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PART B
VANGUARD FIXED INCOME SECURITIES FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
MAY 24, 1994; REVISED MAY 25, 1994
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectus (dated May 24, 1994; Revised May 25, 1994). To
obtain this Prospectus, please call the Investor Information Department:
1-800-662-7447
TABLE OF CONTENTS
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The Fund.......................................... 1
Investment Objective and Policies................. 1
Purchase of Shares................................ 5
Redemption of Shares.............................. 5
Shareholder Services.............................. 6
Investment Limitations............................ 7
Management of the Fund............................ 9
Investment Advisory Services...................... 11
Portfolio Transactions............................ 13
Yield and Total Return............................ 15
Financial Statements.............................. 15
Performance Measures.............................. 16
Other Definitions................................. 17
Appendix--Description of Securities and Ratings... 17
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THE FUND
Vanguard Fixed Income Securities Fund, Inc. (the "Fund") is an open-end,
diversified, management investment company whose shares are currently offered in
nine distinct Portfolios. Each Portfolio of the Fund in effect represents a
separate mutual fund with its own investment objective and policies.
INVESTMENT OBJECTIVE AND POLICIES
The following policies supplement the investment objective and policies set
forth in the Fund's Prospectus:
REPURCHASE AGREEMENTS
Each Portfolio may invest in repurchase agreements with commercial banks,
brokers or dealers either for defensive purposes due to market conditions or to
generate income from its excess cash balances. A repurchase agreement is an
agreement under which the Portfolio acquires a money market instrument
(generally a security issued by the U.S. Government or an agency thereof, a
banker's acceptance or a certificate of deposit) from a commercial bank, broker
or dealer, subject to resale to the seller at an agreed upon price and date
(normally, the next business day). A repurchase agreement may be considered a
loan collateralized by securities. The resale price reflects an agreed upon
interest rate effective for the period the instrument is held by the Portfolio
and is unrelated to the interest rate on the underlying instrument. In
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these transactions, the securities acquired by the Portfolio (including accrued
interest earned thereon) must have a total value in excess of the value of the
repurchase agreement and are held by the Fund's Custodian Bank until
repurchased. In addition, the Fund's Board of Directors will monitor a
Portfolio's repurchase agreement transactions generally and will establish
guidelines and standards for review by the investment adviser of the
creditworthiness of any bank, broker or dealer party to a repurchase agreement
with the Portfolio. No more than an aggregate of 10% of a Portfolio's assets (5%
of total net assets in the case of the GNMA, and Long-Term Corporate
Portfolios), at the time of investment, will be invested in repurchase
agreements having maturities longer than seven days and securities subject to
legal or contractual restrictions on resale, or for which there are no readily
available market quotations.
The use of repurchase agreements involves certain risks. For example, if the
other party to the agreement defaults on its obligation to repurchase the
underlying security at a time when the value of the security has declined, the
Portfolio may incur a loss upon disposition of the security. If the other party
to the agreement becomes insolvent and subject to liquidation or reorganization
under the Bankruptcy Code or other laws, a court may determine that the
underlying security is collateral for a loan by the Portfolio not within the
control of the Portfolio and therefore the realization by the Portfolio on such
collateral may be automatically stayed. Finally, it is possible that the
Portfolio may not be able to substantiate its interest in the underlying
security and may be deemed an unsecured creditor of the other party to the
agreement. While each Portfolio's management acknowledges these risks, it is
expected that they can be controlled through careful monitoring procedures.
LENDING OF SECURITIES
Each Portfolio of the Fund may lend its investment securities to qualified
brokers, dealers, banks or other financial institutions, so long as the terms
and the structure of such loans are not inconsistent with the Investment Company
Act of 1940, as amended, or the Rules and Regulations or interpretations of the
Securities and Exchange Commission thereunder, which currently require that (a)
the borrower pledge and maintain with the Portfolio collateral consisting of
cash, and irrevocable letter of credit or securities issued or guaranteed by the
United States Government having a value at all times not less than 100 percent
of the value of the securities loaned, (b) the borrower add to such collateral
whenever the price of the securities loaned rises (i.e., the borrower "marks to
the market" on a daily basis), (c) the loan be made subject to termination by
the Portfolio at any time and (d) the Portfolio receive reasonable interest on
the loan (which may include the Portfolio's investing any cash collateral in
interest bearing short-term investments), and distributions on the loaned
securities and any increase in their market value. Each Portfolio of the Fund
will not lend securities if, as a result, the aggregate of such loans exceeds
33 1/3% of the value of the Portfolio's total assets. Loan arrangements made by
the Fund will comply with all other applicable regulatory requirements,
including the rules of the New York Stock Exchange, which rules presently
require the borrower, after notice, to redeliver the securities within the
normal settlement time of five business days.
RESTRICTED SECURITIES
Each Portfolio may invest in restricted securities (privately placed debt
securities) and other securities which are not readily marketable, but will not
acquire such securities if as a result they, together with the aggregate of
other securities for which no quotations are readily available, would comprise
more than 15% of the value of the Portfolio's net assets. Pursuant to Rule 144A
under the Securities Act of 1933, as amended, if a substantial market among
qualified institutional buyers develops for restricted securities held by any
Portfolio, the Fund intends to treat such securities as liquid securities, in
accordance with procedures approved by the Fund's Board of Directors.
Restricted securities may be sold only in privately negotiated transactions
or in a public offering with respect to which a registration statement is in
effect under the Securities Act of 1933. Where registration is required, a
Portfolio may be obligated to pay all or part of the registration expenses and a
considerable period may elapse between the time of the decision to sell and the
time the Portfolio may be permitted to
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sell a security under an effective registration statement. If, during such a
period, adverse market conditions were to develop, the Portfolio might obtain a
less favorable price than prevailed when it decided to sell. Restricted
securities will be priced at fair value as determined in good faith by the Board
of Directors. If through the appreciation of restricted securities or the
depreciation of unrestricted securities, a Portfolio should be in a position
where more than 15% of the value of its net assets are invested in illiquid
assets,
including restricted securities, the Portfolio will take appropriate steps to
protect liquidity.
FUTURES CONTRACTS AND OPTIONS
Each Portfolio except the Short-Term Federal Portfolio may enter into
futures contracts, options, and options on futures contracts for several
reasons: to simulate full investment in the underlying securities while
retaining a cash balance for Fund management purposes, to facilitate trading, to
reduce transaction costs, or to seek higher investment returns when a futures
contract is priced more attractively than the underlying equity security or
index. Futures contracts provide for the future sale by one party and purchase
by another party of a specified amount of a specific security at a specified
future time and at a specified price. Futures contracts which are standardized
as to maturity date and underlying financial instrument are traded on national
futures exchanges. Futures exchanges and trading are regulated under the
Commodity Exchange Act by the Commodity Futures Trading Commission ("CFTC"), a
U.S. Government Agency.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Closing
out an open futures position is done by taking an opposite position ("buying" a
contract which has previously been "sold," or "selling" a contract previously
purchased) in an identical contract to terminate the position. Brokerage
commissions are incurred when a futures contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums. Futures contracts are customarily purchased and sold on margin
deposits which may range upward from less than 5% of the value of the contract
being traded.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent that
the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Portfolios
expect to earn interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset
unfavorable changes in the value of securities otherwise held for investment
purposes or expected to be acquired by them. Speculators are less inclined to
own the securities underlying the futures contracts which they trade, and use
futures contracts with the expectation of realizing profits from fluctuations in
the prices of underlying securities. The Portfolios intend to use futures
contracts only for bona fide hedging purposes.
Regulations of the CFTC applicable to the Fund require that all of its
futures transactions constitute bonafide hedging transactions. A Portfolio will
only sell futures contracts to protect securities it owns against price declines
or purchase contracts to protect against an increase in the price of securities
it intends to purchase. As evidence of this hedging interest, the Portfolios
expect that approximately 75% of its futures contract purchases will be
"completed," that is, equivalent amounts of related securities will have been
purchased or are being purchased by a Portfolio upon sale of open futures
contracts.
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Although techniques other than the sale and purchase of futures contracts
could be used to control the Portfolio's exposure to market fluctuations, the
use of futures contracts may be a more effective means of hedging this exposure.
While a Portfolio will incur commission expenses in both opening and closing out
futures positions, these costs are lower than transaction costs incurred in the
purchase and sale of the underlying securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS
A Portfolio of the Fund will not enter into futures contract transactions to
the extent that, immediately thereafter, the sum of its initial margin deposits
on open contracts exceeds 5% of the market value of each Portfolio's total
assets. In addition, a Portfolio of the Fund will not enter into futures
contracts to the extent that its outstanding obligations to purchase securities
under these contracts would exceed 20% of the Portfolio's total assets.
