derivatives or structured securities,
such investments, despite favorable credit ratings, are subject to some risk of
default.
Each Fund may invest in derivatives. The market values of derivatives
or structured securities may vary depending upon the manner in which the
investments have been structured and may fluctuate much more rapidly and to a
much greater extent than investments in other securities. As a result, the
values of such investments may change at rates in excess of rates at which
traditional fixed income securities change and, depending on the structure of a
derivative, would change in a manner opposite to the change in the market value
of a traditional fixed income security. See each Fund's Prospectus and Statement
of Additional Information for further discussion of the risks inherent in the
use of derivatives.
Each Fund may invest in foreign securities. Investing in securities of
foreign issuers generally involves greater risk than investing in securities of
domestic issuers for the following reasons: publicly available information on
issuers and securities may be scarce; many foreign countries do not follow the
same accounting, auditing, and financial reporting standards as are used in the
U.S.; market trading volumes may be smaller, resulting in less liquidity and
more price volatility compared to U.S. securities of comparable quality; there
may be less regulation of securities trading and its participants; the
possibility may exist for expropriation, confiscatory taxation, nationalization,
establishment of exchange controls, political or social instability or negative
<PAGE>
diplomatic developments; and dividend or interest withholding
may be imposed at the source.
Fluctuations in foreign exchange rates impose an additional level of
risk, possibly affecting the value of a Fund's foreign investments and earnings,
gains and losses realized through trades, and the unrealized appreciation or
depreciation of investments. Each Fund may also incur costs when it shifts
assets from one country to another.
REASONS FOR THE REORGANIZATIONS
At a regular meeting held on September 17, 1997, the Board of Trustees
of Keystone Quality considered and approved the Reorganization as in the best
interests of shareholders and determined that the interests of existing
shareholders of Keystone Quality will not be diluted as a result of the
transactions contemplated by the Reorganization.
At a regular meeting held on September 17, 1997, the Board of Trustees
of Keystone Diversified considered and approved the Reorganization as in the
best interests of shareholders and determined that the interests of existing
shareholders of Keystone Diversified will not be diluted as a result of the
transactions contemplated by the Reorganization.
In approving each Plan, the Trustees reviewed various factors about the
respective Funds and the proposed Reorganizations. The Reorganizations are part
of an overall plan to convert the Evergreen Keystone funds into series of
Delaware business trusts and, to the extent practicable, simplify and make
consistent various investment restrictions and policies. Holders of shares of
beneficial interest in a Pennsylvania common law trust may, under certain
circumstances, be held personally liable as partners for the obligations of the
trust. Although provisions of the Declaration of Trust and other legal documents
pertaining to each Fund's affairs seek to minimize the potential for such
liability, some degree of exposure, however unlikely, continues to exist with
respect to the Funds as long as they are governed by Pennsylvania law.
Substantially all written agreements, obligations, instruments, or undertakings
made by Keystone Quality or Keystone Diversified must contain a provision
limiting the obligations created by that transaction to the Fund to which the
transaction relates, as well as related provisions to the effect that the
shareholders of the Fund and Trustees of the Trust under which the Fund operates
are not personally liable thereunder. Although the Declarations of Trust of
Keystone Quality and Keystone Diversified provide for indemnification out of the
Funds' property of any shareholder held personally liable for the obligations of
a Fund solely by reason of his or her being or having been a shareholder, a
shareholder could conceivably
<PAGE>
incur financial loss exceeding any amounts indemnified on account of shareholder
liability if the circumstances were such that the Fund had insufficient assets
or would otherwise be unable to meet its obligations.
As a Delaware business trust, the Evergreen Fixed Income Trust's
operations will be governed by applicable Delaware law rather than by
Pennsylvania law. The Delaware Business Trust Act (the "Delaware Act") provides
that a shareholder of a Delaware business trust shall be entitled to the same
limitation of personal liability extended to stockholders of Delaware
corporations. Shareholders of Delaware corporations do not have personal
liability for obligations of the corporation.
Delaware has obtained a favorable national reputation for its business
laws and business environment. The Delaware courts, which may be called upon to
interpret the Delaware Act, are among the nation's most highly respected and
have an expertise in corporate matters which in part grew out of the fact that
Delaware corporate legal issues are concentrated in the Court of Chancery where
there are no juries and where judges issue written opinions explaining their
decisions. Thus, there is a well established body of precedent which may be
relevant in deciding issues pertaining to a Delaware business trust.
There are other advantages that may be afforded by a Delaware business
trust. Under Delaware law, the Evergreen Fixed Income Trust will have the
flexibility to respond to future business contingencies. For example, the
Trustees will have the power to change the Evergreen Fixed Income Trust to a
corporation, to merge or consolidate it with another entity, to cause each
series to become a separate trust, and to change the Evergreen Fixed Income
Trust's domicile without a shareholder vote. This flexibility could help to
assure that the Evergreen Fixed Income Trust operates under the most advanced
form of organization and could reduce the expense and frequency of future
shareholder meetings for non-investment related issues.
In addition, although it is proposed that Keystone Quality and Keystone
Diversified each sell all of its assets to Evergreen Diversified Bond, a newly
established series of Evergreen Fixed Income Trust, an important part of the
Reorganizations is that Keystone Quality, for all practical purposes, will be
combined with Keystone Diversified. The investment objective and policies of
Evergreen Diversified Bond are substantially identical to those of Keystone
Diversified. Consequently, in considering the Reorganizations, each Fund's
Trustees reviewed the Reorganization in the context of Keystone Quality being
combined with Keystone Diversified.
<PAGE>
There are substantial similarities between Keystone Quality and
Keystone Diversified. Except for the fact that Keystone Diversified may invest a
portion of its assets in high yield, high risk debt securities and may invest
65% of its total assets in debt securities rated slightly lower than those
permitted to be purchased by Keystone Quality with 65% of its assets, Keystone
Quality and Keystone Diversified have substantially similar investment
objectives and policies and comparable risk profiles. See "Comparison of
Investment Objectives and Policies" below. At the same time, the Boards of
Trustees of Keystone Quality and Keystone Diversified evaluated the potential
economies of scale associated with larger mutual funds and concluded that
operational efficiencies may be achieved upon the combination of Keystone
Quality with another Evergreen Keystone fund with a greater level of assets. As
of August 31, 1997, Keystone Diversified's net assets were approximately $458
million and Keystone Quality's net assets were approximately $179 million.
In addition, assuming that an alternative to the Reorganizations would
be to propose that Keystone Quality and Keystone Diversified continue their
existences as separate series of Evergreen Fixed Income Trust, Keystone Quality
would be offered through common distribution channels with the substantially
identical Keystone Diversified. Keystone Quality would also have to bear the
cost of maintaining its separate existence. Keystone believes that the prospect
of dividing the resources of the Evergreen Keystone mutual fund organization
between two substantially identical funds could result in each Fund being
disadvantaged due to an inability to achieve optimum size, performance levels
and the greatest possible economies of scale. Accordingly, for the reasons noted
above and recognizing that there can be no assurance that any economies of scale
or other benefits will be realized, Keystone believes that the proposed
Reorganizations would be in the best interests of each Fund and its
shareholders.
The Board of Trustees of Keystone Quality and the Board of Trustees of
Keystone Diversified met and considered the recommendation of Keystone, and, in
addition, considered among other things, (i) the disadvantages which apply to
operating each Fund as a Pennsylvania common law trust or a series of a
Pennsylvania common law trust; (ii) the advantages which apply to each Fund
operating as a series of a Delaware business trust; (iii) the terms and
conditions of the Reorganization; (iv) whether the Reorganization would result
in the dilution of shareholders' interests; (v) expense ratios, fees and
expenses of Keystone Quality and Keystone Diversified; (vi) the comparative
performance records of each of the Funds; (vii) compatibility of their
investment objectives and policies; (viii) the investment experience, expertise
and resources of Keystone; (ix) service features available to
<PAGE>
shareholders of the respective Funds and Evergreen Diversified Bond; (x) the
fact that FUNB will bear the expenses incurred by Keystone Quality and Keystone
Diversified in connection with the Reorganizations; (xi) the fact that Evergreen
Diversified Bond will assume certain identified liabilities of Keystone Quality
and Keystone Diversified; and (xii) the expected federal income tax consequences
of the Reorganizations.
The Trustees of Keystone Quality also considered the benefits to be
derived by shareholders of Keystone Quality from its combination, for all
practical purposes, with Keystone Diversified. In this regard, the Trustees
considered the potential benefits of being associated with a larger entity and
the economies of scale that could be realized by the participation by
shareholders of Keystone Quality.
In addition, the Trustees of Keystone Quality and Keystone Diversified
considered that there are alternatives available to shareholders of Keystone
Quality and Keystone Diversified, including the ability to redeem their shares,
as well as the option to vote against the Reorganizations.
During their consideration of the Reorganizations the Trustees met with
Fund counsel and counsel to the Independent Trustees regarding the legal issues
involved. The Trustees of Evergreen Fixed Income Trust on behalf of Evergreen
Diversified Bond also approved at a meeting on September 17,
1997 the proposed Reorganizations.
THE TRUSTEES OF KEYSTONE QUALITY RECOMMEND
THAT SHAREHOLDERS APPROVE THE PROPOSED
REORGANIZATION.
THE TRUSTEES OF KEYSTONE DIVERSIFIED RECOMMEND THAT
SHAREHOLDERS APPROVE THE PROPOSED REORGANIZATION.
Agreements and Plans of Reorganization
The following summary is qualified in its entirety by reference to the
Plans (Exhibits A-1 and A-2 hereto).
Each Plan provides that Evergreen Diversified Bond will acquire all of
the assets of Keystone Quality and Keystone Diversified, respectively, in
exchange for shares of Evergreen Diversified Bond and the assumption by
Evergreen Diversified Bond of certain identified liabilities of Keystone Quality
and Keystone Diversified on or about January 23, 1998 or such other date as may
be agreed upon by the parties (the "Closing Date"). Prior to the Closing Date,
Keystone Quality and Keystone Diversified will endeavor to discharge all of
their known liabilities and obligations. Evergreen Diversified Bond will not
assume any liabilities or obligations of Keystone
<PAGE>
Quality and Keystone Diversified other than those reflected in an unaudited
statement of assets and liabilities of Keystone Quality and Keystone Diversified
prepared as of the close of regular trading on the NYSE, currently 4:00 p.m.
Eastern time, on the business day immediately prior to the Closing Date.
Evergreen Diversified Bond will provide the Trustees of Keystone Quality and
Keystone Diversified with certain indemnifications as set forth in each Plan.
The number of full and fractional shares of Evergreen Diversified Bond to be
received by the shareholders of Keystone Quality and Keystone Diversified will
be as follows. Shareholders of Keystone Diversified will receive the number of
shares of each class of Evergreen Diversified Bond equal to the number of shares
of each corresponding class as they currently hold of Keystone Diversified.
Shareholders of Keystone Quality will receive the number of shares of Evergreen
Diversified Bond determined by multiplying the outstanding class of shares of
Keystone Quality by a factor which shall be computed by dividing the net asset
value per share of the respective class of Keystone Quality by the net asset
value per share of the respective class of Evergreen Diversified Bond. Such
computations will take place as of the close of regular trading on the NYSE on
the business day immediately prior to the Closing Date. The net asset value per
share of each class will be determined by dividing assets, less liabilities, in
each case attributable to the respective class, by the total number of
outstanding shares.
State Street Bank and Trust Company, the custodian for the Funds, will
compute the value of Keystone Quality's and Keystone Diversified's respective
portfolio securities. The method of valuation employed will be consistent with
the procedures set forth in the Prospectus and Statement of Additional
Information of Evergreen Diversified Bond, Rule 22c-1 under the 1940 Act, and
with the interpretations of such Rule by the SEC's Division of Investment
Management.
At or prior to the Closing Date, Keystone Quality and Keystone
Diversified will have declared a dividend or dividends and distribution or
distributions which, together with all previous dividends and distributions,
shall have the effect of distributing to each Fund's shareholders (in shares of
each Fund, or in cash, as the shareholder has previously elected) all of each
Fund's investment company taxable income for the taxable period ending on the
Closing Date (computed without regard to any deduction for dividends paid) and
all of its net capital gains realized in all taxable periods ending on the
Closing Date (after reductions for any capital loss carryforward).
As soon after the Closing Date as conveniently practicable, Keystone
Quality and Keystone Diversified will liquidate and distribute pro rata to
shareholders of record as
<PAGE>
of the close of business on the Closing Date the full and fractional shares of
Evergreen Diversified Bond received by each Fund. Such liquidation and
distribution will be accomplished by the establishment of accounts in the names
of each Fund's shareholders on the share records of Evergreen Diversified Bond's
transfer agent. Each account will represent the respective pro rata number of
full and fractional shares of Evergreen Diversified Bond due to each Fund's
shareholders. All issued and outstanding shares of each Fund, including those
represented by certificates, will be canceled. The shares of Evergreen
Diversified Bond to be issued will have no preemptive or conversion rights.
After such distributions and the winding up of its affairs, Keystone Quality and
Keystone Diversified will be terminated. In connection with such terminations,
Keystone Quality and Keystone Diversified will file with the SEC applications
for termination as registered investment companies.
The consummation of each Reorganization is subject to the conditions
set forth in the Plan for Keystone Quality and the Plan for Keystone
Diversified, including approval by each Fund's shareholders, accuracy of various
representations and warranties and receipt of opinions of counsel, including
opinions with respect to those matters referred to in "Federal Income Tax
Consequences" below. Notwithstanding approval of each Fund's shareholders, each
Plan may be terminated (a) by the mutual agreement of the Fund and Evergreen
Diversified Bond; or (b) at or prior to the Closing Date by either party (i)
because of a breach by the other party of any representation, warranty, or
agreement contained therein to be performed at or prior to the Closing Date if
not cured within 30 days, or (ii) because a condition to the obligation of the
terminating party has not been met and it reasonably appears that it cannot be
met.
The expenses of Keystone Quality and Keystone Diversified in connection
with the Reorganizations (including the cost of any proxy soliciting agent) will
be borne by FUNB whether or not the Reorganizations are consummated. The current
Trustees of Keystone Quality and Keystone Diversified, including those Trustees
not continuing to serve as Trustees of Evergreen Fixed Income Trust, will retain
their ability to make claims under their existing directors and officers
insurance policy for a period of three years following the consummation of the
Reorganizations.
If the Reorganization is not approved by shareholders of a Fund, the
Board of Trustees of Keystone Quality and Keystone Diversified, as applicable,
will consider other possible courses of action in the best interests of
shareholders.
Federal Income Tax Consequences
<PAGE>
Each Reorganization is intended to qualify for federal income tax
purposes as a tax-free reorganization under section 368(a) of the Code. As a
condition to the closing of a Reorganization, Keystone Quality and Keystone
Diversified will each receive an opinion of counsel to the effect that, on the
basis of the existing provisions of the Code, U.S. Treasury regulations issued
thereunder, current administrative rules, pronouncements and court decisions,
for federal income tax purposes, upon consummation of the Reorganization:
(1) The transfer of all of the assets of the Fund solely in exchange
for shares of Evergreen Diversified Bond and the assumption by Evergreen
Diversified Bond of certain identified liabilities, followed by the distribution
of Evergreen Diversified Bond's shares by the Fund in dissolution and
liquidation of the Fund, will constitute a "reorganization" within the meaning
of section 368(a)(1)(C) (with respect to Keystone Quality and 368(a)(1)(F) with
respect to Keystone Diversified) of the Code, and Evergreen Diversified Bond and
the Fund will each be a "party to a reorganization" within the meaning of
section 368(b) of the Code;
(2) No gain or loss will be recognized by the Fund on the transfer of
all of its assets to Evergreen Diversified Bond solely in exchange for Evergreen
Diversified Bond's shares and the assumption by Evergreen Diversified Bond of
certain identified liabilities of the Fund or upon the distribution of Evergreen
Diversified Bond's shares to the Fund's shareholders in exchange for their
shares of the Fund;
(3) The tax basis of the assets transferred will be the same to
Evergreen Diversified Bond as the tax basis of such assets to the Fund
immediately prior to the Reorganization, and the holding period of such assets
in the hands of Evergreen Diversified Bond will include the period during which
the assets were held by the Fund;
(4) No gain or loss will be recognized by Evergreen Diversified Bond
upon the receipt of the assets from the Fund solely in exchange for the shares
of Evergreen Diversified Bond and the assumption by Evergreen Diversified Bond
of certain identified liabilities of the Fund;
(5) No gain or loss will be recognized by the Fund's shareholders upon
the issuance of the shares of Evergreen Diversified Bond to them, provided they
receive solely such shares (including fractional shares) in exchange for their
shares of the Fund; and
(6) The aggregate tax basis of the shares of Evergreen Diversified
Bond, including any fractional shares, received by each of the shareholders of
the Fund pursuant to the Reorganization will be the same as the aggregate tax
basis of
<PAGE>
the shares of the Fund held by such shareholder immediately prior to the
Reorganization, and the holding period of the shares of Evergreen Diversified
Bond, including fractional shares, received by each such shareholder will
include the period during which the shares of the Fund exchanged therefor were
held by such shareholder (provided that the shares of the Fund were held as a
capital asset on the date of the Reorganization).
Opinions of counsel are not binding upon the Internal Revenue Service
or the courts. If a Reorganization is consummated but does not qualify as a
tax-free reorganization under the Code, shareholders of Keystone Quality and
Keystone Diversified would recognize a taxable gain or loss equal to the
difference between his or her tax basis in his or her Fund shares and the fair
market value of Evergreen Diversified Bond shares he or she received.
Shareholders of Keystone Quality and Keystone Diversified should consult their
tax advisers regarding the effect, if any, of the proposed Reorganization in
light of their individual circumstances. It is not anticipated that the
securities of the combined portfolio will be sold in significant amounts in
order to comply with the policies and investment practices of Evergreen
Diversified Bond. Since the foregoing discussion relates only to the federal
income tax consequences of the Reorganization, shareholders of Keystone Quality
and Keystone Diversified should also consult their tax advisers as to the state
and local tax consequences, if any, of the Reorganization.
Pro-forma Capitalization
The following table sets forth the capitalizations of Keystone Quality
and Keystone Diversified as of August 31, 1997 and the capitalization of
Evergreen Diversified Bond on a pro forma basis as of that date, giving effect
to the proposed acquisitions of assets at net asset value and the conversion of
certain Class B shares to Class A shares of Keystone Quality and Keystone
Diversified. As a newly created series of Evergreen Fixed Income Trust,
Evergreen Diversified Bond, immediately preceding the Closing Date, will have
nominal assets and liabilities. The pro forma data reflects an exchange ratio of
approximately 0.99 Class B shares of Evergreen Diversified Bond issued for each
share of Keystone Quality and an exchange ratio of approximately 1.00 Class B
share of Evergreen Diversified Bond issued for each share of Keystone
Diversified.
<TABLE>
<CAPTION>
Capitalization of Keystone Quality,
Keystone Diversified and Evergreen
Diversified Bond (Pro Forma)
<PAGE>
Evergreen
Diversified
Bond (After
Keystone Keystone Reorgani-
Quality Diversified zations)
-------- ----------- ------------
<S> <C> <C> <C>
Net Assets
Class A........................ N/A N/A
$555,959,918
Class B........................ $178,993,366 $457,700,855
$80,734,303
Class C........................ N/A N/A N/A
------------ ------------ ------------
Total Net
Assets....................... $178,993,366 $457,700,855 $636,694,121
Net Asset Value Per
Share
Class A........................ N/A N/A $15.42
Class B........................ $15.21 $15.42 $15.42
Class C........................ N/A N/A $15.42
Shares Outstanding
Class A........................ N/A N/A
36,059,000
Class B........................ 11,768,326 29,687,317
5,236,374
Class C........................ N/A N/A N/A
---------- ---------- ----------
All Classes.................... 11,768,326 29,687,317 41,295,374
</TABLE>
The table set forth above should not be relied upon to reflect the
number of shares to be received in the Reorganizations; the actual number of
shares to be received will depend upon the net asset value and number of shares
outstanding of each Fund at the time of the Reorganizations.
Shareholder Information
As of November 10, 1997 (the "Record Date"), there were 11,560,603.402
shares of Keystone Quality outstanding and 28,578,829.229 shares of Keystone
Diversified outstanding.
As of September 30, 1997 the officers and Trustees of Keystone Quality
beneficially owned as a group less than 1% of the outstanding shares of Keystone
Quality. To Keystone Quality's knowledge, the following persons owned
beneficially or of record more than 5% of Keystone Quality's total outstanding
shares as of September 30, 1997:
<PAGE>
<TABLE>
<CAPTION>
Percen- Percentage
tage of Shares of
of Class
Class Outstanding
Before After
No. of Reorgani- Reorgani-
Name and Address Shares zations zations
- ---------------- --------- ---------
------
<S> <C> <C> <C>
Merrill Lynch Pierce 1,339,441 11.61 Class A 3.30
Fenner & Smith Class B 2.90
For the Sole Benefit of
its Customers
Attn: Fund Administration
4800 Deer Lake Drive East
3rd Floor
Jacksonville, FL 32246-
6484
</TABLE>
As of September 30, 1997, the officers and Trustees of Keystone
Diversified beneficially owned as a group less than 1% of the outstanding shares
of Keystone Diversified. To Keystone Diversified's knowledge, the following
persons owned beneficially or of record more than 5% of Keystone Diversified's
total outstanding shares as of September 30, 1997:
Percentage of
Percen- Shares of
tage of Class
Shares Outstanding
After
No. of Before Reorgani-
Name and Address Shares Reorgani- zations
- ---------------- ------ zations ---------
---------
Merrill Lynch Pierce 3,927,911 13.45 Class A 9.62
Fenner & Smith Class B 10.09
For the Sole Benefit of
its Customers
Attn: Fund Administration
4800 Deer Lake Drive East
3rd Floor
Jacksonville, FL 32246-
6484
COMPARISON OF INVESTMENT OBJECTIVES AND POLICIES
The following discussion is based upon and qualified in its entirety by
the descriptions of the respective investment objectives, policies and
restrictions set forth in the respective Prospectuses and Statements of
Additional Information of the Funds. The investment objective, policies and
restrictions of Evergreen Diversified Bond can be found in the Prospectus of
Evergreen Diversified Bond under the caption "Investment Objectives and
Policies." The investment objectives, policies and restrictions of Keystone
Quality and Keystone Diversified can be found in the respective Prospectus of
each Fund under the caption "Investment Objective and Policies."
The investment objectives of Evergreen Diversified Bond and Keystone
Diversified are identical. These Funds seek maximum income without undue risk of
principal. Unlike Evergreen Diversified Bond, the investment objective of
Keystone Diversified cannot be changed without shareholder approval.
The following discussion of Evergreen Diversified Bond's investment
policies and restrictions applies equally to Keystone Diversified. Evergreen
Diversified Bond seeks maximum income by investing at least 65% of its total
assets in bonds which are debt instruments used by issuers to borrow money from
investors. The Fund invests in debt instruments that are normally characterized
by relatively liberal returns and moderate price fluctuations.
Such debt instruments which include both secured and unsecured
obligations will, at the time of investment, be rated within the four highest
categories by Standard & Poor's Ratings Group ("S&P") (AAA, AA, A and BBB), or
by Moody's Investors Service ("Moody's") (Aaa, Aa, A and Baa), or by Fitch
Investors Services, L.P. ("Fitch") (AAA, AA, A and BBB) or, if not rated or
rated under a different system, will be of comparable quality to instruments so
rated, as determined by the Fund's investment adviser. For a description of such
ratings, see Evergreen Diversified Bond's Statement of Additional Information.
The Fund may also invest up to 50% of its assets in foreign securities
and up to 35% of its assets in high yield, high risk bonds and similar
securities rated below BBB by S&P or Fitch or Baa by Moody's. Evergreen
Diversified Bond may also invest in limited partnerships, including master
limited partnerships, participations in bank loans, fixed and
<PAGE>
adjustable rate or stripped bonds, including zero coupon bonds and
payment-in-kind securities, debentures, notes, equipment trust certificates,
U.S. government securities and debt securities convertible into, or exchangeable
for, preferred or common stock. Evergreen Diversified Bond may also invest in
preferred stock, including adjustable rate preferred stock, and warrants which
can be used to purchase or create otherwise permissible investments.
When market conditions warrant, Evergreen Diversified Bond may invest
up to 100% of its assets for temporary defensive purposes in short-term
obligations. Such obligations may include master demand notes, commercial paper
and notes, bank deposits and other financial institution obligations.
Evergreen Diversified Bond may also invest in certain types of
derivative instruments, including interest rate swaps, equity swaps, index
swaps, currency swaps and caps and floors, in addition to forwards, futures,
options, mortgage-backed securities and other asset-backed securities.
The investment objective of Keystone Quality, which cannot be changed
without shareholder approval, is to provide shareholders with the highest
possible income consistent with the preservation of capital. The Fund invests at
least 65% of its assets in high grade bonds rated, at the time of purchase,
within the three highest categories (A or better) by S&P or Moody's or, if
unrated, determined to be of comparable quality by its investment adviser.
Keystone Quality may also invest a portion of its assets in bonds rated BBB by
S&P or Baa by Moody's and in short-term investments. Bonds include U.S.
government securities and municipal bonds. Keystone Quality may invest up to 25%
of its assets in investment grade convertible bonds and up to 25% of its assets
in foreign securities issued by issuers located in developing countries as well
as certain countries with emerging markets.
Short-term investments in which Keystone Quality may invest, which must
mature within one year of their purchase, consist of U.S. government securities;
instruments of banks having assets of at least $500 million, including U.S.
branches of foreign banks and foreign branches of U.S. banks, such as
certificates of deposit, demand and time deposits and bankers' acceptances; high
grade commercial paper; and repurchase agreements secured by U.S. government
securities.
Keystone Quality may also invest in various derivative instruments as
well as limited partnerships, including master limited partnerships, and other
debt securities similar to those discussed above with respect to Evergreen
Diversified Bond.
<PAGE>
The principal differences between Evergreen Diversified Bond and
Keystone Diversified on the one hand, and Keystone Quality on the other, relate
to the minimum credit quality for 65% of the Funds' investments (BBB or better
for Evergreen Diversified Bond and Keystone Diversified and A or better for
Keystone Quality) and Evergreen Diversified Bond's and Keystone Diversified's
ability to invest in high yield, high risk debt securities.
The characteristics of each investment policy and the associated risks
are described in each Fund's respective Prospectus and Statement of Additional
Information. The Funds have other investment policies and restrictions which are
also set forth in the Prospectus and Statement of Additional Information of each
Fund.
COMPARATIVE INFORMATION ON SHAREHOLDERS' RIGHTS
Forms of Organization
Evergreen Fixed Income Trust, Keystone Quality and Keystone Diversified
are open-end management investment companies registered with the SEC under the
1940 Act, which continuously offer shares to the public. Each of Keystone
Quality and Keystone Diversified is organized as a Pennsylvania common law
trust. Evergreen Fixed Income Trust is organized as a Delaware business trust.
Each Trust is governed by a Declaration of Trust, By-Laws and a Board of
Trustees. Each Trust is also governed by applicable Delaware, Pennsylvania and
federal law. Evergreen Diversified Bond is a series of Evergreen Fixed Income
Trust.
Capitalization
The beneficial interests in Evergreen Diversified Bond are represented
by an unlimited number of transferable shares of beneficial interest $.001 par
value per share. The beneficial interests in Keystone Quality and Keystone
Diversified are represented by an unlimited number of transferable shares of
beneficial interest with a $1.00 par value per share. The respective Declaration
of Trust under which each Fund has been established permits the Trustees to
allocate shares into an unlimited number of series, and classes thereof, with
rights determined by the Trustees, all without shareholder approval. Fractional
shares may be issued. Except with respect to Evergreen Diversified Bond where
each share of the Fund is entitled to one vote for each dollar of net asset
value applicable to such share, each Fund's shares have equal voting rights with
respect to matters affecting shareholders of all classes of each Fund and
represent equal proportionate interests in the assets belonging to each class of
shares of the Funds. Shareholders of each Fund are entitled to receive dividends
and other
<PAGE>
amounts as determined by the Trustees. Shareholders of each Fund vote
separately, by class, as to matters, such as approval of or amendments to Rule
12b-1 distribution plans, that affect only their particular class and by series
as to matters, such as approval of or amendments to investment advisory
agreements or proposed reorganizations, that affect only their particular
series.
Shareholder Liability
Under Pennsylvania law, shareholders of a common law trust could, under
certain circumstances, be held personally liable for the obligations of the
trust. However, the respective Declaration of Trust under which Keystone Quality
and Keystone Diversified was established disclaims shareholder liability for
acts or obligations of the series and requires that notice of such disclaimer be
given in each agreement, obligation or instrument entered into or executed by
the Fund or the Trustees. Each Declaration of Trust provides for indemnification
out of the series property for all losses and expenses of any shareholder held
personally liable for the obligations of the series. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
considered remote since it is limited to circumstances in which a disclaimer is
inoperative and the series or the Trust itself would be unable to meet its
obligations.
Under Delaware law, shareholders of a Delaware business trust are
entitled to the same limitation of personal liability extended to stockholders
of Delaware corporations. No similar statutory or other authority limiting
business trust shareholder liability exists in any other state. As a result, to
the extent that Evergreen Fixed Income Trust or a shareholder is subject to the
jurisdiction of courts in those states, the courts may not apply Delaware law,
and may thereby subject shareholders of a Delaware trust to liability. To guard
against this risk, the Declaration of Trust of Evergreen Fixed Income Trust: (a)
provides that any written obligation of the Trust may contain a statement that
such obligation may only be enforced against the assets of the Trust or the
particular series in question and the obligation is not binding upon the
shareholders of the Trust; however, the omission of such a disclaimer will not
operate to create personal liability for any shareholder; and (b) provides for
indemnification out of Trust property of any shareholder held personally liable
for the obligations of Evergreen Fixed Income Trust. Accordingly, the risk of a
shareholder of the Trust incurring financial loss beyond that shareholder's
investment because of shareholder liability is limited to circumstances in
which: (i) the court refuses to apply Delaware law; (ii) no contractual
limitation of liability was in effect; and (iii) the Trust itself would be
unable to meet its obligations. In light of Delaware law, the nature of the
<PAGE>
Trust's business, and the nature of its assets, the risk of personal liability
to a shareholder of Evergreen Fixed Income Trust is remote.
Shareholder Meetings and Voting Rights
Neither Evergreen Fixed Income Trust on behalf of Evergreen Diversified
Bond, Keystone Quality nor Keystone Diversified is required to hold annual
meetings of shareholders. However, a meeting of shareholders for the purpose of
voting upon the question of removal of a Trustee must be called when requested
in writing by the holders of at least 10% of the outstanding shares. In
addition, each is required to call a meeting of shareholders for the purpose of
electing Trustees if, at any time, less than a majority of the Trustees then
holding office were elected by shareholders. Each Trust currently does not
intend to hold regular shareholder meetings. Each Trust does not permit
cumulative voting. Except when a larger quorum is required by applicable law,
twenty-five percent (25%) of Evergreen Diversified Bond and, with respect to
Keystone Quality and Keystone Diversified, a majority of the outstanding shares
entitled to vote on a matter, constitutes a quorum for consideration of such
matter. In all cases, a majority of the shares present and entitled to vote is
sufficient to act on a matter (unless otherwise specifically required by the
applicable governing documents or other law, including the 1940 Act).
Under the Declaration of Trust of Evergreen Fixed Income Trust, each
share of Evergreen Diversified Bond is entitled to one vote for each dollar of
net asset value applicable to each share. Under the current voting provisions
governing Keystone Quality and Keystone Diversified, each share is entitled to
one vote. Over time, the net asset values of the Funds have changed in relation
to one another and are expected to continue to do so in the future. Because of
the divergence in net asset values, a given dollar investment in a Fund with a
lower net asset value will purchase more shares and, under the Funds' current
voting provisions, have more votes than the same investment in a Fund with a
higher net asset value. Under the Declaration of Trust of Evergreen Fixed Income
Trust, voting power is related to the dollar value of the shareholder's
investment rather than to the number of shares held.
Liquidation or Dissolution
In the event of the liquidation of Evergreen Diversified Bond, Keystone
Quality and Keystone Diversified, the shareholders are entitled to receive,
when, and as declared by the Trustees, the excess of the assets belonging to
such Fund or attributable to the class over the liabilities belonging to the
Fund or attributable to the class. In either case, the assets so distributable
to shareholders of the Fund will be
<PAGE>
distributed among the shareholders in proportion to the number of shares of a
class of the Fund held by them and recorded on the books of the Fund.
Liability and Indemnification of Trustees
The Declaration of Trust of each of Keystone Quality and Keystone
Diversified provides that a Trustee will be liable only for his own willful
defaults, but nothing in the Declaration of Trust protects a Trustee against any
liability to which he or she would otherwise be subject by reason of willful
misfeasance, bad faith, gross negligence, or reckless disregard of the duties
involved in the conduct of his office. The Declaration of Trust provides that a
present or former Trustee or officer is entitled to indemnification against
liabilities and expenses with respect to claims related to his or her position
with the Fund, unless such Trustee or officer shall have been adjudicated not to
have acted in good faith in the reasonable belief that his or her action was in
the best interest of the Fund, or unless such Trustee or officer is otherwise
subject to liability to the Fund or its shareholders by reason of willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of his office. In the event of settlement, no such
indemnification shall be provided unless there has been a determination that
such Trustee or officer appears to have acted in good faith in the reasonable
belief that his action was in the best interests of the Fund and that such
indemnification would not protect such person against any liability to the Fund
to which such person would otherwise be subject by reason of willful
misfeasance, bad faith, gross negligence, or reckless disregard of the duties
involved in the conduct of his office.
Under the Declaration of Trust of Evergreen Fixed Income Trust, a
Trustee is liable to the Trust and its shareholders only for such Trustee's own
willful misfeasance, bad faith, gross negligence, or reckless disregard of the
duties involved in the conduct of the office of Trustee or the discharge of such
Trustee's functions. As provided in the Declaration of Trust, each Trustee of
the Trust is entitled to be indemnified against all liabilities against him or
her, including the costs of litigation, unless it is determined that the Trustee
(i) did not act in good faith in the reasonable belief that such Trustee's
action was in or not opposed to the best interests of the Trust; (ii) had acted
with willful misfeasance, bad faith, gross negligence or reckless disregard of
such Trustee's duties; and (iii) in a criminal proceeding, had reasonable cause
to believe that such Trustee's conduct was unlawful (collectively, "disabling
conduct"). A determination that the Trustee did not engage in disabling conduct
and is, therefore, entitled to indemnification may be based upon the outcome of
a court action or administrative
<PAGE>
proceeding or by (a) a vote of a majority of those Trustees who are neither
"interested persons" within the meaning of the 1940 Act nor parties to the
proceeding or (b) an independent legal counsel in a written opinion. The Trust
may also advance money for such litigation expenses provided that the Trustee
undertakes to repay the Trust if his or her conduct is later determined to
preclude indemnification and certain other conditions are met.
The foregoing is only a summary of certain characteristics of the
operations of the Declarations of Trust, By-Laws, Delaware and Pennsylvania law
and is not a complete description of those documents or law. Shareholders should
refer to the provisions of such Declarations of Trust, By-Laws, Delaware and
Pennsylvania law directly for more complete information.
ADDITIONAL INFORMATION
Evergreen Diversified Bond. Information concerning the operation and
management of Evergreen Diversified Bond is incorporated herein by reference
from the Prospectus dated November 10, 1997, a copy of which is enclosed, and
Statement of Additional Information dated November 10, 1997. A copy of such
Statement of Additional Information is available upon request and without charge
by writing to Evergreen Diversified Bond at the address listed on the cover page
of this Prospectus/Proxy Statement or by calling toll-free 1-800-343- 2898.
Keystone Quality. Information about the Fund is included in its current
Prospectus dated February 28, 1997, as supplemented, and in the Statement of
Additional Information of the same date that have been filed with the SEC, all
of which are incorporated herein by reference. A copy of the Prospectus and
Statement of Additional Information are available upon request and without
charge by writing to the address listed on the cover page of this
Prospectus/Proxy Statement or by calling toll-free 1-800-343-2898.
Keystone Diversified. Information about the Fund is included in its
current Prospectus dated December 10, 1996, as supplemented, and in the
Statement of Additional Information of the same date that have been filed with
the SEC, all of which are incorporated herein by reference. A copy of the
Prospectus and Statement of Additional Information are available upon request
and without charge by writing to the address listed on the cover page of this
Prospectus/Proxy Statement or by calling toll-free 1-800-343-2898.
Evergreen Diversified Bond, Keystone Quality and Keystone Diversified
are each subject to the informational requirements of the Securities Exchange
Act of 1934 and the 1940 Act, and
<PAGE>
in accordance therewith file reports and other information, including proxy
material and charter documents, with the SEC. These items can be inspected and
copies obtained at the Public Reference Facilities maintained by the SEC at 450
Fifth Street, N.W., Washington, D.C. 20549, and at the SEC's Regional Offices
located at Northwest Atrium Center, 500 West Madison Street, Chicago, Illinois
60661-2511 and Seven World Trade Center, Suite 1300, New York, New York 10048.
VOTING INFORMATION CONCERNING THE MEETINGS
This Prospectus/Proxy Statement is furnished in connection with a
solicitation of proxies by the Trustees of Keystone Quality and Keystone
Diversified to be used at each Special Meeting of Shareholders to be held at
3:00 p.m., January 6, 1998, at the offices of the Evergreen Keystone Funds, 200
Berkeley Street, Boston, Massachusetts 02116, and at any adjournments thereof.
This Prospectus/Proxy Statement, along with a Notice of the meeting and a proxy
card, is first being mailed to shareholders of Keystone Quality and Keystone
Diversified on or about November 14, 1997. Only shareholders of record as of the
close of business on the Record Date will be entitled to notice of, and to vote
at, the Meeting or any adjournment thereof. The holders of a majority of the
outstanding shares entitled to vote of each Fund at the close of business on the
Record Date present in person or represented by proxy will constitute a quorum
for the Meeting. If the enclosed form of proxy is properly executed and returned
in time to be voted at the Meeting, the proxies named therein will vote the
shares represented by the proxy in accordance with the instructions marked
thereon. Unmarked proxies will be voted FOR the proposed Reorganization and FOR
any other matters deemed appropriate. Proxies that reflect abstentions and
"broker non-votes" (i.e., shares held by brokers or nominees as to which (i)
instructions have not been received from the beneficial owners or the persons
entitled to vote or (ii) the broker or nominee does not have discretionary
voting power on a particular matter) will be counted as shares that are present
and entitled to vote for purposes of determining the presence of a quorum, but
will have the effect of being counted as votes against the Plan since the vote
required is a majority of the shares present and entitled to vote. A proxy may
be revoked at any time on or before the Meeting by written notice to the
Secretary of Keystone Quality or Keystone Diversified, as applicable, 200
Berkeley Street, Boston, Massachusetts 02116. Unless revoked, all valid proxies
will be voted in accordance with the specifications thereon or, in the absence
of such specifications, FOR approval of the Plan and the Reorganization
contemplated thereby.
Approval of each Plan will require the affirmative vote of a majority
of the shares present and entitled to vote at
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Meetings at which a quorum of each Fund's shares is present. Each full share
outstanding is entitled to one vote and each fractional share outstanding is
entitled to a proportionate share of one vote.
Proxy solicitations will be made primarily by mail, but proxy
solicitations may also be made by telephone, telegraph or personal solicitations
conducted by officers and employees of FUNB, its affiliates or other
representatives of Keystone Quality and Keystone Diversified (who will not be
paid for their soliciting activities). Shareholder Communications Corporation
("SCC") and its agents have been engaged by Keystone Quality and Keystone
Diversified to assist in soliciting proxies, and may call shareholders to ask if
they would be willing to authorize SCC to execute a proxy on their behalf
authorizing the voting of their shares in accordance with the instructions given
over the telephone by the shareholders. In addition, shareholders may call SCC
at 1-800-733-8481 extension 404 between the hours of 9:00 a.m. and 11:00 p.m.
Eastern time in order to initiate the processing of their votes by telephone.
SCC will utilize a telephone vote solicitation procedure designed to
authenticate the shareholder's identity by asking the shareholder to provide his
or her social security number (in the case of an individual) or taxpayer
identification number (in the case of an entity). The shareholder's telephone
instructions will be implemented in a proxy executed by SCC and a confirmation
will be sent to the shareholder to ensure that the vote has been authorized in
accordance with the shareholder's instructions. Although a shareholder's vote
may be solicited and cast in this manner, each shareholder will receive a copy
of this Prospectus/Proxy Statement and may vote by mail using the enclosed proxy
card. The Funds believe that this telephonic voting system complies with
applicable law and have reviewed opinions of counsel to that effect.
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If you wish to participate in the Meeting, but do not wish to give your
proxy by telephone, you may still submit the proxy card included with this
Prospectus/Proxy Statement or attend in person. Any proxy given by you, whether
in writing or by telephone, is revocable.
In the event that sufficient votes to approve a Reorganization are not
received by January 6, 1998, the persons named as proxies may propose one or
more adjournments of the Meeting to permit further solicitation of proxies. In
determining whether to adjourn the Meeting, the following factors may be
considered: the percentage of votes actually cast, the percentage of negative
votes actually cast, the nature of any further solicitation and the information
to be provided to shareholders with respect to the reasons for the solicitation.
Any such adjournment will require an affirmative vote by the holders of a
majority of the shares present in person or by proxy and entitled to vote at the
Meeting. The persons named as proxies will vote upon such adjournment after
consideration of all circumstances which may bear upon a decision to adjourn the
Meeting.
A shareholder who objects to a proposed Reorganization will not be
entitled under either Pennsylvania law or the Declaration of Trust of Keystone
Quality or Keystone Diversified, as applicable, to demand payment for, or an
appraisal of, his or her shares. However, shareholders should be aware that the
Reorganizations as proposed are not expected to result in recognition of gain or
loss to shareholders for federal income tax purposes and that, if the
Reorganizations are consummated, shareholders will be free to redeem the shares
of Evergreen Diversified Bond which they receive in the transaction at their
then-current net asset value. Shares of Keystone Quality and Keystone
Diversified may be redeemed at any time prior to the consummation of the
Reorganizations. Shareholders of Keystone Quality and Keystone Diversified may
wish to consult their tax advisers as to any differing consequences of redeeming
Fund shares prior to the
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Reorganizations or exchanging such shares in the Reorganizations.
Keystone Quality and Keystone Diversified do not hold annual
shareholder meetings. If a Reorganization is not approved, shareholders wishing
to submit proposals for consideration for inclusion in a proxy statement for a
subsequent shareholder meeting should send their written proposals to the
Secretary of Keystone Quality or Keystone Diversified, as applicable, at the
address set forth on the cover of this Prospectus/Proxy Statement such that they
will be received by the Funds in a reasonable period of time prior to any such
meeting.
The votes of the shareholders of Evergreen Diversified Bond are not
being solicited by this Prospectus/Proxy Statement and are not required to carry
out the Reorganizations.
NOTICE TO BANKS, BROKER-DEALERS AND VOTING TRUSTEES AND THEIR NOMINEES.
Please advise Keystone Quality and Keystone Diversified whether other persons
are beneficial owners of shares for which proxies are being solicited and, if
so, the number of copies of this Prospectus/Proxy Statement needed to supply
copies to the beneficial owners of the respective shares.
FINANCIAL STATEMENTS AND EXPERTS
The financial statements of Keystone Quality as of October 31, 1996,
and the financial statements and financial highlights for the periods indicated
therein, have been incorporated by reference herein and in the Registration
Statement in reliance upon the report of KPMG Peat Marwick LLP, independent
certified public accountants, incorporated by reference herein, and upon the
authority of said firm as experts in accounting and auditing.
The financial statements of Keystone Diversified as of August 31, 1997,
and the financial statements and financial highlights for the periods indicated
therein, have been incorporated by reference herein and in the Registration
Statement in reliance upon the report of KPMG Peat Marwick LLP, independent
certified public accountants, incorporated by reference herein, and upon the
authority of said firm as experts in accounting and auditing.
LEGAL MATTERS
Certain legal matters concerning the issuance of shares of Evergreen
Diversified Bond will be passed upon by Sullivan & Worcester LLP, Washington,
D.C.
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OTHER BUSINESS
The Trustees of Keystone Quality and Keystone Diversified do not intend
to present any other business at the Meeting. If, however, any other matters are
properly brought before the Meeting, the persons named in the accompanying form
of proxy will vote thereon in accordance with their judgment.
THE RESPECTIVE TRUSTEES OF KEYSTONE QUALITY AND KEYSTONE DIVERSIFIED
RECOMMEND APPROVAL OF EACH RESPECTIVE PLAN AND ANY UNMARKED PROXIES WITHOUT
INSTRUCTIONS TO THE CONTRARY WILL BE VOTED IN FAVOR OF APPROVAL OF THE PLANS.
November 14, 1997
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EXHIBIT A-1
AGREEMENT AND PLAN OF REORGANIZATION
THIS AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") is made as
of this 30th day of September, 1997, by and between the Evergreen Fixed Income
Trust, a Delaware business trust, with its principal place of business at 200
Berkeley Street, Boston, Massachusetts 02116 (the "Trust"), with respect to its
Evergreen Diversified Bond Fund series (the "Acquiring Fund"), and Keystone
Quality Bond Fund (B-1), a Pennsylvania common law trust ("Keystone Trust"),
with its principal place of business at 200 Berkeley Street, Boston,
Massachusetts 02116, with respect to its Keystone Quality Bond Fund (B-1) series
(the "Selling Fund").
This Agreement is intended to be, and is adopted as, a plan of
reorganization and liquidation within the meaning of Section 368 (a)(1)(C) of
the United States Internal Revenue Code of 1986, as amended (the "Code"). The
reorganization (the "Reorganization") will consist of (i) the transfer of all of
the assets of the Selling Fund in exchange solely for shares of beneficial
interest, $.001 par value per share, of the Acquiring Fund (the "Acquiring Fund
Shares"); (ii) the assumption by the Acquiring Fund of certain identified
liabilities of the Selling Fund; and (iii) the distribution, after the Closing
Date hereinafter referred to, of the Acquiring Fund Shares to the shareholders
of the Selling Fund in liquidation of the Selling Fund as provided herein, all
upon the terms and conditions hereinafter set forth in this Agreement.
WHEREAS, the Selling Fund is the sole investment series of, and the
Acquiring Fund is a separate investment series of, an open-end, registered
investment company of the management type, and the Selling Fund owns securities
that generally are assets of the character in which the Acquiring Fund is
permitted to invest;
WHEREAS, both Funds are authorized to issue their shares
of beneficial interest;
WHEREAS, the Trustees of the Trust have determined that the exchange of
all of the assets of the Selling Fund for Acquiring Fund Shares and the
assumption of certain identified liabilities of the Selling Fund by the
Acquiring Fund on the terms and conditions hereinafter set forth are in the best
interests of the Acquiring Fund's shareholders;
WHEREAS, the Trustees of Keystone Trust have determined that the
Selling Fund should exchange all of its assets and certain identified
liabilities for Acquiring Fund Shares and that the interests of the existing
shareholders of the Selling
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Fund will not be diluted as a result of the transactions
contemplated herein;
NOW, THEREFORE, in consideration of the premises and of the covenants
and agreements hereinafter set forth, the parties hereto covenant and agree as
follows:
ARTICLE I
TRANSFER OF ASSETS OF THE SELLING FUND IN EXCHANGE FOR
THE ACQUIRING FUND SHARES AND ASSUMPTION OF SELLING FUND
LIABILITIES AND LIQUIDATION OF THE SELLING FUND
1.1 THE EXCHANGE. Subject to the terms and conditions herein set forth
and on the basis of the representations and warranties contained herein, the
Selling Fund agrees to transfer all of the Selling Fund's assets as set forth in
paragraph 1.2 to the Acquiring Fund. The Acquiring Fund agrees in exchange
therefor (i) to deliver to the Selling Fund the number of Acquiring Fund Shares,
including fractional Acquiring Fund Shares, determined by multiplying the shares
outstanding of each class of the Selling Fund by the ratio computed by dividing
the net asset value per share of each such class of the Selling Fund by the net
asset value per share of the corresponding class of Acquiring Fund Shares
computed in the manner and as of the time and date set forth in paragraph 2.2;
and (ii) to assume certain identified liabilities of the Selling Fund, as set
forth in paragraph 1.3. Such transactions shall take place at the closing
provided for in paragraph 3.1 (the "Closing Date").
1.2 ASSETS TO BE ACQUIRED. The assets of the Selling Fund to be
acquired by the Acquiring Fund shall consist of all property, including, without
limitation, all cash, securities, commodities, and futures interests and
dividends or interest receivables, that is owned by the Selling Fund and any
deferred or prepaid expenses shown as an asset on the books of the Selling Fund
on the Closing Date.
The Selling Fund has provided the Acquiring Fund with its most recent
audited financial statements, which contain a list of all of Selling Fund's
assets as of the date thereof. The Selling Fund hereby represents that as of the
date of the execution of this Agreement there have been no changes in its
financial position as reflected in said financial statements other than those
occurring in the ordinary course of its business in connection with the purchase
and sale of securities and the payment of its normal operating expenses. The
Selling Fund reserves the right to sell any of such securities, but will not,
without the prior written approval of the Acquiring Fund, acquire any additional
securities other than securities of the type in which the Acquiring Fund is
permitted to invest.
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The Acquiring Fund will, within a reasonable time prior to the Closing
Date, furnish the Selling Fund with a statement of the Acquiring Fund's
investment objectives, policies, and restrictions and a list of the securities,
if any, on the Selling Fund's list referred to in the second sentence of this
paragraph that do not conform to the Acquiring Fund's investment objectives,
policies, and restrictions. In the event that the Selling Fund holds any
investments that the Acquiring Fund may not hold, the Selling Fund will dispose
of such securities prior to the Closing Date. In addition, if it is determined
that the Selling Fund and the Acquiring Fund portfolios, when aggregated, would
contain investments exceeding certain percentage limitations imposed upon the
Acquiring Fund with respect to such investments, the Selling Fund if requested
by the Acquiring Fund will dispose of a sufficient amount of such investments as
may be necessary to avoid violating such limitations as of the Closing Date.
1.3 LIABILITIES TO BE ASSUMED. The Selling Fund will endeavor to
discharge all of its known liabilities and obligations prior to the Closing
Date. Except as specifically provided in this paragraph 1.3, the Acquiring Fund
shall assume the liabilities, expenses, costs, charges and reserves reflected on
a Statement of Assets and Liabilities of the Selling Fund prepared on behalf of
the Selling Fund, as of the Valuation Date (as defined in paragraph 2.1), in
accordance with generally accepted accounting principles consistently applied
from the prior audited period. The Acquiring Fund shall assume only those
liabilities of the Selling Fund reflected in such Statement of Assets and
Liabilities and shall not except as specifically provided in this paragraph 1.3
assume any other liabilities, whether absolute or contingent, known or unknown,
accrued or unaccrued, all of which shall remain the obligation of the Selling
Fund. The Acquiring Fund hereby agrees with Keystone Trust and each Trustee of
Keystone Trust: (i) to indemnify each Trustee of Keystone Trust against all
liabilities and expenses referred to in the indemnification provisions of
Keystone Trust's Declaration of Trust and By-Laws, to the extent provided
therein, incurred by any Trustee of Keystone Trust; and (ii) in addition to the
indemnification provided in (i) above, to indemnify each Trustee of Keystone
Trust against all liabilities and expenses and pay the same as they arise and
become due, without any exception, limitation or requirement of approval by any
person, and without any right to require repayment thereof by any such Trustee
(unless such Trustee has had the same repaid to him or her) based upon any
subsequent or final disposition or findings made in connection therewith or
otherwise, if such action, suit or other proceeding involves such Trustee's
participation in authorizing or permitting or acquiescing in, directly or
indirectly, by action or inaction, the making of any distribution in any manner
of all or any assets of the Selling Fund without making
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provision for the payment of any liabilities of any kind, fixed or contingent,
of the Selling Fund, which liabilities were not actually and consciously
personally known to such Trustee to exist at the time of such Trustee's
participation in so authorizing or permitting or acquiescing in the making of
any such distribution.
In addition, upon completion of the Reorganization, for purposes of
calculating the maximum amount permitted to be charged to the Acquiring Fund
under the National Association of Securities Dealers, Inc. Conduct Rule 2830,
minus the amount of the sales charges paid or accrued (including asset based
sales charges), plus permitted interest ("Aggregate NASD Cap"), the Acquiring
Fund will add to its Aggregate NASD Cap immediately prior to the Reorganization
the Aggregate NASD Cap of the Selling Fund immediately prior to the
Reorganization.
1.4 LIQUIDATION AND DISTRIBUTION. On or as soon after the Closing Date
as is conveniently practicable (the "Liquidation Date"), (a) the Selling Fund
will liquidate and distribute pro rata to the Selling Fund's shareholders of
record, determined as of the close of business on the Valuation Date (the
"Selling Fund Shareholders"), the Acquiring Fund Shares received by the Selling
Fund pursuant to paragraph 1.1; and (b) the Selling Fund will thereupon proceed
to dissolve as set forth in paragraph 1.8 below. Such liquidation and
distribution will be accomplished by the transfer of the Acquiring Fund Shares
then credited to the account of the Selling Fund on the books of the Acquiring
Fund to open accounts on the share records of the Acquiring Fund in the names of
the Selling Fund Shareholders and representing the respective pro rata number of
the Acquiring Fund Shares due such shareholders. All issued and outstanding
shares of the Selling Fund will simultaneously be canceled on the books of the
Selling Fund. The Acquiring Fund shall not issue certificates representing the
Acquiring Fund Shares in connection with such exchange.
1.5 OWNERSHIP OF SHARES. Ownership of Acquiring Fund Shares will be
shown on the books of the Acquiring Fund's transfer agent. Shares of the
Acquiring Fund will be issued in the manner described in the combined Prospectus
and Proxy Statement on Form N-14 to be distributed to shareholders of the
Selling Fund as described in paragraph 5.7.
1.6 TRANSFER TAXES. Any transfer taxes payable upon issuance of the
Acquiring Fund Shares in a name other than the registered holder of the Selling
Fund shares on the books of the Selling Fund as of that time shall, as a
condition of such issuance and transfer, be paid by the person to whom such
Acquiring Fund Shares are to be issued and transferred.
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1.7 REPORTING RESPONSIBILITY. Any reporting responsibility of the
Selling Fund is and shall remain the responsibility of the Selling Fund up to
and including the Closing Date and such later date on which the Selling Fund is
terminated.
1.8 TERMINATION. The Selling Fund shall be terminated promptly
following the Closing Date and the making of all distributions pursuant to
paragraph 1.4.
ARTICLE II
VALUATION
2.1 VALUATION OF ASSETS. The value of the Selling Fund's assets to be
acquired by the Acquiring Fund hereunder shall be the value of such assets
computed as of the close of business on the New York Stock Exchange on the
business day next preceding the Closing Date (such time and date being
hereinafter called the "Valuation Date"), using the valuation procedures set
forth in the Trust's Declaration of Trust and the Acquiring Fund's then current
prospectus and statement of additional information or such other valuation
procedures as shall be mutually agreed upon by the parties.
2.2 VALUATION OF SHARES. The net asset value per share of the Acquiring
Fund Shares shall be the net asset value per share computed as of the close of
business on the New York Stock Exchange on the Valuation Date, using the
valuation procedures set forth in the Trust's Declaration of Trust and the
Acquiring Fund's then current prospectus and statement of additional
information.
2.3 SHARES TO BE ISSUED. The number of the Acquiring Fund Shares of
each class to be issued (including fractional shares, if any) in exchange for
the Selling Fund's assets shall be determined by multiplying the shares
outstanding of each class of the Selling Fund by the ratio computed by dividing
the net asset value per share of the Selling Fund attributable to each of its
classes by the net asset value per share of the respective classes of the
Acquiring Fund determined in accordance with paragraph 2.2.
2.4 DETERMINATION OF VALUE. All computations of value shall be made by
State Street Bank and Trust Company in accordance with its regular practice in
pricing the shares and assets of the Acquiring Fund.
ARTICLE III
CLOSING AND CLOSING DATE
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3.1 CLOSING DATE. The Closing (the "Closing") shall take place on or
about January 23, 1998 or such other date as the parties may agree to in writing
(the "Closing Date"). All acts taking place at the Closing shall be deemed to
take place simultaneously immediately prior to the opening of business on the
Closing Date unless otherwise provided. The Closing shall be held as of 9:00
a.m. at the offices of the Evergreen Keystone Funds, 200 Berkeley Street,
Boston, MA 02116, or at such other time and/or place as the parties may agree.
3.2 CUSTODIAN'S CERTIFICATE. State Street Bank and Trust Company, as
custodian for the Selling Fund (the "Custodian"), shall deliver at the Closing a
certificate of an authorized officer stating that (a) the Selling Fund's
portfolio securities, cash, and any other assets shall have been delivered in
proper form to the Acquiring Fund on the Closing Date; and (b) all necessary
taxes including all applicable federal and state stock transfer stamps, if any,
shall have been paid, or provision for payment shall have been made, in
conjunction with the delivery of portfolio securities by the Selling Fund.
3.3 EFFECT OF SUSPENSION IN TRADING. In the event that on the Valuation
Date (a) the New York Stock Exchange or another primary trading market for
portfolio securities of the Acquiring Fund or the Selling Fund shall be closed
to trading or trading thereon shall be restricted; or (b) trading or the
reporting of trading on said Exchange or elsewhere shall be disrupted so that
accurate appraisal of the value of the net assets of the Acquiring Fund or the
Selling Fund is impracticable, the Valuation Date shall be postponed until the
first business day after the day when trading shall have been fully resumed and
reporting shall have been restored.
3.4 TRANSFER AGENT'S CERTIFICATE. Evergreen Service Company, as
transfer agent for the Selling Fund as of the Closing Date ("ESC"), shall
deliver at the Closing a certificate of an authorized officer stating that its
records contain the names and addresses of the Selling Fund Shareholders and the
number and percentage ownership of outstanding shares owned by each such
shareholder immediately prior to the Closing. The Acquiring Fund shall issue and
deliver or cause ESC, its transfer agent as of the Closing Date, to issue and
deliver a confirmation evidencing the Acquiring Fund Shares to be credited on
the Closing Date to the Secretary of Keystone Trust on behalf of the Selling
Fund or provide evidence satisfactory to the Selling Fund that such Acquiring
Fund Shares have been credited to the Selling Fund's account on the books of the
Acquiring Fund. At the Closing, each party shall deliver to the other such bills
of sale, checks, assignments, share certificates, if any,
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receipts and other documents as such other party or its
counsel may reasonably request.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES
4.1 REPRESENTATIONS OF THE SELLING FUND. The Selling
Fund represents and warrants to the Acquiring Fund as follows:
(a) The Selling Fund is the sole investment series of a
Pennsylvania common law trust duly organized, validly existing, and in good
standing under the laws of The Commonwealth of Pennsylvania.
(b) The Selling Fund is the sole investment series of a
Pennsylvania common law trust that is registered as an investment company
classified as a management company of the open-end type, and its registration
with the Securities and Exchange Commission (the "Commission") as an investment
company under the Investment Company Act of 1940, as amended (the "1940 Act"),
is in full force and effect.
(c) The current prospectus and statement of additional
information of the Selling Fund conform in all material respects to the
applicable requirements of the Securities Act of 1933, as amended (the "1933
Act"), and the 1940 Act and the rules and regulations of the Commission
thereunder and do not include any untrue statement of a material fact or omit to
state any material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they were made,
not misleading.
(d) The Selling Fund is not, and the execution, delivery, and
performance of this Agreement (subject to shareholder approval) will not result,
in violation of any provision of Keystone Trust's Declaration of Trust or
By-Laws or of any material agreement, indenture, instrument, contract, lease, or
other undertaking to which the Selling Fund is a party or by which it is bound.
(e) The Selling Fund has no material contracts or other
commitments (other than this Agreement) that will be terminated with liability
to it prior to the Closing Date.
(f) Except as otherwise disclosed in writing to and accepted
by the Acquiring Fund, no litigation, administrative proceeding, or
investigation of or before any court or governmental body is presently pending
or to its knowledge threatened against the Selling Fund or any of its properties
or assets, which, if adversely determined, would materially and adversely affect
its financial condition, the conduct of
<PAGE>
its business, or the ability of the Selling Fund to carry out the transactions
contemplated by this Agreement. The Selling Fund knows of no facts that might
form the basis for the institution of such proceedings and is not a party to or
subject to the provisions of any order, decree, or judgment of any court or
governmental body that materially and adversely affects its business or its
ability to consummate the transactions herein contemplated.
(g) The financial statements of the Selling Fund at October
31, 1996 are in accordance with generally accepted accounting principles
consistently applied, and such statements (copies of which have been furnished
to the Acquiring Fund) fairly reflect the financial condition of the Selling
Fund as of such date, and there are no known contingent liabilities of the
Selling Fund as of such date not disclosed therein.
(h) Since October 31, 1996 there has not been any material
adverse change in the Selling Fund's financial condition, assets, liabilities,
or business other than changes occurring in the ordinary course of business, or
any incurrence by the Selling Fund of indebtedness maturing more than one year
from the date such indebtedness was incurred, except as otherwise disclosed to
and accepted by the Acquiring Fund. For the purposes of this subparagraph (h), a
decline in the net asset value of the Selling Fund shall not constitute a
material adverse change.
(i) At the Closing Date, all federal and other tax returns and
reports of the Selling Fund required by law to have been filed by such dates
shall have been filed, and all federal and other taxes shown due on said returns
and reports shall have been paid, or provision shall have been made for the
payment thereof. To the best of the Selling Fund's knowledge, no such return is
currently under audit, and no assessment has been asserted with respect to such
returns.
(j) For each fiscal year of its operation, the Selling Fund
has met the requirements of Subchapter M of the Code for qualification and
treatment as a regulated investment company and has distributed in each such
year all net investment income and realized capital gains.
(k) All issued and outstanding shares of the Selling Fund are,
and at the Closing Date will be, duly and validly issued and outstanding, fully
paid and non-assessable by the Selling Fund (except that, under Pennsylvania
law, Selling Fund Shareholders could under certain circumstances be held
personally liable for obligations of the Selling Fund). All of the issued and
outstanding shares of the Selling Fund will, at the time of the Closing Date, be
held by the persons and in the amounts set forth in the records of the transfer
<PAGE>
agent as provided in paragraph 3.4. The Selling Fund does not have outstanding
any options, warrants, or other rights to subscribe for or purchase any of the
Selling Fund shares, nor is there outstanding any security convertible into any
of the Selling Fund shares.
(l) At the Closing Date, the Selling Fund will have good and
marketable title to the Selling Fund's assets to be transferred to the Acquiring
Fund pursuant to paragraph 1.2 and full right, power, and authority to sell,
assign, transfer, and deliver such assets hereunder, and, upon delivery and
payment for such assets, the Acquiring Fund will acquire good and marketable
title thereto, subject to no restrictions on the full transfer thereof,
including such restrictions as might arise under the 1933 Act, other than as
disclosed to the Acquiring Fund and accepted by the Acquiring Fund.
(m) The execution, delivery, and performance of this Agreement
have been duly authorized by all necessary action on the part of the Selling
Fund and, subject to approval by the Selling Fund Shareholders, this Agreement
constitutes a valid and binding obligation of the Selling Fund, enforceable in
accordance with its terms, subject as to enforcement, to bankruptcy, insolvency,
reorganization, moratorium, and other laws relating to or affecting creditors'
rights and to general equity principles.
(n) The information to be furnished by the Selling Fund for
use in no-action letters, applications for orders, registration statements,
proxy materials, and other documents that may be necessary in connection with
the transactions contemplated hereby shall be accurate and complete in all
material respects and shall comply in all material respects with federal
securities and other laws and regulations thereunder applicable thereto.
(o) The Proxy Statement of the Selling Fund to be included in
the Registration Statement (as defined in paragraph 5.7)(other than information
therein that relates to the Acquiring Fund) will, on the effective date of the
Registration Statement and on the Closing Date, not contain any untrue statement
of a material fact or omit to state a material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which such statements were made, not misleading.
4.2 REPRESENTATIONS OF THE ACQUIRING FUND. The Acquiring
Fund represents and warrants to the Selling Fund as follows:
(a) The Acquiring Fund is a separate investment
series of a Delaware business trust duly organized, validly
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existing and in good standing under the laws of the State of
Delaware.
(b) The Acquiring Fund is a separate investment series of a
Delaware business trust that is registered as an investment company classified
as a management company of the open-end type, and its registration with the
Commission as an investment company under the 1940 Act is in full force and
effect.
(c) The current prospectuses and statement of additional
information of the Acquiring Fund conform in all material respects to the
applicable requirements of the 1933 Act and the 1940 Act and the rules and
regulations of the Commission thereunder and do not include any untrue statement
of a material fact or omit to state any material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading.
(d) The Acquiring Fund is not, and the execution, delivery and
performance of this Agreement will not result, in violation of the Trust's
Declaration of Trust or By-Laws or of any material agreement, indenture,
instrument, contract, lease, or other undertaking to which the Acquiring Fund is
a party or by which it is bound.
(e) Except as otherwise disclosed in writing to the Selling
Fund and accepted by the Selling Fund, no litigation, administrative proceeding
or investigation of or before any court or governmental body is presently
pending or to its knowledge threatened against the Acquiring Fund or any of its
properties or assets, which, if adversely determined, would materially and
adversely affect its financial condition and the conduct of its business or the
ability of the Acquiring Fund to carry out the transactions contemplated by this
Agreement. The Acquiring Fund knows of no facts that might form the basis for
the institution of such proceedings and is not a party to or subject to the
provisions of any order, decree, or judgment of any court or governmental body
that materially and adversely affects its business or its ability to consummate
the transactions contemplated herein.
(f) The Acquiring Fund has no known liabilities of a material
amount, contingent or otherwise.
(g) At the Closing Date, there will not be any material
adverse change in the Acquiring Fund's financial condition, assets, liabilities,
or business other than changes occurring in the ordinary course of business, or
any incurrence by the Acquiring Fund of indebtedness maturing more than one year
from the date such indebtedness was incurred, except as otherwise disclosed to
and accepted by the Selling
<PAGE>
Fund. For the purposes of this subparagraph (g), a decline in
the net asset value of the Acquiring Fund shall not constitute
a material adverse change.
(h) At the Closing Date, all federal and other tax returns and
reports of the Acquiring Fund required by law then to be filed by such dates
shall have been filed, and all federal and other taxes shown due on said returns
and reports shall have been paid or provision shall have been made for the
payment thereof. To the best of the Acquiring Fund's knowledge, no such return
is currently under audit, and no assessment has been asserted with respect to
such returns.
(i) All issued and outstanding Acquiring Fund Shares are, and
at the Closing Date will be, duly and validly issued and outstanding, fully paid
and non-assessable. The Acquiring Fund does not have outstanding any options,
warrants, or other rights to subscribe for or purchase any Acquiring Fund
Shares, nor is there outstanding any security convertible into any Acquiring
Fund Shares.
(j) The execution, delivery, and performance of this Agreement
have been duly authorized by all necessary action on the part of the Acquiring
Fund, and this Agreement constitutes a valid and binding obligation of the
Acquiring Fund enforceable in accordance with its terms, subject as to
enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other
laws relating to or affecting creditors' rights and to general equity
principles.
(k) The Acquiring Fund Shares to be issued and delivered to
the Selling Fund, for the account of the Selling Fund Shareholders, pursuant to
the terms of this Agreement will, at the Closing Date, have been duly authorized
and, when so issued and delivered, will be duly and validly issued Acquiring
Fund Shares, and will be fully paid and non-assessable.
(l) The information to be furnished by the Acquiring Fund for
use in no-action letters, applications for orders, registration statements,
proxy materials, and other documents that may be necessary in connection with
the transactions contemplated hereby shall be accurate and complete in all
material respects and shall comply in all material respects with federal
securities and other laws and regulations applicable thereto.
(m) The Prospectus and Proxy Statement (as defined in
paragraph 5.7) to be included in the Registration Statement (only insofar as it
relates to the Acquiring Fund) will, on the effective date of the Registration
Statement and on the Closing Date, not contain any untrue statement of a
material fact or omit to state a material fact required to be stated
<PAGE>
therein or necessary to make the statements therein, in light of the
circumstances under which such statements were made, not misleading.
(n) The Acquiring Fund agrees to use all reasonable efforts to
obtain the approvals and authorizations required by the 1933 Act, the 1940 Act,
and such of the state Blue Sky or securities laws as it may deem appropriate in
order to continue its operations after the Closing Date.
ARTICLE V
COVENANTS OF THE ACQUIRING FUND AND THE SELLING FUND
5.1 OPERATION IN ORDINARY COURSE. The Acquiring Fund and the Selling
Fund each will operate its business in the ordinary course between the date
hereof and the Closing Date, it being understood that such ordinary course of
business will include customary dividends and distributions.
5.2 APPROVAL OF SHAREHOLDERS. Keystone Trust will call a meeting of the
Selling Fund Shareholders to consider and act upon this Agreement and to take
all other action necessary to obtain approval of the transactions contemplated
herein.
5.3 INVESTMENT REPRESENTATION. The Selling Fund covenants that the
Acquiring Fund Shares to be issued hereunder are not being acquired for the
purpose of making any distribution thereof other than in accordance with the
terms of this Agreement.
5.4 ADDITIONAL INFORMATION. The Selling Fund will assist the Acquiring
Fund in obtaining such information as the Acquiring Fund reasonably requests
concerning the beneficial ownership of the Selling Fund shares.
5.5 FURTHER ACTION. Subject to the provisions of this Agreement, the
Acquiring Fund and the Selling Fund will each take, or cause to be taken, all
action, and do or cause to be done, all things reasonably necessary, proper or
advisable to consummate and make effective the transactions contemplated by this
Agreement, including any actions required to be taken after the Closing Date.
5.6 STATEMENT OF EARNINGS AND PROFITS. As promptly as practicable, but
in any case within sixty days after the Closing Date, the Selling Fund shall
furnish the Acquiring Fund, in such form as is reasonably satisfactory to the
Acquiring Fund, a statement of the earnings and profits of the Selling Fund for
federal income tax purposes that will be carried over by the Acquiring Fund as a
result of Section 381 of the Code, and which will be reviewed by its independent
<PAGE>
auditors and certified by Keystone Trust's President and
Treasurer.
