VANGUARD(R) MASSACHUSETTS
TAX-EXEMPT FUND
SEMIANNUAL
[PHOTO OF SHIP]
May 31, 2000
[A MEMBER OF
THE VANGUARD GROUP(R) LOGO]
HAVE THE PRINCIPLES OF INVESTING CHANGED?
In a world of frenetic change in business, technology, and the
financialmarkets, it is natural to wonder whether the basic principles of
investing have changed.
We don't think so.
The most successful investors over the coming decade will be those who
began the new century with a fundamental understanding of risk and who had the
discipline to stick with long-term investment programs.
Certainly, investors today confront a challenging, even unprecedented,
environment.Valuations of market indexes are at or near historic highs. The
strength and duration of the bull market in U.S. stocks have inflated people's
expectations and diminished their recognition of the market's considerable
risks. And the incredible divergence in stock returns--many technology-related
stocks gained 100% or more in 1999, yet prices fell for more than half of all
stocks--has made some investors question the idea of diversification.
And then there is the Internet. Undeniably, it is a powerful medium for
communications and transacting business. For investors, the Internet is a vast
source of information about investments, and online trading has made it
inexpensive and convenient to trade stocks and invest in mutual funds.
However, new tools do not guarantee good workmanship. Information is
not the same as wisdom. Indeed, much of the information, opinion, and rumor that
swirl about financial markets each day amounts to "noise" of no lasting
significance. And the fact that rapid-fire trading is easy does not make it
beneficial. Frequent trading is almost always counterpro-ductive because
costs--even at low commission rates--and taxes detract from the returns that the
markets provide. Sadly, many investors jump into a "hot" mutual fund just in
time to see it cool off. Meanwhile, long-term fund investors are hurt by
speculative trading activity because they bear part of the costs involved in
accommodating purchases and redemptions.
Vanguard believes that intelligent investors should resist short-term
thinking and focus instead on a few time-tested principles:
o Invest for the long term. Pursuing your long-term investment goals is
more like a marathon than a sprint.
o Diversify your investments with holdings in stocks, bonds, and cash
investments. Remember that, at any moment, some part of a diversified portfolio
will lag other parts, and be wary of taking on more risk by "piling onto" the
best-performing part of your holdings. Today's leader could well be tomorrow's
laggard.
o Step back from the daily frenzy of the markets; focus on your overall
asset allocation.
o Capture as much of the market's return as possible by minimizing
costs and taxes.
Costs and taxes diminish long-term returns while doing nothing to reduce the
risks you incur as an investor.
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CONTENTS
REPORT FROM THE CHAIRMAN 1 FUND PROFILE 8
THE MARKETS IN PERSPECTIVE 4 PERFORMANCE SUMMARY 10
REPORT FROM THE ADVISER 6 FINANCIAL STATEMENTS 11
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All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc.,
unless otherwise noted."Standard & Poor's(R)," "S&P(R)," "S&P 500(R)," "Standard
& Poor's 500," and "500" are trademarks of The McGraw-Hill Companies, Inc. Frank
Russell Company is the owner of trademarks and copyrights relating to the
Russell Indexes. "Wilshire 5000(R)" and "Wilshire 4500" are trademarks of
Wilshire Associates Incorporated.
<PAGE>
REPORT FROM THE CHAIRMAN
[PHOTO OF JOHN J. BRENNAN]
JOHN J. BRENNAN
Interest rates for most municipal bonds ratcheted higher during the six
months ended May 31, 2000--the first half of Vanguard Massachusetts Tax-Exempt
Fund's fiscal year--and bond prices generally declined. In this environment,
municipal bonds earned positive total returns, as price declines only partially
offset the interest income earned during the period.
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TOTAL RETURNS
SIX MONTHS ENDED
MAY 31, 2000
----------------------------------------------------------------
Vanguard Massachusetts
Tax-Exempt Fund 1.0%
----------------------------------------------------------------
Average Massachusetts
Municipal Debt Fund* 0.5%
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*Derived from data provided by Lipper Inc.
As you can see in the adjacent table, our fund earned a six-month total
return (capital change plus reinvested dividends) of 1.0%, which topped that of
its average peer. Our fund's total return is based on a decrease in net asset
value from $9.25 per share on November 30, 1999, to $9.10 per share on May 31,
2000, and is adjusted for dividends totaling $0.237 per share paid from net
investment income. For Massachusetts residents, income earned by our fund is
exempt from federal and Massachusetts income taxes, but may be subject to local
taxes and to the alternative minimum tax.