RISK FACTORS IN FUTURES TRANSACTIONS
Positions in futures contracts may be closed out only on an Exchange which
provides a secondary market for such futures. However, there can be no assurance
that a liquid secondary market will exist for any particular futures contract at
any specific time. Thus, it may not be possible to close a futures position. In
the event of adverse price movements, a Portfolio would continue to be required
to make daily cash payments to maintain its required margin. In such situations,
if the Portfolio has insufficient cash, it may have to sell portfolio securities
to meet daily margin requirements at a time when it may be disadvantageous to do
so. In addition, the Portfolio may be required to make delivery of the
instruments underlying futures contracts it holds. The inability to close
options and futures positions also could have an adverse impact on the ability
to effectively hedge it.
A Portfolio will minimize the risk that it will be unable to close out a
futures contract by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the contract. Additionally, a portfolio incurs
the risk that the adviser will incorrectly predict future interest rate trends.
However, because the futures strategies of the Portfolio are engaged in only for
hedging purposes, the Adviser does not believe that the Portfolio is subject to
the risks of loss frequently associated with futures transactions. The Portfolio
would presumably have sustained comparable losses if, instead of the futures
contract, it had invested in the underlying financial instrument and sold it
after the decline.
Utilization of futures transactions by the Portfolio does involve the risk
of imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is also
possible that the Portfolio could both lose money on futures contracts and also
experience a decline in value of its portfolio securities. There is also the
risk of loss by the Portfolio of margin deposits in the event of bankruptcy of a
broker with whom the Portfolio has an open position in a futures contract or
related option.
Most 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
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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
future positions and subjecting some futures traders to substantial losses.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS
Except for transactions a Portfolio has identified as hedging transactions,
the Portfolio is required for Federal income tax purposes to recognize as income
for each taxable year its net unrealized gains and losses on certain futures
contracts held as of the end of the year as well as those actually realized
during the year. In most cases, any gain or loss recognized with respect to a
futures contract is considered to be 60% long-term capital gain or loss and 40%
short-term capital gain or loss, without regard to the holding period of the
contract. Furthermore, sales of futures contracts which are intended to hedge
against a change in the value of securities held by the Portfolio may affect the
holding period of such securities and, consequently, the nature of the gain or
loss on such securities upon disposition.
In order for the Portfolio to continue to qualify for Federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest, income derived from loans of securities, gains from the sale of
securities or of foreign currencies or other income derived with respect to the
Portfolio's business of investing in securities or currencies. 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 Portfolio's annual gross
income. It is anticipated that any net gain realized from the closing out of
futures contracts will be considered gain from the sale of securities and
therefore be qualifying income for purposes of the 90% requirement. In order to
avoid realizing excessive gains on securities held less than three months, the
Portfolio may be required to defer the closing out of futures contracts beyond
the time when it would otherwise be advantageous to do so. It is anticipated
that unrealized gains on futures contracts, which have been open for less than
three months as of the end of the Portfolio's fiscal year and which are
recognized for tax purposes, will not be considered gains on sales of securities
held less than three months for the purpose of the 30% test.
A Portfolio will distribute to shareholders annually any net capital gains
which have been recognized for Federal income tax purposes (including unrealized
gains at the end of the Portfolio's fiscal year) on futures transactions. Such
distributions will be combined with distributions of capital gains realized on
the Portfolio's other investments and shareholders will be advised on the nature
of the transactions.
PURCHASE OF SHARES
Each Portfolio reserves the right in its sole discretion (i) to suspend the
offering of its shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interest of the Fund, and (iii) to
reduce or waive the minimum for initial and subsequent investments for certain
fiduciary accounts such as employee benefit plans or under circumstances where
certain economies can be achieved in sales of the Portfolio's shares.
REDEMPTION OF SHARES
Each Portfolio may suspend redemption privileges or postpone the date of
payment (i) during any period that the New York Stock Exchange is closed, or
trading on the Exchange is restricted as determined by the Securities and
Exchange Commission (the "Commission"), (ii) during any period when an emergency
exists as defined by the rules of the Commission as a result of which it is not
reasonably practicable for a Portfolio to dispose of securities owned by it, or
fairly to determine the value of its assets, and (iii) for such other periods as
the Commission may permit.
The Fund has made an election with the Commission to pay in cash all
redemptions requested by any shareholder of record limited in amount during any
90-day period to the lesser of $250,000 or 1% of the net
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assets of the Fund at the beginning of such period. Such commitment is
irrevocable without the prior approval of the Commission. Redemptions in excess
of the above limits may be paid in whole or in part, in readily marketable
investment securities or in cash, as the Directors may deem advisable; however,
payment will be made wholly in cash unless the Directors believe that economic
or market conditions exist which would make such a practice detrimental to the
best interests of the Fund. If redemptions are paid in investment securities,
such securities will be valued as set forth in the Prospectus under "The Share
Price of Each Portfolio" and a redeeming shareholder would normally incur
brokerage expenses if he converted these securities to cash.
No charge is made by a Portfolio for redemptions. Any redemption may be more
or less than the shareholder's cost depending on the market value of the
securities held by the Portfolio.
SIGNATURE GUARANTEES
To protect your account, the Fund and Vanguard from fraud, signature
guarantees are required for certain redemptions. Signature guarantees enable the
Fund to verify the identity of the person who has authorized a redemption from
your account. SIGNATURE GUARANTEES ARE REQUIRED IN CONNECTION WITH: (1)
REDEMPTIONS INVOLVING MORE THAN $25,000 ON THE DATE OF RECEIPT BY VANGUARD OF
ALL NECESSARY DOCUMENTS; (2) ALL REDEMPTIONS, REGARDLESS OF THE AMOUNT INVOLVED,
WHEN THE PROCEEDS ARE TO BE PAID TO SOMEONE OTHER THAN THE REGISTERED OWNER(S),
AND/OR TO AN ADDRESS OTHER THAN THE ADDRESS OF RECORD; AND (3) SHARE TRANSFER
REQUESTS. These requirements are not applicable to redemptions in Vanguard's
prototype retirement plans, except in connection with: (1) distributions made
when the proceeds are to be paid to someone other than the plan participant; (2)
certain authorizations to effect exchanges by telephone; and (3) when proceeds
are to be wired. These requirements may be waived by the Fund in certain
instances.
A guarantor must be a bank, broker or any other guarantor that Vanguard
deems acceptable. NOTARIES PUBLIC ARE NOT ACCEPTABLE GUARANTORS.
The signature guarantees must appear either: (1) on the written request for
redemption; (2) on a separate instrument for assignment ("stock power") which
should specify the total number of shares to be redeemed; or (3) on all stock
certificates tendered for redemption and, if shares held by the Fund are also
being redeemed, on the letter or stock power.
SHAREHOLDER SERVICES
EXCHANGE PRIVILEGE
Each Portfolio's shares may be exchanged without cost for shares of any
other Portfolio, or for the shares of any open-end Fund currently offering its
shares to new investors in The Vanguard Group ("Vanguard"). A shareholder of any
other open-end Fund in Vanguard may likewise exchange his shares for shares of
any of the Fund's Portfolios. Exchange requests may be made either by mail,
telephone or telegraph.
Telephone and telegraph exchanges (referred to as "expedited exchanges")
will be accepted only if the account of the shareholder and the registration of
the two accounts is identical. Requests for expedited exchanges received prior
to the close of the New York Stock Exchange (generally 4:00 p.m. Eastern time)
will be processed at the next determined net asset value after such request is
received. Requests received after the close of the New York Stock Exchange
(generally 4:00 p.m. Eastern time) will be processed on the next business day.
NO EXPEDITED EXCHANGES WILL BE ACCEPTED INTO, OR FROM, VANGUARD EXPLORER FUND,
VANGUARD BALANCED INDEX FUND, VANGUARD INDEX TRUST FUND, VANGUARD INTERNATIONAL
EQUITY INDEX FUND--EUROPEAN, PACIFIC AND EMERGING MARKETS PORTFOLIOS, AND
VANGUARD QUANTITATIVE PORTFOLIOS. Neither the Fund nor Vanguard will be
responsible for the authenticity of exchange instructions received by telephone
or telegraph, provided that reasonable security procedures are observed.
Expedited exchanges may also be subject to limitations as to amounts and
frequency, and to other restrictions
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established by the Board of Directors to assure that such exchanges do not
disadvantage the Fund and its shareholders. Shareholders may obtain the terms of
these limitations, which may be revised at any time, from Vanguard.
Any such exchange will be based on the respective net asset values of the
shares involved. There are no sales commissions or charges of any kind. Before
making an exchange, a shareholder should consider the investment objectives and
policies of the Portfolio or fund to be purchased, and other relevant
information (including the minimum initial investment), which can be found in
the prospectus relating to that particular Portfolio or fund. A prospectus for
any of the Vanguard funds or Portfolios may be obtained from Vanguard.