5.7 PREPARATION OF FORM N-14 REGISTRATION STATEMENT. The Selling Fund
will provide the Acquiring Fund with information reasonably necessary for the
preparation of a prospectus, which will include the proxy statement, referred to
in paragraph 4.1(o) (the "Prospectus and Proxy Statement"), all to be included
in a Registration Statement on Form N-14 of the Acquiring Fund (the
"Registration Statement"), in compliance with the 1933 Act, the Securities
Exchange Act of 1934, as amended (the "1934 Act"), and the 1940 Act in
connection with the meeting of the Selling Fund Shareholders to consider
approval of this Agreement and the transactions contemplated herein.
ARTICLE VI
CONDITIONS PRECEDENT TO OBLIGATIONS OF THE SELLING FUND
The obligations of the Selling Fund to consummate the transactions
provided for herein shall be subject, at its election, to the performance by the
Acquiring Fund of all the obligations to be performed by it hereunder on or
before the Closing Date, and, in addition thereto, the following further
conditions:
6.1 All representations, covenants, and warranties of the Acquiring
Fund contained in this Agreement shall be true and correct as of the date hereof
and as of the Closing Date with the same force and effect as if made on and as
of the Closing Date, and the Acquiring Fund shall have delivered to the Selling
Fund a certificate executed in its name by the Trust's President or Vice
President and its Treasurer or Assistant Treasurer, in form and substance
reasonably satisfactory to the Selling Fund and dated as of the Closing Date, to
such effect and as to such other matters as the Selling Fund shall reasonably
request.
6.2 The Selling Fund shall have received on the Closing Date an opinion
from Sullivan & Worcester LLP, counsel to the Acquiring Fund, dated as of the
Closing Date, in a form reasonably satisfactory to the Selling Fund, covering
the following points:
(a) The Acquiring Fund is a separate investment series of a
Delaware business trust duly organized, validly existing and in good standing
under the laws of the State of Delaware and has the power to own all of its
properties and assets and to carry on its business as presently conducted.
(b) The Acquiring Fund is a separate investment
series of a Delaware business trust registered as an
<PAGE>
investment company under the 1940 Act, and, to such counsel's knowledge, such
registration with the Commission as an investment company under the 1940 Act is
in full force and effect.
(c) This Agreement has been duly authorized, executed, and
delivered by the Acquiring Fund, and, assuming that the Prospectus and Proxy
Statement, and Registration Statement comply with the 1933 Act, the 1934 Act,
and the 1940 Act and the rules and regulations thereunder and, assuming due
authorization, execution and delivery of this Agreement by the Selling Fund, is
a valid and binding obligation of the Acquiring Fund enforceable against the
Acquiring Fund in accordance with its terms, subject as to enforcement, to
bankruptcy, insolvency, reorganization, moratorium, and other laws relating to
or affecting creditors' rights generally and to general equity principles.
(d) Assuming that a consideration therefor not less than the
net asset value thereof has been paid, the Acquiring Fund Shares to be issued
and delivered to the Selling Fund on behalf of the Selling Fund Shareholders as
provided by this Agreement are duly authorized and upon such delivery will be
legally issued and outstanding and fully paid and non-assessable, and no
shareholder of the Acquiring Fund has any preemptive rights in respect thereof.
(e) The Registration Statement, to such counsel's knowledge,
has been declared effective by the Commission and no stop order under the 1933
Act pertaining thereto has been issued, and to the knowledge of such counsel, no
consent, approval, authorization or order of any court or governmental authority
of the United States or the State of Delaware is required for consummation by
the Acquiring Fund of the transactions contemplated herein, except such as have
been obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be
required under state securities laws.
ARTICLE VII
CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING FUND
The obligations of the Acquiring Fund to complete the transactions
provided for herein shall be subject, at its election, to the performance by the
Selling Fund of all the obligations to be performed by it hereunder on or before
the Closing Date and, in addition thereto, the following conditions:
7.1 All representations, covenants, and warranties of the Selling Fund
contained in this Agreement shall be true and correct as of the date hereof and
as of the Closing Date with the same force and effect as if made on and as of
the Closing
<PAGE>
Date, and the Selling Fund shall have delivered to the Acquiring Fund on the
Closing Date a certificate executed in its name by Keystone Trust's President or
Vice President and the Treasurer or Assistant Treasurer, in form and substance
satisfactory to the Acquiring Fund and dated as of the Closing Date, to such
effect and as to such other matters as the Acquiring Fund shall reasonably
request.
7.2 The Selling Fund shall have delivered to the Acquiring Fund a
statement of the Selling Fund's assets and liabilities, together with a list of
the Selling Fund's portfolio securities showing the tax costs of such securities
by lot and the holding periods of such securities, as of the Closing Date,
certified by the Treasurer of Keystone Trust.
7.3 The Acquiring Fund shall have received on the Closing Date an
opinion of Sullivan & Worcester LLP, counsel to the Selling Fund, in a form
satisfactory to the Acquiring Fund covering the following points:
(a) The Selling Fund is the sole investment series of a
Pennsylvania common law trust duly organized, validly existing and in good
standing under the laws of The Commonwealth of Pennsylvania and has the power to
own all of its properties and assets and to carry on its business as presently
conducted.
(b) The Selling Fund is the sole investment series of a
Pennsylvania common law trust registered as an investment company under the 1940
Act, and, to such counsel's knowledge, such registration with the Commission as
an investment company under the 1940 Act is in full force and effect.
(c) This Agreement has been duly authorized, executed and
delivered by the Selling Fund, and, assuming that the Prospectus and Proxy
Statement, and Registration Statement comply with the 1933 Act, the 1934 Act,
and the 1940 Act and the rules and regulations thereunder and, assuming due
authorization, execution, and delivery of this Agreement by the Acquiring Fund,
is a valid and binding obligation of the Selling Fund enforceable against the
Selling Fund in accordance with its terms, subject as to enforcement, to
bankruptcy, insolvency, reorganization, moratorium and other laws relating to or
affecting creditors' rights generally and to general equity principles.
(d) To the knowledge of such counsel, no consent, approval,
authorization or order of any court or governmental authority of the United
States or The Commonwealth of Pennsylvania is required for consummation by the
Selling Fund of the transactions contemplated herein, except such as have been
obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be
required under state securities laws.
<PAGE>
ARTICLE VIII
FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING
FUND AND THE SELLING FUND
If any of the conditions set forth below do not exist on or before the
Closing Date with respect to the Selling Fund or the Acquiring Fund, the other
party to this Agreement shall, at its option, not be required to consummate the
transactions contemplated by this Agreement:
8.1 This Agreement and the transactions contemplated herein shall have
been approved by the requisite vote of the holders of the outstanding shares of
the Selling Fund in accordance with the provisions of Keystone Trust's
Declaration of Trust and By-Laws and certified copies of the resolutions
evidencing such approval shall have been delivered to the Acquiring Fund.
Notwithstanding anything herein to the contrary, neither the Acquiring Fund nor
the Selling Fund may waive the conditions set forth in this paragraph 8.1.
8.2 On the Closing Date, the Commission shall not have issued an
unfavorable report under Section 25(b) of the 1940 Act, nor instituted any
proceeding seeking to enjoin the consummation of the transactions contemplated
by this Agreement under Section 25(c) of the 1940 Act and no action, suit or
other proceeding shall be threatened or pending before any court or governmental
agency in which it is sought to restrain or prohibit, or obtain damages or other
relief in connection with, this Agreement or the transactions contemplated
herein.
8.3 All required consents of other parties and all other consents,
orders, and permits of federal, state and local regulatory authorities
(including those of the Commission and of state Blue Sky securities authorities,
including any necessary "no-action" positions of and exemptive orders from such
federal and state authorities) to permit consummation of the transactions
contemplated hereby shall have been obtained, except where failure to obtain any
such consent, order, or permit would not involve a risk of a material adverse
effect on the assets or properties of the Acquiring Fund or the Selling Fund,
provided that either party hereto may for itself waive any of such conditions.
8.4 The Registration Statement shall have become effective under the
1933 Act, and no stop orders suspending the effectiveness thereof shall have
been issued and, to the best knowledge of the parties hereto, no investigation
or proceeding for that purpose shall have been instituted or be pending,
threatened or contemplated under the 1933 Act.
<PAGE>
8.5 The Selling Fund shall have declared a dividend or dividends which,
together with all previous such dividends, shall have the effect of distributing
to the Selling Fund Shareholders all of the Selling Fund's investment company
taxable income for all taxable periods ending on the Closing Date (computed
without regard to any deduction for dividends paid) and all of its net capital
gains realized in all taxable periods ending on the Closing Date (after
reduction for any capital loss carryforward).
8.6 The parties shall have received a favorable opinion of Sullivan &
Worcester LLP, addressed to the Acquiring Fund and the Selling Fund
substantially to the effect that for federal income tax purposes:
(a) The transfer of all of the Selling Fund assets in exchange
for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
certain stated liabilities of the Selling Fund followed by the distribution of
the Acquiring Fund Shares to the Selling Fund in dissolution and liquidation of
the Selling Fund will constitute a "reorganization" within the meaning of
Section 368(a)(1)(C) of the Code and the Acquiring Fund and the Selling Fund
will each be a "party to a reorganization" within the meaning of Section 368(b)
of the Code.
(b) No gain or loss will be recognized by the Acquiring Fund
upon the receipt of the assets of the Selling Fund solely in exchange for the
Acquiring Fund Shares and the assumption by the Acquiring Fund of certain stated
liabilities of the Selling Fund.
(c) No gain or loss will be recognized by the Selling Fund
upon the transfer of the Selling Fund assets to the Acquiring Fund in exchange
for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
certain stated liabilities of the Selling Fund or upon the distribution (whether
actual or constructive) of the Acquiring Fund Shares to Selling Fund
Shareholders in exchange for their shares of the Selling Fund.
(d) No gain or loss will be recognized by the Selling Fund
Shareholders upon the exchange of their Selling Fund shares for the Acquiring
Fund Shares in liquidation of the Selling Fund.
(e) The aggregate tax basis for the Acquiring Fund Shares
received by each Selling Fund Shareholder pursuant to the Reorganization will be
the same as the aggregate tax basis of the Selling Fund shares held by such
shareholder immediately prior to the Reorganization, and the holding period of
the Acquiring Fund Shares to be received by each Selling Fund Shareholder will
include the period during which
<PAGE>
the Selling Fund shares exchanged therefor were held by such shareholder
(provided the Selling Fund shares were held as capital assets on the date of the
Reorganization).
(f) The tax basis of the Selling Fund assets acquired by the
Acquiring Fund will be the same as the tax basis of such assets to the Selling
Fund immediately prior to the Reorganization, and the holding period of the
assets of the Selling Fund in the hands of the Acquiring Fund will include the
period during which those assets were held by the Selling Fund.
Notwithstanding anything herein to the contrary, neither the Acquiring
Fund nor the Selling Fund may waive the conditions set forth in this paragraph
8.6.
8.7 The Acquiring Fund shall have received from KPMG Peat Marwick LLP a
letter addressed to the Acquiring Fund, in form and substance satisfactory to
the Acquiring Fund, to the effect that:
(a) they are independent certified public accountants with
respect to the Selling Fund within the meaning of the 1933 Act and the
applicable published rules and regulations thereunder;
(b) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards) consisting of a reading
of any unaudited pro forma financial statements included in the Registration
Statement and Prospectus and Proxy Statement, and inquiries of appropriate
officials of Keystone Trust responsible for financial and accounting matters,
nothing came to their attention that caused them to believe that such unaudited
pro forma financial statements do not comply as to form in all material respects
with the applicable accounting requirements of the 1933 Act and the published
rules and regulations thereunder;
(c) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the Capitalization Table
appearing in the Registration Statement and Prospectus and Proxy Statement has
been obtained from and is consistent with the accounting records of the Selling
Fund;
(d) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the pro forma financial
statements that are included in the Registration Statement and Prospectus and
<PAGE>
Proxy Statement were prepared based on the valuation of the Selling Fund's
assets in accordance with the Trust's Declaration of Trust and the Acquiring
Fund's then current prospectus and statement of additional information pursuant
to procedures customarily utilized by the Acquiring Fund in valuing its own
assets; and
(e) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the data utilized in the
calculations of the projected expense ratios appearing in the Registration
Statement and Prospectus and Proxy Statement agree with underlying accounting
records of the Selling Fund or with written estimates by Selling Fund's
management and were found to be mathematically correct.
In addition, the Acquiring Fund shall have received from KPMG Peat
Marwick LLP a letter addressed to the Acquiring Fund dated on the Closing Date,
in form and substance satisfactory to the Acquiring Fund, to the effect, that on
the basis of limited procedures agreed upon by the Acquiring Fund (but not an
examination in accordance with generally accepted auditing standards), the
calculation of net asset value per share of the Selling Fund as of the Valuation
Date was determined in accordance with generally accepted accounting practices
and the portfolio valuation practices of the Acquiring Fund.
8.8 The Selling Fund shall have received from KPMG Peat Marwick LLP a
letter addressed to the Selling Fund, in form and substance satisfactory to the
Selling Fund, to the effect that:
(a) they are independent certified public accountants with
respect to the Acquiring Fund within the meaning of the 1933 Act and the
applicable published rules and regulations thereunder;
(b) on the basis of limited procedures agreed upon by the
Selling Fund and described in such letter (but not an examination in accordance
with generally accepted auditing standards) consisting of a reading of any
unaudited pro forma financial statements included in the Registration Statement
and Prospectus and Proxy Statement, and inquiries of appropriate officials of
the Trust responsible for financial and accounting matters, nothing came to
their attention that caused them to believe that such unaudited pro forma
financial statements do not comply as to form in all material respects with the
applicable accounting requirements of the 1933 Act and the published rules and
regulations thereunder;
(c) on the basis of limited procedures agreed upon
by the Selling Fund and described in such letter (but not an
<PAGE>
examination in accordance with generally accepted auditing standards), the
Capitalization Table appearing in the Registration Statement and Prospectus and
Proxy Statement has been obtained from and is consistent with the accounting
records of the Acquiring Fund; and
(d) on the basis of limited procedures agreed upon by the
Selling Fund (but not an examination in accordance with generally accepted
auditing standards), the data utilized in the calculations of the projected
expense ratio appearing in the Registration Statement and Prospectus and Proxy
Statement agree with written estimates by each Fund's management and were found
to be mathematically correct.
8.9 The Acquiring Fund and the Selling Fund shall also have received
from KPMG Peat Marwick LLP a letter addressed to the Acquiring Fund and the
Selling Fund, dated on the Closing Date in form and substance satisfactory to
the Funds, setting forth the federal income tax implications relating to capital
loss carryforwards (if any) of the Selling Fund and the related impact, if any,
of the proposed transfer of all of the assets of the Selling Fund to the
Acquiring Fund and the ultimate dissolution of the Selling Fund, upon the
shareholders of the Selling Fund.
ARTICLE IX
EXPENSES
9.1 Except as otherwise provided for herein, all expenses of the
transactions contemplated by this Agreement incurred by the Selling Fund and the
Acquiring Fund will be borne by First Union National Bank. Such expenses
include, without limitation, (a) expenses incurred in connection with the
entering into and the carrying out of the provisions of this Agreement; (b)
expenses associated with the preparation and filing of the Registration
Statement under the 1933 Act covering the Acquiring Fund Shares to be issued
pursuant to the provisions of this Agreement; (c) registration or qualification
fees and expenses of preparing and filing such forms as are necessary under
applicable state securities laws to qualify the Acquiring Fund Shares to be
issued in connection herewith in each state in which the Selling Fund
Shareholders are resident as of the date of the mailing of the Prospectus and
Proxy Statement to such shareholders; (d) postage; (e) printing; (f) accounting
fees; (g) legal fees; and (h) solicitation costs of the transaction.
Notwithstanding the foregoing, the Acquiring Fund shall pay its own federal and
state registration fees.
ARTICLE X
ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES
<PAGE>
10.1 The Acquiring Fund and the Selling Fund agree that neither party
has made any representation, warranty or covenant not set forth herein and that
this Agreement constitutes the entire agreement between the parties.
10.2 The representations, warranties, and covenants contained in this
Agreement or in any document delivered pursuant hereto or in connection herewith
shall survive the consummation of the transactions contemplated hereunder.
ARTICLE XI
TERMINATION
11.1 This Agreement may be terminated by the mutual agreement of the
Acquiring Fund and the Selling Fund. In addition, either the Acquiring Fund or
the Selling Fund may at its option terminate this Agreement at or prior to the
Closing Date because:
(a) of a breach by the other of any representation, warranty,
or agreement contained herein to be performed at or prior to the Closing Date,
if not cured within 30 days; or
(b) a condition herein expressed to be precedent to the
obligations of the terminating party has not been met and it reasonably appears
that it will not or cannot be met.
11.2 In the event of any such termination, in the absence of willful
default, there shall be no liability for damages on the part of either the
Acquiring Fund, the Selling Fund, Keystone Trust, the Trust, the respective
Trustees or officers, to the other party or its Trustees or officers.
ARTICLE XII
AMENDMENTS
This Agreement may be amended, modified, or supplemented in such manner
as may be mutually agreed upon in writing by the authorized officers of the
Selling Fund and the Acquiring Fund; provided, however, that following the
meeting of the Selling Fund Shareholders called by the Selling Fund pursuant to
paragraph 5.2 of this Agreement, no such amendment may have the effect of
changing the provisions for determining the number of the Acquiring Fund Shares
to be issued to the Selling Fund Shareholders under this Agreement to the
detriment of such shareholders without their further approval.
ARTICLE XIII
HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT;
LIMITATION OF LIABILITY
<PAGE>
13.1 The Article and paragraph headings contained in this Agreement are
for reference purposes only and shall not affect in any way the meaning or
interpretation of this Agreement.
13.2 This Agreement may be executed in any number of counterparts, each
of which shall be deemed an original.
13.3 This Agreement shall be governed by and construed in accordance
with the laws of the State of Delaware, without giving effect to the conflicts
of laws provisions thereof; provided, however, that the due authorization,
execution and delivery of this Agreement, in the case of Keystone Trust, shall
be governed and construed in accordance with the laws of The Commonwealth of
Pennsylvania, without giving effect to the conflicts of laws provisions thereof.
13.4 This Agreement shall bind and inure to the benefit of the parties
hereto and their respective successors and assigns, but no assignment or
transfer hereof or of any rights or obligations hereunder shall be made by any
party without the written consent of the other party. Nothing herein expressed
or implied is intended or shall be construed to confer upon or give any person,
firm, or corporation, other than the parties hereto and their respective
successors and assigns, any rights or remedies under or by reason of this
Agreement.
13.5 It is expressly agreed that the obligations of the Selling Fund
hereunder shall not be binding upon any of the Trustees, shareholders, nominees,
officers, agents, or employees of Keystone Trust personally, but shall bind only
the trust property of the Selling Fund, as provided in the Declaration of Trust
of Keystone Trust. The execution and delivery of this Agreement have been
authorized by the Trustees of Keystone Trust and signed by authorized officers
of Keystone Trust, acting as such, and neither such authorization by such
Trustees nor such execution and delivery by such officers shall be deemed to
have been made by any of them individually or to impose any liability on any of
them personally, but shall bind only the trust property of the Selling Fund as
provided in the Declaration of Trust of Keystone Trust.
IN WITNESS WHEREOF, the parties have duly executed and sealed this
Agreement, all as of the date first written above.
EVERGREEN FIXED INCOME TRUST
ON BEHALF OF EVERGREEN
DIVERSIFIED BOND FUND
<PAGE>
By: /s/ JOHN J. PILEGGI
Name: John J. Pileggi
Title: President
KEYSTONE QUALITY BOND
FUND (B-1)
By: /s/ JOHN J. PILEGGI
Name: John J. Pileggi
Title: President
<PAGE>
EXHIBIT A-2
AGREEMENT AND PLAN OF REORGANIZATION
THIS AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") is made as
of this 30th day of September, 1997, by and between the Evergreen Fixed Income
Trust, a Delaware business trust, with its principal place of business at 200
Berkeley Street, Boston, Massachusetts 02116 (the "Trust"), with respect to its
Evergreen Diversified Bond Fund series (the "Acquiring Fund"), and Keystone
Diversified Bond Fund (B- 2), a Pennsylvania common law trust ("Keystone
Trust"), with its principal place of business at 200 Berkeley Street, Boston,
Massachusetts 02116, with respect to its Keystone Diversified Bond Fund (B-2)
series (the "Selling Fund").
This Agreement is intended to be, and is adopted as, a plan of
reorganization and liquidation within the meaning of Section 368(a)(1)(F) of the
United States Internal Revenue Code of 1986, as amended (the "Code"). The
reorganization (the "Reorganization") will consist of (i) the transfer of all of
the assets of the Selling Fund in exchange solely for shares of beneficial
interest, $.001 par value per share, of the Acquiring Fund (the "Acquiring Fund
Shares"); (ii) the assumption by the Acquiring Fund of certain identified
liabilities of the Selling Fund; and (iii) the distribution, after the Closing
Date hereinafter referred to, of the Acquiring Fund Shares to the shareholders
of the Selling Fund in liquidation of the Selling Fund as provided herein, all
upon the terms and conditions hereinafter set forth in this Agreement.
WHEREAS, the Selling Fund is the sole investment series of, and the
Acquiring Fund is a separate investment series of, an open-end, registered
investment company of the management type, and the Selling Fund owns securities
that generally are assets of the character in which the Acquiring Fund is
permitted to invest;
WHEREAS, both Funds are authorized to issue their shares
of beneficial interest;
WHEREAS, the Trustees of the Trust have determined that the exchange of
all of the assets of the Selling Fund for Acquiring Fund Shares and the
assumption of certain identified liabilities of the Selling Fund by the
Acquiring Fund on the terms and conditions hereinafter set forth are in the best
interests of the Acquiring Fund's shareholders;
WHEREAS, the Trustees of Keystone Trust have determined that the
Selling Fund should exchange all of its assets and certain identified
liabilities for Acquiring Fund Shares and that the interests of the existing
shareholders of the Selling
<PAGE>
Fund will not be diluted as a result of the transactions
contemplated herein;
NOW, THEREFORE, in consideration of the premises and of the covenants
and agreements hereinafter set forth, the parties hereto covenant and agree as
follows:
ARTICLE I
TRANSFER OF ASSETS OF THE SELLING FUND IN EXCHANGE FOR
THE ACQUIRING FUND SHARES AND ASSUMPTION OF SELLING FUND
LIABILITIES AND LIQUIDATION OF THE SELLING FUND
1.1 THE EXCHANGE. Subject to the terms and conditions herein set forth
and on the basis of the representations and warranties contained herein, the
Selling Fund agrees to transfer all of the Selling Fund's assets as set forth in
paragraph 1.2 to the Acquiring Fund. The Acquiring Fund agrees in exchange
therefor (i) to deliver to the Selling Fund the number of Acquiring Fund Shares,
including fractional Acquiring Fund Shares, determined by multiplying the shares
outstanding of each class of the Selling Fund by the ratio computed by dividing
the net asset value per share of each such class of the Selling Fund by the net
asset value per share of the corresponding class of Acquiring Fund Shares
computed in the manner and as of the time and date set forth in paragraph 2.2;
and (ii) to assume certain identified liabilities of the Selling Fund, as set
forth in paragraph 1.3. Such transactions shall take place at the closing
provided for in paragraph 3.1 (the "Closing Date").
1.2 ASSETS TO BE ACQUIRED. The assets of the Selling Fund to be
acquired by the Acquiring Fund shall consist of all property, including, without
limitation, all cash, securities, commodities, and futures interests and
dividends or interest receivables, that is owned by the Selling Fund and any
deferred or prepaid expenses shown as an asset on the books of the Selling Fund
on the Closing Date.
The Selling Fund has provided the Acquiring Fund with its most recent
audited financial statements, which contain a list of all of Selling Fund's
assets as of the date thereof. The Selling Fund hereby represents that as of the
date of the execution of this Agreement there have been no changes in its
financial position as reflected in said financial statements other than those
occurring in the ordinary course of its business in connection with the purchase
and sale of securities and the payment of its normal operating expenses. The
Selling Fund reserves the right to sell any of such securities, but will not,
without the prior written approval of the Acquiring Fund, acquire any additional
securities other than securities of the type in which the Acquiring Fund is
permitted to invest.
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The Acquiring Fund will, within a reasonable time prior to the Closing
Date, furnish the Selling Fund with a statement of the Acquiring Fund's
investment objectives, policies, and restrictions and a list of the securities,
if any, on the Selling Fund's list referred to in the second sentence of this
paragraph that do not conform to the Acquiring Fund's investment objectives,
policies, and restrictions. In the event that the Selling Fund holds any
investments that the Acquiring Fund may not hold, the Selling Fund will dispose
of such securities prior to the Closing Date. In addition, if it is determined
that the Selling Fund and the Acquiring Fund portfolios, when aggregated, would
contain investments exceeding certain percentage limitations imposed upon the
Acquiring Fund with respect to such investments, the Selling Fund if requested
by the Acquiring Fund will dispose of a sufficient amount of such investments as
may be necessary to avoid violating such limitations as of the Closing Date.
1.3 LIABILITIES TO BE ASSUMED. The Selling Fund will endeavor to
discharge all of its known liabilities and obligations prior to the Closing
Date. Except as specifically provided in this paragraph 1.3, the Acquiring Fund
shall assume the liabilities, expenses, costs, charges and reserves reflected on
a Statement of Assets and Liabilities of the Selling Fund prepared on behalf of
the Selling Fund, as of the Valuation Date (as defined in paragraph 2.1), in
accordance with generally accepted accounting principles consistently applied
from the prior audited period. The Acquiring Fund shall assume only those
liabilities of the Selling Fund reflected in such Statement of Assets and
Liabilities and shall not except as specifically provided in this paragraph 1.3
assume any other liabilities, whether absolute or contingent, known or unknown,
accrued or unaccrued, all of which shall remain the obligation of the Selling
Fund. The Acquiring Fund hereby agrees with Keystone Trust and each Trustee of
Keystone Trust: (i) to indemnify each Trustee of Keystone Trust against all
liabilities and expenses referred to in the indemnification provisions of
Keystone Trust's Declaration of Trust and By-Laws, to the extent provided
therein, incurred by any Trustee of Keystone Trust; and (ii) in addition to the
indemnification provided in (i) above, to indemnify each Trustee of Keystone
Trust against all liabilities and expenses and pay the same as they arise and
become due, without any exception, limitation or requirement of approval by any
person, and without any right to require repayment thereof by any such Trustee
(unless such Trustee has had the same repaid to him or her) based upon any
subsequent or final disposition or findings made in connection therewith or
otherwise, if such action, suit or other proceeding involves such Trustee's
participation in authorizing or permitting or acquiescing in, directly or
indirectly, by action or inaction, the making of any distribution in any manner
of all or any assets of the Selling Fund without making
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provision for the payment of any liabilities of any kind, fixed or contingent,
of the Selling Fund, which liabilities were not actually and consciously
personally known to such Trustee to exist at the time of such Trustee's
participation in so authorizing or permitting or acquiescing in the making of
any such distribution.
In addition, upon completion of the Reorganization, for purposes of
calculating the maximum amount permitted to be charged to the Acquiring Fund
under the National Association of Securities Dealers, Inc. Conduct Rule 2830,
minus the amount of the sales charges paid or accrued (including asset based
sales charges), plus permitted interest ("Aggregate NASD Cap"), the Acquiring
Fund will add to its Aggregate NASD Cap immediately prior to the Reorganization
the Aggregate NASD Cap of the Selling Fund immediately prior to the
Reorganization.
1.4 LIQUIDATION AND DISTRIBUTION. On or as soon after the Closing Date
as is conveniently practicable (the "Liquidation Date"), (a) the Selling Fund
will liquidate and distribute pro rata to the Selling Fund's shareholders of
record, determined as of the close of business on the Valuation Date (the
"Selling Fund Shareholders"), the Acquiring Fund Shares received by the Selling
Fund pursuant to paragraph 1.1; and (b) the Selling Fund will thereupon proceed
to dissolve as set forth in paragraph 1.8 below. Such liquidation and
distribution will be accomplished by the transfer of the Acquiring Fund Shares
then credited to the account of the Selling Fund on the books of the Acquiring
Fund to open accounts on the share records of the Acquiring Fund in the names of
the Selling Fund Shareholders and representing the respective pro rata number of
the Acquiring Fund Shares due such shareholders. All issued and outstanding
shares of the Selling Fund will simultaneously be canceled on the books of the
Selling Fund. The Acquiring Fund shall not issue certificates representing the
Acquiring Fund Shares in connection with such exchange.
1.5 OWNERSHIP OF SHARES. Ownership of Acquiring Fund Shares will be
shown on the books of the Acquiring Fund's transfer agent. Shares of the
Acquiring Fund will be issued in the manner described in the combined Prospectus
and Proxy Statement on Form N-14 to be distributed to shareholders of the
Selling Fund as described in paragraph 5.7.
1.6 TRANSFER TAXES. Any transfer taxes payable upon issuance of the
Acquiring Fund Shares in a name other than the registered holder of the Selling
Fund shares on the books of the Selling Fund as of that time shall, as a
condition of such issuance and transfer, be paid by the person to whom such
Acquiring Fund Shares are to be issued and transferred.
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1.7 REPORTING RESPONSIBILITY. Any reporting responsibility of the
Selling Fund is and shall remain the responsibility of the Selling Fund up to
and including the Closing Date and such later date on which the Selling Fund is
terminated.
1.8 TERMINATION. The Selling Fund shall be terminated promptly
following the Closing Date and the making of all distributions pursuant to
paragraph 1.4.
ARTICLE II
VALUATION
2.1 VALUATION OF ASSETS. The value of the Selling Fund's assets to be
acquired by the Acquiring Fund hereunder shall be the value of such assets
computed as of the close of business on the New York Stock Exchange on the
business day next preceding the Closing Date (such time and date being
hereinafter called the "Valuation Date"), using the valuation procedures set
forth in the Trust's Declaration of Trust and the Acquiring Fund's then current
prospectus and statement of additional information or such other valuation
procedures as shall be mutually agreed upon by the parties.
2.2 VALUATION OF SHARES. The net asset value per share of the Acquiring
Fund Shares shall be the net asset value per share computed as of the close of
business on the New York Stock Exchange on the Valuation Date, using the
valuation procedures set forth in the Trust's Declaration of Trust and the
Acquiring Fund's then current prospectus and statement of additional
information.
2.3 SHARES TO BE ISSUED. The number of Acquiring Fund Shares of each
class to be issued (including fractional shares, if any) in exchange for the
Selling Fund's assets shall be determined by multiplying the shares outstanding
of each class of the Selling Fund by the ratio computed by dividing the net
asset value per share of the Selling Fund attributable to each of its classes by
the net asset value per share of the respective classes of the Acquiring Fund
determined in accordance with paragraph 2.2.
2.4 DETERMINATION OF VALUE. All computations of value shall be made by
State Street Bank and Trust Company in accordance with its regular practice in
pricing the shares and assets of the Acquiring Fund.
ARTICLE III
CLOSING AND CLOSING DATE
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3.1 CLOSING DATE. The Closing (the "Closing") shall take place on or
about January 23, 1998 or such other date as the parties may agree to in writing
(the "Closing Date"). All acts taking place at the Closing shall be deemed to
take place simultaneously immediately prior to the opening of business on the
Closing Date unless otherwise provided. The Closing shall be held as of 9:00
a.m. at the offices of the Evergreen Keystone Funds, 200 Berkeley Street,
Boston, MA 02116, or at such other time and/or place as the parties may agree.
3.2 CUSTODIAN'S CERTIFICATE. State Street Bank and Trust Company, as
custodian for the Selling Fund (the "Custodian"), shall deliver at the Closing a
certificate of an authorized officer stating that (a) the Selling Fund's
portfolio securities, cash, and any other assets shall have been delivered in
proper form to the Acquiring Fund on the Closing Date; and (b) all necessary
taxes including all applicable federal and state stock transfer stamps, if any,
shall have been paid, or provision for payment shall have been made, in
conjunction with the delivery of portfolio securities by the Selling Fund.
3.3 EFFECT OF SUSPENSION IN TRADING. In the event that on the Valuation
Date (a) the New York Stock Exchange or another primary trading market for
portfolio securities of the Acquiring Fund or the Selling Fund shall be closed
to trading or trading thereon shall be restricted; or (b) trading or the
reporting of trading on said Exchange or elsewhere shall be disrupted so that
accurate appraisal of the value of the net assets of the Acquiring Fund or the
Selling Fund is impracticable, the Valuation Date shall be postponed until the
first business day after the day when trading shall have been fully resumed and
reporting shall have been restored.
3.4 TRANSFER AGENT'S CERTIFICATE. Evergreen Service Company, as
transfer agent for the Selling Fund as of the Closing Date ("ESC"), shall
deliver at the Closing a certificate of an authorized officer stating that its
records contain the names and addresses of the Selling Fund Shareholders and the
number and percentage ownership of outstanding shares owned by each such
shareholder immediately prior to the Closing. The Acquiring Fund shall issue and
deliver or cause ESC, its transfer agent as of the Closing Date, to issue and
deliver a confirmation evidencing the Acquiring Fund Shares to be credited on
the Closing Date to the Secretary of Keystone Trust or provide evidence
satisfactory to the Selling Fund that such Acquiring Fund Shares have been
credited to the Selling Fund's account on the books of the Acquiring Fund. At
the Closing, each party shall deliver to the other such bills of sale, checks,
assignments, share certificates, if any, receipts and other documents as such
other party or its counsel may reasonably request.
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ARTICLE IV
REPRESENTATIONS AND WARRANTIES
4.1 REPRESENTATIONS OF THE SELLING FUND. The Selling
Fund represents and warrants to the Acquiring Fund as follows:
(a) The Selling Fund is the sole investment series of a
Pennsylvania common law trust duly organized, validly existing, and in good
standing under the laws of The Commonwealth of Pennsylvania.
(b) The Selling Fund is the sole investment series of a
Pennsylvania common law trust that is registered as an investment company
classified as a management company of the open-end type, and its registration
with the Securities and Exchange Commission (the "Commission") as an investment
company under the Investment Company Act of 1940, as amended (the "1940 Act"),
is in full force and effect.
(c) The current prospectus and statement of additional
information of the Selling Fund conform in all material respects to the
applicable requirements of the Securities Act of 1933, as amended (the "1933
Act"), and the 1940 Act and the rules and regulations of the Commission
thereunder and do not include any untrue statement of a material fact or omit to
state any material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they were made,
not misleading.
(d) The Selling Fund is not, and the execution, delivery, and
performance of this Agreement (subject to shareholder approval) will not result,
in violation of any provision of Keystone Trust's Declaration of Trust or
By-Laws or of any material agreement, indenture, instrument, contract, lease, or
other undertaking to which the Selling Fund is a party or by which it is bound.
(e) The Selling Fund has no material contracts or other
commitments (other than this Agreement) that will be terminated with liability
to it prior to the Closing Date.
(f) Except as otherwise disclosed in writing to and accepted
by the Acquiring Fund, no litigation, administrative proceeding, or
investigation of or before any court or governmental body is presently pending
or to its knowledge threatened against the Selling Fund or any of its properties
or assets, which, if adversely determined, would materially and adversely affect
its financial condition, the conduct of its business, or the ability of the
Selling Fund to carry out the transactions contemplated by this Agreement. The
Selling Fund knows of no facts that might form the basis for the
<PAGE>
institution of such proceedings and is not a party to or subject to the
provisions of any order, decree, or judgment of any court or governmental body
that materially and adversely affects its business or its ability to consummate
the transactions herein contemplated.
(g) The financial statements of the Selling Fund at August 31,
1997 are in accordance with generally accepted accounting principles
consistently applied, and such statements (copies of which have been furnished
to the Acquiring Fund) fairly reflect the financial condition of the Selling
Fund as of such date, and there are no known contingent liabilities of the
Selling Fund as of such date not disclosed therein.
(h) Since August 31, 1997 there has not been any material
adverse change in the Selling Fund's financial condition, assets, liabilities,
or business other than changes occurring in the ordinary course of business, or
any incurrence by the Selling Fund of indebtedness maturing more than one year
from the date such indebtedness was incurred, except as otherwise disclosed to
and accepted by the Acquiring Fund. For the purposes of this subparagraph (h), a
decline in the net asset value of the Selling Fund shall not constitute a
material adverse change.
(i) At the Closing Date, all federal and other tax returns and
reports of the Selling Fund required by law to have been filed by such dates
shall have been filed, and all federal and other taxes shown due on said returns
and reports shall have been paid, or provision shall have been made for the
payment thereof. To the best of the Selling Fund's knowledge, no such return is
currently under audit, and no assessment has been asserted with respect to such
returns.
(j) For each fiscal year of its operation, the Selling Fund
has met the requirements of Subchapter M of the Code for qualification and
treatment as a regulated investment company and has distributed in each such
year all net investment income and realized capital gains.
(k) All issued and outstanding shares of the Selling Fund are,
and at the Closing Date will be, duly and validly issued and outstanding, fully
paid and non-assessable by the Selling Fund (except that, under Pennsylvania
law, Selling Fund Shareholders could under certain circumstances be held
personally liable for obligations of the Selling Fund). All of the issued and
outstanding shares of the Selling Fund will, at the time of the Closing Date, be
held by the persons and in the amounts set forth in the records of the transfer
agent as provided in paragraph 3.4. The Selling Fund does not have outstanding
any options, warrants, or other rights to subscribe for or purchase any of the
Selling Fund shares, nor
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is there outstanding any security convertible into any of the
Selling Fund shares.
(l) At the Closing Date, the Selling Fund will have good and
marketable title to the Selling Fund's assets to be transferred to the Acquiring
Fund pursuant to paragraph 1.2 and full right, power, and authority to sell,
assign, transfer, and deliver such assets hereunder, and, upon delivery and
payment for such assets, the Acquiring Fund will acquire good and marketable
title thereto, subject to no restrictions on the full transfer thereof,
including such restrictions as might arise under the 1933 Act, other than as
disclosed to the Acquiring Fund and accepted by the Acquiring Fund.
(m) The execution, delivery, and performance of this Agreement
have been duly authorized by all necessary action on the part of the Selling
Fund and, subject to approval by the Selling Fund Shareholders, this Agreement
constitutes a valid and binding obligation of the Selling Fund, enforceable in
accordance with its terms, subject as to enforcement, to bankruptcy, insolvency,
reorganization, moratorium, and other laws relating to or affecting creditors'
rights and to general equity principles.
(n) The information to be furnished by the Selling Fund for
use in no-action letters, applications for orders, registration statements,
proxy materials, and other documents that may be necessary in connection with
the transactions contemplated hereby shall be accurate and complete in all
material respects and shall comply in all material respects with federal
securities and other laws and regulations thereunder applicable thereto.
(o) The Proxy Statement of the Selling Fund to be included in
the Registration Statement (as defined in paragraph 5.7)(other than information
therein that relates to the Acquiring Fund) will, on the effective date of the
Registration Statement and on the Closing Date, not contain any untrue statement
of a material fact or omit to state a material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which such statements were made, not misleading.
4.2 REPRESENTATIONS OF THE ACQUIRING FUND. The Acquiring
Fund represents and warrants to the Selling Fund as follows:
(a) The Acquiring Fund is a separate investment series of a
Delaware business trust duly organized, validly existing and in good standing
under the laws of the State of Delaware.
<PAGE>
(b) The Acquiring Fund is a separate investment series of a
Delaware business trust that is registered as an investment company classified
as a management company of the open-end type, and its registration with the
Commission as an investment company under the 1940 Act is in full force and
effect.
(c) The current prospectuses and statement of additional
information of the Acquiring Fund conform in all material respects to the
applicable requirements of the 1933 Act and the 1940 Act and the rules and
regulations of the Commission thereunder and do not include any untrue statement
of a material fact or omit to state any material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading.
(d) The Acquiring Fund is not, and the execution, delivery and
performance of this Agreement will not result, in violation of the Trust's
Declaration of Trust or By-Laws or of any material agreement, indenture,
instrument, contract, lease, or other undertaking to which the Acquiring Fund is
a party or by which it is bound.
(e) Except as otherwise disclosed in writing to the Selling
Fund and accepted by the Selling Fund, no litigation, administrative proceeding
or investigation of or before any court or governmental body is presently
pending or to its knowledge threatened against the Acquiring Fund or any of its
properties or assets, which, if adversely determined, would materially and
adversely affect its financial condition and the conduct of its business or the
ability of the Acquiring Fund to carry out the transactions contemplated by this
Agreement. The Acquiring Fund knows of no facts that might form the basis for
the institution of such proceedings and is not a party to or subject to the
provisions of any order, decree, or judgment of any court or governmental body
that materially and adversely affects its business or its ability to consummate
the transactions contemplated herein.
(f) The Acquiring Fund has no known liabilities of a material
amount, contingent or otherwise.
(g) At the Closing Date, there will not be any material
adverse change in the Acquiring Fund's financial condition, assets, liabilities,
or business other than changes occurring in the ordinary course of business, or
any incurrence by the Acquiring Fund of indebtedness maturing more than one year
from the date such indebtedness was incurred, except as otherwise disclosed to
and accepted by the Selling Fund. For the purposes of this subparagraph (g), a
decline in the net asset value of the Acquiring Fund shall not constitute a
material adverse change.
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(h) At the Closing Date, all federal and other tax returns and
reports of the Acquiring Fund required by law then to be filed by such dates
shall have been filed, and all federal and other taxes shown due on said returns
and reports shall have been paid or provision shall have been made for the
payment thereof. To the best of the Acquiring Fund's knowledge, no such return
is currently under audit, and no assessment has been asserted with respect to
such returns.
(i) All issued and outstanding Acquiring Fund Shares are, and
at the Closing Date will be, duly and validly issued and outstanding, fully paid
and non-assessable. The Acquiring Fund does not have outstanding any options,
warrants, or other rights to subscribe for or purchase any Acquiring Fund
Shares, nor is there outstanding any security convertible into any Acquiring
Fund Shares.
(j) The execution, delivery, and performance of this Agreement
have been duly authorized by all necessary action on the part of the Acquiring
Fund, and this Agreement constitutes a valid and binding obligation of the
Acquiring Fund enforceable in accordance with its terms, subject as to
enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other
laws relating to or affecting creditors' rights and to general equity
principles.
(k) The Acquiring Fund Shares to be issued and delivered to
the Selling Fund, for the account of the Selling Fund Shareholders, pursuant to
the terms of this Agreement will, at the Closing Date, have been duly authorized
and, when so issued and delivered, will be duly and validly issued Acquiring
Fund Shares, and will be fully paid and non-assessable.
(l) The information to be furnished by the Acquiring Fund for
use in no-action letters, applications for orders, registration statements,
proxy materials, and other documents that may be necessary in connection with
the transactions contemplated hereby shall be accurate and complete in all
material respects and shall comply in all material respects with federal
securities and other laws and regulations applicable thereto.
(m) The Prospectus and Proxy Statement (as defined in
paragraph 5.7) to be included in the Registration Statement (only insofar as it
relates to the Acquiring Fund) will, on the effective date of the Registration
Statement and on the Closing Date, not contain any untrue statement of a
material fact or omit to state a material fact required to be stated therein or
necessary to make the statements therein, in light of the circumstances under
which such statements were made, not misleading.
<PAGE>
(n) The Acquiring Fund agrees to use all reasonable efforts to
obtain the approvals and authorizations required by the 1933 Act, the 1940 Act,
and such of the state Blue Sky or securities laws as it may deem appropriate in
order to continue its operations after the Closing Date.
ARTICLE V
COVENANTS OF THE ACQUIRING FUND AND THE SELLING FUND
5.1 OPERATION IN ORDINARY COURSE. The Acquiring Fund and the Selling
Fund each will operate its business in the ordinary course between the date
hereof and the Closing Date, it being understood that such ordinary course of
business will include customary dividends and distributions.
5.2 APPROVAL OF SHAREHOLDERS. Keystone Trust will call a meeting of the
Selling Fund Shareholders to consider and act upon this Agreement and to take
all other action necessary to obtain approval of the transactions contemplated
herein.
5.3 INVESTMENT REPRESENTATION. The Selling Fund covenants that the
Acquiring Fund Shares to be issued hereunder are not being acquired for the
purpose of making any distribution thereof other than in accordance with the
terms of this Agreement.
5.4 ADDITIONAL INFORMATION. The Selling Fund will assist the Acquiring
Fund in obtaining such information as the Acquiring Fund reasonably requests
concerning the beneficial ownership of the Selling Fund shares.
5.5 FURTHER ACTION. Subject to the provisions of this Agreement, the
Acquiring Fund and the Selling Fund will each take, or cause to be taken, all
action, and do or cause to be done, all things reasonably necessary, proper or
advisable to consummate and make effective the transactions contemplated by this
Agreement, including any actions required to be taken after the Closing Date.
5.6 STATEMENT OF EARNINGS AND PROFITS. As promptly as practicable, but
in any case within sixty days after the Closing Date, the Selling Fund shall
furnish the Acquiring Fund, in such form as is reasonably satisfactory to the
Acquiring Fund, a statement of the earnings and profits of the Selling Fund for
federal income tax purposes that will be carried over by the Acquiring Fund as a
result of Section 381 of the Code, and which will be reviewed by its independent
auditors and certified by Keystone Trust's President and Treasurer.
5.7 PREPARATION OF FORM N-14 REGISTRATION STATEMENT.
The Selling Fund will provide the Acquiring Fund with
<PAGE>
information reasonably necessary for the preparation of a prospectus, which will
include the proxy statement, referred to in paragraph 4.1(o) (the "Prospectus
and Proxy Statement"), all to be included in a Registration Statement on Form
N-14 of the Acquiring Fund (the "Registration Statement"), in compliance with
the 1933 Act, the Securities Exchange Act of 1934, as amended (the "1934 Act"),
and the 1940 Act in connection with the meeting of the Selling Fund Shareholders
to consider approval of this Agreement and the transactions contemplated herein.
ARTICLE VI
CONDITIONS PRECEDENT TO OBLIGATIONS OF THE SELLING FUND
The obligations of the Selling Fund to consummate the transactions
provided for herein shall be subject, at its election, to the performance by the
Acquiring Fund of all the obligations to be performed by it hereunder on or
before the Closing Date, and, in addition thereto, the following further
conditions:
6.1 All representations, covenants, and warranties of the Acquiring
Fund contained in this Agreement shall be true and correct as of the date hereof
and as of the Closing Date with the same force and effect as if made on and as
of the Closing Date, and the Acquiring Fund shall have delivered to the Selling
Fund a certificate executed in its name by the Trust's President or Vice
President and its Treasurer or Assistant Treasurer, in form and substance
reasonably satisfactory to the Selling Fund and dated as of the Closing Date, to
such effect and as to such other matters as the Selling Fund shall reasonably
request.
6.2 The Selling Fund shall have received on the Closing Date an opinion
from Sullivan & Worcester LLP, counsel to the Acquiring Fund, dated as of the
Closing Date, in a form reasonably satisfactory to the Selling Fund, covering
the following points:
(a) The Acquiring Fund is a separate investment series of a
Delaware business trust duly organized, validly existing and in good standing
under the laws of the State of Delaware and has the power to own all of its
properties and assets and to carry on its business as presently conducted.
(b) The Acquiring Fund is a separate investment series of a
Delaware business trust registered as an investment company under the 1940 Act,
and, to such counsel's knowledge, such registration with the Commission as an
investment company under the 1940 Act is in full force and effect.
<PAGE>
(c) This Agreement has been duly authorized, executed, and
delivered by the Acquiring Fund, and, assuming that the Prospectus and Proxy
Statement, and Registration Statement comply with the 1933 Act, the 1934 Act,
and the 1940 Act and the rules and regulations thereunder and, assuming due
authorization, execution and delivery of this Agreement by the Selling Fund, is
a valid and binding obligation of the Acquiring Fund enforceable against the
Acquiring Fund in accordance with its terms, subject as to enforcement, to
bankruptcy, insolvency, reorganization, moratorium, and other laws relating to
or affecting creditors' rights generally and to general equity principles.
(d) Assuming that a consideration therefor not less than the
net asset value thereof has been paid, the Acquiring Fund Shares to be issued
and delivered to the Selling Fund on behalf of the Selling Fund Shareholders as
provided by this Agreement are duly authorized and upon such delivery will be
legally issued and outstanding and fully paid and non-assessable, and no
shareholder of the Acquiring Fund has any preemptive rights in respect thereof.
(e) The Registration Statement, to such counsel's knowledge,
has been declared effective by the Commission and no stop order under the 1933
Act pertaining thereto has been issued, and to the knowledge of such counsel, no
consent, approval, authorization or order of any court or governmental authority
of the United States or the State of Delaware is required for consummation by
the Acquiring Fund of the transactions contemplated herein, except such as have
been obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be
required under state securities laws.
ARTICLE VII
CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING FUND
The obligations of the Acquiring Fund to complete the transactions
provided for herein shall be subject, at its election, to the performance by the
Selling Fund of all the obligations to be performed by it hereunder on or before
the Closing Date and, in addition thereto, the following conditions:
7.1 All representations, covenants, and warranties of the Selling Fund
contained in this Agreement shall be true and correct as of the date hereof and
as of the Closing Date with the same force and effect as if made on and as of
the Closing Date, and the Selling Fund shall have delivered to the Acquiring
Fund on the Closing Date a certificate executed in its name by Keystone Trust's
President or Vice President and the Treasurer or Assistant Treasurer, in form
and substance satisfactory to the Acquiring Fund and dated as of the Closing
<PAGE>
Date, to such effect and as to such other matters as the Acquiring Fund shall
reasonably request.
7.2 The Selling Fund shall have delivered to the Acquiring Fund a
statement of the Selling Fund's assets and liabilities, together with a list of
the Selling Fund's portfolio securities showing the tax costs of such securities
by lot and the holding periods of such securities, as of the Closing Date,
certified by the Treasurer of Keystone Trust.
7.3 The Acquiring Fund shall have received on the Closing Date an
opinion of Sullivan & Worcester LLP, counsel to the Selling Fund, in a form
satisfactory to the Acquiring Fund covering the following points:
(a) The Selling Fund is the sole investment series of a
Pennsylvania common law trust duly organized, validly existing and in good
standing under the laws of The Commonwealth of Pennsylvania and has the power to
own all of its properties and assets and to carry on its business as presently
conducted.
(b) The Selling Fund is the sole investment series of a
Pennsylvania common law trust registered as an investment company under the 1940
Act, and, to such counsel's knowledge, such registration with the Commission as
an investment company under the 1940 Act is in full force and effect.
(c) This Agreement has been duly authorized, executed and
delivered by the Selling Fund, and, assuming that the Prospectus and Proxy
Statement, and Registration Statement comply with the 1933 Act, the 1934 Act,
and the 1940 Act and the rules and regulations thereunder and, assuming due
authorization, execution, and delivery of this Agreement by the Acquiring Fund,
is a valid and binding obligation of the Selling Fund enforceable against the
Selling Fund in accordance with its terms, subject as to enforcement, to
bankruptcy, insolvency, reorganization, moratorium and other laws relating to or
affecting creditors' rights generally and to general equity principles.
(d) To the knowledge of such counsel, no consent, approval,
authorization or order of any court or governmental authority of the United
States or The Commonwealth of Pennsylvania is required for consummation by the
Selling Fund of the transactions contemplated herein, except such as have been
obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be
required under state securities laws.
ARTICLE VIII
FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING
FUND AND THE SELLING FUND
<PAGE>
If any of the conditions set forth below do not exist on or before the
Closing Date with respect to the Selling Fund or the Acquiring Fund, the other
party to this Agreement shall, at its option, not be required to consummate the
transactions contemplated by this Agreement:
8.1 This Agreement and the transactions contemplated herein shall have
been approved by the requisite vote of the holders of the outstanding shares of
the Selling Fund in accordance with the provisions of Keystone Trust's
Declaration of Trust and By-Laws and certified copies of the resolutions
evidencing such approval shall have been delivered to the Acquiring Fund.
Notwithstanding anything herein to the contrary, neither the Acquiring Fund nor
the Selling Fund may waive the conditions set forth in this paragraph 8.1.
8.2 On the Closing Date, the Commission shall not have issued an
unfavorable report under Section 25(b) of the 1940 Act, nor instituted any
proceeding seeking to enjoin the consummation of the transactions contemplated
by this Agreement under Section 25(c) of the 1940 Act and no action, suit or
other proceeding shall be threatened or pending before any court or governmental
agency in which it is sought to restrain or prohibit, or obtain damages or other
relief in connection with, this Agreement or the transactions contemplated
herein.
8.3 All required consents of other parties and all other consents,
orders, and permits of federal, state and local regulatory authorities
(including those of the Commission and of state Blue Sky securities authorities,
including any necessary "no-action" positions of and exemptive orders from such
federal and state authorities) to permit consummation of the transactions
contemplated hereby shall have been obtained, except where failure to obtain any
such consent, order, or permit would not involve a risk of a material adverse
effect on the assets or properties of the Acquiring Fund or the Selling Fund,
provided that either party hereto may for itself waive any of such conditions.
8.4 The Registration Statement shall have become effective under the
1933 Act, and no stop orders suspending the effectiveness thereof shall have
been issued and, to the best knowledge of the parties hereto, no investigation
or proceeding for that purpose shall have been instituted or be pending,
threatened or contemplated under the 1933 Act.
8.5 The Selling Fund shall have declared a dividend or dividends which,
together with all previous such dividends, shall have the effect of distributing
to the Selling Fund Shareholders all of the Selling Fund's investment company
taxable income for all taxable periods ending on the Closing Date (computed
without regard to any deduction for dividends
<PAGE>
paid) and all of its net capital gains realized in all taxable periods ending on
the Closing Date (after reduction for any capital loss carryforward).
8.6 The parties shall have received a favorable opinion of Sullivan &
Worcester LLP, addressed to the Acquiring Fund and the Selling Fund
substantially to the effect that for federal income tax purposes:
(a) The transfer of all of the Selling Fund assets in exchange
for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
certain stated liabilities of the Selling Fund followed by the distribution of
the Acquiring Fund Shares to the Selling Fund in dissolution and liquidation of
the Selling Fund will constitute a "reorganization" within the meaning of
Section 368(a)(1)(F) of the Code and the Acquiring Fund and the Selling Fund
will each be a "party to a reorganization" within the meaning of Section 368(b)
of the Code.
(b) No gain or loss will be recognized by the Acquiring Fund
upon the receipt of the assets of the Selling Fund solely in exchange for the
Acquiring Fund Shares and the assumption by the Acquiring Fund of certain stated
liabilities of the Selling Fund.
(c) No gain or loss will be recognized by the Selling Fund
upon the transfer of the Selling Fund assets to the Acquiring Fund in exchange
for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
certain stated liabilities of the Selling Fund or upon the distribution (whether
actual or constructive) of the Acquiring Fund Shares to Selling Fund
Shareholders in exchange for their shares of the Selling Fund.
(d) No gain or loss will be recognized by the Selling Fund
Shareholders upon the exchange of their Selling Fund shares for the Acquiring
Fund Shares in liquidation of the Selling Fund.
(e) The aggregate tax basis for the Acquiring Fund Shares
received by each Selling Fund Shareholder pursuant to the Reorganization will be
the same as the aggregate tax basis of the Selling Fund shares held by such
shareholder immediately prior to the Reorganization, and the holding period of
the Acquiring Fund Shares to be received by each Selling Fund Shareholder will
include the period during which the Selling Fund shares exchanged therefor were
held by such shareholder (provided the Selling Fund shares were held as capital
assets on the date of the Reorganization).
(f) The tax basis of the Selling Fund assets
acquired by the Acquiring Fund will be the same as the tax
<PAGE>
basis of such assets to the Selling Fund immediately prior to the
Reorganization, and the holding period of the assets of the Selling Fund in the
hands of the Acquiring Fund will include the period during which those assets
were held by the Selling Fund.
Notwithstanding anything herein to the contrary, neither the Acquiring
Fund nor the Selling Fund may waive the conditions set forth in this paragraph
8.6.
8.7 The Acquiring Fund shall have received from KPMG Peat Marwick LLP a
letter addressed to the Acquiring Fund, in form and substance satisfactory to
the Acquiring Fund, to the effect that:
(a) they are independent certified public accountants with
respect to the Selling Fund within the meaning of the 1933 Act and the
applicable published rules and regulations thereunder;
(b) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards) consisting of a reading
of any unaudited pro forma financial statements included in the Registration
Statement and Prospectus and Proxy Statement, and inquiries of appropriate
officials of Keystone Trust responsible for financial and accounting matters,
nothing came to their attention that caused them to believe that such unaudited
pro forma financial statements do not comply as to form in all material respects
with the applicable accounting requirements of the 1933 Act and the published
rules and regulations thereunder;
(c) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the Capitalization Table
appearing in the Registration Statement and Prospectus and Proxy Statement has
been obtained from and is consistent with the accounting records of the Selling
Fund;
(d) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the pro forma financial
statements that are included in the Registration Statement and Prospectus and
Proxy Statement were prepared based on the valuation of the Selling Fund's
assets in accordance with the Trust's Declaration of Trust and the Acquiring
Fund's then current prospectus and statement of additional information pursuant
to procedures customarily utilized by the Acquiring Fund in valuing its own
assets; and
<PAGE>
(e) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the data utilized in the
calculations of the projected expense ratios appearing in the Registration
Statement and Prospectus and Proxy Statement agree with underlying accounting
records of the Selling Fund or with written estimates by Selling Fund's
management and were found to be mathematically correct.
In addition, the Acquiring Fund shall have received from KPMG Peat
Marwick LLP a letter addressed to the Acquiring Fund dated on the Closing Date,
in form and substance satisfactory to the Acquiring Fund, to the effect, that on
the basis of limited procedures agreed upon by the Acquiring Fund (but not an
examination in accordance with generally accepted auditing standards), the
calculation of net asset value per share of the Selling Fund as of the Valuation
Date was determined in accordance with generally accepted accounting practices
and the portfolio valuation practices of the Acquiring Fund.
8.8 The Selling Fund shall have received from KPMG Peat Marwick LLP a
letter addressed to the Selling Fund, in form and substance satisfactory to the
Selling Fund, to the effect that:
(a) they are independent certified public accountants with
respect to the Acquiring Fund within the meaning of the 1933 Act and the
applicable published rules and regulations thereunder;
(b) on the basis of limited procedures agreed upon by the
Selling Fund and described in such letter (but not an examination in accordance
with generally accepted auditing standards) consisting of a reading of any
unaudited pro forma financial statements included in the Registration Statement
and Prospectus and Proxy Statement, and inquiries of appropriate officials of
the Trust responsible for financial and accounting matters, nothing came to
their attention that caused them to believe that such unaudited pro forma
financial statements do not comply as to form in all material respects with the
applicable accounting requirements of the 1933 Act and the published rules and
regulations thereunder;
(c) on the basis of limited procedures agreed upon by the
Selling Fund and described in such letter (but not an examination in accordance
with generally accepted auditing standards), the Capitalization Table appearing
in the Registration Statement and Prospectus and Proxy Statement has been
obtained from and is consistent with the accounting records of the Acquiring
Fund; and
<PAGE>
(d) on the basis of limited procedures agreed upon by the
Selling Fund (but not an examination in accordance with generally accepted
auditing standards), the data utilized in the calculations of the projected
expense ratio appearing in the Registration Statement and Prospectus and Proxy
Statement agree with written estimates by each Fund's management and were found
to be mathematically correct.
8.9 The Acquiring Fund and the Selling Fund shall also have received
from KPMG Peat Marwick LLP a letter addressed to the Acquiring Fund and the
Selling Fund, dated on the Closing Date in form and substance satisfactory to
the Funds, setting forth the federal income tax implications relating to capital
loss carryforwards (if any) of the Selling Fund and the related impact, if any,
of the proposed transfer of all of the assets of the Selling Fund to the
Acquiring Fund and the ultimate dissolution of the Selling Fund, upon the
shareholders of the Selling Fund.
ARTICLE IX
EXPENSES
9.1 Except as otherwise provided for herein, all expenses of the
transactions contemplated by this Agreement incurred by the Selling Fund and the
Acquiring Fund will be borne by First Union National Bank. Such expenses
include, without limitation, (a) expenses incurred in connection with the
entering into and the carrying out of the provisions of this Agreement; (b)
expenses associated with the preparation and filing of the Registration
Statement under the 1933 Act covering the Acquiring Fund Shares to be issued
pursuant to the provisions of this Agreement; (c) registration or qualification
fees and expenses of preparing and filing such forms as are necessary under
applicable state securities laws to qualify the Acquiring Fund Shares to be
issued in connection herewith in each state in which the Selling Fund
Shareholders are resident as of the date of the mailing of the Prospectus and
Proxy Statement to such shareholders; (d) postage; (e) printing; (f) accounting
fees; (g) legal fees; and (h) solicitation costs of the transaction.
Notwithstanding the foregoing, the Acquiring Fund shall pay its own federal and
state registration fees.
ARTICLE X
ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES
10.1 The Acquiring Fund and the Selling Fund agree that neither party
has made any representation, warranty or covenant not set forth herein and that
this Agreement constitutes the entire agreement between the parties.
<PAGE>
10.2 The representations, warranties, and covenants contained in this
Agreement or in any document delivered pursuant hereto or in connection herewith
shall survive the consummation of the transactions contemplated hereunder.
ARTICLE XI
TERMINATION
11.1 This Agreement may be terminated by the mutual agreement of the
Acquiring Fund and the Selling Fund. In addition, either the Acquiring Fund or
the Selling Fund may at its option terminate this Agreement at or prior to the
Closing Date because:
(a) of a breach by the other of any representation, warranty,
or agreement contained herein to be performed at or prior to the Closing Date,
if not cured within 30 days; or
(b) a condition herein expressed to be precedent to the
obligations of the terminating party has not been met and it reasonably appears
that it will not or cannot be met.
11.2 In the event of any such termination, in the absence of willful
default, there shall be no liability for damages on the part of either the
Acquiring Fund, the Selling Fund, Keystone Trust, the Trust, the respective
Trustees or officers, to the other party or its Trustees or officers.
ARTICLE XII
AMENDMENTS
This Agreement may be amended, modified, or supplemented in such manner
as may be mutually agreed upon in writing by the authorized officers of the
Selling Fund and the Acquiring Fund; provided, however, that following the
meeting of the Selling Fund Shareholders called by the Selling Fund pursuant to
paragraph 5.2 of this Agreement, no such amendment may have the effect of
changing the provisions for determining the number of the Acquiring Fund Shares
to be issued to the Selling Fund Shareholders under this Agreement to the
detriment of such shareholders without their further approval.
ARTICLE XIII
HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT;
LIMITATION OF LIABILITY
13.1 The Article and paragraph headings contained in this Agreement are
for reference purposes only and shall not affect in any way the meaning or
interpretation of this Agreement.
<PAGE>
13.2 This Agreement may be executed in any number of counterparts, each
of which shall be deemed an original.
13.3 This Agreement shall be governed by and construed in accordance
with the laws of the State of Delaware, without giving effect to the conflicts
of laws provisions thereof; provided, however, that the due authorization,
execution and delivery of this Agreement, in the case of Keystone Trust, shall
be governed and construed in accordance with the laws of The Commonwealth of
Pennsylvania, without giving effect to the conflicts of laws provisions thereof.
13.4 This Agreement shall bind and inure to the benefit of the parties
hereto and their respective successors and assigns, but no assignment or
transfer hereof or of any rights or obligations hereunder shall be made by any
party without the written consent of the other party. Nothing herein expressed
or implied is intended or shall be construed to confer upon or give any person,
firm, or corporation, other than the parties hereto and their respective
successors and assigns, any rights or remedies under or by reason of this
Agreement.
13.5 It is expressly agreed that the obligations of the Selling Fund
hereunder shall not be binding upon any of the Trustees, shareholders, nominees,
officers, agents, or employees of Keystone Trust personally, but shall bind only
the trust property of the Selling Fund, as provided in the Declaration of Trust
of Keystone Trust. The execution and delivery of this Agreement have been
authorized by the Trustees of Keystone Trust and signed by authorized officers
of Keystone Trust, acting as such, and neither such authorization by such
Trustees nor such execution and delivery by such officers shall be deemed to
have been made by any of them individually or to impose any liability on any of
them personally, but shall bind only the trust property of the Selling Fund as
provided in the Declaration of Trust of Keystone Trust.
IN WITNESS WHEREOF, the parties have duly executed and sealed this
Agreement, all as of the date first written above.
EVERGREEN FIXED INCOME
TRUST
ON BEHALF OF EVERGREEN
DIVERSIFIED BOND FUND
By: /s/ JOHN J. PILEGGI
Name: John J. Pileggi
<PAGE>
Title: President
KEYSTONE DIVERSIFIED BOND
FUND (B-2)
By: /s/ JOHN J. PILEGGI
Name: John J. Pileggi
Title: President
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
Acquisition of the Assets of
KEYSTONE QUALITY BOND FUND (B-1)
200 Berkeley Street
Boston, Massachusetts 02116
(800) 343-2898
and
KEYSTONE DIVERSIFIED BOND FUND (B-2)
200 Berkeley Street
Boston, Massachusetts 02116
(800) 343-2898
By and In Exchange For Shares of
EVERGREEN DIVERSIFIED BOND FUND
a Series of
EVERGREEN FIXED INCOME TRUST
200 Berkeley Street
Boston, Massachusetts 02116
(800) 343-2898
This Statement of Additional Information, relating specifically to the
proposed transfer of the assets and liabilities of the Keystone Quality Bond
Fund (B-1), ("Keystone Quality"), and Keystone Diversified Bond Fund (B-2)
("Keystone Diversified"), to Evergreen Diversified Bond Fund ("Evergreen
Diversified Bond"), a series of the Evergreen Fixed Income Trust in exchange, as
applicable, for Class B shares of beneficial interest, $.001 par value per
share, of Evergreen Diversified Bond, consists of this cover page and the
following described documents, each of which is attached hereto and incorporated
by reference herein:
(1) The Statement of Additional Information of Keystone
Quality dated February 28, 1997;
(2) The Statement of Additional Information of Keystone
Diversified dated December 10, 1996, as
supplemented;
(3) Annual Report of Keystone Quality for the year ended
October 31, 1996;
(4) Semi-Annual Report of Keystone Quality for the six
month period ended April 30, 1997;
<PAGE>
(5) Annual Report of Keystone Diversified for the year
ended August 31, 1997; and
(6) Pro-Forma Combining Financial Statements (unaudited) dated
February 28, 1997.
This Statement of Additional Information, which is not a prospectus,
supplements, and should be read in conjunction with, the Prospectus/Proxy
Statement of Evergreen Diversified Bond, Keystone Quality and Keystone
Diversified dated November 14, 1997. A copy of the Prospectus/Proxy Statement
may be obtained without charge by calling or writing to Evergreen Diversified
Bond, Keystone Quality or Keystone Diversified at the telephone numbers or
addresses set forth above.
The date of this Statement of Additional Information is November 14,
1997.
<PAGE>
KEYSTONE QUALITY BOND FUND (B-1)
PART B
STATEMENT OF ADDITIONAL INFORMATION
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
KEYSTONE QUALITY BOND FUND (B-1)
FEBRUARY 28, 1997
This statement of additional information is not a prospectus but
relates to, and should be read in conjunction with, the prospectus of Keystone
Quality Bond Fund (B-1) (the "Fund") dated February 28, 1997. You may obtain a
copy of the prospectus from the Fund's principal underwriter, Evergreen Keystone
Distributor, Inc. or your broker-dealer. See "Service Providers" below.
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TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Page
The Fund ....................................................2
Service Providers............................................2
Investment Restrictions......................................3
Distributions and Taxes......................................4
Valuation of Securities......................................5
Brokerage....................................................5
Sales Charge.................................................7
Distribution Plan............................................8
Trustees and Officers.......................................10
Investment Adviser..........................................13
Principal Underwriter.......................................15
Sub-administrator...........................................16
The Trust Agreement.........................................16
Expenses ...................................................17
Standardized Total Return and Yield Quotations..............18
Financial Statements........................................19
Additional Information......................................19
<PAGE>
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THE FUND
- --------------------------------------------------------------------------------
The Fund is an open-end, diversified management investment company. The
Fund's investment objective is to provide shareholders with the highest possible
income consistent with preservation of principal.
Certain information about the Fund is contained in its prospectus. This
statement of additional information provides additional information about the
Fund that may be of interest to some investors.
- --------------------------------------------------------------------------------
SERVICE PROVIDERS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SERVICE PROVIDER
- ----------------------------------------- -----------------------------------------------------------------------
<S> <C>
Investment adviser (referred to Keystone Investment Management Company, 200
in this SAI as "Keystone") Street, Boston, Massachusetts 02116
(Keystone is a wholly-
owned subsidiary of First Union Keystone, Inc., ("First
Union Keystone") also located at 200 Berkeley Street,
Boston, Massachusetts 02116)
Principal underwriter ( referred Evergreen Keystone Distributor, Inc. (formerly Evergreen
to in this SAI as "EKD") Funds Distributor, Inc.), 125 W. 55th Street, New York,
New York 10019.
Marketing services agent and Evergreen Keystone Investment Services, Inc. (formerly
predecessor to EKD (referred to Keystone Investment Distributors Company), 200 Berkeley
in this SAI as "EKIS") Street, Boston, Massachusetts 02116
Sub-administrator (referred to in The BISYS Group, Inc., 3435 Stelzer Road, Columbus, Ohio
this SAI as "BISYS") 43219
Transfer and dividend Evergreen Keystone Service Company, 200 Berkeley
disbursing agent (referred to in Street, Boston, Massachusetts 02116 (EKSC is a wholly-
this SAI as "EKSC") owned subsidiary of Keystone)
Independent auditors KPMG Peat Marwick LLP, 99 High Street, Boston,
Massachusetts 02110, Certified Public Accountants
Custodian State Street Bank and Trust Company, 225 Franklin
Street, Boston, Massachusetts 02110,
</TABLE>
<PAGE>
3
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INVESTMENT RESTRICTIONS
- --------------------------------------------------------------------------------
FUNDAMENTAL INVESTMENT RESTRICTIONS
The Fund has adopted the fundamental investment restrictions set forth
below, which may not be changed without a vote of the majority of the Fund's
outstanding shares (as defined in the Investment Company Act of 1940 (the "1940
Act")). Unless otherwise stated, all references to Fund assets are in terms of
current market value.