The fund's yield rose from 5.17% at the end of November 1999 to 5.62%
on May 31. For taxpayers in the highest federal income tax bracket (39.6%), the
taxable equivalent yield at the end of the period was about 9.3%.
THE PERIOD IN REVIEW
The U.S. economy expanded impressively during the six months ended May 31, but
the terrific pace of economic growth stoked fears of higher inflation--and,
thus, higher interest rates. These fears put pressure on the prices of both
stocks and bonds, making it a volatile six months for stocks, particularly for
technology shares, and a generally lackluster half-year for bonds.
The Federal Reserve Board continued its campaign to head off inflation
by hiking its target for short-term interest rates by a full percentage point
during the half-year. The yield of the 10-year U.S. Treasury note rose only
slightly, to 6.27% on May 31 from 6.19% six months earlier, and the yield of
3-month Treasury bills rose by 32 basis points (0.32 percentage point) to close
the period at 5.62%. However, the yield of the benchmark 30-year Treasury bond
fell from 6.29% on November 30, 1999, to 6.01% on May 31, 2000. This decline
resulted from the decreasing supply of long-term Treasury debt-- a development
that drove prices higher and yields lower for the longest-term Treasuries.
Yields of high-grade, long-term municipal bonds ended the half-year at
5.91%, up a tiny bit from 5.87% when the period began. Yields on top-grade
(MIG-1) 3-month notes rose 35 basis points to 4.15% on May 31.
Relative to U.S. Treasury bonds, longer-term municipal bonds are
extremely attractive, particularly for investors in higher income tax brackets.
On May 31,the yield of a high-grade, long-term municipal bond was equal to about
98% of the yield of the 30-year U.S. Treasury bond, whose interest is subject to
federal income tax. The spread between long-term Treasury bonds and munis was
unusually thin because of the heavy
1
<PAGE>
demand for--and, thus, lower yields of--long-term Treasuries. For securities
with maturities of 10 years, the yield of municipal bonds was equal to about
85% of the yield of Treasuries, a proportion in line with the long-term
historical rate.
The U.S. stock market advanced during the six months, though as the
period progressed investors' favor shifted toward value-oriented stocks and away
from growth shares. The Wilshire 5000 Total Market Index, a measure of the
entire U.S. stock market, gained 2.4% for the half-year. Among large-
capitalization stocks, the returns of value stocks outpaced those of growth-
oriented shares by nearly 2 percentage points (3.6% for the Standard &
Poor's 500/BARRA Value Index; 1.9% for the S&P 500/BARRA Growth Index).The
split was especially evident from March through May, when large value stocks
gained 10.0% and large growth stocks slipped -0.4%
PERFORMANCE OVERVIEW
Vanguard Massachusetts Tax-Exempt Fund earned 1.0% for the six months, ahead of
the 0.5% return of its average peer and even with the return of the Lehman
Brothers Municipal Bond Index, which exists outside the real world of operating
expenses and transaction costs.
Of course, a six-month return tells only part of the story of a bond
fund's performance. It's important to note that semiannual returns for bond
funds account for only half of the year's interest income, while prices fully
and immediately reflect movements in interest rates--rising when rates fall and
falling when rates rise. For perspective, it's important to consider a full
year's interest income when evaluating a bond fund. During the 12 months ended
May 31, 2000, our fund recorded a negative total return of -2.3%, consisting of
an income return of 4.7% and a price decline of -7.0%.
Also, keep in mind that rising interest rates, which cause bond prices
to fall, are not entirely bad news for fixed income investors. For long-term
bonds, a rise in interest rates causes an immediate price decline, but the
long-term effect can be beneficial because there is more income to reinvest at
higher yields. Conversely, when interest rates drop, bond prices rise
immediately, but over the long haul, lower rates diminish the income earned on
reinvested dividends.
Though bond prices can swing dramatically, over the long run it is
interest income that accounts for virtually all of a bond fund's total return.
As such, municipal bonds that now offer a yield of about 5.5% can provide a
solid long-term return, particularly if inflation remains at relatively low
levels.