For Federal income tax purposes an exchange between funds or Portfolios is a
taxable event and, accordingly, a capital gain or loss may be realized. The
exchange privilege may be modified or terminated at any time, and any of the
Portfolios or Vanguard funds may limit or discontinue the offering of its shares
without notice to shareholders.
TRANSFER OF SHARES
Fund shares may be transferred to another person by sending appropriate
written instructions to Vanguard. The account must be clearly identified and
include the number of shares to be transferred and the signatures of all
registered owners. The signature on the letter of instructions or any stock
power must be guaranteed. As in the case of withdrawals, the written request
must be received in "Good Order" before any transfer can be made.
INFORMATION FOR SHAREHOLDERS
Following any purchase or redemption, a shareholder will receive a statement
which reflects all activity during the current calendar year. Each shareholder
will also receive a quarterly statement, which includes valuation as of the day
the statement is prepared.
Shareholders will receive semi-annual financial statements audited at least
annually by independent accountants whose selection is ratified by shareholders.
INVESTMENT LIMITATIONS
The Fund is subject to the following limitations which may not be changed
with respect to a particular Portfolio without the approval of at least a
majority of the outstanding voting securities (as defined in the Investment
Company Act of 1940) of that Portfolio. A Portfolio will not:
(1) Invest in commodities or commodity contracts or purchase or sell
real estate, although it may purchase and sell marketable securities of
companies which deal in real estate or interests therein; except that each
Portfolio except the Short-Term Federal Portfolio may invest in bond futures
contracts, bond options and options on bond futures contracts to the extent
that not more than 5% of its assets are required as deposit margin for
futures contracts and not more than 20% of its assets are invested in such
instruments at any time;
(2) Write, purchase or sell warrants, put or call options, or
combinations thereof, except as specified above in (1);
(3) Invest in interests in oil, gas, or other mineral exploration or
development programs;
(4) Make loans to other persons (except by (i) the purchase of the debt
obligations in which the Portfolio is authorized to invest in accordance
with its investment policies, and (ii) as provided under "Lending of
Securities");
(5) Purchase securities on margin or sell securities short, except as
specified above in (1);
(6) With respect to 75% of assets, purchase for the Portfolio more than
10% of the outstanding voting securities of any issuer, except securities
issued or guaranteed by the U.S. Government or any of its agencies or
instrumentalities;
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(7) With respect to 75% of assets, purchase securities of any issuer
(except obligations of the U.S. Government and its agencies and
instrumentalities) if as a result more than 5% of the value of the
Portfolio's total assets would be invested in the securities of such issuer;
(8) Borrow money, except that the Portfolio may borrow from banks (or
through reverse repurchase agreements), for temporary or emergency (not
leveraging) purposes, including the meeting of redemption requests which
might otherwise require the untimely disposition of securities, in an amount
not exceeding 15% of the value of the Portfolio's net assets (including the
amount borrowed and the value of any outstanding reverse repurchase
agreements) at the time the borrowing is made. Whenever borrowings exceed 5%
of the value of the Portfolio's net assets, the Portfolio will not make any
additional investments;
(9) Pledge, mortgage or hypothecate the Portfolio's assets to an extent
greater than 5% of the value of its total assets;
(10) Purchase or otherwise acquire any security if, as a result, more
than 15% of its net assets would be invested in securities that are illiquid
(included in this limitation is the Fund's investment in The Vanguard Group,
Inc.);
(11) Invest for the purpose of controlling management of any company;
(12) Invest in securities of other investment companies, except as may
be acquired as a part of a merger, consolidation or acquisition of assets or
otherwise to the extent permitted by Section 12 of the Investment Company
Act of 1940. The Portfolio will invest only in investment companies which
have investment objectives and investment policies consistent with those of
the Portfolio;
(13) Invest more than 5% of the value of the Portfolio's total assets
in securities of companies which have (with predecessors) a record of less
than three years continuous operation, except investments in obligations
guaranteed by the U.S. Government, or issued by its agencies or
instrumentalities;
(14) Concentrate its investments in a particular industry, although it
may invest up to 25% of the Portfolio's total assets (taken at value) in the
securities of issuers, all of which conduct their principal business
activities in the same industry, provided that (i) this limitation does not
apply to obligations issued or guaranteed by the U.S. Government, or its
agencies or instrumentalities, and (ii) utility companies will be divided
according to their services; for example, gas, gas transmission, electric
and gas, electric, and telephone will each be considered a separate
industry, and (iii) financial service companies will be classified according
to the end users of their services, as follows: Finance-Automobiles,
Finance-Banks, Finance-Consumers and Finance-Diversified; and
(15) Engage in the business of underwriting securities issued by other
persons, except to the extent that the Fund may technically be deemed to be
an underwriter under the Securities Act of 1933, as amended, in disposing of
investment securities.
The above-referenced investment limitations are considered at the time that
portfolio securities are purchased. Notwithstanding these limitations, the Fund
may own all or any portion of the securities of, or make loans to, or contribute
to the costs or other financial requirements of any company which will be
wholly-owned by the Fund and one or more other investment companies and is
primarily engaged in the business of providing, at cost, management,
administrative or related services to the Fund and other investment companies.
See "MANAGEMENT OF THE FUND." As a non-fundamental policy each Portfolio may not
purchase or retain securities of an issuer if an officer or director of such
issuer is an officer or Director of the Fund or its investment adviser and one
or more of such officers or Directors of the Fund or its investment adviser owns
beneficially more than 1/2% of the shares or securities of such issuer and all
such directors and officers owning more than 1/2% of such shares or securities
together own more than 5% of such shares or securities.
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MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS
The Officers of the Fund manage its day to day operations and are
responsible to the Fund's Board of Directors. The Directors set broad policies
for each Fund and choose its Officers. The following is a list of the Directors
and Officers of the Fund and a statement of their present positions and
principal occupations during the past five years. The mailing address of the
Directors and Officers of the Fund is Post Office Box 876, Valley Forge, PA
19482.
JOHN C. BOGLE, CHAIRMAN, CHIEF EXECUTIVE OFFICER AND DIRECTOR*
Chairman, Chief Executive Officer, and Director of The Vanguard Group, Inc.,
and of each of the investment companies in The Vanguard Group; Director of The
Mead Corporation and General Accident Insurance.
JOHN J. BRENNAN, PRESIDENT & DIRECTOR*
President and Director of The Vanguard Group, Inc., and of each of the other
investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, DIRECTOR
Chairman and Chief Executive Officer, Rhone-Poulenc Rorer, Inc.; Director of
Immune Response Corp. and Sun Company, Inc.; Trustee, Universal Health Realty
Income Trust.
BARBARA BARNES HAUPTFUHRER, DIRECTOR
Director of The Great Atlantic and Pacific Tea Company, ALCO Standard, Corp.,
Raytheon Company, Knight-Ridder, Inc. and Massachusetts Mutual Life Insurance
Co.
BRUCE K. MACLAURY, DIRECTOR
President, The Brookings Institution; Director of Dayton Hudson Corporation,
American Express Bank, Ltd. and The St. Paul Companies, Inc.
BURTON G. MALKIEL, DIRECTOR
Chemical Bank Chairmen's Professor of Economics, Princeton University;
Director of Prudential Insurance Co. of America, Amdahl Corporation, Baker
Fentress & Co., Jeffrey Co. and The Southern New England Telephone Company.
ALFRED M. RANKIN, JR. DIRECTOR
President, Chief Executive Officer and Director of NACCO Industries, Inc.;
Director of The BF Goodrich Company, The Standard Products Company and The
Reliance Electric Company.
JOHN C. SAWHILL, DIRECTOR
President and Chief Executive Officer, The Nature Conservancy; formerly,
Director and Senior Partner, McKinsey & Co.; President, New York University;
Director of Pacific Gas and Electric Company and NACCO Industries.
JAMES O. WELCH, JR., DIRECTOR
Retired Chairman of Nabisco Brands, Inc., retired Vice Chairman and Director
of RJR Nabisco; Director of TECO Energy, Inc.
J. LAWRENCE WILSON, DIRECTOR
Chairman and Director of Rohm & Haas Company; Director of Cummins Energy
Company and Vanderbilt University; Trustee of the Culver Educational
Foundation.
RAYMOND J. KLAPINSKY, SECRETARY*
Senior Vice President and Secretary of The Vanguard Group, Inc.; Secretary of
each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND, TREASURER*
Treasurer of The Vanguard Group, Inc. and of each of the investment companies
in The Vanguard Group.
KAREN E. WEST, CONTROLLER*
Vice President of The Vanguard Group. Inc.; Controller of each of the
investment companies in The Vanguard Group.
---------
* OFFICERS OF THE FUND ARE "INTERESTED PERSONS" AS DEFINED IN THE INVESTMENT
COMPANY ACT OF 1940.