The Fund may not do the following:
(1) with respect to 75% of its total assets, invest more than 5% of the
value of its total assets, determined at market or other fair value at the time
of purchase, in the securities of any one issuer, or invest in more than 10% of
the outstanding voting securities of any one issuer, all as determined
immediately after such investment; provided that these limitations do not apply
to investments in securities issued or guaranteed by the U.S. government or its
agencies or instrumentalities;
(2) borrow money, except that the Fund may (a) borrow money from banks
for temporary or emergency purposes in aggregate amounts up to 10% of the value
of the Fund's net assets (computed at cost), or (b) enter into reverse
repurchase agreements, provided that bank borrowings and reverse repurchase
agreements, in aggregate, shall not exceed 10% of the value of the Fund's net
assets;
(3) underwrite securities, except that the Fund may purchase securities
from issuers thereof or others and dispose of such securities in a manner
consistent with its other investment policies; in the disposition of restricted
securities the Fund may be deemed to be an underwriter, as defined in the
Securities Act of 1933 (the "1933 Act");
(4) purchase or sell real estate or interests in real estate, except
that it may purchase and sell securities secured by real estate and securities
of companies which invest in real estate, and will not purchase or sell
commodities or commodity contracts, except that the Fund may engage in currency
or other financial futures contracts and related options transactions;
(5) invest for the primary purpose of exercising control over or
management of any one issuer;
(6) make margin purchases or short sales of securities;
(7) make loans, except that the Fund may purchase money market
securities, enter into repurchase agreements, buy publicly and privately
distributed debt securities and lend limited amounts of its portfolio securities
to broker-dealers; all such investments must be consistent with the Fund's
investment objective and policies;
(8) invest more than 25% of its assets in the securities of issuers in
any single industry other than securities issued by banks and savings and loan
associations or securities issued or guaranteed by the U.S. government, its
agencies or instrumentalities; and
(9) purchase the securities of any other investment company except in
the open market and at customary brokerage rates and in no event more than 3% of
the voting securities of any investment company.
In addition, the Fund will not issue senior securities, except as
appropriate to evidence indebtedness which the portfolio is permitted to incur
pursuant to Investment Restriction (2) above and except for shares of any
additional series or portfolios which may be established by the Trustees.
If a percentage limit is satisfied at the time of investment or
borrowing, a later increase or decrease resulting from a change in the value of
a security or a decrease in Fund assets is not a violation of the limit.
The Fund has no current intention of attempting to increase its net
income by borrowing and intends to repay any borrowings made in accordance with
the fourth investment restriction enumerated above before it makes any
additional investments.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS
With respect to illiquid securities, the Fund intends to follow the
policies of the Securities and Exchange Commission. Currently, the Fund will not
invest more than 15% of its net assets in illiquid securities. Also, the Fund
will treat securities as illiquid if it may not sell or dispose of the security
in the ordinary course of business within seven days at approximately the value
at which the Fund has valued such securities on its books.
- --------------------------------------------------------------------------------
DISTRIBUTIONS AND TAXES
- --------------------------------------------------------------------------------
You will ordinarily receive distributions in shares, unless you elect
before the record date to receive them as cash. Unless the Fund receives
instructions to the contrary, it will assume that you wish to receive that
distribution and future gains and income distributions in shares. Your
instructions continue in effect until changed in writing. If you have not opted
to receive cash, the Fund will determine the number of shares that you should
receive based on its net asset value per share as computed at the close of
business on the ex-dividend date after adjustment for the distribution.
Capital gains distributions that reduce the net asset value of your
shares below your cost are, to the extent of the reduction, a return of your
investment. Since distributions of capital gains depend upon profits realized
from the sale of the Fund's portfolio securities, they may or may not occur.
Distributions are taxable whether you receive them in cash or
additional shares. Long-term capital gains distributions are taxable as such
regardless of how long you have held the shares. If, however, you hold the
Fund's shares for less than six months and redeem them at a loss, you will
recognize a long-term capital loss to the extent of the long-term capital gain
distribution received in connection with such shares. The Fund intends to
distribute only such net capital gains and income as it has predetermined, to
the best of its ability, to be taxable as ordinary income. Since the Fund's
income distributions are largely derived from interest on bonds they are not to
any significant degree eligible for the corporate 70% dividends received
deduction. Distributions designated by the Fund as capital gains are not
eligible for the corporate 70% dividends received deduction
The Fund will advise you annually as to the federal income tax status
of your distributions. These comments relating to the taxation of dividends and
distributions paid on the Fund's shares relate solely to federal income
taxation. Your dividends and distributions may also be subject to state and
local taxes.
- --------------------------------------------------------------------------------
VALUATION OF SECURITIES
- --------------------------------------------------------------------------------
Current values for the Fund's portfolio securities are determined in
the following manner:
(1) securities traded on the established exchanges are valued on the
basis of the last sales price on the exchange where the securities are primarily
traded prior to the time of the valuation;
(2) securities traded in the over-the-counter market, for which
complete quotations are readily available, are valued at the mean of the bid and
asked prices at the time of valuation;
(3) short-term investments maturing in sixty days or less are valued at
amortized cost (original purchase cost as adjusted for amortization of premium
or accretion of discount), which, when combined with accrued interest,
approximates market;
(4) short-term investments maturing in more than sixty days for which
market quotations are readily available are valued at market value;
(5) short-term investments maturing in more than sixty days when
purchased that are held on the sixtieth day prior to maturity are valued at
amortized cost (market value on the sixtieth day adjusted for amortization of
premium or accretion of discount), which, when combined with accrued interest,
approximates market; and
(6) the Board of Trustees values the following at prices it deems in
good faith to be fair: (a) securities, including restricted securities, for
which complete quotations are not readily available, (b) listed securities if in
the Fund's opinion the last sales price does not reflect a current market value
or if no sale occurred, and (c) other assets.
The Fund believes that reliable market quotations are generally not
readily available for purposes of valuing fixed income securities. As a result,
depending on the particular securities owned by the Fund, it is likely that most
of the valuations for such securities will be based upon their fair value
determined under procedures that have been approved by the Fund's Board of
Trustees. The Fund's Board of Trustees has authorized the use of a pricing
service to determine the fair value of the Fund's fixed income securities and
certain other securities.
- --------------------------------------------------------------------------------
BROKERAGE
- --------------------------------------------------------------------------------
SELECTION OF BROKERS
In effecting transactions in portfolio securities for the Fund,
Keystone seeks the best execution of orders at the most favorable prices.
Keystone determines whether a broker has provided the Fund with best execution
and price in the execution of a securities transaction by evaluating, among
other things:
1. overall direct net economic result to the Fund,
2. the efficiency with which the transaction is effected,
3. the broker's ability to effect the transaction where a large
block is involved,
4. the broker's readiness to execute potentially difficult
transactions in the future,
5. the financial strength and stability of the broker, and
6. the receipt of research services, such as analyses and reports
concerning issuers, industries, securities, economic factors
and trends and other statistical and factual information
("research services").
The Fund's management weighs these considerations in determining the
overall reasonableness of the brokerage commissions paid.
Should the Fund or Keystone receive services from a broker, the Fund
would consider such services to be in addition to, and not in lieu of, the
services Keystone is required to perform under the Advisory Agreement. Keystone
believes that the cost, value and specific application of such services are
indeterminable and cannot be practically allocated between the Fund and its
other clients who may indirectly benefit from the availability of such
information. Similarly, the Fund may indirectly benefit from information made
available as a result of transactions effected for Keystone's other clients.
Under the Advisory Agreement, Keystone is permitted to pay higher brokerage
commissions for brokerage and research services in accordance with Section 28(e)
of the Securities Exchange Act of 1934. In the event Keystone follows such a
practice, it will do so on a basis that is fair and equitable to the Fund.
Neither the Fund nor Keystone intends on placing securities
transactions with any particular broker. The Fund's Board of Trustees has
determined, however, that the Fund may consider sales of Fund shares as a factor
when selecting brokers to execute portfolio transactions, subject to the
requirements of best execution described above.
BROKERAGE COMMISSIONS
The Fund expects to purchase and sell its securities and temporary
instruments through principal transactions. Bonds and money market instruments
are normally purchased directly from the issuer or from an underwriter or market
maker for the securities. In general, the Fund will not pay brokerage
commissions for such purchases. Purchases from underwriters will include the
underwriting commission or concession, and purchases from dealers serving as
market makers will include a dealer's mark-up or reflect a dealer's mark-down.
Where transactions are made in the over-the-counter market, the Fund will deal
with primary market makers unless more favorable prices are otherwise
obtainable.
GENERAL BROKERAGE POLICIES
In order to take advantage of the availability of lower purchase
prices, the Fund may participate, if and when practicable, in group bidding for
the direct purchase from an issuer of certain securities.
Keystone makes investment decisions for the Fund independently from
those of its other clients. It may frequently develop, however, that Keystone
will make the same investment decision for more than one client. Simultaneous
transactions are inevitable when the same security is suitable for the
investment objective of more than one account. When two or more of its clients
are engaged in the purchase or sale of the same security, Keystone will allocate
the transactions according to a formula that is equitable to each of its
clients. Although, in some cases, this system could have a detrimental effect on
the price or volume of the Fund's securities, the Fund believes that in other
cases its ability to participate in volume transactions will produce better
executions.
The Fund does not purchase portfolio securities from or sell portfolio
securities to Keystone, EKD, or any of their affiliated persons, as defined in
the 1940 Act.
The Board of Trustees periodically reviews the Fund's brokerage policy.
In the event of further regulatory developments affecting the securities
exchanges and brokerage practices generally, the Board of Trustees may change,
modify or eliminate any of the foregoing practices.
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SALES CHARGE
- --------------------------------------------------------------------------------
The Fund may charge a contingent deferred sales charge (a "CDSC") when
you redeem certain of its shares within four calendar years after the month in
which you purchase the shares. The Fund charges a CDSC as reimbursement for
certain expenses, such as commissions or shareholder servicing fees, that it has
incurred in connection with the sale of its shares (see "Distribution Plan"). If
imposed, the Fund deducts the CDSC from the redemption proceeds you would
otherwise receive. CDSCs attributable to your shares are, to the extent
permitted by the National Association of Securities Dealers, Inc. ("NASD"), paid
to EKD or its predecessor.
CALCULATING THE CDSC
The CDSC is a declining percentage of the lesser of (1) the net asset
value of the shares you redeemed, or (2) the total cost of such shares. The CDSC
is calculated according to the following schedule:
Redemption Timing CDSC
During the calendar year of purchase..................4.00%
During the calendar year after the
year of purchase....................................3.00%
During the second calendar
year after the year of purchase.....................2.00%
During the third calendar year
after the year of purchase..........................1.00%
Thereafter............................................0.00%
In determining whether a CDSC is payable and, if so, the percentage
charge applicable, the Fund will first redeem shares not subject to a CDSC and
will then redeem shares you have held the longest.
SHARES THAT ARE NOT SUBJECT TO A SALES CHARGE OR CDSC
SALES CHARGE WAIVERS. The Fund may sell shares at the public offering
price, which is equal to net asset value, without the imposition of a sales
charge to:
1. any Director, Trustee, officer, full-time employee or sales
representative of the Fund, Keystone, First Union Keystone,
EKD or their affiliates, who has held such position for at
least ninety days; and
2. the pension and profit-sharing plans established by such
companies and their affiliates, for the benefit of their
Directors, Trustees, officers, full-time employees and sales
representatives.
However, the Fund will only sell shares to these parties upon the
purchaser's written assurance that he or she is buying the shares for investment
purposes only. Such purchasers may not resell the securities except through
redemption by the Fund.
CDSC WAIVERS. The Fund does not impose a CDSC when the amount you are
redeeming represents:
1. an increase in the value of the shares redeemed (the value of
your account with respect to shares purchased prior to January
1, 1997) above the total cost of such shares due to increases
in the net asset value per share of the Fund;
2. certain shares for which the Fund did not pay a commission on
issuance, including shares acquired through reinvestment of
dividend income and capital gains distributions;
3. shares you have held for all or part of more than four
consecutive calendar years;
4. shares that are held in the accounts of a shareholder who has
died or become disabled;
5. a lump-sum distribution from a 401(k) plan or other benefit
plan qualified under the Employee Retirement Income Security
Act of 1974 ("ERISA");
6. automatic withdrawals from the ERISA plan of a shareholder who
is a least 59 1/2 years old;
7. shares in an account that the Fund has closed because the
account has an aggregate net asset value of less than $1,000;
8. automatic withdrawals under a Systematic Income Plan of up to
1% per month of your initial account balance;
9. withdrawals consisting of loan proceeds to a retirement plan
participant;
10. financial hardship withdrawals made by a retirement plan
participant;
11. withdrawals consisting of returns of excess contributions or
excess deferral amounts made to a retirement plan; or
12. shares purchased by a bank or trust company in a single
account in the name of such bank or trust company as trustee
if the initial investment in shares of the Fund, any other
Fund in the Keystone Classic Fund Family, Keystone Precious
Metals Holdings, Inc., Keystone International Fund Inc.,
Keystone Tax Free Fund, Keystone Liquid Trust and/or any
Keystone America Fund, is at least $500,000 and any commission
paid by the Fund and such other fund at the time of such
purchase is not more than 1% of the amount invested.
EXCHANGES. The Fund does not charge a CDSC on exchanges of shares
between funds in the Keystone Fund Family that have adopted distribution plans
pursuant to Rule 12b-1 under the 1940 Act. If you do exchange shares of one such
fund for shares of another such fund, the Fund will deem the calendar year of
the exchange, for purposes of any future CDSC, to be the year the shares
tendered for exchange were originally purchased.
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DISTRIBUTION PLAN
- --------------------------------------------------------------------------------
Rule 12b-1 under the 1940 Act permits investment companies, such as the
Fund, to use their assets to bear the expenses of distributing their shares if
they comply with various conditions, including the adoption of a distribution
plan containing certain provisions set forth in Rule 12b-1. The Fund bears some
of the costs of selling its shares under a distribution plan adopted pursuant to
Rule 12b-1 (the "Distribution Plan").
The Fund's Distribution Plan provides that the Fund may expend up to
0.3125% quarterly (approximately 1.25% annually) of the average daily net asset
value of its shares to pay distribution costs for sales of its shares and to pay
shareholder service fees. The NASD limits such annual expenditures
to 1.00%, of which 0.75% may be used to pay such distribution costs and 0.25%
may be used to pay shareholder service fees. The NASD also limits the aggregate
amount that the Fund may pay for such distribution costs to 6.25% of gross share
sales since the inception of the Fund's Distribution Plan plus interest at the
prime rate plus 1.00% on unpaid amounts thereof (less any CDSCs paid by
shareholders to EKD or EKIS).
Payments under the Distribution Plan are currently made to EKD (which
may reallow all or part to others, such as broker-dealers) (1) as commissions
for Fund shares sold; (2) as shareholder service fees in respect of shares
maintained by the recipient and outstanding on the Fund's books for specific
periods; and (3) as interest. Amounts paid or accrued to EKD and EKIS in the
aggregate may not exceed the annual limitation referred to above. EKD generally
reallows to broker-dealers or others a commission equal to 4.00% of the price
paid for each Fund share sold. In addition, EKD generally reallows to
broker-dealers or others a shareholder service fee at a rate of 0.25% per annum
of the net asset value of shares maintained by such recipient and outstanding on
the books of the Fund for specified periods.
If the Fund is unable to pay EKD a commission on a new sale because the
annual maximum (0.75% of average daily net assets) has been reached, EKD
intends, but is not obligated, to continue to accept new orders for the purchase
of Fund shares and to pay commissions and service fees to broker-dealers in
excess of the amount it currently receives from the Fund ("Advances"). While the
Fund is under no contractual obligation to reimburse such Advances, EKD and
EKIS, its predecessor, intend to seek full reimbursement for Advances from the
Fund (together with interest at the prime rate plus 1.00%) at such time in the
future as, and to the extent that, payment thereof by the Fund would be within
permitted limits. If the Fund's Independent Trustees (Trustees who are not
interested persons, as defined in the 1940 Act, and who have no direct or
indirect financial interest in the operation of the Fund's Distribution Plan or
any agreement related thereto) authorize such payments, the effect will be to
extend the period of time during which the Fund incurs the maximum amount of
costs allowed by the Distribution Plan.
The total amounts paid by the Fund under the foregoing arrangements may
not exceed the maximum Distribution Plan limit specified above, and the amounts
and purposes of expenditures under the Distribution Plan must be reported to the
Independent Trustees quarterly. The Independent Trustees may require or approve
changes in the implementation or operation of the Distribution Plan, and may
require that total expenditures by the Fund under the Distribution Plan be kept
within limits lower than the maximum amount permitted by the Distribution Plan
as stated above. If such costs are not limited by the Independent Trustees, such
costs could, for some period of time, be higher than such costs permitted by
most other plans presently adopted by other investment companies.
The Distribution Plan may be terminated at any time by vote of the
Independent Trustees, or by vote of a majority of the outstanding shares of the
Fund. If the Distribution Plan is terminated, EKD will ask the Independent
Trustees to take whatever action they deem appropriate under the circumstances
with respect to payment of Advances.
Any change in the Distribution Plan that would materially increase the
distribution expenses of the Fund provided for in the Distribution Plan requires
shareholder approval. Otherwise, the Distribution Plan may be amended by votes
of both (1) the Fund's Trustees and (2) the Independent Trustees cast in person
at a meeting called for the purpose of voting on such amendment.
While the Distribution Plan is in effect, the Fund is required to
commit the selection and nomination of candidates for Independent Trustees to
the discretion of the Independent Trustees.
The Independent Trustees of the Fund have determined that the sales of
the Fund's shares resulting from payments under the Distribution Plan have
benefitted the Fund.
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TRUSTEES AND OFFICERS
- --------------------------------------------------------------------------------
The Trustees and officers of the Fund, their addresses, their principal
occupations and some of their affiliations over the last five years are as
follows:
<TABLE>
<CAPTION>
<S> <C>
FREDERICK AMLING: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Professor, Finance Department,
George Washington University; President, Amling & Company
(investment advice); and former Member, Board of Advisers, Cre
dito Emilano (banking).
LAURENCE B. ASHKIN: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee of all funds in the Evergreen
Family of Funds other than Evergreen Investment Trust; real
estate developer and construction consultant; and President of
Centrum Equities and Centrum Properties, Inc.
CHARLES A. AUSTIN III: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Investment Counselor to Appleton Partners, Inc.;
and former Managing Director, Seaward Management Corporation investment advice).
*FOSTER BAM: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of all the funds in the
Evergreen Family of Funds other than Evergreen Investment
Trust; Partner in the law firm of Cummings & Lockwood; Director,
Symmetrix, Inc. (sulphur company) and Pet Practice, Inc.
(veterinary services); and former Director, Chartwell Group Ltd.
(Manufacturer of office furnishings and accessories), Waste
Disposal Equipment Acquisition Corporation and Rehabilitation
Corporation of America (rehabilitation hospitals).
*GEORGE S. BISSELL: Chief Executive Officer of the Fund and each of the other funds in
the Keystone Families of Funds; Chairman of the Board and
Trustee of the Fund; Chairman of the Board and Trustee or
Director of all other funds in the Keystone Families of Funds;
Chairman of the Board and Trustee of Anatolia College; Trustee
of University Hospital (and Chairman of its Investment
Committee); former Director and Chairman of the Board of
Hartwell Keystone; and former Chairman of the Board, Director
and Chief Executive Officer of Keystone Investments.
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Principal, Padanaram Associates,
Inc.; and former Executive Director, Coalition of Essential Schools,
Brown University.
CHARLES F. CHAPIN: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; and former Director, Peoples Bank
(Charlotte, NC).
K. DUN GIFFORD: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee, Treasurer and Chairman of
the Finance Committee, Cambridge College; Chairman Emeritus
and Director, American Institute of Food and Wine; Chairman
and President, Oldways Preservation and Exchange Trust (educa
tion); former Chairman of the Board, Director, and Executive Vice
President, The London Harness Company; former Managing Part
ner, Roscommon Capital Corp.; former Chief Executive Officer,
Gifford Gifts of Fine Foods; former Chairman, Gifford, Drescher
& Associates (environmental consulting); and former Director,
Keystone Investments and Keystone.
JAMES S. HOWELL: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Chairman and Trustee or Director of all the
funds in the Evergreen Family of Funds; former Chairman of the
Distribution Foundation for the Carolinas; and former Vice
President of Lance Inc. (food manufacturing).
LEROY KEITH, JR.: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Chairman of the Board and Chief
Executive Officer, Carson Products Company; Director of Phoenix
Total Return Fund and Equifax, Inc.; Trustee of Phoenix Series
Fund, Phoenix Multi-Portfolio Fund, and The Phoenix Big Edge
Series Fund; and former President, Morehouse College.
F. RAY KEYSER, JR.: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Chairman and Of Counsel, Keyser,
Crowley & Meub, P.C.; Member, Governor's (VT) Council of Eco
nomic Advisers; Chairman of the Board and Director, Central
Vermont Public Service Corporation and Lahey Hitchcock Clinic;
Director, Vermont Yankee Nuclear Power Corporation, Grand
Trunk Corporation, Grand Trunk Western Railroad, Union
Mutual Fire Insurance Company, New England Guaranty
Insurance Company, Inc., and the Investment Company Institute;
former Director and President, Associated Industries of Vermont;
former Director of Keystone, Central Vermont Railway, Inc., S.K.I.
Ltd., and Arrow Financial Corp.; and former Director and
Chairman of the Board, Proctor Bank and Green Mountain Bank.
GERALD M. MCDONNELL: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of the Evergreen funds; and
Sales Representative with Nucor-Yamoto, Inc. (Steel producer).
THOMAS L. MCVERRY: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of the Evergreen funds;
former Vice President and Director of Rexham Corporation; and
former Director of Carolina Cooperative Federal Credit Union.
*WILLIAM WALT PETTIT: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of all the funds in the
Evergreen Family of Funds; and Partner in the law firm of
Holcomb and Pettit, P.A.
DAVID M. RICHARDSON: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Vice Chair and former Executive Vice
President, DHR International, Inc. (executive recruitment);
former Senior Vice President, Boyden International Inc. (executive
recruitment); and Director, Commerce and Industry Association
of New Jersey, 411 International, Inc., and J&M Cumming Paper
Co.
RUSSELL A. SALTON, III MD: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of all the funds in the
Evergreen Family of Funds; Medical Director, U.S. Health
Care/Aetna Health Services; and former Managed Health Care
Consultant; former President, Primary Physician Care.
MICHAEL S. SCOFIELD: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Trustee or Director of all the funds in the
Evergreen Family of Funds; and Attorney, Law Offices of Michael
S. Scofield.
RICHARD J. SHIMA: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Chairman, Environmental Warranty,
Inc. (insurance agency); Executive Consultant, Drake Beam
Morin, Inc. (executive outplacement); Director of Connecticut
Natural Gas Corporation, Hartford Hospital, Old State House
Association, Middlesex Mutual Assurance Company, and Enhance
Financial Services, Inc.; Chairman, Board of Trustees, Hartford
Graduate Center; Trustee, Greater Hartford YMCA; former
Director, Vice Chairman and Chief Investment Officer, The
Travelers Corporation; former Trustee, Kingswood-Oxford School;
and former Managing Director and Consultant, Russell Miller,
Inc.
ANDREW J. SIMONS: Trustee of the Fund; Trustee or Director of all other funds in the
Keystone Families of Funds; Partner, Farrell, Fritz, Caemmerer,
Cleary, Barnosky & Armentano, P.C.; Adjunct Professor of Law
and former Associate Dean, St. John's University School of Law;
Adjunct Professor of Law, Touro College School of Law; and
former President, Nassau County Bar Association.
JOHN J. PILEGGI: President and Treasurer of the Fund; President and Treasurer of
all other funds in the Keystone Families of Funds; President and
Treasurer of all the funds in the Evergreen Family of Funds;
Senior Managing Director, Furman Selz LLC since 1992;
Managing Director from 1984 to 1992; Consultant to BISYS Fund
Services since 1996; 230 Park Avenue, Suite 910, New York, NY.
GEORGE O. MARTINEZ: Secretary of the Fund; Secretary of all other funds in the Keystone
Families of Funds; Secretary of all other funds in the Evergreen Family of Funds;
Senior Vice President and Director of Administration and Regulatory Services,
BISYS Fund Services since 1995; Vice President/Assistant General Counsel, Alliance
Capital Management from 1988 to 1995; 3435 Stelzer Road, Columbus, Ohio.
</TABLE>
* This Trustee may be considered an "interested person" of the Fund within the
meaning of the 1940 Act.
The Fund does not pay any direct remuneration to any officer or Trustee
who is an "affiliated person" of Keystone or any of its affiliates. See
"Investment Adviser." During the fiscal year ended October 31, 1996, the
unaffiliated Trustees (who numbered 10 during that period) received retainers or
fees totaling $31,867 from the Fund. Annual retainers and meeting fees paid by
all funds in the Keystone Families of Funds (which includes over 30 mutual
funds) for the fiscal year ended October 31, 1996 totaled approximately $411,000
.. As of January 31, 1997, the Trustees and officers beneficially owned less than
1% of each of the Fund's then outstanding shares.
Except as set forth above, the address of all of the Fund's Trustees
and the address of the Fund is 200 Berkeley Street, Boston, Massachusetts
02116-5034.
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INVESTMENT ADVISER
- --------------------------------------------------------------------------------
Subject to the general supervision of the Fund's Board of Trustees,
Keystone provides investment advice, management and administrative services to
the Fund.
On December 11, 1996, the predecessor corporation to First Union
Keystone, Keystone Investments, Inc. ("Keystone Investments") and indirectly
each subsidiary of Keystone Investments, including Keystone, were acquired (the
"Acquisition") by First Union National Bank of North Carolina ("FUNB"), a
wholly-owned subsidiary of First Union. Keystone Investments was acquired by
FUNB by merger into a wholly-owned subsidiary of FUNB, which entity then assumed
the First Union Keystone name and succeeded to the business of the predecessor
corporation. Contemporaneously with the Acquisition, the Fund entered into a new
investment advisory agreement with Keystone and into a principal underwriting
agreement with EKD, an indirect wholly-owned subsidiary of The BISYS Group, Inc.
("BISYS"). The new investment advisory agreement (the "Advisory Agreement") was
approved by the shareholders of the Fund on December 9, 1996, and became
effective on December 11, 1996. As a result of the above transactions, Keystone
Management, Inc. ("Keystone Management"), which, prior to the Acquisition, acted
as the Fund's investment manager, no longer acts as such to the Fund. Keystone
currently provides the Fund with all the services that may previously have been
provided by Keystone Management.
<PAGE>
14
First Union Keystone and each of its subsidiaries, including Keystone,
are now indirectly owned by First Union. First Union is headquartered in
Charlotte, North Carolina, and had $140 billion in consolidated assets as of
December 31, 1996. First Union and its subsidiaries provide a broad range of
financial services to individuals and businesses throughout the United States.
The Capital Management Group of FUNB and Evergreen Asset Management Corp.,
wholly-owned subsidiaries of FUNB, manage or otherwise oversee the investment of
over $60 billion in assets belonging to a wide range of clients, including the
Evergreen Family of Funds.
Pursuant to the Advisory Agreement and subject to the supervision of
the Fund's Board of Trustees, Keystone furnishes to the Fund investment
advisory, management and administrative services, office facilities, and
equipment in connection with its services for managing the investment and
reinvestment of the Fund's assets. Keystone pays for all of the expenses
incurred in connection with the provision of its services.
All charges and expenses, other than those specifically referred to as
being borne by Keystone, will be paid by the Fund, including, but not limited
to, (1) custodian charges and expenses; (2) bookkeeping and auditors' charges
and expenses; (3) transfer agent charges and expenses; (4) fees and expenses of
Independent Trustees; (5) brokerage commissions, brokers' fees and expenses; (6)
issue and transfer taxes; (7) costs and expenses under the Distribution Plans;
(8) taxes and trust fees payable to governmental agencies; (9) the cost of share
certificates; (10) fees and expenses of the registration and qualification of
the Fund and its shares with the Commission or under state or other securities
laws; (11) expenses of preparing, printing and mailing prospectuses, statements
of additional information, notices, reports and proxy materials to shareholders
of the Fund; (12) expenses of shareholders' and Trustees' meetings; (13) charges
and expenses of legal counsel for the Fund and for the Independent Trustees of
the Fund on matters relating to the Fund; and (14) charges and expenses of
filing annual and other reports with the Commission and other authorities, and
all extraordinary charges and expenses of the Fund.
The Fund pays Keystone a fee for its services at the annual rate set
forth below:
Aggregate Net
Asset Value of the
Management Fee Income Shares of the Fund
- ----------------------------------------------------------------------------
2% of gross dividend and
interest income plus
0.50% of the first $ 100,000,000 plus
0.45% of the next $ 100,000,000 plus
0.40% of the next $ 100,000,000 plus
0.35% of the next $ 100,000,000 plus
0.30% of the next $ 100,000,000 plus
0.25% of amounts over $ 500,000,000.
Keystone's fee is computed as of the close of business each business day and
payable monthly.
Under the Advisory Agreement, any liability of Keystone in connection
with rendering services thereunder is limited to situations involving its
willful misfeasance, bad faith, gross negligence or reckless disregard of its
duties.
The Advisory Agreement continues in effect for two years from its
effective date and, thereafter, from year to year only if approved at least
annually by the Board of Trustees of the Fund or by a vote of a majority of the
Fund's outstanding shares (as defined in the 1940 Act). In either case, the
terms of the Advisory Agreement and continuance thereof must be approved by the
vote of a majority of the Independent Trustees cast in person at a meeting
called for the purpose of voting on such approval. The Advisory Agreement may be
terminated, without penalty, on 60 days' written notice by the Fund's Board of
Trustees or by a vote of a majority of outstanding shares. The Advisory
Agreement will terminate automatically upon its assignment.
- --------------------------------------------------------------------------------
PRINCIPAL UNDERWRITER
- --------------------------------------------------------------------------------
The Fund has entered into a Principal Underwriting Agreement (the
"Underwriting Agreement") with EKD. EKD, which is not affiliated with First
Union, replaces EKIS as the Funds' principal underwriter. EKIS may no longer act
as principal underwriter of the Funds due to regulatory restrictions imposed by
the Glass-Steagall Act upon national banks such as FUNB and their affiliates,
that prohibit such entities from acting as the underwriters of mutual fund
shares. While EKIS may no longer act as principal underwriter of the Funds as
discussed above, EKIS may continue to receive compensation from the Fund or EKD
in respect of underwriting and distribution services performed prior to the
termination of EKIS as principal underwriter. In addition, EKIS may also be
compensated by EKD for the provision of certain marketing support services to
EKD at an annual rate of up to .75% of the average daily net assets of the Fund,
subject to certain restrictions.
EKD, as agent, has agreed to use its best efforts to find purchasers
for the shares. EKD may retain and employ representatives to promote
distribution of the shares and may obtain orders from broker-dealers, and
others, acting as principals, for sales of shares to them. The Underwriting
Agreement provides that EKD will bear the expense of preparing, printing, and
distributing advertising and sales literature and prospectuses used by it. In
its capacity as principal underwriter, EKD or EKIS, its predecessor, may receive
payments from the Fund pursuant to the Fund's Distribution Plan.
The Underwriting Agreement provides that it will remain in effect as
long as its terms and continuance are approved annually (i) by a vote of a
majority of the Independent Trustees, and (ii) by vote of a majority of the
Trustees, in each case, cast in person at a meeting called for that purpose.
The Underwriting Agreement may be terminated, without penalty, on 60
days' written notice by the Board of Trustees or by a vote of a majority of
outstanding shares. The Underwriting Agreement will terminate automatically upon
its assignment.
From time to time, if, in EKD's judgment, it could benefit the sales of
Fund shares, EKD may provide to selected broker-dealers promotional materials
and selling aids, including, but not limited to, personal computers, related
software, and Fund data files.
- --------------------------------------------------------------------------------
SUB-ADMINISTRATOR
- --------------------------------------------------------------------------------
BISYS provides personnel to serve as officers of the Funds, and certain
administrative services to the Funds pursuant to a sub-administration agreement
for its services under that agreement, BISYS receives a fee from Keystone at the
maximum annual rate of .01% of the average daily net assets of the Fund.
- --------------------------------------------------------------------------------
THE TRUST AGREEMENT
- --------------------------------------------------------------------------------
TRUST AGREEMENT
The Fund is a Pennsylvania common law trust established under a Trust
Agreement dated July 15, 1935, restated and amended as of December 19, 1989 (the
"Trust Agreement"). The Trust Agreement provides for a Board of Trustees, and
enables the Fund to enter into an agreement with an investment manager and/or
adviser to provide the Fund with investment advisory, management and
administrative services. A copy of the Trust Agreement is filed as an exhibit to
the Fund's Registration Statement, of which this statement of additional
information is a part. This summary is qualified in its entirety by reference to
the Trust Agreement.
DESCRIPTION OF SHARES
The Trust Agreement authorizes the issuance of an unlimited number of
shares of beneficial interest and the creation of additional series and/or
classes of series of Fund shares. Each share represents an equal proportionate
interest in the Fund with each other share of that class. Upon liquidation,
shares are entitled to a pro rata share in the net assets of their class of Fund
shares. Shareholders shall have no preemptive or conversion rights. Shares are
transferable. The Fund currently intends to issue only one class of shares.
SHAREHOLDER LIABILITY
Pursuant to court decisions or other theories of law, shareholders of a
Pennsylvania common law trust, could possibly be held personally liable for the
obligations of the trust. The possibility of the Fund's shareholders incurring
financial loss under such circumstances appears to be remote, however, because
the Trust Agreement (1) contains an express disclaimer of shareholder liability
for obligations of the Fund; (2) requires that notice of such disclaimer be
given in each agreement, obligation or instrument entered into or executed by
the Fund or the Trustees; and (3) provides for indemnification out of Fund
property for any shareholder held personally liable for the obligations of the
Fund.
VOTING RIGHTS
Under the terms of the Trust Agreement, the Fund does not hold annual
meetings. At meetings called for the initial election of Trustees or to consider
other matters, shares are entitled to one vote per share. Shares generally vote
together as one class on all matters. No amendment may be made to the Trust
Agreement that adversely affects any class of shares without the approval of a
majority of the shares of that class. There shall be no cumulative voting in the
election of Trustees.
After a meeting as described above, no further meetings of shareholders
for the purpose of electing Trustees will be held, unless required by law until
such time as less than a majority of the Trustees holding office have been
elected by shareholders, at which time the Trustees then in office will call a
shareholders' meeting for the election of Trustees.
Except as set forth above, the Trustees shall continue to hold office
indefinitely unless otherwise required by law and may appoint successor
Trustees. A Trustee may cease to hold office or may be removed from office (as
the case may be) (1) at any time by a two-thirds vote of the remaining Trustees;
(2) when such Trustee becomes mentally or physically incapacitated; or (3) at a
special meeting of shareholders by a two-thirds vote of the outstanding shares.
Any Trustee may voluntarily resign from office.
LIMITATION OF TRUSTEES' LIABILITY
The Trust Agreement provides that a Trustee shall be liable only for
his own willful defaults and, if reasonable care has been exercised in the
selection of officers, agents, employees or investment advisers, shall not be
liable for any neglect or wrongdoing of any such person; provided, however, that
nothing in the Trust Agreement shall protect a Trustee against any liability for
his willful misfeasance, bad faith, gross negligence or reckless disregard of
his duties.
The Trustees have absolute and exclusive control over the management
and disposition of all assets of the Fund and may perform such acts as in their
sole judgment and discretion are necessary and proper for conducting the
business and affairs of the Fund or promoting the interests of the Fund and the
shareholders.
- --------------------------------------------------------------------------------
EXPENSES
- --------------------------------------------------------------------------------
INVESTMENT ADVISORY FEES
For each of the Fund's last three fiscal years, the table below lists
the total dollar amounts paid by (1) the Fund to Keystone Management, the Fund's
former investment manager, for investment management and administrative services
rendered and (2) by Keystone Management to Keystone for investment advisory
services rendered. For more information, see "Investment Adviser."
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Percent of Fund's
Fee Paid to Keystone Average Net Assets Fee Paid to
Management under represented by Keystone under
Fiscal Year Ended the Management Keystone the Advisory
October 31, Agreement Management's Fee Agreement
- ------------------------- ---------------------------- ---------------------------- -----------------------
1996 $1,578,211 0.60% $1,341,479
1995 $1,876,672 0.60% $1,595,171
1994 $2,193,546 0.56% $1,864,514
</TABLE>
DISTRIBUTION PLAN EXPENSES
For the fiscal year ended October 31, 1996, the Fund paid $2,645,899 to
EKIS under its Distribution Plan. For more information, see "Distribution
Plans."
UNDERWRITING COMMISSIONS
For each of the Fund's last three fiscal years, the table below lists
the aggregate dollar amounts of underwriting commissions (front-end sales
charges, plus distribution fees, plus CDSCs) paid with respect to the public
distribution of the Fund's shares. The table also indicates the aggregate dollar
amount of underwriting commissions retained by EKIS. For more information, see
"Principal Underwriter" and "Sales Charges."
<TABLE>
<CAPTION>
<S> <C> <C>
Aggregate Dollar Amount of
Fiscal Year Ended Aggregate Dollar Amount of Underwriting Commissions
October 31, Underwriting Commissions Retained by EKD or EKIS
- -------------------------- ---------------------------------------- -----------------------------------------
1996 $2,235,405 $1,897,428
1995 $2,719,026 $2,221,208
1994 $3,526,112 $2,363,825
</TABLE>
BROKERAGE COMMISSIONS
The Fund paid no brokerage commissions for the fiscal years ended
October 31, 1994, 1995 and 1996.
- --------------------------------------------------------------------------------
STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
- --------------------------------------------------------------------------------
Total return quotations for the Fund as they may appear from time to
time in advertisements are calculated by finding the average annual compounded
rates of return over the one, five and ten year periods on a hypothetical $1,000
investment which would equate the initial amount invested to the ending
redeemable value. To the initial investment all dividends and distributions are
added, and all recurring fees charged to all shareholder accounts are deducted.
The ending redeemable value assumes a complete redemption at the end of the one,
five or ten year periods.
The annual total return for the one year period ended October 31, 1996
was 1.03% (including applicable sales charge). The average annual total return
for the five and ten year periods ended October 31, 1996 were 5.69% and 6.31%,
respectively (including applicable sales charge).
Current yield quotations as they may appear from time to time in
advertisements will consist of a quotation based on a 30-day period ended on the
date of the most recent balance sheet of the Fund, computed by dividing the net
investment income per share earned during the period by the maximum offering
price per share on the last day of the base period. The Fund's current yield for
the 30-day period ended October 31, 1996 was 5.23%.
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The following financial statements of the Fund are incorporated by
reference herein from the Fund's Annual Report, as filed with the SEC:
Schedule of Investments as of October 31, 1996;
Financial Highlights for each of the years in the ten-year period ended
October 31, 1996;
Statement of Assets and Liabilities as of October 31, 1996;
Statement of Operations for the year ended October 31, 1996;
Statements of Changes in Net Assets for each of the years in the
two-year period ended October 31, 1996;
Notes to Financial Statements; and
Independent Auditors' Report dated November 29, 1996.
A copy of the Fund's Annual Report will be furnished upon request and
without charge. Requests may be made in writing to EKSC, P.O. Box 2121, Boston,
Massachusetts 02106-2121, or by calling EKSC toll free at 1-800-343-2898.
- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
To the best of the Fund's knowledge, as of January 31, 1997, the
following was the only shareholder of record who owned 5% or more the Fund's
outstanding shares:
% of Fund
Merrill Lynch Pierce Fenner & Smith 12.503%
For Sole Benefit of Its Customers
Attn: Fund Administration
4800 Deer Lake Drive East, 3rd Floor
Jacksonville, FL 32246-6484
Except as otherwise stated in its prospectus or required by law, the
Fund reserves the right to change the terms of the offer stated in its
prospectus without shareholder approval, including the right to impose or change
fees for services provided.
If conditions arise that would make it undesirable for the Fund to pay
for all redemptions in cash, the Fund may authorize payment to be made in
portfolio securities or other property. The Fund has obligated itself, however,
under the 1040 Act, to redeem for cash all shares presented for redemption by
any one shareholder up to the lesser of $250,000 or 1.00% of the Fund's net
assets in any 90-day period. Securities delivered in payment of redemptions
would be valued at the same value assigned to them in computing the net asset
value per share and would, to the extent permitted by law, be readily
marketable. Shareholders receiving such securities would incur brokerage costs
upon the securities' sale.
No dealer, salesman or other person is authorized to give any
information or to make any representation not contained in the Fund's
prospectus, this statement of additional information or in supplemental sales
literature issued by the Fund or EKD, and no person is entitled to rely on any
information or representation not contained therein.
The Fund's prospectus and this statement of additional information omit
certain information contained in the registration statement filed with the SEC,
which may be obtained from the SEC's principal office in Washington, D.C. upon
payment of the fee prescribed by the rules and regulations promulgated by the
SEC.
<PAGE>
APPENDIX
CORPORATE BOND RATINGS
S&P CORPORATE BOND RATINGS
An S&P corporate bond rating is a current assessment of the
creditworthiness of an obligor, including obligors outside the United States,
with respect to a specific obligation. This assessment may take into
consideration obligors such as guarantors, insurers, or lessees. Ratings of
foreign obligors do not take into account currency exchange and related
uncertainties. The ratings are based on current information furnished by the
issuer or obtained by S&P from other sources it considers reliable.
The ratings are based, in varying degrees, on the following
considerations:
a. Likelihood of default - capacity and willingness of the
obligor as to the timely payment of interest and repayment of
principal in accordance with the terms of the obligation;
b. Nature of and provisions of the obligation; and
c. Protection afforded by and relative position of the obligation in
the event of bankruptcy, reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, ratings from AA to BBB may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
Bond ratings are as follows:
1. AAA - Debt rated AAA has the highest rating assigned by S&P.
Capacity to pay interest and repay principal is extremely
strong.
2. AA - Debt rated AA has a very strong capacity to pay interest and
repay principal and differs from the higher rated issues only in a small degree.
3. A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
4. BBB - Debt rated BBB is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher rated categories.
5. BB, B, CCC, CC AND C - Debt rated BB, B, CCC, CC and C is regarded,
on balance, as predominantly speculative with respect to capacity to pay
interest and repay principal in accordance with the terms of the obligation. BB
indicates the lowest degree of speculation and C the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
MOODY'S CORPORATE BOND RATINGS
Moody's ratings are as follows:
1. AAA - Bonds that are rated AAA are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt-edge." Interest payments are protected by a large or 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.
2. AA - Bonds that are rated AA are judged to be of high quality by all
standards. Together with the AAA group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present that
make the long term risks appear somewhat larger than in AAA securities.
3. A - Bonds that 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 that suggest a susceptibility to impairment sometime in the
future.
4. BAA - Bonds that are rated BAA are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
5. BA - Bonds that are rated BA are judged to have speculative
elements. Their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and thereby
not well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
6. B - Bonds that are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from AA through B in its corporate bond rating system. The
modifier 1 indicates that the security 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 generic rating
category.
COMMON AND PREFERRED STOCK RATINGS
S&P'S EARNINGS AND DIVIDEND RANKINGS FOR COMMON STOCKS
Because the investment process involves assessment of various factors,
such as product and industry position, corporate resources and financial policy,
with results that make some common stocks more highly esteemed than others, S&P
believes that earnings and dividend performance is the end result of the
interplay of these factors and that, over the long run, the record of this
performance has a considerable bearing on relative quality. S&P rankings,
however, do not reflect all of the factors, tangible or intangible, that bear on
stock quality.
Growth and stability of earnings and dividends are deemed key elements
in establishing S&P earnings and dividend rankings for common stocks, which
capsulize the nature of this record in a single symbol.
S&P has established a computerized scoring system based on per-share
earnings and dividend records of the most recent ten years, a period deemed long
enough to measure a company's performance under varying economic conditions. S&P
measures growth, stability within the trend line and cyclicity. The ranking
system also makes allowances for company size, since large companies have
certain inherent advantages over small ones. From these scores for earnings and
dividends are determined.
The final score for each stock is measured against a scoring matrix
determined by analysis of the scores of a large and representative sample which
is reviewed and sometimes modified with the following ladder of rankings:
A+ Highest B+ Average C Lowest
A High B Below Average D In Reorganization
A- Above Average B- Lower
S&P believes its rankings are not a forecast of future market price
performance but are basically an appraisal of past performance of earnings and
dividends and relative current standing.
MOODY'S COMMON STOCK RANKINGS
Moody's presents a concise statement of the important characteristics
of a company and an evaluation of the grade (quality) of its common stock. Data
presented includes: (a) capsule stock information which reveals short and long
term growth and yield afforded by the indicated dividend, based on a recent
price; (b) a long term price chart which shows patterns of monthly stock price
movements and monthly trading volumes; (c) a breakdown of a company's capital
account which aids in determining the degree of conservatism or financial
leverage in a company's balance sheet; (d) interim earnings for the current year
to date, plus three previous years; (e) dividend information; (f) company
background; (g) recent corporate developments; (h) prospects for a company in
the immediate future and the next few years; and (i) a ten year comparative
statistical analysis.
This information provides investors with information on what a company
does, how it has performed in the past, how it is performing currently and what
its future performance prospects appear to be.
These characteristics are then evaluated and result in a grading, or
indication of quality. The grade is based on an analysis of each company's
financial strength, stability of earnings and record of dividend payments. Other
considerations include conservativeness of capitalization, depth and caliber of
management, accounting practices, technological capabilities and industry
position. Evaluation is represented by the following grades:
(1) High Grade
(2) Investment Grade
(3) Medium Grade
(4) Speculative Grade
MOODY'S PREFERRED STOCK RATINGS
Preferred stock ratings and their definitions are as follows:
1. AAA: An issue that is rated AAA is considered to be a
top-quality preferred stock. This rating indicates good asset
protection and the least risk of dividend impairment within
the universe of preferred stocks.
2. AA: An issue that is rated AA is considered a high-grade
preferred stock. This rating indicates that there is a
reasonable assurance that earnings and asset protection will
remain relatively well maintained in the foreseeable future.
3. A: An issue that is rated A is considered to be an
upper-medium grade preferred stock. While risks are judged to
be somewhat greater then in the AAA and AA classification,
earnings and asset protection are, nevertheless, expected to
be maintained at adequate levels.
4. BAA: An issue that is rated BAA is considered to be a
medium-grade preferred stock,neither highly protected nor
poorly secured. Earnings and asset protection appear adequate
at present but may be questionable over any great length of
time.
5. BA: An issue that is rated BA is considered to have
speculative elements and its future cannot be considered well
assured. Earnings and asset protection may be very moderate
and not well- safeguarded during adverse periods. Uncertainty
of position characterizes preferred stocks in this class.
6. B: An issue that is rated B generally lacks the
characteristics of a desirable investment. Assurance of
dividend payments and maintenance of other terms of the issue
over any long period of time may be small.
7. CAA: An issue that is rated CAA is likely to be in arrears on
dividend payments. This rating designation does not purport to
indicate the future status of payments.
8. CA: An issue that is rated CA is speculative in a high degree
and is likely to be in arrears on dividends with little
likelihood of eventual payments.
9. C: This is the lowest rated class of preferred or preference
stock. Issues so rated can be regarded as having extremely
poor prospects of ever attaining any real investment standing.
Moody's applies numerical modifiers 1, 2 and 3 in each rating
classification: the modifier 1 indicates that the security 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
generic rating category.
LIMITED PARTNERSHIPS
The Fund may invest in limited and master limited partnerships. A
limited partnership is a partnership consisting of one or more general partners,
jointly and severally responsible as ordinary partners, and by whom the business
is conducted, and one or more limited partners who contribute cash as capital to
the partnership and who generally are not liable for the debts of the
partnership beyond the amounts contributed. Limited partners are not involved in
the day-to-day management of the partnership. They receive income, capital gains
and other tax benefits associated with the partnership project in accordance
with terms established in the partnership agreement. Typical limited
partnerships are in real estate, oil and gas and equipment leasing, but they
also finance movies, research and development and other projects.
For an organization classified as a partnership under the Internal
Revenue Code, each item of income, gain, loss, deduction and credit is not taxed
at the partnership level but flows through to the holder of the partnership
unit. This allows the partnership to avoid taxation and to pass through income
to the holder of the partnership unit at lower individual rates.
A master limited partnership is a publicly traded limited partnership.
The partnership units are registered with the Securities and Exchange Commission
and are freely exchanged on a securities exchange or in the over-the-counter
market.
MONEY MARKET INSTRUMENTS
The Fund's investments in commercial paper are limited to those rated
A-1 by Standard & Poor's Corporation, PRIME-1 by Moody's Investors Service, Inc.
or F-1 by Fitch Investors Service, Inc. These ratings and other money market
instruments are described as follows:
COMMERCIAL PAPER RATINGS
Commercial paper rated A-1 by Standard & Poor's has the following
characteristics: Liquidity ratios are adequate to meet cash requirements. The
issuer's long-term senior debt is rated A or better, although in some cases BBB
credits may be allowed. The issuer has access to at least two additional
channels of borrowing. Basic earnings and cash flow have an upward trend with
allowance made for unusual circumstances. Typically, the issuer's industry is
well established and the issuer has a strong position within the industry.
The rating PRIME-1 is the highest commercial paper rating assigned by
Moody's. Among the factors considered by Moody's in assigning ratings are the
following: (1) evaluation of the management of the issuer; (2) economic
evaluation of the issuer's industry or industries and an appraisal of
speculative-type risks which may be inherent in certain areas; (3) evaluation of
the issuer's products in relation to competition and customer acceptance; (4)
liquidity; (5) amount and quality of long-term debt; (6) trend of earnings over
a period of ten years; (7) financial strength of a parent company and the
relationships that exist with the issuer; and (8) recognition by the management
of obligations which may be present or may arise as a result of public
preparations to meet such obligations. Relative strength or weakness of the
above factors determines how the issuer's commercial paper is rated within
various categories.
The rating F-1 is the highest rating assigned by Fitch. Among the
factors considered by Fitch in assigning this rating are: (1) the issuer's
liquidity; (2) its standing in the industry; (3) the size of its debt; (4) its
ability to service its debt; (5) its profitability; (6) its return on equity;
(7) its alternative sources of financing; and (8) its ability to access the
capital markets. Analysis of the relative strength or weakness of these factors
and others determines whether an issuer's commercial paper is rated F-1.
UNITED STATES GOVERNMENT SECURITIES
Securities issued or guaranteed by the United States Government include
a variety of Treasury securities that differ only in their interest rates,
maturities and dates of issuance. Treasury bills have maturities of one year or
less. Treasury notes have maturities of one to ten years and Treasury bonds
generally have maturities of greater than ten years at the date of issuance.
Securities issued or guaranteed by the United States ("U.S.")
Government or its agencies or instrumentalities include direct obligations of
the United States Treasury and securities issued or guaranteed by the Federal
Housing Administration, Farmers Home Administration, Export-Import Bank of the
United States, Small Business Administration, Government National Mortgage
Association, General Services Administration, Central Bank for Cooperatives,
Federal Home Loan Banks, Federal Loan Mortgage Corporation, Federal Intermediate
Credit Banks, Federal Land Banks, Maritime Administration, The Tennessee Valley
Authority, District of Columbia Armory Board and Federal National Mortgage
Association.
Some obligations of United States Government agencies and
instrumentalities, such as Treasury bills and Government National Mortgage
Association pass-through certificates, are supported by the full faith and
credit of the United States; others, such as securities of Federal Home Loan
Banks, by the right of the issuer to borrow from the Treasury; still others,
such as bonds issued by the Federal National Mortgage Association, a private
corporation, are supported only by the credit of the instrumentality. Because
the United States Government is not obligated by law to provide support to an
instrumentality it sponsors, the Fund will invest in the securities issued by
such an instrumentality only when Keystone determines that the credit risk with
respect to the instrumentality does not make its securities unsuitable
investments. United States Government securities will not include international
agencies or instrumentalities in which the United States Government, its
agencies or instrumentalities participate, such as the World Bank, the Asian
Development Bank or the InterAmerican Development Bank, or issues insured by the
Federal Deposit Insurance Corporation.
CERTIFICATES OF DEPOSIT
Certificates of deposit are receipts issued by a bank in exchange for
the deposit of funds. The issuer agrees to pay the amount deposited plus
interest to the bearer of the receipt on the date specified on the certificate.
The certificate usually can be traded in the secondary market prior to maturity.
Certificates of deposit will be limited to U.S. dollar-denominated
certificates of United States banks, including their branches abroad, and of
U.S. branches of foreign banks that are members of the Federal Reserve System or
the Federal Deposit Insurance Corporation and have at least $1 billion in
deposits as of the date of their most recently published financial statements.
BANKERS' ACCEPTANCES
Bankers' acceptances typically arise from short term credit
arrangements designed to enable businesses to obtain funds to finance commercial
transactions. Generally, an acceptance is a time draft drawn on a bank by an
exporter or an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by the bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
earning asset or it may be sold in the secondary market at the going rate of
discount for a specific maturity. Although maturities for acceptances can be as
long as 270 days, most acceptances have maturities of six months or less.
Bankers' acceptances acquired by the Fund must have been accepted by U.S.
commercial banks, including foreign branches of U.S. commercial banks, having
total deposits at the time of purchase in excess of $1 billion and must be
payable in U.S. dollars.
OPTIONS TRANSACTIONS
The Fund is authorized to write (i.e., sell) covered call options and
to purchase call options to close out covered call options previously written. A
call option obligates a writer to sell, and gives a purchaser the right to buy,
the underlying security at the stated exercise price at any time until the
stated expiration date.
The Fund will only write call options that are covered, which means
that the Fund will own the underlying security (or other securities, such as
convertible securities, that are acceptable for escrow) when it writes the call
option and until the Fund's obligation to sell the underlying security is
extinguished by exercise or expiration of the call option or the purchase of a
call option covering the same underlying security and having the same exercise
price and expiration date. The Fund will receive a premium for writing a call
option, but will give up, until the expiration date, the opportunity to profit
from an increase in the underlying security's price above the exercise price.
The Fund will retain the risk of loss from a decrease in the price of the
underlying security. The writing of covered call options is a conservative
investment technique believed to involve relatively little risk (in contrast to
the writing of naked options which the Fund will not do) but capable of
enhancing the Fund's total return.
The premium received by the Fund for writing a covered call option will
be recorded as a liability in the Fund's statement of assets and liabilities.
This liability will be adjusted daily to the option's current market value,
which will be the latest sale price at the time as of which the net asset value
per share of the Fund is computed (the close of the New York Stock Exchange),
or, in the absence of such sale, at the latest bid quotation. The liability will
be extinguished upon expiration of the option, the purchase of an identical
option in a closing transaction or delivery of the underlying security upon
exercise of the option.
Many options are traded on registered securities exchanges. Options
traded on such exchanges are issued by the Options Clearing Corporation, a
clearing corporation which assumes responsibility for the completion of options
transactions.
The Fund will purchase call options only to close out a covered call
option it has written. When it appears that a covered call option written by the
Fund is likely to be exercised, the Fund may consider it appropriate to avoid
having to sell the underlying security. Or, the Fund may wish to extinguish a
covered call option which it has written in order to be free to sell the
underlying security to realize a profit on the previously written call option or
to write another covered call option on the underlying security. In all such
instances, the Fund can close out the previously written call option by
purchasing a call option on the same underlying security with the same exercise
price and expiration date. (The Fund may, under certain circumstances, also be
able to transfer a previously written call option.) The Fund will realize a
short-term capital gain if the amount paid to purchase the call option plus
transaction costs is less than the premium received for writing the covered call
option. The Fund will realize a short-term capital loss if the amount paid to
purchase the call option plus transaction costs is greater than the premium
received for writing the covered call option.
A previously written call option can be closed out by purchasing an
identical call option only in a secondary market for the call option. Although
the Fund will generally write only those options for which there appears to be
an active secondary market, there is no assurance that a liquid secondary market
will exist for any particular option at any particular time, and for some
options no secondary market may exist. In such event it might not be possible to
effect a closing transaction in a particular option. If the Fund as a covered
call option writer is unable to effect a closing purchase transaction, it will
not be able to sell the underlying securities until the option expires or it
delivers the underlying securities upon exercise.
If a substantial number of the call options written by the Fund are
exercised, the Fund's rate of portfolio turnover may exceed historical levels.
This would result in higher transaction costs, including brokerage commissions.
The Fund will pay brokerage commissions in connection with the writing of
covered call options and the purchase of call options to close out previously
written options. Such brokerage commissions are normally higher than those
applicable to purchases and sales of portfolio securities.
In the past the Fund has qualified for, and elected to receive, the
special tax treatment afforded regulated investment companies under Subchapter M
of the Internal Revenue Code. Although the Fund intends to continue to qualify
for such tax treatment, in order to do so it must, among other things, derive
less than 30% of its gross income from gains from the sale or other disposition
of securities held for less than three months. Because of this, the Fund may be
restricted in the writing of call options where the underlying securities have
been held less than three months, in the writing of covered call options that
expire in less than three months, and in effecting closing purchases with
respect to options that were written less than three months earlier. As a
result, the Fund may elect to forego otherwise favorable investment
opportunities and may elect to avoid or delay effecting closing purchases or
selling portfolio securities, with the risk that a potential loss may be
increased or a potential gain may be reduced or turned into a loss.
Under the Internal Revenue Code of 1954, as amended, gain or loss
attributable to a closing transaction and premiums received by the Fund for
writing a covered call option that is not exercised may constitute short-term
capital gain or loss. Under provisions of the Tax Reform Act of 1986, effective
for taxable years beginning after October 22, 1986, a gain on an option
transaction that qualifies as a "designated hedge" transaction under Treasury
regulations may be offset by realized or unrealized losses on such designated
transaction. The netting of gain against such losses could result in a reduction
in gross income from options transactions for purposes of the 30 percent test.
FUTURES CONTRACTS AND RELATED OPTIONS TRANSACTIONS
The Fund intends to enter into currency and other financial futures
contracts as a hedge against changes in prevailing levels of interest or
currency exchange rates to seek relative stability of principal and to establish
more definitely the effective return on securities held or intended to be
acquired by the Fund or as a hedge against changes in the prices of securities
or currencies held by the Fund or to be acquired by the Fund. The Fund's hedging
may include sales of futures as an offset against the effect of expected
increases in interest or currency exchange rates or securities prices and
purchases of futures as an offset against the effect of expected declines in
interest or currency exchange rates.
For example, when the Fund anticipates a significant market or market
sector advance, it will purchase a stock index futures contract as a hedge
against not participating in such advance at a time when the Fund is not fully
invested. The purchase of a futures contract serves as a temporary substitute
for the purchase of individual securities which may then be purchased in an
orderly fashion. As such purchases are made, an equivalent amount of index based
futures contracts would be terminated by offsetting sales. In contrast, the Fund
would sell stock index futures contracts in anticipation of or in a general
market or market sector decline that may adversely affect the market value of
the Fund's portfolio. To the extent that the Fund's portfolio changes in value
in correlation with a given index, the sale of futures contracts on that index
would substantially reduce the risk to the portfolio of a market decline or
change in interest rates, and, by so doing, provide an alternative to the
liquidation of the Fund's securities positions and the resulting transaction
costs.
The Fund intends to engage in options transactions that are related to
commodity futures contracts for hedging purposes and in connection with the
hedging strategies described above.
Although techniques other than sales and purchases of futures contracts
and related options transactions could be used to reduce the Fund's exposure to
interest rate and/or market fluctuations, the Fund may be able to hedge its
exposure more effectively and perhaps at a lower cost through using futures
contracts and related options transactions. While the Fund does not intend to
take delivery of the instruments underlying futures contracts it holds, the Fund
does not intend to engage in such futures contracts for speculation.
FUTURES CONTRACTS
Futures contracts are transactions in the commodities markets rather
than in the securities markets. A futures contract creates an obligation by the
seller to deliver to the buyer the commodity specified in the contract at a
specified future time for a specified price. The futures contract creates an
obligation by the buyer to accept delivery from the seller of the commodity
specified at the specified future time for the specified price. In contrast, a
spot transaction creates an immediate obligation for the seller to deliver and
the buyer to accept delivery of and pay for an identified commodity. In general,
futures contracts involve transactions in fungible goods such as wheat, coffee
and soybeans. However, in the last decade an increasing number of futures
contracts have been developed that specify currencies, financial instruments or
financially based indexes as the underlying commodity.
U.S. futures contracts are traded only on national futures exchanges
and are standardized as to maturity date and underlying financial instrument.
The principal financial futures exchanges in the United States are The Board of
Trade of the City of Chicago, the Chicago Mercantile Exchange, the International
Monetary Market (a division of the Chicago Mercantile Exchange), the New York
Futures Exchange and the Kansas City Board of Trade. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership, which is also
responsible for handling daily accounting of deposits or withdrawals of margin.
A futures commission merchant (Broker) effects each transaction in connection
with futures contracts for a commission. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission (CFTC) and National Futures Association (NFA).
INTEREST RATE FUTURES CONTRACTS
The sale of an interest rate futures contract creates an obligation by
the Fund, as seller, to deliver the type of financial instrument specified in
the contract at a specified future time for a specified price. The purchase of
an interest rate futures contract creates an obligation by the Fund, as
purchaser, to accept delivery of the type of financial instrument specified at a
specified future time for a specified price. The specific securities delivered
or accepted, respectively, at settlement date, are not determined until at or
near that date. The determination is in accordance with the rules of the
exchange on which the futures contract sale or purchase was made.
Currently, interest rate futures contracts can be purchased or sold on
90-day U.S. Treasury bills, U.S. Treasury bonds, U.S. Treasury notes with
maturities between 6 1/2 and 10 years, Government National Mortgage Association
(GNMA) certificates, 90-day domestic bank certificates of deposit, 90-day
commercial paper, and 90-day Eurodollar certificates of deposit. It is expected
that futures contracts trading in additional financial instruments will be
authorized. The standard contract size is $100,000 for futures contracts in U.S.
Treasury bonds, U.S. Treasury notes and GNMA certificates, and $1,000,000 for
the other designated contracts. While U.S. Treasury bonds, U.S. Treasury bills
and U.S. Treasury notes are backed by the full faith and credit of the U.S.
government and GNMA certificates are guaranteed by a U.S. government agency, the
futures contracts in U.S. government securities are not obligations of the U.S.
Treasury.
INDEX BASED FUTURES CONTRACTS
STOCK INDEX FUTURES CONTRACTS
A stock index assigns relative values to the common stocks included in
the index. The index fluctuates with changes in the market values of the common
stocks so included. stock index futures contract is a bilateral agreement by
which two parties agree to take or make delivery of an amount of cash equal to a
specified dollar amount times the difference between the closing value of the
stock index on the expiration date of the contract and the price at which the
futures contract is originally made. No physical delivery of the underlying
stocks in the index is made.
Currently, stock index futures contracts can be purchased or sold on
the Standard and Poor's Corporation (S&P) Index of 500 Stocks, the S&P Index of
100 Stocks, the New York Stock Exchange Composite Index, the Value Line Index
and the Major Market Index. It is expected that futures contracts trading in
additional stock indices will be authorized. The standard contract size is $500
times the value of the index.
The Fund does not believe that differences between existing stock
indices will create any differences in the price movements of the stock index
futures contracts in relation to the movements in such indices. However, such
differences in the indices may result in differences in correlation of the
futures with movements in the value of the securities being hedged.
OTHER INDEX BASED FUTURES CONTRACTS
It is expected that bond index and other financially based index
futures contracts will be developed in the future. It is anticipated that such
index based futures contracts will be structured in the same way as stock index
futures contracts but will be measured by changes in interest rates, related
indexes or other measures, such as the consumer price index. In the event that
such futures contracts are developed the Fund will sell interest rate index and
other index based futures contracts to hedge against changes which are expected
to affect the Fund's portfolio.
The purchase or sale of a futures contract differs from the purchase or
sale of a security, in that no price or premium is paid or received. Instead, to
initiate trading an amount of cash, cash equivalents,
money market instruments, or U.S. Treasury bills equal to approximately 1 1/2%
(up to 5%) of the contract amount must be deposited by the Fund with the Broker.
This amount is known as the initial margin. The nature of the initial margin in
futures transactions is different from that of a margin in security
transactions. Futures contract margin does not involve the borrowing of funds by
the customer to finance the transactions. Rather, the initial margin is in the
nature of a performance bond or good faith deposit on the contract which is
returned to the Fund upon termination of the futures contract assuming all
contractual obligations have been satisfied. The margin required for a
particular futures contract is set by the exchange on which the contract is
traded, and may be significantly modified from time to time by the exchange
during the term of the contract.
Subsequent payments, called a variation margin, to the Broker and from
the Broker, are made on a daily basis as the value of the underlying instrument
or index fluctuates making the long and short positions in the futures contract
more or less valuable, a process known as mark-to-market. For example, when the
Fund has purchased a futures contract and the price of the underlying financial
instrument or index has risen, that position will have increased in value and
the Fund will receive from the Broker a variation margin payment equal to that
increase in value. Conversely, where the Fund has purchased a futures contract
and the price of the underlying financial instrument or index has declined, the
position would be less valuable and the Fund would be required to make a
variation margin payment to the Broker. At any time prior to expiration of the
futures contract, the Fund may elect to close the position. A final
determination of variation margin is then made, additional cash is required to
be paid to or released by the Broker, and the Fund realizes a loss or gain.
The Fund intends to enter into arrangements with its Custodian and with
Brokers to enable its initial margin and any variation margin to be held in a
segregated account by its Custodian on behalf of the Broker.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of financial instruments, and index based futures
contracts call for the delivery of cash equal to the difference between the
closing value of the index on the expiration date of the contract and the price
at which the futures contract is originally made, in most cases such futures
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out a futures contract sale is effected by an offsetting
transaction in which the Fund enters into a futures contract purchase for the
same aggregate amount of the specific type of financial instrument or index and
same delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is paid the difference and thus realizes a gain. If the
offsetting purchase price exceeds the sale price, the Fund pays the difference
and realizes a loss. Similarly, the closing out of a futures contract purchase
is effected by an offsetting transaction in which the Fund enters into a futures
contract sale. If the offsetting sale price exceeds the purchase price, the Fund
realizes a gain. If the purchase price exceeds the offsetting sale price the
Fund realizes a loss. The amount of the Fund's gain or loss on any transaction
is reduced or increased, respectively, by the amount of any transaction costs
incurred by the Fund.
As an example of an offsetting transaction, the contractual obligations
arising from the sale of one contract of September U.S. Treasury bills on an
exchange may be fulfilled at any time before delivery of the contract is
required (i.e., on a specified date in September, the "delivery month") by the
purchase of one contract of September U.S. Treasury bills on the same exchange.
In such instance the difference between the price at which the futures contract
was sold and the price paid for the offsetting purchase after allowance for
transaction costs represents the profit or loss to the Fund.
There can be no assurance, however, that the Fund will be able to enter
into an offsetting transaction with respect to a particular contract at a
particular time. If the Fund is not able to enter into an offsetting
transaction, the Fund will continue to be required to maintain the margin
deposits on the contract and to complete the contract according to its terms.
OPTIONS ON CURRENCY AND OTHER FINANCIAL FUTURES
The Fund intends to purchase call and put options on currency and other
financial futures contracts and sell such options to terminate an existing
position. Options on currency and other financial futures contracts are similar
to options on stocks except that an option on a currency or other financial
futures contract gives the purchaser the right, in return for the premium paid,
to assume a position in a futures contract (a long position if the option is a
call and a short position if the option is a put) rather than to purchase or
sell stock, currency or other financial instruments at a specified exercise
price at any time during the period of the option. Upon exercise of the option,
the delivery of the futures position by the writer of the option to the holder
of the option will be accompanied by delivery of the accumulated balance in the
writer's futures margin account. This amount represents the amount by which the
market price of the futures contract at exercise exceeds, in the case of a call,
or is less than, in the case of a put, the exercise price of the option on the
futures contract. If an option is exercised on the last trading day prior to the
expiration date of the option, the settlement will be made entirely in cash
equal to the difference between the exercise price of the option and value of
the futures contract.
The Fund intends to use options on currency and other financial futures
contracts in connection with hedging strategies. In the future the Fund may use
such options for other purposes.
PURCHASE OF PUT OPTIONS ON FUTURES CONTRACTS
The purchase of protective put options on commodity futures contracts
is analogous to the purchase of protective puts on individual stocks, where an
absolute level of protection is sought below which no additional economic loss
would be incurred by the Fund. Put options may be purchased to hedge a portfolio
of stocks or debt instruments or a position in the futures contract upon which
the put option is based.
PURCHASE OF CALL OPTIONS ON FUTURES CONTRACTS
The purchase of a call option on a commodity futures contract
represents a means of obtaining temporary exposure to market appreciation at
limited risk. It is analogous to the purchase of a call option on an individual
stock which can be used as a substitute for a position in the stock itself.
Depending on the pricing of the option compared to either the futures contract
upon which it is based, or upon the price of the underlying financial instrument
or index itself, the purchase of a call option may be less risky than the
ownership of the interest rate or index based futures contract or the underlying
securities. Call options on commodity futures contracts may be purchased to
hedge against an interest rate increase or a market advance when the Fund is not
fully invested.
USE OF NEW INVESTMENT TECHNIQUES INVOLVING CURRENCY OR OTHER FINANCIAL FUTURES
CONTRACTS OR RELATED OPTIONS
The Fund may employ new investment techniques involving currency and
other financial futures contracts and related options. The Fund intends to take
advantage of new techniques in these areas which may be developed from time to
time and which are consistent with the Fund's investment objective. The Fund
believes that no additional techniques have been identified for employment by
the Fund in the foreseeable future other than those described above.