A key ingredient in our success is our significant cost advantage over
similar funds. Our fund has an annualized expense ratio (expenses as a
percentage of average net assets) of 0.19%, just a fraction of the 1.16% charged
by the average Massachusetts tax-exempt fund. Our cost advantage, which provides
us with a head start in our quest to outperform our competitors, and the
skillful management of our investment adviser, Vanguard Fixed Income Group,
create a powerful combination that we believe will continue to benefit our
shareholders.
IN SUMMARY
The argument for holding bonds as well as stocks in a balanced portfolio is an
enduring one that is not based on past returns or projections of future returns.
Fixed income investments add to a portfolio's diversification, and interest
income is a valuable and durable component of total return that, when compounded
over long periods, plays an important role in accumulating wealth. For
Massachusetts residents, the triple tax benefit of a Massachusetts municipal
bond fund can be especially valuable.
2
<PAGE>
History has taught us that investors who maintain balanced portfolios
of well- diversified stock funds, bond funds, and money market funds generally
find it easierto maintain their equilibrium in turbulent times. We urge you to
base your investment plans on your own goals, time horizon, and risk tolerance--
and then to stick with those plans over the long haul.
/s/
John J. Brennan
Chairman and Chief Executive Officer
June 14, 2000
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IN MEMORY
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It is with great sadness that I report the death of John C. Sawhill, an
independent trustee of the fund and a member of The Vanguard Group's board of
directors since 1991. John, an economist who was president and chief executive
officer of The Nature Conservancy, died on May 18 at age 63. He was a senior
lecturer at the Harvard Business School and had formerly served as president of
New York University and as deputy secretary of the U.S. Department of Energy
under President Jimmy Carter. John was a remarkable man who was full of energy,
vigor, and life. His experience and wisdom added a great deal to Vanguard, and
his death is a blow to everyone who knew and loved him. Though John's work on
behalf of our funds was often carried on behind the scenes, he was a dedicated
advocate for the best interests of our shareholders. He will be missed.
3
<PAGE>
THE MARKETS IN PERSPECTIVE
SIX MONTHS ENDED MAY 31, 2000
Strong crosscurrents pushed and tugged at financial markets during the six
months ended May 31, 2000. Positive influences included very strong economic
growth and rising corporate profits. Negative factors included tighter monetary
policy, higher inflation, and concerns about stock valuations.
Interest rates rose in most segments of the bond market, and bond
prices slipped. Stock prices rose slightly, on balance, although wide day-to-day
price swings were frequent.
Uncertainty in both the bond and stock markets centered on the
surprising performance of the U.S. economy, which grew at a torrid 7.3% pace in
the final three months of 1999 and at a still-robust 5.4% during the first
quarter of 2000. With U.S. unemployment at around 4.0% of the workforce, the
Federal Reserve Board continued to be concerned that inflation would worsen
unless the economic expansion slowed. The Fed raised short-term interest rates
by 0.25 percentage point in February and again in March, before boosting rates
by 0.50 percentage point in mid-May. These boosts, following three
quarter-percentage-point increases in 1999, took the Fed's target for short-term
rates to 6.5%. By the end of May, some signs of slowing had emerged in the
economy, although it was not certain that the Fed had finished applying the
brakes.
Evidence on inflation was ambiguous. The Consumer Price Index increased
1.8% and 3.1%, respectively, for the six- and twelve-month periods ended May 31,
but much of the increase was due to higher energy and food prices. Core
inflation, which excludes those sectors, was up a less-scary 2.4% during the
twelve months ended May 31.
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TOTAL RETURNS
PERIODS ENDED MAY 31, 2000
------------------------------
6 MONTHS 1 YEAR 5 YEARS*
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STOCKS
S&P 500 Index 2.9% 10.5% 23.8%
Russell 2000 Index 5.5 9.9 13.5
Wilshire 5000 Index 2.4 10.7 22.3
MSCI EAFE Index 0.7 17.4 10.4
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BONDS
Lehman Aggregate Bond Index 1.4% 2.1% 6.0%
Lehman 10 Year Municipal Bond Index 0.7 -0.2 5.3
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 2.7 5.2 5.2
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OTHER
Consumer Price Index 1.8% 3.1% 2.4%
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*Annualized.