B-9
<PAGE>
THE VANGUARD GROUP
Vanguard Fixed Income Securities Fund is a member of The Vanguard Group of
Investment Companies. Through their jointly owned subsidiary, The Vanguard
Group, Inc. ("Vanguard"), the Fund and the other funds in the Group obtain at
cost virtually all of their corporate management, administrative and
distribution services. Vanguard also provides investment advisory services on an
at-cost basis to certain of the Vanguard funds.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the funds and also
furnishes the funds with necessary office space, furnishings and equipment. Each
fund pays its share of Vanguard's net expenses which are allocated among the
funds under methods approved by the Board of Directors (Trustees) of each fund.
In addition, each fund bears its own direct expenses, such as legal, auditing
and custodian fees.
The Vanguard Group was established and operates under a Funds' Service
Agreement which was approved by the shareholders of each of the Funds. The
amounts which each of the Funds have invested are adjusted from time to time in
order to maintain the proportionate relationship between each Fund's relative
net assets and its contribution to Vanguard's capital. At January 31, 1994, the
Fund had contributed capital of $3,348,000 to Vanguard, representing 16.7% of
Vanguard's capitalization. The Funds' Service Agreement provides for the
following arrangement: (1) each Vanguard Fund may invest a maximum of 0.40% of
its assets in Vanguard and (2) there is no restriction on the maximum cash
investment that the Vanguard Funds may make in Vanguard.
MANAGEMENT. Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Funds by third parties. During the
fiscal year ended January 31, 1994, the Fund's share of Vanguard's actual net
costs of operation relating to management and administrative services (including
transfer agency) totaled approximately $42,470,000.
DISTRIBUTION. Vanguard provides all distribution and marketing activities
for the Funds in the Group. Vanguard Marketing Corporation, a wholly-owned
subsidiary of The Vanguard Group, Inc., acts as Sales Agent for shares of the
Funds, in connection with any sales made directly to investors in the states of
Florida, Missouri, New York, Ohio, Texas and such other states as it may be
required.
The principal distribution expenses are for advertising, promotional
materials and marketing personnel. Distribution services may also include
organizing and offering to the public, from time to time, one or more new
investment companies which will become members of the Group. The Directors and
officers of Vanguard determine the amount to be spent annually on distribution
activities, the manner and amount to be spent on each Fund, and whether to
organize new investment companies.
One half of the distribution expenses of a marketing and promotional nature
is allocated among the Funds based upon their relative net assets. The remaining
one half of these expenses is allocated among the Funds based upon each Fund's
sales for the preceding 24 months relative to the total sales of the Funds as a
Group, provided, however, that no Fund's aggregate quarterly rate of
contribution for distribution expenses of a marketing and promotional nature
shall exceed 125% of the average distribution expense rate for the Group, and
that no Fund shall incur annual distribution expenses in excess of 20/100 of 1%
of its average month-end net assets. During the fiscal year ended January 31,
1994, the Fund paid approximately $5,500,000 of the Group's distribution and
marketing expenses, which represented an effective annual rate of .03% of 1% of
the Fund's average net assets.
INVESTMENT ADVISORY SERVICES. Vanguard also provides investment advisory
services to the Short-Term Corporate, Short-Term Federal, Short-Term U.S.
Treasury, Intermediate-Term Corporate, Intermediate-Term U.S. Treasury and
Long-Term U.S. Treasury Portfolios of the Fund, Vanguard Money Market Reserves,
Vanguard Admiral Funds, Vanguard Institutional Portfolios, Vanguard Bond Index
Fund, Vanguard Municipal Bond Fund, Vanguard Florida Insured Tax-Free Fund,
Vanguard California Tax-Free Fund, Vanguard New Jersey Tax-Free
B-10
<PAGE>
Fund, Vanguard New York Insured Tax-Free Fund, Vanguard Ohio Tax-Free Fund,
Vanguard Pennsylvania Tax-Free Fund, and the Money Market and High-Grade Bond
Portfolios of Vanguard Variable Insurance Fund. These services are provided on
an at-cost basis from a money management staff employed directly by Vanguard.
The compensation and other expenses of this staff are paid by the Funds
utilizing these services.
REMUNERATION OF DIRECTORS AND OFFICERS. The Fund pays each Director, who is
not also an Officer, an annual fee plus travel and other expenses incurred in
attending Board meetings. The Fund's Officers and employees are paid by Vanguard
which, in turn, is reimbursed by the Fund, and each other Fund in the Group, for
its proportionate share of Officers' and employees' salaries and retirement
benefits.
The following information is furnished with respect to the Directors and
Officers of the Fund for whom the Fund's proportionate shares of remuneration
exceeded $60,000 for the fiscal year ended January 31, 1994 and for all
Directors and Officers as a group:
<TABLE>
<CAPTION>
NAMES AND CAPACITIES IN WHICH
REMUNERATION WAS RECEIVED REMUNERATION
------------------------------------------------------- --------------
<S> <C>
John C. Bogle, Chief Executive Officer................. $ 507,065
John J. Brennan, President and Director................ $ 226,304
All Directors and Officers as a Group (12)............. $ 981,042(1)
<FN>
---------
(1) Includes approximately $99,000 of fees and expenses paid by the Fund to
its "non-interested" Directors, and the Fund's proportionate share of
remuneration paid by Vanguard to all Officers of the Fund, as a group.
(2) Includes the Fund's proportionate share of retirement benefits paid by
Vanguard under its Retirement and Thrift Plans to all Officers and
Directors of the Company as a group. Under its retirement plan, Vanguard
contributes annually an amount equal to 10% of each officer's annual
compensation plus 5.7% of that part of the Officer's compensation during
the year that exceeds the Social Security Taxable Wage Base then in
effect. Under the Thrift Plan, all officers are permitted to make pre-tax
basic contributions in a maximum amount equal to 4% of total compensation.
Vanguard matches the basic contributions on a 100% basis. The Fund's
proportionate share of retirement contributions paid by Vanguard under its
retirement and thrift plans on behalf of all eligible Officers of the
Fund, as a group, during the 1994 fiscal year was $102,511. Directors who
are not Officers are paid an annual fee based on the number of years of
service on the Board, up to fifteen years of service, upon retirement. The
fee is equal to $1,000 for each year of service and each investment
company member of The Vanguard Group contributes a proportionate amount to
this fee based on its relative net assets. This fee is paid, subsequent to
a Director's retirement, for a period of ten years or until the death of a
retired Director.
</TABLE>
INVESTMENT ADVISORY SERVICES GNMA, LONG-TERM CORPORATE
AND HIGH YIELD CORPORATE PORTFOLIOS
The Fund employs Wellington Management Company (the "Adviser") under an
investment advisory agreement dated May 31, 1993 to manage the investment and
reinvestment of the assets of the Fund's GNMA, Long-Term Corporate and High
Yield Corporate Portfolios and to continuously review, supervise and administer
the investment program for each such Portfolio. The Adviser discharges its
responsibilities subject to the control of the officers and Directors of the
Fund.
The GNMA, Long-Term Corporate, and High Yield Corporate Portfolios pay the
Adviser an aggregate fee at the end of each fiscal quarter, calculated by
applying a quarterly rate, based on the following annual percentage rates, to
the aggregate average month-end net assets of the three Portfolios for the
quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
----------------------------------- ------
<S> <C>
First $2.5 billion................. .125%
Next $2.5 billion.................. .100%
Next $2.5 billion.................. .075%
Over $7.5 billion.................. .050%
</TABLE>
B-11
<PAGE>
The fee, as determined above, is allocated to each Portfolio based on the
relative net assets of each. Provided, however, that following such allocation:
(a) the fee to be paid by the GNMA Portfolio is then reduced by seventy-five
percent (75%); (b) the fee to be paid by the Long-Term Corporate Portfolio is
then reduced by fifty percent (50%); and (c) the fee to be paid by the High
Yield Corporate Portfolio is then reduced by twenty-five percent (25%).
During the fiscal years ended January 30, 1992, 1993 and 1994, the three
Portfolios paid the following advisory fees to WMC:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED JANUARY 31,
--------------------------------------
PORTFOLIO 1992 1993 1994
------------------------- ---------- ---------- -------------
<S> <C> <C> <C>
GNMA..................... $1,060,000 $1,341,000 1,454,000
Long-Term Corporate...... 849,000 1,026,000 1,252,000
High Yield Corporate..... 918,000 1,286,000 1,455,000
</TABLE>
The fees set forth above were paid under the terms of a previous advisory
agreement that called for a higher rate of fees. The present agreement continues
until May 30, 1995, and may be continued thereafter for successive one year
periods, as long as such continuance is specifically approved at least annually
(a) by a vote of a majority of those members of the Board of Directors of the
Fund who are not parties to the agreement or interested persons of any such
party, cast in person at a meeting called for the purpose of voting such
approval, and (b) by the Board of Directors of the Fund or by vote of a majority
of the outstanding shares of each of the GNMA, Long-Term Corporate and High
Yield Corporate Portfolios. Provided, however, that if the holders of any one of
these Portfolios fail to approve the agreement, the Adviser may continue to
serve as investment adviser to the Portfolio which approved the agreement, and
to the Portfolio which did not approve the agreement until new arrangements have
been made. The agreement may be terminated by any Portfolio at any time, without
penalty, by vote of the Board of Directors of the Fund or by vote of a majority
of the outstanding shares of the Portfolio on 60 days' written notice to the
Adviser, or by the Adviser on 90 days' written notice to the Fund. The agreement
will automatically terminate in the event of its assignment.