LIMITATIONS ON PURCHASE AND SALE OF FUTURES CONTRACTS AND RELATED OPTIONS ON
SUCH FUTURES CONTRACTS
The Fund will not enter into a futures contract if, as a result
thereof, more than 5% of the Fund's total assets (taken at market value at the
time of entering into the contract) would be committed to margin deposits on
such futures contracts.
The Fund intends that its futures contracts and related options
transactions will be entered into for traditional hedging purposes. That is,
futures contracts will be sold to protect against a decline in the price of
securities that the Fund owns or futures contracts will be purchased to protect
the Fund against an increase in the price of securities it intends to purchase.
The Fund does not intend to enter into futures contracts for speculation.
In instances involving the purchase of futures contracts by the Fund,
an amount of cash and cash equivalents, equal to the market value of the futures
contracts will be deposited in a segregated account with the Fund's Custodian
and/or in a margin account with a Broker to collateralize the position and
thereby insure that the use of such futures is unleveraged.
FEDERAL INCOME TAX TREATMENT
For federal income tax purposes, the Fund is required to recognize as
income for each taxable year its net unrealized gains and losses on futures
contracts as of the end of the year as well as those actually realized during
the year. Any gain or loss recognized with respect to a futures contract is
considered to be 60% long term and 40% short term, without regard to the holding
period of the contract. In the case of a futures transaction classified as a
"mixed straddle," the recognition of losses may be deferred to a later taxable
year. The federal income tax treatment of gains or losses from transactions in
options on futures is unclear.
In order for the Fund to continue to qualify for federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income. Any net gain realized
from the closing out of futures contracts, for purposes of the 90% requirement,
will be qualifying income. In addition, gains realized on the sale or other
disposition of securities held for less than three months must be limited to
less than 30% of the Fund's annual gross income. The 1986 Tax Act added a
provision that effectively treats both positions in certain hedging transactions
as a single transaction for the purpose of the 30% requirement. The provision
provides that, in the case of any "designated hedge," increases and decreases in
the value of positions of the hedge are to be netted for the purposes of the 30%
requirement. However, in certain situations, in order to avoid realizing a gain
within a three month period, the Fund may be required to defer the closing out
of a contract beyond the time when it would otherwise be advantageous to do so.
RISKS OF FUTURES CONTRACTS
Currency and other financial futures contracts prices are volatile and
are influenced, among other things, by changes in stock prices, market
conditions, prevailing interest rates and anticipation of future stock prices,
market movements or interest rate changes, all of which in turn are affected by
economic conditions, such as government fiscal and monetary policies and
actions, and national and international political and economic events.
At best, the correlation between changes in prices of futures contracts
and of the securities being hedged can be only approximate. The degree of
imperfection of correlation depends upon circumstances, such as variations in
speculative market demand for futures contracts and for securities, including
technical influences in futures contracts trading; differences between the
securities being hedged and the financial instruments and indexes underlying the
standard futures contracts available for trading, in such respects as interest
rate levels, maturities and creditworthiness of issuers, or identities of
securities comprising the index and those in the Fund's portfolio. A decision of
whether, when and how to hedge involves the exercise of skill and judgment, and
even a well-conceived hedge may be unsuccessful to some degree because of market
behavior or unexpected interest rate trends.
Because of the low margin deposits required, futures trading involves
an extremely high degree of leverage. As a result, a relatively small price
movement in a futures contract may result in immediate and substantial loss, as
well as gain, to the investor. For example, if at the time of purchase, 10% of
the value of the futures contract is deposited as margin, a 10% decrease in the
value of the futures contract would result in a total loss of the margin
deposit, before any deduction for the transaction costs, if the account were
then closed out, and a 15% decrease would result in a loss equal to 150% of the
original margin deposit. Thus, a purchase or sale of a futures contract may
result in losses in excess of the amount invested in the futures contract.
However, the Fund would presumably have sustained comparable losses if, instead
of entering into the futures contract, it had invested in the underlying
financial instrument. Furthermore, in order to be certain that the Fund has
sufficient assets to satisfy its obligations under a futures contract, the Fund
will establish a segregated account in connection with its futures contracts
which will hold cash or cash equivalents equal in value to the current value of
the underlying instruments or indices less the margins on deposit.
Most U.S. futures exchanges limit the amount of fluctuation permitted
in futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
RISKS OF OPTIONS ON FUTURES CONTRACTS
In addition to the risks described above for currency and other
financial futures contracts, there are several special risks relating to options
on futures contracts. The ability to establish and close out positions on such
options will be subject to the development and maintenance of a liquid secondary
market. There is no assurance that a liquid secondary market will exist for any
particular contract or at any particular time. The Fund will not purchase
options on any futures contract unless and until it believes that the market for
such options has developed sufficiently that the risks in connection with such
options are not greater than the risks in connection with the futures contracts.
Compared to the use of futures contracts, the purchase of options on such
futures contracts involves less potential risk to the Fund because the maximum
amount at risk is the premium paid for the options (plus transaction costs).
However, there may be circumstances when the use of an option on a futures
contract would result in a loss to the Fund, even though the use of a futures
contract would not, such as when there is no movement in the level of the
futures contract.
FOREIGN CURRENCY TRANSACTIONS
The Fund may invest in securities of foreign issuers. When the Fund
invests in foreign securities they usually will be denominated in foreign
currencies and the Fund temporarily may hold funds in foreign currencies. Thus,
the Fund's share value will be affected by changes in exchange rates.
FORWARD CURRENCY CONTRACTS
As one way of managing exchange rate risk, the Fund may engage in
forward currency exchange contracts (agreements to purchase or sell currencies
at a specified price and date). Under the contract, the exchange rate for the
transaction (the amount of currency the Fund will deliver or receive when the
contract is completed) is fixed when the Fund enters into the contract. The Fund
usually will enter into these contracts to stabilize the U.S. dollar value of a
security it has agreed to buy or sell. The Fund also may use these contracts to
hedge the U.S. dollar value of a security it already owns, particularly if the
Fund expects a decrease in the value of the currency in which the foreign
security is denominated. Although the Fund will attempt to benefit from using
forward contracts, the success of its hedging strategy will depend on Keystone's
ability to predict accurately the future exchange rate between foreign
currencies and the U.S. dollar. The value of the Fund's investments denominated
in foreign currencies will depend on the relative strength of those currencies
and the U.S. dollar, and the Fund may be affected favorably or unfavorably by
changes in the exchange rates or exchange control regulations between foreign
currencies and the dollar. Changes in foreign currency exchange rates also may
affect the value of dividends and interest earned, gains and losses realized on
the sale of securities and net investment income and gains, if any, to be
distributed to shareholders by the Fund.
CURRENCY FUTURES CONTRACTS
Currency futures contracts are bilateral agreements under which two
parties agree to take or make delivery of a specified amount of a currency at a
specified future time for a specified price. Trading of currency futures
contracts in the United States is regulated under the Commodity Exchange Act by
the Commodity Futures Trading Commission (CFTC) and National Futures Association
(NFA). Currently the only national futures exchange on which currency futures
are traded is the International Monetary Market of the Chicago Mercantile
Exchange. Foreign currency futures trading is conducted in the same manner and
subject to the same regulations as trading in interest rate and index based
futures. The Fund intends to engage in currency futures contracts for hedging
purposes, and not for speculation. The Fund may engage in currency futures
contracts for other purposes if authorized to do so by the Board. The hedging
strategies that will be used by the Fund in connection with foreign currency
futures contracts are similar to those described above for forward foreign
currency exchange contracts.
Currently, currency futures contracts for the British Pound Sterling,
Canadian Dollar, Dutch Guilder, Deutsche Mark, Japanese Yen, Mexican Peso, Swiss
Franc and French Franc can be purchased or sold for U.S. dollars through the
International Monetary Market. It is expected that futures contracts trading in
additional currencies will be authorized. The standard contract sizes are
L125,000 for the Pound, 125,000 for the Guilder, Mark, Swiss and French Francs,
C$100,000 for the Canadian Dollar, Y12,500,000 for the Yen, and 1,000,000 for
the Peso. In contrast to Forward Currency Exchange Contracts which can be traded
at any time, only four value dates per year are available, the third Wednesday
of March, June, September and December.
FOREIGN CURRENCY OPTIONS TRANSACTIONS
Foreign currency options (as opposed to futures) are traded in a
variety of currencies in both the United States and Europe. On the Philadelphia
Stock Exchange, for example, contracts for half the size of the corresponding
futures contracts on the Chicago Board Options Exchange are traded with up to
nine months maturity in Marks, Sterling, Yen, Swiss francs and Canadian dollars.
Options can be exercised at any time during the contract life and require a
deposit subject to normal margin requirements. Since a futures contract must be
exercised, the Fund must continually make up the margin balance. As a result, a
wrong price move could result in the Fund losing more than the original
investment as it cannot walk away from the futures contract as it can an option
contract.
The Fund will purchase call and put options and sell such options to
terminate an existing position. Options on foreign currency are similar to
options on stocks except that an option on an interest rate and/or index based
futures contract gives the purchaser the right, in return for the premium paid,
to purchase or sell foreign currency, rather than to purchase or sell stock, at
a specified exercise price at any time during the period of the option.
The Fund intends to use foreign currency option transactions in
connection with hedging strategies.
PURCHASE OF PUT OPTIONS ON FOREIGN CURRENCIES
The purchase of protective put options on a foreign currency is
analogous to the purchase of protective puts on individual stocks, where an
absolute level of protection is sought below which no additional economic loss
would be incurred by the Fund. Put options may be purchased to hedge a portfolio
of foreign stocks or foreign debt instruments or a position in the foreign
currency upon which the put option is based.
PURCHASE OF CALL OPTIONS ON FOREIGN CURRENCIES
The purchase of a call option on foreign currency represents a means of
obtaining temporary exposure to market appreciation at limited risk. It is
analogous to the purchase of a call option on an individual stock which can be
used as a substitute for a position in the stock itself. Depending on the
pricing of the option compared to either the foreign currency upon which it is
based, or upon the price of the foreign stock or foreign debt instruments, the
purchase of a call option may be less risky than the ownership of the foreign
currency or the foreign securities. The Fund would purchase a call option on a
foreign currency to hedge against an increase in the foreign currency or a
foreign market advance when the Fund is not fully invested.
The Fund may employ new investment techniques involving forward foreign
currency exchange contracts, foreign currency futures contracts and options on
foreign currencies in order to take advantage of new techniques in these areas
which may be developed from time to time and which are consistent with the
Fund's investment objective. The Fund believes that no additional techniques
have been identified for employment by the Fund in the foreseeable future other
than those described above.
CURRENCY TRADING RISKS
Currency exchange trading may involve significant risks. The four major
types of risk the Fund faces are exchange rate risk, interest rate risk, credit
risk and country risk.
EXCHANGE RATE RISK
Exchange rate risk results from the movement up and down of foreign
currency values in response to shifting market supply and demand. When the Fund
buys or sells a foreign currency, an exposure called an open position is
created. Until the time that position can be "covered" by selling or buying an
equivalent amount of the same currency, the Fund is exposed to the risk that the
exchange rate might move against it. Since exchange rate changes can readily
move in one direction, a position carried overnight or over a number of days
involves greater risk than one carried a few minutes or hours. Techniques such
as foreign currency forward and futures contracts and options on foreign
currency are intended to be used by the Fund to reduce exchange rate risk.
MATURITY GAPS AND INTEREST RATE RISK
Interest rate risk arises whenever there are mismatches or gaps in the
maturity structure of the Fund's foreign exchange currency holdings, which is
the total of its outstanding spot and forward or futures contracts.
Foreign currency transactions often involve borrowing short term and
lending longer term to benefit from the normal tendency of interest rates to be
higher for longer maturities. However in foreign exchange trading, while the
maturity pattern of interest rates for one currency is important, it is the
differential between interest rates for two currencies that is decisive.
CREDIT RISK
Whenever the Fund enters into a foreign exchange contract, it faces a
risk, however small, that the counterparty will not perform under the contract.
As a result there is a credit risk, although no extension of "credit" is
intended. To limit credit risk, the Fund intends to evaluate the
creditworthiness of each other party. The Fund does not intend to trade more
than 5% of its net assets under foreign exchange contracts with one party.
Credit risk exists because the Fund's counterparty may be unable or
unwilling to fulfill its contractual obligations as a result of bankruptcy or
insolvency or when foreign exchange controls prohibit payment. In any foreign
exchange transaction, each party agrees to deliver a certain amount of currency
to the other on a particular date. In establishing its hedges a Fund relies on
each contract being completed. If the contract is not performed, then the Fund's
hedge is eliminated, and the Fund is exposed to any changes in exchange rates
since the contract was originated. To put itself in the same position it would
have been in had the contract been performed, the Fund must arrange a new
transaction. However, the new transaction may have to be arranged at an adverse
exchange rate. The trustee for a bankrupt company may elect to perform those
contracts which are advantageous to the company but disclaim those contracts
which are disadvantageous, resulting in losses to the Fund.
Another form of credit risk stems from the time zone differences
between the U.S. and foreign nations. If the Fund sells sterling it generally
must pay pounds to a counterparty earlier in the day than it will be credited
with dollars in New York. In the intervening hours, the buyer can go into
bankruptcy or can be declared insolvent. Thus, the dollars may never be credited
to the Fund.
COUNTRY RISK
At one time or another, virtually every country has interfered with
international transactions in its currency. Interference has taken the form of
regulation of the local exchange market, restrictions on foreign investment by
residents or limits on inflows of investment funds from abroad. Governments take
such measures for example to improve control over the domestic banking system or
to influence the pattern of receipts and payments between residents and
foreigners. In those cases, restrictions on the exchange market or on
international transactions are intended to affect the level or movement of the
exchange rate. Occasionally a serious foreign exchange shortage may lead to
payment interruptions or debt servicing delays, as well as interference in the
exchange market. It has become increasingly difficult to distinguish foreign
exchange or credit risk from country risk.
Changes in regulations or restrictions usually do have an important
exchange market impact. Most disruptive are changes in rules which interfere
with the normal payments mechanism. If government regulations change and a
counterparty is either forbidden to perform or is required to do something
extra, then the Fund might be left with an unintended open position or an
unintended maturity mismatch. Dealing with such unintended long or short
positions could result in unanticipated costs to the Fund.
Other changes in official regulations influence international
investment transactions. If one of the factors affecting the buying or selling
of a currency changes, the exchange rate is likely to respond. Changes in such
controls often are unpredictable and can create a significant exchange rate
response.
Many major countries have moved toward liberalization of exchange and
payments restrictions in recent years or accepted the principle that
restrictions should be relaxed. A few industrial countries have moved in the
other direction. Important liberalizations were carried out by Switzerland, the
United Kingdom and Japan. They dismantled mechanisms for restricting either
foreign exchange inflows (Switzerland), outflows (Britain) or elements of both
(Japan). By contrast, France and Mexico have tightened foreign exchange
controls.
Overall, many exchange markets are still heavily restricted. Several
countries limit access to the forward market to companies financing documented
export or import transactions in an effort to insulate the market from purely
speculative activities. Some of these countries permit local traders to enter
into forward contracts with residents but prohibit certain forward transactions
with nonresidents. By comparison, other countries have strict controls on
exchange transactions by residents, but permit free exchange transactions
between local traders and non-residents. A few countries have established tiered
markets, funneling commercial transactions through one market and financial
transactions through another. Outside the major industrial countries, relatively
free foreign exchange markets are rare and controls on foreign currency
transactions are extensive.
Another aspect of country risk has to do with the possibility that the
Fund may be dealing with a foreign trader whose home country is facing a
payments problem. Even though the foreign trader intends to perform on its
foreign exchange contracts, the contracts are tied to other external liabilities
the country has incurred. As a result performance may be delayed, and can result
in unanticipated cost to the Fund. This aspect of country risk is a major
element in the Fund's credit judgment as to with whom it will deal and in what
amounts.
<PAGE>
KEYSTONE DIVERSIFIED BOND FUND (B-2)
PART B
STATEMENT OF ADDITIONAL INFORMATION
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
KEYSTONE DIVERSIFIED BOND FUND (B-2)
December 10, 1996
This statement of additional information is not a prospectus, but
relates to, and should be read in conjunction with, the prospectus of Keystone
Diversified Bond Fund (B-2) (the "Fund") dated December 10, 1996. A copy of the
prospectus may be obtained from the Fund's principal underwriter, Keystone
Investment Distributors Company (the "Principal Underwriter"), or your
broker-dealer. The Principal Underwriter is located at 200 Berkeley Street,
Boston, Massachusetts, 02116-5034.
TABLE OF CONTENTS
Page
Investment Objective and Policies........................................2
Investment Restrictions..................................................2
Valuation of Securities..................................................4
Distributions and Taxes..................................................4
Sales Charges............................................................5
Distribution Plan........................................................7
The Trust Agreement......................................................8
Investment Management...................................................10
Trustees and Officers...................................................12
Principal Underwriter...................................................15
Brokerage...............................................................16
Expenses................................................................18
Standardized Total Return
and Yield Quotations.................................................19
Financial Statements....................................................20
Additional Information..................................................20
Appendix...............................................................A-1
INVESTMENT OBJECTIVE AND POLICIES
The Fund is an open-end, diversified management investment company,
commonly known as a mutual fund. The Fund's investment objective is to provide
shareholders with maximum income without undue risk of principal. To achieve
this objective, the Fund invests primarily in bonds and obligations that are
normally characterized by liberal returns and moderate price fluctuations. Such
bonds, which include both secured and unsecured debt obligations, as a group
possess a fairly high degree of dependability of interest payments. While the
Fund's primary objective is income, the Fund gives careful consideration to
security of principal, marketability and diversification. The Fund invests
primarily in securities of domestic companies, but may also invest up to 25% of
its assets in foreign securities.
Certain information about the Fund is contained in its prospectus. This
statement of additional information provides additional information about the
Fund that may be of interest to some investors.
INVESTMENT RESTRICTIONS
Fundamental Investment Restrictions
The Fund has adopted the fundamental investment restrictions set forth
below, which may not be changed without a vote of the majority of the Fund's
outstanding voting shares (as defined in the Investment Company Act of 1940 (the
"1940 Act")). Unless otherwise stated, all references to Fund assets are in
terms of current market value.
The Fund may not do the following:
(1) with respect to 75% of its total assets, invest more than 5% of the
value of its total assets, determined at market or other fair value at the time
of purchase, in the securities of any one issuer, or invest in more than 10% of
the outstanding voting securities of any one issuer, all as determined
immediately after such investment; provided that these limitations do not apply
to investments in securities issued or guaranteed by the United States ("U.S.")
government or its agencies or instrumentalities;
(2) invest more than 5% of the value of its total assets in companies
which have been in operation for less than three years;
(3) borrow money, except that the Fund may (a) borrow money from banks
for temporary or emergency purposes in aggregate amounts up to 10% of the value
of the Fund's net assets (computed at cost), or (b) enter into reverse
repurchase agreements;
(4) underwrite securities, except that the Fund may purchase securities
from issuers thereof or others and dispose of such securities in a manner
consistent with its other investment policies; in the disposition of restricted
securities the Fund may be deemed to be an underwriter, as defined in the
Securities Act of 1933 (the "1933 Act");
(5) purchase or sell real estate or interests in real estate, except
that it may purchase and sell securities secured by real estate and securities
of companies which invest in real estate, and will not purchase or sell
commodities or commodity contracts, except that the Fund may engage in currency
or other financial futures contracts and related options transactions;
(6) invest for the primary purpose of exercising control over or
management of any issuer;
(7) make margin purchases or short sales of securities;
(8) make loans, except that the Fund may make, purchase or hold debt
securities and other debt investments, including loans, consistent with its
investment objective, lend limited portfolio securities valued at not more than
15% of its total assets to broker-dealers, and enter into repurchase agreements;
(9) invest more than 25% of its assets in the securities of issuers in
any single industry, other than securities issued by banks and savings and loan
associations or securities issued or guaranteed by the U.S. government, its
agencies or instrumentalities; and
(10) purchase the securities of any other investment company except in
the open market and at customary brokerage rates and in no event more than 3% of
the voting securities of any investment company.
If a percentage limit is satisfied at the time of investment or
borrowing, a later increase or decrease resulting from a change in the value of
a security or a decrease in Fund assets is not a violation of the limit.
The Fund has no current intention of attempting to increase its net
income by borrowing and currently intends to repay any borrowings made in
accordance with the fourth investment restriction enumerated above before it
makes any additional investments.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS
The Fund intends to follow policies of the Securities and Exchange
Commission as they are adopted from time to time with respect to illiquid
securities, including, at this time, (1) treating as illiquid, securities which
may not be sold or disposed of in the ordinary course of business within seven
days at approximately the value at which the Fund has valued such securities on
its books and (2) limiting its holdings of such securities to 15% of its net
assets.
Portfolio securities of the Fund may not be purchased from or sold or
loaned to Keystone Management, Keystone, or any affiliate thereof, or any of
their Directors, officers or employees.
VALUATION OF SECURITIES
Current values for the Fund's portfolio securities are determined in
the following manner:
(1) securities traded on an established exchange are valued on the
basis of the last sales price on the exchange where the securities are primarily
traded prior to the time of the valuation;
(2) securities traded in the over-the-counter market, for which
complete quotations are readily available, are valued at the mean of the bid and
asked prices at the time of valuation;
(3) short-term investments with initial or remaining maturities of
sixty days or less are valued at amortized cost (original purchase cost as
adjusted for amortization of premium or accretion of discount), which, when
combined with accrued interest, approximates market;
(4) short-term investments maturing in more than sixty days for which
market quotations are readily available are valued at current market value; and
(5) the Board of Trustees values the following securities at prices it
deems in good faith to be fair: (a) securities, including restricted securities,
for which complete quotations are not readily available; (b) listed securities,
if in the Fund's opinion the last sales price does not reflect a current market
value or if no sale occurred; and (c) other assets.
While market quotations may be readily available for certain long-term
corporate bonds and notes, such investments are stated at fair value on the
basis of valuations furnished by a pricing service, approved by the Board of
Trustees, which determines valuations for normal, institutionalsize trading
units of such securities using methods based on market transactions for
comparable securities and various relationships between securities that are
generally recognized by institutional traders.
DISTRIBUTIONS AND TAXES
The Fund ordinarily makes distributions in shares of the Fund or, at
the option of the shareholder, in cash. All shareholders may reinvest dividends
without being subject to a deferred sales charge when shares so purchased are
redeemed. Shareholders who have opted prior to the record date to receive shares
with regard to capital gains and/or income distributions will have the number of
such shares determined on the basis of the share value computed at the end of
the day on the ex-dividend date after adjustment for the distribution. Net asset
value is used in computing the appropriate number of shares in both a capital
gains distribution and an income distribution reinvestment.
The Fund will make distributions from its net investment income on or
about the 5th day of each month and net capital gains, if any, at least
annually. Unless the Fund receives instructions to the contrary from a
shareholder before the record date, it will assume that the shareholder wishes
to receive that distribution and future gains and income distributions in
shares. Instructions continue in effect until changed in writing.
The Fund's income distributions are largely derived from interest on
bonds and thus are not to any significant degree eligible, in whole or in part,
for the 70% corporate dividends received deduction. Distributed long-term
capital gains are taxable as such to the shareholder whether received in cash or
in additional Fund shares and regardless of the period of time Fund shares have
been held by the shareholder. If the net asset value of the Fund's shares is
reduced below a shareholder's cost by distribution of capital gains realized on
sales of securities, such distribution, to the extent of the reduction, would be
a return of investment though taxable as stated above. Since distributions of
capital gains depend upon profits actually realized from the sale of securities
by the Fund, they may or may not occur. The foregoing comments relating to the
taxation of dividends and distributions paid on the Fund's shares relate solely
to federal income taxation. Such dividends and distributions may also be subject
to state and local taxes.
SALES CHARGES
The Fund may charge a contingent deferred sales charge (a "CDSC") when
you redeem certain of its shares within four calendar years after the month in
which you purchase the shares. The Fund charges a CDSC as reimbursement for
certain expenses, such as commissions or shareholder servicing fees, that it has
incurred in connection with the sale of its shares (see "Distribution Plan"). If
imposed, the Fund deducts the CDSC from the redemption proceeds you would
otherwise receive. CDSCs attributable to your shares are, to the extent
permitted by the National Association of Securities Dealers, Inc. ("NASD"), paid
to the Principal Underwriter.
CALCULATING THE CDSC
The CDSC is a declining percentage of the lesser of (1) the net asset
value of the shares you redeemed, or (2) the total cost of such shares. The CDSC
is calculated according to the following schedule:
1. 4% of amounts redeemed during the calendar year of purchase;
2. 3% of amounts redeemed during the calendar year after the year
of purchase;
3. 2% of amounts redeemed during the second calendar year after
the year of purchase;
and
4. 1% of amounts redeemed during the third calendar year after
the year of purchase.
The Fund does not charge a CDSC on shares redeemed after the third
calendar year after the year of purchase. Also, in determining whether a CDSC is
payable and, if so, the percentage charge applicable, the Fund will first redeem
shares not subject to a CDSC and will then redeem shares you have held the
longest.
CDSC WAIVERS
REDEMPTIONS. The Fund does not impose a CDSC when the amount you are
redeeming represents:
1. an increase in the value of the shares redeemed (the value of
your account with respect to shares purchased prior to January
1, 1997) above the total cost of such shares due to increases
in the net asset value per share of the Fund;
2. certain shares for which the Fund did not pay a commission on
issuance, including shares acquired through reinvestment of
dividend income and capital gains distributions;
3. shares you have held for all or part of more than four
consecutive calendar years;
4. shares that are held in the accounts of a shareholder who has
died or become disabled;
5. a lump-sum distribution from a 401(k) plan or other benefit
plan qualified under the Employee Retirement Income Security
Act of 1974 ("ERISA");
6. automatic withdrawals from the ERISA plan of a shareholder who
is a least 59 1/2 years old;
7. shares in an account that the Fund has closed because the
account has an aggregate net asset value of less than $1,000;
8. automatic withdrawals under a Systematic Income Plan of up to
1% per month of your initial account balance;
9. withdrawals consisting of loan proceeds to a retirement plan
participant;
10. financial hardship withdrawals made by a retirement plan
participant;
11. withdrawals consisting of returns of excess contributions or
excess deferral amounts made to a retirement plan; or
12. shares purchased by a bank or trust company in a single
account in the name of such bank or trust company as trustee
if the initial investment in shares of the Fund, any other
Fund in the Keystone Fund Family, Keystone Precious Metals
Holdings, Inc., Keystone International Fund Inc., Keystone Tax
Free Fund, Keystone Liquid Trust and/or any Keystone America
Fund, is at least $500,000 and any commission paid by the Fund
and such other fund at the time of such purchase is not more
than 1% of the amount invested.
EXCHANGES. The Fund does not charge a CDSC on exchanges of shares
between funds in the Keystone Fund Family that have adopted distribution plans
pursuant to Rule 12b-1 under the 1940 Act. If you do exchange shares of one such
fund for shares of another such fund, the Fund will deem the calendar year of
the exchange, for purposes of any future CDSC, to be the year the shares
tendered for exchange were originally purchased.
SALES. The Fund may sell shares at the public offering price, which is
equal to the net asset value, without the imposition of a CDSC to:
1. any Director, Trustee, officer, full-time employee or sales
representative of the Fund, Keystone, Keystone Investments,
the Principal Underwriter or their affiliates, who has held
such position for at least ninety days; and
2. the pension and profit-sharing plans established by such
companies and their affiliates, for the benefit of their
Directors, Trustees, officers, full-time employees and sales
representatives.
However, the Fund will only sell shares to these parties upon the
purchaser's written assurance that he or she is buying the shares for investment
purposes only. Such purchasers may not resell the securities except through
redemption by the Fund.
DISTRIBUTION PLAN
Rule 12b-1 under the 1940 Act permits investment companies, such as the
Fund, to use their assets to bear the expenses of distributing their shares if
they comply with various conditions, including the adoption of a distribution
plan containing certain provisions set forth in Rule 12b-1. The Fund bears some
of the costs of selling its shares under a distribution plan adopted pursuant to
Rule 12b-1 (the "Distribution Plan").
The Fund's Distribution Plan provides that the Fund may expend up to
0.3125% quarterly (approximately 1.25% annually) of the average daily net asset
value of its shares to pay distribution costs for sales of its shares and to pay
shareholder service fees. The NASD limits such annual expenditures to 1.00%, of
which 0.75% may be used to pay such distribution costs and 0.25% may be used to
pay shareholder service fees. The NASD also limits the aggregate amount that the
Fund may pay for such distribution costs to 6.25% of gross share sales since the
inception of the Fund's Distribution Plan plus interest at the prime rate plus
1% on unpaid amounts thereof (less any CDSCs paid by shareholders to the
Principal Underwriter) remaining from time to time.
Payments under the Distribution Plan are currently made to the
Principal Underwriter (which may reallow all or part to others, such as
broker-dealers) (1) as commissions for Fund shares sold; and (2) as shareholder
service fees in respect of shares maintained by the recipients and outstanding
on the Fund's books for specific periods. Amounts paid or accrued to the
Principal Underwriter under (1) and (2) in the aggregate may not exceed the
annual limitation referred to above. In addition, the Principal Underwriter
generally reallows to broker-dealers or others a commission equal to 4.00% of
the price paid for each Fund share sold as well as a shareholder service fee at
a rate of 0.25% per annum of the net asset value of shares maintained by such
recipients and outstanding on the books of the Fund for specified periods.
If the Fund is unable to pay the Principal Underwriter a commission on
a new sale because the annual maximum (0.75% of average daily net assets) has
been reached, the Principal Underwriter intends, but is not obligated, to
continue to accept new orders for the purchase of Fund shares and to pay
commissions and service fees to broker-dealers in excess of the amount it
currently receives from the Fund ("Advances"). While the Fund is under no
contractual obligation to pay such Advances, the Principal Underwriter intends
to seek full payment of Advances from the Fund (together with interest at the
prime rate plus 1%) at such time in the future as, and to the extent that,
payment thereof by the Fund would be within permitted limits. If the Fund's
Independent Trustees (Trustees who are not interested persons as defined in the
1940 Act) (the "Independent Trustees") authorize such payments, the effect will
be to extend the period of time during which the Fund incurs the maximum amount
of costs allowed by the Distribution Plan.
The total amounts paid by the Fund under the foregoing arrangements may
not exceed the maximum Distribution Plan limit specified above, and the amounts
and purposes of expenditures under the Distribution Plan must be reported to the
Fund's Independent Trustees quarterly. The Fund's Independent Trustees may
require or approve changes in the implementation or operation of the
Distribution Plan, and may require that total expenditures by the Fund under the
Distribution Plan be kept within limits lower than the maximum amount permitted
by the Distribution Plan as stated above. If such costs are not limited by the
Independent Trustees, such costs could, for some period of time, be higher than
such costs permitted by most other plans presently adopted by other investment
companies.
The Distribution Plan may be terminated at any time by vote of the
Independent Trustees, or by vote of a majority of the outstanding voting
securities of the Fund. If the Distribution Plan is terminated, the Principal
Underwriter will ask the Independent Trustees to take whatever action they deem
appropriate under the circumstances with respect to payment of Advances.
Any change in the Distribution Plan that would materially increase the
distribution expenses of the Fund provided for in the Distribution Plan requires
shareholder approval. Otherwise, the Distribution Plan may be amended by votes
of both (1) the Fund's Trustees and (2) the Independent Trustees cast in person
at a meeting called for the purpose of voting on such amendment.
While the Distribution Plan is in effect, the Fund is required to
commit the selection and nomination of candidates for Independent Trustees to
the discretion of the Independent Trustees.
The Independent Trustees of the Fund have determined that the sales of
the Fund's shares resulting from payments under the Distribution Plan have
benefitted the Fund.
THE TRUST AGREEMENT
The Fund is a Pennsylvania common law trust established under a
Restatement of Trust Agreement, restated and amended as of December 19, 1989
(the "Trust Agreement"). The Trust Agreement provides for a Board of Trustees,
and enables the Fund to enter into an agreement with an investment manager
and/or adviser to provide the Fund with investment advisory, management and
administrative services. A copy of the Trust Agreement is filed as an exhibit to
the Fund's Registration Statement, of which this statement of additional
information is a part. This summary is qualified in its entirety by reference to
the Trust Agreement.
DESCRIPTION OF SHARES
The Trust Agreement authorizes the issuance of an unlimited number of
shares of beneficial interest and the creation of additional series and/or
classes of series of Fund shares. Each share represents an equal proportionate
interest in the Fund with each other share of that class. Upon liquidation,
shares are entitled to a pro rata share in the net assets of their class of Fund
shares. Shareholders shall have no preemptive or conversion rights. Shares are
transferable. The Fund currently intends to issue only one class of shares.
SHAREHOLDER LIABILITY
Pursuant to court decisions or other theories of law, shareholders of a
Pennsylvania common law trust could possibly be held personally liable for the
obligations of the Fund. The possibility of Fund shareholders incurring
financial loss under such circumstances appears to be remote, however, because
the Trust Agreement (1) contains an express disclaimer of shareholder liability
for obligations of the Fund; (2) requires that notice of such disclaimer be
given in each agreement, obligation, or instrument entered into or executed by
the Fund or the Trustees; and (3) provides for indemnification out of Fund
property for any shareholder held personally liable for the obligations of the
Fund.
VOTING RIGHTS
Under the terms of the Trust Agreement, the Fund does not hold annual
meetings. At meetings called for the initial election of Trustees or to consider
other matters, shares are entitled to one vote per share. Shares generally vote
together as one class on all matters. No amendment may be made to the Trust
Agreement that adversely affects any class of shares without the approval of a
majority of the shares of that class. There shall be no cumulative voting in the
election of Trustees.
After meeting as described above, no further meetings of shareholders
for the purpose of electing Trustees will be held, unless required by law or
until such time as less than a majority of the Trustees holding office have been
elected by shareholders, at which time the Trustees then in office will call a
shareholders' meeting for the election of Trustees.
Except as set forth above, the Trustees shall continue to hold office
indefinitely, unless otherwise required by law and may appoint successor
Trustees. A Trustee may cease to hold office or may be removed from office (as
the case may be) (1) at any time by two-thirds vote of the remaining Trustees;
(2) when such Trustee becomes mentally or physically incapacitated; or (3) at a
special meeting of shareholders by a two-thirds vote of the outstanding shares.
Any Trustee may voluntarily resign from office.
LIMITATION OF TRUSTEES' LIABILITY
The Trust Agreement provides that a Trustee shall be liable only for
his own willful defaults and, if reasonable care has been exercised in the
selection of officers, agents, employees or investment advisers, shall not be
liable for any neglect or wrongdoing of any such person; provided, however, that
nothing in the Trust Agreement shall protect a Trustee against any liability for
his willful misfeasance, bad faith, gross negligence, or reckless disregard of
his duties.
The Trustees have absolute and exclusive control over the management
and disposition of all assets of the Fund and may perform such acts as in their
sole judgment and discretion are necessary and proper for conducting the
business and affairs of the Fund or promoting the interests of the Fund and the
shareholders.
INVESTMENT MANAGEMENT
INVESTMENT MANAGER
Subject to the general supervision of the Fund's Board of Trustees,
Keystone Management, located at 200 Berkeley Street, Boston, Massachusetts
02116-5034 is responsible for the overall management of the Fund's business and
affairs. Keystone Management, organized in 1989, is a wholly-owned subsidiary of
Keystone. Its directors and principal executive officers have been affiliated
with Keystone, a seasoned investment adviser, for a number of years. Keystone
Management also serves as investment manager to each of the other funds in the
Keystone Fund Family and to certain other funds in the Keystone Investments
Family of Funds.
Except as otherwise noted below, pursuant to an Investment Management
Agreement with the Fund (the "Management Agreement"), Keystone Management
manages and administers the operation of the Fund and manages the investment and
reinvestment of the Fund's assets in conformity with the Fund's investment
objectives and restrictions. The Management Agreement stipulates that Keystone
Management shall provide office space and all necessary office facilities,
equipment, and personnel in connection with its services under the Management
Agreement. The Management Agreement also stipulates that Keystone Management
will pay or reimburse the Fund for the compensation of Fund officers and
Trustees who are affiliated with the investment manager as well as pay all
expenses of Keystone Management incurred in connection with the provision of its
services. All charges and expenses, other than those specifically referred to as
being borne by Keystone Management, will be paid by the Fund, including, but not
limited to, custodian charges and expenses; bookkeeping and auditors' charges
and expenses; transfer agent charges and expenses; fees of Independent Trustees;
brokerage commissions, brokers' fees and expenses; issue and transfer taxes;
costs and expenses under the Distribution Plan; taxes and trust fees payable to
governmental agencies; the cost of share certificates; fees and expenses of the
registration and qualification of the Fund and its shares with the Securities
and Exchange Commission (sometimes referred to herein as the "SEC" or the
"Commission") or under state or other securities laws; expenses of preparing,
printing, and mailing prospectuses, statements of additional information,
notices, reports, and proxy materials to shareholders of the Fund; expenses of
shareholders' and Trustees' meetings; charges and expenses of legal counsel for
the Fund and for the Trustees of the Fund on matters relating to the Fund;
charges and expenses of filing annual and other reports with the SEC and other
authorities; and all extraordinary charges and expenses of the Fund.
Services performed by Keystone Management include (1) performing
research and planning with respect to (a) the Fund's qualification as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986, as amended, (b) tax treatment of the Fund's portfolio investments, (c) tax
treatment of special corporate actions (such as reorganizations), (d) state tax
matters affecting the Fund, and (e) the Fund's distributions of income and
capital gains; (2) preparing the Fund's federal and state tax returns; and (3)
providing services to the Fund's shareholders in connection with federal and
state taxation and distributions of income and capital gains.
The Fund pays Keystone Management a fee for its services at the annual
rate set forth below:
Aggregate Net
Asset Value of the
Management Fee Income Shares of the Fund
- --------------------------------------------------------------------------
2% of Gross Dividend and
Interest Income Plus
0.50% of the first $ 100,000,000 plus
0.45% of the next $ 100,000,000 plus
0.40% of the next $ 100,000,000 plus
0.35% of the next $ 100,000,000 plus
0.30% of the next $ 100,000,000 plus
0.25% of amounts over $ 500,000,000;
computed as of the close of business on each business day and payable daily.
The Management Agreement continues in effect only if approved at least
annually (i) by the Fund's Board of Trustees or by a vote of a majority of the
outstanding shares and (ii) by the vote of a majority of the Independent
Trustees cast in person at a meeting called for the purpose of voting on such
approval. The Management Agreement may be terminated, without penalty, on 60
days' written notice by the Fund's Board of Trustees or by a vote of a majority
of outstanding shares. The Management Agreement will terminate automatically
upon its "assignment," as that term is defined in the 1940 Act.
The Management Agreement permits Keystone Management to enter into an
agreement with Keystone or another investment adviser, under which Keystone or
such other investment adviser, as investment adviser, will provide substantially
all the services to be provided by Keystone Management under the Management
Agreement. The Management Agreement also permits Keystone Management to delegate
to Keystone or another investment adviser substantially all of the investment
manager's rights, duties, and obligations under the Management Agreement.
INVESTMENT ADVISER
Pursuant to the Management Agreement, Keystone Management has entered
into an Investment Advisory Agreement with Keystone (the "Advisory Agreement"),
under which Keystone Management has delegated all of its investment management
functions, except for certain administrative and management services, to
Keystone. As a result, subject to the supervision of the Fund's Board of
Trustees, Keystone performs services on behalf of the Fund that are
substantially similar to those described above with respect to Keystone
Management.
Keystone has provided investment advisory and management services to
investment companies and private accounts since 1932. Keystone is a wholly-owned
subsidiary of Keystone Investments. Both Keystone and Keystone Investments are
located at 200 Berkeley Street, Boston, Massachusetts 02116- 5034.
Keystone Investments is a private corporation predominantly owned by
current and former members of management of Keystone and its affiliates. The
shares of Keystone Investments common stock beneficially owned by management are
held in a number of voting trusts, the trustees of which are George S. Bissell,
Albert H. Elfner, III, Edward F. Godfrey, Ralph J. Spuehler, Jr. and Rosemary D.
Van Antwerp. Keystone Investments provides accounting, bookkeeping, legal,
personnel, and general corporate services to Keystone Management, Keystone,
their affiliates, and the Keystone Investments Family of Funds.
Pursuant to the Advisory Agreement, Keystone receives for its services
an annual fee equal to 85% of the management fee received by Keystone Management
under the Management Agreement.
Keystone Investments has recently entered into an Agreement and Plan of
Acquisition and Merger with First Union Corporation ("First Union"), pursuant to
which Keystone Investments will be merged with and into a wholly-owned
subsidiary of First Union National Bank of North Carolina ("FUNB-NC") (the
"Merger"). The surviving corporation will assume the name "Keystone Investments,
Inc." Subject to a number of conditions being met, it is currently anticipated
that the Merger will take place on or around December 11, 1996. Thereafter,
Keystone Investments, Inc. would be a subsidiary of FUNB-NC.
If consummated, the proposed Merger will be deemed to cause an
assignment, within the meaning of the 1940 Act, of both the Management Agreement
and the Advisory Agreement. Consequently, the completion of the Merger is
contingent upon, among other things, the approval of the Fund's shareholders of
a new investment advisory and management agreement between the Fund and Keystone
("the "New Advisory Agreement"). The Fund's Trustees have approved the terms of
the New Advisory Agreement, subject to the approval of shareholders and the
completion of the Merger, and have called a special meeting of shareholders to
obtain their approval of, among other things, the New Advisory Agreement. The
meeting is expected to be held in December 1996. The proposed New Advisory
Agreement has terms, including fees payable thereunder, that are substantively
identical to those in the current agreements.
TRUSTEES AND OFFICERS
The Trustees and officers of the Fund, their principal occupations and
some of their affiliations over the last five years are as follows:
*ALBERT H. ELFNER, III: President, Chief Executive Officer and Trustee of the
Fund; Chairman of the Board, President and Chief Executive Officer of
Keystone Investments, Keystone, Keystone Management and Keystone
Software, Inc. ("Keystone Software"); President, Chief Executive
Officer and Trustee or Director of all other funds in the Keystone
Investments Family of Funds; Chairman of the Board and Director of
Keystone Institutional Company, Inc. ("Keystone Institutional")and
Keystone Fixed Income Advisors ("KFIA"); Director and President of
Keystone Asset Corporation, Keystone Capital Corporation and Keystone
Trust Company; Director of the Principal Underwriter, KIRC, and
Fiduciary Investment Company, Inc. ("FICO"); Director of Boston
Children's Services Association; Trustee of Anatolia College, Middlesex
School, and Middlebury College; Member, Board of Governors, New England
Medical Center; former Director and President of Hartwell Keystone
Advisers, Inc. ("Hartwell Keystone"); former Director and Vice
President, Robert Van Partners, Inc.; and former Trustee of Neworld
Bank.
FREDERICK AMLING: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of Funds; Professor, Finance
Department, George Washington Uni versity; President, Amling & Company
(investment advice); and former Member, Board of Advisers, Credito
Emilano (banking).
CHARLES A. AUSTIN III: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of Funds; Investment Counselor
to Appleton Partners, Inc.; and former Managing Director, Seaward
Management Corporation (investment advice).
*GEORGE S. BISSELL: Chairman of the Board and Trustee of the Fund; Chairman of
the Board and Trustee or Director of all other funds in the Keystone
Investments Family of Funds; Director of Keystone Investments; Chairman
of the Board and Trustee of Anatolia College; Trustee of University
Hospital (and Chairman of its Investment Committee); former Director
and Chairman of the Board of Hartwell Keystone; and former Chairman of
the Board and Chief Executive Officer of Keystone Investments.
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of Funds; Principal, Padanaram
Associates, Inc.; and former Executive Director, Coalition of Essential
Schools, Brown University.
CHARLES F. CHAPIN: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Investments Family of Funds; and former Director,
Peoples Bank (Charlotte, NC).
K. DUN GIFFORD: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of Funds; Trustee, Treasurer,
and Chairman of the Finance Committee, Cambridge College; Chairman
Emeritus and Director, American Institute of Food and Wine; Chairman
and President, Oldways Preservation and Exchange Trust (education);
Former Chairman of the Board, Director, and Executive Vice President,
The London Harness Company; former Managing Partner, Roscommon Capital
Corp.; former Chief Executive Offi cer, Gifford Gifts of Fine Foods;
former Chairman, Gifford, Drescher & Associates (environ mental
consulting); and former Director, Keystone Investments and Keystone.
LEROY KEITH, JR.: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Investments Family of Funds; Chairman of the Board and
Chief Executive Officer, Carson Products Company; Director of Phoenix
Total Return Fund and Equifax, Inc.; Trustee of Phoenix Series Fund,
Phoenix Multi-Portfolio Fund, and The Phoenix Big Edge Series Fund; and
former President, Morehouse College.
F. RAY KEYSER, JR.: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of Funds; Chairman and Of
Counsel, Keyser, Crowley, Meub, Layden, Kulig & Sullivan P.C.; Member,
Governor's (VT) Council of Economic Advisers; Chairman of the Board and
Director, Central Vermont Public Service Corporation and Lahey
Hitchcock Clinic; Director, Vermont Yankee Nuclear Power Corporation,
Grand Trunk Corporation, Grand Trunk Western Railroad, Union Mutual
Fire Insurance Company, New England Guaranty Insurance Company, Inc.,
and the Investment Company Institute; former Director and President,
Associated Industries of Vermont; former Director of Keystone, Central
Vermont Railway, Inc., S.K.I. Ltd., and Arrow Financial Corp.; and
former Director and Chairman of the Board, Hitchcock Clinic, Proctor
Bank, and Green Mountain Bank.
DAVID M. RICHARDSON: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of Funds; Vice Chair and
former Executive Vice President, DHR International, Inc. (executive
recruitment); former Senior Vice President, Boyden International Inc.
(executive recruitment); and Director, Commerce and Industry
Association of New Jersey, 411 International, Inc., and J & M Cumming
Paper Co.
RICHARD J. SHIMA: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Investments Family of Funds; Chairman, Environmental
Warranty, Inc. (insurance agency); Executive Consultant, Drake Beam
Morin, Inc. (executive outplacement); Director of Connecticut Natural
Gas Corporation, Hartford Hospital, Old State House Association,
Middlesex Mutual Assurance Company, and Enhance Financial Services,
Inc.; Chairman, Board of Trustees, Hartford Graduate Center; Trustee,
Greater Hartford YMCA; former Director, Vice Chairman and Chief
Investment Officer, The Travelers Corporation; former Trustee,
Kingswood-Oxford School; and former Managing Director and Consultant,
Russell Miller, Inc.
ANDREW J. SIMONS: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Investments Family of Funds; Partner, Farrell, Fritz,
Caemmerer, Cleary, Barnosky & Armentano, P.C.; Adjunct Professor of Law
and former Associate Dean, St. John's University School of Law; Adjunct
Professor of Law, Touro College School of Law; and former President,
Nassau County Bar Association.
EDWARD F. GODFREY: Senior Vice President of the Fund; Senior Vice President of
all other funds in the Keystone Investments Family of Funds; Director,
Senior Vice President, Chief Financial Officer, and Treasurer of
Keystone Investments, the Principal Underwriter, Keystone Asset
Corporation, Keystone Capital Corporation, and Keystone Trust Company;
Treasurer of Keystone Institutional and FICO; Treasurer and Director of
Keystone Management and Keystone Software; Vice President and Treasurer
of KFIA; Director of KIRC; former Treasurer and Director of Hartwell
Keystone; and former Treasurer of Robert Van Partners, Inc.
JAMES R. McCALL: Senior Vice President of the Fund; Senior Vice President of
all other funds in the Keystone Investments Family of Funds; and
President of Keystone.
J. KEVIN KENELY: Treasurer of the Fund; Treasurer of all other funds in
the Keystone Investments Family of Funds; Vice President and former
Controller of Keystone Investments, Keystone, the Principal
Underwriter, FICO, and Keystone Software; and former Controller of
Keystone Asset Corporation and Keystone Capital Corporation.
ROSEMARY D. VAN ANTWERP: Senior Vice President and Secretary of the Fund; Senior
Vice President and Secretary of all other funds in the Keystone
Investments Family of Funds; Senior Vice President, General Counsel,
and Secretary of Keystone; Senior Vice President, General Counsel,
Secretary, and Director of the Principal Underwriter, Keystone
Management, and Keystone Software; Senior Vice President and General
Counsel of Keystone Institutional; Senior Vice President, General
Counsel, and Director of FICO and KIRC; Vice President and Secretary of
KFIA; Senior Vice President, General Counsel, and Secretary of Keystone
Investments, Keystone Asset Corporation, Keystone Capital Corporation,
and Keystone Trust Company; and former Senior Vice President and
Secretary of Hartwell Keystone and Robert Van Partners, Inc.
CHRISTOPHER P. CONKEY: Vice President of the Fund; Vice President of certain
other funds in the Keystone Investments Family of Funds; and Senior
Vice President of Keystone.
* This Trustee may be considered an "interested person" of the Fund within the
meaning of the 1940 Act.
Mr. Bissell and Mr. Elfner are "interested persons" of the Fund by
virtue of their positions as officers and/or Directors of Keystone Investments
and several of its affiliates including Keystone, Keystone Management, the
Principal Underwriter, and KIRC. Mr. Bissell and Mr. Elfner both own shares of
Keystone Investments. Mr. Bissell is a Director of Keystone Investments. Mr.
Elfner is Chairman of the Board, Chief Executive Officer, and Director of
Keystone Investments.
For the fiscal year ended August 31, 1996, none of the Trustees and
officers of Keystone received any direct remuneration from the Fund. For the
calendar year ended December 31, 1995, annual retainers and meeting fees paid by
all funds in the Keystone Investments Family of Funds (which includes over 30
mutual funds) totaled approximately $450,716. As of November 30, 1996, none of
the Trustees and officers of Keystone beneficially owned any of the Fund's then
outstanding shares.
The address of all the Fund's Trustees and officers and the address of
the Fund is 200 Berkeley Street, Boston, Massachusetts 02116-5034.
PRINCIPAL UNDERWRITER
The Fund has entered into a Principal Underwriting Agreement (the
"Underwriting Agreement") with Keystone Investment Distributors Company, the
Principal Underwriter. The Principal Underwriter is a Delaware corporation and
is wholly-owned by Keystone.
The Principal Underwriter, as agent, has agreed to use its best efforts
to find purchasers for the shares. The Principal Underwriter may retain and
employ representatives to promote distribution of the shares and may obtain
orders from broker-dealers, and others, acting as principals, for sales of
shares to them. The Underwriting Agreement provides that the Principal
Underwriter will bear the expense of preparing, printing, and distributing
advertising and sales literature and prospectuses used by it. In its capacity as
principal underwriter, the Principal Underwriter may receive payments from the
Fund pursuant to the Fund's Distribution Plan.
The Underwriting Agreement provides that it will remain in effect as
long as its terms and continuance are approved annually (i) by a vote of a
majority of the Fund's Independent Trustees cast in person at a meeting called
for that purpose and (ii) by vote of a majority of Trustees or by vote of a
majority of the outstanding shares.
The Underwriting Agreement may be terminated, without penalty, on 60
days' written notice by the Board of Trustees or by a vote of a majority of
outstanding shares. The Underwriting Agreement will terminate automatically
upon its "assignment," as that term is defined in the 1940 Act.
From time to time, if, in the Principal Underwriter's judgment, it
could benefit the sales of Fund shares, the Principal Underwriter may provide to
selected broker-dealers promotional materials and selling aids, including, but
not limited to, personal computers, related software, and Fund data files.
In addition to an assignment of the Fund's Management Agreement and
Advisory Agreement, the Merger, if consummated, will also be deemed to cause an
assignment, as defined by the 1940 Act, of the Underwriting Agreement. As a
result, the Fund's Trustees have approved the following agreements, subject to
the Merger's completion: (i) a principal underwriting agreement with Evergreen
Funds Distributor, Inc. ("EFD") and the Fund; (ii) a marketing services
agreement between the Principal Underwriter and EFD with respect to the Fund;
and (iii) a subadministration agreement between Keystone and Furman Selz LLC
with respect to the Fund. EFD is a wholly-owned subsidiary of Furman Selz LLC.
It is currently anticipated that on or about January 2, 1997, Furman Selz LLC
will transfer EFD, and Furman Selz's related services, to BISYS Group, Inc.
("BISYS") (the "Transfer"). The Fund's Trustees have also approved, subject to
completion of the Transfer, (i) a new principal underwriting agreement between
EFD and the Fund; (ii) a new marketing services agreement between the Principal
Underwriter and EFD with respect to the Fund; and (iii) a subadministration
agreement between Keystone and BISYS with respect to the Fund. The terms of such
agreements will be substantively identical to the terms of the agreements to be
executed upon completion of the Merger.
BROKERAGE
SELECTION OF BROKERS
In effecting transactions in portfolio securities for the Fund,
Keystone seeks the best execution of orders at the most favorable prices.
Keystone determines whether a broker has provided the Fund with best execution
and price in the execution of a securities transaction by evaluating, among
other things:
1. overall direct net economic result to the Fund,
2. the efficiency with which the transaction is effected,
3. the broker's ability to effect the transaction where a large
block is involved,
4. the broker's readiness to execute potentially difficult
transactions in the future,
5. the financial strength and stability of the broker, and
6. the receipt of research services, such as analyses and reports
concerning issuers, industries, securities, economic factors
and trends and other statistical and factual information.
The Fund's management weighs these considerations in determining the
overall reasonableness of the brokerage commissions paid.
Should the Fund or Keystone receive research and other statistical and
factual information from a broker, the Fund would consider such services to be
in addition to, and not in lieu of, the services Keystone is required to perform
under the Advisory Agreement. Keystone believes that the cost, value and
specific application of such information are indeterminable and cannot be
practically allocated between the Fund and its other clients who may indirectly
benefit from the availability of such information. Similarly, the Fund may
indirectly benefit from information made available as a result of transactions
effected for Keystone's other clients. Under the Advisory Agreement, Keystone is
permitted to pay higher brokerage commissions for brokerage and research
services in accordance with Section 28(e) of the Securities Exchange Act of
1934. In the event Keystone follows such a practice, it will do so on a basis
that is fair and equitable to the Fund.
Neither the Fund nor Keystone intends on placing securities
transactions with any particular broker. The Fund's Board of Trustees has
determined, however, that the Fund may consider sales of Fund shares as a factor
in the selection of brokers to execute portfolio transactions, subject to the
requirements of best execution described above.
BROKERAGE COMMISSIONS
The Fund expects to purchase and sell its securities and temporary
instruments through principal transactions. Bonds and money market instruments
are normally purchased directly from the issuer or from an underwriter or market
maker for the securities. In general, the Fund will not pay brokerage
commissions for such purchases. Purchases from underwriters will include the
underwriting commission or concession, and purchases from dealers serving as
market makers will include a dealer's mark-up or reflect a dealer's mark-down.
Where transactions are made in the over-the-counter market, the Fund will deal
with primary market makers unless more favorable prices are otherwise
obtainable.
GENERAL BROKERAGE POLICIES
In order to take advantage of the availability of lower purchase
prices, the Fund may participate, if and when practicable, in group bidding for
the direct purchase from an issuer of certain securities.
Keystone makes investment decisions for the Fund independently from
those of its other clients. It may frequently develop, however, that Keystone
will make the same investment decision for more than one client. Simultaneous
transactions are inevitable when the same security is suitable for the
investment objective of more than one account. When two or more of its clients
are engaged in the purchase or sale of the same security, Keystone will allocate
the transactions according to a formula that is equitable to each of its
clients. Although, in some cases, this system could have a detrimental effect on
the price or volume of the Fund's securities, the Fund believes that in other
cases its ability to participate in volume transactions will produce better
executions.
The Fund does not purchase portfolio securities from or sell portfolio
securities to Keystone, the Principal Underwriter, or any of their affiliated
persons, as defined in the 1940 Act.
The Board of Trustees will, from time to time, review the Fund's
brokerage policy. Because of the possibility of further regulatory developments
affecting the securities exchanges and brokerage practices generally, the Board
of Trustees may change, modify or eliminate any of the foregoing practices.
EXPENSES
INVESTMENT ADVISORY FEES
For each of the Fund's last three fiscal years, the table below lists the
total dollar amounts paid by (1) the Fund to Keystone Management for services
rendered under the Management Agreement and (2) by Keystone Management to
Keystone for services rendered under the Advisory Agreement. For more
information, see "Investment Management."
Percent of Fund's Fee Paid to
Fee Paid to Keystone Average Net Assets Keystone under
Management under represented by the Advisory
Fiscal Year Ended the Management Keystone Agreement
August 31, Agreement Management's Fee
- ----------------- -------------------- ------------------- ---------------
1996 $3,481,728 0.53% $2,959,469
1995 $3,982,976 0.53% $3,385,529
1994 $4,624,138 0.50% $3,930,517
DISTRIBUTION PLAN EXPENSES
For the fiscal year ended August 31, 1996, the Fund paid $6,610,025 to the
Principal Underwriter under its Distribution Plan. For more information, see
"Distribution Plans."
UNDERWRITING COMMISSIONS
For each of the Fund's last three fiscal years, the table below lists the
aggregate dollar amounts of underwriting commissions (front-end sales charges,
plus distribution fees, plus CDSCs) paid with respect to the public distribution
of the Fund's shares. The table also indicates the aggregate dollar amount of
underwriting commissions retained by the Principal Underwriter. For more
information, see "Principal Underwriter" and "Sales Charges."
Aggregate Dollar Amount of
Underwriting Commissions
Fiscal Year Ended Aggregate Dollar Amount of Retained by the Principal
August 31, Underwriting Commissions Underwriter
- ------------------ -------------------------- ---------------------------
1996 $5,596,658 $4,615,371
1995 $6,676,954 $5,231,567
1994 $8,143,311 $4,368,060
BROKERAGE COMMISSIONS
The Fund paid no brokerage commissions for the fiscal years ended
August 31, 1994, 1995 and 1996.
STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
Total return quotations for the Fund as they may appear from time to
time in advertisements are calculated by finding the average annual compounded
rates of return over the one, five, and ten year periods on a hypothetical
$1,000 investment that would equate the initial amount invested to the ending
redeemable value. To the initial investment all dividends and distributions are
added, and all recurring fees charged to all shareholder accounts are deducted.
The ending redeemable value assumes a complete redemption at the end of the one,
five, or ten year periods.
The cumulative total returns for the Fund for the one, five, and ten
year periods ended August 31, 1996 were 4.03% (including CDSCs), 42.98% and
85.41%, respectively. The compounded average annual rates of return for the one,
five, and ten year periods ended August 31, 1996 were 4.03% (including CDSCs),
7.41% and 6.37%, respectively.
Current yield quotations as they may appear from time to time in
advertisements will consist of a quotation based on a 30-day period ended on the
date of the most recent balance sheet of the Fund, computed by dividing the net
investment income per share earned during the period by the maximum offering
price per share on the last day of the base period.
The Fund's current yield for the 30-day period ended August 31, 1996
was 6.95%.
FINANCIAL STATEMENTS
The following financial statements of the Fund are incorporated by
reference herein from the Fund's Annual Report, as filed with the Commission:
Schedule of Investment as of August 31, 1996;
Statement of Assets and Liabilities as of August 31, 1996;
Statement of Operations for the year ended August 31, 1996;
Statements of Changes in Net Assets for each of the years in the
two-year period ended August 31, 1996;
Financial Highlights for each of the years in the ten-year period
ended August 31, 1996;
Notes to Financial Statements; and
Independent Auditors' Report dated September 27, 1996.
A copy of the Fund's Annual Report will be furnished upon request and
without charge. Requests may be made in writing to KIRC, P.O. Box 2121, Boston,
Massachusetts 02106-2121, or by calling KIRC toll free at 1-800-343-2898.
ADDITIONAL INFORMATION
State Street Bank and Trust Company, located at 225 Franklin Street,
Boston, Massachusetts 02110, is the custodian of all securities and cash of the
Fund (the "Custodian"). The Custodian may hold securities of some foreign
issuers outside the U.S. The Custodian, in addition to its custodial services,
is responsible for accounting and related recordkeeping on behalf of the Fund.
KPMG Peat Marwick LLP, located at 99 High Street, Boston, Massachusetts
02110, Certified Public Accountants, are the Fund's independent auditors.
KIRC, located at 200 Berkeley Street, Boston, Massachusetts 02116-5034,
is a wholly-owned subsidiary of Keystone, and is the Fund's transfer agent and
dividend disbursing agent.
On November 30, 1996, Merrill Lynch, Pierce, Fenner & Smith, For Sole
Benefit of its Customers, Attn.: Fund Administration, 4800 Deer Lake Drive E,
3rd Floor, Jacksonville, FL 32246-6484, owned 14.26% of the Fund's then
outstanding shares.
Except as otherwise stated in its prospectus or required by law, the
Fund reserves the right to change the terms of the offer stated in its
prospectus without shareholder approval, including the right to impose or change
fees for services provided.
If conditions arise that would make it undesirable for the Fund to pay
for all redemptions in cash, the Fund may authorize payment to be made in
portfolio securities or other property. The Fund has obligated itself, however,
under the 1940 Act to redeem for cash all shares presented for redemption by any
one shareholder up to the lesser of $250,000 or 1.00% of the Fund's net assets
in any 90-day period. Securities delivered in payment of redemptions would be
valued at the same value assigned to them in computing the net asset value per
share and would, to the extent permitted by law, be readily marketable.
Shareholders receiving such securities would incur brokerage costs upon the
securities' sale.
No dealer, salesman, or other person is authorized to give any
information or to make any representation not contained in the Fund's
prospectus, this statement of additional information, or in supplemental sales
literature issued by the Fund or the Principal Underwriter. No person is
entitled to rely on any information or representation not contained therein.
The Fund's prospectus and this statement of additional information omit
certain information contained in the Fund's Registration Statement filed with
the Securities and Exchange Commission ("SEC"), which may be obtained from the
SEC's principal office in Washington, D.C. upon payment of the fee prescribed by
the rules and regulations promulgated by the SEC.
<PAGE>
A - 1
APPENDIX
COMMON AND PREFERRED STOCK RATINGS
A. S&P'S EARNINGS AND DIVIDEND RANKINGS FOR COMMON STOCKS
Because the investment process involves assessment of various factors,
such as product and industry position, corporate resources, and financial
policy, with results that make some common stocks more highly esteemed than
others, Standard & Poor's Corporation ("S&P") believes that earnings and
dividend performance is the end result of the interplay of these factors and
that, over the long run, the record of this performance has a considerable
bearing on relative quality. S&P rankings, however, do not reflect all of the
factors, tangible or intangible, that bear on stock quality.
Growth and stability of earnings and dividends are deemed key elements
in establishing S&P earnings and dividend rankings for common stocks, which
capsulize the nature of this record in a single symbol.
S&P has established a computerized scoring system based on per share
earnings and dividend records of the most recent ten years, a period deemed long
enough to measure a company's performance under varying economic conditions. S&P
measures growth, stability within the trend line, and cyclicality. The ranking
system also makes allowances for company size, since large companies have
certain inherent advantages over small ones. From these, scores for earnings and
dividends are determined.
The final score for each stock is measured against a scoring matrix
determined by analysis of the scores of a large and representative sample which
is reviewed and sometimes modified with the following ladder of rankings:
A+ Highest B+ Average C Lowest
- -- ------- -- ------- - ------
A High B Below Average D In Reorganization
- -- ---- -- ------------- - -----------------
A- Above Average B- Lower
- -- ------------- -- -----
S&P believes its rankings are not a forecast of future market price
performance, but are basically an appraisal of past performance of earnings and
dividends, and relative current standing.
B. MOODY'S COMMON STOCK RANKINGS
Moody's Investor Service ("Moody's") presents a concise statement of
the important characteristics of a company and an evaluation of the grade
(quality) of its common stock. Data presented includes: (a) capsule stock
information which reveals short and long term growth and yield afforded by the
indicated dividend, based on a recent price; (b) a long term price chart which
shows patterns of monthly stock price movements and monthly trading volumes; (c)
a breakdown of a company's capital account which aids in determining the degree
of conservatism or financial leverage in a company's balance sheet; (d) interim
earnings for the current year to date, plus three previous years; (e) dividend
information; (f) company background; (g) recent corporate developments; (h)
prospects for a company in the immediate future and the next few years; and (i)
a ten year comparative statistical analysis.
This information provides investors with information on what a company
does, how it has performed in the past, how it is performing currently, and what
its future performance prospects appear to be.
A - 2
These characteristics are then evaluated and result in a grading, or
indication of quality. The grade is based on an analysis of each company's
financial strength, stability of earnings, and record of dividend payments.
Other considerations include conservativeness of capitalization, depth and
caliber of management, accounting practices, technological capabilities, and
industry position. Evaluation is represented by the following grades:
(1) High Grade
(2) Investment Grade
(3) Medium Grade
(4) Speculative Grade
C. MOODY'S PREFERRED STOCK RATINGS
Preferred stock ratings and their definitions are as follows:
1. aaa: An issue that is rated aaa is considered to be a top-quality
preferred stock. This rating indicates good asset protection and the least risk
of dividend impairment within the universe of preferred stocks.
2. aa: An issue that is rated aa is considered a high-grade preferred
stock. This rating indicates that there is a reasonable assurance that earnings
and asset protection will remain relatively well maintained in the foreseeable
future.
3. a: An issue that is rated a is considered to be an upper-medium
grade preferred stock. While risks are judged to be somewhat greater than in the
aaa and aa classification, earnings and asset protection are, nevertheless,
expected to be maintained at adequate levels.
4. baa: An issue that is rated baa is considered to be a medium-grade
preferred stock, neither highly protected nor poorly secured. Earnings and asset
protection appear adequate at present but may be questionable over any great
length of time.
5. ba: An issue that is rated ba is considered to have speculative
elements and its future cannot be considered well assured. Earnings and asset
protection may be very moderate and not well safeguarded during adverse periods.
Uncertainty of position characterizes preferred stocks in this class.
6. b: An issue that is rated b generally lacks the characteristics of a
desirable investment. Assurance of dividend payments and maintenance of other
terms of the issue over any long period of time may be small.
7. caa: An issue that is rated caa is likely to be in arrears on
dividend payments. This rating designation does not purport to indicate the
future status of payments.
8. ca: An issue that is rated ca is speculative in a high degree and is
likely to be in arrears on dividends with little likelihood of eventual
payments.
9. c: This is the lowest rated class of preferred or preference stock.
Issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers 1, 2 and 3 in each rating
classification: the modifier 1 indicates that the security 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
generic rating category.
A - 3
LIMITED PARTNERSHIPS
The Fund may invest in limited and master limited partnerships. A
limited partnership is a partnership consisting of one or more general partners,
jointly and severally responsible as ordinary partners, and by whom the business
is conducted, and one or more limited partners who contribute cash as capital to
the partnership and who generally are not liable for the debts of the
partnership beyond the amounts contributed. Limited partners are not involved in
the day-to-day management of the partnership. They receive income, capital gains
and other tax benefits associated with the partnership project in accordance
with terms established in the partnership agreement. Typical limited
partnerships are in real estate, oil and gas and equipment leasing, but they
also finance movies, research and development, and other projects.
For an organization classified as a partnership under the Internal
Revenue Code, each item of income, gain, loss, deduction, and credit is not
taxed at the partnership level but flows through to the holder of the
partnership unit. This allows the partnership to avoid double taxation and to
pass through income to the holder of the partnership unit at lower individual
rates.
A master limited partnership is a publicly traded limited partnership.
The partnership units are registered with the Securities and Exchange Commission
and are freely exchanged on a securities exchange or in the over-the-counter
market.
CORPORATE BOND RATINGS
A. S&P CORPORATE BOND RATINGS
An S&P corporate bond rating is a current assessment of the
creditworthiness of an obligor, including obligors outside the United States,
with respect to a specific obligation. This assessment may take into
consideration obligors such as guarantors, insurers, or lessees. Ratings of
foreign obligors do not take into account currency exchange and related
uncertainties. The ratings are based on current information furnished by the
issuer or obtained by S&P from other sources it considers reliable.
The ratings are based, in varying degrees, on the following
considerations:
a. Likelihood of default - capacity and willingness of the obligor as
to the timely payment of interest and repayment of principal in accordance with
the terms of the obligation;
b. Nature of and provisions of the obligation; and
c. Protection afforded by and relative position of the obligation in
the event of bankruptcy, reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, ratings from AA to A may be modified by the addition of a plus or minus
sign to show relative standing within the major rating categories.
Bond ratings are as follows:
1. AAA - Debt rated AAA has the highest rating assigned by S&P.
Capacity to pay interest and repay principal is extremely strong.
2. AA - Debt rated AA has a very strong capacity to pay interest and
repay principal and differs from the higher rated issues only in small degree.
<PAGE>
A - 4
3. A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
4. BBB - Debt rated BBB is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher rated categories.
5. BB, B, CCC, CC and C - Debt rated BB, B, CCC, CC and C is regarded,
on balance, as predominantly speculative with respect to capacity to pay
interest and repay principal in accordance with the terms of the obligation. BB
indicates the lowest degree of speculation and C the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
B. MOODY'S CORPORATE BOND RATINGS
Moody's ratings are as follows:
1. Aaa - Bonds which are rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment risk and are generally
referred to as "gilt-edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
2. Aa - Bonds which are rated Aa are judged to be of high quality by
all standards. Together with the Aaa group they comprise what are generally
known as high-grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long term risks appear somewhat larger than in Aaa
securities.
3. 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.
4. Baa - Bonds which are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
5. 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.
6. B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the
<PAGE>
A - 5
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 generic rating category.
ZERO COUPON "STRIPPED" BONDS
A zero coupon "stripped" bond represents ownership in serially maturing
interest payments or principal payments on specific underlying notes and bonds,
including coupons relating to such notes and bonds. The interest and principal
payments are direct obligations of the issuer. Coupon zero coupon bonds of any
series mature periodically from the date of issue of such series through the
maturity date of the securities related to such series. Principal zero coupon
bonds mature on the date specified therein, which is the final maturity date of
the related securities. Each zero coupon bond entitles the holder to receive a
single payment at maturity. There are no periodic interest payments on a zero
coupon bond. Zero coupon bonds are offered at discounts from their face amounts.