U.S. STOCK MARKETS
Optimism about long-term prospects for technology, media, and telecommunications
companies dominated the equity markets through the first three months of the
period. But sentiment shifted suddenly in mid-March, sending the tech and
telecom groups sharply lower. The tech-heavy Nasdaq Composite Index, for
example, registered a 41.1% return from November 30 through February 29, only to
give back most of the gains over the next three months. End result: a 2.4%
return for the six months ended May 31.
The overall stock market, as measured by the Wilshire 5000 Index, also
returned 2.4%. Value stocks, those characterized by above-average dividend
yields and below-average price/earnings and price/book value ratios, enjoyed a
resurgence beginning in mid-March.
4
<PAGE>
For the full six months, the value components of both the large-capitalization
S&P 500 Index and the small-cap Russell 2000 Index outperformed the indexes'
growth components.
Within the S&P 500, the half-year's best return was the 48% gain
recorded by "other energy" stocks, including oil-drilling and services companies
that benefited from a continuing rise in oil prices. The producer-durables
sector gained 18%, largely because of big gains for a number of manufacturers of
telecommunications gear and semiconductor testing and fabrication equipment.
Technology stocks, which now account for about one-quarter of the total stock
market's value, gained about 12% for the six months.
Poor performers included the utilities sector (-14% return), which was
hurt by downturns in several large telephone stocks, and many consumer staples
(-9%) and consumer-discretionary (-6%) companies. Prices fell steeply for a
number of high-profile retailers, beverage and food makers, tobacco companies,
and entertainment enterprises.
U.S. BOND MARKETS
The Federal Reserve's influence on interest rates is strongest for short-term
securities.Over the six months, the Fed pushed up the rate charged on overnight
loans between banks by 1 percentage point to 6.5%. Yields of 3-month U.S.
Treasury bills rose only one-third as far (0.32 percentage point, or 32 basis
points), to 5.62%. And long-term Treasury yields moved even less. The 10-year
Treasury note rose just 8 basis points to 6.27% as of May 31, and yields
fell for very long-term Treasury bonds due to a cutback in issuance of new
bonds. As a result of the shrinking supply of long-term bonds, the yield of the
30-year Treasury bond declined 28 basis points--from 6.29% to 6.01%--during the
half-year.
Because short-term rates moved higher while long-term rates declined,
there was an unusual "inversion" in the yield curve. Instead of sloping
upward--with yields increasing along with the maturity of Treasury
securities--the curve sloped down. The 6.01% yield of 30-year Treasuries on May
31 was 70 basis points below the 6.71% yield on 3-year Treasury notes.
Corporate and municipal bonds did not perform as well as Treasury
securities, and the yield curve for these sectors remained positive--yields of
long-term bonds remained higher than those of short-term securities. The Lehman
Aggregate Bond Index, a proxy for the overall taxable bond market, returned
1.4%, as a price decline of 2% offset most of the 3.4% income provided by bonds
during the half-year.
INTERNATIONAL STOCK MARKETS
A stronger U.S. dollar and weak Asian markets made the half-year a lackluster
one for U.S. investors in foreign stocks. Improving economic growth in most of
the world helped a number of markets in Europe, Asia, and Latin America to
produce good gains in their local currencies. However, the U.S. dollar increased
in value versus most currencies, significantly reducing the returns received by
dollar-based investors. (Conversely, when the dollar falls in value, returns
from abroad are enhanced for U.S. investors.)
The overall return in dollars from developed foreign markets was a
scant 0.7%, as measured by the Morgan Stanley Capital International Europe,
Australasia, Far East (EAFE) Index. However, in local currencies, the EAFE Index
return for the six months was a very
respectable 7.8%.
In Europe, where stocks benefited from a continuance of corporate
acquisitions, an average 12.8% gain in local-currency terms was reduced to 4.7%
for U.S. investors because of the dollar's strength. Stocks in the Pacific
region, which is dominated by Japan, returned -7.0% in dollars, as a -2.0%
return in local-currency terms was further diminished by the dollar's gains. The
Select Emerging Markets Free Index returned -2.8% in U.S. dollars.
5
<PAGE>
REPORT FROM THE ADVISER
The economy continued its robust expansion during the six months ended May 31,
2000, the first half of the fiscal year for Vanguard Massachusetts Tax-Exempt
Fund. The unemployment rate fell as low as 3.9% and the economy grew at an
annual rate of more than 5% during the half-year.