The Fund's Board of Directors may, without the approval of shareholders,
provide for:
A. The employment of a new investment adviser pursuant to the terms of
a new advisory agreement, either as a replacement for an existing adviser or
as an additional adviser.
B. A change in the terms of an advisory agreement.
C. The continued employment of an existing adviser on the same
advisory contract terms where a contract has been assigned because of a
change in control of the adviser.
Any such change will only be made upon not less than 30 days' prior written
notice to shareholders, which shall include the information concerning the
adviser that would have normally been included in a proxy statement.
Because the Adviser provides only investment advisory services to the Fund
and has no control over the Fund's expenses, the Adviser has not undertaken to
guarantee expenses of the Fund. The Officers of the Fund have worked out
alternative arrangements with state authorities which require an expense
guarantee.
DESCRIPTION OF THE ADVISER. Wellington Management Company, 75 State Street,
Boston, MA, is a Massachusetts general partnership, of which the following
persons are managing partners: Robert W. Doran, Duncan M. McFarland, and John B.
Neff.
B-12
<PAGE>
SHORT-TERM CORPORATE, SHORT-TERM FEDERAL,
SHORT-TERM U.S. TREASURY, INTERMEDIATE-TERM CORPORATE, INTERMEDIATE-TERM U.S.
TREASURY AND LONG-TERM U.S. TREASURY PORTFOLIOS
The Short-Term Corporate, Short-Term Federal, Short-Term U.S. Treasury,
Intermediate-Term Corporate, Intermediate-Term U.S. Treasury and Long-Term U.S.
Treasury Portfolios receive all investment advisory services on an
"internalized," at-cost, basis from an experienced investment management staff
employed directly by Vanguard. This staff also provides investment advisory
services to Vanguard Money Market Reserves, Vanguard Institutional Portfolios,
Vanguard Bond Index Fund, Vanguard Municipal Bond Fund, Vanguard California
Tax-Free Fund, Vanguard Florida Insured Tax-Free Fund, Vanguard New Jersey
Tax-Free Fund, Vanguard Ohio Tax-Free Fund, Vanguard New York Insured Tax-Free
Fund, Vanguard Pennsylvania Tax-Free Fund and the Money Market and High-Grade
Bond Portfolios of Vanguard Variable Insurance Fund. The compensation and other
expenses of the staff are allocated among the Portfolios of the Fund and the
other Funds listed above. During the fiscal years ended January 31, 1992, 1993
and 1994, the Short-Term Corporate Portfolio's share of these expenses totaled
approximately $97,000, $202,000 and $298,000, respectively. During the fiscal
years ended January 31, 1992, 1993 and 1994, the Long-Term U.S. Treasury
Portfolio's share of these expenses totaled approximately $126,000, $75,000 and
$84,000, respectively. During the fiscal years ended January 31, 1992, 1993 and
1994, the Short-Term Federal Portfolio's shares of these expenses totaled
approximately $44,000, $124,000 and $173,000, respectively. For the period
October 28, 1991 to January 31, 1992, 1993 and 1994 the Short-Term and
Intermediate-Term U.S. Treasury Portfolios' share of these expenses each totaled
approximately $25,000, $34,000 and $79,000, respectively.
The investment management staff is supervised by the senior Officers of the
Fund. The senior Officers, who are also Officers of Vanguard, Vanguard Money
Market Reserves, Vanguard Institutional Portfolios, Vanguard Bond Index Fund,
Vanguard Municipal Bond Fund, Vanguard State Tax-Exempt Funds, and Vanguard
Variable Insurance Fund, are directly responsible to the Board of Directors of
the Fund. The Board of Directors, elected annually by shareholders, sets broad
policies for the Fund and chooses its Officers.
PORTFOLIO TRANSACTIONS GNMA, LONG-TERM CORPORATE
AND HIGH YIELD CORPORATE PORTFOLIOS
The investment advisory agreement authorizes the Adviser (with the approval
of the Fund's Board of Directors) to select the brokers or dealers that will
execute the purchases and sales of portfolio securities for the Fund and directs
the Adviser to use its best efforts to obtain the best available price and most
favorable execution as to all transactions for the Fund. The Adviser has
undertaken to execute each investment transaction at a price and commission
which provides the most favorable total cost or proceeds reasonably obtainable
under the circumstances.
In placing portfolio transactions, the Adviser will use its best judgment to
choose the broker most capable of providing the brokerage services necessary to
obtain best available price and most favorable execution. The full range and
quality of brokerage services available will be considered in making these
determinations. In those instances where it is reasonably determined that more
than one broker can offer the brokerage services needed to obtain the best
available price and most favorable execution, consideration may be given to
those brokers which supply investment research and statistical information and
provide other services in addition to execution services to the Fund and/or the
Adviser. The Adviser considers such information useful in the performance of its
obligations under the agreement but is unable to determine the amount by which
such services may reduce its expenses.
The investment advisory agreement also incorporates the concepts of Section
28(e) of the Securities Exchange Act of 1934 by providing that, subject to the
approval of the Fund's Board of Directors, the Adviser may cause the Fund to pay
a broker-dealer which furnishes brokerage and research services a
B-13
<PAGE>
higher commission than that which might be charged by another broker-dealer for
effecting the same transaction; provided that such commission is deemed
reasonable in terms of either that particular transaction or the overall
responsibilities of the Adviser to the Fund and the other Funds in the Group.
Currently, it is the Fund's policy that the Adviser may at times pay higher
commissions in recognition of brokerage services felt necessary for the
achievement of better execution of certain securities transactions that
otherwise might not be available. The Adviser will only pay such higher
commissions if it believes this to be in the best interest of the Fund. Some
brokers or dealers who may receive such higher commissions in recognition of
brokerage services related to execution of securities transactions are also
providers of research information to the Adviser and/or the Fund. However, the
Adviser has informed the Fund that it will not pay higher commission rates
specifically for the purpose of obtaining research services.
Some securities considered for investment by the Fund may also be
appropriate for other Funds and/ or clients served by the Adviser. If purchase
or sale of securities consistent with the investment policies of the Fund and
one or more of these other Funds or clients served by the Adviser are considered
at or about the same time, transactions in such securities will be allocated
among the several Funds and clients in a manner deemed equitable by the Adviser.
SHORT-TERM CORPORATE, SHORT-TERM FEDERAL,
SHORT-TERM U.S. TREASURY, INTERMEDIATE-TERM CORPORATE, INTERMEDIATE-TERM U.S.
TREASURY, AND LONG-TERM U.S. TREASURY PORTFOLIO
Brokers or dealers who execute transactions for the Short-Term Corporate,
Short-Term Federal, Short-Term U.S. Treasury, Intermediate-Term Corporate,
Intermediate-Term U.S. Treasury, and Long-Term U.S. Treasury Portfolios are
selected by Vanguard's investment management staff, which is responsible for
using its best efforts to obtain the best available price and most favorable
execution for each transaction. Principal transactions are made directly with
issuers, underwriters and market makers and usually do not involve brokerage
commissions, although underwriting commissions and dealer mark-ups may be
involved. Brokerage transactions are placed with brokers deemed most capable of
providing favorable terms; where more than one broker can offer such terms,
consideration may be given to brokers who provide the staff with research and
statistical information.
Vanguard's investment management staff may occasionally make recommendations
to other Vanguard Funds or clients which result in their purchasing or selling
securities simultaneously with the Portfolios. As a result, the demand for
securities being purchased or the supply of securities being sold may increase,
and this could have an adverse effect on the price of those securities. It is
the staff's policy not to favor one client over another in making
recommendations or placing an order. If two or more clients are purchasing a
given security on the same day from the same broker-dealer, such transactions
may be averaged as to price.
ALL PORTFOLIOS
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be made through such
firms. However, the Fund may place portfolio orders with qualified brokers or
dealers who recommend the shares of the Fund to their clients and may, when a
number of brokers and dealers can provide comparable best price and execution on
a particular transaction, consider the sale of shares by a broker or dealer in
selecting among qualified brokers or dealers.