In general, owners of zero coupon bonds have substantially all the
rights and privileges of owners of the underlying coupon obligations or
principal obligations. Owners of zero coupon bonds have the right upon default
on the underlying coupon obligations or principal obligations to proceed
directly and individually against the issuer and are not required to act in
concert with other holders of zero coupon bonds.
For federal income tax purposes, a purchaser of principal zero coupon
bonds or coupon zero coupon bonds (either initially or in the secondary market)
is treated as if the buyer had purchased a corporate obligation issued on the
purchase date with an original issue discount equal to the excess of the amount
payable at maturity over the purchase price. The purchaser is required to take
into income each year as ordinary income an allocable portion of such discounts
determined on a "constant yield" method. Any such income increases the holder's
tax basis for the zero coupon bond, and any gain or loss on a sale of the zero
coupon bonds relative to the holder's basis, as so adjusted, is a capital gain
or loss. If the holder owns both principal zero coupon bonds and coupon zero
coupon bonds representing interest in the same underlying issue of securities, a
special basis allocation rule (requiring the aggregate basis to be allocated
among the items sold and retained based on their relative fair market values at
the time of sale) may apply to determine the gain or loss on a sale of any such
zero coupon bonds items.
PAYMENT-IN-KIND SECURITIES
Payment-in-Kind ("PIK") securities pay interest in either cash or
additional securities, at the issuer's option, for a specified period. The
issuer's option to pay in additional securities typically ranges from one to six
years, compared to an average maturity for all PIK securities of 11 years. Call
protection and sinking fund features are comparable to those offered on
traditional debt issues.
PIKs, like zero coupon bonds, are designed to give an issuer
flexibility in managing cash flow. Several PIKs are senior debt. In other cases,
where PIKs are subordinated, most senior lenders view them as equity
equivalents.
An advantage of PIKs for the issuer - as with zero coupon securities -
is that interest payments are automatically compounded (reinvested) at the
stated coupon rate, which is not the case with cashpaying securities. However,
PIKs are gaining popularity over zeros since interest payments in additional
securities can be monetized and are more tangible than accretion of a discount.
As a group, PIK bonds trade flat (i.e., without accrued interest).
Their price is expected to reflect an amount representing accreted interest
since the last payment. PIKs generally trade at higher yields than comparable
cash-paying securities of the same issuer. Their premium yield is the result of
the lesser desirability of non-cash interest, the more limited audience for
non-cash paying securities, and
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the fact that many PIKs have been issued to equity investors who do not normally
own or hold such securities.
Calculating the true yield on a PIK security requires a discounted cash
flow analysis if the security (ex interest) is trading at a premium or a
discount, because the realizable value of additional payments is equal to the
current market value of the underlying security, not par.
Regardless of whether PIK securities are senior or deeply subordinated,
issuers are highly motivated to retire them because they are usually their most
costly form of capital. 68% of the PIK debentures issued prior to 1987 have
already been redeemed, and approximately 35% of the over $10 billion PIK
debentures issued through year-end 1988 have been retired.
EQUIPMENT TRUST CERTIFICATES
Equipment Trust Certificates are a mechanism for financing the purchase
of transportation equipment, such as railroad cars and locomotives, trucks,
airplanes and oil tankers.
Under an equipment trust certificate, the equipment is used as the
security for the debt and title to the equipment is vested in a trustee. The
trustee leases the equipment to the user, i.e. the railroad, airline, trucking
or oil company. At the same time equipment trust certificates in an aggregate
amount equal to a certain percentage of the equipment's purchase price are sold
to lenders. The trustee pays the proceeds from the sale of certificates to the
manufacturer. In addition, the company using the equipment makes an initial
payment of rent equal to their balance of the purchase price to the trustee,
which the trustee then pays to the manufacturer. The trustee collects lease
payments from the company and uses the payments to pay interest and principal on
the certificates. At maturity, the certificates are redeemed and paid, the
equipment is sold to the company and the lease is terminated.
Generally, these certificates are regarded as obligations of the
company that is leasing the equipment and are shown as liabilities on its
balance sheet. However, the company does not own the equipment until all the
certificates are redeemed and paid. In the event the company defaults under its
lease, the trustee terminates the lease. If another lessee is available, the
trustee leases the equipment to another user and makes payments on the
certificates from new lease rentals.
MONEY MARKET INSTRUMENTS
The Fund's investments in commercial paper are limited to those rated
A-1 by S&P, Prime-1 by Moody's or F-1 by Fitch Investors Service, Inc.
("Fitch"). These ratings and other money market instruments are described as
follows:
COMMERCIAL PAPER RATINGS
Commercial paper rated A-1 by S&P has the following characteristics:
Liquidity ratios are adequate to meet cash requirements. The issuer's long-term
senior debt is rated A or better, although in some cases BBB credits may be
allowed. The issuer has access to at least two additional channels of borrowing.
Basic earnings and cash flow have an upward trend with allowance made for
unusual circumstances. Typically, the issuer's industry is well established and
the issuer has a strong position within the industry.
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Among the factors considered by Moody's in assigning ratings are the
following: (1) evaluation of the management of the issuer; (2) economic
evaluation of the issuer's industry or industries and an appraisal of
speculative-type risks which may be inherent in certain areas; (3) evaluation of
the issuer's products in
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relation to competition and customer acceptance; (4) liquidity; (5) amount and
quality of long-term debt; (6) trend of earnings over a period of ten years; (7)
financial strength of a parent company and the relationships which exist with
the issuer; and (8) recognition by the management of obligations which may be
present or may arise as a result of public preparations to meet such
obligations. Relative strength or weakness of the above factors determines how
the issuer's commercial paper is rated within various categories.
The rating F-1 is the highest rating assigned by Fitch. Among the
factors considered by Fitch in assigning this rating are: (1) the issuer's
liquidity; (2) its standing in the industry; (3) the size of its debt; (4) its
ability to service its debt; (5) its profitability; (6) its return on equity;
(7) its alternative sources of financing; and (8) its ability to access the
capital markets. Analysis of the relative strength or weakness of these factors
and others determines whether an issuer's commercial paper is rated F-1.
UNITED STATES GOVERNMENT SECURITIES
Securities issued or guaranteed by the U.S. government include a
variety of Treasury securities that differ only in their interest rates,
maturities and dates of issuance. Treasury bills have maturities of one year or
less. Treasury notes have maturities of one to ten years and Treasury bonds
generally have maturities of greater than ten years at the date of issuance.
Securities issued or guaranteed by U.S. government agencies or
instrumentalities include direct obligations of the U.S. Treasury and securities
issued or guaranteed by the Federal Housing Administration, Farmers Home
Administration, Export-Import Bank of the U.S., Small Business Administration,
Government National Mortgage Association, General Services Administration,
Central Bank for Cooperatives, Federal Home Loan Banks, Federal Loan Mortgage
Corporation, Federal Intermediate Credit Banks, Federal Land Banks, Maritime
Administration, The Tennessee Valley Authority, District of Columbia Armory
Board, and Federal National Mortgage Association.
Some obligations of U.S. government agencies and instrumentalities,
such as Treasury bills and Government National Mortgage Association pass-through
certificates, are supported by the full faith and credit of the U.S.; others,
such as securities of Federal Home Loan Banks, by the right of the issuer to
borrow from the Treasury; still others, such as bonds issued by the Federal
National Mortgage Association, a private corporation, are supported only by the
credit of the instrumentality. Because the U.S. government is not obligated by
law to provide support to an instrumentality it sponsors, the Fund will invest
in the securities issued by such an instrumentality only when Keystone
determines that the credit risk with respect to the instrumentality does not
make its securities unsuitable investments. U.S. government securities will not
include international agencies or instrumentalities in which the U.S.
government, its agencies, or instrumentalities participate, such as the World
Bank, the Asian Development Bank or the InterAmerican Development Bank, or
issues insured by the Federal Deposit Insurance Corporation or Federal Savings
and Loan Insurance Corporation.
CERTIFICATES OF DEPOSIT
Certificates of deposit are receipts issued by a bank in exchange for
the deposit of funds. The issuer agrees to pay the amount deposited plus
interest to the bearer of the receipt on the date specified on the certificate.
The certificate usually can be traded in the secondary market prior to maturity.
Certificates of deposit will be limited to U.S. dollar-denominated
certificates of U.S. banks (including their branches abroad) and of U.S.
branches of foreign banks, which are members of the Federal Reserve System or
the Federal Deposit Insurance Corporation, and have at least $1 billion in
assets as of the date of their most recently published financial statements, or
of savings and loan associations which are members of the Federal Savings and
Loan Insurance Corporation, and have at least $1 billion in deposits as of the
date of their most recently published financial statements.
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The Fund will not acquire time deposits or obligations issued by the
International Bank for Reconstruction and Development, the Asian Development
Bank or the Inter-American Development Bank. Additionally, the Fund does not
currently intend to purchase such foreign securities (except to the extent that
certificates of deposit of foreign branches of U.S. banks may be deemed foreign
securities) or purchase certificates of deposit, bankers' acceptances or other
similar obligations issued by foreign banks.
BANKERS' ACCEPTANCES
Bankers' acceptances typically arise from short term credit
arrangements designed to enable businesses to obtain funds to finance commercial
transactions. Generally, an acceptance is a time draft drawn on a bank by an
exporter or an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by the bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
earning asset or it may be sold in the secondary market at the going rate of
discount for a specific maturity. Although maturities for acceptances can be as
long as 270 days, most acceptances have maturities of six months or less.
Bankers' acceptances acquired by the Fund must have been accepted by U.S.
commercial banks, including foreign branches of U.S. commercial banks, having
total deposits at the time of purchase in excess of $1 billion and must be
payable in U.S. dollars.
OPTIONS TRANSACTIONS
WRITING COVERED OPTIONS
The Fund writes only covered options. Options written by the Fund will
normally have expiration dates of not more than nine months from the date
written. The exercise price of the options may be below, equal to, or above the
current market values of the underlying securities at the times the options are
written.
Unless the option has been exercised, the Fund may close out an option
it has written by effecting a closing purchase transaction, whereby it purchases
an option covering the same underlying security and having the same exercise
price and expiration date ("of the same series") as the one it has written. If
the Fund desires to sell a particular security on which it has written a call
option, it will effect a closing purchase transaction prior to or concurrently
with the sale of the security. If the Fund is able to enter into a closing
purchase transaction, the Fund will realize a profit (or loss) from such
transaction if the cost of such transaction is less (or more) than the premium
received from the writing of the option.
An option position may be closed out only in a secondary market for an
option of the same series. Although the Fund will generally write only those
options for which there appears to be an active secondary market, there is no
assurance that a liquid secondary market will exist for any particular option at
any particular time, and for some options no secondary market may exist. In such
event it might not be possible to effect a closing transaction in a particular
option. If the Fund as a covered call option writer is unable to effect a
closing purchase transaction, it will not be able to sell the underlying
securities until the option expires or it delivers the underlying securities
upon exercise.
Because the Fund intends to qualify as a regulated investment company
under the Internal Revenue Code, the extent to which the Fund may write covered
call options and enter into so-called "straddle" transactions involving put and
call options may be limited.
Many options are traded on registered securities exchanges. Options
traded on such exchanges are issued by the Options Clearing Corporation ("OCC"),
a clearing corporation which assumes responsibility for the completion of
options transactions.
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PURCHASING PUT AND CALL OPTIONS
The Fund can close out a put or call option it has written by effecting
a closing purchase transaction; for example, the Fund may close out a put or
call option it has written by buying an option identical to the one it has
written. If, however, a secondary market does not exist at a time the Fund
wishes to effect a closing sale transaction, the Fund will have to exercise the
option to realize any profit. If a covered call option writer cannot effect a
closing transaction, it cannot sell the underlying securities until the option
expires or is exercised. In addition, in a transaction in which the Fund does
not own the security underlying a put option it has purchased, the Fund would be
required, in the absence of a secondary market, to purchase the underlying
security before it could exercise the option, thereby incurring additional
transaction costs.
The Fund may also purchase call options for the purpose of offsetting
previously written call options of the same series.
The Fund will not purchase a put option if, as a result of such
purchase, more than 10% of its total assets would be invested in premiums for
such options. The Fund's ability to purchase put and call options may be limited
by the Internal Revenue Code's requirements for qualification as a regulated
investment company.
OPTION WRITING AND RELATED RISKS
The Fund may write covered call and put options. A call option gives
the purchaser of the option the right to buy, and the writer the obligation to
sell, the underlying security at the exercise price during the option period.
Conversely, a put option gives the purchaser the right to sell, and the writer
the obligation to buy, the underlying security at the exercise price during the
option period.
So long as the obligation of the writer continues, the writer may be
assigned an exercise notice by the broker-dealer through whom the option was
sold. The exercise notice would require the writer to deliver, in the case of a
call, or take delivery of, in the case of a put, the underlying security against
payment of the exercise price. This obligation terminates upon expiration of the
option, or at such earlier time as the writer effects a closing purchase
transaction by purchasing an option of the same series as the one previously
sold. Once an option has been exercised, the writer may not execute a closing
purchase transaction. For options traded on national securities exchanges
(Exchanges), to secure the obligation to deliver the underlying security in the
case of a call option, the writer of the option is required to deposit in escrow
the underlying security or other assets in accordance with the rules of the OCC,
an institution created to interpose itself between buyers and sellers of
options. Technically, the OCC assumes the order side of every purchase and sale
transaction on an Exchange and, by doing so, gives its guarantee to the
transaction.
The principal reason for writing options on a securities portfolio is
to attempt to realize, through the receipt of premiums, a greater return than
would be realized on the underlying securities alone. In return for the premium,
the covered call option writer has given up the opportunity for profit from a
price increase in the underlying security above the exercise price so long as
the option remains open, but retains the risk of loss should the price of the
security decline. Conversely, the put option writer gains a profit, in the form
of a premium, so long as the price of the underlying security remains above the
exercise price, but assumes an obligation to purchase the underlying security
from the buyer of the put option at the exercise price, even though the security
price may fall below the exercise price at any time during the option period. If
an option expires, the writer realizes a gain in the amount of the premium. Such
a gain may, in the case of a covered call option, be offset by a decline in the
market value of the underlying security during the option period. If a call
option is exercised, the writer realizes a gain or loss from the sale of the
underlying security. If a put option is exercised, the writer must fulfill his
obligation to purchase the underlying security at the exercise price, which will
usually exceed the then
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market value of the underlying security. In addition, the premium paid for the
put effectively increases the cost of the underlying security, thus reducing the
yield otherwise available from such securities.
Because the Fund can write only covered options, it may at times be
unable to write additional options unless it sells a portion of its portfolio
holdings to obtain new debt securities against which it can write options. This
may result in higher portfolio turnover and correspondingly greater brokerage
commissions and other transaction costs.
To the extent that a secondary market is available, the covered option
writer may close out options it has written prior to the assignment of an
exercise notice by purchasing, in a closing purchase transaction, an option of
the same series as the option previously written. If the cost of such a closing
purchase, plus transaction costs, is greater than the premium received upon
writing the original option, the writer will incur a loss in the transaction.
OPTIONS TRADING MARKETS
Options that the Fund will trade are generally listed on national
securities exchanges (Exchanges). Exchanges on which such options currently are
traded are the Chicago Board Options Exchange and the New York, American,
Pacific, and Philadelphia Stock Exchanges. Options on some securities may not be
listed on any Exchange but traded in the over-the-counter market. Options traded
in the over-the-counter market involve the additional risk that securities
dealers participating in such transactions would fail to meet their obligations
to the Fund. The use of options traded in the over-the-counter market may be
subject to limitations imposed by certain state securities authorities. In
addition to the limits on its use of options discussed herein, the Fund is
subject to the investment restrictions described in the prospectus and the
statement of additional information.
The staff of the Securities and Exchange Commission is of the view that
the premiums that a Fund pays for the purchase of unlisted options, and the
value of securities used to cover unlisted options written by the Fund, are
considered to be invested in illiquid securities or assets for the purpose of
calculating whether the Fund is in compliance with its fundamental investment
restrictions relating to illiquid securities.
SPECIAL CONSIDERATIONS APPLICABLE TO OPTIONS
On Treasury Bonds and Notes. Because trading interest in U.S. Treasury
bonds and notes tends to center on the most recently auctioned issues, new
series of options with expirations to replace expiring options on particular
issues will not be introduced indefinitely. Instead, the expirations introduced
at the commencement of options trading on a particular issue will be allowed to
run their course, with the possible addition of a limited number of new
expirations as the original ones expire. Options trading on each series of bonds
or notes will thus be phased out as new options are listed on the more recent
issues, and a full range of expiration dates will not ordinarily be available
for every series on which options are traded.
On Treasury Bills. Because the deliverable U.S. Treasury bill changes
from week to week, writers of U.S. Treasury bill call options cannot provide in
advance for their potential exercise settlement obligations by acquiring and
holding the underlying security. However, if the Fund holds a long position in
U.S. Treasury bills with a principal amount corresponding to the option contract
size, the Fund may be hedged from a risk standpoint. In addition, the Fund will
maintain in a segregated account with its Custodian liquid assets maturing no
later than those which would be deliverable in the event of an assignment of an
exercise notice to ensure that it can meet its open option obligations.
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On GNMA Certificates. Options on GNMA certificates are not currently
traded on any Exchange. However, the Fund may purchase and write such options in
the over-the-counter market or, should they commence trading, on any Exchange.
Since the remaining principal balance of GNMA certificates declines
each month as a result of mortgage payments, the Fund, as a writer of a covered
GNMA call holding GNMA certificates as "cover" to satisfy its delivery
obligation in the event of assignment of an exercise notice, may find that its
GNMA certificates no longer have a sufficient remaining principal balance for
this purpose. Should this occur, the Fund will enter into a closing purchase
transaction or will purchase additional GNMA certificates from the same pool (if
obtainable) or replacement GNMA certificates in the cash market in order to
remain covered.
A GNMA certificate held by the Fund to cover an option position in any
but the nearest expiration month may cease to present cover for the option in
the event of a decline in the GNMA coupon rate at which new pools are originated
under the FHA/VA loan ceiling in effect at any given time. Should this occur,
the Fund will no longer be covered, and the Fund will either enter into a
closing purchase transaction or replace the GNMA certificate with a certificate
which represents cover. When the Fund closes its position or replaces the GNMA
certificate, it may realize an unanticipated loss and incur transaction costs.
Risks Pertaining to the Secondary Market. An option position may be
closed out only in a secondary market for an option of the same series. Although
the Fund will generally purchase or write only those options for which there
appears to be an active secondary market, there is no assurance that a liquid
secondary market will exist for any particular option at any particular time,
and for some options no secondary market may exist. In such event, it might not
be possible to effect closing transactions in particular options, with the
result that the Fund would have to exercise its options in order to realize any
profit and might incur transaction costs in connection therewith. If the Fund as
a covered call option writer is unable to effect a closing purchase transaction
in a secondary market, it will not be able to sell the underlying security until
the option expires or it delivers the underlying security upon exercise.
Reasons for the absence of a liquid secondary market include the
following: (i) insufficient trading interest in certain options; (ii)
restrictions imposed on transactions; (iii) trading halts, suspensions, or other
restrictions imposed with respect to particular classes or series of options or
underlying securities; (iv) interruption of the normal operations on an Exchange
or by a broker; (v) inadequacy of the facilities of an Exchange, the OCC or a
broker to handle current trading volume; or (vi) a decision by one or more
Exchanges or a broker to discontinue the trading of options (or a particular
class or series of options), in which event the secondary market in that class
or series of options would cease to exist, although outstanding options that had
been issued as a result of trades would generally continue to be exercisable in
accordance with their terms.
The hours of trading for options on U.S. government securities may not
conform to the hours during which the underlying securities are traded. To the
extent that the option markets close before the markets for the underlying
securities, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
FUTURES CONTRACTS AND RELATED OPTIONS TRANSACTIONS
The Fund intends to enter into currency and other financial futures
contracts as a hedge against changes in prevailing levels of interest or
currency exchange rates to seek relative stability of principal and to establish
more definitely the effective return on securities held or intended to be
acquired by the Fund or as a hedge against changes in the prices of securities
or currencies held by the Fund or to be acquired by the Fund. The Fund's hedging
may include sales of futures as an offset against the effect
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of expected increases in interest or currency exchange rates or securities
prices and purchases of futures as an offset against the effect of expected
declines in interest or currency exchange rates or securities prices.
For example, when the Fund anticipates a significant market or market
sector advance, it will purchase a stock index futures contract as a hedge
against not participating in such advance at a time when the Fund is not fully
invested. The purchase of a futures contract serves as a temporary substitute
for the purchase of individual securities which may then be purchased in an
orderly fashion. As such purchases are made, an equivalent amount of index based
futures contracts would be terminated by offsetting sales. In contrast, the Fund
would sell stock index futures contracts in anticipation of or in a general
market or market sector decline that may adversely affect the market value of
the Fund's portfolio. To the extent that the Fund's portfolio changes in value
in correlation with a given index, the sale of futures contracts on that index
would substantially reduce the risk to the portfolio of a market decline or
change in interest rates, and, by so doing, provide an alternative to the
liquidation of the Fund's securities positions and the resulting transaction
costs.
The Fund intends to engage in options transactions which are related to
currency and other financial futures contracts for hedging purposes and in
connection with the hedging strategies described above.
Although techniques other than sales and purchases of futures contracts
and related options transactions could be used to reduce the Fund's exposure to
interest rate and/or market fluctuations, the Fund may be able to hedge its
exposure more effectively and perhaps at a lower cost through using futures
contracts and related options transactions. While the Fund does not intend to
take delivery of the instruments underlying futures contracts it holds, the Fund
does not intend to engage in such futures contracts for speculation.
FUTURES CONTRACTS
Futures contracts are transactions in the commodities markets rather
than in the securities markets. A futures contract creates an obligation by the
seller to deliver to the buyer the commodity specified in the contract at a
specified future time for a specified price. The futures contract creates an
obligation by the buyer to accept delivery from the seller of the commodity
specified at the specified future time for the specified price. In contrast, a
spot transaction creates an immediate obligation for the seller to deliver and
the buyer to accept delivery of and pay for an identified commodity. In general,
futures contracts involve transactions in fungible goods, such as wheat, coffee,
and soybeans. However, in the last decade an increasing number of futures
contracts have been developed which specify currencies, financial instruments or
financially based indexes as the underlying commodity.
U.S. futures contracts are traded only on national futures exchanges
and are standardized as to maturity date and underlying financial instrument.
The principal financial futures exchanges in the U.S. are The Board of Trade of
the City of Chicago, the Chicago Mercantile Exchange, the International Monetary
Market (a division of the Chicago Mercantile Exchange), the New York Futures
Exchange and the Kansas City Board of Trade. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership, which is also
responsible for handling daily accounting of deposits or withdrawals of margin.
A futures commission merchant (Broker) effects each transaction in connection
with futures contracts for a commission. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission (CFTC) and National Futures Association (NFA).
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INTEREST RATE FUTURES CONTRACTS
The sale of an interest rate futures contract creates an obligation by
the Fund, as seller, to deliver the type of financial instrument specified in
the contract at a specified future time for a specified price. The purchase of
an interest rate futures contract creates an obligation by the Fund, as
purchaser, to accept delivery of the type of financial instrument specified at a
specified future time for a specified price. The specific securities delivered
or accepted, respectively, at settlement date are not determined until at or
near that date. The determination is in accordance with the rules of the
exchange on which the futures contract sale or purchase was made.
Currently, interest rate futures contracts can be purchased or sold on
90-day U.S. Treasury bills, U.S. Treasury bonds, U.S. Treasury notes with
maturities between 6 1/2 and 10 years, Government National Mortgage Association
(GNMA) certificates, 90-day domestic bank certificates of deposit, 90-day
commercial paper, and 90-day Eurodollar certificates of deposit. It is expected
that futures contracts trading in additional financial instruments will be
authorized. The standard contract size is $100,000 for futures contracts in U.S.
Treasury bonds, U.S. Treasury notes, and GNMA certificates, and $1,000,000 for
the other designated contracts. While U.S. Treasury bonds, U.S. Treasury bills,
and U.S. Treasury notes are backed by the full faith and credit of the U.S.
government and GNMA certificates are guaranteed by a U.S. government agency, the
futures contracts in U.S. government securities are not obligations of the U.S.
Treasury.
INDEX BASED FUTURES CONTRACTS
STOCK INDEX FUTURES CONTRACTS
A stock index assigns relative values to the common stocks included in
the index. The index fluctuates with changes in the market values of the common
stocks so included. A stock index futures contract is a bilateral agreement by
which two parties agree to take or make delivery of an amount of cash equal to a
specified dollar amount times the difference between the closing value of the
stock index on the expiration date of the contract and the price at which the
futures contract is originally made. No physical delivery of the underlying
stocks in the index is made.
Currently, stock index futures contracts can be purchased or sold on
the S&P Index of 500 Stocks, the S&P Index of 100 Stocks, the New York Stock
Exchange Composite Index, the Value Line Index, and the Major Market Index. It
is expected that futures contracts trading in additional stock indices will be
authorized. The standard contract size is $500 times the value of the index.
The Fund does not believe that differences between existing stock
indices will create any differences in the price movements of the stock index
futures contracts in relation to the movements in such indices. However, such
differences in the indices may result in differences in correlation of the
futures with movements in the value of the securities being hedged.
OTHER INDEX BASED FUTURES CONTRACTS
It is expected that bond index and other financially based index
futures contracts will be developed in the future. It is anticipated that such
index based futures contracts will be structured in the same way as stock index
futures contracts but will be measured by changes in interest rates, related
indices or other measures, such as the consumer price index. In the event that
such futures contracts are developed, the Fund will sell interest rate index and
other index based futures contracts to hedge against changes which are expected
to affect the Fund's portfolio.
The purchase or sale of a futures contract differs from the purchase or
sale of a security, in that no price or premium is paid or received. Instead, to
initiate trading an amount of cash, cash equivalents, money market instruments,
or U.S. Treasury bills equal to approximately 1 1/2% (up to 5%) of the contract
amount must be deposited by the Fund with the Broker. This amount is known as
initial margin. The nature of initial margin in futures transactions is
different from that of margin in security
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transactions. Futures contract margin does not involve the borrowing of funds by
the customer to finance the transactions. Rather, the initial margin is in the
nature of a performance bond or good faith deposit on the contract which is
returned to the Fund upon termination of the futures contract assuming all
contractual obligations have been satisfied. The margin required for a
particular futures contract is set by the exchange on which the contract is
traded, and may be significantly modified from time to time by the exchange
during the term of the contract.
Subsequent payments, called variation margin, to the Broker and from
the Broker, are made on a daily basis as the value of the underlying instrument
or index fluctuates, making the long and short positions in the futures contract
more or less valuable, a process known as mark-to-market. For example, when the
Fund has purchased a futures contract and the price of the underlying financial
instrument or index has risen, that position will have increased in value, and
the Fund will receive from the Broker a variation margin payment equal to that
increase in value. Conversely, where the Fund has purchased a futures contract
and the price of the underlying financial instrument or index has declined, the
position would be less valuable and the Fund would be required to make a
variation margin payment to the Broker. At any time prior to expiration of the
futures contract, the Fund may elect to close the position. A final
determination of variation margin is then made, additional cash is required to
be paid to or released by the Broker, and the Fund realizes a loss or gain.
The Fund intends to enter into arrangements with its Custodian and with
Brokers to enable its initial margin and any variation margin to be held in a
segregated account by its Custodian on behalf of the Broker.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of financial instruments, and index based futures
contracts call for the delivery of cash equal to the difference between the
closing value of the index on the expiration date of the contract and the price
at which the futures contract is originally made, in most cases such futures
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out a futures contract sale is effected by an offsetting
transaction in which the Fund enters into a futures contract purchase for the
same aggregate amount of the specific type of financial instrument or index and
same delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is paid the difference and thus realizes a gain. If the
offsetting purchase price exceeds the sale price, the Fund pays the difference
and realizes a loss. Similarly, the closing out of a futures contract purchase
is effected by an offsetting transaction in which the Fund enters into a futures
contract sale. If the offsetting sale price exceeds the purchase price, the Fund
realizes a gain. If the purchase price exceeds the offsetting sale price, the
Fund realizes a loss. The amount of the Fund's gain or loss on any transaction
is reduced or increased, respectively, by the amount of any transaction costs
incurred by the Fund.
As an example of an offsetting transaction, the contractual obligations
arising from the sale of one contract of September U.S. Treasury bills on an
exchange may be fulfilled at any time before delivery of the contract is
required (i.e., on a specified date in September, the "delivery month") by the
purchase of one contract of September U.S. Treasury bills on the same exchange.
In such instance the difference between the price at which the futures contract
was sold and the price paid for the offsetting purchase after allowance for
transaction costs represents the profit or loss to the Fund.
There can be no assurance, however, that the Fund will be able to enter
into an offsetting transaction with respect to a particular contract at a
particular time. If the Fund is not able to enter into an offsetting
transaction, the Fund will continue to be required to maintain the margin
deposits on the contract and to complete the contract according to its terms.
OPTIONS ON CURRENCY AND OTHER FINANCIAL FUTURES
The Fund intends to purchase call and put options on currency and other
financial futures contracts and sell such options to terminate an existing
position. Options on currency and other
<PAGE>
A - 15
financial futures contracts are similar to options on stocks except that an
option on a currency or other financial futures contract gives the purchaser the
right, in return for the premium paid, to assume a position in a futures
contract (a long position if the option is a call and a short position if the
option is a put) rather than to purchase or sell stock, currency or other
financial instruments making up a financial futures index, at a specified
exercise price at any time during the period of the option. Upon exercise of the
option, the delivery of the futures position by the writer of the option to the
holder of the option will be accompanied by delivery of the accumulated balance
in the writer's futures margin account. This amount represents the amount by
which the market price of the futures contract at exercise exceeds, in the case
of a call, or is less than, in the case of a put, the exercise price of the
option on the futures contract. If an option is exercised the last trading day
prior to the expiration date of the option, the settlement will be made entirely
in cash equal to the difference between the exercise price of the option and
value of the futures contract.
The Fund intends to use options on currency and other financial futures
contracts in connection with hedging strategies. In the future, the Fund may use
such options for other purposes.
PURCHASE OF PUT OPTIONS ON FUTURES CONTRACTS
The purchase of protective put options on commodity futures contracts
is analagous to the purchase of protective puts on individual stocks, where an
absolute level of protection is sought below which no additional economic loss
would be incurred by the Fund. Put options may be purchased to hedge a portfolio
of stocks or debt instruments or a position in the futures contract upon which
the put option is based.
PURCHASE OF CALL OPTIONS ON FUTURES CONTRACTS
The purchase of a call option on currency or other financial futures
contract represents a means of obtaining temporary exposure to market
appreciation at limited risk. It is analogous to the purchase of a call option
on an individual stock, which can be used as a substitute for a position in the
stock itself. Depending on the pricing of the option compared to either the
futures contract upon which it is based, or upon the price of the underlying
financial instrument or index itself, the purchase of a call option may be less
risky than the ownership of the interest rate or index based futures contract or
the underlying securities. Call options on currency or other financial futures
contracts may be purchased to hedge against an interest rate increase or a
market advance when the Fund is not fully invested.
Use of New Investment Techniques Involving Currency and Other Financial Futures
Contracts or Related Options
The Fund may employ new investment techniques involving currency and
other financial futures contracts and related options. The Fund intends to take
advantage of new techniques in these areas which may be developed from time to
time, and which are consistent with the Fund's investment objective. The Fund
believes that no additional techniques have been identified for employment by
the Fund in the foreseeable future other than those described above.
Limitations on Purchase and Sale of Futures Contracts and Related Options on
Such Futures Contracts
The Fund will not enter into a futures contract if, as a result
thereof, more than 5% of the Fund's total assets (taken at market value at the
time of entering into the contract) would be committed to margin deposits on
such futures contracts.
The Fund intends that its futures contracts and related options
transactions will be entered into for traditional hedging purposes. That is,
futures contracts will be sold to protect against a decline in the price of
securities that the Fund owns or futures contracts will be purchased to protect
the Fund
<PAGE>
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against an increase in the price of securities it intends to purchase. The Fund
does not intend to enter into futures contracts for speculation.
In instances involving the purchase of futures contracts by the Fund,
an amount of cash and cash equivalents, equal to the market value of the futures
contracts, will be deposited in a segregated account with the Fund's Custodian
and/or in a margin account with a Broker to collateralize the position and
thereby insure that the use of such futures is unleveraged.
FEDERAL INCOME TAX TREATMENT
For federal income tax purposes, the Fund is required to recognize as
income for each taxable year its net unrealized gains and losses on futures
contracts as of the end of the year as well as those actually realized during
the year. Any gain or loss recognized with respect to a futures contract is
considered to be 60% long term and 40% short term, without regard to the holding
period of the contract. In the case of a futures transaction classified as a
"mixed straddle," the recognition of losses may be deferred to a later taxable
year. The federal income tax treatment of gains or losses from transactions in
options on futures is unclear.
In order for the Fund to continue to qualify for federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income. Any net gain realized
from the closing out of futures contracts, for purposes of the 90% requirement,
will be qualifying income. In addition, gains realized on the sale or other
disposition of securities held for less than three months must be limited to
less than 30% of the Fund's annual gross income. The 1986 Tax Act added a
provision which effectively treats both positions in certain hedging
transactions as a single transaction for the purpose of the 30% requirement. The
provision provides that, in the case of any "designated hedge," increases and
decreases in the value of positions of the hedge are to be netted for the
purposes of the 30% requirement. However, in certain situations, in order to
avoid realizing a gain within a three month period, the Fund may be required to
defer the closing out of a contract beyond the time when it would otherwise be
advantageous to do so.
RISKS OF FUTURES CONTRACTS
Currency and other financial futures contracts prices are volatile and
are influenced, among other things, by changes in stock prices, market
conditions, prevailing interest rates and anticipation of future stock prices,
market movements or interest rate changes, all of which in turn are affected by
economic conditions, such as government fiscal and monetary policies and
actions, and national and international political and economic events.
At best, the correlation between changes in prices of futures contracts
and of the securities being hedged can be only approximate. The degree of
imperfection of correlation depends upon circumstances, such as variations in
speculative market demand for futures contracts and for securities, including
technical influences in futures contracts trading; differences between the
securities being hedged and the financial instruments and indices underlying the
standard futures contracts available for trading, in such respects as interest
rate levels, maturities and creditworthiness of issuers, or identities of
securities comprising the index and those in the Fund's portfolio. In addition,
futures contract transactions involve the remote risk that a party be unable to
fulfill its obligations and that the amount of the obligation will be beyond the
ability of the clearing broker to satisfy. A decision of whether, when, and how
to hedge involves the exercise of skill and judgment, and even a well-conceived
hedge may be unsuccessful to some degree because of market behavior or
unexpected interest rate trends.
Because of the low margin deposits required, futures trading involves
an extremely high degree of leverage. As a result, a relatively small price
movement in a futures contract may result in immediate and substantial loss, as
well as gain, to the investor. For example, if at the time of purchase, 10% of
the value of the futures contract is deposited as margin, a 10% decrease in the
value of the futures contract
<PAGE>
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would result in a total loss of the margin deposit, before any deduction for the
transaction costs, if the account were then closed out, and a 15% decrease would
result in a loss equal to 150% of the original margin deposit. Thus, a purchase
or sale of a futures contract may result in losses in excess of the amount
invested in the futures contract. However, the Fund would presumably have
sustained comparable losses if, instead of entering into the futures contract,
it had invested in the underlying financial instrument. Furthermore, in order to
be certain that the Fund has sufficient assets to satisfy its obligations under
a futures contract, the Fund will establish a segregated account in connection
with its futures contracts which will hold cash or cash equivalents equal in
value to the current value of the underlying instruments or indices less the
margins on deposit.
Most U.S. futures exchanges limit the amount of fluctuation permitted
in futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
RISKS OF OPTIONS ON FUTURES CONTRACTS
In addition to the risks described above for currency and other
financial futures contracts, there are several special risks relating to options
on futures contracts. The ability to establish and close out positions on such
options will be subject to the development and maintenance of a liquid secondary
market. There is no assurance that a liquid secondary market will exist for any
particular contract or at any particular time. The Fund will not purchase
options on any futures contract unless and until it believes that the market for
such options has developed sufficiently that the risks in connection with such
options are not greater than the risks in connection with the futures contracts.
Compared to the use of futures contracts, the purchase of options on such
futures contracts involves less potential risk to the Fund because the maximum
amount at risk is the premium paid for the options (plus transaction costs).
However, there may be circumstances when the use of an option on a futures
contract would result in a loss to the Fund, even though the use of a futures
contract would not, such as when there is no movement in the level of the
futures contract.
FOREIGN CURRENCY TRANSACTIONS
The Fund may invest in securities of foreign issuers. When the Fund
invests in foreign securities they usually will be denominated in foreign
currencies, and the Fund temporarily may hold funds in foreign currencies. Thus,
the Fund's share value will be affected by changes in exchange rates.
FORWARD CURRENCY CONTRACTS
As one way of managing exchange rate risk, the Fund may engage in
forward currency exchange contracts (agreements to purchase or sell currencies
at a specified price and date). Under the contract, the exchange rate for the
transaction (the amount of currency the Fund will deliver or receive when the
contract is completed) is fixed when the Fund enters into the contract. The Fund
usually will enter into these contracts to stabilize the U.S. dollar value of a
security it has agreed to buy or sell. The Fund also may use these contracts to
hedge the U.S. dollar value of a security it already owns, particularly if the
Fund expects a decrease in the value of the currency in which the foreign
security is denominated. Although the Fund will attempt to benefit from using
forward contracts, the success of its hedging strategy will depend on Keystone's
ability to predict accurately the future exchange rates between foreign
currencies and the U.S. dollar. The value of the Fund's investments denominated
in foreign
<PAGE>
A - 18
currencies will depend on the relative strength of those currencies and the U.S.
dollar, and the Fund may be affected favorably or unfavorably by changes in the
exchange rate or exchange control regulations between foreign currencies and the
U.S. dollar. Changes in foreign currency exchange rates also may affect the
value of dividends and interest earned, gains and losses realized on the sale of
securities and net investment income and gains, if any, to be distributed to
shareholders by the Fund.
CURRENCY FUTURES CONTRACTS
Currency futures contracts are bilateral agreements under which two
parties agree to take or make delivery of a specified amount of a currency at a
specified future time for a specified price. Trading of currency futures
contracts in the U.S. is regulated under the Commodity Exchange Act by the
Commodity Futures Trading Commission (CFTC) and National Futures Association
(NFA). Currently, the only national futures exchange on which currency futures
are traded is the International Monetary Market of the Chicago Mercantile
Exchange. Foreign currency futures trading is conducted in the same manner and
subject to the same regulations as trading in interest rate and index based
futures. The Fund intends to engage in currency futures contracts only for
hedging purposes, and not for speculation. The Fund may engage in currency
futures contracts for other purposes if authorized to do so by the Board. The
hedging strategies which will be used by the Fund in connection with foreign
currency futures contracts are similar to those described above for forward
foreign currency exchange contracts.
Currently currency futures contracts for the British Pound Sterling,
Canadian Dollar, Dutch Guilder, Deutsche Mark, Japanese Yen, Mexican Peso, Swiss
Franc, and French Franc can be purchased or sold for U.S. dollars through the
International Monetary Market. It is expected that futures contracts trading in
additional currencies will be authorized. The standard contract sizes are
L125,000 for the Pound, 125,000 for the Guilder, Mark, French Francs, and Swiss
Francs, C$100,000 for the Canadian Dollar, Y12,500,000 for the Yen, and
1,000,000 for the Peso. In contrast to Forward Currency Exchange Contracts which
can be traded at any time, only four value dates per year are available, the
third Wednesday of March, June, September, and December.
FOREIGN CURRENCY OPTIONS TRANSACTIONS
Foreign currency options (as opposed to futures) are traded in a
variety of currencies in both the U,S, and Europe. On the Philadelphia Stock
Exchange, for example, contracts for half the size of the corresponding futures
contracts on the Chicago Board Options Exchange are traded with up to nine
months maturity in Marks, Sterling, Yen, Swiss Francs and Canadian Dollars.
Options can be exercised at any time during the contract life and require a
deposit subject to normal margin requirements. Since a futures contract must be
exercised, the Fund must continually make up the margin balance. As a result, a
wrong price move could result in the Fund losing more than the original
investment as it cannot walk away from the futures contract as it can an option
contract.
The Fund will purchase call and put options and sell such options to
terminate an existing position. Options on foreign currency are similar to
options on stocks except that an option on an interest rate and/or index based
futures contract gives the purchaser the right, in return for the premium paid,
to purchase or sell foreign currency, rather than to purchase or sell stock, at
a specified exercise price at any time during the period of the option.
The Fund intends to use foreign currency option transactions in
connection with hedging strategies.
<PAGE>
A - 19
PURCHASE OF PUT OPTIONS ON FOREIGN CURRENCIES
The purchase of protective put options on a foreign currency is
analagous to the purchase of protective puts on individual stocks, where an
absolute level of protection is sought below which no additional economic loss
would be incurred by the Fund. Put options may be purchased to hedge a portfolio
of foreign stocks or foreign debt instruments or a position in the foreign
currency upon which the put option is based.
PURCHASE OF CALL OPTIONS ON FOREIGN CURRENCIES
The purchase of a call option on foreign currency represents a means of
obtaining temporary exposure to market appreciation at limited risk. It is
analogous to the purchase of a call option on an individual stock, which can be
used as a substitute for a position in the stock itself. Depending on the
pricing of the option compared to either the foreign currency upon which it is
based, or upon the price of the foreign stock or foreign debt instruments, the
purchase of a call option may be less risky than the ownership of the foreign
currency or the foreign securities. The Fund would purchase a call option on a
foreign currency to hedge against an increase in the foreign currency or a
foreign market advance when the Fund is not fully invested.
The Fund may employ new investment techniques involving forward foreign
currency exchange contracts, foreign currency futures contracts, and options on
foreign currencies in order to take advantage of new techniques in these areas
which may be developed from time to time, and which are consistent with the
Fund's investment objective. The Fund believes that no additional techniques
have been identified for employment by the Fund in the foreseeable future other
than those described above.
CURRENCY TRADING RISKS
Currency exchange trading may involve significant risks. The four major
types of risk the Fund faces are exchange rate risk, interest rate risk, credit
risk, and country risk.
EXCHANGE RATE RISK
Exchange rate risk results from the movement up and down of foreign
currency values in response to shifting market supply and demand. When the Fund
buys or sells a foreign currency, an exposure, called an open position, is
created. Until the time that position can be "covered" by selling or buying an
equivalent amount of the same currency, the Fund is exposed to the risk that the
exchange rate might move against it. Since exchange rate changes can readily
move in one direction, a position carried overnight or over a number of days
involves greater risk than one carried a few minutes or hours. Techniques, such
as foreign currency forward and futures contracts and options on foreign
currency, are intended to be used by the Fund to reduce exchange rate risk.
MATURITY GAPS AND INTEREST RATE RISK
Interest rate risk arises whenever there are mismatches or gaps in the
maturity structure of the Fund's foreign exchange currency holdings, which is
the total of its outstanding spot and forward or futures contracts.
Foreign currency transactions often involve borrowing short term and
lending longer term to benefit from the normal tendency of interest rates to be
higher for longer maturities. However, in foreign exchange trading, while the
maturity pattern of interest rates for one currency is important, it is the
differential between interest rates for two currencies that is decisive.
CREDIT RISK
Whenever the Fund enters into a foreign exchange contract, it faces a
risk, however small, that the counterparty will not perform under the contract.
As a result, there is a credit risk, although no
<PAGE>
A - 20
extension of "credit" is intended. To limit credit risk, the Fund intends to
evaluate the creditworthiness of each other party. The Fund does not intend to
trade more than 5% of its net assets under foreign exchange contracts with one
party.
Credit risk exists because the Fund's counterparty may be unable or
unwilling to fulfill its contractual obligations as a result of bankruptcy or
insolvency or when foreign exchange controls prohibit payment. In any foreign
exchange transaction, each party agrees to deliver a certain amount of currency
to the other on a particular date. In establishing its hedges, a Fund relies on
each contract being completed. If the contract is not performed, then the Fund's
hedge is eliminated, and the Fund is exposed to any changes in exchange rates
since the contract was originated. To put itself in the same position it would
have been in had the contract been performed, the Fund must arrange a new
transaction. However, the new transaction may have to be arranged at an adverse
exchange rate. The trustee for a bankrupt company may elect to perform those
contracts which are advantageous to the company but disclaim those contracts
which are disadvantageous, resulting in losses to the Fund.
Another form of credit risk stems from the time zone differences
between the U.S. and foreign nations. If the Fund sells sterling, it generally
must pay pounds to a counterparty earlier in the day than it will be credited
with U.S. dollars in New York. In the intervening hours, the buyer can go into
bankruptcy or can be declared insolvent. Thus, the U.S. dollars may never be
credited to the Fund.
<PAGE>
A - 21
COUNTRY RISK
At one time or another, virtually every country has interfered with
international transactions in its currency. Interference has taken the form of
regulation of the local exchange market, restrictions on foreign investment by
residents, or limits on inflows of investment funds from abroad. Governments
take such measures, for example, to improve control over the domestic banking
system or to influence the pattern of receipts and payments between residents
and foreigners. In those cases, restrictions on the exchange market or on
international transactions are intended to affect the level or movement of the
exchange rate. Occasionally, a serious foreign exchange shortage may lead to
payment interruptions or debt servicing delays, as well as interference in the
exchange market. It has become increasingly difficult to distinguish foreign
exchange or credit risk from country risk.
Changes in regulations or restrictions usually do have an important
exchange market impact. Most disruptive are changes in rules which interfere
with the normal payments mechanism. If government regulations change and a
counterparty is either forbidden to perform or is required to do something
extra, then the Fund might be left with an unintended open position or an
unintended maturity mismatch. Dealing with such unintended long or short
positions could result in unanticipated costs to the Fund.
Other changes in official regulations influence international
investment transactions. If one of the factors affecting the buying or selling
of a currency changes, the exchange rate is likely to respond. Changes in such
controls often are unpredictable and can create a significant exchange rate
response.
Many major countries have moved toward liberalization of exchange and
payments restrictions in recent years or accepted the principle that
restrictions should be relaxed. A few industrial countries have moved in the
other direction. Important liberalizations were carried out by Switzerland, the
United Kingdom, and Japan. They dismantled mechanisms for restricting either
foreign exchange inflows (Switzerland), outflows (the United Kingdom) or
elements of both (Japan). By contrast, France and Mexico have recently tightened
foreign exchange controls.
Overall, many exchange markets are still heavily restricted. Several
countries limit access to the forward market to companies financing documented
export or import transactions in an effort to insulate the market from purely
speculative activities. Some of these countries permit local traders to enter
into forward contracts with residents but prohibit certain forward transactions
with nonresidents. By comparison, other countries have strict controls on
exchange transactions by residents, but permit free exchange transactions
between local traders and non-residents. A few countries have established tiered
markets, funneling commercial transactions through one market and financial
transactions through another. Outside the major industrial countries, relatively
free foreign exchange markets are rare and control on foreign currency
transactions are extensive.
Another aspect of country risk has to do with the possibility that the
Fund may be dealing with a foreign trader whose home country is facing a
payments problem. Even though the foreign trader intends to perform on its
foreign exchange contracts, the contracts are tied to other external liabilities
the country has incurred. As a result, performance may be delayed, and can
result in unanticipated cost to the Fund. This aspect of country risk is a major
element in the Fund's credit judgment as to with whom it will deal and in what
amounts.
<PAGE>
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KEYSTONE
FAMILY OF FUNDS
[DIAMOND]
Balanced Fund (K-1)
Diversified Bond Fund (B-2)
Growth and Income Fund (S-1)
High Income Bond Fund (B-4)
International Fund Inc.
Liquid Trust
Mid-Cap Growth Fund (S-3)
Precious Metals Holdings, Inc.
Quality Bond Fund (B-1)
Small Company Growth Fund (S-4)
Strategic Growth Fund (K-2)
Tax Free Fund
- ------------------------------------------------------------------------------
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied by
the Fund's current prospectus. The prospectus contains important information
about the Fund including fees and expenses. Read it carefully before you invest
or send money. For a free prospectus on other Keystone funds, contact your
financial adviser or call Keystone.
[KEYSTONE INVESTMENTS LOGO]
P.O. Box 2121
Boston, Massachusetts 02106-2121
B1-R-12/96
15.7M
<PAGE>
- ------------------------------------------------------------------------------
KEYSTONE
[PHOTO OF COUPLE ON BEACH]
QUALITY
BOND FUND (B-1)
- ------------------------------------------------------------------------------
[KEYSTONE LOGO]
ANNUAL REPORT
OCTOBER 31, 1996
<PAGE>
PAGE 1
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Keystone Quality Bond Fund (B-1)
Seeks generous income and capital preservation from high quality bonds.
Dear Shareholder:
We are pleased to report on the activities of Keystone Quality Bond Fund
(B-1) for the twelve-month period which ended October 31, 1996. Following our
letter we have included a discussion with your Fund's manager and complete
financial information.
Performance
Your Fund returned 5.08% for the six-month period and 3.99% for the
twelve-month period which ended October 31, 1996. For the same periods, the
Lehman Aggregate Bond Index--a widely recognized index of corporate,
government and mortgage securities--returned 5.29% for the six-month period
and 5.83% for the twelve-month period.
Keystone Quality Bond Fund (B-1) provided satisfactory performance during a
period of sharp price fluctuations as interest rates rose and then fell in
reaction to changing economic conditions. Fund performance improved
particularly during the last six months of the period.
While interest rates were relatively unchanged from their levels of one year
ago, the credit markets endured considerable short-term price volatility
during the twelve-month period. In November and December 1995, interest rates
trended down as economic growth slowed from moderate levels, inflation
remained under control and the government appeared to be making progress
toward reducing the federal budget deficit. Most investors expected these
trends to continue into 1996. On October 31, 1996 the benchmark 30-year U.S.
Treasury bond yielded 6.35%. By January 1996 Treasuries had reached a low of
5.97% on this favorable news.
During the first quarter of 1996 economic reports showed
stronger-than-expected economic growth and employment gains, which increased
fears of higher inflation rates. Because inflation reduces returns to bond
holders, interest rates generally rose with each economic report that
indicated strong growth. By early July rates had peaked at 7.19%. As rates
rose, prices generally declined for nearly all fixed income investments.
Expectations of stronger growth moderated during the third quarter of 1996
as it appeared that the strong growth of the first half of the year was
slowing. Still watchful for signs of future inflation, investors gained
confidence that this favorable environment could be sustained and interest
rates began to move within a narrow range. On October 31, 1996 the 30-year
Treasury stood at 6.82%, not far from where it was at the beginning of the
fiscal period.
Portfolio strategy
Over the past six months, we restructured Keystone Quality Bond Fund (B-1) to
improve stability and enhance long-term potential total returns. We invested
a portion of the Fund in government bonds of Canada, Germany and Spain. With
their attractive yields, high quality and solid economic fundamentals, we
believed these investments offered good relative values. All transactions
were currency-hedged into U.S. dollars to protect the portfolio from foreign
currency fluctuations.
We also increased your Fund's investments in collateralized mortgage
obligations (CMOs), asset-backed securities, and bonds in the bank and
finance sectors. We believe these securities contributed favorably to your
Fund's income and total return. In its entirety, we believe the portfolio's
new structure increased diversification while maintaining a high degree of
quality and liquidity.
(continued on next page)
<PAGE>
PAGE 2
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Keystone Quality Bond Fund (B-1)
Keystone Quality Bond Fund (B-1) is designed for conservative,
income-oriented investors. We invest in a selection of high quality fixed
income securities, which include among others, U.S. government obligations,
mortgage-backed and asset-backed securities, and high-quality corporate
bonds. We apply careful credit analysis in selecting high quality securities
for the portfolio. We attempt to identify securities that we believe will
perform well given our expectations for the market environment. We believe
that your Fund's ability to diversify and be flexible are key elements in
navigating the changing conditions of the fixed income markets.
Looking ahead, we anticipate a stable-to-positive environment for high
quality bonds. We expect moderate economic growth and low inflation to
provide a positive background for interest rates to move within a narrow
range through early 1997.
New portfolio manager
After 20 years of distinguished service with Keystone, your Fund's manager
Barbara McCue has retired effective September 30, 1996. The leader of
Keystone's high grade bond team, Christopher P. Conkey, has assumed
responsibilities as your Fund's portfolio manager. Mr. Conkey is a Chartered
Financial Analyst and has over 13 years of investment experience. He
currently manages several other Keystone funds that invest in high grade
bonds. We look forward to his contribution to your Fund's management.
Keystone acquired by First Union Corporation
On another note, we are pleased to inform you that Keystone has been acquired
by First Union Corporation. First Union is a financial services firm based in
Charlotte, North Carolina. It is the nation's sixth largest bank holding
company with assets of approximately $130 billion. First Union, through its
wholly-owned subsidiary Evergreen Asset Management Corp., together with
Keystone mutual funds, manages more than $30 billion in 70 mutual funds.
While Keystone will remain a separate entity and will continue to provide
investment advisory and management services to the Fund, services will be
provided under the "Evergreen Keystone Funds" name. We believe First Union's
acquisition of Keystone strengthens the investment management services we
provide you.
We appreciate your continued support of Keystone Quality Bond Fund (B-1). If
you have any questions or comments about your investment, we encourage you to
write to us.
Sincerely,
/s/ Albert H. Elfner, III
- -------------------------
Albert H. Elfner, III
Chairman and President
Keystone Investments, Inc.
/s/ George S. Bissell
- -------------------------
George S. Bissell
Chairman of the Board
Keystone Funds
December 1996
<PAGE>
PAGE 3
- --------------------------------
A Discussion With
Your Fund Manager
[PHOTO OF CHRISTOPHER P. CONKEY]
Christopher P. Conkey is portfolio manager of your Fund and
heads Keystone's high grade bond team. A Chartered
Financial Analyst, Mr. Conkey has 13 years of experience
managing fixed-income investments. He holds a BA in
economics from Clark University and an MBA in finance from
Boston University. Together with analysts David J. Bowers
and Gary E. Pzegeo, he evaluates interest rate and credit risk
in selecting high quality bonds for Keystone fixed income funds.
Q What was the investment climate like for high quality bonds over the past
year?
A The climate for high quality bonds changed several times over the past
year. There was a high degree of price volatility throughout much of the
period, as investors revised their interest rate and economic forecasts.
Despite these fluctuations, however, interest rates were relatively unchanged
at the end of this reporting period from one year ago.
Q What changed the outlooks for interest rates and the economy?
A Stronger-than-expected growth in employment and consumer spending in the
first quarter of 1996 caused investors to revise their economic and interest
rate forecasts. Interest rates had fallen to near historic lows during much
of 1995 on the outlook for a slow economy and low inflation. The reports of
strength in employment and consumer activity stimulated concerns
that the economy might be more robust than expected.
Interest rates rose and bond prices fell during that time.
By mid-year, signs of moderating economic growth appeared, relieving
inflation fears. While watchful of preliminary signs of future inflation,
investors became more confident that this trend of moderate growth and low
inflation could be sustained.
Q What strategies did you employ during these changing market climates?
A We restructured the portfolio's assets and adjusted its average maturity.
We believe the combination reduced the Fund's risk to U.S. interest rate
fluctuations, increased yield and improved diversification.
First, we reduced the Fund's holdings in U.S. government securities from 48%
to 5% of net assets. Since U.S. government securities carry no credit risk,
their prices are primarily influenced by the movement in interest rates. We
believe reducing the portfolio's exposure to interest rate risk increased
stability, particularly in light of the price volatility over the past year.
We reinvested the proceeds from these sales in non-dollar foreign government
bonds, collateralized mortgage obligations (CMOs), asset-backed securities,
and bonds in the bank and finance sectors. These bonds improved
diversification, increased income, and provided price appreciation to the
Fund's portfolio.
Fund Profile
Objective: Seeks the highest possible income consistent with preservation of
principal.
Commencement of investment operations: September 11, 1935
Average quality: AA+
Average maturity: 11 years
Net assets: $229 million
Newspaper symbol: "QultyB1"
<PAGE>
PAGE 4
- --------------------------------
Keystone Quality Bond Fund (B-1)
Asset Allocation
as of October 31, 1996
[TABULAR REPRESENTATION OF PIE CHART]
Corporates (31.7%)
Collateralized mortgage obligations (CMOs) (22.3%)
Foreign (15.6%)
Mortgage-backed (13.6%)
Asset-backed (10.6%)
U.S. government & agency (5.1%)
Other(1) (1.1%)
(as a percent of net assets)
We adjusted average maturity, ultimately shortening it when interest rates
rose last spring. As of October 31, 1996, the Fund's average maturity stood
at 11 years. The average quality of Keystone Quality Bond Fund (B-1) was AA+,
the second highest rating available from Standard and Poor's Corporation.
Q Why did you invest in the foreign sector?
A The foreign sector offered higher yields and greater potential for capital
appreciation than many domestic alternatives. We did not increase credit risk
in the foreign sector, preferring to emphasize securities with high quality
ratings. Further, all of the investments were currency-hedged, to protect our
holdings from foreign currency exchange rate changes.
We invested in the government bonds of Canada, Germany and Spain; countries
that we believed offered attractive values based on solid economic
fundamentals, stable political environments and large, liquid securities
markets. In fact, interest rates in these countries have fallen over the past
year resulting in price appreciation. In addition, our foreign investments
avoided the price declines experienced in the U.S. credit markets.
Q How about other sectors?
A Collateralized mortgage obligations and asset-backed securities also
offered investors higher yields than U.S. government bonds, while enabling
the Fund to maintain credit quality. We invested in well structured,
AAA-rated securities. We concentrated on commercial loans and securities that
were collateralized by home equity loans and credit card receivables. We
chose these sectors because of their link to the consumer. Consumer
confidence ran high throughout the period, due to strength in employment,
income growth, and improving net wealth which was caused by a rising stock
market and generally higher housing prices. We believed that the strength of
the consumer sector would have a favorable effect on these securities versus
alternative investments.
We also increased the Fund's investments in the bank and finance sector as
interest rates rose. We believed that higher U.S. rates would eventually slow
economic growth. Slower growth historically has resulted in falling interest
rates. Typically, banks and finance companies have benefitted from this type
of environment. Towards the end of the reporting period this scenario of
lower rates appeared to be unfolding.
Q What is your outlook for the next six months?
A We believe the next six months should be a neutral environment for high
quality bonds with interest rates fluctuating in a narrow range. We
anticipate moderate economic growth accompanied by low inflation. On an
annual basis, we think the economy will grow at a pace of 2-2-1/2% and that
inflation, as measured by the consumer price index (CPI), will stay in the
area of 3%.
Q With interest rates at relatively low levels, do you believe that bonds
offer good long term value?
A We believe they do. While nominal interest rates have been relatively low,
"real" interest rates, or the rate received by investors after subtracting
inflation, continues to be attractive. For example, the 30-year U.S. Treasury
bond had a yield of 6.82% as of October 31, 1996.
- ---------------
(1) Includes repurchase agreement, and other assets and liabilities.
<PAGE>
PAGE 5
- --------------------------------
Portfolio Quality Summary
as of October 31, 1996
[TABULAR REPRESENTATION OF PIE CHART]
AAA (36.3%)
U.S. government and agency(3) (26.6%)
A (15.2%)
AA (11.0%)
BBB (10.9%)
(as a percentage of portfolio assets)
Inflation was recently about 3%. Thus, the real return after subtracting
inflation was approximately 3.82% at the end of the period, a historically
attractive level.
Like most investments, high quality bonds can experience periods of
short-term price volatility. Over the long-run, however, high-quality bonds
have demonstrated relative stability and attractive income. We believe high
quality bonds will continue to produce solid total returns in the future. In
our opinion, the Fund serves an important role in a well-rounded investment
portfolio.
- ------------
(2) Where Standard & Poor's ratings were not available, we have used ratings
from Moody's Investor Service, Inc., Fitch Investors' Service, Inc., or
ratings assigned by another nationally recognized statistical rating
organization.
(3) Includes all U.S. government and agency securities including CMOs, asset-
backed and mortgage pass-through securities issued by the U.S. government
or its agencies.
Ratings are very important to evaluating bonds. What do they mean?
Bond ratings provide an indication of the relative investment quality of an
issuer. Each rating agency uses its own criteria for assigning ratings. In
general, each agency examines the ability of an issuer to maintain debt
protection levels in periods of recession as well as recovery. Bonds with
identical ratings are not necessarily equal. Different industries have
different business risks. However, most bonds within a certain rating
category tend to have similar characteristics. The following table briefly
defines investment grade bond ratings.
Investment Grade Bond Ratings
Moody's Investors Service S&P
Aaa AAA Highest Quality,
lowest likelihood of default
Aa AA High Quality
A A Upper Medium Grade
Baa BBB Medium Grade
We use bond ratings as one component of our credit research. For Keystone
Quality Bond Fund (B-1), we consider only investment-grade securities. That
is, bonds rated AAA, AA, A, and BBB. Lower rated bonds are considered
speculative grade.
[DIAMOND]
This column is intended to answer questions about your Fund.
If you have a question you would like answered, please write to:
Evergreen Keystone Investment Services, Inc.
Attn: Shareholder Communications, 22nd Floor
200 Berkeley Street, Boston, Massachusetts 02116-5034.
<PAGE>
PAGE 6
- --------------------------------
Keystone Quality Bond Fund (B-1)
Your Fund's Performance
Growth of an investment in
Keystone Quality Bond Fund (B-1)
[MOUNTAIN CHART]
In Thousands
Initial Reinvested
Investment Distributions
10/86 10000 10000
8937 9756
10/88 9045 10740
9125 11794
10/90 8708 12259
9160 13986
10/92 9160 15065
9377 16647
10/94 8256 15603
8816 17739
10/96 8685 18447
A $10,000 investment in Keystone Quality Bond Fund (B-1) made
on October 31, 1986 with all distributions reinvested as worth $18,447
on October 31, 1996. Past performance is no guarantee of future results.
Twelve-Month Performance as of October 31, 1996
- ------------------------------------------------------
Total return* 3.99%
Net asset value 10/31/95 $15.42
10/31/96 $15.19
Distributions $ 0.82
Capital gains None
* Before deduction of contingent deferred sales charge (CDSC).
Historical Record as of October 31, 1996
- -------------------------------------------------------
If you If you did
Cumulative total return redeemed not redeem
1-year 1.03% 3.99%
5-year 31.89% 31.89%
10-year 84.47% 84.47%
Average annual total return
1-year 1.03% 3.99%
5-year 5.69% 5.69%
10-year 6.31% 6.31%
The "if you redeemed" returns reflect the deduction of the 3% CDSC for those
investors who sold Fund shares after one calendar year. Investors who
retained their fund investment earned the returns reported in the second
column of the table.
The investment return and principal value will fluctuate so that your
shares, when redeemed, may be worth more or less than the original cost. Past
performance is no guarantee of future results.
Shareholders may exchange shares for another Keystone fund by calling or
writing to Keystone directly, or through Keystone's Automated Response Line
(KARL). The Fund reserves the right to change or terminate the exchange
offer.
<PAGE>
PAGE 7
- --------------------------------
Growth of an Investment
Comparison of change in value of a $10,000 investment
in Keystone Quality Bond Fund (B-1), the Lehman
Aggregate Bond Index and the Consumer Price Index.
In Thousands October 1986 through October 1996
Fund Average
Annual Total Return
- -------------------------------------
1 Year 5 Year 10 Year
1.03% 5.69% 6.31%
[LINE CHART]
Fund LABI CPI
10/86 10000 10000 10000
9756 10205 10453
10/88 10740 11374 10898
11794 12726 11387
10/90 12259 13528 12103
13986 15663 12457
10/92 15065 17204 12856
16647 19247 13209
10/94 15603 18539 13554
17739 21441 13935
10/96 18447 22692 14306
Past performance is no guarantee of future results. The one-year return
reflects the deduction of the Fund's 3% contingent sales charge for shares
held for at least one year. The Consumer Price Index is through September
30, 1996.
This chart graphically compares your Fund's performance to certain investment
indexes. It is the result of fund performance guidelines issued by the
Securities and Exchange Commission. The intent is to provide investors with
more information about their investment.
Components of the chart
The chart is composed of several lines that represent the accumulated value
of an initial $10,000 investment for the period indicated. The lines
illustrate a hypothetical investment in:
1. Keystone Quality Bond Fund (B-1)
Your Fund seeks the highest possible income consistent with preservation of
principal. The return is quoted after deducting sales charges (if
applicable), fund expenses, and transaction costs and assumes reinvestment of
all distributions.
2. Lehman Aggregate Bond Index (LABI)
The LABI is a broad-based, unmanaged fixed income index of U.S. government,
corporate and mortgage-backed securities. It represents the price change and
coupon income of several thousand securities of various credit qualities and
maturities. Securities are selected and compiled by Lehman Brothers, Inc.
according to criteria that may be unrelated to your Fund's investment
objective. It would be difficult for most individual investors to duplicate
this index.
3. Consumer Price Index (CPI)
This index is a widely recognized measure of the cost of goods and services
produced in the U.S. The index contains factors such as prices of services,
housing, food, transportation and electricity which are compiled by the U.S.
Bureau of Labor Statistics. The CPI is generally considered a valuable
benchmark for investors who seek to outperform increases in the cost of
living.
These indexes do not include transaction costs associated with buying and
selling securities, and do not hold cash to meet redemptions. It would be
difficult for most individual investors to duplicate these indexes.
Understanding what the chart means
The chart demonstrates your Fund's performance in relation to a well known
investment index and to increases in the cost of living. It is important to
understand what the chart shows and does not show.
This illustration is useful because it charts Fund and index performance
over the same time frame and over a long period. Long-term performance is a
more reliable and useful measure of performance than measurements of
short-term returns or temporary swings in the market. Your financial adviser
can help you
<PAGE>
PAGE 8
- --------------------------------
Keystone Quality Bond Fund (B-1)
evaluate fund performance in conjunction with the other important financial
considerations such as safety, stability and consistency.
Limitations of the chart
The chart, however, limits the evaluation of Fund performance in several
ways. Because the measurement is based on total returns over an extended
period of time, the comparison often favors those funds which emphasize
capital appreciation when the market is rising. Likewise, when the market is
declining, the comparison usually favors those funds which take less risk.
Performance can be distorted
Funds which are more conservative in their orientation and which place an
emphasis on capital preservation will tend to compare less favorably when the
market is rising. In addition, funds which have income as one of their
objectives also will tend to compare less favorably to relevant indexes.
Indexes may also reflect the performance of some securities which a fund may
be prohibited from buying. A bond fund, for example, may be limited to
investments in only high quality bonds, or a stock fund may only be able to
buy stocks that have been traded on a stock exchange for a minimum number of
years or stocks that have a certain market capitalization. Indexes usually do
not have the same investment restrictions as your Fund.
Indexes do not include costs of investing
The comparison is further limited in its utility because the indexes do not
take into account any deductions for sales charges, transaction costs or
other fund expenses. Your Fund's performance figures do reflect such
deductions. Sales charges--whether up-front or deferred--pay for the cost of
the investment advice of your financial adviser. Transaction costs pay for
the costs of buying and selling securities for your Fund's portfolio. Fund
expenses pay for the costs of investment management and various shareholder
services. None of these costs are reflected in index total returns. The
comparison is not completely realistic because an index cannot be duplicated
by an investor--even an unmanaged index--without incurring some charges and
expenses.
One of several measures
The chart is one of several tools you can use to understand your investment.
It should be read in conjunction with the Fund's prospectus, and annual and
semiannual reports. Also, your financial adviser, who understands your
personal financial situation, can best explain the features of your Keystone
fund and how it applies to your financial needs.
Future returns may be different
Shareholders also should be mindful that the long-run performance of either
the Fund or the indexes is not representative of what shareholders should
expect to receive from their Fund investment in the future; it is presented
to illustrate only past performance and is not a guarantee of future returns.
<PAGE>
PAGE 9
- --------------------------------
Glossary of
Mutual Fund Terms
MUTUAL FUND--A company which combines the investment money of many people
whose financial goals are similar, and invests that money in a variety of
securities. A mutual fund allows the smaller investor the benefits of
diversification, professional management and constant supervision usually
available only to large investors.
PORTFOLIO MANAGER--An investment professional who is responsible for
managing a portfolio's assets prudently and making appropriate investment
decisions, such as which securities to buy, hold and sell, based on the
investment objectives of the portfolio.
STOCK--Equity or ownership interest in a corporation, which represents a
claim on the corporation's assets and earnings.
BOND--Security issued by a government or corporation to those from whom it
has borrowed money. A bond usually promises to pay interest income to the
bondholder at regular intervals and to repay the entire amount borrowed at
maturity date.
CONVERTIBLE SECURITY--A corporate security (usually preferred stock or
bonds) that is exchangeable for a set number of another security type
(usually common stocks) at a pre-stated price.
MONEY MARKET FUND--A mutual fund whose assets are invested in a diversified
portfolio of short- term securities, including commercial paper, bankers'
acceptances, certificates of deposit and other short-term instruments. The
fund pays income which can fluctuate daily. Liquidity and safety of principal
are primary objectives.
NET ASSET VALUE (NAV) PER SHARE--The value of one share of a mutual fund.
The NAV per share is determined by subtracting a fund's total liabilities
from its total assets, and dividing that amount by the number of fund shares
outstanding.
DIVIDEND--A per share distribution of the income earned from the fund's
portfolio holdings. When a dividend distribution is made, the fund's net
asset value drops by the amount of the distribution because the distribution
is no longer considered part of the fund's assets.
CAPITAL GAIN--The profit from the sale of securities, less any losses.
Capital gains are paid to fund shareholders on a per share basis. When a
capital gain distribution is made, the fund's net asset value drops by the
amount of the distribution because the distribution is no longer considered
part of the fund's assets.
YIELD--The annualized rate of income as measured against the current net
asset value of fund shares.
TOTAL RETURN--The change in value of a fund investment over a specified
period of time, taking into account the change in a fund's market price and
the reinvestment of all fund distributions.