A fear of inflation roiled the markets, as investors focused on rising
short-term rates. On three occasions the Federal Reserve Board increased the
federal funds rate to slow economic growth. In turn, this led to a noticeable
increase in stock market volatility. Throughout the tumult, the tax-exempt bond
market remained relatively calm. A typical long-term, high-quality municipal
bond started the period with a 5.87% yield and ended it with a barely changed
yield of 5.91%. Importantly, the transition from 1999 to 2000 went smoothly,
without negative effects for either the issuers of municipal bonds or the
financial markets.
Although other markets were volatile during the half-year, tax-exempt
bonds were a solid, if unglamorous, investment, and your fund continued to
dutifully turn out consistent tax-exempt dividends. Often the municipal
securities market lacks the dramatic allure of the stock market. However,
tax-exempt securities are a reliable workhorse for the total return of an
investor's portfolio.
The fund earned a tax-free return of 1.0% during the half-year, double
the 0.5% return of the average Massachusetts municipal bond fund and equal to
the return of the Lehman Municipal Bond Index, our unmanaged benchmark.
LOW DEMAND, LOW SUPPLY
During the half-year, few new investors entered the municipal bond market.
Indeed, most tax-exempt funds experienced net outflows of cash, as investors
redeemed shares to finance other purchases or to pay federal taxes. During this
time, the low demand for municipal bonds improved their value relative to
taxable bonds. As of May 31, a highly rated, long-term state general obligation
bond provided 98% of the income of a similar U.S. Treasury security, even though
interest paid on the municipal bond is generally exempt from federal income tax,
while interest on Treasuries is not. Investors in the top (39.6%) federal income
tax bracket, therefore, received 2.3 percentage points in additional yield,
after taxes, from high-quality, long-term muni bonds than from similar
Treasuries. Such attractive relative yields have rarely endured.
The supply of newly issued tax-exempt bonds so far in 2000 is a
staggering 30% lower than last year. The stronger economy has boosted the
finances of local governments, so fewer issuers need to tap the credit markets.
The drop in new municipal bond issuance has supported prices for existing
tax-exempt securities,especially in states with relatively high taxes. However,
the effects of reduced supply have largely been offset by tepid demand for
municipal bonds. At some point, we can expect that muni bond prices will rise
in relation to those of taxable bonds and that the spread between yields of
municipals and taxable bonds will widen.
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INVESTMENT PHILOSOPHY
The adviser believes that the fund, while operating within stated maturity and
stringent quality targets, can achieve a high level of current income that is
exempt from federal and Massachusetts income taxes by investing in high-quality
securities issued by Massachusetts state, county, and municipal governments.
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6
<PAGE>
MATURITY SPREADS NARROW, CREDIT SPREADS WIDEN
For municipal bonds, as for other fixed income investments, the spread in yields
between issues with short-and long-term maturities has narrowed. In the
tax-exempt market, the gap in yields between a 1-year bond and a 30-year bond is
only 1.4 percentage points, down from about 2.0 percentage points. In the
Treasury bond market, short-term yields are currently higher than yields for
long-term bonds. This is unusual, because investors typically require higher
yields to lend money for longer periods. The anomaly reflects the Federal
Reserve Board's raising of short-term rates and the fall in supply of long-term
Treasury bonds. Even if the Fed keeps raising interest rates, we expect yields
for tax-exempt bonds to maintain their usual upward-sloping curve, with yields
rising as maturities increase.
During the half-year, the spread between yields of high-quality
municipal bonds and yields of lower-quality bonds widened. This meant that
lower-quality bond prices lagged those of high-quality bonds and that investors
were demanding higher yields to take on higher credit risk. During the period,
the extra income paid by bonds with the lowest investment-grade rating (Baa/BBB)
versus those with the highest quality (AAA) increased from 0.50 to 0.75
percentage point. This reversed the trend of recent years, when credit spreads
narrowed to historical lows as investors stretched for incrementally higher
returns by buying lower-quality bonds.
The trend toward wider credit-quality spreads began with bonds used to
finance hospitals and other health care facilities. Most health care providers
have credit ratings in the middle or lower tiers of investment-grade ratings.
Rising cost pressures and reductions in expense reimbursement from health
insurers have taken a toll. Investors are cautious and have demanded higher
yields to hold bonds from these issuers, a trend that has spilled over into all
lower-quality sectors.