The total brokerage commissions paid by the Fund for the fiscal year ended
January 31, 1992 was $28,014. The Fund did not incur any brokerage commissions
in the 1993 and 1994 fiscal years.
B-14
<PAGE>
YIELD AND TOTAL RETURN
The yield* of each portfolio of the Fund for the 30-day period ended January
31, 1994 is set forth below:
<TABLE>
<S> <C>
Short-Term U.S. Treasury Portfolio................................ 4.09%
Short-Term Federal Portfolio...................................... 4.43%
Short-Term Corporate Portfolio.................................... 4.56%
Intermediate-Term U.S. Treasury Portfolio......................... 5.21%
GNMA Portfolio.................................................... 5.67%(2)
Long-Term U.S. Treasury Portfolio................................. 6.03%
Long-Term Corporate Portfolio..................................... 6.36%
High Yield Corporate Portfolio.................................... 8.02%(1)
Intermediate-Term Corporate....................................... 5.41%
<FN>
---------
* THE YIELD FOR EACH PORTFOLIO OF THE FUND IS CALCULATED DAILY. FURTHER, IN
CALCULATING THE YIELD, THE PREMIUMS AND DISCOUNTS ON ASSET-BACKED SECURITIES
ARE NOT AMORTIZED.
(1) YIELD FOR THE HIGH YIELD CORPORATE PORTFOLIO REFLECTS A PREMIUM BASED ON
THE POSSIBILITY THAT INTEREST PAYMENTS ON SOME BONDS MAY BE REDUCED OR
ELIMINATED. ALSO, SINCE BONDS WITH HIGHER INTEREST COUPONS MAY BE REPLACED
BY BONDS WITH LOWER COUPONS, INCOME DIVIDENDS ARE SUBJECT TO REDUCTION.
(2) YIELD FOR THE GNMA PORTFOLIO CALCULATED TO TAKE INTO ACCOUNT ESTIMATED
PREPAYMENT RISK OF MORTGAGE-BACKED OBLIGATIONS. LOWER INTEREST RATES ARE
LIKELY TO FURTHER ACCELERATE THESE PREPAYMENTS; IF SO, DIVIDEND INCOME
WOULD BE REDUCED. YIELD WOULD BE 5.95% UNDER SEC CALCULATION METHODOLOGY.
</TABLE>
The average annual total return of each portfolio of the Fund for the one,
five and ten year periods ending January 31, 1994 is set forth below:
<TABLE>
<CAPTION>
1 YEAR ENDED 5 YEARS ENDED 10 YEARS
1/31/94 1/31/94 ENDED 1/31/94
------------ ------------- -------------
<S> <C> <C> <C>
Short-Term U.S. Treasury
Portfolio......................... +5.5% +7.5%* N/A
Short-Term Federal Portfolio....... +6.2% +9.2% +8.6%*
Short-Term Corporate Portfolio..... +6.1% +9.5% +9.9%
GNMA Portfolio..................... +5.2% +10.6% +10.9%
Intermediate-Term U.S. Treasury
Portfolio......................... +10.1% +11.9%* N/A
Intermediate-Term Corporate
Portfolio......................... +1.7%* N/A N/A
Long-Term U.S. Treasury
Portfolio......................... +16.1% +13.0% +10.3%
Long-Term Corporate Portfolio...... +13.8% +13.3% +12.4%
High Yield Corporate Portfolio..... +17.5% +11.0% +11.6%
<FN>
---------
* Since inception: Short-Term Federal Portfolio--December 31, 1987
Long-Term U.S. Treasury Portfolio--May 19, 1986
Short-Term U.S. Treasury and Intermediate-Term U.S. Treasury
Portfolios--
began operations October 28, 1991
Intermediate-Term Corporate--November 1, 1993
</TABLE>
FINANCIAL STATEMENTS
The Fund's financial statements for the fiscal year ended January 31, 1994,
including the financial highlights for each of the five years in the period
ended January 31, 1994, appearing in the Fund's 1994 Annual Report to
Shareholders, and the reports thereon of Price Waterhouse, independent
accountants, also appearing in the Annual Report, are incorporated by reference
in this Statement of Additional Information.
B-15
<PAGE>
PERFORMANCE MEASURES
Each of the investment company members of the Vanguard Group, including each
Portfolio of Vanguard Fixed Income Securities, Inc., may, from time to time, use
one or more of the following unmanaged indices for comparative performance
purposes.
STANDARD AND POOR'S 500 COMPOSITE STOCK PRICE INDEX--is a well diversified list
of 500 companies representing the U.S. Stock Market.
WILSHIRE 5000 EQUITY INDEX--consists of nearly 5,000 common equity securities,
covering all stocks in the U.S. for which daily pricing is available.
WILSHIRE 4500 EQUITY INDEX--consists of all stocks in the Wilshire 5000 except
for the 500 stocks in the Standard and Poor's 500 Index.
MORGAN STANLEY CAPITAL INTERNATIONAL EAFE INDEX--is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australia and the Far East.
GOLDMAN SACHS 100 CONVERTIBLE BOND INDEX--currently includes 67 bonds and 33
preferreds. The original list of names was generated by screening for
convertible issues of 100 million or greater in market capitalization. The index
is priced monthly.
SALOMON BROTHERS GNMA INDEX--includes pools of mortgages originated by private
lenders and guaranteed by the mortgage pools of the Government National Mortgage
Association.
SALOMON BROTHERS HIGH-GRADE CORPORATE BOND INDEX--consists of publicly issued,
non-convertible corporate bonds rated AA or AAA. It is a value-weighted, total
return index, including approximately 800 issues with maturities of 12 years or
greater.
SALOMON BROTHERS BROAD INVESTMENT-GRADE BOND--is a market-weighted index that
contains approximately 4700 individually priced investment-grade corporate bonds
rated BBB or better, U.S. Treasury/ agency issues and mortgage passthrough
securities.
SHEARSON LEHMAN LONG-TERM TREASURY BOND--is composed of all bonds covered by the
Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
MERRILL LYNCH CORPORATE & GOVERNMENT BOND--consists of over 4,500 U.S. Treasury,
Agency and investment grade corporate bonds.
SHEARSON LEHMAN CORPORATE (BAA) BOND INDEX--all publicly offered fixed rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $25 million outstanding. This index
includes over 1,000 issues.
BOND BUYER MUNICIPAL INDEX (20 YEAR) BOND--is a yield index on current coupon
high grade general obligation municipal bonds.
STANDARD & POOR'S PREFERRED INDEX--is a yield index based upon the average yield
for four high grade, non-callable preferred stock issues.
NASDAQ INDUSTRIAL INDEX--is composed of more than 3,000 industrial issues. It is
a value-weighted index calculated on price change only and does not include
income.
COMPOSITE INDEX--70% Standard & Poor's 500 Index and 30% NASDAQ Industrial
Index.
COMPOSITE INDEX--35% Standard & Poor's 500 Index and 65% Salomon Brothers High
Grade Bond Index.
COMPOSITE INDEX--65% Standard & Poor's 500 Index, 35% Salomon Brothers High
Grade Bond Index.
B-16
<PAGE>
LEHMAN BROTHERS AGGREGATE BOND INDEX--is a market weighted index that contains
individually priced U.S. Treasury, agency, corporate, and mortgage pass-through
securities corporate rated BBB- or better. The Index has a market value of over
$4 trillion.
LEHMAN BROTHERS MUTUAL FUND SHORT (1-5) GOVERNMENT/CORPORATE INDEX--is a market
weighted index that contains individually priced U.S. Treasury, agency, and
corporate investment grade bonds rated BBB- or better with maturities between 1
and 5 years. The index has a market value of over $1.3 trillion.
LEHMAN BROTHERS MUTUAL FUND INTERMEDIATE (5-10) GOVERNMENT/CORPORATE INDEX--is a
market weighted index that contains individually priced U.S. Treasury, agency,
and corporate securities rated BBB- or better with maturities between 5 and 10
years. The index has a market value of over $600 billion.
LEHMAN BROTHERS MUTUAL FUND LONG (10+) GOVERNMENT/CORPORATE INDEX--is a market
weighted index that contains individually priced U.S. Treasury, agency, and
corporate securities rated BBB- or better with maturities greater than 10 years.
The index has a market value of over $900 billion.
LEHMAN BROTHERS INTERMEDIATE-TERM CORPORATE BOND INDEX--consists of all
investment grade corporate debt with maturities of 5 to 10 years.
OTHER DEFINITIONS
Marketing literature for the Portfolios of Vanguard Fixed Income Securities
Fund, Inc., may from time to time refer to or discuss a Portfolio's DURATION.
Duration is the weighted average life of a Portfolio's debt instruments measured
on a present-value basis; it is generally superior to average weighted maturity
as a measure of a Portfolio's potential volatility due to changes in interest
rates.