SHORT-TERM--An investment with a maturity of one year or less.
LONG-TERM--An investment with a maturity of greater than one year.
AVERAGE MATURITY--The average number of days until the notes, drafts,
acceptances, bonds or other debt instruments in a portfolio become due and
payable.
OFFERING PRICE--The offering price of a share of a mutual fund is the price
at which the share is sold to the public.
<PAGE>
PAGE 10
- --------------------------------
Keystone Quality Bond Fund (B-1)
SCHEDULE OF INVESTMENTS--October 31, 1996
<TABLE>
<CAPTION>
Interest Maturity Par Market
Rate Date Value Value
================================================================================================================
<S> <C> <C> <C> <C> <C>
FIXED INCOME (98.9%)
CORPORATE BONDS & NOTES (31.7%)
AIRCRAFT (0.9%)
Boeing Co. 7.875% 2043 $2,000,000 $ 2,146,420
- ----------------------------------------------------------------------------------------------------------------
BANK & FINANCE (13.0%)
AmSouth Bancorp. Subord. Deb. 6.750 2025 3,500,000 3,461,920
Associates Corp. North America Sr. Notes 7.625 2000 1,500,000 1,560,375
International Bank for
Reconstruction & Development
(World Bank) Deb. 8.250 2016 5,000,000 5,629,550
International Lease Finance
Corp. Notes 6.250 2000 2,235,000 2,219,377
Mellon Bank Corp. Subord. Notes 7.625 2007 3,500,000 3,665,340
NationsBank Corp. Subord. Notes 7.500 2006 4,500,000 4,656,555
Paine Webber Group, Inc. Sr. Notes 7.490 2004 3,500,000 3,545,500
Smith Barney Holdings, Inc. Notes 7.125 2006 3,000,000 3,016,770
Wachovia Corp. Subord. Notes 6.605 2025 2,000,000 1,974,840
- ----------------------------------------------------------------------------------------------------------------
29,730,227
- ----------------------------------------------------------------------------------------------------------------
CAPITAL GOODS (1.9%)
John Deere Capital Corp. Deb. 8.625 2019 4,000,000 4,280,000
- ----------------------------------------------------------------------------------------------------------------
CONSUMER GOODS (2.9%)
ConAgra, Inc. Sr. Notes 7.125 2026 3,000,000 3,070,440
Mattel, Inc. Notes 6.750 2000 3,500,000 3,455,760
- ----------------------------------------------------------------------------------------------------------------
6,526,200
- ----------------------------------------------------------------------------------------------------------------
DIVERSIFIED COMPANIES (0.5%)
Grand Metro Investment Corp.
(Eff. Yield 8.13%) (e) Co. Gtd. 0.000 2004 2,000,000 1,225,100
- ----------------------------------------------------------------------------------------------------------------
DRUGS (0.8%)
Lilly (Eli) & Co. Notes 6.570 2016 2,000,000 1,871,560
- ----------------------------------------------------------------------------------------------------------------
INSURANCE (4.6%)
AMBAC, Inc. Deb. 9.375 2011 2,000,000 2,414,500
Lumbermans Mutual Co. (d) Subord. Notes 9.150 2026 2,000,000 2,175,400
MBIA, Inc. Deb. 7.000 2025 4,000,000 3,816,280
Vesta Insurance Group, Inc. Deb. 8.750 2025 2,000,000 2,182,980
- ----------------------------------------------------------------------------------------------------------------
10,589,160
- ----------------------------------------------------------------------------------------------------------------
OIL (4.4%)
Atlantic Richfield Co. Deb. 9.875 2016 3,000,000 3,770,790
Occidental Petroleum Corp. Deb. 10.125 2009 3,000,000 3,716,970
Oslo Seismic Services, Inc. (d) 1st Pfd. Mtg. Notes 8.280 2011 2,500,000 2,577,375
- ----------------------------------------------------------------------------------------------------------------
10,065,135
- ----------------------------------------------------------------------------------------------------------------
<PAGE>
PAGE 11
- --------------------------------
SCHEDULE OF INVESTMENTS--October 31, 1996
Interest Maturity Par Market
Rate Date Value Value
================================================================================================================
RETAIL (1.1%)
Kohl's Corp. Notes 7.375% 2011 $ 2,500,000 $ 2,524,800
- ----------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS (1.6%)
Sprint Corp. Deb. 9.250 2022 3,000,000 3,619,688
- ----------------------------------------------------------------------------------------------------------------
TOTAL CORPORATE BONDS & NOTES (COST--$70,823,953) 72,578,290
================================================================================================================
COLLATERALIZED MORTGAGE OBLIGATIONS (22.3%)
American Southwest Financial
Securities (Est. Mat. 1998) (b) Series 1994-C2 Class A3 8.000 2010 4,400,000 4,500,375
Asset Securitization Corp. (Est.
Mat. 2010) (b) Series 1996-D3 Class A3 7.526 2026 1,416,414 1,457,357
Criimi Mae Financial Corp. (Est.
Mat. 2004) (b) Series 1 Class A 7.000 2033 956,632 925,542
DeBartolo Limited Capital
Partnership (Est. Mat. 2001)
(b) (d) Series 1 Class B1 7.610 2004 1,550,000 1,598,437
FNMA REMIC Trust (Est. Mat.
2001) (b) Series 1996-17 Class A 6.000 2004 3,500,000 3,409,219
FNMA REMIC Trust (Est. Mat.
2004) (b) Series 1993-156 Class B 6.500 2018 2,800,000 2,697,604
FNMA REMIC Trust (Est. Mat.
2002) (b) Series 1996-28 Class PE 6.500 2020 5,000,000 4,957,031
FNMA REMIC Trust (Est. Mat.
2005) (b) Series 1992-181 Class PK 6.500 2021 4,000,000 3,862,480
FNMA REMIC Trust (Est. Mat.
2007) (b) Series 1993-38 Class L 5.000 2022 2,500,000 2,116,400
GS Mortgage Security Corp. (Est.
Mat. 2005) (b) Series 1996-PL Class A2 7.410 2027 1,850,000 1,851,156
KS Mortgage Capital LP (Est.
Mat. 1999) (b) (d) Series 1995-1 Class A1 7.041 2002 2,890,543 2,911,319
Merrill Lynch Trust (Est. Mat.
2005) (b) Series 35 Class G 8.450 2018 2,700,000 2,874,636
Morgan Stanley Capital I (Est.
Mat. 2004) (b) (d) Series 1996-WF Class 1B 6.586 2028 1,000,000 965,938
Paine Webber Mortgage Acceptance
Corp. IV (Est. Mat. 1997) (b) Series 1993-5 Class A3 6.875 2008 1,457,376 1,459,198
RASTA (Est. Mat. 1999) (b) Series 1996-AS Class A3 7.750 2026 3,000,000 3,034,453
Residential Accredit Loans, Inc. Series 1996-QS4 Class
(Est. Mat. 2005) (b) Series 1996-QS4 Class AI10 7.900 2026 3,500,000 3,582,031
Residential Funding Corp. (Est.
Mat. 1997) (b) Series 1994-S15 Class A1 7.750 2024 2,958,697 2,990,119
Ryland Acceptance Corp. (Est.
Mat. 2004) (b) Series 1988-E, 2 PAC 7.950 2019 2,794,173 2,828,206
Structured Asset Securities
Corp. (Est. Mat. 2000) (b) Series 1996-CFL Class B 6.303 2028 2,963,625 2,886,756
- ----------------------------------------------------------------------------------------------------------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (COST--$50,578,120) 50,908,257
================================================================================================================
FOREIGN BONDS (NON U.S. DOLLARS) (14.3%)
Canadian Government Deb. 7.500 2003 11,000,000 8,879,114
Canadian Dollars
Canadian Government Deb. 8.750 2005 14,300,000 12,423,138
Canadian Dollars
Germany (Republic of) Deb. 6.500 2003 6,652,000 4,609,488
German Marks
Germany (Republic of) Deb. 6.875 2005 9,750,000 6,826,416
German Marks
- ----------------------------------------------------------------------------------------------------------------
TOTAL FOREIGN BONDS (NON U.S. DOLLARS) (COST--$30,889,476) 32,738,156
================================================================================================================
<PAGE>
PAGE 12
- --------------------------------
Keystone Quality Bond Fund (B-1)
SCHEDULE OF INVESTMENTS--October 31, 1996
Interest Maturity Par Market
Rate Date Value Value
================================================================================================================
MORTGAGE-BACKED SECURITIES (13.6%)
FHLMC Pool #303865 8.500% 1997 $ 23,337 $ 24,100
FHLMC Pool #607352 7.680 2022 820,651 856,046
FHLMC Pool #846298 7.191 2022 2,201,840 2,266,519
FNMA Pool #303664 6.500 2008 6,248,506 6,188,895
FNMA Pool #338867 6.500 2011 4,978,113 4,895,626
FNMA Pool #124945 7.617 2031 1,226,907 1,279,824
GNMA Pool #410254 7.000 2025 4,337,207 4,253,152
GNMA Pool #411526 7.000 2025 3,161,961 3,100,683
GNMA Pool #423413 7.000 2025 3,427,252 3,360,832
GNMA Pool #405576 6.500 2026 5,015,631 4,794,592
- ----------------------------------------------------------------------------------------------------------------
TOTAL MORTGAGE-BACKED SECURITIES (COST--$30,936,080) 31,020,269
================================================================================================================
ASSET-BACKED SECURITIES (10.6%)
CoreStates Home Equity Trust Series 1996-1 Class A4 7.000 2012 3,000,000 2,949,375
Ford Credit Auto Owner Trust Series 1996-B Class A4 6.300 2001 3,614,000 3,629,811
Merrill Lynch Mortgage
Investors, Inc. Series 1991-D Class A 9.000 2011 491 501
Merrill Lynch Mortgage
Investors, Inc. Series 1991-G Class B 9.150 2011 3,550,242 3,720,654
Merrill Lynch Mortgage
Investors, Inc. Series 1992-B Class B 8.500 2012 2,012,027 2,076,774
Merrill Lynch Mortgage
Investors, Inc. Series 1992-D Class B 8.500 2017 2,364,881 2,487,146
Olympic Auto Receivables Series 1996-C 6.800 2002 3,000,000 3,042,188
Southern Pacific Secured Assets
Corp. Series 1996-3 Class A4 7.600 2027 3,300,000 3,338,156
University Support Services,
Inc. Series 1992-D 9.074 2007 915,000 916,716
World Omni Automobile Lease
Trust Series 1996-B Class A3 6.250 2002 2,000,000 2,003,750
- ----------------------------------------------------------------------------------------------------------------
TOTAL ASSET-BACKED SECURITIES (COST--$23,560,144) 24,165,071
================================================================================================================
UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (5.1%)
FHLB Deb. 8.700 2005 1,000,000 1,030,620
FHLMC Deb. 7.800 2016 2,000,000 2,065,000
U.S. Treasury Bonds 7.875 2021 4,200,000 4,756,500
U.S. Treasury Bonds 6.875 2025 1,250,000 1,277,925
U.S. Treasury Bonds 6.000 2026 2,900,000 2,645,351
- ----------------------------------------------------------------------------------------------------------------
TOTAL UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (COST--$11,454,386) 11,775,396
================================================================================================================
FOREIGN BONDS (U.S. DOLLARS) (1.3%) (COST--$3,098,550)
Bayer Corp. (d) Notes 7.125 2015 3,000,000 2,940,870
- ----------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME (COST--$221,340,709) 226,126,309
================================================================================================================
<PAGE>
PAGE 13
- --------------------------------
SCHEDULE OF INVESTMENTS--October 31, 1996
Interest Maturity Par Market
Rate Date Value Value
================================================================================================================
Keystone Joint Repurchase Agreement
(Investments in repurchase agreements, in a
joint trading account, purchased 10/31/96) (c) 5.565% 11/1/96 $307,047 $ 307,000
- ----------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (COST--$221,647,709) (A) 226,433,309
OTHER ASSETS AND LIABILITIES--NET (1.0%) 2,215,850
- ----------------------------------------------------------------------------------------------------------------
NET ASSETS (100%) $228,649,159
================================================================================================================
</TABLE>
(a) The cost of investments for federal income tax purposes is $222,327,705.
Gross unrealized appreciation and depreciation on investments, based on
identified tax cost at October 31, 1996, are as follows:
Gross unrealized appreciation $4,681,003
Gross unrealized depreciation (575,399)
----------
Net unrealized appreciation $4,105,604
==========
(b) The estimated maturity of a Collateralized Mortgage Obligation ("CMO") is
based on current and projected prepayment rates. Changes in interest
rates can cause the estimated maturity to differ from the listed dates.
(c) The repurchase agreements are fully collateralized by U.S. government
and/or agency obligations based on market prices at October 31, 1996.
(d) Securities that may be resold to "qualified institutional buyers" under
Rule 144A or securities offered pursuant to Section 4(2) of the Federal
Securities Act of 1933, as amended. These securities have been determined
to be liquid under guidelines established by the Board of Trustees.
(e) Effective yield (calculated at date of purchase) is the yield at which
the bond accretes on an annualized basis until maturity date.
Legend of Portfolio Abbreviations
FHLB--Federal Home Loan Bank
FHLMC--Federal Home Loan Mortgage Corporation
FNMA--Federal National Mortgage Association
GNMA--Government National Mortgage Association
RASTA--Residential Asset Securitization Trust Association
REMIC--Real Estate Mortgage Investment Conduit
PAC--Planned Amortization Class
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
<TABLE>
<CAPTION>
Unrealized
Exchange U.S. $ value at In Exchange Appreciation/
Date October 31, 1996 for U.S. $ (Depreciation)
==================================================================================================
<S> <C> <C> <C> <C>
Forward Foreign Currency Exchange Contracts to Buy:
Contracts to Receive
11/7/96 4,900,000 German Marks $ 3,237,007 $ 3,227,400 $ 9,607
11/29/96 8,569,000 Canadian Dollars 6,404,794 6,284,884 119,910
Forward Foreign Currency Exchange Contracts to Sell:
Contracts to Deliver
11/7/96 22,251,500 German Marks 14,699,645 15,104,211 404,566
11/29/96 36,579,000 Canadian Dollars 27,340,527 26,841,063 (499,464)
</TABLE>
See Notes to Financial Statements
<PAGE>
PAGE 14
- --------------------------------
Keystone Quality Bond Fund (B-1)
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout each year)See Notes to Financial Statements.
<TABLE>
<CAPTION>
Year Ended October 31,
1996 1995 1994 1993 1992
==================================================================================================
<S> <C> <C> <C> <C> <C>
Net asset value beginning of year $ 15.42 $ 14.44 $ 16.40 $ 15.92 $ 15.92
- --------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income 0.75 0.87 0.76 0.96 1.04
Net realized and unrealized gain
(loss) on investments, closed
futures contracts and foreign
currency related transactions (0.16) 1.05 (1.76) 0.66 0.15
- --------------------------------------------------------------------------------------------------
Total from investment operations 0.59 1.92 (1.00) 1.62 1.19
- --------------------------------------------------------------------------------------------------
Less distributions from:
Net investment income (0.76) (0.87) (0.76) (0.96) (1.04)
In excess of net investment income 0 (0.05) (0.09) (0.18) (0.15)
Tax basis return of capital (0.06) (0.02) (0.11) 0 0
- --------------------------------------------------------------------------------------------------
Total distributions (0.82) (0.94) (0.96) (1.14) (1.19)
- --------------------------------------------------------------------------------------------------
Net asset value end of year $ 15.19 $ 15.42 $ 14.44 $ 16.40 $ 15.92
==================================================================================================
Total return (a) 3.99% 13.69% (6.27%) 10.50% 7.71%
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.95%(b) 1.96%(b) 1.86% 1.94% 2.01%
Net investment income 5.06% 5.86% 5.05% 5.85% 6.40%
Portfolio turnover rate 231% 244% 169% 190% 102%
- --------------------------------------------------------------------------------------------------
Net assets end of year (thousands) $228,649 $310,791 $327,276 $458,925 $456,912
==================================================================================================
</TABLE>
<TABLE>
<CAPTION>
1991 1990 1989 1988 1987
==================================================================================================
<S> <C> <C> <C> <C> <C>
Net asset value beginning of year $ 15.11 $ 15.85 $ 15.71 $ 15.52 $ 17.30
- --------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income 1.08 1.11 1.21 1.19 1.20
Net realized and unrealized gain
loss) on investments, closed
futures contracts and foreign
currency related transactions 0.99 (0.53) 0.25 0.32 (1.59)
- --------------------------------------------------------------------------------------------------
Total from investment operations 2.07 0.58 1.46 1.51 (0.39)
- --------------------------------------------------------------------------------------------------
Less distributions from:
Net investment income (1.08) (1.18) (1.32) (1.32) (1.39)
In excess of net investment income (0.18) (0.14) 0 0 0
Tax basis return of capital 0 0 0 0 0
- --------------------------------------------------------------------------------------------------
Total distributions (1.26) (1.32) (1.32) (1.32) (1.39)
- --------------------------------------------------------------------------------------------------
Net asset value end of year $ 15.92 $ 15.11 $ 15.85 $ 15.71 $ 15.52
==================================================================================================
Total return (a) 14.09% 3.93% 9.82% 10.09% (2.44%)
Ratios/supplemental data
Ratios to average net assets:
Total expenses 2.04% 1.95% 1.82% 1.64% 1.56%
Net investment income 6.95% 7.45% 7.61% 7.49% 7.32%
Portfolio turnover rate 158% 117% 116% 153% 127%
- --------------------------------------------------------------------------------------------------
Net assets end of year (thousands) $453,528 $408,330 $462,425 $447,454 $440,836
==================================================================================================
</TABLE>
(a) Excluding applicable sales charges.
(b) The ratio of total expenses to average net assets includes indirectly
paid expenses. Excluding indirectly paid expenses, the expense ratios
would have been 1.93% and 1.94% for the years ended October 31, 1996 and
1995, respectively.
See Notes to Financial Statements.
<PAGE>
PAGE 15
- --------------------------------
STATEMENT OF ASSETS AND LIABILITIES
October 31, 1996
=======================================================================
Assets (Note 2)
Investments at market value (identified cost--
$221,647,709) $226,433,309
Cash 492
Receivable for:
Investments sold 36,889
Interest 2,873,463
Fund shares sold 10,499
Unrealized appreciation on forward foreign currency
exchange contracts 534,083
Prepaid expenses and other assets 52,276
- -----------------------------------------------------------------------
Total assets 229,941,011
- -----------------------------------------------------------------------
Liabilities (Notes 2 and 5)
Payable for:
Fund shares redeemed 366,406
Distributions to shareholders 365,366
Unrealized depreciation on forward foreign currency
exchange contracts 499,464
Due to related parties 6,219
Other accrued expenses 54,397
- -----------------------------------------------------------------------
Total liabilities 1,291,852
- -----------------------------------------------------------------------
Net assets $228,649,159
=======================================================================
Net assets represented by
Paid-in capital $255,530,019
Accumulated distributions in excess of net
investment income (399,985)
Accumulated net realized loss on investments and
foreign currency related transactions (31,308,109)
Net unrealized appreciation on investments and
foreign currency related transactions 4,827,234
- -----------------------------------------------------------------------
Total net assets $228,649,159
- -----------------------------------------------------------------------
Net asset value per share (Note 2)
Net assets of $228,649,159 / 15,055,747 shares
outstanding $ 15.19
=======================================================================
STATEMENT OF OPERATIONS
Year Ended October 31, 1996
=======================================================================
Investment income
Interest $18,504,392
- -----------------------------------------------------------------------
Expenses (Notes 4, 5 and 6)
Management fee $ 1,578,211
Transfer agent fees 627,068
Accounting, auditing and legal fees 53,738
Custodian fees 142,613
Trustees' fees and expenses 31,867
Distribution Plan expenses 2,645,899
Other 65,509
- -----------------------------------------------------------------------
Total expenses 5,144,905
Less: Expenses paid indirectly (30,574)
- -----------------------------------------------------------------------
Net expenses 5,114,331
- -----------------------------------------------------------------------
Net investment income 13,390,061
- -----------------------------------------------------------------------
Net realized and unrealized loss on
investments and foreign currency
related transactions (Notes 1 and 3)
Net realized loss on:
Investments (1,910,620)
Foreign currency related
transactions (273,044)
- -----------------------------------------------------------------------
Net realized loss on investments
and foreign currency
related transactions (2,183,664)
- -----------------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) on:
Investments (1,978,287)
Foreign currency related
transactions 41,634
- -----------------------------------------------------------------------
Net change in unrealized appreciation
(depreciation) on investments and
foreign currency
related transactions (1,936,653)
- -----------------------------------------------------------------------
Net realized and unrealized loss on
investments and foreign currency
related transactions (4,120,317)
- -----------------------------------------------------------------------
Net increase in net assets resulting
from operations $ 9,269,744
=======================================================================
See Notes to Financial Statements.
<PAGE>
PAGE 16
- --------------------------------
Keystone Quality Bond Fund (B-1)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Ended October 31,
1996 1995
===================================================================================================
<S> <C> <C>
Operations
Net investment income $ 13,390,061 $ 18,237,187
Net realized loss on investments, closed futures contracts and
foreign currency related transactions (2,183,664) (6,749,977)
Net change in unrealized appreciation (depreciation) on
investments and foreign currency related transactions (1,936,653) 28,285,126
- ---------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations 9,269,744 39,772,336
- ---------------------------------------------------------------------------------------------------
Distributions to shareholders from (Note 1)
Net investment income (13,289,851) (18,237,187)
In excess of net investment income 0 (763,245)
Tax basis return of capital (950,184) (472,154)
- ---------------------------------------------------------------------------------------------------
Total distributions to shareholders (14,240,035) (19,472,586)
- ---------------------------------------------------------------------------------------------------
Capital share transactions (Note 2)
Proceeds from shares sold 44,210,094 78,243,761
Payments for shares redeemed (130,171,813) (126,927,895)
Net asset value of shares issued in reinvestment of dividends
and distributions 8,789,681 11,900,336
- ---------------------------------------------------------------------------------------------------
Net decrease in net assets resulting from capital share
transactions (77,172,038) (36,783,798)
- ---------------------------------------------------------------------------------------------------
Total decrease in net assets (82,142,329) (16,484,048)
Net assets
Beginning of year 310,791,488 327,275,536
- ---------------------------------------------------------------------------------------------------
End of year [including accumulated distributions in excess of
net investment income as follows: 1996--($399,985) and
1995--($575,212)] (Note 1) $ 228,649,159 $ 310,791,488
===================================================================================================
</TABLE>
See Notes to Financial Statements.
<PAGE>
PAGE 17
- --------------------------------
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies
Keystone Quality Bond Fund (B-1) (the "Fund") is a Pennsylvania common law
trust for which Keystone Management, Inc. ("KMI") is the Investment Manager
and Keystone Investment Management Company ("Keystone") is the Investment
Adviser. Keystone is a wholly-owned subsidiary of Keystone Investments, Inc.
("KII") and KMI is, in turn, a wholly-owned subsidiary of Keystone. The Fund
is registered under the Investment Company Act of 1940, as amended (the "1940
Act"), as a diversified, open-end investment company. The Fund seeks the
highest possible income consistent with preservation of principal. The Fund
invests primarily in high and investment grade corporate bonds, which possess
a high degree of dependability of interest and principal payments.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles,
which require management to make estimates and assumptions that affect
amounts reported herein. Although actual results could differ from these
estimates, any such differences are expected to be immaterial to the net
assets of the Fund.
A. Valuation of Securities
U.S. Government obligations held by the Fund are valued at the mean between
the over-the-counter bid and asked prices, as furnished by an independent
pricing service. Listed corporate bonds, other fixed income securities,
mortgage and other asset-backed securities, and other related securities are
valued at prices provided by an independent pricing service. In determining
value for normal institutional-size transactions, the pricing service uses
methods based on market transactions for comparable securities and various
relationships between securities that are generally recognized by
institutional traders. Securities for which valuations are not available from
an independent pricing service (including restricted securities) are valued
at fair value as determined in good faith according to procedures established
by the Board of Trustees.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value. Short-term
securities with greater than 60 days to maturity are valued at market value.
B. Repurchase Agreements
Pursuant to an exemptive order issued by the Securities
and Exchange Commission, the Fund, along with certain other Keystone funds,
may transfer uninvested cash balances into a joint trading account. These
balances are invested in one or more repurchase agreements that are fully
collateralized by U.S. Treasury and/or Federal Agency obligations.
Securities pledged as collateral for repurchase agreements are held by the
custodian on the Fund's behalf. The Fund monitors the adequacy of the
collateral daily and will require the seller to provide additional collateral
in the event the market value of the securities pledged falls below the
carrying value of the repurchase agreement.
C. Reverse Repurchase Agreements
The Fund enters into reverse repurchase agreements with qualified third-party
broker-dealers. Interest on the value of reverse repurchase agreements is
based upon competitive market rates at the time of issuance. At the time the
Fund enters into a reverse repurchase agreement, it will establish and
maintain a segregated account with its custodian containing liquid assets
having a value not less than the repurchase price (including accrued
interest). If the counterparty to the transaction is rendered insolvent, the
ultimate realiza-
<PAGE>
PAGE 18
- --------------------------------
Keystone Quality Bond Fund (B-1)
tion of the securities to be repurchased by the Fund may be delayed or
limited.
D. Foreign Currency
The books and records of the Fund are maintained in United States (U.S.)
dollars. Foreign currency amounts are translated into United States dollars
as follows: market value of investments, assets and liabilities at the daily
rate of exchange; purchases and sales of investments, income and expenses at
the rate of exchange prevailing on the respective dates of such transactions.
Net unrealized foreign exchange gain (loss) resulting from changes in foreign
currency exchange rates is a component of net unrealized appreciation
(depreciation) on investments and foreign currency transactions. Net realized
foreign currency gains and losses resulting from changes in exchange rates
include foreign currency gains and losses between trade date and settlement
date on investment securities transactions, foreign currency transactions and
the difference between the amounts of interest and dividends recorded on the
books of the Fund and the amount actually received. The portion of foreign
currency gains and losses related to fluctuations in exchange rates between
the initial purchase trade date and subsequent sale trade date is included in
realized gain (loss) on foreign currency transactions.
E. Futures Contracts
In order to gain exposure to or protect against changes in security values,
the Fund may buy and sell futures contracts.
The initial margin deposited with a broker when entering into a futures
transaction is subsequently adjusted by daily payments or receipts as the
value of the contract changes. Such changes are recorded as unrealized gains
or losses. Realized gains or losses are recognized upon closing the contract.
Risks of entering into futures contracts include (i) the possibility of an
illiquid market for the contract, (ii) the possibility that a change in value of
the contract may not correlate with changes in the value of the underlying
instrument or index, and (iii) the credit risk that the other party will not
fulfill their obligations under the contract. Futures contracts also involve
elements of market risk in excess of the amount reflected in the statement of
assets and liabilities.
F. Forward Foreign Currency Exchange Contracts
The Fund may enter into forward foreign currency exchange contracts ("forward
contracts") to settle portfolio
purchases and sales of securities denominated in a foreign currency and to
hedge certain foreign currency assets or liabilities. Forward contracts are
recorded at the forward rate and are marked-to-market daily. Realized gains
and losses arising from such transactions are included in net realized gain
(loss) on foreign currency related transactions. The Fund bears the risk of
an unfavorable change in the foreign currency exchange rate underlying the
forward contract and is subject to the credit risk that the other party will
not fulfill their obligations under the contract. Forward contracts involve
elements of market risk in excess of the amount reflected in the statement of
assets and liabilities.
G. Security Transactions and Investment Income
Securities transactions are accounted for no later than one business day
after the trade date. Realized gains and losses are computed on the
identified cost basis. Interest income is recorded on the accrual basis and
includes amortization of discounts.
H. Federal Income Taxes
The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). Thus, the Fund is relieved of any federal income tax liability by
distributing all of its net tax-
<PAGE>
PAGE 19
- --------------------------------
able investment income and net taxable capital gains, if any, to its
shareholders. The Fund also intends to avoid excise tax liability by making
the required distributions under the Code. Accordingly, no provision for
federal income tax is required.
I. Distributions
The Fund distributes net investment income monthly and net capital gains, if
any, at least annually. Distributions to shareholders are recorded at the
close of business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations which may differ from generally
accepted accounting principles. These differences are primarily due to
differing treatment for paydown gains (losses) and foreign currency
transactions.
2. Capital Share Transactions
The Fund's Trust Agreement, as amended and restored, authorizes the issuance
of an unlimited number of shares of beneficial interest with a par value of
$1.00. Transactions in shares of the Fund were as follows:
Year ended October 31,
1996 1995
- -------------------------------------------------------------
Shares sold 2,902,677 5,215,666
Shares redeemed (8,577,419) (8,523,861)
Shares issued in reinvestment
of dividends and
distributions 581,588 799,017
- -------------------------------------------------------------
Net decrease (5,093,154) (2,509,178)
=============================================================
3. Securities Transactions
Cost of purchases and proceeds from sales of investment securities (excluding
short-term securities) for the year ended October 31, 1996 were as follows:
Cost of Proceeds
Purchases from Sales
- ----------------------------------------------------
Non-U.S. Government $309,095,323 $255,751,880
U.S. Government 282,174,491 402,430,535
====================================================
The average daily balance of reverse repurchase agreements outstanding
during the year ended October 31, 1996 was approximately $7,133,000 at a
weighted average interest rate of 3.65%. The maximum amount of borrowing
during the year was $17,694,856 (including accrued interest).
As of October 31, 1996, the Fund has a capital loss carryover for federal
income tax purposes of approximately $30,627,000 which expires as follows:
$2,251,000--1998; $20,145,000--2002; $6,153,000--2003; and $2,078,000--2004.
4. Distribution Plan
The Fund bears some of the costs of selling its shares under a Distribution
Plan (the "Plan") adopted pursuant to Rule 12b-1 under the 1940 Act. Under
the Plan, the Fund pays its principal underwriter, Keystone Investment
Distributors Company ("KIDC"), a wholly-owned subsidiary of Keystone, amounts
which are calculated and paid daily.
Under the Plan, the Fund pays a distribution fee amount which may not exceed
1.00% of the Fund's average daily net assets. Of that amount, 0.75% is used
to pay distribution expenses and 0.25% may be used to pay service fees.
Contingent deferred sales charges paid by redeeming shareholders may be paid
to KIDC.
The Plan may be terminated at any time by vote of the Independent Trustees
or by vote of a majority of the outstanding voting shares of the Fund.
However,
<PAGE>
PAGE 20
- --------------------------------
Keystone Quality Bond Fund (B-1)
after the termination of the Plan, at the discretion of the Board of
Trustees, payments to KIDC may continue as compensation for its services
which had been earned while the Plan was in effect.
KIDC intends, but is not obligated, to continue to pay distribution costs
that exceed the current annual payments from the Fund. KIDC intends to seek
full payment of such distribution costs from the Fund at such time in the
future as, and to the extent that, payment thereof by the Fund would be
within permitted limits.
Total unpaid distribution costs at October 31, 1996 amounted to $9,151,321.
5. Investment Management Agreement and Other Affiliated Transactions
Under the terms of the Investment Management Agreement between KMI and the
Fund, KMI provides investment management and administrative services to the
Fund. In return, KMI is paid a management fee, computed and paid daily, at an
annual rate of 2.00% of the Fund's gross investment income plus an amount
determined by applying percentage rates starting at 0.50% and declining as
net assets increase to 0.25% per annum, to the average daily net asset value
of the Fund.
KMI has entered into an Investment Advisory Agreement with Keystone under
which Keystone provides investment advisory and management services to the
Fund. In return for its services, Keystone receives an annual fee equal to
85% of the management fee received by KMI.
During the year ended October 31, 1996, the Fund paid or accrued $23,191 to
Keystone for certain accounting services. The Fund paid or accrued $627,068
to Keystone Investor Resource Center, Inc., a wholly-owned subsidiary of
Keystone, for services rendered as the Fund's transfer and dividend
disbursing agent.
Certain officers and/or Directors of Keystone are also officers and/or
Trustees of the Fund. Officers of Keystone and affiliated Trustees receive no
compensation directly from the Fund.
6. Expense Offset Arrangement
The Fund has entered into an expense offset arrangement with its custodian.
For the year ended October 31, 1996, the Fund incurred total custody fees of
$142,613 and received a credit of $30,574 pursuant to this expense offset
arrangement, resulting in a net custody expense of $112,039. The assets
deposited with the custodian under this expense offset arrangement could have
been invested in income-producing assets.
7. Subsequent Distribution to Shareholders
A distribution from net investment income of $0.065 per share was declared
payable on December 5, 1996 to shareholders of record November 25, 1996. This
distribution is not reflected in the accompanying financial statements.
8. Agreement and Plan of Acquisition
On September 6, 1996, KII entered into an Agreement and Plan of Acquisition
and Merger with First Union Corporation ("First Union") and First Union
National Bank of North Carolina ("FUNB-NC") and certain other parties
pursuant to which KII will be merged with and into a wholly-owned subsidiary
of FUNB-NC. Subject to the receipt of required regulatory and shareholder
approvals, the proposed merger is expected to take place in December 1996.
<PAGE>
PAGE 21
- --------------------------------
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Quality Bond Fund (B-1)
We have audited the accompanying statement of assets and liabilities of
Keystone Quality Bond Fund (B-1), including the schedule of investments, as
of October 31, 1996, and the related statement of operations for the year
then ended, the statements of changes in net assets for each of the years in
the two-year period then ended, and the financial highlights for each of the
years in the ten-year period then ended. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. Our procedures included confirmation of
securities owned as of October 31, 1996 by correspondence with the custodian
and brokers. An audit includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Keystone Quality Bond Fund (B-1) as of October 31, 1996, the results of its
operations for the year then ended, the changes in its net assets for each of
the years in the two-year period then ended, and the financial highlights for
each of the years in the ten-year period then ended in conformity with
generally accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
November 29, 1996
<PAGE>
PAGE 22
- --------------------------------
Keystone Quality Bond Fund (B-1)
Federal Tax Status--Fiscal 1996 Distributions (Unaudited)
During the fiscal year ended October 31, 1996, distributions of $0.82 per
share were paid in shares or cash. This total includes a nontaxable return of
capital equal to $0.06 per share. The remaining dividends are taxable to
shareholders as ordinary income in the year in which received by them or
credited to their accounts and are not eligible for the corporate dividend
received deduction.
In January 1997, we will send you complete information on the distributions
paid during the calendar year 1996 to help you in completing your federal tax
return.
<PAGE>
Keystone's Services
for Shareholders
KEYSTONE AUTOMATED RESPONSE LINE (KARL)--Receive up-to-date account
information on your balance, last transaction and recent Fund distribution.
You may also process transactions such as investments, redemptions and
exchanges using a touch-tone telephone as well as receive quotes on price,
yield, and total return of your Keystone Fund. Call toll-free,
1-800-346-3858.
EASY ACCESS TO INFORMATION ON YOUR ACCOUNT--Information about your Keystone
account is available 24 hours a day through KARL. To speak with a Shareholder
Services representative about your account, call toll-free 1-800-343-2898
between 8:00 A.M. and 6:00 P.M. Eastern time. Retirement Plan investors
should call 1-800-247-4075.
ADDITIONS TO YOUR ACCOUNT--You can buy additional shares for your account at
any time, with no minimum additional investment.
REINVESTMENT OF DISTRIBUTIONS--You can compound the return on your
investment by automatically reinvesting your Fund's distributions at net
asset value with no sales charge.
EXCHANGE PRIVILEGE--You may move your money among funds in the same Keystone
family quickly and easily for a nominal service fee. KARL gives you the added
ability to move your money any time of day, any day of the week. Keystone
offers a variety of funds with different investment objectives for your
changing investment needs.
ELECTRONIC FUNDS TRANSFER (EFT)-- Referred to as the "paper-less
transaction," EFT allows you to take advantage of a variety of preauthorized
account transactions, including automatic monthly investments and systematic
monthly or quarterly withdrawals. EFT is a quick, safe and accurate way to
move money between your bank account and your Keystone account.
CHECK WRITING--Shareholders of Keystone Liquid Trust may exercise the check
writing privilege to draw from their accounts.
EASY REDEMPTION--KARL makes redemption services available to you 24 hours a
day, every day of the year. The amount you receive may be more or less than
your original account value depending on the value of fund shares at time of
redemption.
RETIREMENT PLANS--Keystone offers a full range of retirement plans,
including IRA, SEP-IRA, profit sharing, money purchase, and defined
contribution plans. For more information, please call Retirement Plan
Services, toll-free at 1-800-247-4075.
Keystone is committed to providing you with quality, responsive account
service. We will do our best to assist you and your financial adviser in
carrying out your investment plans.
<PAGE>
PAGE 1
KEYSTONE QUALITY BOND FUND (B-1)
SEEKS GENEROUS INCOME AND CAPITAL PRESERVATION FROM HIGH QUALITY BONDS.
Dear Shareholder:
We are writing to report on the activities of Keystone Quality Bond Fund (B-1)
for the six-month period which ended April 30, 1997. Following our letter is a
discussion with your Fund's manager and complete financial information.
PERFORMANCE
Your Fund returned 0.80% for the six-month period and 5.92% for the twelve-month
period which ended April 30, 1997. For the same periods, the Lehman Aggregate
Bond Index-- a widely recognized index of corporate, government and mortgage
securities-- returned 1.71% and 7.08%, respectively.
We believe your Fund performed satisfactorily in a difficult interest rate
environment, where interest rates rose in the first three months of the period
and declined in the last three months.
MARKET ENVIRONMENT
While interest rates finished the period at approximately the same level at
which they started, they experienced significant fluctuations during the six
months. During the period, the yield of the benchmark 30-year U.S. Treasury bond
swung from a low yield of 6.35% to a high yield of 7.17%. These fluctuations
resulted from investors' responses to reports of spurts and slowdowns in
economic growth. As investors monitored changes in economic activity, they
adjusted their outlooks for future inflation and Federal Reserve interest rate
policy, creating fluctuations in both interest rates and bond prices.
PORTFOLIO STRATEGY
We continued our strategy of focusing on bonds that would generate a high level
of income and present attractive relative value. Throughout, we emphasized high
credit quality. We downplayed strategies designed to anticipate interest rate
movements. This was particularly appropriate in light of the interest rate
environment over the past six months. As of April 30, 1997, the average maturity
of the Fund's portfolio was 11.9 years.
The Fund's structure reflects a thorough analysis of price relationships
between various fixed-income sectors and securities, as well as their potential
for capital appreciation. In terms of sectors, we invested primarily in
corporate bonds, mortgage-backed and asset-backed securities and foreign
government bonds, all of which tend to provide higher yields than U.S.
government securities. All of the Fund's foreign transactions were
currency-hedged into U.S. dollars to protect the portfolio from currency
fluctuations. While your Fund also invested in U.S. government securities, it
was usually done to maintain a neutral interest rate stance or to build
liquidity in anticipation of opportunity in other fixed-income sectors.
Keystone Quality Bond Fund (B-1) is designed for conservative, income-oriented
investors. We invest in a selection of high quality fixed-income securities,
which include among others, U.S. government obligations, mortgage-backed and
asset-backed securities, and high quality corporate bonds. As of April 30, 1997
the average quality of the Fund was AA.
OUTLOOK
Going forward, we expect further strength in employment growth, disposable
income and consumer confidence, which could lead to temporarily higher interest
rates. Longer-term, we believe the Federal Reserve Board's dedication to prevent
rising inflation will prove beneficial to fixed-income investors. We expect to
see solid, yet tempered economic growth and low inflation to create a positive
environment for high quality bonds.
-- CONTINUED--
<PAGE>
PAGE 2
KEYSTONE QUALITY BOND FUND (B-1)
We appreciate your continued support of Keystone Quality Bond Fund (B-1). If
you have any questions or comments about your investment, we encourage you to
write to us.
Sincerely,
/s/ Albert H. Elfner, III (photo of (photo of
Albert H. Elfner, III Albert H. George S.
PRESIDENT Elfner, III Bissell
KEYSTONE INVESTMENT MANAGEMENT COMPANY appears here) appears here)
/s/ George S. Bissell
George S. Bissell
CHAIRMAN
KEYSTONE FUNDS
June 1997
<PAGE>
PAGE 3
A Discussion With
Your Fund Manager
(photo of
Christopher P. Conkey
appears here)
CHRISTOPHER P. CONKEY IS CHIEF INVESTMENT OFFICER OF KEYSTONE'S FIXED
INCOME GROUP AND WAS THE SENIOR PORTFOLIO MANAGER OF YOUR FUND FOR THE
SIX-MONTH PERIOD ENDING APRIL 30, 1997. MR. CONKEY IS ASSISTED BY GARY
PZEGEO, A KEYSTONE VICE PRESIDENT AND PORTFOLIO MANAGER.
Q WHAT DID INTEREST RATES DO OVER THE PAST SIX MONTHS?
A Interest rates fluctuated within a wide but well defined range, ending the
period at about where they started. The driving force behind this movement was
changing investor expectations of economic strength and its effect on future
inflation.
Economic activity accelerated in both the fourth quarter of 1996 and the first
quarter of 1997, raising concerns that stronger growth would stimulate future
inflation. The Federal Reserve Board validated these concerns when it raised the
Federal Funds rate by 1/4% in March 1997. The Federal Funds rate is the rate at
which banks lend to each other overnight and is a benchmark for short-term
interest rates. Despite this widespread anticipation of higher prices, inflation
has remained well contained. However, we continue to monitor signs of upward
pressure on wages.
Q WHAT STRATEGIES DID YOU USE IN MANAGING THE FUND?
A We continued to implement our strategy of emphasizing bonds that would
maximize the yield of the Fund and avoided trying to anticipate interest rate
movements. This was especially important over the last six months, as interest
rates first fell and then rose, before finishing largely unchanged. We based our
sector and security selections on relative value, as well as outlook for capital
appreciation. We chose what we believed to be the optimal mix of U.S. government
securities, corporate bonds, asset-backed and mortgage-backed securities and
foreign government bonds.
Q SPECIFICALLY, HOW DID YOU ALLOCATE THE FUND'S ASSETS?
A In terms of sectors, we emphasized corporate bonds, mortgage-backed and
asset-backed securities and foreign bonds. These sectors enhanced the income of
the Fund. We selected each sector-- as well as the bonds within each
sector-- based on relative value and the potential for capital appreciation.
While we also invested in U.S. government securities, we used that sector
primarily to maintain a neutral interest rate stance; and to enhance liquidity
in anticipation of opportunity in other sectors.
FUND PROFILE
OBJECTIVE: Seeks generous income and capital preservation from high quality
bonds.
INCEPTION DATE: September 11, 1935
AVERAGE MATURITY: 11.9 years
NET ASSETS: $192,920,024
<PAGE>
PAGE 4
KEYSTONE QUALITY BOND FUND (B-1)
During the period, 5%-15% of the Fund's net assets were invested in the
government bonds of Canada, Germany, Spain and the United Kingdom. All of these
transactions were currency-hedged. Foreign bonds outperformed many domestic
investment alternatives. Providing higher yields and solid capital appreciation,
they benefited from their countries' positive economic fundamentals which
included declining fiscal deficits and low inflation. During the period, we took
profits in the foreign sector and reallocated assets to U.S. government
securities. At that time, we believed the U.S. offered better relative value and
greater potential for declining interest rates.
Q WHAT IS YOUR OUTLOOK FOR THE NEXT SIX MONTHS?
A We believe that interest rates could rise over the near-term and decline
longer-term. Employment, income growth and consumer activity continue to be
strong; and investors remain concerned that this strength creates pressures for
future inflation. With this sentiment in the market, we would not be surprised
to see investors nudge interest rates higher. We also think the Federal Reserve
Board may raise interest rates again, in a preemptive move to keep inflation
low.
Longer-term, we think that economic activity will remain solid, but that there
will be a tempering in its rate of growth. We expect inflation to be
well-contained. Historically, a climate of steady economic growth and low
inflation has provided a positive environment for bonds.
(Diamond appears here)
THIS COLUMN IS INTENDED TO ANSWER QUESTIONS ABOUT YOUR FUND.
IF YOU HAVE A QUESTION YOU WOULD LIKE ANSWERED, PLEASE WRITE TO:
EVERGREEN KEYSTONE INVESTMENT SERVICES, INC.
ATTN: SHAREHOLDER COMMUNICATIONS
201 SOUTH COLLEGE STREET, SUITE 400,
CHARLOTTE, N.C. 28288-1195
<PAGE>
PAGE 5
Your Fund's
Performance
(Chart appears here with the following head and plot points:)
Growth of an investment in
Keystone Quality Bond Fund (B-1)
4/87 4/89 4/91 4/93 4/95 4/97
Reinvested Distributions (Customer to fill in plot points)
Initial Investment
A $10,000 investment in Keystone Quality Bond Fund (B-1) made on April 30, 1987
with all distributions reinvested was worth $18,652 on April 30, 1997. Past
performance is no guarantee of future results.
<TABLE>
<CAPTION>
SIX-MONTH PERFORMANCE AS OF APRIL 30, 1997
<S> <C> <C> <C>
Total return* 0.80%
Net asset value 10/31/96 $15.19
4/30/97 $14.92
Dividends $0.39
Capital gains None
</TABLE>
* BEFORE DEDUCTION OF CONTINGENT DEFERRED SALES CHARGE (CDSC).
<TABLE>
<CAPTION>
HISTORICAL RECORD AS OF APRIL 30, 1997
<S> <C> <C>
IF YOU IF YOU DID
CUMULATIVE TOTAL RETURN REDEEMED NOT REDEEM
<S> <C> <C>
1-year 2.92% 5.92%
5-year 29.37% 29.37%
10-year 86.52% 86.52%
AVERAGE ANNUAL TOTAL RETURN
1-year 2.92% 5.92%
5-year 5.29% 5.29%
10-year 6.43% 6.43%
</TABLE>
The "if you redeemed" returns reflect the deduction of the 3% contingent
deferred sales charge for those investors who sold Fund shares after one
calendar year. Investors who retained their fund investment earned the returns
reported in the second column of the table.
The investment return and principal value will fluctuate so that your shares,
when redeemed, may be worth more or less than their original cost.
You may exchange shares for another Keystone fund by phone or in writing. You
may also exchange funds through the Evergreen Keystone Express Line. The Fund
reserves the right to change or terminate the exchange offer.
<PAGE>
PAGE 6
KEYSTONE QUALITY BOND FUND (B-1)
SCHEDULE OF INVESTMENTS-- APRIL 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
FIXED INCOME (96.1%)
CORPORATE BONDS & NOTES (31.0%)
<C> <S> <C>
AIRCRAFT (1.1%)
$ 2,000,000 Boeing Co.,
7.88%, 4/15/43.............. $ 2,080,060
BANK & FINANCE (13.4%)
2,000,000 ABN AMRO Holdings N.V.,
7.30%, 12/1/26.............. 1,843,280
3,500,000 AmSouth Bancorp., Subord. Deb.
6.75%, 11/1/25.............. 3,378,375
1,500,000 Associates Corp. North
America,
Sr. Notes,
7.63%, 3/1/00............... 1,535,205
1,250,000 Commercial Credit Corp.
Putable Asset Trust,
6.45%, 10/18/99 (c)......... 1,241,000
2,000,000 Export Import Bank of Korea,
Notes,
7.10%, 3/15/07.............. 2,001,800
5,000,000 General Motors Acceptance
Corp.,
Notes,
7.13%, 5/1/01............... 5,009,050
2,485,000 International Lease Finance
Corp.,
Notes,
6.25%, 10/15/00............. 2,440,543
2,000,000 Mellon Bank Capital II,
8.00%, 1/15/27.............. 1,960,860
4,500,000 Sun Canada Financial Co.,
6.63%, 12/15/07 (c)......... 4,275,180
2,265,000 Wachovia Corp., Subord. Notes,
6.61%, 10/1/25.............. 2,207,492
25,892,785
CONSUMER GOODS (1.8%)
3,500,000 Mattel, Inc., Notes,
6.75%, 5/15/00.............. 3,493,280
DIVERSIFIED COMPANIES (0.6%)
2,000,000 Grand Metro Investment Corp.,
Co. Gtd.,
0.00%, 1/6/04
(Eff. Yield 8.13%) (d)...... 1,245,400
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
CORPORATE BONDS & NOTES (CONTINUED)
<C> <S> <C>
INSURANCE (1.2%)
$ 2,000,000 AMBAC, Inc., Deb.,
9.38%, 8/1/11............... $ 2,340,700
OIL (5.2%)
3,000,000 Occidental Petroleum Corp.,
Deb.,
10.13%, 9/15/09............. 3,609,120
2,452,474 Oslo Seismic Services, Inc.,
1st Pfd. Mtg. Notes,
8.28%, 6/1/11 (c)........... 2,490,929
4,000,000 Tennessee Gas Pipeline Co.,
Deb.,
7.50%, 4/1/17............... 3,964,966
10,065,015
RETAIL (1.3%)
2,500,000 Kohl's Corp., Notes,
7.38%, 10/15/11............. 2,448,700
TELECOMMUNICATIONS (1.8%)
3,000,000 GTE Corp., Notes,
8.75%, 11/1/21.............. 3,391,500
TOBACCO (1.5%)
3,000,000 Philip Morris Companies, Inc.,
Sr. Notes,
7.20%, 2/1/07............... 2,877,000
TRANSPORTATION (1.5%)
3,000,000 Golden State Petroleum
Transportation Corp., Deb.,
8.04%, 2/1/19 (c)........... 2,922,656
UTILITIES (1.6%)
2,000,000 Citizens Utilities Co.,
7.05%, 10/1/46.............. 1,838,740
1,250,000 Korea Electric & Power Corp.,
Deb.,
7.00%, 2/1/27............... 1,215,650
3,054,390
TOTAL CORPORATE BONDS & NOTES
(COST-- $60,710,386)........................ 59,811,486
</TABLE>
<PAGE>
PAGE 7
SCHEDULE OF INVESTMENTS-- APRIL 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
COLLATERALIZED MORTGAGE
OBLIGATIONS (22.7%)
<C> <S> <C>
Asset Securitization Corp.:
$ 1,000,000 Series 1997-D4 Class A2,
7.41%, 4/14/27
(Est. Mat. 2011) (a)........ $ 1,013,906
1,416,414 Series 1996-D3 Class A3,
7.71%, 10/13/26
(Est. Mat. 2009) (a)........ 1,426,594
888,227 Criimi Mae Financial Corp.,
Series 1 Class A,
7.00%, 1/1/33,
(Est. Mat. 2005) (a)........ 847,424
FHLMC:
3,500,000 Series 1701 Class PH,
6.50%, 3/15/09
(Est. Mat. 2005) (a)........ 3,377,500
1,650,000 Series 117 Class G,
8.50%, 1/15/21
(Est. Mat. 2009) (a)........ 1,718,146
FNMA REMIC Trust:
3,500,000 Series 1996-17 Class A,
6.00%, 8/25/04
(Est. Mat. 2002) (a)........ 3,352,344
2,800,000 Series 1993-156 Class B,
6.50%, 4/25/18
(Est. Mat. 2003) (a)........ 2,649,500
5,000,000 Series 1993-G09 Class H,
7.00%, 12/25/20
(Est. Mat. 2004) (a)........ 4,846,875
2,500,000 Series 1993-38 Class L,
5.00%, 8/25/22
(Est. Mat. 2007) (a)........ 2,076,550
1,850,000 GS Mortgage Security Corp.,
Series 1996-PL Class A2,
7.41%, 2/15/27
(Est. Mat. 2006) (a)........ 1,794,789
2,997,109 Independent National Mortgage
Corp.,
Series 1997-A Class A,
7.84%, 11/1/26
(Est. Mat. 2006) (a)........ 2,929,674
1,317,367 KS Mortgage Capital LP,
Series 1995-1 Class A1,
7.04%, 4/20/02
(Est. Mat. 1999) (a) (c).... 1,314,897
PRINCIPAL
AMOUNT VALUE
COLLATERALIZED MORTGAGE
OBLIGATIONS (CONTINUED)
<C> <S> <C>
$ 2,700,000 Merrill Lynch Trust,
Series 35 Class G,
8.45%, 11/1/18
(Est. Mat. 2007) (a)........ $ 2,826,549
1,000,000 Morgan Stanley Capital I,
Series 1996-WF Class 1B,
6.59%, 11/15/28
(Est. Mat. 2005) (a) (c).... 949,062
1,106,788 Paine Webber Mortgage
Acceptance Corp. IV,
Series 1993-5 Class A3,
6.88%, 6/25/08
(Est. Mat. 1998) (a)........ 1,104,713
3,000,000 RASTA,
Series 1996-AS Class A3,
7.75%, 9/25/26
(Est. Mat. 1999) (a)........ 3,003,517
3,500,000 Residential Accredit Loans,
Inc.,
Series 1996-QS4 Class AI10,
7.90%, 8/25/26
(Est. Mat. 2014) (a)........ 3,496,582
2,212,212 Residential Funding Corp.,
Series 1994-S15 Class A1,
7.75%, 7/25/24
(Est. Mat. 1998) (a)........ 2,219,114
2,793,863 Ryland Acceptance Corp.,
Series 1988-E, 2 PAC,
7.95%, 1/1/19
(Est. Mat. 2005) (a)........ 2,800,848
TOTAL COLLATERALIZED MORTGAGE
OBLIGATIONS (COST-- $44,099,671)........... 43,748,584
ASSET-BACKED SECURITIES (16.2%)
<C> <S> <C>
2,000,000 Auto Receivables Trust,
Series 1995-D,
6.40%, 4/20/03.............. 1,981,945
1,000,000 ContiMortgage Home Equity
Loans, Inc.,
Series 1996-4 Class A9,
6.88%, 1/15/28.............. 967,870
3,100,000 CoreStates Home Equity Trust,
Series 1996-1 Class A4,
7.00%, 6/15/12.............. 3,019,594
4,400,000 Ford Credit Auto Owner Trust,
Series 1996-B Class A4,
6.30%, 1/15/01.............. 4,378,000
</TABLE>
<PAGE>
PAGE 8
KEYSTONE QUALITY BOND FUND (B-1)
SCHEDULE OF INVESTMENTS-- APRIL 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
ASSET-BACKED SECURITIES (CONTINUED)
<C> <S> <C>
$ 4,000,000 Headlands Mortgage Securities,
Inc., Series 1997-2 Class
A10,
7.75%. 5/25/27.............. $ 4,012,500
Merrill Lynch Mortgage Investors, Inc.:
371 Series 1991-D Class A,
9.00%, 7/15/11.............. 378
3,420,522 Series 1991-G Class B,
9.15%, 10/15/11............. 3,566,955
1,867,508 Series 1992-B Class B,
8.50%, 4/15/12.............. 1,906,015
2,170,712 Series 1992-D Class B,
8.50%, 6/15/17.............. 2,236,593
3,000,000 Olympic Auto Receivables,
Series 1996-C,
6.80%, 3/15/02.............. 3,008,130
3,300,000 Southern Pacific Secured
Assets Corp.,
Series 1996-3 Class A4,
7.60%, 10/25/27............. 3,262,875
765,000 University Support Services,
Inc.,
Series 1992-D,
9.07%, 11/1/07.............. 764,522
2,100,000 World Omni Automobile
Lease Trust,
Series 1997 Class A4,
6.90%, 5/5/20............... 2,114,112
TOTAL ASSET-BACKED SECURITIES
(COST-- $30,926,386)....................... 31,219,489
UNITED STATES GOVERNMENT
(AND AGENCY) ISSUES (13.3%)
<C> <S> <C>
1,000,000 FHLB, Deb.,
8.70%, 1/12/05.............. 1,014,530
FHLMC:
2,250,000 Deb.,
6.70%, 1/5/07............... 2,211,322
2,000,000 Deb.,
7.80%, 9/12/16.............. 2,029,380
PRINCIPAL
AMOUNT VALUE
UNITED STATES GOVERNMENT
(AND AGENCY) ISSUES (CONTINUED)
<C> <S> <C>
U.S. Treasury Bonds:
$ 1,000,000 6.50%, 11/15/26............. $ 939,220
1,200,000 7.88%, 2/15/21.............. 1,311,744
U.S. Treasury Notes:
1,600,000 6.50%, 10/15/06............. 1,573,744
16,500,000 6.63%, 3/31/02.............. 16,530,855
TOTAL UNITED STATES GOVERNMENT
(AND AGENCY) ISSUES
(COST-- $25,607,659)....................... 25,610,795
FOREIGN BONDS (NON U.S. DOLLARS) (8.3%)
<C> <S> <C>
7,250,000 CD Canadian Government, Deb.,
8.75%,12/1/05............... 5,926,110
Germany (Republic of), Deb.:
6,652,000 DM 6.50%, 7/15/03................ 4,100,364
9,750,000 DM 6.88%, 5/12/05................ 6,080,942
TOTAL FOREIGN BONDS (NON U.S.
DOLLARS) (COST-- $17,577,850).............. 16,107,416
MORTGAGE-BACKED SECURITIES (3.1%)
<C> <S> <C>
$ 7,633 FHLMC Pool #303865,
8.50%, 10/1/97.............. 7,865
6,220,971 FNMA Pool #303664,
6.50%, 12/1/08.............. 6,076,458
TOTAL MORTGAGE-BACKED SECURITIES
(COST-- $6,242,370)........................ 6,084,323
FOREIGN BONDS (U.S. DOLLARS) (1.5%)
(COST-- $3,098,550)
<C> <S> <C>
3,000,000 Bayer Corp., Notes,
7.13%, 10/1/15 (c).......... 2,838,000
TOTAL FIXED INCOME
(COST-- $188,262,872)...................... 185,420,093
<C> <S> <C>
</TABLE>
<PAGE>
PAGE 9
SCHEDULE OF INVESTMENTS-- APRIL 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
REPURCHASE AGREEMENT (2.6%)
(COST-- $4,961,000)
<C> <S> <C>
$ 4,961,000 Keystone Joint Repurchase Agreement,
(Investments in repurchase agreements
in a joint trading account,
purchased 4/30/97, maturity
value $4,961,758)
5.50%, 5/1/97 (b).......... $ 4,961,000
VALUE
TOTAL INVESTMENTS
(COST-- $193,223,872) 98.7% $190,381,093
OTHER ASSETS AND LIABILITIES--
NET 1.3% 2,538,931
<C> <S> <C>
NET ASSETS 100.0% $192,920,024
</TABLE>
(a) The estimated maturity of a Collateralized Mortgage Obligation ("CMO") is
based on current and projected prepayment rates. Changes in interest rates
can cause the estimated maturity to differ from the listed dates.
(b) The repurchase agreements are fully collateralized by U.S. government
and/or agency obligations based on market prices at April 30, 1997.
(c) Securities that may be resold to "qualified institutional buyers" under
Rule 144A or securities offered pursuant to Section 4(2) of the Federal
Securities Act of 1933, as amended. These securities have been determined
to be liquid under guidelines established by the Board of Trustees.
(d) Effective yield (calculated at date of purchase) is the yield at which the
bond accretes on an annualized basis until maturity date.
LEGEND OF PORTFOLIO ABBREVIATIONS:
CD-- Canadian Dollar
DM-- German Deutsche Mark
FHLB-- Federal Home Loan Bank
FHLMC-- Federal Home Loan Mortgage Corporation
FNMA-- Federal National Mortgage Association
PAC-- Planned Amortization Class
RASTA-- Residential Asset Securitization Trust Association
REMIC-- Real Estate Mortgage Investment Conduit
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
<TABLE>
<CAPTION>
EXCHANGE U.S. $ VALUE AT IN EXCHANGE UNREALIZED
DATE APRIL 30, 1997 FOR U.S. $ APPRECIATION
<S> <C> <C> <C> <C>
<CAPTION>
Foward Foreign Currency Exchange Contracts to Sell:
Contracts to Deliver
<S> <C> <C> <C> <C>
5/9/97 18,688,000 German Deutsche Marks 10,797,750 11,409,941 $612,191
5/27/97 8,530,350 Canadian Dollars 6,117,884 6,303,835 185,951
$798,142
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 10
KEYSTONE QUALITY BOND FUND (B-1)
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
APRIL 30, 1997 YEAR ENDED OCTOBER 31,
(UNAUDITED) 1996 1995 1994 1993 1992 1991 1990 1989
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE BEGINNING
OF PERIOD $15.19 $15.42 $14.44 $16.40 $15.92 $15.92 $15.11 $15.85 $15.71
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income 0.38 0.75 0.87 0.76 0.96 1.04 1.08 1.11 1.21
Net realized and
unrealized gain (loss)
on investments
and foreign currency
related transactions (0.26) (0.16) 1.05 (1.76) 0.66 0.15 0.99 (0.53) 0.25
Total from investment
operations 0.12 0.59 1.92 (1.00) 1.62 1.19 2.07 0.58 1.46
LESS DISTRIBUTIONS FROM:
Net investment income (0.39) (0.76) (0.87) (0.76) (0.96) (1.04) (1.08) (1.18) (1.32)
In excess of net
investment income 0 0 (0.05) (0.09) (0.18) (0.15) (0.18) (0.14) 0
Tax basis return of
capital 0 (0.06) (0.02) (0.11) 0 0 0 0 0
Total distributions (0.39) (0.82) (0.94) (0.96) (1.14) (1.19) (1.26) (1.32) (1.32)
NET ASSET VALUE END OF
PERIOD $14.92 $15.19 $15.42 $14.44 $16.40 $15.92 $15.92 $15.11 $15.85
TOTAL RETURN (A) 0.80% 3.99% 13.69% (6.27%) 10.50% 7.71% 14.09% 3.93% 9.82%
RATIOS/SUPPLEMENTAL DATA
Ratios to average net
assets:
Total expenses 2.01%(b) 1.95% 1.96% 1.86% 1.94% 2.01% 2.04% 1.95% 1.82%
Expenses excluding
indirectly paid
expenses 2.00%(b) 1.93% 1.94% -- -- -- -- -- --
Net investment income 5.09%(b) 5.06% 5.86% 5.05% 5.85% 6.40% 6.95% 7.45% 7.61%
Portfolio turnover rate 99% 231% 244% 169% 190% 102% 158% 117% 116%
NET ASSETS END OF PERIOD
(THOUSANDS) $192,920 $228,649 $310,791 $327,276 $458,925 $456,912 $453,528 $408,330 $462,425
1988
NET ASSET VALUE BEGINNING
OF PERIOD $15.52
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income 1.19
Net realized and
unrealized gain (loss)
on investments
and foreign currency
related transactions 0.32
Total from investment
operations 1.51
LESS DISTRIBUTIONS FROM:
Net investment income (1.32)
In excess of net
investment income 0
Tax basis return of
capital 0
Total distributions (1.32)
NET ASSET VALUE END OF
PERIOD $15.71
TOTAL RETURN (A) 10.09%
RATIOS/SUPPLEMENTAL DATA
Ratios to average net
assets:
Total expenses 1.64%
Expenses excluding
indirectly paid
expenses --
Net investment income 7.49%
Portfolio turnover rate 153%
NET ASSETS END OF PERIOD
(THOUSANDS) $447,454
</TABLE>
(a) Excluding applicable sales charges.
(b) Annualized.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 11
STATEMENT OF ASSETS AND LIABILITIES
APRIL 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
<S> <C>
ASSETS
Investments at market value
(identified cost-- $193,223,872) $190,381,093
Cash 37,094
Foreign currency (cost-- $3,505) 3,492
Receivable for investments sold 7,063,719
Interest receivable 2,595,196
Net unrealized appreciation on forward
foreign
currency exchange contracts 798,142
Receivable for closed forward foreign
currency
exchange contracts 72,557
Receivable for Fund shares sold 9,747
Prepaid expenses and other assets 91,815
Total assets 201,052,855
LIABILITIES
Payable for investments purchased 7,082,738
Payable for Fund shares redeemed 516,018
Distributions to shareholders 311,189
Distribution fees payable 150,764
Due to related parties 36,387
Accrued expenses and other liabilities 35,735
Total liabilities 8,132,831
NET ASSETS $192,920,024
NET ASSETS REPRESENTED BY
Paid-in capital $223,406,039
Accumulated distributions in excess of net
investment income (452,062)
Accumulated net realized loss on investments
and foreign currency related transactions (27,921,856)
Net unrealized depreciation on investments
and foreign currency related transactions (2,112,097)
Total net assets $192,920,024
NET ASSET VALUE PER SHARE
Net assets of $192,920,024 4 12,927,464
shares outstanding $ 14.92
</TABLE>
STATEMENT OF OPERATIONS
SIX MONTHS ENDED APRIL 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
<S> <C> <C>
INVESTMENT INCOME
Interest (net of withholding taxes
of $2,920) $7,446,588
EXPENSES
Distribution Plan expenses $1,048,603
Management fee 641,936
Transfer agent fees 276,715
Custodian fees 62,086
Professional fees 21,869
Trustees' fees and expenses 19,998
Other 43,670
Total expenses 2,114,877
Less: Expenses paid indirectly (13,174)
Net expenses 2,101,703
Net investment income 5,344,885
NET REALIZED AND UNREALIZED GAIN
(LOSS) ON INVESTMENTS AND FOREIGN
CURRENCY RELATED TRANSACTIONS
Net realized gain on:
Investments 2,043,813
Foreign currency related
transactions 1,342,440
Net realized gain on investments
and foreign currency related
transactions 3,386,253
Net change in unrealized
appreciation (depreciation) on:
Investments (7,628,379)
Foreign currency related
transactions 689,048
Net change in unrealized
appreciation (depreciation) on
investments and foreign currency
related transactions (6,939,331)
Net realized and unrealized loss on
investments and foreign currency
related transactions (3,553,078)
Net increase in net assets
resulting from operations $1,791,807
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 12
KEYSTONE QUALITY BOND FUND (B-1)
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
APRIL 30, 1997 YEAR ENDED
(UNAUDITED) OCTOBER 31, 1996
<S> <C> <C>
OPERATIONS
Net investment income $ 5,344,885 $ 13,390,061
Net realized gain (loss) on investments and foreign currency related transactions 3,386,253 (2,183,664)
Net change in unrealized appreciation (depreciation) on investments and foreign
currency related transactions (6,939,331) (1,936,653)
Net increase in net assets resulting from operations 1,791,807 9,269,744
DISTRIBUTIONS TO SHAREHOLDERS FROM
Net investment income (5,396,962) (13,289,851)
Tax basis return of capital 0 (950,184)
Total distributions to shareholders (5,396,962) (14,240,035)
CAPITAL SHARE TRANSACTIONS
Proceeds from shares sold 13,436,496 44,210,094
Payments for shares redeemed (48,890,087) (130,171,813)
Net asset value of shares issued in reinvestment of dividends and distributions 3,329,611 8,789,681
Net decrease in net assets resulting from capital share transactions (32,123,980) (77,172,038)
Total decrease in net assets (35,729,135) (82,142,329)
NET ASSETS
Beginning of period 228,649,159 310,791,488
End of period [including accumulated distributions in excess of net investment
income as follows: 1997-- ($452,062) and 1996-- ($399,985)] $192,920,024 $228,649,159
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 13
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
Keystone Quality Bond Fund (B-1) (the "Fund") is a Pennsylvania common law trust
for which Keystone Investment Management Company ("Keystone") is the Investment
Adviser and Manager. Keystone was formerly a wholly-owned subsidiary of Keystone
Investments, Inc. ("KII") and is currently a subsidiary of First Union Keystone,
Inc. First Union Keystone, Inc. is a wholly-owned subsidiary of First Union
National Bank of North Carolina which in turn is a wholly-owned subsidiary of
First Union Corporation ("First Union"). The Fund is registered under the
Investment Company Act of 1940, as amended (the "1940 Act"), as a diversified,
open-end investment management company. The Fund's investment objective is to
provide the highest possible income consistent with preservation of principal.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles, which
require management to make estimates and assumptions that affect amounts
reported herein. Although actual results could differ from these estimates, any
such differences are expected to be immaterial to the net assets of the Fund.
A. VALUATION OF SECURITIES
U.S. Government obligations held by the Fund are valued at the mean between the
over-the-counter bid and asked prices as furnished by an independent pricing
service. Listed corporate bonds, other fixed-income securities, mortgage and
other asset-backed securities, and other related securities are valued at prices
provided by an independent pricing service. In determining value for normal
institutional-size transactions, the pricing service uses methods based on
market transactions for comparable securities and various relationships between
securities which are generally recognized by institutional traders. Securities
for which valuations are not available from an independent pricing service
(including restricted securities) are valued at fair value as determined in good
faith according to procedures established by the Board of Trustees.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value. Short-term
securities with greater than 60 days to maturity are valued at market value.
B. REPURCHASE AGREEMENTS
Pursuant to an exemptive order issued by the Securities and Exchange Commission,
the Fund, along with certain other Keystone funds, may transfer uninvested cash
balances into a joint trading account. These balances are invested in one or
more repurchase agreements that are fully collateralized by U.S. Treasury and/or
Federal Agency obligations.
Securities pledged as collateral for repurchase agreements are held by the
custodian on the Fund's behalf. The Fund monitors the adequacy of the collateral
daily and will require the seller to provide additional collateral in the event
the market value of the securities pledged falls below the carrying value of the
repurchase agreement.
C. REVERSE REPURCHASE AGREEMENTS
The Fund enters into reverse repurchase agreements with qualified third-party
broker-dealers. Interest on the value of reverse repurchase agreements is based
upon competitive market rates at the time of issuance. At the time the Fund
enters into a reverse repurchase agreement, it will establish and maintain a
segregated account with its custodian containing liquid assets having a value
not less than the repurchase price (including accrued interest). If the
counterparty to the transaction is rendered insolvent, the ultimate realization
of the securities to be repurchased by the Fund may be delayed or limited.
D. FOREIGN CURRENCY
The books and records of the Fund are maintained in United States (U.S.)
dollars. Foreign currency amounts are translated into United States dollars as
follows:
<PAGE>
PAGE 14
KEYSTONE QUALITY BOND FUND (B-1)
market value of investments, assets and liabilities at the daily rate of
exchange; purchases and sales of investments, income and expenses at the rate of
exchange prevailing on the respective dates of such transactions. Net unrealized
foreign exchange gain (loss) resulting from changes in foreign currency exchange
rates is a component of net unrealized appreciation (depreciation) on
investments and foreign currency related transactions. Net realized foreign
currency gains and losses resulting from changes in exchange rates include
foreign currency gains and losses between trade date and settlement date on
investment securities transactions, foreign currency transactions and the
difference between the amounts of interest and dividends recorded on the books
of the Fund and the amount actually received. The portion of foreign currency
gains and losses related to fluctuations in exchange rates between the initial
purchase trade date and subsequent sale trade date is included in realized gain
(loss) on foreign currency related transactions.
E. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund may enter into forward foreign currency exchange contracts ("forward
contracts") to settle portfolio purchases and sales of securities denominated in
a foreign currency and to hedge certain foreign currency assets or liabilities.
Forward contracts are recorded at the forward rate and marked-to-market daily.
Realized gains and losses arising from such transactions are included in net
realized gain (loss) on foreign currency related transactions. The Fund bears
the risk of an unfavorable change in the foreign currency exchange rate
underlying the forward contract and is subject to the credit risk that the other
party will not fulfill their obligations under the contract. Forward contracts
involve elements of market risk in excess of the amounts reflected in the
statement of assets and liabilities.
F. SECURITY TRANSACTIONS AND INVESTMENT INCOME
Securities transactions are accounted for no later than one business day after
the trade date. Realized gains and losses are computed on the identified cost
basis. Interest income is recorded on the accrual basis and includes
amortization of discounts.
G. FEDERAL INCOME TAXES
The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). Thus, the Fund is relieved of any federal income tax liability by
distributing all of its net taxable investment income and net taxable capital
gains, if any, to its shareholders. The Fund also intends to avoid excise tax
liability by making the required distributions under the Code. Accordingly, no
provision for federal income taxes is required.
H. DISTRIBUTIONS
The Fund distributes net investment income monthly and net capital gains, if
any, at least annually. Distributions to shareholders are recorded at the close
of business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally accepted
accounting principles. These differences are primarily due to differing
treatment for paydown gains (losses) and foreign currency related transactions
for income tax purposes that have been recognized for financial statement
purposes.
<PAGE>
PAGE 15
2. CAPITAL SHARE TRANSACTIONS
The Fund's Trust Agreement, as amended and restated, authorizes the issuance of
an unlimited number of shares of beneficial interest with a par value of $1.00.
Transactions in shares of the Fund were as follows:
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED
4/30/97 10/31/96
<S> <C> <C>
Shares sold 889,910 2,902,677
Shares redeemed (3,240,696) (8,577,419)
Shares issued in
reinvestment of
dividends and
distributions 222,503 581,588
Net decrease (2,128,283) (5,093,154)
</TABLE>
3. SECURITIES TRANSACTIONS
Cost of purchases and proceeds from sales of investment securities (excluding
short-term securities) were as follows for the six months ended April 30, 1997:
<TABLE>
<CAPTION>
COST OF PROCEEDS FROM
PURCHASES SALES
<S> <C> <C>
Non-U.S. Government $103,862,951 $ 148,886,635
U.S. Government 99,782,061 89,637,339
</TABLE>
The average daily balance of reverse repurchase agreements outstanding during
the six months ended April 30, 1997 was approximately $4,320,000 at a weighted
average interest rate of 4.59%. The maximum amount of borrowing during the six
months ended April 30, 1997 was $11,290,271 (including accrued interest).
As of October 31, 1996, the Fund had a capital loss carryover for federal
income tax purposes of approximately $30,627,000 which expires as follows:
$2,251,000-- 1998; $20,145,000-- 2002; $6,153,000-- 2003 and $2,078,000-- 2004.
4. DISTRIBUTION PLANS
The Fund bears some of the costs of selling its shares under a Distribution Plan
(the "Plan") adopted pursuant to Rule 12b-1 under the 1940 Act. Under the Plan,
the Fund pays its principal underwriter amounts which are calculated and paid
monthly.
On December 11, 1996, the Fund entered into a principal underwriting agreement
with Evergreen Keystone Distributor, Inc. (formerly, Evergreen Funds
Distributor, Inc.) ("EKD"), a wholly-owned subsidiary of The BISYS Group Inc.
Prior to December 11, 1996, Evergreen Keystone Investment Services, Inc.
(formerly, Keystone Investment Distributors Company) ("EKIS"), a wholly-owned
subsidiary of Keystone, served as the Fund's principal underwriter.
Under the Plan, the Fund pays a distribution fee which may not exceed 1.00% of
the Fund's average daily net assets. Of that amount, 0.75% is used to pay
distribution expenses and 0.25% may be used to pay service fees.
Contingent deferred sales charges paid by redeeming shareholders are paid to
EKD or its predecessor.
The Plan may be terminated at any time by vote of the Independent Trustees or
by vote of a majority of the outstanding voting shares of the Fund. However,
after the termination of the Plan, and at the discretion of the Independent
Trustees, payments to EKIS and/or EKD may continue as compensation for services
which had been earned while the Plan was in effect.
EKD intends, but is not obligated, to continue to pay distribution costs that
exceed the current annual payments from the Fund. EKD intends to seek full
payment of such distribution costs from the Fund at such time in the future as,
and to the extent that, payment thereof would be within permitted limits.
At April 30, 1997 total unpaid distribution costs were $8,422,778.
5. INVESTMENT ADVISORY AND MANAGEMENT AGREEMENT AND OTHER AFFILIATED
TRANSACTIONS
Under an investment advisory and management agreement dated December 11, 1996,
Keystone serves as the Investment Adviser and Manager to the Fund. Keystone
provides the Fund with investment advisory and management services. In return,
Keystone is paid a management fee, computed at an annual rate of 2.00%
<PAGE>
PAGE 16
KEYSTONE QUALITY BOND FUND (B-1)
of the Fund's gross investment income plus an amount determined by applying
percentage rates starting at 0.50% and declining as net assets increase to 0.25%
per annum, to the average daily net asset value of the Fund.
Prior to December 11, 1996, Keystone Management, Inc. ("KMI"), a wholly-owned
subsidiary of Keystone, served as Investment Manager to the Fund and provided
investment management and administrative services. Under an investment advisory
agreement between KMI and Keystone, Keystone served as the Investment Adviser
and provided investment advisory and management services to the Fund. In return
for its services, Keystone received an annual fee equal to 85% of the management
fee received by KMI.
During the six months ended April 30, 1997, the Fund paid or accrued $14,382
to Keystone for certain accounting services. Evergreen Keystone Service Company
(formerly, Keystone Investor Resource Center, Inc.), a wholly-owned subsidiary
of Keystone, serves as the Fund's transfer and dividend disbursing agent.
Officers of the Fund and affiliated Trustees receive no compensation directly
from the Fund.
6. EXPENSE OFFSET ARRANGEMENT
The Fund has entered into an expense offset arrangement with its custodian. For
the six months ended April 30, 1997, the Fund incurred total custody fees of
$62,086 and received a credit of $13,174 pursuant to this expense offset
arrangement, resulting in a net custody expense of $48,912. The assets deposited
with the custodian under this expense offset arrangement could have been
invested in income-producing assets.
<PAGE>
PAGE 17
ADDITIONAL INFORMATION
(UNAUDITED)
Shareholders of the Fund considered and acted upon the proposals listed below at
a special meeting of shareholders held Monday, December 9, 1996. In addition,
below each proposal are the results of that vote.
1. TO ELECT THE FOLLOWING TRUSTEES:
<TABLE>
<CAPTION>
AFFIRMATIVE WITHHELD
<S> <C> <C>
Frederick Amling 9,563,926 326,591
Laurence B. Ashkin 9,559,675 330,842
Charles A. Austin III 9,564,546 325,971
Foster Bam 9,561,429 329,088
George S. Bissell 9,557,891 332,626
Edwin D. Campbell 9,564,531 325,986
Charles F. Chapin 9,564,296 326,221
K. Dun Gifford 9,566,511 324,006
James S. Howell 9,563,039 327,478
Leroy Keith, Jr. 9,563,551 326,966
F. Ray Keyser 9,563,661 326,856
Gerald M. McDonnell 9,565,174 325,343
Thomas L. McVerry 9,564,296 326,221
William Walt Pettit 9,562,124 328,393
David M. Richardson 9,564,660 325,857
Russell A. Salton, III M.D. 9,563,049 327,468
Michael S. Scofield 9,566,481 324,036
Richard J. Shima 9,564,645 325,872
Andrew J. Simons 9,558,242 332,275
</TABLE>
2. TO APPROVE AN INVESTMENT ADVISORY AND MANAGEMENT AGREEMENT BETWEEN THE FUND
AND KEYSTONE INVESTMENT MANAGEMENT COMPANY:
<TABLE>
<S> <C>
Affirmative 9,363,597
Against 187,893
Abstain 339,027
</TABLE>
<PAGE>
KEYSTONE
FAMILY OF FUNDS
(Diamond appears here)
Balanced Fund (K-1)
Diversified Bond Fund (B-2)
Growth and Income Fund (S-1)
High Income Bond Fund (B-4)
International Fund Inc.
Liquid Trust
Mid-Cap Growth Fund (S-3)
Precious Metals Holdings, Inc.
Quality Bond Fund (B-1)
Small Company Growth Fund (S-4)
Strategic Growth Fund (K-2)
Tax Free Fund
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied by
the Fund's current prospectus. The prospectus contains important information
about the Fund including fees and expenses. Read it carefully before you invest
or send money. For a free prospectus on other Evergreen Keystone funds, contact
your financial adviser or call Evergreen Keystone.
(Logo appears here
Evergreen Keystone
Funds)
P.O. Box 2121 (Recycle logo appears here)
Boston, Massachusetts 02106-2121
B1-R REV01
6/97
KEYSTONE
(Photo of senior citizens with bikes appears here)
QUALITY
BOND FUND (B-1)
(Logo appears here
Evergreen Keystone
Funds)
SEMI-ANNUAL REPORT
APRIL 30, 1997
<PAGE>
PAGE 1
KEYSTONE DIVERSIFIED BOND FUND (B-2)
SEEKS GENEROUS INCOME AND CAPITAL PRESERVATION FROM A BROAD SPECTRUM OF BONDS.
Dear Shareholder:
We are pleased to report on the performance of Keystone Diversified Bond Fund
(B-2) for the 12-month fiscal year that ended on August 31, 1997. Following our
report, we have included a discussion with your Fund's manager and complete
financial information.
PERFORMANCE
Your Fund returned 12.25% for the 12-month period that ended on August 31, 1997.
The Lehman Aggregate Bond Index, a broad based index of corporate, government
and mortgage-backed securities, returned 10.00% for the same
12-month period.
We believe your Fund performed very well during the year. This strong
performance was achieved by following an active management strategy that
emphasizes research into sectors and individual bond issues while avoiding
attempts to anticipate interest rate shifts.
ENVIRONMENT
During the year, the U.S. economy was marked by moderate growth, restrained
inflation and, despite some short-term volatility caused by periodic concerns
about either inflation or recession, interest rates that tended to trade in a
well-defined range. Within this relatively healthy environment, corporate bonds
and mortgage-backed securities tended to outperform low risk government bonds,
and high yield securities outperformed investment grade corporate bonds.
Internationally, we witnessed solid economic growth, although the rate of
growth was somewhat slower in Japan and Europe. While foreign interest rates
tended to trend downward, returns from unhedged foreign investments tended to be
limited by the strength of the U.S. dollar.
STRATEGY
During the period, Fund management emphasized corporate bonds and
mortgage-backed securities because of the health of the U.S. economy and the
strength of corporate earnings. More than half the portfolio (56%) was allocated
to corporate bonds at the end of the period. In the investment grade bond area,
the Fund emphasized the finance sector, which benefited from the low inflation
environment. In the high yield area, the Fund emphasized highly liquid, better
quality securities from non-cyclical industries. High yield bonds tended to
outperform other sectors during the year, and as the year progressed your Fund
took profits from high yield bonds and re-allocated assets to other areas,
reducing the high yield commitment from about 30% to about 26% of net assets.
The Fund also invested in foreign opportunities, with about 13% of net assets
in foreign bonds at the end of the fiscal year. All foreign investments,
however, were either hedged or denominated in the U.S. dollar, to minimize
currency risk.
Throughout the year, the Fund minimized interest-rate anticipation as a key
component of its strategy. With interest rate volatility low and relatively
stable rates, little benefit was seen in trying to anticipate the direction of
rates.
At the conclusion of the fiscal year on August 31, 1997, average weighted
maturity was 11.4 years, and average credit quality was A.
-- CONTINUED--
<PAGE>
PAGE 2
KEYSTONE DIVERSIFIED BOND FUND (B-2)
OUTLOOK
Looking toward the future, we expect a general environment of moderate growth to
continue. However, the major uncertainty facing the market is whether cyclical
inflation pressures will rise. If this occurs, it is possible the Federal
Reserve Board may again raise short-term rates, as it did in March, to stave off
inflation.
Given this outlook, fund management intends to keep the fund well positioned
for an environment of growth, seeking relative values in the corporate and
mortgage-backed security areas, while limiting the exposure to short-term
interest rate volatility.
Thank you for your support of Keystone Diversified Bond Fund (B-2).
Sincerely,
Albert H. Elfner, III
CHAIRMAN
KEYSTONE INVESTMENT MANAGEMENT CO.
George S. Bissell
CHAIRMAN OF THE BOARD
KEYSTONE FUNDS
(photo of Albert H. Elfner, III) (photo of George S. Bissell)
ALBERT H. ELFNER, III GEORGE S. BISSELL
October 1997
<PAGE>
PAGE 3
A Discussion With
Your Fund's Manager
(photo of Christopher P. Conkey)
CHRISTOPHER P. CONKEY IS CHIEF INVESTMENT OFFICER OF KEYSTONE'S FIXED
INCOME GROUP AND THE PORTFOLIO MANAGER OF YOUR FUND. A CHARTERED FINANCIAL
ANALYST, MR. CONKEY HAS 14 YEARS OF EXPERIENCE MANAGING FIXED-INCOME
INVESTMENTS. HE HOLDS A BA IN ECONOMICS FROM CLARK UNIVERSITY AND AN MBA
IN FINANCE FROM BOSTON UNIVERSITY. MR. CONKEY IS SUPPORTED IN MANAGING THE
FUND BY RICHARD CRYAN, A KEYSTONE SENIOR VICE PRESIDENT AND PORTFOLIO
MANAGER WHO SPECIALIZES IN MANAGING HIGH YIELD BOND PORTFOLIOS.
WHAT WAS THE ENVIRONMENT LIKE DURING THE YEAR?
If you looked back over the 12 months in the United States, you would see a
period of moderate growth, low inflation, stable monetary policy and excellent
credit conditions. Interest rates traded within a very well defined range.
However, there was significant short-term volatility within the period. Over the
full year, interest rates, as reflected by the 30-year U.S. Treasury bond, went
from 7.12% on August 31, 1996 to 6.61% on August 31, 1997. During the year,
spreads tightened, meaning the difference narrowed between interest rates paid
by one type of bond and another.
Long-term rates declined more than short-term rates, and rates paid by high
yield corporate bonds declined more than rates paid by investment grade bonds or
government bonds.
When you consider the low inflation of the period, bond returns were very
attractive, with low volatility.
WHAT KIND OF INVESTMENT TACTICS DID YOU EMPLOY DURING THE PERIOD?
We use an active management style, and we look for areas in the fixed income
markets where we can find relative value. During the year, there was very little
opportunity to take advantage of trends in interest rates, and we didn't try to
anticipate in which direction rates might move. As a consequence, Treasury bonds
tended to be de-emphasized. Rather, we focused on sector and issue selection and
international opportunities. In particular, we focused on credit opportunities
in the corporate area, as well as in mortgage-backed securities. We tended to
emphasize corporate bonds, both investment grade and high yield, which together
accounted for about 56% of the portfolio at the end of the year. In the
investment grade area, we tended to emphasize debt from the finance sector,
which benefited from the environment of stable growth and low inflation. In the
high yield area, we tended to emphasize liquid, better quality securities.
PORTFOLIO ALLOCATIONS AUGUST 31, 1997
CREDIT QUALITY (AS A PERCENTAGE OF PORTFOLIO ASSETS)
(pie chart with following plot points)
Not rated 1.33%
AAA 33.93%
AA 10.39%
A 13.09%
BBB 14.51%
BB 12.45%
B 14.30%
PORTFOLIO ALLOCATIONS ARE SUBJECT TO CHANGE.
<PAGE>
PAGE 4
KEYSTONE DIVERSIFIED BOND FUND (B-2)
We had our greatest high yield weightings in the cable and media areas, which we
believe are less cyclical than other industrial areas. We also had an emphasis
on mortgage-backed securities, about 22% of the portfolio at the end of the
year. This was a period, because of the health of the economy and the strength
of corporate earnings, in which high yield bonds outperformed other parts of the
fixed income market. Over the period, as relative value changed because of the
superior performance of high yield bonds, we actually took some of our profits
from this sector and redeployed to other areas. High yield bonds, for example,
during the year went from about 30% of the portfolio's net assets to about 26%.
During the year, credit quality and maturity remained relatively unchanged.
Average credit quality at the end of the fiscal period was A. Average weighted
maturity was 11.4 years, while duration-- another indication of interest rate
sensitivity-- was 5.94 years.
HOW DID INTERNATIONAL INVESTMENTS FARE DURING THE YEAR?
Very well. Foreign government bonds tended to outperform domestic bonds during
the year. At the end of the year, 13.4% of net assets were in foreign bonds,
which were either hedged back into the U.S. dollar or denominated in U.S.
dollars. The Fund took no currency risk, which was good, because the strength of
the U.S. dollar tended to undermine gains from unhedged foreign investments. Our
foreign investments were mostly government bonds from Germany, Canada and
Denmark.
We had an environment of solid global economic growth, led by the strength of
the U.S. economy. Growth tended to be slow in Europe and Japan, but overall the
global economy was in balance, with relatively low interest rate volatility.
HOW WOULD YOU DESCRIBE THE INVESTMENT STRATEGY OF THE FUND?
We draw on the Keystone investment process. Our investment philosophy is built
on the premise of active management, with a primary focus on total return. Our
goal is to seek consistently superior performance over full market cycles. The
investment process can best be described as a combination of a policy-driven
(top down) and sector rotation/security selection (bottom up) approach.
HOW DOES THIS PROCESS WORK?
The process consists of three stages. First, our Fixed Income Policy Committee
meets monthly to formulate macroeconomic projections. Specific emphasis is
placed on analysis of the business cycle, monetary policy, fiscal policy,
international issues and social and demographic trends. Second, given this
macroeconomic framework, we determine the optimal exposure to interest rate
risk, credit risk and asset allocation. We are aware of changing interest rates,
but we minimize interest rate anticipation. Finally, portfolio managers and
analysts work together to determine and implement appropriate sector weightings
and issue selection.
WHAT IS YOUR CURRENT OUTLOOK?
Basically, we see a continuation of moderate economic growth. We believe,
however, that cyclical pressures that sometimes lead to inflation are rising.
Unemployment, for example, is relatively low, and this could lead to pressure on
prices. The fixed income market is concerned about the possibility that the
Federal Reserve Board could raise short-term rates in anticipation of inflation.
If the FED does tighten money supply, we think it will move slowly.
Given this outlook, we are emphasizing securities that offer attractive
income, and we are avoiding taking risks with longer maturities. We think the
Fund is very well positioned for an environment of stronger economic growth.
(graphic of diamond)
THIS COLUMN IS INTENDED TO ANSWER QUESTIONS ABOUT YOUR FUND.
IF YOU HAVE A QUESTION YOU WOULD LIKE ANSWERED, PLEASE WRITE TO:
EVERGREEN KEYSTONE INVESTMENT SERVICES, INC.
ATTN: SHAREHOLDER COMMUNICATIONS
201 SOUTH COLLEGE STREET, SUITE 400,
CHARLOTTE, N.C. 28288-1195
<PAGE>
PAGE 5
Growth of an Investment
Keystone Diversified Bond Fund (B-2)
In Thousands
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Dividend Reinvestment (Customer please fill in) Total Value: $19,973
Initial Investment
8/87 8/88 8/89 8/90 8/91 8/92 8/93 8/94 8/95 8/96 8/97
</TABLE>
A $10,000 investment in Keystone Diversified Bond Fund (B-2) made on August 31,
1987 with all distributions reinvested was worth $19,973 on August 31,1997. Past
performance is no guarantee of future results.
Comparison of a change in value if a $10,000 investment in Keystone Diversified
Bond Fund (B-2), the Lehman Aggregate Bond Index (LABI) and the Consumer Price
Index (CPI).
In Thousands
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Fund (Customer please fill in) $19,973
CPI $14,130
LABI $23,715
8/87 8/88 8/89 8/90 8/91 8/92 8/93 8/94 8/95 8/96 8/97
</TABLE>
Past performance is no guarntee of future results. The Lehman Aggregate Bond
Index is an unmanaged, marks index. The index does not include transaction costs
associated with buying and selling securities, nor any management fees. The
cunsumer Price Index, a measure of inflation, is through August 31, 1997.
The cumulative and average annual total returns with sales charge calculations
reflect the deduction of the 3% contingent deferred sales charge (CDSC) for
those investors who sold Fund shares after one calendar year. Investors who
retained their investment earned the returns in the lines called "w/o sales
charge."
The investment return and principal value will fluctuate so that your shares,
when redeemed, may be worth more or less than the original cost. Past
performance is no guarantee of future results.
You may exchange your shares for another Keystone Classic fund by phone or in
writing. The Fund reserves the right to change or terminate the exchange offer.
<TABLE>
<CAPTION>
HISTORICAL RECORD
<S> <C>
CUMULATIVE TOTAL RETURN
<S> <C>
1 year w/o sales charge 12.25%
1 year w/ sales charge 9.25%
5 years 37.31%
10 years 99.73%
AVERAGE ANNUAL TOTAL RETURN
1 year w/o sales charge 12.25%
1 year w/ sales charge 9.25%
5 years 6.55%
10 years 7.16%
</TABLE>
<PAGE>
PAGE 6
KEYSTONE DIVERSIFIED BOND FUND (B-2)
SCHEDULE OF INVESTMENTS-- AUGUST 31, 1997
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
<CAPTION>
INDUSTRIAL BONDS AND NOTES-- 55.8%
<C> <S> <C>
ADVERTISING & RELATED
SERVICES-- 0.9%
$ 1,000,000 Hollinger International,
Senior Subord. Notes,
9.25%, 2/1/06................. $ 1,030,000
2,000,000 K-III Communications
Corporation,
Senior Note,
8.50%, 2/1/06................. 2,010,000
1,250,000 Lamar Advertising Company,
Senior Subord. Note,
9.625%, 12/1/06............... 1,325,000
4,365,000
AEROSPACE-- 1.2%
5,000,000 Northrop Grumman Corporation,
Debenture,
9.375%, 10/15/24.............. 5,667,400
BUILDING & CONSTRUCTION-- 1.1%
2,000,000 H M H Properties Inc.,
Senior Secured Note, Series B,
9.50%, 5/15/05................ 2,085,000
2,500,000 Johns Manville International
Group Inc., Senior Note,
10.875%, 12/15/04............. 2,796,875
4,881,875
CHEMICALS-- 0.7%
1,500,000 Freedom Chemical Company,
Senior Subord. Note,
10.625%, 10/15/06............. 1,582,500
1,450,000 Huntsman Polymers Corporation,
Senior Note,
11.75%, 12/1/04............... 1,660,250
3,242,750
CONSUMER PRODUCTS &
SERVICES-- 2.5%
1,000,000 Aurora Foods Inc.,
Senior Subord. Note Series C,
9.875%, 2/15/07 (b)........... 1,015,000
1,000,000 Consumers International Inc.,
Senior Secured Note,
10.25%, 4/1/05 (b)............ 1,070,000
2,500,000 Coty Inc.,
Senior Subord. Note,
10.25%, 5/1/05................ 2,681,250
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
<CAPTION>
INDUSTRIAL BONDS AND NOTES-- CONTINUED
<C> <S> <C>
CONSUMER PRODUCTS &
SERVICES-- CONTINUED
$ 1,175,000 Drypers Corporation,
Senior Note, Series B,
10.25%, 6/15/07............... $ 1,175,000
3,500,000 Revlon Worldwide Corporation,
Senior Secured Discount Note,
Series B,
(Eff. Yield 12.95%) (e),
0.00%, 3/15/98................ 3,325,000
2,000,000 Scotts and Sons Company,
Senior Subord. Note,
9.875%, 8/1/04................ 2,145,000
11,411,250
DIVERSIFIED COMPANIES-- 3.0%
6,000,000 General Electric Capital
Corporation,
Guaranteed Notes,
7.50%, 8/21/35................ 6,293,160
5,000,000 Grand Metropolitan Investment
Corporation,
Guaranteed Senior Note,
7.45%, 4/15/35................ 5,314,900
2,000,000 ISP Holdings Inc.,
Senior Note, Series B,
9.75%, 2/15/02................ 2,150,000
13,758,060
ELECTRICAL EQUIPMENT &
ELECTRONICS-- 0.2%
750,000 Amphenol Corporation,
Senior Subord. Note,
9.875%, 5/15/07............... 787,500
ENERGY-- 0.8%
2,000,000 Dawson Production Services Inc.,
Senior Note,
9.375%, 2/1/07................ 2,060,000
1,500,000 Energy Corporation America,
Senior Subord. Note,
9.50%, 5/15/07 (b)............ 1,500,000
3,560,000
FINANCE & BANKING-- 12.3%
3,000,000 ABN-Amro Bank NV,
Subord. Debenture,
7.30%, 12/1/26................ 2,876,580
</TABLE>
<PAGE>
PAGE 7
SCHEDULE OF INVESTMENTS-- AUGUST 31, 1997
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
INDUSTRIAL BONDS AND NOTES-- CONTINUED
<C> <S> <C>
FINANCE & BANKING-- CONTINUED
$10,000,000 Amsouth Bancorporation,
Subord. Debenture,
6.75%, 11/1/25................ $ 9,881,500
5,000,000 Commercial Credit Group, Inc.,
Notes,
10.00%, 5/15/09............... 6,137,900
2,500,000 First Nationwide Holdings Inc.,
Senior Exchange Note,
12.25%, 5/15/01............... 2,775,000
5,000,000 General Motors Acceptance
Corporation, Note,
7.125%, 5/1/01................ 5,082,800
2,400,000 Green Tree Financial
Corporation,
Senior Subord. Note,
10.25%, 6/1/02................ 2,714,448
2,500,000 Hutchinson Whampoa Finance
Limited,
6.988%, 8/1/37................ 2,446,025
2,889,073 Marine Midland Bank,
8.00%, 11/25/24............... 2,883,656
9,000,000 Mellon Bank Capital II,
Debenture,
7.995%, 1/15/27............... 8,998,290
2,000,000 Norwest Financial Inc., Note,
6.625%, 7/15/04............... 1,982,220
5,300,000 PVNGS II Funding Corporation
Inc.,
8.00%, 12/30/15............... 5,554,877
5,000,000 Travelers Insurance Trust
Preferred Debenture,
7.75%, 12/1/36................ 4,864,350
56,197,646
FOOD RETAILING & DISTRIBUTION-- 0.4%
1,750,000 AFC Enterprises Inc.,
Senior Subord. Note,
10.25%, 5/15/07 (b)........... 1,802,500
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
<CAPTION>
INDUSTRIAL BONDS AND NOTES-- CONTINUED
<C> <S> <C>
GAMING-- 0.4%
$ 1,250,000 Horseshoe Gaming LLC,
9.375%, 6/15/07............... $ 1,275,000
750,000 Riviera Holdings Corporation,
Guaranteed 1st Mortgage Note,
10.00%, 8/15/04 (b)........... 740,625
2,015,625
HEALTHCARE PRODUCTS &
SERVICES-- 0.7%
2,000,000 Genesis Health Ventures Inc.,
Senior Subord. Note,
9.25%, 10/1/06................ 2,050,000
1,000,000 Vencor Inc.,
Senior Subord. Note,
8.625%, 7/15/07 (b)........... 1,000,000
3,050,000
HOTELS AND RESTAURANTS-- 0.7%
2,000,000 California Hotel Finance
Corporation,
11.00%, 12/1/02............... 2,105,000
1,000,000 Wyndham Hotel Corporation,
Senior Subord. Note,
10.50%, 5/15/06............... 1,130,000
3,235,000
INDUSTRIAL SPECIALTY PRODUCTS
& SERVICES-- 0.9%
1,000,000 Coach USA Inc.,
Senior Subord. Note,
9.375%, 7/1/07 (b)............ 997,500
2,000,000 HS Resources Inc.,
9.25%, 11/15/06............... 2,020,000
1,250,000 Polymer Group Inc.,
Senior Subord. Note,
9.00%, 7/1/07 (b)............. 1,250,000
4,267,500
INFORMATION SERVICES &
TECHNOLOGY-- 0.5%
2,000,000 Unisys Corporation,
Senior Note,
11.75%, 10/15/04.............. 2,210,000
</TABLE>
<PAGE>
PAGE 8
KEYSTONE DIVERSIFIED BOND FUND (B-2)
SCHEDULE OF INVESTMENTS-- AUGUST 31, 1997
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
INDUSTRIAL BONDS AND NOTES-- CONTINUED
<C> <S> <C>
INSURANCE-- 10.8%
$ 5,000,000 Lumbermens Mutual Casualty
Company,
Senior Subord. Note,
9.15%, 7/1/26 (b)............. $ 5,590,350
MBIA Inc.:
10,500,000 9.375%, 2/15/11................. 12,607,560
3,500,000 7.15%, 7/15/27.................. 3,475,036
10,000,000 Nationwide CSN Trust,
Senior Notes,
9.875%, 2/15/25 (b)........... 11,042,900
4,300,000 Prudential Life Insurance
Corporation,
7.125%, 7/1/07 (b)............ 4,263,719
2,000,000 Reliance Group Holdings Inc.,
Senior Subord. Debenture,
9.75%, 11/15/03............... 2,094,480
10,000,000 SunLife Canada, US Capital Trust
I,
Capital Securities,
8.526%, 5/29/49 (b)........... 10,432,600
49,506,645
METALS & MINING-- 0.5%
2,000,000 AK Steel Corporation,
Senior Note,
10.75%, 4/1/04................ 2,165,000
MACHINERY-- DIVERSIFIED-- 2.1%
8,850,000 John Deere Capital Corporation,
8.625%, 8/1/19................ 9,431,711
LEISURE & TOURISM-- 1.5%
2,500,000 Affinity Group Inc.,
11.50%, 10/15/03.............. 2,681,250
2,000,000 Casino America Inc.,
Senior Secured Note,
12.50%, 8/1/03................ 2,100,000
2,250,000 Six Flags Theme Parks Inc.,
Senior Disc. Notes, Step Bond,
(Eff. Yield 11.12%) (e),
12.25%, 6/15/05............... 2,323,125
7,104,375
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
<CAPTION>
INDUSTRIAL BONDS AND NOTES-- CONTINUED
<C> <S> <C>
OIL-- 0.7%
$ 1,075,000 Synder Oil Corporation,
Senior Subord. Note,
8.75%, 6/15/07................ $ 1,080,375
2,000,000 Triton Energy Ltd,
Senior Note,
9.25%, 4/15/05................ 2,120,000
3,200,375
PAPER & PACKAGING-- 0.5%
2,000,000 Tembec Finance Corporation,
Guaranteed Senior Note,
9.875%, 9/30/05............... 2,095,000
PUBLISHING, BROADCASTING &
ENTERTAINMENT-- 3.2%
1,500,000 American Media Operations Inc.,
Senior Subord. Note,
11.625%, 11/15/04............. 1,642,500
1,000,000 Fox/Liberty Networks LLC,
Senior Discount Note,
(Eff. Yield 10.80%) (e),
0.00%, 8/15/07 (b)............ 615,000
1,175,000 Fundy Cable Limited,
Senior Secured Second Priority
Note,
11.00%, 11/15/05.............. 1,271,938
800,000 Hollywood Entertainment
Corporation,
Senior Subord. Note,
10.625%, 8/15/04 (b).......... 817,000
2,000,000 SFX Broadcasting Inc.,
Senior Subord. Note,
10.75%, 5/15/06............... 2,160,000
2,500,000 Sinclair Broadcast Group Inc.,
Senior Subord. Note,
10.00%, 9/30/05............... 2,612,500
5,000,000 Time Warner Inc.,
9.15%, 2/1/23................. 5,664,750
14,783,688
</TABLE>
<PAGE>
PAGE 9
SCHEDULE OF INVESTMENTS-- AUGUST 31, 1997
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
INDUSTRIAL BONDS AND NOTES-- CONTINUED
<C> <S> <C>
RETAIL-- 1.1%
$ 2,000,000 Cole National Group Inc.,
Senior Note,
11.25%, 10/1/01............... $ 2,185,000
2,000,000 Finlay Fine Jewelry Corporation,
Senior Note,
10.625%, 5/1/03............... 2,100,000
950,000 Marsh Supermarkets Inc.,
Senior Subord. Note,
8.875%, 8/1/07 (b)............ 940,500
5,225,500
STATE & LOCAL DEBT-- 1.1%
4,806,071 Los Angeles, California, Fire
Safety Improvement Bond Act,
Assessment District #1,
8.48%, 9/2/15 (b)............. 5,067,401
TELECOMMUNICATIONS-- 4.4%
2,250,000 Capital Funding
Corporation,
Debenture,
7.12%, 7/15/07................ 2,187,000
5,000,000 Continental Cablevision Inc.,
9.00%, 9/1/08................. 5,679,300
3,750,000 Millicom International Cellular
S.A.,
Senior Subord. Discount Note,
13.50%, 6/1/06................ 2,817,187
1,175,000 Nextel Communications Inc.,
Senior Discount Note,
(Eff. Yield 9.34%) (e),
0.00%, 9/1/03................. 1,116,250
2,000,000 Talton Holdings Inc.,
Senior Note,
11.00%, 6/30/07 (b)........... 2,110,000
4,000,000 Telewest PLC,
Senior Discount Debenture,
(Eff. Yield 9.825%) (e),
0.00%, 10/1/07................ 2,970,000
3,000,000 Vanguard Cellular Systems Inc.,
Senior Debenture,
9.375%, 4/15/06............... 3,082,500
19,962,237
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
<CAPTION>
INDUSTRIAL BONDS AND NOTES-- CONTINUED
<C> <S> <C>
TEXTILE & APPAREL-- 0.6%
$ 700,000 Delta Mills Inc.,
Senior Note,
9.625%, 9/1/07 (b)............ $ 703,500
2,000,000 Dominion Textile USA Inc.,
Senior Note,
8.875%, 11/1/03............... 2,040,000
2,743,500
TRANSPORTATION-- 3.0%
2,000,000 Airplane Pass Through Trust,
Series 1 Class D, Subord.
Bond,
10.88%, 3/15/19............... 2,327,160
500,000 Equimar Shipholdings Limited,
Guaranteed 1st Preferred Ship
Mortgage Note,
9.875%, 7/1/07................ 480,000
4,000,000 Golden State Petroleum
Transportation Corporation,
1st Preferred Mortgage Note,
8.04%, 2/1/19 (b)............. 4,079,600
2,000,000 Hayes Wheels International,
Senior Subord. Note,
9.125%, 7/15/07 (b)........... 2,030,000
4,500,000 Norfolk Southern Corporation,
Note,
7.05%, 5/1/37................. 4,613,355
13,530,115
TOTAL INDUSTRIAL BONDS AND NOTES
(COST $248,816,293)......... 255,267,653
<CAPTION>
COLLATERALIZED MORTGAGE OBLIGATIONS-- 19.3%
<C> <S> <C>
3,000,000 Asset Securitization
Corporation,
Series 96-D3 Class A3,
(Est. Maturity 2010)(a),
7.693%, 10/31/26.............. 3,173,880
3,600,000 BA Mortgage Securities Inc.,
Series 1997-1 Class M,
(Est. Maturity 2009) (a),
7.50%, 7/25/26................ 3,599,438
2,984,358 Chase Mortgage Finance
Corporation,
Series 1994L Class B1,
(Est. Maturity 2005) (a),
7.88%, 11/25/25 (b)........... 2,945,188
</TABLE>
<PAGE>
PAGE 10
KEYSTONE DIVERSIFIED BOND FUND (B-2)
SCHEDULE OF INVESTMENTS-- AUGUST 31, 1997
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
COLLATERALIZED MORTGAGE
OBLIGATIONS-- CONTINUED
<C> <S> <C>
$ 5,000,000 Credit Suisse First Boston
Mortgage,
Series 97 C1 Class A1C,
(Est. Maturity 2007) (a),
7.24%, 4/20/07................ $ 5,107,812
3,100,860 Criimi Mae Financial
Corporation,
Series 1 Class A,
(Est. Maturity 2011) (a),
7.00%, 1/1/33................. 3,019,463
5,000,000 Federal Home Loan Mortgage
Corporation,
Series 47 Class A,
(Est. Maturity 2004) (a),
5.00%, 2/25/22................ 4,500,000
191,912 Federal Home Loan Mortgage PC
Gtd, Series 8 Class SB,
(Est. Maturity 2006) (a)(d),
9.60%, 3/25/23................ 158,147
FHA Charles River Mortgage:
(Est. Maturity 1999) (a)
6,735,768 9.13%, 8/1/34................... 7,264,105
4,996,003 10.25%, 8/1/34.................. 5,286,395
12,510,527 FNMA,
Series 1993-248 Class A,
(Est. Maturity 2004) (a),
3.492%, 8/25/23............... 9,542,279
5,700,000 FNMA, Gtd.,
REMIC Trust 1993 SC,
(Est. Maturity 2004) (a),
5.469%, 10/25/08.............. 4,948,313
5,176,790 GE Capital Mortgage Services
Inc.,
REMIC MC 1994-10 Class A14,
(Est. Maturity 2001) (a),
6.50%, 3/25/24................ 5,026,339
7,958,723 Independent National Mortgage
Corp.,
Series 1997-A,
(Est. Maturity 2006) (a),
7.85%, 12/26/26 (b)........... 8,005,182
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
<CAPTION>
COLLATERALIZED MORTGAGE
OBLIGATIONS-- CONTINUED
<C> <S> <C>
Morgan Stanley Capital I Inc.
Commercial Mortgage:
$ 3,300,000 Certificate 1997-C1 Class B
(Est. Maturity 2007) (a)
7.69%, 2/15/20................ $ 3,456,750
2,000,000 Series 1997 WF1 Class A2
(Est. Maturity 2007) (a) (b)
7.22%, 5/15/07................ 2,048,750
2,832,819 Paine Webber Mortgage
Acceptance Corporation IV,
Series 1993-4 Class M1,
(Est. Maturity 2005) (a),
7.50%, 5/25/23................ 2,862,033
PNC Mortgage Securities
Corporation:
2,498,344 Series 1997-4 Class 2PP1
(Est. Maturity 2000) (a)
7.25%, 7/25/27.............. 2,479,406
4,984,171 Series 1997-4 Class 2PP3
(Est. Maturity 2008) (a)
7.50%, 7/25/27.............. 5,021,553
5,000,000 Residential Asset Securitization
Trust,
Series 1996-A3 Class A9,
(Est. Maturity 2006) (a),
7.50%, 7/25/26................ 4,935,156
4,889,260 Ryland Acceptance Corporation
IV, Series 88 Class E,
(Est. Maturity 2000) (a),
7.95%, 1/1/19................. 4,979,369
TOTAL COLLATERALIZED MORTGAGE
OBLIGATIONS
(COST $86,950,244)............ 88,359,558
<CAPTION>
FOREIGN BONDS (NON U.S. DOLLARS)-- 8.6%
<C> <S> <C>
18,400,000 Canada Government,
CAD 8.75%, 12/1/05.................. 15,676,946
59,177,000 Kingdom of Denmark, Bonds,
DKK 7.00%, 11/15/07................. 9,065,944
24,700,000 Federal Republic of Germany,
DEM Bonds,
6.875%, 5/12/05............... 14,889,246
TOTAL FOREIGN BONDS (NON U.S.
DOLLARS) (COST $42,642,729)... 39,632,136
</TABLE>
<PAGE>
PAGE 11
SCHEDULE OF INVESTMENTS-- AUGUST 31, 1997
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
FOREIGN BONDS (U.S. DOLLARS)-- 4.8%
<C> <S> <C>
$ 2,000,000 APP International Finance
Company B.V.,
Secured Senior Notes,
11.75%, 10/1/05............... $ 2,105,000
650,000 Azteca Holdings S.A. De CV,
Senior Secured Note,
11.00%, 6/15/02 (b)........... 679,250
3,500,000 Grupo Televisa S.A. De CV,
Senior Notes, Series B,
11.875%, 5/15/06 (b).......... 3,989,475
3,000,000 Indah Kiat International Finance
Company B.V.,
Gtd Secured Note,
12.50%, 6/15/06............... 3,277,500
4,000,000 Ispat Mexicana SA,
Senior Unsecured Debenture,
10.375%, 3/15/01.............. 4,225,000
5,000,000 Petrozuata Finance Inc.,
Bond, Series A,
7.63%, 4/1/09 (b)............. 5,091,600
650,000 Polytama International Finance
B.V.,
Guaranteed Secured Note,
11.25%, 6/15/07............... 625,625
2,000,000 Stena AB, Senior Notes,
10.50%, 12/15/05.............. 2,190,000
TOTAL FOREIGN BONDS (U.S.
DOLLARS)
(COST $20,492,316).......... 22,183,450
<CAPTION>
ASSET- BACKED SECURITIES-- 2.5%
<C> <S> <C>
Merrill Lynch Mortgage Investors
Inc.
1,292,601 Series 1992-D Class B
(Est. Maturity 2001) (a)
8.50%, 7/15/17.............. 1,355,330
5,000,000 Series 1996-C1 Class B
(Est. Maturity 2006) (a)
7.42%, 4/25/28.............. 5,133,594
5,000,000 Zale Funding Trust,
Series 94-1 Class A2,
(Est. Maturity 1999) (a),
7.325%, 3/15/03............... 5,062,500
TOTAL ASSET-BACKED SECURITIES
(COST $11,418,706).............. 11,551,424
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
<CAPTION>
U.S. GOVERNMENT & AGENCY OBLIGATIONS-- 6.0%
<C> <S> <C>
$74,050,000 United States Treasury Bond STRIPS
(Eff. Yield 6.83%) (e),
0.00%, 11/15/21............... $ 14,559,711
11,250,000 United States Treasury Bonds,
7.875%, 2/15/21............... 12,786,300
TOTAL U.S. GOVERNMENT & AGENCY
OBLIGATIONS
(COST $26,432,963)............ 27,346,011
<CAPTION>
SHARES
COMMON STOCKS-- 0.1% (COST $2)
<C> <S> <C>
DIVERSIFIED COMPANIES-- 0.1%
1,618 PM Holdings Corporation......... 566,300
<CAPTION>
PREFERRED STOCKS-- 0.4%
(COST $1,600,000)
<C> <S> <C>
TELECOMMUNICATIONS-- 0.4%
16,000 Adelphia Communications
Corporation (b)............... 1,720,000
<CAPTION>
PRINCIPAL
AMOUNT
REPURCHASE AGREEMENT-- 1.0%
(COST $4,425,000)
<C> <S> <C>
$ 4,425,000 Keystone Joint Repurchase
Agreement, (Investments in
repurchase agreements, in a
joint trading account
5.58% dated 8/29/97, due
9/2/97 maturity value
$4,427,746) (c)............... 4,425,000
</TABLE>
<TABLE>
<C> <S> <C> <C>
TOTAL INVESTMENTS--
(COST $442,778,253).................. 98.5% 451,051,532
OTHER ASSETS AND
LIABILITIES-- NET.................... 1.5 6,649,323
NET ASSETS............................. 100.0% $457,700,855
</TABLE>
<PAGE>
PAGE 12
KEYSTONE DIVERSIFIED BOND FUND (B-2)
SCHEDULE OF INVESTMENTS-- AUGUST 31, 1997
(a) The estimated maturity of a Collateralized Mortgage Obligation ("CMO") is
based on current and projected prepayment rates. Changes in interest rates
can cause the estimated maturity to differ from the listed dates.
(b) Securities that may be resold to "qualified institutional buyers" under Rule
144A or securities offered pursuant to Section 4(2) of the Federal
Securities Act of 1933, as amended. These securities have been determined to
be liquid under guidelines established by the Board of Trustees.
(c) The repurchase agreements are fully collateralized by U.S. government
and/or agency obligations based on market prices at August 31, 1997.
(d) Inverse floater.
(e) Effective yield (calculated at date of purchase) is the yield at which the
bond accretes on an annualized basis until maturity date.
LEGEND OF PORTFOLIO ABBREVIATIONS:
FHA-- Federal Housing Authority
FNMA-- Federal National Mortgage Association
REMIC-- Real Estate Mortgage Investment Conduit
STRIPS-- Separate Trading of Registered Interest and Principal of Securities
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
<TABLE>
<CAPTION>
NET
EXCHANGE U.S. $ VALUE AT IN EXCHANGE UNREALIZED
DATE AUGUST 31, 1997 FOR U.S. $ DEPRECIATION
<S> <C> <C> <C> <C>
<CAPTION>
Foward Foreign Currency Exchange Contracts to Sell:
Contracts to Deliver
<S> <C> <C> <C> <C>
10/14/97 66,264,000 Danish Krone 9,665,463 9,571,573 $ (93,890)
11/12/97 27,658,000 Deutsche Marks 15,399,906 14,895,319 (504,587)
11/26/97 22,438,000 Canadian Dollars 16,244,776 16,201,891 (42,885)
$(641,362)
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 13
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR)
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
1997 1996 1995 1994 1993
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE BEGINNING OF YEAR $14.65 $15.09 $15.28 $17.06 $16.44
INCOME FROM INVESTMENT OPERATIONS
Net investment income 0.91 0.95 1.06 1.06 1.28
Net realized and unrealized gain (loss) on investments and
foreign currency related transactions 0.84 (0.35) 0.11 (1.62) 0.70
Total from investment operations 1.75 0.60 1.17 (0.56) 1.98
LESS DISTRIBUTIONS FROM:
Net investment income (0.93) (0.96) (1.06) (1.22) (1.28)
In excess of net investment income (0.05) 0 (0.22) 0 (0.08)
Tax basis return of capital 0 (0.08) (0.08) 0 0
Net realized gain on investments 0 0 0 0 0
Total distributions (0.98) (1.04) (1.36) (1.22) (1.36)
NET ASSET VALUE END OF YEAR $15.42 $14.65 $15.09 $15.28 $17.06
TOTAL RETURN (A) 12.25% 4.03% 8.13% (3.53%) 12.73%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses 1.88% 1.84% 1.81% 1.75% 1.89%
Total expenses excluding indirectly paid expenses 1.87% 1.83% -- -- --
Net investment income 6.07% 6.42% 7.05% 6.48% 7.73%
PORTFOLIO TURNOVER RATE 138% 246% 178% 200% 133%
NET ASSETS END OF YEAR (THOUSANDS) $457,701 $559,792 $734,837 $814,245 $1,004,393
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
1992 1991 1990 1989 1988
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE BEGINNING OF YEAR $15.37 $15.51 $17.74 $17.99 $18.91
INCOME FROM INVESTMENT OPERATIONS
Net investment income 1.33 1.33 1.53 1.71 1.78
Net realized and unrealized gain (loss) on investments and
foreign currency related transactions 1.14 0.17 (1.94) (0.13) (0.81)
Total from investment operations 2.47 1.50 (0.41) 1.58 0.97
LESS DISTRIBUTIONS FROM:
Net investment income (1.33) (1.63) (1.61) (1.83) (1.85)
In excess of net investment income (0.07) (0.01) (0.21) 0 0
Tax basis return of capital 0 0 0 0 0
Net realized gain on investments 0 0 0 0 (0.04)
Total distributions (1.40) (1.64) (1.82) (1.83) (1.89)
NET ASSET VALUE END OF YEAR $16.44 $15.37 $15.51 $17.74 $17.99
TOTAL RETURN (A) 16.88% 10.58% (2.44%) 9.23% 5.61%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses 1.99% 1.94% 1.89% 1.84% 1.68%
Total expenses excluding indirectly paid expenses -- -- -- -- --
Net investment income 8.29% 8.74% 9.26% 9.52% 9.82%
PORTFOLIO TURNOVER RATE 117% 101% 43% 47% 46%
NET ASSETS END OF YEAR (THOUSANDS) $902,339 $814,528 $860,615 $1,000,305 $838,892
</TABLE>
(a) Excluding applicable sales charges.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 14
KEYSTONE DIVERSIFIED BOND FUND (B-2)
STATEMENT OF ASSETS AND LIABILITIES
AUGUST 31, 1997
<TABLE>
<CAPTION>
<S> <C>
ASSETS
Investments at market value
(identified cost-- $442,778,253) $451,051,532
Cash 132
Interest receivable 7,087,330
Receivable for investments sold 1,751,296
Receivable for Fund shares sold 114,872
Prepaid expenses and other assets 128,392
Total assets 460,133,554
LIABILITIES
Distributions payable 1,030,132
Net unrealized depreciation on forward
foreign currency exchange contracts 641,362
Distribution fees payable 473,689
Payable for Fund shares redeemed 193,838
Due to related parties 8,400
Accrued Trustees' fees and expenses 1,093
Accrued expenses and other liabilities 84,185
Total liabilities 2,432,699
NET ASSETS $457,700,855
NET ASSETS REPRESENTED BY
Paid-in capital $607,639,863
Undistributed net investment income 2,801,682
Accumulated net realized loss on investments
and foreign currency related transactions (160,349,985)
Net unrealized appreciation on investments
and foreign currency related transactions 7,609,295
Total net assets $457,700,855
NET ASSET VALUE PER SHARE
Net asset value of $457,700,855(division sign)29,687,317
outstanding shares of beneficial interest $ 15.42
</TABLE>
STATEMENT OF OPERATIONS
YEAR ENDED AUGUST 31, 1997
<TABLE>
<CAPTION>
<S> <C> <C>
INVESTMENT INCOME
Interest $40,714,972
Other income 107,991
Total investment income 40,822,963
EXPENSES
Distribution Plan expenses $ 5,106,010
Management fee 2,835,152
Transfer agent fees 1,203,224
Custodian fees 252,608
Administrative services fees 65,837
Trustees' fees and expenses 47,515
Other 166,909
Total expenses 9,677,255
Less: Indirectly paid expenses (50,654)
Net expenses 9,626,601
Net investment income 31,196,362
NET REALIZED AND UNREALIZED GAIN
ON INVESTMENTS AND FOREIGN
CURRENCY RELATED TRANSACTIONS
Net realized gain on:
Investments 10,233,263
Foreign currency related
transactions 5,320,208
Net realized gain on investments
and foreign currency related
transactions 15,553,471
Net change in unrealized
appreciation (depreciation) on:
Investments 13,588,288
Foreign currency related
transactions (237,516)
Net change in unrealized
appreciation (depreciation) on
investments and foreign currency
related transactions 13,350,772
Net realized and unrealized gain
on investments and foreign
currency related transactions 28,904,243
Net increase in net assets
resulting from operations $60,100,605
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 15
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
1997 1996
<S> <C> <C>
OPERATIONS
Net investment income $ 31,196,362 $ 42,141,831
Net realized gain on investments and foreign currency related transactions 15,553,471 323,307
Net change in unrealized appreciation (depreciation) on investments and foreign
currency related transactions 13,350,772 (14,654,381)
Net increase in net assets resulting from operations 60,100,605 27,810,757
DISTRIBUTIONS TO SHAREHOLDERS FROM
Net investment income (31,196,362) (42,020,420)
In excess of net investment income (1,746,263) 0
Tax basis return of capital 0 (2,935,918)
Total distributions to shareholders (32,942,625) (44,956,338)
CAPITAL SHARE TRANSACTIONS
Proceeds from shares sold 33,102,013 89,671,653
Payments for shares redeemed (180,458,236) (273,136,100)
Net asset value of shares issued in reinvestment of dividends and distributions 18,107,160 25,564,686
Total decrease from capital share transactions (129,249,063) (157,899,761)
Total decrease in net assets (102,091,083) (175,045,342)
NET ASSETS:
Beginning of year 559,791,938 734,837,280
End of year [Including undistributed net investment income (accumulated distributions
in excess of net investment income) as follows: 1997-- $2,801,682 and
1996-- ($1,446,954)] $457,700,855 $559,791,938
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 16
KEYSTONE DIVERSIFIED BOND FUND (B-2)
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
Keystone Diversified Bond Fund (B-2) (the "Fund") is registered under the
Investment Company Act of 1940, as amended (the "1940 Act"), as a diversified,
open-end management investment company.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles, which
require management to make estimates and assumptions that affect amounts
reported herein. Actual results could differ from these estimates.
A. VALUATION OF SECURITIES
U.S. Government obligations held by the Fund are valued at the mean between the
over-the-counter bid and asked prices as furnished by an independent pricing
service. Corporate bonds, other fixed income securities and mortgage and other
asset-backed securities are valued at prices provided by an independent pricing
service. In determining value for normal institutional-size transactions, the
pricing service uses methods based on market transactions for comparable
securities and various relationships between similar securities which are
generally recognized by institutional traders. Securities for which valuations
are not available from an independent pricing service (including restricted
securities) are valued at fair value as determined in good faith according to
procedures established by the Board of Trustees.
Securities traded on a national securities exchange or included on the NASDAQ
National Market System ("NMS") are valued at the last reported sales price in
the exchange where they are primarily traded. The Fund values securities traded
on an exchange or NMS for which there has been no sale and other securities
traded on the over-the-counter market at the mean between the last reported bid
and asked price.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value.
B. REPURCHASE AGREEMENTS
Pursuant to an exemptive order issued by the Securities and Exchange Commission,
the Fund, along with certain other Keystone funds, may transfer uninvested cash
balances into a joint trading account. These balances are invested in one or
more repurchase agreements that are fully collateralized by U.S. Treasury and/or
Federal Agency obligations.
Securities pledged as collateral for repurchase agreements are held by the
custodian on the Fund's behalf. The Fund monitors the adequacy of the collateral
daily and will require the seller to provide additional collateral in the event
the market value of the securities pledged falls below the carrying value of the
repurchase agreement.
C. REVERSE REPURCHASE AGREEMENTS
The Fund enters into reverse repurchase agreements with qualified third-party
broker-dealers. Interest on the value of reverse repurchase agreements is based
upon competitive market rates at the time of issuance. At the time the Fund
enters into a reverse repurchase agreement, it will establish and maintain a
segregated account with its custodian containing liquid assets having a value
not less than the repurchase price (including accrued interest). If the
counterparty to the transaction is rendered insolvent, the ultimate realization
of the securities to be repurchased by the Fund may be delayed or limited.
D. FOREIGN CURRENCY
The books and records of the Fund are maintained in United States (U.S.)
dollars. Foreign currency amounts are translated into United States dollars as
follows: market value of investments, assets and liabilities at the daily rate
of exchange; purchases and sales of investments, income and expenses at the rate
of exchange prevailing on the respective dates of such transactions. Net
unrealized foreign exchange gain (loss) resulting from changes in foreign
currency exchange rates is a component of net unrealized appreciation
(depreciation)
<PAGE>
PAGE 17
on investments and foreign currency related transactions. Net realized foreign
currency gains and losses resulting from changes in exchange rates include
foreign currency gains and losses between trade date and settlement date on
investment securities transactions and foreign currency related transactions.
Net realized foreign currency gains and losses resulting from the difference
between the amounts of interest and dividends recorded on the books of the Fund
and the amount actually received are included in interest and dividend income.
The portion of foreign currency gains and losses related to fluctuations in
exchange rates between the initial purchase trade date and subsequent sale trade
date is included in realized gain (loss) on foreign currency related
transactions.
E. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund may enter into forward foreign currency exchange contracts ("forward
contracts") to settle portfolio purchases and sales of securities denominated in
a foreign currency and to hedge certain foreign currency assets or liabilities.
Forward contracts are recorded at the forward rate and marked-to-market daily.
Realized gains and losses arising from such transactions are included in net
realized gain (loss) on foreign currency related transactions. The Fund bears
the risk of an unfavorable change in the foreign currency exchange rate
underlying the forward contract and is subject to the credit risk that the other
party will not fulfill their obligations under the contract. Forward contracts
involve elements of market risk in excess of the amount reflected in the
statement of assets and liabilities.
F. SECURITY TRANSACTIONS AND INVESTMENT INCOME
Securities transactions are accounted for no later than one business day after
the trade date. Realized gains and losses are computed on the identified cost
basis. Interest income is recorded on the accrual basis and includes
amortization of discounts. Dividend income is recorded on the ex-dividend date.
G. FEDERAL INCOME TAXES
The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). Thus, the Fund is relieved of any federal income tax liability by
distributing all of its net taxable investment income and net taxable capital
gains, if any, to its shareholders. The Fund also intends to avoid excise tax
liability by making the required distributions under the Code. Accordingly, no
provision for federal income taxes is required. To the extent that realized
capital gains can be offset by capital loss carryforwards, it is the Fund's
policy not to distribute such gains.
H. DISTRIBUTIONS
Distributions from net investment income for the Fund are declared daily and
paid monthly. Distributions from net realized capital gains, if any, are paid at
least annually. Distributions to shareholders are recorded at the close of
business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally accepted
accounting principles. These differences are primarily due to differing tr
eatment for paydown gains (losses) and for foreign securities related
transactions.
2. CAPITAL SHARE TRANSACTIONS
The Fund's Restatement of Trust Agreement authorizes the issuance of an
unlimited number of shares of beneficial interest with a par value of $1.00.
Transactions in shares of the Fund were as follows:
<TABLE>
<CAPTION>
YEAR ENDED AUGUST 31,
1997 1996
<S> <C> <C>
Shares sold 2,182,629 5,954,123
Shares redeemed (11,912,272) (18,152,163)
Shares issued in reinvestment
of dividends and
distributions 1,195,855 1,709,087
Net decrease (8,533,788) (10,488,953)
</TABLE>
<PAGE>
PAGE 18
KEYSTONE DIVERSIFIED BOND FUND (B-2)
3. SECURITIES TRANSACTIONS
Cost of purchases and proceeds from sales of investment securities (excluding
short-term securities) were as follows for the year ended August 31, 1997:
<TABLE>
<CAPTION>
COST OF PROCEEDS
PURCHASES FROM SALES
<S> <C> <C>
Non-U.S.Government $484,209,025 $568,746,313
U.S. Government 201,738,252 244,675,885
</TABLE>
The average daily balance of reverse repurchase agreements outstanding during
the year ended August 31, 1997 was $6,879,127 at a weighted average interest
rate of 4.64%. The maximum amount of borrowing during the year ended August 31,
1997 was $16,852,313 (including accrued interest).
On August 31, 1997, the cost of investments for federal income tax purposes
was $442,778,613, gross unrealized appreciation of investments was $13,048,948
and gross unrealized depreciation of investments was $4,776,029, resulting in
net unrealized appreciation of $8,272,919 for income tax purposes.
As of August 31, 1997, the Fund had a capital loss carryover for federal
income tax purposes of approximately $160,349,000 which expires as follows:
$28,691,000-- 1998; $85,002,000-- 1999; $26,644,000-- 2003 and
$20,012,000-- 2004.
4. DISTRIBUTION PLAN
Evergreen Keystone Distributor, Inc. ("EKD"), a wholly-owned subsidiary of The
BISYS Group Inc. ("BISYS"), serves as principal underwriter to the Fund. Prior
to December 11, 1996, Evergreen Keystone Investment Services, Inc. ("EKIS"), a
wholly-owned subsidiary of Keystone Investment Management Company ("Keystone"),
served as the Fund's principal underwriter.
The Fund has adopted a Distribution Plan (the "Plan") as allowed by Rule 12b-1
of the 1940 Act. The Plan permits the Fund to reimburse its principal
underwriter for costs related to selling shares of the Fund and for various
other services. These costs, which consist primarily of commissions and services
fees to broker-dealers who sell shares of the Fund, are paid by shareholders
through expenses called "Distribution Plan expenses". Under the Plan, the Fund
currently pays a distribution fee which may not exceed 1.00% of the average
daily net assets of the Fund, of which 0.75% is used to pay distribution
expenses and 0.25% may be used to pay shareholder service fees.
The principal underwriter may pay 12b-1 fees greater than the allowable
amounts the Fund is permitted to pay. The Fund may reimburse the principal
underwriter for such excess amounts in later years with annual interest at the
prime rate plus 1.00%.
The Plan may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting shares
of the Fund. However, after the termination of the Plan, and subject to the
discretion of the Independent Trustees, payments to EKIS and/or EKD may continue
as compensation for services which had been provided while the Plan was in
effect.
EKD intends, but is not obligated, to continue to pay distribution costs
that exceed the current annual payments from the Fund. EKD intends to seek full
payment of such distribution costs from the Fund at such time in the future as,
and to the extent that payment thereof would be within permitted limits.
Contingent deferred sales charges paid by redeeming shareholders are paid to EKD
or its predecessor.
5. INVESTMENT MANAGEMENT AGREEMENT AND OTHER AFFILIATED TRANSACTIONS
Keystone serves as the investment adviser and manager to the Fund. In return,
Keystone is paid a management fee that is calculated daily and paid monthly. The
management fee is computed at an annual rate of 2.00% of the Fund's gross
investment income plus an amount determined by applying percentage rates
starting at 0.50% and declining as net assets increase to 0.25% per annum, to
the average daily net asset value of the Fund. Prior to December 11, 1996,
Keystone Management, Inc. ("KMI"), a wholly-owned subsidiary of Keystone, served
as investment manager to the Fund and provided investment management and
administrative services.
<PAGE>
PAGE 19
Under an investment advisory agreement between KMI and Keystone, Keystone served
as the investment adviser and provided investment advisory and management
services to the Fund. In return for its services, Keystone received an annual
fee equal to 85% of the management fee received by KMI.
Effective January 1, 1997, BISYS became the sub-administrator to the Fund.
This service is paid by Keystone and is not a Fund expense. As sub-
administrator, BISYS provides the officers of the Fund.
During the year ended August 31, 1997, the Fund paid or accrued $65,837 to EKIS
for certain administrative services. Evergreen Keystone Service Company, a
wholly-owned subsidiary of Keystone, serves as the Fund's transfer and dividend
disbursing agent. Officers of the Fund and affiliated Trustees receive no
compensation directly from the Fund.
6. EXPENSE OFFSET ARRANGEMENT
The Fund has entered into an expense offset arrangement with its custodian. The
assets deposited with the custodian under this expense offset arrangement could
have been invested in income-producing assets.
<PAGE>
PAGE 20
INDEPENDENT AUDITORS' REPORT
THE TRUSTEES AND SHAREHOLDERS
KEYSTONE DIVERSIFIED BOND FUND (B-2)
We have audited the accompanying statement of assets and liabilities of Keystone
Diversified Bond Fund (B-2), including the schedule of investments, as of August
31, 1997, and the related statement of operations for the year then ended, the
statements of changes in net assets for each of the years in the two-year period
then ended, and the financial highlights for each of the years in the ten-year
period then ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
August 31, 1997 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Keystone Diversified Bond Fund (B-2) as of August 31, 1997, the results of its
operations for the year then ended, the changes in its net assets for each of
the years in the two-year period then ended, and the financial highlights for
each of the years in the ten-year period then ended in conformity with generally
accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
October 10, 1997
<PAGE>
PAGE 21
KEYSTONE DIVERSIFIED BOND FUND (B-2)
FEDERAL TAX STATUS-- FISCAL 1997 DISTRIBUTIONS (UNAUDITED)
The per share distributions paid to you for fiscal 1997, whether taken in shares
or cash, are as follows:
<TABLE>
<S> <C>
Income Dividends $0.98
</TABLE>
In January 1998, complete information on the calendar year 1997 distributions
will be forwarded to you to assist you in completing your 1997 federal income
tax return.
<PAGE>
KEYSTONE
FAMILY OF FUNDS
(photo of diamond)
Balanced Fund (K-1)
Diversified Bond Fund (B-2)
Growth and Income Fund (S-1)
High Income Bond Fund (B-4)
International Fund Inc.
Precious Metals Holdings, Inc.
Quality Bond Fund (B-1)
Small Company Growth Fund (S-4)
Strategic Growth Fund (K-2)
Tax Free Fund
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied by
the Fund's current prospectus. The prospectus contains important information
about the Fund including fees and expenses. Read it carefully before you invest
or send money. For a free prospectus on other Evergreen Keystone funds, contact
your financial adviser or call Evergreen Keystone.
<TABLE>
<C> <S>
NOT
FDIC MAY LOSE VALUE
INSURED NO BANK GUARANTEE
EVERGREEN KEYSTONE DISTRIBUTOR, INC.
Evergreen KeystoneSM is a Service Mark of
Evergreen
Keystone Investment Services, Inc.
Copyright 1997.
</TABLE>
B2-R Rev 01
KEYSTONE
(Photo Exists in Film ONLY.