As you have come to expect, Vanguard has maintained a steady commitment
to higher-quality issues. We have sought to provide superior income by keeping
expenses low, so that more of the funds' gross income flows to you, rather than
by taking on increased credit risk. The market's recent focus on credit quality
has helped our performance relative to peer funds.
IAN A. MACKINNON, MANAGING DIRECTOR
CHRISTOPHER M. RYON, PRINCIPAL
PAMELA WISEHAUPT TYNAN, PRINCIPAL
DANIEL S. SOLENDER, PRINCIPAL
VANGUARD FIXED INCOME GROUP
June 13, 2000
7
<PAGE>
FUND PROFILE
MASSACHUSETTS TAX-EXEMPT FUND
This Profile provides a snapshot of the fund's characteristics as of May 31,
2000, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on page 9.
FINANCIAL ATTRIBUTES INVESTMENT FOCUS
--------------------------------------------- --------------------------------
MASSACHUSETTS LEHMAN
TAX-EXEMPT INDEX* [grid]
---------------------------------------------
Number of Issues 104 38,998 AVERAGE MATURITY LONG
Yield 5.6% -- CREDIT QUALITY HIGH
Yield to Maturity 5.8% --
Average Coupon 5.3% 5.5%
Average Maturity 16.3 years 13.4 years
Average Quality AA AA+
Average Duration 9.4 years 7.5 years
Expense Ratio 0.19%** --
Cash Reserves 1.1% --
*Lehman Municipal Bond Index.
**Annualized.
DISTRIBUTION BY CREDIT QUALITY DISTRIBUTION BY MATURITY
(% OF PORTFOLIO) (% OF PORTFOLIO)
--------------------------------- -----------------------------------
AAA 65.9% Under 1 Year 7.5%
AA 17.8 1-5 Years 2.2
A 0.7 5-10 Years 15.7
BBB 15.6 10-20 Years 48.8
BB 0.0 20-30 Years 21.4
B 0.0 Over 30 Years 4.4
--------------------------------- -----------------------------------
Total 100.0% Total 100.0%
8
<PAGE>
AVERAGE COUPON. The average interest rate paid on the securities held by a fund.
It is expressed as a percentage of face value.
AVERAGE DURATION. An estimate of how much a bond fund's share price will
fluctuate in response to a change in interest rates. To see how the price could
shift, multiply the fund's duration by the change in rates. If interest rates
rise by one percentage point, the share price of a fund with an average duration
of five years would decline by about 5%. If rates decrease by a percentage
point, the fund's share price would rise by 5%.
Average Maturity. The average length of time until bonds held by a fund reach
maturity (or are called) and are repaid. In general, the longer the average
maturity, the more a fund's share price will fluctuate in response to changes in
market interest rates.
AVERAGE QUALITY. An indicator of credit risk, this figure is the average of
the ratings assigned to a fund's securities holdings by credit-rating agencies.
The agencies make their judgment after appraising an issuer's ability to meet
its obligations. Quality is graded on a scale, with Aaa or AAA indicating the
most creditworthy bond issuers and A-1 or MIG-1 indicating the most creditworthy
issuers of money market securities.
CASH RESERVES. The percentage of a fund's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing securities. This
figure does not include cash invested in futures contracts to simulate bond
investment.
DISTRIBUTION BY CREDIT QUALITY. This breakdown of a fund's securities by
credit rating can help in gauging the risk that returns could be affected by
defaults or other credit problems.
DISTRIBUTION BY MATURITY. An indicator of interest rate risk. In general, the
higher the concentration of longer-maturity issues, the more a fund's share
price will fluctuate in response to changes in interest rates. Expense Ratio.
The percentage of a fund's average net assets used to pay its annual
administrative and advisory expenses. These expenses directly reduce returns to
investors.
INVESTMENT FOCUS. This grid indicates the focus of a fund in terms of two
attributes: average maturity (short, medium, or long) and average credit quality
(high, medium, or low).
NUMBER OF ISSUES. An indicator of diversification. The more separate issues a
fund holds, the less susceptible it is to a price decline stemming from the
problems of a particular issue.
YIELD. A snapshot of a fund's interest income. The yield, expressed as a
percentage of the fund's net asset value, is based on income earned over the
past 30 days and is annualized, or projected forward for the coming year.