Unlike a Portfolio's average weighted maturity, which takes into account
only the stated maturity date of the Portfolio's debt instruments, duration
represents a weighted average of both interest and principal payments,
discounted by the current yield-to-maturity of the securities held. For example,
a four-year, zero-coupon bond, which pays interest only upon maturity (along
with principal), has both a maturity and duration of 4 years. However, a
four-year bond priced at par with an 8% coupon has a maturity of 4 years but a
duration of 3.6 years (at an 8% yield), reflecting the bond's earlier payment of
interest.
In general, a bond with a longer duration will fluctuate more in price than
a bond with a shorter duration. Also, for small changes in interest rates,
duration serves to approximate the resulting change in a bond's price. For
example, a 1% change in interest rates will cause roughly a 4% move in the price
of a zero-coupon bond with a 4 year duration, while an 8% coupon bond (with a
3.6 year duration) will change by approximately 3.6%.
APPENDIX--DESCRIPTION OF SECURITIES AND RATINGS
I. DESCRIPTION OF BOND RATINGS
Excerpts from Moody's Investors Service, Inc., ("Moody's") description of
its four highest bond ratings: Aaa--judged to be the best quality. They carry
the smallest degree of investment risk; Aa--judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds; A--possess many favorable investment attributes and are to be
considered as "upper medium grade obligations"; Baa--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. Ba--judged to have speculative
elements; their future cannot be considered as well assured; B--generally lack
characteristics of the desirable investment; Caa--are of poor standing. Such
issues may be in default or there may be present elements of danger with respect
to principal or interest; Ca--speculative in a high degree; often in default;
C--lowest rated class of bonds; regarded as having extremely poor prospects.
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Moody's also supplies numerical indicators 1, 2 and 3 to rating categories.
The modifier 1 indicates that the security is in the higher end of its rating
category; the modifier 2 indicates a mid-range ranking; and 3 indicates a
ranking toward the lower end of the category.
Excerpts from Standard & Poor's Corporation ("S&P") description of its five
highest bond ratings: AAA--highest grade obligations. Capacity to pay interest
and repay principal is extremely strong; AA-- also qualify as high grade
obligations. A very strong capacity to pay interest and repay principal and
differs from AAA issues only in small degree; A--regarded as upper medium grade.
They have a strong capacity to pay interest and repay principal although it is
somewhat susceptible to the adverse effects of changes in circumstances and
economic conditions than debt in higher rated categories; BBB--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. This group is the lowest which qualifies for commercial bank
investment. BB, B, CCC, CC-- predominately speculative with respect to capacity
to pay interest and repay principal in accordance with terms of the obligation;
BB indicates the lowest degree of speculation and CC the highest.
S&P applies indicators "+," no character, and "-" to its rating categories.
The indicators show relative standing within the major rating categories.
II. DESCRIPTION OF GNMA MORTGAGE-BACKED CERTIFICATES
GNMA (Government National Mortgage Association) Certificates are mortgage
backed securities. The Certificates evidence part ownership of a pool of
mortgage loans. The Certificates which the GNMA Portfolio will purchase are of
the "modified pass-through" type. "Modified pass-through" Certificates entitle
the holder to receive all interest and principal payments owed on the mortgage
pool, net of fees paid to the "issuer" and GNMA, regardless of whether or not
the mortgagor actually makes the payment.
THE GNMA GUARANTEE. The National Housing Act authorizes GNMA to guarantee
the timely payment of principal of and interest on securities backed by a group
(or pool) of mortgages insured by FHA or FHMA, or guaranteed by VA. The GNMA
guarantee is backed by the full faith and credit of the U.S. Government. GNMA is
also empowered to borrow without limitation from the U.S. Treasury if necessary
to make any payments required under its guarantee.
THE LIFE OF GNMA CERTIFICATES. The average life of GNMA Certificates is
likely to be substantially less than the original maturity of the mortgage pools
underlying the securities. Prepayments of principal by mortgagors and mortgage
foreclosures will usually result in the return of the greatest part of principal
invested well before the maturity of the mortgages in the pool. (Note: Due to
the GNMA guarantee, foreclosures impose no risk to principal investment.) As
prepayment rates of individual mortgage pools will vary widely, it is not
possible to accurately predict the average life of a particular issue of GNMA
Certificates. However, statistics published by the FHA are normally used as an
indicator of the expected average life of GNMA Certificates. These statistics
indicate that the average life of single-family dwelling mortgages with 25-30
year maturities, the type of mortgages backing the vast majority of GNMA
Certificates, is approximately 12 years. For this reason, it is standard
practice to treat GNMA Certificates as 30-year mortgage-backed securities which
prepay fully in the twelfth year.
YIELD CHARACTERISTICS OF GNMA CERTIFICATES. The coupon rate of interest of
GNMA Certificates is lower than the interest rate paid on the VA-guaranteed or
FHA-insured mortgages underlying the Certificates, but only by the amount of the
fees paid to GNMA and the issuer. For the most common type of mortgage pool,
containing single-family dwelling mortgages. GNMA receives an annual fee of 0.06
of 1% of the outstanding principal for providing its guarantee, and the issuer
is paid an annual fee of 0.44 of 1% for assembling the mortgage pool and for
passing through monthly payments of interest and principal to Certificate
holders.
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The coupon rate by itself, however, does not indicate the yield which will
be earned on the Certificates for the following reasons:
1. Certificates may be issued at a premium or discount, rather than at
par.
2. After issuance, Certificates may trade in the secondary market at a
premium or discount.
3. Interest is earned monthly, rather than semi-annually as for
traditional bonds. Monthly compounding has the effect of raising the
effective yield earned on GNMA Certificates.
4. The actual yield of each GNMA Certificate is influenced by the
prepayment experience of the mortgage pool underlying the Certificate. That
is, if mortgagors pay off their mortgages early, the principal returned to
Certificate holders may be reinvested at more or less favorable rates.
In quoting yields for GNMA Certificates, the standard practice is to assume
that the Certificates will have a 12 year life. Compared on this basis, GNMA
Certificates have historically yielded roughly .25 of 1% more than high grade
corporate bonds and .50 of 1% more than U.S. Government and U.S. Government
Agency bonds. As the life of individual pools may vary widely, however, the
actual yield earned on any issue of GNMA Certificates may differ significantly
from the yield estimated on the assumption of a 12 year life.
MARKET FOR GNMA CERTIFICATES. Since the inception of the GNMA
Mortgage-Backed Securities program in 1970, the amount of GNMA Certificates
outstanding has grown rapidly. The size of the market and the active
participation in the secondary market by securities dealers and many types of
investors make the GNMA Certificates a highly liquid instrument. Prices of GNMA
Certificates are readily available from securities dealers and depend on, among
other things, the level of market rates, the Certificate's coupon rate and the
prepayment experience of the pool of mortgages backing each Certificate.
"WHEN ISSUED" SECURITIES. GNMA securities may be purchased and sold on a
when issued and delayed delivery basis. Delayed delivery or when issued
transactions arise when securities are purchased or sold by a Portfolio with
payment and delivery taking place in the future in order to secure what is
considered to be an advantageous price and yield to the Portfolio at the time of
entering into the transaction. When the Portfolio engages in when issued and
delayed delivery transactions, the Portfolio relies on the buyer or seller, as
the case may be, to consummate the sale. Failure to do so may result in the
Portfolio missing the opportunity of obtaining a price or yield considered to be
advantageous. When issued and delayed delivery transactions may be expected to
occur a month or more before delivery is due. However, no payment or delivery is
made by the Portfolio until it receives payment or delivery from the other party
to the transaction. A separate account of liquid assets equal to the value of
such purchase commitments will be maintained until payment is made. To the
extent the Portfolio engages in when issued and delayed delivery transactions,
it will do so for the purpose of acquiring securities consistent with its
investment objective and policies and not for the purpose of investment
leverage.
III. COMMERCIAL PAPER
A Portfolio may invest in commercial paper (including variable amount master
demand notes) rated A-1 or better by Standard & Poor's or Prime-1 by Moody's,
or, if unrated, issued by a corporation having an outstanding unsecured debt
issue rated A or better by Moody's or by Standard & Poor's. Commercial paper
refers to short-term, unsecured promissory notes issued by corporations to
finance short-term credit needs. Commercial paper is usually sold on a discount
basis and has a maturity at the time of issuance not exceeding nine months.
Variable amount master demand notes are demand obligations that permit the
investment of fluctuating amounts at varying market rates of interest pursuant
to arrangement between the issuer and a commercial bank acting as agent for the
payees of such notes, whereby both parties have the right to vary the amount of
the outstanding indebtedness on the notes. Because variable amount master demand
notes are direct lending arrangements between a lender and a borrower, it is not
generally contemplated that such instruments will be traded, and there is no
secondary market for these notes, although they are redeemable (and thus
immediately repayable by the borrower) at
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face value, plus accrued interest, at any time. In connection with the
Portfolio's investment in variable amount master demand notes, Vanguard's
investment management staff will monitor, on an ongoing basis, the earning
power, cash flow and other liquidity ratios of the issuer, and the borrower's
ability to pay principal and interest on demand.