Will See on Dylux)
DIVERSIFIED BOND
FUND (B-2)
EVERGREEN KEYSTONE
(LOGO) FUNDS SM (LOGO)
ANNUAL REPORT
AUGUST 31, 1997
62492F
<PAGE>
Keystone Diversified Bond Fund
PRO FORMA COMBINING FINANCIAL STATEMENTS (UNAUDITED)
PORTFOLIO OF INVESTMENTS (000's)
February 28, 1997
<TABLE>
<CAPTION>
Keystone
Diversified Bond Fund (B-2)
----------------------------
Interest Maturity Principal Market
Rate Date Value Value
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
FIXED INCOME (98.1%)
INDUSTRIAL BONDS & NOTES (45.6%)
Advertising & Publishing (0.5%)
K-III Communications Corporation (b) Sr. Notes 8.50% 2006 $2,000 $2,000
Lamar Advertising Corporation Co. Gtd. 9.675 2006 1,250 1,306
- ------------------------------------------------------------------------------------------------------------------------------------
3,306
- ------------------------------------------------------------------------------------------------------------------------------------
Aircraft (0.3%)
Boeing Co. Deb. 7.875 2043
Amusements (1.5%)
Casino America, Incorporated Sr. Secd. Notes 12.500 2003 3,500 3,588
Six Flags Theme Parks,
Incorporated (Eff. Yield 11.12%) (c) Sr. Disc. Notes 0.000 2005 2,250 2,228
Trump Atlantic City Associates 1st Mtge. Notes 11.250 2006 5,000 4,825
- ------------------------------------------------------------------------------------------------------------------------------------
10,641
- ------------------------------------------------------------------------------------------------------------------------------------
Broadcasting (0.4%)
Sinclair Broadcast Group, Incorporated Sr. Notes (Subord.) 10.000 2005 2,500 2,613
Building Materials (1.7%)
Continental Homes Holding Corporation Sr. Notes 10.000 2006 3,000 3,150
HMH Properties, Incorporated Sr. Secd. Notes 9.500 2005 5,000 5,263
Schuller International Group, Incorporated Sr. Notes 10.875 2004 2,500 2,775
Webb Corporation Sr. Notes (Subord.) 9.750 2008 1,000 1,019
- ------------------------------------------------------------------------------------------------------------------------------------
12,207
- ------------------------------------------------------------------------------------------------------------------------------------
Cable (1.0%)
Comcast Corporation (Eff. Yield 11.72%) (c) Sr. (Subord.) Disc. Deb. 0.000 2000 3,380 2,476
Continental Cablevision Sr. Notes 8.625 2003 3,500 3,776
Fundy Cable Limited Sr. Secd. Second Priority Note 11.000 2005 1,175 1,251
- ------------------------------------------------------------------------------------------------------------------------------------
7,503
- ------------------------------------------------------------------------------------------------------------------------------------
Capital Goods (1.3%)
John Deere Capital Corporation Deb. 8.625 2019 8,850 9,488
Chemicals (0.5%)
ISP Holdings Sr. Notes 9.750 2002 2,166 2,307
Rexene Corporation Sr. Notes 11.750 2004 1,450 1,642
- ------------------------------------------------------------------------------------------------------------------------------------
3,949
- ------------------------------------------------------------------------------------------------------------------------------------
Consumer Goods (1.9%)
Coty, Incorporated Sr. Notes (Subord.) 10.250 2005 2,500 2,750
Mattel Inc. Notes 6.750 2000
Revlon Worldwide
Corporation (Eff. Yield 12.95%) (c) Sr. Secd. Disc. Notes 0.000 1998 3,500 3,281
Revlon Worldwide
Corporation (Eff. Yield 10.75%) (b)(c) Sr. Secd. Disc. Notes 0.000 2001 6,840 4,486
- ------------------------------------------------------------------------------------------------------------------------------------
10,517
- ------------------------------------------------------------------------------------------------------------------------------------
Diversified Companies (2.3%)
General Electric Capital Corporation Notes 7.500 2035 6,000 6,110
Grand Metropolitan Investment Corporation Sr. Notes 7.450 2035 9,000 9,483
Grand Metropolitan Investment Corporation
(Eff. Yield 8.13%) (c) Co. Gtd. 0.000 2004
- ------------------------------------------------------------------------------------------------------------------------------------
15,593
- ------------------------------------------------------------------------------------------------------------------------------------
Energy and Electrical Products (0.9%)
Affinity Group Sr. Notes 11.500 2003 2,500 2,625
Arrow Electronics, Incorporated Sr. Notes 7.000 2007 3,800 3,737
- ------------------------------------------------------------------------------------------------------------------------------------
6,362
- ------------------------------------------------------------------------------------------------------------------------------------
Finance (11.6%)
ABN Amro Bank Subord. Debs. 7.300 2026 3,000 2,787
Amsouth Bancorporation Subord. Debs. 6.750 2025 10,000 9,769
APP International Finance Company B. V. Secd. Sr. Notes 11.750 2005 2,000 2,205
Associates Corp. North America Sr. Notes 7.625 2000
Commercial Credit Corp. (b) Putable Asset Trust 6.450 1999
Commercial Credit Group, Incorporated Notes 10.000 2009 5,000 6,057
First Nationwide Holdings Sr. Notes 12.500 2003 2,500 2,825
Fleet Capital II Notes 7.920 2026
International Lease Finance Corp. Notes 6.250 2000
JPM Capital Trust II Deb. 7.950 2027 5,000 5,042
Lehman Brothers Holdings Sr. Notes 8.800 2015
Mellon Bank Capital II Deb. 7.995 2027
NB Capital Trust II Notes 7.830 2026 9,000 8,965
Paine Webber Group, Incorporated Sr. Notes 7.625 2008 10,000 10,081
Paine Webber Group, Incorporated (a) Med. Term Notes 7.490 2004
Smith Barney Holdings Notes 7.125 2006
Sun Canada Financial Co. (b) Co. Gtd. 6.625 2007
Tembec Finance Corporation Sr. Notes 9.875 2005 2,000 2,015
Wachovia Corp. Subord. Notes 6.605 2025
WFS Financial Owner Trust Subord. Notes 6.400 2003
- ------------------------------------------------------------------------------------------------------------------------------------
49,746
- ------------------------------------------------------------------------------------------------------------------------------------
Foods (0.4%)
TLC Beatrice International Holdings, Incorporated Sr. Secd. Notes 11.500 2005 3,000 3,210
Healthcare (0.5%)
Genesis Health Ventures, Incorporated Sr. Notes (Subord.) 9.250 2006 3,250 3,315
Hotels (0.1%)
Wyndham Hotel Corporation Sr. Notes (Subord.) 10.500 2006 1,000 1,070
Insurance (7.0%)
AMBAC, Inc. Deb. 9.375 2011
Lumbermens Mutual Casualty Corporation (b) Sr. Notes (Subord.) 9.150 2026 5,000 5,477
MBIA, Incorporated Deb. 9.375 2011 15,250 18,040
MBIA, Incorporated Deb. 7.000 2025
Nationwide CSN Trust (b) Sr. Notes 9.875 2025 10,000 10,923
Reliance Group Holdings, Incorporated Sr. Deb. (Subord.) 9.750 2003 4,000 4,220
Vesta Insurance Group, Inc., Trust I Deb. 8.525 2027
- ------------------------------------------------------------------------------------------------------------------------------------
38,660
- ------------------------------------------------------------------------------------------------------------------------------------
Metals and Mining (0.5%)
Koppers Industries, Incorporated Sr. Notes 8.500 2004 3,500 3,430
Municipals (0.7%)
Los Angeles, California (b) Fire Safety Improvements
<CAPTION>
Keystone
Quality Bond Fund (B-1) Pro Forma Combined
----------------------- -------------------
Principal Market Principal Market
Value Value Adjustments Value Value
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
FIXED INCOME (98.1%)
INDUSTRIAL BONDS & NOTES (45.6%)
Advertising & Publishing (0.5%)
K-III Communications Corporation (b) Sr. Notes $2,000 $2,000
Lamar Advertising Corporation Co. Gtd. 1,250 1,306
- ------------------------------------------------------------------------------------------------------------------------------------
3,306
- ------------------------------------------------------------------------------------------------------------------------------------
Aircraft (0.3%)
Boeing Co. Deb. 2,000 2,113 2,000 2,113
Amusements (1.5%)
Casino America, Incorporated Sr. Secd. Notes 3,500 3,588
Six Flags Theme Parks,
Incorporated (Eff. Yield 11.12%) (c) Sr. Disc. Notes 2,250 2,228
Trump Atlantic City Associates 1st Mtge. Notes 5,000 4,825
- ------------------------------------------------------------------------------------------------------------------------------------
10,641
- ------------------------------------------------------------------------------------------------------------------------------------
Broadcasting (0.4%)
Sinclair Broadcast Group, Incorporated Sr. Notes (Subord.) 2,500 2,613
Building Materials (1.7%)
Continental Homes Holding Corporation Sr. Notes 3,000 3,150
HMH Properties, Incorporated Sr. Secd. Notes 5,000 5,263
Schuller International Group, Incorporated Sr. Notes 2,500 2,775
Webb Corporation Sr. Notes (Subord.) 1,000 1,019
- ------------------------------------------------------------------------------------------------------------------------------------
12,207
- ------------------------------------------------------------------------------------------------------------------------------------
Cable (1.0%)
Comcast Corporation (Eff. Yield 11.72%) (c) Sr. (Subord.) Disc. Deb. 3,380 2,476
Continental Cablevision Sr. Notes 3,500 3,776
Fundy Cable Limited Sr. Secd. Second Priority Note 1,175 1,251
- ------------------------------------------------------------------------------------------------------------------------------------
7,503
- ------------------------------------------------------------------------------------------------------------------------------------
Capital Goods (1.3%)
John Deere Capital Corporation Deb. 8,850 9,488
Chemicals (0.5%)
ISP Holdings Sr. Notes 2,166 2,307
Rexene Corporation Sr. Notes 1,450 1,642
- ------------------------------------------------------------------------------------------------------------------------------------
3,949
- ------------------------------------------------------------------------------------------------------------------------------------
Consumer Goods (1.9%)
Coty, Incorporated Sr. Notes (Subord.) 2,500 2,750
Mattel Inc. Notes 3,500 3,510 3,500 3,510
Revlon Worldwide
Corporation (Eff. Yield 12.95%) (c) Sr. Secd. Disc. Notes 3,500 3,281
Revlon Worldwide
Corporation (Eff. Yield 10.75%) (b)(c) Sr. Secd. Disc. Notes 6,840 4,486
- ------------------------------------------------------------------------------------------------------------------------------------
3,510 14,027
- ------------------------------------------------------------------------------------------------------------------------------------
Diversified Companies (2.3%)
General Electric Capital Corporation Notes 6,000 6,110
Grand Metropolitan Investment Corporation Sr. Notes 9,000 9,483
Grand Metropolitan Investment Corporation
(Eff. Yield 8.13%) (c) Co. Gtd. 2,000 1,245 2,000 1,245
- ------------------------------------------------------------------------------------------------------------------------------------
1,245 16,838
- ------------------------------------------------------------------------------------------------------------------------------------
Energy and Electrical Products (0.9%)
Affinity Group Sr. Notes 2,500 2,625
Arrow Electronics, Incorporated Sr. Notes 3,800 3,737
- ------------------------------------------------------------------------------------------------------------------------------------
6,362
- ------------------------------------------------------------------------------------------------------------------------------------
Finance (11.6%)
ABN Amro Bank Subord. Debs. 2,000 1,858 5,000 4,645
Amsouth Bancorporation Subord. Debs. 3,500 3,419 13,500 13,188
APP International Finance Company B. V. Secd. Sr. Notes 2,000 2,205
Associates Corp. North America Sr. Notes 1,500 1,543 1,500 1,543
Commercial Credit Corp. (b) Putable Asset Trust 1,250 1,245 1,250 1,245
Commercial Credit Group, Incorporated Notes 5,000 6,057
First Nationwide Holdings Sr. Notes 2,500 2,825
Fleet Capital II Notes 3,000 2,964 3,000 2,964
International Lease Finance Corp. Notes 2,485 2,447 2,485 2,447
JPM Capital Trust II Deb. 5,000 5,042
Lehman Brothers Holdings Sr. Notes 3,500 3,893 3,500 3,893
Mellon Bank Capital II Deb. 2,000 1,987 2,000 1,987
NB Capital Trust II Notes 9,000 8,965
Paine Webber Group, Incorporated Sr. Notes 10,000 10,081
Paine Webber Group, Incorporated (a) Med. Term Notes 4,500 3,549 3,500 3,549
Smith Barney Holdings Notes 3,000 2,969 3,000 2,969
Sun Canada Financial Co. (b) Co. Gtd. 4,500 4,271 4,500 4,271
Tembec Finance Corporation Sr. Notes 2,000 2,015
Wachovia Corp. Subord. Notes 2,265 2,228 2,265 2,228
WFS Financial Owner Trust Subord. Notes 2,000 1,988 2,000 1,988
- ------------------------------------------------------------------------------------------------------------------------------------
34,361 84,107
- ------------------------------------------------------------------------------------------------------------------------------------
Foods (0.4%)
TLC Beatrice International Holdings,
Incorporated Sr. Secd. Notes 3,000 3,210
Healthcare (0.5%)
Genesis Health Ventures, Incorporated Sr. Notes (Subord.) 3,250 3,315
Hotels (0.1%)
Wyndham Hotel Corporation Sr. Notes (Subord.) 1,000 1,070
Insurance (7.0%)
AMBAC, Inc. Deb. 2,000 2,373 2,000 2,373
Lumbermens Mutual Casualty Corporation (b) Sr. Notes (Subord.) 3,000 3,286 8,000 8,763
MBIA, Incorporated Deb. 15,250 18,040
MBIA, Incorporated Deb. 4,000 3,721 4,000 3,721
Nationwide CSN Trust (b) Sr. Notes 10,000 10,923
Reliance Group Holdings, Incorporated Sr. Deb. (Subord.) 4,000 4,220
Vesta Insurance Group, Inc., Trust I Deb. 2,000 2,023 2,000 2,023
- ------------------------------------------------------------------------------------------------------------------------------------
11,403 50,063
- ------------------------------------------------------------------------------------------------------------------------------------
Metals and Mining (0.5%)
Koppers Industries, Incorporated Sr. Notes 3,500 3,430
</TABLE>
<PAGE>
Keystone Diversified Bond Fund
PRO FORMA COMBINING FINANCIAL STATEMENTS (UNAUDITED)
PORTFOLIO OF INVESTMENTS (000'S)
February 28, 1997
<TABLE>
<CAPTION>
Keystone
Diversified Bond
Fund (B-2)
-------------------
Interest Maturity Principal Market
Rate Date Value Value
====================================================================================================================================
<S> <C> <C> <C> <C> <C>
Assessment District #1 8.480 2015 4,896 5,086
Oil and Oil Services (3.8%)
Apache Corporation Deb. 7.625 2096 2,500 2,461
Occidental Petroleum Corporation Sr. Deb. 10.125 2009 5,500 6,700
Oslo Seismic Services, Inc. (b) 1st Prf. Mtg. Notes 8.280 2011 9,810 10,051
Stena AB Sr. Notes 10.500 2005 2,000 2,190
- ------------------------------------------------------------------------------------------------------------------------------------
21,402
- ------------------------------------------------------------------------------------------------------------------------------------
Retail (0.7%)
Cole National Group, Incorporated Sr. Notes 11.250 2001 2,000 2,205
Kohl's Corp. Notes 7.375 2011
- ------------------------------------------------------------------------------------------------------------------------------------
2,205
- ------------------------------------------------------------------------------------------------------------------------------------
Telecommunications (5.1%)
Adelphia Communications Corporation (b) Sr. Notes 9.875 2007 2,000 1,935
American Media Operations Corporation Sr. Notes (Subord.) 11.625 2004 4,000 4,400
Benedek Communications (Eff. Yield 12.24%) (b) (c) Sr. (Subord.) Disc. Notes 0.000 2006 3,750 2,391
Cablevision Systems Corporation Sr. Deb. (Subord.) 9.875 2013 1,500 1,508
Cablevision Systems Corporation Sr. Deb. (Subord.) 10.500 2016 1,500 1,575
Comcast Corporation Sr. Deb. (Subord.) 10.625 2012 2,500 2,813
GTE Corp. Notes 8.750 2021
Marcus Cable Operations Limited
Partnership (Eff. Yield 10.91%) (c) Sr. (Subord.) Disc. Notes 0.000 2004 3,000 2,505
Millicom International Cellular S. A. (b) Sr. (Subord.) Notes 13.500 2006 3,750 2,531
Pricecellular Wireless Corporation (Eff. Yield
10.52%) (c) Sr. Disc. Notes 0.000 2003 4,025 3,643
SFX Broadcasting, Incorporated Sr. Notes (Subord.) 10.750 2006 3,500 3,780
Telewest PLC (Eff. Yield 9.83%) (c) Sr. Disc. Deb. 0.000 2007 5,000 3,438
Vanguard Cellular Systems, Incorporated Sr. Deb. 9.375 2006 3,000 3,045
- ------------------------------------------------------------------------------------------------------------------------------------
33,564
- ------------------------------------------------------------------------------------------------------------------------------------
Tobacco (0.4%)
Philip Morris Companies, Inc. Sr. Notes 7.200 2007
Transportation (1.0%)
Golden State Petroleum Transportation Corporation (b) 1st Pfd. Mtge. Notes 8.040 2019 4,000 3,959
Utilities (1.5%)
Citizens Utilities Co. Deb. 7.050 2046
El Paso Electric Company 1st Mtge. Bds. 9.400 2011 5,000 5,381
Korea Electric & Power Corp. Deb. 7.000 2027
- ------------------------------------------------------------------------------------------------------------------------------------
5,381
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INDUSTRIAL BONDS & NOTES (Cost - $323,097) 253,207
- ------------------------------------------------------------------------------------------------------------------------------------
FOREIGN BONDS (U.S. DOLLARS) (2.5%)
Bayer Corp. (b) Sr. Notes 7.125 2015
Grupo Televisa S.A. (b) Sr. Notes 11.875 2006 1,500 1,669
Indah Kiat International Finance Company B. V. Sr. Secd. Notes 12.500 2006 3,000 3,360
Ispat Mexicana S.A. Sr. Unsecd. Deb. 10.375 2001 4,000 4,070
Republic of Argentina Deb. 11.375 2017 1,800 1,913
Transportacion Maritima Mexicana Sr. Notes 10.000 2006 3,500 3,474
TV Azteca S.A. de C.V. (b) Sr. Notes 10.500 2007 750 761
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FOREIGN BONDS (U.S. DOLLARS) (Cost - $17,003) 15,247
- ------------------------------------------------------------------------------------------------------------------------------------
FOREIGN BONDS (NON U.S. DOLLARS) (11.3%)
Canada Government Deb. 8.750 2005 18,400 15,647
Canadian Dollars
Federal Republic of Germany Deb. 6.500 2003 16,813 10,799
German Marks
Federal Republic of Germany Deb. 6.875 2005 24,700 16,121
German Marks
United Kingdom Treasury Deb. Govt. Gtd. 7.000 2001 9,670 15,796
Pound Sterling
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FOREIGN BONDS (NON U.S. DOLLARS) (Cost - $84,586) 58,363
- ------------------------------------------------------------------------------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS (20.8%)
Asset Securitization Corporation (Est. Mat. 2011) (a) Series 1996-D3 7.707 2026 3,000 3,060
Asset Securitization Corporation (Est. Mat. 2011) (a) Series 1996-D3 7.526 2026
Chase Mortgage Finance Corporation (Est. Mat. 2005)
(a) (b) Series 1994-L 7.875 2025 3,016 2,938
Collateralized Mortgage Investors Trust (Est. Mat.
1997) (a) Series 6 Class D 8.800 2006 581 580
Criimi Mae Financial Corporation (Est. Mat. 2003) (a) Series 1 Class A 7.000 2033 3,237 3,108
DLJ Mortgage Acceptance Corporation (Est. Mat.
2007) (a) Series 1997 7.818 2026 8,000 7,870
DLJ Mortgage Acceptance Corporation (Est. Mat.
2007) (a) Series 1997 7.817 2026
FHA Pool #02043143 (Est. Mat. 1999) (a) Blair House Project 9.125 2034 3,374 3,648
FHA Pool #02043143 (Est. Mat. 1999) (a) Blair House Project 10.250 2034 2,501 2,651
FHLMC (Est. Mat. 2010) (a) Series G8 Class SB inverse floater 9.600 2023 192 158
FHLMC Trust (Est. Mat. 2004) (a) Series 47, Class A 5.000 2022 5,000 4,398
FHLMC Trust (Est. Mat. 2005) (a) Series 1701, Class PH 6.500 2009
FHLMC Trust (Est. Mat. 2009) (a) Series 117, Class G 8.500 2021
FNMA REMIC Trust (Est. Mat. 2002) (a) Series 1996-17, Class A 6.000 2004
FNMA REMIC Trust (Est. Mat. 2003) (a) Series 1993-156 Class B 6.500 2018
FNMA REMIC Trust (Est. Mat. 2004) (a) Series 1993-G09 Class H 7.000 2020
FNMA REMIC Trust (Est. Mat. 2005) (a) Series 1992-181 Class PK 6.500 2021
FNMA (Est. Mat. 2004) (a) Series 1993-248, Class SA 3.213 2023 12,511 9,082
FNMA (Est. Mat. 2004) (a) Series 1993-196, Class SC 5.374 2008 5,700 4,742
FNMA Trust (Est. Mat. 2007) (a) Series 1993 038 Class L 5.000 2022 5,000 4,186
GS Mortgage Securities Corporation (Est. Mat. 2007) (a) Series 1996-PL 7.410 2027 4,700 4,601
KS Mortgage Capital LP (Est. Mat. 1999) (a) (b) Series 1995-1, Class A1 6.983 2030
Marine Midland (Est. Mat. 1997) (a) Series 1991-3 8.000 2024 3,435 3,430
Merrill Lynch Mortgage Investors, Incorporated (Est.
Mat. 2007) (a) Series 1996-C1 7.420 2026 5,000 4,963
Merrill Lynch Mortgage Investors, Incorporated (Est.
Mat. 2000) (a) Series 1992 D Class B 8.500 2017 1,407 1,463
Merrill Lynch Trust (Est. Mat. 2007) (a) Series 35 Class G 8.450 2018
Morgan Stanley, Incorporated (Est. Mat. 2001) (a) (b) Series 1996 Class A 6.475 2010 4,910 4,767
Morgan Stanley, Incorporated (Est. Mat. 2006) (a) (b) Series 1996-WF1 Class B 6.587 2006 2,000 1,904
Morgan Stanley, Incorporated (Est. Mat. 2006) (a) (b) Series 1996-WF1 Class B 6.590 2028
Paine Webber Mortgage Acceptance Corporation IV
(Est. Mat. 2006) (a) Series 1993-4 7.500 2023 2,852 2,803
Paine Webber Mortgage Acceptance Corporation IV
(Est. Mat. 1998) (a) Series 1993-5 Class A3 6.875 2008
Residential Asset Securitization Trust (Est. Mat.
2008) (a) Series 1996-A3 Class A9 7.500 2026 5,000 4,767
Residential Asset Securitization Trust (Est. Mat.
1999) (a) Series 1996-A5 Class A3 7.750 2026
Residential Accredit Loans, Inc. (Est. Mat. 2014) (a) Series 1996-QS4 Class AI10 7.900 2026
<CAPTION>
Keystone
Quality Bond
Fund (B-1) Pro Forma Combined
---------------- ------------------
Principal Market Principal Market
Value Value Adjustment Value Value
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Assessment District #1 4,896 5,086
Oil and Oil Services (3.8%)
Apache Corporation Deb. 2,500 2,461
Occidental Petroleum Corporation Sr. Deb. 3,000 3,655 8,500 10,355
Oslo Seismic Services, Inc. (b) 1st Prf. Mtg. Notes 2,452 2,513 12,262 12,564
Stena AB Sr. Notes 2,000 2,190
- -----------------------------------------------------------------------------------------------------------------------------------
6,168 27,570
- -----------------------------------------------------------------------------------------------------------------------------------
Retail (0.7%)
Cole National Group, Incorporated Sr. Notes 2,000 2,205
Kohl's Corp. Notes 2,500 2,479 2,500 2,479
- -----------------------------------------------------------------------------------------------------------------------------------
2,479 4,684
- -----------------------------------------------------------------------------------------------------------------------------------
Telecommunications (5.1%)
Adelphia Communications Corporation (b) Sr. Notes 2,000 1,935
American Media Operations Corporation Sr. Notes (Subord.) 4,000 4,400
Benedek Communications (Eff. Yield 12.24%) (b) (c) Sr. (Subord.) Disc. Notes 3,750 2,391
Cablevision Systems Corporation Sr. Deb. (Subord.) 1,500 1,508
Cablevision Systems Corporation Sr. Deb. (Subord.) 1,500 1,575
Comcast Corporation Sr. Deb. (Subord.) 2,500 2,813
GTE Corp. Notes 3,000 3,440 3,000 3,440
Marcus Cable Operations Limited
Partnership (Eff. Yield 10.91%) (c) Sr. (Subord.) Disc. Notes 3,000 2,505
Millicom International Cellular S. A. (b) Sr. (Subord.) Notes 3,750 2,531
Pricecellular Wireless Corporation (Eff. Yield
10.52%) (c) Sr. Disc. Notes 4,025 3,643
SFX Broadcasting, Incorporated Sr. Notes (Subord.) 3,500 3,780
Telewest PLC (Eff. Yield 9.83%) (c) Sr. Disc. Deb. 5,000 3,438
Vanguard Cellular Systems, Incorporated Sr. Deb. 3,000 3,045
- -----------------------------------------------------------------------------------------------------------------------------------
3,440 37,004
- -----------------------------------------------------------------------------------------------------------------------------------
Tobacco (0.4%)
Philip Morris Companies, Inc. Sr. Notes 3,000 2,974 3,000 2,974
Transportation (1.0%)
Golden State Petroleum Transportation Corporation (b) 1st Pfd. Mtge. Notes 3,000 2,969 7,000 6,928
Utilities (1.5%)
Citizens Utilities Co. Deb. 2,000 1,872 2,000 1,872
El Paso Electric Company 1st Mtge. Bds. 5,000 5,381
Korea Electric & Power Corp. Deb. 3,250 3,242 3,250 3,242
- -----------------------------------------------------------------------------------------------------------------------------------
5,114 10,495
- -----------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL INDUSTRIAL BONDS & NOTES (Cost - $323,097) 75,776 328,983
- -----------------------------------------------------------------------------------------------------------------------------------
FOREIGN BONDS (U.S. DOLLARS) (2.5%)
Bayer Corp. (b) Sr. Notes 3,000 2,873 3,000 2,873
Grupo Televisa S.A. (b) Sr. Notes 1,500 1,669
Indah Kiat International Finance Company B. V. Sr. Secd. Notes 3,000 3,360
Ispat Mexicana S.A. Sr. Unsecd. Deb. 4,000 4,070
Republic of Argentina Deb. 1,800 1,913
Transportacion Maritima Mexicana Sr. Notes 3,500 3,474
TV Azteca S.A. de C.V. (b) Sr. Notes 750 761
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL FOREIGN BONDS (U.S. DOLLARS) (Cost - $17,003) 2,873 18,120
- -----------------------------------------------------------------------------------------------------------------------------------
FOREIGN BONDS (NON U.S. DOLLARS) (11.3%)
Canada Government Deb. 7,250 6,165 25,650 21,812
Federal Republic of Germany Deb. 6,652 4,273 23,465 15,072
Federal Republic of Germany Deb. 9,750 6,364 34,450 22,485
United Kingdom Treasury Deb. Govt. Gtd. 3,820 6,240 13,490 22,036
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL FOREIGN BONDS (NON U.S. DOLLARS) (Cost - $84,586) 23,042 81,405
- -----------------------------------------------------------------------------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS (20.8%)
Asset Securitization Corporation (Est. Mat. 2011) (a) Series 1996-D3 3,000 3,060
Asset Securitization Corporation (Est. Mat. 2011) (a) Series 1996-D3 1,416 1,445 1,416 1,445
Chase Mortgage Finance Corporation (Est. Mat. 2005)
(a) (b) Series 1994-L 3,016 2,938
Collateralized Mortgage Investors Trust (Est. Mat.
1997) (a) Series 6 Class D 581 580
Criimi Mae Financial Corporation (Est. Mat. 2003) (a) Series 1 Class A 925 888 4,162 3,996
DLJ Mortgage Acceptance Corporation (Est. Mat.
2007) (a) Series 1997 8,000 7,870
DLJ Mortgage Acceptance Corporation (Est. Mat.
2007) (a) Series 1997 3,000 2,951 3,000 2,951
FHA Pool #02043143 (Est. Mat. 1999) (a) Blair House Project 3,374 3,648
FHA Pool #02043143 (Est. Mat. 1999) (a) Blair House Project 2,501 2,651
FHLMC (Est. Mat. 2010) (a) Series G8 Class SB inverse floater 192 158
FHLMC Trust (Est. Mat. 2004) (a) Series 47, Class A 5,000 4,398
FHLMC Trust (Est. Mat. 2005) (a) Series 1701, Class PH 3,500 3,409 3,500 3,409
FHLMC Trust (Est. Mat. 2009) (a) Series 117, Class G 1,650 1,721 1,650 1,721
FNMA REMIC Trust (Est. Mat. 2002) (a) Series 1996-17, Class A 3,500 3,356 3,500 3,356
FNMA REMIC Trust (Est. Mat. 2003) (a) Series 1993-156 Class B 2,800 2,655 2,800 2,655
FNMA REMIC Trust (Est. Mat. 2004) (a) Series 1993-G09 Class H 5,000 4,906 5,000 4,906
FNMA REMIC Trust (Est. Mat. 2005) (a) Series 1992-181 Class PK 4,000 3,829 4,000 3,829
FNMA (Est. Mat. 2004) (a) Series 1993-248, Class SA 12,511 9,082
FNMA (Est. Mat. 2004) (a) Series 1993-196, Class SC 5,700 4,742
FNMA Trust (Est. Mat. 2007) (a) Series 1993 038 Class L 2,500 2,093 7,500 6,279
GS Mortgage Securities Corporation (Est. Mat. 2007) (a) Series 1996-PL 1,850 1,811 6,550 6,412
KS Mortgage Capital LP (Est. Mat. 1999) (a) (b) Series 1995-1, Class A1 2,807 2,808 2,807 2,808
Marine Midland (Est. Mat. 1997) (a) Series 1991-3 3,435 3,430
Merrill Lynch Mortgage Investors, Incorporated (Est.
Mat. 2007) (a) Series 1996-C1 5,000 4,963
Merrill Lynch Mortgage Investors, Incorporated (Est.
Mat. 2000) (a) Series 1992 D Class B 1,407 1,463
Merrill Lynch Trust (Est. Mat. 2007) (a) Series 35 Class G 2,700 2,855 2,700 2,855
Morgan Stanley, Incorporated (Est. Mat. 2001) (a) (b) Series 1996 Class A 4,910 4,767
Morgan Stanley, Incorporated (Est. Mat. 2006) (a) (b) Series 1996-WF1 Class B 2,000 1,904
Morgan Stanley, Incorporated (Est. Mat. 2006) (a) (b) Series 1996-WF1 Class B 1,000 952 1,000 952
Paine Webber Mortgage Acceptance Corporation IV
(Est. Mat. 2006) (a) Series 1993-4 2,852 2,803
Paine Webber Mortgage Acceptance Corporation IV
(Est. Mat. 1998) (a) Series 1993-5 Class A3 1,221 1,221 1,221 1,221
Residential Asset Securitization Trust (Est. Mat.
2008) (a) Series 1996-A3 Class A9 5,000 4,767
Residential Asset Securitization Trust (Est. Mat.
1999) (a) Series 1996-A5 Class A3 3,000 3,013 3,000 3,013
Residential Accredit Loans, Inc. (Est. Mat. 2014) (a) Series 1996-QS4 Class AI10 3,500 3,533 3,500 3,533
</TABLE>
<PAGE>
Keystone Diversified Bond Fund
PRO FORMA COMBINING FINANCIAL STATEMENTS (UNAUDITED)
PORTFOLIO OF INVESTMENTS (000's)
February 28, 1997
<TABLE>
<CAPTION>
Keystone
Diversified
Bond Fund (B-2)
------------------------
Interest Maturity Principal Market
Rate Date Value Value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Residential Funding Corp. (Est. Mat. 1998) (a) Series 1994-s15 Class A1 7.750 2024
Ryland Acceptance Corporation (Est. Mat. 2000) (a) Series 88, Class E 7.950 2019 9,779 9,818
Shearson Lehman, Incorporated (Est. Mat. 2004) (a) Series V, Class 5 7.500 2019 5,000 4,963
Volvo Car Finance Grantor Trust
(Eff. Yield 6.62%) (Est. Mat. 1996) (a) (b) (c) Series 1993-2 Class A 0.000 1997 105 105
Zale Funding Trust (Est. Mat. 1999) (a) Series 1994-1 Class A2 7.325 2003 11,000 11,120
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (Cost - $149,976) 101,125
- ------------------------------------------------------------------------------------------------------------------------------------
ASSET - BACKED SECURITIES (4.1%)
Cargill Lease Receivables Trust Series 1996-A Class A2 6.430 2005 4,000 3,951
ContiMortgage Home Equity Loans, Inc. Series 1995-D 6.880 2028
CoreStates Home Equity Trust Series 1996-1 Class A4 7.000 2012
Ford Credit Auto Owner Trust Series 1996-B Class A4 6.300 2001
Merrill Lynch Mortgage Investors, Inc. Series 1991-D Class A 9.000 2011
Merrill Lynch Mortgage Investors, Inc. Series 1991-G Class B 9.150 2011
Merrill Lynch Mortgage Investors, Inc. Series 1992-B Class B 8.500 2012
Merrill Lynch Mortgage Investors, Inc. Series 1992-D Class B 8.500 2017
Olympic Automobile Receivables Series 1996-C 6.800 2002
Southern Pacific Secured Assets Corp. Series 1996-3 Class A4 7.600 2027
University Support Services, Inc. Series 1992-D 9.070 2007
World Omni Automobile Lease Trust Series 1996-B Class A3 6.250 2002
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSET-BACKED SECURITIES (Cost - $29,116) 3,951
- ------------------------------------------------------------------------------------------------------------------------------------
UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (12.9%)
FHLB Deb. 8.700 2005
FHLMC Global Note 6.700 2007 5,575 5,531
FHLMC Deb. 7.800 2016
United States Treasury Bonds 6.500 2026 8,300 7,919
United States Treasury Bonds 7.875 2021 26,250 29,041
United States Treasury Notes 6.250 2002 8,250 8,195
United States Treasury Notes 6.500 2006 5,215 5,174
United States Treasury Strip (Eff. Yield 8.71%) (c) 0.000 2021 106,250 18,893
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL UNITED STATES GOVERNMENT ISSUES (Cost - $92,995) 74,753
- ------------------------------------------------------------------------------------------------------------------------------------
MORTGAGE-BACKED SECURITIES (0.9%)
FHLMC Pool #303865 8.500 1997
FNMA Pool #303664 6.500 2010
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL MORTGAGE-BACKED SECURITIES (Cost - $6,356)
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME (Cost - $703,129) 506,646
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Common Stock (0.0%) Shares
<S> <C> <C>
PH Holdings Corporation (d) 0 * 0 *
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Interest Maturity Maturity Market
Rate Date Value Value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
REPURCHASE AGREEMENT (3.6%) (Cost - $25,700)
Keystone Joint Repurchase Agreement
(Investments in repurchase agreements, in a
joint trading account, purchased 2/28/97) (e) 5.413 3/3/97 $21,283 $21,273
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (Cost - $728,829) 527,919
OTHER ASSETS AND LIABILITIES-NET (-1.7%) (12,030)
- ------------------------------------------------------------------------------------------------------------------------------------
NET ASSETS (100%) $515,889
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Keystone
Quality
Bond Fund (B-1) Pro Forma Combined
------------------ -------------------
Principal Market Adjust- Principal Market
Value Value ment Value Value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Residential Funding Corp. (Est. Mat. 1998) (a) Series 1994-s15 Class A1 2,412 2,427 2,412 2,427
Ryland Acceptance Corporation (Est. Mat. 2000) (a) Series 88, Class E 2,794 2,805 12,573 12,623
Shearson Lehman, Incorporated (Est. Mat. 2004) (a) Series V, Class 5 5,000 4,963
Volvo Car Finance Grantor Trust
(Eff. Yield 6.62%) (Est. Mat. 1996) (a) (b) (c) Series 1993-2 Class A 105 105
Zale Funding Trust (Est. Mat. 1999) (a) Series 1994-1 Class A2 11,000 11,120
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (Cost - $149,976) 48,678 149,803
- -----------------------------------------------------------------------------------------------------------------------------------
ASSET - BACKED SECURITIES (4.1%)
Cargill Lease Receivables Trust Series 1996-A Class A2 4,000 3,951
ContiMortgage Home Equity Loans, Inc. Series 1995-D 1,000 987 1,000 987
CoreStates Home Equity Trust Series 1996-1 Class A4 3,100 3,043 3,100 3,043
Ford Credit Auto Owner Trust Series 1996-B Class A4 4,400 4,386 4,400 4,386
Merrill Lynch Mortgage Investors, Inc. Series 1991-D Class A 1 1 1 1
Merrill Lynch Mortgage Investors, Inc. Series 1991-G Class B 3,462 3,623 3,462 3,623
Merrill Lynch Mortgage Investors, Inc. Series 1992-B Class B 1,913 1,959 1,913 1,959
Merrill Lynch Mortgage Investors, Inc. Series 1992-D Class B 2,233 2,322 2,233 2,322
Olympic Automobile Receivables Series 1996-C 3,000 3,024 3,000 3,024
Southern Pacific Secured Assets Corp. Series 1996-3 Class A4 3,300 3,292 3,300 3,292
University Support Services, Inc. Series 1992-D 815 816 815 816
World Omni Automobile Lease Trust Series 1996-B Class A3 2,100 2,089 2,100 2,089
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSET-BACKED SECURITIES (Cost - $29,116) 25,542 29,493
- -----------------------------------------------------------------------------------------------------------------------------------
UNITED STATES GOVERNMENT (AND AGENCY) ISSUES (12.9%)
FHLB Deb. 1,000 1,020 1,000 1,020
FHLMC Global Note 5,750 5,705 11,325 11,236
FHLMC Deb. 2,000 2,049 2,000 2,049
United States Treasury Bonds 8,300 7,919
United States Treasury Bonds 1,200 1,328 27,450 30,369
United States Treasury Notes 8,250 8,195
United States Treasury Notes 8,300 8,235 13,515 13,409
United States Treasury Strip (Eff. Yield 8.71%) (c) 106,250 18,893
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL UNITED STATES GOVERNMENT ISSUES (Cost - $92,995) 18,337 93,090
- -----------------------------------------------------------------------------------------------------------------------------------
MORTGAGE-BACKED SECURITIES (0.9%)
FHLMC Pool #303865 13 13 13 13
FNMA Pool #303664 6,329 6,226 6,329 6,226
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL MORTGAGE-BACKED SECURITIES (Cost - $6,356) 6,239 6,239
- -----------------------------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME (Cost - $703,129) 200,487 707,133
- -----------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Common Stock (0.0%)
<S> <C> <C>
PH Holdings Corporation (d) 0 * 0 *
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
Maturity Market
Value Value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
REPURCHASE AGREEMENT (3.6%) (Cost - $25,700)
Keystone Joint Repurchase Agreement
(Investments in repurchase agreements, in a
joint trading account, purchased 2/28/97) (e) $4,427 $4,427 $25,700
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (Cost - $728,829) 204,914 732,833
OTHER ASSETS AND LIABILITIES-NET (-1.7%) (160) (12,190)
- ------------------------------------------------------------------------------------------------------------------------------------
NET ASSETS (100%) $204,754 $720,643
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) The estimated maturity of a Collateralized Mortgage Obligation ("CMO") is
based on current and projected prepayment rates. Changes in interest rates
can cause the estimated maturity to differ from the listed date.
(b) Securities that may be resold to "qualified institutional buyers" under rule
144A or securities offered pursuant to Section 4(2) of the Securities Act of
1933, as amended. These securities have been determined to be liquid under
guidelines established by the Board of Trustees.
(c) Effective yield (calculated at date of purchase) is the yield at which the
bond accretes on an annual basis until maturity date. (d) Non-income
producing security. (e) The repurchase agreements are fully collateralized
by U.S. government and/or agency obligations based on market prices at
February 28, 1997.
(d) Non-Income producing security.
(e) The repurchase agreements are fully collateralized by U.S. government and/or
agency obligations based on market prices at February 28, 1997.
* Represents an amount less than 1,000 shares/dollars.
Legend of Portfolio Abbreviations:
FHA - Federal Housing Administration
FHLMC - Federal Home Loan Mortgage Corporation
FNMA - Federal National Mortgage Association
See Notes to Pro Forma Combining Financial Statements.
<PAGE>
KEYSTONE DIVERSIFIED BOND FUND (B-2)
Pro Forma Combining Financial Statements (unaudited)
Statement of Assets and Liabilities (000's)
February 28, 1997
<TABLE>
<CAPTION>
Keystone Keystone
Diversified Bond Quality Bond Pro Forma
Fund (B-2) Fund (B-1) Adjustments Combined
------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Investments at value (cost $728,829) $527,919 $204,914 $732,833
Cash 252 141 393
Interest receivable 9,002 3,238 12,240
Receivable for investment sold 6,911 2 6,913
Receivable for Fund shares sold 138 21 159
Tax reclaim receivable 0 28 28
Net unrealized appreciation on forward foreign
currency exchange contracts 771 305 1,076
Prepaid expenses and other assets 130 89 219
----------------------------------------------- --------------
Total Assets 545,123 208,738 0 753,861
Liabilities:
Payable for investments purchased 17,717 3,008 20,725
Payable for reverse repurchase agreement 8,066 0 8,066
Distributions to shareholders 1,267 322 1,589
Payable for Fund shares redeemed 1,233 269 1,502
Distribution fee payable 873 261 1,134
Due to related parties 13 98 111
Net unrealized depreciation on forward foreign
currency exchange contracts 30 12 42
Accrued expenses 35 14 49
----------------------------------------------- --------------
Total Liabilities 29,234 3,984 0 33,218
Net Assets $515,889 $204,754 $0 $720,643
==================================================================
Net assets are comprised of:
Paid-in capital 672,745 233,313 906,058
Accumulated distributions in excess of net
investment income (2,715) (346) (3,061)
Accumulated net realized loss on investments ($160,079) ($27,131) ($187,210)
Net unrealized appreciation (depreciation) of investments
and foreign currency related transactions 5,938 ($1,082) 4,856
----------------------------------------------- --------------
Net Assets $515,889 $204,754 $0 $720,643
==================================================================
Class A Shares
Net Assets - - $629,305 a $629,305
Shares of beneficial interest outstanding - - 41,547 a 41,452
(95)b
Net Asset Value - - $15.18
Maximum Offer Price - 4.75% - - $15.94
Class B Shares
Net Assets $515,889 $204,754 ($629,305)a $ 91,338
Shares of beneficial interest outstanding 33,981 13,594 (41,547)a 6,016
(12)b
Net Asset Value $15.18 $15.06 $15.18
Class C Shares
Net Assets - - -
Shares of beneficial interest outstanding - - -
Net Asset Value - - -
</TABLE>
a Reflects the conversion of Class B shares purchased before 1/1/95 into
Class A.
b Reflects the adjustment for the conversion of the remaining shares of the of
B-1 into B-2.
See Notes to Pro Forma Combining Financial Statements.
<PAGE>
KEYSTONE DIVERSIFIED BOND FUND (B-2)
Pro Forma Combining Financial Statements (unaudited)
Statement of Operations (000's)
Year Ended February 28, 1997
<TABLE>
<CAPTION>
Keystone Keystone
Diversified Bond Quality Bond Pro Forma
Fund (B-2) Fund (B-1) Adjustments Combined
------------------------------------------------- --------------
<S> <C> <C> <C> <C>
Investment Income:
Interest income $47,239 $16,932 $64,171
------------------------------------------------- --------------
Expenses:
Management fee 3,120 1,440 (506)a 4,054
Distribution fee 5,713 2,382 8,095
Transfer agent fee 1,350 576 1,926
Custodian fee 291 137 (37)b 391
Professional fees 46 29 (20)c 55
Registration and filing fees 41 38 (19)c 60
Reports and notices to shareholders 28 10 (5)c 33
Administrative personnel & service fees 25 22 (20)c 27
Insurance expense 26 8 34
Trustees fees 27 31 (31)c 27
Miscellaneous 14 1 (5)c 10
------------------------------------------------- --------------
Total expenses 10,681 4,674 (643) 14,712
Less: Indirectly paid expenses (69) (31) (100)
------------------------------------------------- --------------
Net Expenses 10,612 4,643 (643) 14,612
------------------------------------------------- --------------
Net investment income 36,627 12,289 643 49,559
Net realized and unrealized gain (loss) on investments:
Net realized gain (loss) on investments 7,396 (1,026) 6,370
Net change in unrealized appreciation
(depreciation) on investments (2,324) (1,892) (4,216)
------------------------------------------------- --------------
Net realized and unrealized gain (loss) on investments 5,072 (2,918) 0 2,154
Net increase in net assets resulting from operations $41,699 $9,371 $643 $51,713
================================================= ==============
</TABLE>
a Reflects decrease as break points are reached with a higher combined assets
level.
b Reflects a decrease due to custody contract asset fee break points attained
with a higher combined assets level.
c Reflects expected cost savings when the funds combine.
See Notes to Pro Forma Combining Financial Statements.
<PAGE>
KEYSTONE DIVERSIFIED BOND FUND (B-2)
Notes to Pro Forma Combining Financial Statements (Unaudited)
February 28, 1997
1. Basis of Combination - The Pro Forma Statement of Assets and Liabilities,
including the Pro Forma Portfolio of Investments, and the related Pro Forma
Statement of Operations ("Pro Forma Statements") reflect the accounts of
Keystone Diversified Bond Fund ("B-2") and Keystone Quality Bond Fund ("B-1") at
February 28, 1997 and for the year then ended.
The Pro Forma Statements give effect to the proposed Agreement and Plan of
Reorganizations (the "Reorganizations") to be submitted to shareholders of each
of B-1 and B-2. The Reorganizations provide for the acquisition of all assets
and liabilities of B-1 and B-2 by Evergreen Diversified Bond Fund ("Evergreen
Diversified"), a series of Evergreen Fixed Income Trust, in exchange for shares
of Evergreen Diversified. Thereafter, there will be a distribution of such
shares of Evergreen Diversified to shareholders of B-1 and B-2 in liquidation
and subsequent termination thereof. As a result of the Reorganizations, the
shareholders of B-1 and B-2 will become the owners of that number of full and
fractional shares of Evergreen Diversified having an aggregate net asset value
equal to the aggregate net asset value of their respective class of shares of
B-1 and B-2 as of the close of business immediately prior to the date that such
Fund's assets are exchanged for shares of Evergreen Diversified.
The Pro Forma Statements reflect the expenses of each Fund in carrying out its
obligations under the Reorganizations as though the merger occurred at the
beginning of the period presented. It is anticipated that before the
Reorganizations occur, B-1 and B-2 will each begin to offer multiple classes of
shares (Class A, Class B and Class C) each of which will be similar in all
respects to the Class A, Class B and Class C shares of Evergreen Diversified and
concurrently the then outstanding shares of B-1 and B-2 will become Class B
shares of each Fund. Also, the Class B shares of B-1 and B-2 purchased prior to
January 1, 1995 will be converted to Class A shares of each Fund at that time.
Shareholders will receive the same class of shares of Evergreen Diversified held
by them in each Fund prior to the Reorganizations. As reflected in the Pro Forma
Statements, B-2 will be the accounting survivor upon completion of the
Reorganization.
The information contained herein is based on the experience of each Fund for the
period ended February 28, 1997 and is designed to permit shareholders of the
consolidating mutual funds to evaluate the financial effect of the proposed
Reorganizations. The expenses of B-1 and B-2 in connection with the
Reorganizations (including the cost of any proxy soliciting agents) will be
borne by First Union National Bank of North Carolina.
The Pro Forma Statements should be read in conjunction with the historical
financial statements of each Fund incorporated by reference in the Statement of
Additional Information.
2. Shares of Beneficial Interest - The Pro Forma net asset values per share
assumes the issuance of shares of Evergreen Diversified Class A, Class B and
Class C which would have been issued at February 28, 1997 in connection with the
proposed Reorganizations. Shareholders of B-2 would receive the same number of
shares of each class as they held on February 28, 1997. Shareholders of B-1
would receive shares of Evergreen Diversified based on a conversion ratio
<PAGE>
determined on February 28, 1997. The conversion ratio is calculated by dividing
the net asset value of each class of B-1 by the net asset value per share of the
respective class of B-2.
3. Pro Forma Operations - The Pro Forma Statement of Operations assumes similar
rates of gross investment income for the investments of each Fund. Accordingly,
the combined gross investment income is equal to the sum of the Funds' gross
investment income. Pro Forma operating expenses include the actual expenses of
each Fund adjusted to reflect the expected expenses of the combined entity. The
investment advisory and distribution fees have been charged to the combined Fund
based on the fee schedule in effect for B-2 at the combined level of average net
assets for the year ended February 28, 1997.
EVERGREEN FIXED INCOME TRUST
PART C
OTHER INFORMATION
Item 15. Indemnification.
The response to this item is incorporated by reference to "Liability
and Indemnification of Trustees" under the caption "Comparative Information on
Shareholders' Rights" in Part A of this Registration Statement.
Item 16. Exhibits:
Number Description
1 Declaration of Trust (1)
2 By-Laws (1)
3 Not applicable
4 Agreements and Plans of Reorganization (included
as Exhibits A-1 and A-2 to the Prospectus
contained in Part A to this registration
statement)
5 Declaration of Trust Articles II, III.(6)(c),
IV.(3), IV.(8), V, VI, VII, VIII and By-Laws
Articles II, III, and VIII
6 Investment Advisory Agreement between Keystone
Investment Management Company and the Registrant
(1)
7(A) Distribution Agreement between Evergreen Keystone
Distributor, Inc. and the Registrant (1)
(B) Form of Dealer Agreement for Class A, Class B and Class C
shares used by Evergreen Keystone Distributor, Inc. (1)
8 Deferred Compensation Plan (1)
9 Custody Agreement between State Street Bank and
Trust Company and Registrant (1)
10(A) Rule 12b-1 Distribution Plan (1)
(B) Multiple Class Plan (1)
11 Opinion and consent of counsel as to the legality
of the shares being issued (3)
12 Tax opinion and consent of counsel (2)
13 Not applicable
14 Consent of KPMG Peat Marwick LLP (2)
15 Not applicable
16 Powers of Attorney (3)
17(A) Forms of Proxy Card (2)
(B) Registrant's Rule 24f-2 Declaration (1)
- ----------------------
<PAGE>
(1) Incorporated by reference to Registrant's registration statement (File
Nos. 333-37433/811-08415) (the "Registration Statement") dated October
8, 1997.
(2) Filed herewith.
(3) Previously filed .
Item 17. Undertakings.
(1) The undersigned Registrant agrees that prior to any public
reoffering of the securities registered through the use of a prospectus that is
a part of this Registration Statement by any person or party who is deemed to be
an underwriter within the meaning of Rule 145(c) of the Securities Act of 1933,
the reoffering prospectus will contain the information called for by the
applicable registration form for reofferings by persons who may be deemed
underwriters, in addition to the information called for by the other items of
the applicable form.
(2) The undersigned Registrant agrees that every prospectus that is
filed under paragraph (1) above will be filed as a part of an amendment to the
Registration Statement and will not be used until the amendment is effective,
and that, in determining any liability under the Securities Act of 1933, each
post-effective amendment shall be deemed to be a new Registration Statement for
the securities offered therein, and the offering of the securities at that time
shall be deemed to be the initial bona fide offering of them.
(3) The undersigned Registrant agrees to file, by post-effective
amendment, opinions of counsel or copies of an Internal Revenue Service ruling
supporting the tax consequences of the proposed Reorganizations within a
reasonable time after receipt of such opinions or rulings.
<PAGE>
SIGNATURES
As required by the Securities Act of 1933, this Registration Statement
has been signed on behalf of the Registrant, in the City of New York and State
of New York, on the 9th day of November, 1997.
EVERGREEN FIXED INCOME
TRUST
By: /s/ John J. Pileggi
----------------------
Name: John J. Pileggi
Title: President
As required by the Securities Act of 1933, the following persons have
signed this Registration Statement in the capacities on the 9th day of November,
1997.
Signatures Title
- ---------- -----
/s/John J. Pileggi President and
- ------------------ Treasurer
John J. Pileggi
/s/Laurence B. Ashkin* Trustee
- ---------------------
Laurence B. Ashkin
/s/Charles A. Austin III* Trustee
- -------------------------
Charles A. Austin III
/s/K. Dun Gifford* Trustee
- -----------------
K. Dun Gifford
/s/James S. Howell* Trustee
- ------------------
James S. Howell
/s/Leroy Keith, Jr.* Trustee
- -------------------
Leroy Keith, Jr.
/s/Gerald M. McDonnell* Trustee
- ----------------------
Gerald M. McDonnell
/s/Thomas L. McVerry* Trustee
- --------------------
<PAGE>
Thomas L. McVerry
/s/William Walt Pettit* Trustee
- ---------------------
William Walt Pettit
/s/David M. Richardson* Trustee
- ----------------------
David M. Richardson
/s/Russell A. Salton III* Trustee
- -------------------------
Russell A. Salton III
/s/Michael S. Scofield* Trustee
- ----------------------
Michael S. Scofield
/s/Richard J. Shima* Trustee
- -------------------
Richard J. Shima
* By: /s/Martin J. Wolin
------------------
Martin J. Wolin
Attorney-in-Fact
Martin J. Wolin, by signing his name hereto, does hereby sign this
document on behalf of each of the above-named individuals pursuant to powers of
attorney duly executed by such persons and included as Exhibit 16 to this
Registration Statement.
<PAGE>
INDEX TO EXHIBITS
N-14
EXHIBIT NO.
12 Tax Opinion and Consent of Counsel
13 Consent of KPMG Peat Marwick LLP
17(A) Forms of Proxy
- --------------------
<PAGE>
SULLIVAN & WORCESTER LLP
1025 CONNECTICUT AVENUE, N.W.
WASHINGTON, D.C. 20036
TELEPHONE: 202-775-8190
FACSIMILE: 202-293-2275
767 THIRD AVENUE ONE POST OFFICE SQUARE
NEW YORK, NEW YORK 10017 BOSTON, MASSACHUSETTS 02109
TELEPHONE: 212-486-8200 TELEPHONE: 617-338-2800
FACSIMILE: 212-758-2151 FACSIMILE: 617-338-2880
November 7, 1997
Keystone Diversified Bond Fund (B-2)
Keystone Quality Bond Fund (B-1)
Evergreen Diversified Bond Fund
200 Berkeley Street
Boston, Massachusetts 02116
Re: Conversion of Keystone Diversified Bond Fund (B-2)
to a Series of a Delaware Business Trust (Evergreen
Diversified Bond Fund), and Acquisition of Assets of
Keystone Quality Bond Fund (B-1) by Evergreen
Diversified Bond Fund
Ladies and Gentlemen:
You have asked for our opinion as to certain Federal income tax
consequences of the transactions described below.
Parties to the Transaction. Keystone Diversified Bond Fund (B-2)
("Target Fund I") is a series of a Pennsylvania common law trust with the same
name.
Keystone Quality Bond Fund (B-1) ("Target Fund II") is a series of a
Pennsylvania common law trust with the same name.
Evergreen Diversified Bond Fund ("Acquiring Fund") is a
series of Evergreen Fixed Income Trust, a Delaware business
trust.
Description of Proposed Transaction. The proposed transaction involves
two steps, Transaction 1 and Transaction 2. In Transaction 1, Acquiring Fund
will issue its shares to Target Fund I and assume certain stated liabilities of
Target Fund I, in exchange for all of the assets of Target Fund I. Target Fund I
will then immediately dissolve and distribute all of the Acquiring Fund shares
which it holds to its shareholders pro rata in proportion to their shareholdings
in Target Fund I, in complete redemption of all outstanding shares of Target
Fund I.
In Transaction 2, which will occur immediately following the closing of
Transaction 1, Acquiring Fund will acquire all
<PAGE>
of the assets of Target Fund II in exchange for shares of
Acquiring Fund of equivalent value and the assumption of
<PAGE>
certain specified liabilities of Target Fund II. Target Fund II will then
immediately dissolve and distribute all of the Acquiring Fund shares which it
holds to its shareholders pro rata in proportion to their shareholdings in
Target Fund II, in complete redemption of all outstanding shares of Target Fund
II.
Scope of Review and Assumptions
In rendering our opinion, we have reviewed and relied upon the form of
Agreement and Plan of Reorganization (each, a "Reorganization Agreement")
between Acquiring Fund and Target Fund I (in the case of Transaction 1) and
between Acquiring Fund and Target Fund II (in the case of Transaction 2), each
of which is enclosed in a draft prospectus/proxy statement dated November 14,
1997 which describes the proposed transactions, and on the information provided
in such prospectus/proxy statement. We have relied, without independent
verification, upon the factual statements made therein, and assume that there
will be no change in material facts disclosed therein between the date of this
letter and the date of the closing of the Transactions. We further assume that
the Transactions will be carried out in accordance with the Reorganization
Agreements. We have also relied upon the following representations, each of
which has been made to us by officers of the Trusts of which Acquiring Fund,
Target Fund I and Target Fund II are series:
Representations as to Transaction 1
A. Target Fund I has not redeemed and will not redeem the shares of any
of its shareholders in connection with Transaction 1, except to the extent
necessary to comply with its legal obligation to redeem its shares.
B. The management of Acquiring Fund has no plan or intention to redeem
or reacquire any of the Acquiring Fund shares to be received by Target Fund I
shareholders in connection with Transaction 1, except to the extent necessary to
comply with its legal obligation to redeem its shares.
C. The management of Acquiring Fund has no plan or intention to sell or
dispose of any of the assets of Target Fund I which will be acquired by
Acquiring Fund in Transaction 1 except for dispositions made in the ordinary
course of business.
D. Following Transaction 1, Acquiring Fund will continue the historic
business of Target Fund I in a substantially unchanged manner as part of the
regulated investment company business of Acquiring Fund, or will use a
significant portion of Target Fund I's historic business assets in a business.
E. Acquiring Fund will not make any payment of cash or of property
other than shares to Target Fund I or to any shareholder of Target Fund I in
connection with Transaction 1.
<PAGE>
F. To the best knowledge of management of Target Fund I, there is no
plan or intention on the part of the holders of shares of Target Fund I to sell,
exchange or otherwise dispose of any of the shares of Acquiring Fund received in
the transaction.
G. Immediately following consummation of the transaction, Acquiring
Fund will possess the same assets and liabilities, except for assets used to pay
expenses incurred in connection with the transaction, as those possessed by
Target Fund I immediately prior to Transaction 1.
H. Neither Target Fund I nor Acquiring Fund expects to issue additional
shares other than in the ordinary course of its business as a regulated
investment company or in Transaction 2.
I. Acquiring Fund has never carried on a business and will not carry on
any business between the date of this letter and the date of closing of
Transaction 1.
Representations as to Transaction 2
A. Acquiring Fund will acquire from Target Fund II at least 90% of the
fair market value of the net assets and at least 70% of the fair market value of
the gross assets held by Target Fund II immediately prior to Transaction 2. For
purposes of this representation, assets of Target Fund II used to pay
reorganization expenses, cash retained to pay liabilities, and redemptions and
distributions (except for regular and normal distributions) made by Target Fund
II immediately preceding the transfer which are part of the plan of
reorganization will be considered as assets held by Target Fund II immediately
prior to the transfer.
B. To the best of the knowledge of management of Target Fund II, there
is no plan or intention on the part of the shareholders of Target Fund II to
sell, exchange, or otherwise dispose of a number of Acquiring Fund shares
received in Transaction 2 that would reduce the former Target Fund II
shareholders' ownership of Acquiring Fund shares to a number of shares having a
value, as of the date of closing of Transaction 2 (the "Closing Date"), of less
than 50 percent of the value of all of the formerly outstanding shares of Target
Fund II as of the same date. For purposes of this representation, Target Fund II
shares exchange for cash or other property will be treated as outstanding Target
Fund II shares on the Closing Date. There are no dissenters' rights in
Transaction 2 and no cash will be exchanged for Target Fund II shares in lieu of
fractional shares of Acquiring Fund. Moreover, shares of Target Fund II and
shares of Acquiring Fund held by Target Fund II shareholders and otherwise sold,
redeemed, or disposed of prior or subsequent to Transaction 2 will be considered
in making this representation.
<PAGE>
C. Target Fund II has not redeemed and will not redeem the shares of
any of its shareholders in connection with Transaction 2 except to the extent
necessary to comply with its legal obligation to redeem its shares.
D. The management of Acquiring Fund has no plan or intention to redeem
or reacquire any of the Acquiring Fund shares to be received by Target Fund II
shareholders in connection with Transaction 2 except to the extent necessary to
comply with its legal obligation to redeem its shares.
E. The management of Acquiring Fund has no plan or intention to sell or
dispose of any of the assets of Target Fund II which will be acquired by
Acquiring Fund in Transaction 2 except for dispositions made in the ordinary
course of business, and to the extent necessary to enable Acquiring Fund to
comply with its legal obligation to redeem its shares.
F. Following Transaction 2, Acquiring Fund will continue the historic
business of Target Fund II in a substantially unchanged manner as part of the
regulated investment company business of Acquiring Fund, or will use a
significant portion of Target Fund II's historic business assets in a business.
G. There is no intercorporate indebtedness between Acquiring Fund and
Target Fund II.
H. Acquiring Fund does not own, directly or indirectly, and has not
owned in the last five years, directly or indirectly, any shares of Target Fund
II. Acquiring Fund will not acquire any shares of Target Fund II prior to the
Closing Date.
I. Acquiring Fund will not make any payment of cash or of property
other than shares to Target Fund II or to any shareholder of Target Fund II in
connection with Transaction 2.
J. Pursuant to the Reorganization Agreement, the shareholders of Target
Fund II will receive solely Acquiring Fund voting shares in exchange for their
voting shares of Target Fund II.
K. The fair market value of the Acquiring Fund shares to be received by
the Target Fund II shareholders will be approximately equal to the fair market
value of the Target Fund II shares surrendered in exchange therefor.
L. Subsequent to the transfer of Target Fund II's assets to Acquiring
Fund pursuant to the Reorganization Agreement, Target Fund II will distribute
the shares of Acquiring Fund, together with other assets it may have, in final
liquidation as expeditiously as possible.
<PAGE>
M. The sum of the liabilities of Target Fund II to be assumed by
Acquiring Fund and the expenses of Transaction 2 does not exceed twenty percent
of the fair market value of the assets of Target Fund II.
General Representations
A. None of Acquiring Fund, Target Fund I or Target Fund II are under
the jurisdiction of a court in a Title 11 or similar case within the meaning of
Section 368(a)(3)(A) of the Internal Revenue Code of 1986, as amended (the
"Code").
B. Each of Acquiring Fund, Target Fund I and Target Fund II are treated
as a corporation for federal income tax purposes and at all times in its
existence has qualified as a regulated investment company, as defined in Section
851 of the Code.
C. The foregoing representations are true on the date of this letter
and will be true on the date of closing of Transaction 2.
Opinions
Based on and subject to the foregoing, and our examination of the legal
authority we have deemed to be relevant, we have the following opinions:
Opinions as to Transaction 1:
1. The acquisition by Acquiring Fund of substantially all of the assets
of Target Fund I solely in exchange for shares of Acquiring Fund and the
assumption by Acquiring Fund of Target Fund I's liabilities, if any, followed by
the distribution by Target Fund I of said Acquiring Fund shares to the
shareholders of Target Fund I in exchange for their Target Fund I shares, will
constitute a reorganization within the meaning of Section 368(a)(1)(F) of the
Code, and Acquiring Fund and Target Fund I will each be "a party to a
reorganization" within the meaning of Section 368(b) of the Code.
2. No gain or loss will be recognized to Target Fund I upon the
transfer of substantially all of its assets to Acquiring Fund solely in exchange
for Acquiring Fund shares and assumption by Acquiring Fund of any liabilities of
Target Fund I, or upon the distribution of such Acquiring Fund shares to the
shareholders of Target Fund I in exchange for all of their Target Fund I shares.
3. No gain or loss will be recognized by Acquiring Fund upon the
receipt of the assets of Target Fund I (including any cash retained initially by
Target Fund I to pay liabilities but later transferred) solely in exchange for
Acquiring Fund shares and assumption by Acquiring Fund of any liabilities of
Target Fund I.
<PAGE>
4. The basis of the assets of Target Fund I acquired by Acquiring Fund
will be the same as the basis of those assets in the hands of Target Fund I
immediately prior to the transfer, and the holding period of the assets of
Target Fund I in the hands of Acquiring Fund will include the period during
which those assets were held by Target Fund I.
5. The shareholders of Target Fund I will recognize no gain or loss
upon the exchange of all of their Target Fund I shares solely for Acquiring Fund
shares.
6. The basis of the Acquiring Fund shares to be received by the Target
Fund I shareholders will be the same as the basis of the Target Fund I shares
surrendered in exchange therefor.
7. The holding period of the Acquiring Fund shares to be received by
the Target Fund I shareholders will include the period during which the Target
Fund I shares surrendered in exchange therefor were held, provided the Target
Fund I shares were held as a capital asset on the date of the exchange.
Opinions as to Transaction 2:
1. The acquisition by Acquiring Fund of substantially all of the assets
of Target Fund II solely in exchange for voting shares of Acquiring Fund and
assumption of certain specified liabilities of Target Fund II followed by the
distribution by Target Fund II of said Acquiring Fund shares to the shareholders
of Target Fund II in exchange for their Target Fund II shares will constitute a
reorganization within the meaning of Section 368(a)(1)(C) of the Code, and
Acquiring Fund and Target Fund II will each be "a party to a reorganization"
within the meaning of Section 368(b) of the Code.
2. No gain or loss will be recognized to Target Fund II upon the
transfer of substantially all of its assets to Acquiring Fund solely in exchange
for Acquiring Fund voting shares and assumption by Acquiring Fund of certain
specified liabilities of Target Fund II, or upon the distribution of such
Acquiring Fund voting shares to the shareholders of Target Fund II in exchange
for all of their Target Fund II shares.
3. No gain or loss will be recognized by Acquiring Fund upon the
receipt of the assets of Target Fund II (including any cash retained initially
by Target Fund II to pay liabilities but later transferred) solely in exchange
for Acquiring Fund voting shares and assumption by Acquiring Fund of any
liabilities of Target Fund II.
4. The basis of the assets of Target Fund II acquired by Acquiring Fund
will be the same as the basis of those assets in the hands of Target Fund II
immediately prior to the transfer, and the holding period of the assets of
Target Fund
<PAGE>
II in the hands of Acquiring Fund will include the period during which those
assets were held by Target Fund II.
5. The shareholders of Target Fund II will recognize no gain or loss
upon the exchange of all of their Target Fund II shares solely for Acquiring
Fund voting shares. Gain, if any, will be realized by Target Fund II
shareholders who in exchange for their Target Fund II shares receive other
property or money in addition to Acquiring Fund shares, and will be recognized,
but not in excess of the amount of cash and the value of such other property
received. If the exchange has the effect of the distribution of a dividend, then
the amount of gain recognized that is not in excess of the ratable share of
undistributed earnings and profits of Target Fund II will be treated as a
dividend.
6. The basis of the Acquiring Fund voting shares to be received by the
Target Fund II shareholders will be the same as the basis of the Target Fund II
shares surrendered in exchange therefor.
7. The holding period of the Acquiring Fund voting shares to be
received by the Target Fund II shareholders will include the period during which
the Target Fund II shares surrendered in exchange therefor were held, provided
the Target Fund II shares were held as a capital asset on the date of the
exchange.
This opinion letter is delivered to you in satisfaction of the
requirements of Section 8.6 of each Reorganization Agreement. We hereby consent
to the filing of this opinion as an exhibit to the Registration Statement on
Form N-14 and to use of our name and any reference to our firm in such
Registration Statement or in the Prospectus/Proxy Statement constituting a part
thereof. In giving such consent, we do not thereby admit that we come within the
category of persons whose consent is required under Section 7 of the Securities
Act of 1933, as amended, or the rules and regulations of the Securities and
Exchange Commission thereunder.
Very truly yours,
/s/SULLIVAN & WORCESTER LLP
---------------------------
SULLIVAN & WORCESTER LLP
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
The Trustees and Shareholders
Evergreen Fixed Income Trust
We consent to:
1) the use of our report dated October 10, 1997 for Keystone
Diversified Bond Fund (B-2) incorporated by reference
herein;
2) the use of our report dated November 29, 1996 for Keystone Quality Bond
Fund (B-1) incorporated by reference herein; and
3) the reference to our firm under the caption "FINANCIAL
STATEMENTS AND EXPERTS" in the prospectus/proxy
statement.
/s/KPMG Peat Marwick LLP
------------------------
KPMG Peat Marwick LLP
Boston, Massachusetts
November 11, 1997
<PAGE>
EVERY SHAREHOLDER'S VOTE IS IMPORTANT!
THE BOARD OF TRUSTEES RECOMMENDS A VOTE "FOR" EACH PROPOSAL.
PLEASE VOTE, SIGN, DATE AND PROMPTLY RETURN
YOUR PROXY IN THE ENCLOSED ENVELOPE TODAY!
Please detach at perforation before mailing.
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
KEYSTONE QUALITY BOND FUND (B-1)
PROXY FOR THE SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON JANUARY 6, 1998
The undersigned, revoking all Proxies heretofore given, hereby appoints
Dorothy E. Bourassa, Terrence J. Cullen, Martin Wolin or Rosemary Van Antwerp or
any of them as Proxies of the undersigned, with full power of substitution, to
vote on behalf of the undersigned all shares of Keystone Quality Bond Fund (B-1)
("Keystone Quality") that the undersigned is entitled to vote at the special
meeting of shareholders of Keystone Quality to be held at 3:00 p.m. on Tuesday,
January 6, 1998 at the offices of the Evergreen Keystone Funds, 26th Floor, 200
Berkeley Street, Boston, Massachusetts 02116 and at any adjournments thereof, as
fully as the undersigned would be entitled to vote if personally present, as
follows:
NOTE: PLEASE SIGN EXACTLY AS YOUR NAME(S)
APPEAR ON THIS PROXY. If joint owners,
EITHER may sign this Proxy. When signing
as attorney, executor, administrator,
trustee, guardian, or custodian for a
minor, please give your full title. When
signing on behalf of a corporation or as a
partner for a partnership, please give the
full corporate or partnership name and
your title, if any.
Date , 199
----------------------------------------
----------------------------------------
<PAGE>
Signature(s) and Title(s), if applicable
<PAGE>
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF
TRUSTEES OF THE KEYSTONE QUALITY. THIS PROXY WILL BE VOTED AS
SPECIFIED BELOW WITH RESPECT TO THE ACTION TO BE TAKEN ON THE
FOLLOWING PROSPOSALS. THE SHARES REPRESENTED HEREBY WILL BE
VOTED AS INDICATED OR FOR THE PROPOSALS IF NO CHOICE IS
INDICATED. THE BOARD OF TRUSTEES OF KEYSTONE QUALITY
RECOMMENDS A VOTE FOR THE PROPOSALS. PLEASE MARK YOUR VOTE
BELOW IN BLUE OR BLACK INK. DO NOT USE RED INK. EXAMPLE: X
---
1. To approve an Agreement and Plan of Reorganization whereby Evergreen
Diversified Bond Fund, a series of Evergreen Fixed Income Trust, will (i)
acquire all of the assets of Keystone Quality in exchange for shares of
Evergreen Diversified Bond Fund; and (ii) assume certain identified liabilities
of Keystone Quality, as substantially described in the accompanying
Prospectus/Proxy Statement.
---- FOR ---- AGAINST ---- ABSTAIN
2. To consider and vote upon such other matters as may properly come
before said meeting or any adjournments thereof.
<PAGE>
<PAGE>
EVERY SHAREHOLDER'S VOTE IS IMPORTANT!
THE BOARD OF TRUSTEES RECOMMENDS A VOTE "FOR" EACH PROPOSAL.
PLEASE VOTE, SIGN, DATE AND PROMPTLY RETURN
YOUR PROXY IN THE ENCLOSED ENVELOPE TODAY!
Please detach at perforation before mailing.
- - - - - - - - - -- - - - - - - - - - - - - - - - - - - - - - -
KEYSTONE DIVERSIFIED BOND FUND (B-2)
PROXY FOR THE SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON JANUARY 6, 1998
The undersigned, revoking all Proxies heretofore given, hereby appoints
Dorothy E. Bourassa, Terrence J. Cullen, Martin Wolin or Rosemary Van Antwerp or
any of them as Proxies of the undersigned, with full power of substitution, to
vote on behalf of the undersigned all shares of Keystone Diversified Bond Fund
(B-2) ("Keystone Diversified") that the undersigned is entitled to vote at the
special meeting of shareholders of Keystone Diversified to be held at 3:00 p.m.
on Tuesday, January 6, 1998 at the offices of the Evergreen Keystone Funds, 26th
Floor, 200 Berkeley Street, Boston, Massachusetts 02116 and at any adjournments
thereof, as fully as the undersigned would be entitled to vote if personally
present, as follows:
NOTE: PLEASE SIGN EXACTLY AS YOUR NAME(S)
APPEAR ON THIS PROXY. If joint owners,
EITHER may sign this Proxy. When signing
as attorney, executor, administrator,
trustee, guardian, or custodian for a
minor, please give your full title. When
signing on behalf of a corporation or as a
partner for a partnership, please give the
full corporate or partnership name and
your title, if any.
Date , 199
----------------------------------------
<PAGE>
----------------------------------------
Signature(s) and Title(s), if applicable
<PAGE>
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF
TRUSTEES OF KEYSTONE DIVERSIFIED. THIS PROXY WILL BE VOTED AS
SPECIFIED BELOW WITH RESPECT TO THE ACTION TO BE TAKEN ON THE
FOLLOWING PROSPOSALS. THE SHARES REPRESENTED HEREBY WILL BE
VOTED AS INDICATED OR FOR THE PROPOSALS IF NO CHOICE IS
INDICATED. THE BOARD OF TRUSTEES OF KEYSTONE DIVERSIFIED
RECOMMENDS A VOTE FOR THE PROPOSALS. PLEASE MARK YOUR VOTE
BELOW IN BLUE OR BLACK INK. DO NOT USE RED INK. EXAMPLE: X
---
1. To approve an Agreement and Plan of Reorganization whereby Evergreen
Diversified Bond Fund, a series of Evergreen Fixed Income Trust, will (i)
acquire all of the assets of Keystone Diversified in exchange for shares of
Evergreen Diversified Bond Fund; and (ii) assume certain identified liabilities
of Keystone Diversified, as substantially described in the accompanying
Prospectus/Proxy Statement.
---- FOR ---- AGAINST ---- ABSTAIN
2. To consider and vote upon such other matters as may properly come
before said meeting or any adjournments thereof.
<PAGE>
<PAGE>