YIELD TO MATURITY. The rate of return an investor would receive if the
securities held by a fund were held to their maturity dates.
9
<PAGE>
PERFORMANCE SUMMARY
MASSACHUSETTS TAX-EXEMPT FUND
All of the data on this page represent past performance, which cannot be used to
predict future returns that may be achieved by the fund. Note, too, that both
share price and return can fluctuate widely. An investor's shares, when
redeemed, could be worth more or less than their original cost.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: DECEMBER 9, 1998-MAY 31, 2000
------------------------------------------------------- -------------------------------------------------
MASSACHUSETTS TAX-EXEMPT FUND LEHMAN* MASSACHUSETTS TAX-EXEMPT FUND LEHMAN*
<S> <C> <C> <C> <C> <S> <C> <C> <C> <C>
FISCAL CAPITAL INCOME TOTAL TOTAL FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN YEAR RETURN RETURN RETURN RETURN
------------------------------------------------------- -------------------------------------------------
1999 -7.5% 4.1% -3.4% -1.4% 2000** -1.6% 2.6% 1.0% 1.0%
------------------------------------------------------- -------------------------------------------------
</TABLE>
*Lehman Municipal Bond Index.
**Six months ended May 31, 2000.
See Financial Highlights table on page 17 for dividend information since the
fund's inception.
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED MARCH 31, 2000*
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INCEPTION SINCE INCEPTION
DATE ---------------------------
1 YEAR CAPITAL INCOME TOTAL
Massachusetts Tax-Exempt Fund 12/9/1998 -1.53% -5.32% 4.49% -0.83%
--------------------------------------------------------------------------------
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
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FINANCIAL STATEMENTS
MAY 31, 2000 (UNAUDITED)
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's municipal bond holdings,
including each security's market value on the last day of the reporting period
and information on credit enhancements (insurance or letters of credit).
Securities are grouped and subtotaled according to their insured or noninsured
status. Other assets are added to, and liabilities are subtracted from, the
value of Total Municipal Bonds to calculate the fund's Net Assets. Finally, Net
Assets are divided by the outstanding shares of the fund to arrive at its share
price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table
displaying the composition of the fund's net assets on both a dollar and
per-share basis. Undistributed Net Investment Income is usually zero because the
fund distributes its net income to shareholders as a dividend each day. Any
realized gains must be distributed annually, so the bulk of net assets consists
of Paid in Capital (money invested by shareholders). The balance shown for
Accumulated Net Realized Gains usually approximates the amount available to
distribute to shareholders as taxable capital gains as of the statement date,
but may differ because certain investments or transactions may be treated
differently for financial statement and tax purposes. Any Accumulated Net
Realized Losses, and any cumulative excess of distributions over net realized
gains, will appear as negative balances. Unrealized Appreciation (Depreciation)
is the difference between the value of the fund's investments and their cost,
and reflects the gains (losses) that would be realized if the fund were to sell
all of its investments at their statement-date values.
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FACE MARKET
MATURITY AMOUNT VALUE*
MASSACHUSETTS TAX-EXEMPT FUND COUPON DATE (000) (000)
-----------------------------------------------------------------------------------------------------------------------------------
MUNICIPAL BONDS (98.9%)
-----------------------------------------------------------------------------------------------------------------------------------
ISSUER INSURED (55.6%)
Beverly MA GO 4.75% 9/1/2016(2) 1,025 891
Beverly MA GO 4.80% 9/1/2017(2) 1,080 936
Boston MA Water & Sewer Rev. 5.00% 11/1/2028(3) 1,750 1,480
Chelsea MA GO 5.50% 6/15/2009(2) 90 91
Easton MA GO 5.00% 10/1/2017(1) 1,205 1,082
Haverhill MA GO 5.00% 6/1/2016(3) 1,420 1,290
Lynn MA GO 5.25% 6/1/2013(2) 1,530 1,473
Lynn MA Water & Sewer Rev. 5.125% 12/1/2017(4) 2,000 1,816
Malden MA GO 5.00% 10/1/2015(2) 500 457
Marlborough MA GO 6.75% 6/15/2008(3) 1,400 1,532
Mashpee MA GO 5.125% 2/1/2011(1) 1,025 998
Mashpee MA GO 5.35% 2/1/2012(1) 1,525 1,507
Massachusetts Bay Transp. Auth. 5.00% 3/1/2028(1) 2,495 2,115
Massachusetts Dev. Finance Agency Rev. (Brooks School) 5.125% 7/1/2015(1) 560 523
Massachusetts Dev. Finance Agency Rev. (Brooks School) 5.125% 7/1/2016(1) 585 542
Massachusetts Dev. Finance Agency Rev. VRDO (Brooks School) 4.25% 6/8/2000(1) 800 800
Massachusetts Educ. Financing Auth. Educ. Loan Rev. 4.55% 7/1/2009(2) 2,000 1,800
Massachusetts Educ. Financing Auth. Educ. Loan Rev. 4.65% 7/1/2010(2) 1,500 1,350
Massachusetts Educ. Financing Auth. Educ. Loan Rev. 6.05% 12/1/2017(1) 3,000 2,984
Massachusetts Frontier Regional School Dist. GO 5.00% 6/15/2017(2) 1,000 896
Massachusetts Health & Educ. Fac. Auth. Rev. (Bentley College) 5.00% 7/1/2023(1) 2,500 2,156
Massachusetts Health & Educ. Fac. Auth. Rev.