Commercial paper rated A-1 by Standard & Poor's has the following
characteristics: (1) liquidity ratios are adequate to meet cash requirements;
(2) long-term senior debt is rated "A" or better; (3) the issuer has access to
at least two additional channels of borrowing; (4) basic earnings and cash flow
have an upward trend with allowance made for unusual circumstances; (5)
typically, the issuer's industry is well established and the issuer has a strong
position within the industry; (6) the reliability and quality of management are
unquestioned. Relative strength or weakness of the above factors determine
whether the issuer's commercial paper is A-1, A-2 or A-3. 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 the appraisal of speculative-type risks which may be inherent
in certain areas; (3) evaluation of the issuer's products in relation to
completion 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 interest questions and preparations to meet such
obligations.
IV. U.S. GOVERNMENT SECURITIES
The term "U.S. Government securities" refers to a variety of securities
which are issued or guaranteed by the United States Treasury, by various
agencies of the United States Government, and by various instrumentalities which
have been established or sponsored by the United States Government. The term
also refers to "repurchase agreements" collateralized by such securities.
U.S. Treasury securities are backed by the "full faith and credit" of the
United States. Securities issued or guaranteed by Federal agencies and U.S.
Government sponsored instrumentalities may or may not be backed by the full
faith and credit of the United States. In the case of securities not backed by
the full faith and credit of the United States, the investor must look
principally to the agency or instrumentality issuing or guaranteeing the
obligation for ultimate repayment, and may not be able to assert a claim against
the United States itself in the event the agency or instrumentality does not
meet its commitment.
Some of the U.S. Government agencies that issue or guarantee securities
include the Export-Import Bank of the United States, Farmers Home
Administration, Federal Housing Administration, Maritime Administration, Small
Business Administration, and The Tennessee Valley Authority.
An instrumentality of the U.S. Government is a government agency organized
under Federal charter with government supervision. Instrumentalities issuing or
guaranteeing securities include, among others, Federal Home Loan Banks, the
Federal Land Banks, Central Bank for Cooperatives, Federal Intermediate Credit
Banks, and the Federal National Mortgage Association.
V. BANK OBLIGATIONS
Time deposits are non-negotiable deposits maintained in a banking
institution for a specified period of time at a stated interest rate.
Certificates of deposit are negotiable short-term obligations of commercial
banks. Variable rate certificates of deposit are certificates of deposit on
which the interest rate is periodically adjusted prior to their stated maturity
based upon a specified market rate. As a result of these adjustments, the
interest rate on these obligations may be increased or decreased periodically.
Frequently, dealers selling variable rate certificates of deposit to a Portfolio
will agree to repurchase such instruments, at the Portfolio's option, at par on
or near the coupon dates. The dealers' obligations to repurchase these
instruments are subject to conditions imposed by various dealers; such
conditions typically are the continued credit standing of the issuer and the
existence of reasonably orderly market conditions. The
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Portfolio is also able to sell variable rate certificates of deposit in the
secondary market. Variable rate certificates of deposit normally carry a higher
interest rate than comparable fixed rate certificates of deposit. A bankers'
acceptance is a time draft drawn on a commercial bank by a borrower usually in
connection with an international commercial transaction (to finance the import,
export, transfer or storage of goods). The borrower is liable for payment as
well as the bank, which unconditionally guarantees to pay the draft at its face
amount on the maturity date. Most acceptances have maturities of six months or
less and are traded in the secondary markets prior to maturity.
VI. SHORT AND INTERMEDIATE TERM CORPORATE DEBT SECURITIES
Outstanding non-convertible corporate debt securities (e.g. bonds and
debentures) which are rated Baa3 or better either by Moody's Investors Service,
Inc. ("Moody's") or BBB or better by Standard & Poor's Corporation ("Standard &
Poor's") are considered investment grade.
VII. FOREIGN INVESTMENTS
The Short-Term Corporate, Intermediate-Term Corporate, High Yield Corporate
and Long-Term Corporate Portfolios may invest in the securities (payable in U.S.
dollars) of foreign issues and in the securities of foreign branches of U.S.
banks such as negotiable certificates of deposit (Eurodollars). Because the
Portfolios invest in such securities, investment in the Portfolios involves
investment risks that are different in some respects from an investment in a
fund which invests only in debt obligations of U.S. issuers. Such risks may
include future political and economic developments, the possible imposition of
withholding taxes on interest income payable on the securities held, possible
seizure or nationalization of foreign deposits, the possible establishment of
exchange controls or the adoption of other restrictions by foreign governments
which may adversely affect the payment of principal and interest on securities
held by the Portfolios, difficulty in obtaining and enforcing court judgements
abroad, the possibility of restrictions on investments in other jurisdictions,
reduced levels of government regulation of securities markets in foreign
countries, and difficulties in effecting the repatriation of capital invested
abroad. A Portfolio will not purchase any such foreign security if, as a result,
more than 20% of the value of the Portfolio's total assets would be invested in
such securities.
VIII. ZERO COUPON TREASURY BONDS
The Short-Term Federal, Intermediate-Term U.S. Treasury, Short-Term U.S.
Treasury and Long-Term U.S. Treasury Portfolios may invest in zero coupon
Treasury bonds, a term used to describe U.S. Treasury notes and bonds which have
been stripped of their unmatured interest coupons, or the coupons themselves,
and also receipts or certificates representing interest in such stripped debt
obligations and coupons. The timely payment of coupon interest and principal on
these instruments remains guaranteed by the "full faith and credit" of the
United States Government.
A zero coupon bond does not pay interest. Instead, it is issued at a
substantial discount to its "face value"--what it will be worth at maturity. The
difference between a security's issue or purchase price and its face value
represents the imputed interest an investor will earn if the security is held
until maturity. For tax purposes, a portion of this imputed interest is deemed
as income received by zero coupon bondholders each year. The Fund, which expects
to qualify as a regulated investment company, intends to pass along such
interest as a component of a Portfolio's distributions of net investment income.
Zero coupon bonds may offer investors the opportunity to earn higher yields
than those available on U.S. Treasury bonds of similar maturity. However, zero
coupon bond prices may also exhibit greater price volatility than ordinary debt
securities because of the manner in which their principal and interest is
returned to the investor.
IX. COLLATERALIZED MORTGAGE OBLIGATIONS
The Short-Term Federal, Short-Term Corporate, Intermediate-Term Corporate
and the Short-, Intermediate-and Long-Term U.S. Treasury Portfolios may invest
in collateralized mortgage obligations (CMOs),
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bonds that are collateralized by whole loan mortgages or mortgage pass-through
securities. The bonds issued in a CMO deal are divided into groups, and each
group of bonds is referred to as a "tranche". Under the CMO structure, the cash
flows generated by the mortgages or mortgage pass-through securities in the
collateral pool are used to first pay interest and then pay principal to the CMO
bondholders. The bonds issued under a CMO structure are retired sequentially as
opposed to the pro rata return of principal found in traditional pass-through
obligations. Subject to the various provisions of individual CMO issues, the
cash flow generated by the underlying collateral (to the extent it exceeds the
amount required to pay the stated interest) is used to retire the bonds. Under
the CMO structure, the repayment of principal among the different tranches is
prioritized in accordance with the terms of the particular CMO issuance. The
"fastest-pay" tranche of bonds, as specified in the prospectus for the issuance,
would initially receive all principal payments. When that tranche of bonds is
retired, the next tranche, or tranches, in the sequence, as specified in the
prospectus, receive all of the principal payments until they are retired. The
sequential retirement of bond groups continues until the last tranche, or group
of bonds, is retired. Accordingly, the CMO structure allows the issuer to use
cash flows of long maturity, monthly-pay collateral to formulate securities with
short, intermediate and long final maturities and expected average lives. The
primary risks involved in any mortgage security, such as a CMO issuance, is its
exposure to prepayment risk. To the extent a particular tranche is exposed to
this risk, the bondholder is generally compensated in the form of higher yield.
In order to provide security, in addition to the underlying collateral, many CMO
issues also include minimum reinvestment rate and minimum sinking-fund
guarantees. Typically, the Portfolios will invest in those CMOs that most
appropriately reflect their average maturities and market risk profiles.
Consequently, the Short-Term Portfolios invest only in CMOs with highly
predictable short-term average maturities. Similarly, the Intermediate-and
Long-Term Treasury Portfolios will invest in those CMOs that carry market risks
consistent with intermediate-and long-term bonds.
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