(Berklee College of Music) 5.00% 10/1/2017(1)** 1,250 1,123
Massachusetts Health & Educ. Fac. Auth. Rev.
(Boston Medical Center) 5.00% 7/1/2019(1) 50 43
Massachusetts Health & Educ. Fac. Auth. Rev.
(Boston Medical Center) 5.25% 7/1/2012(1) 150 142
Massachusetts Health & Educ. Fac. Auth. Rev.
(Brandeis Univ.) 5.25% 10/1/2016(1) 550 516
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FACE MARKET
MATURITY AMOUNT VALUE*
MASSACHUSETTS TAX-EXEMPT FUND COUPON DATE (000) (000)
-----------------------------------------------------------------------------------------------------------------------------------
Massachusetts Health & Educ. Fac. Auth. Rev.
(Harvard Pilgrim Health) 4.75% 7/1/2022(4) 1,000 787
Massachusetts Health & Educ. Fac. Auth. Rev.
(Harvard Pilgrim Health) 5.00% 7/1/2018(4) 80 68
Massachusetts Health & Educ. Fac. Auth. Rev. (Lahey Clinic) 7.85% 7/1/2003(1) 360 386
Massachusetts Health & Educ. Fac. Auth. Rev.
(Massachusetts General Hosp.) 6.25% 7/1/2012(2) 500 532
Massachusetts Health & Educ. Fac. Auth. Rev. (Northeastern Univ.) 5.00% 10/1/2017(1) 970 867
Massachusetts Health & Educ. Fac. Auth. Rev. (Northeastern Univ.) 5.00% 10/1/2022(1) 1,750 1,515
Massachusetts Health & Educ. Fac. Auth. Rev.
(Partners Healthcare System) 5.25% 7/1/2003(4) 80 80
Massachusetts Health & Educ. Fac. Auth. Rev.
(Partners Healthcare System) 5.25% 7/1/2015(1) 390 359
Massachusetts Health & Educ. Fac. Auth. Rev.
(Partners Healthcare System) 5.375% 7/1/2024(1) 1,640 1,461
Massachusetts Health & Educ. Fac. Auth. Rev.
(Univ. of Massachusetts Memorial) 5.00% 7/1/2018(2) 550 475
Massachusetts Health & Educ. Fac. Auth. Rev.
(Univ. of Massachusetts) 5.875% 10/1/2029(3) 5,000 4,874
Massachusetts Housing Finance Agency
Single Family Housing Rev. 5.15% 12/1/2012(2) 3,300 3,045
Massachusetts Ind. Finance Agency Rev.
(College of the Holy Cross) 5.50% 3/1/2016(1) 1,000 965
Massachusetts Port Auth. Rev. 5.25% 7/1/2008(4) 2,000 1,970
Massachusetts Port Auth. Rev. (US Airways) 5.25% 9/1/2011(1) 1,480 1,423
Massachusetts Port Auth. Rev. (US Airways) 5.25% 9/1/2012(1) 1,535 1,458
Massachusetts Port Auth. Rev. (US Airways) 5.25% 9/1/2013(1) 1,610 1,513
Massachusetts Special Obligation Rev. 5.50% 6/1/2010(2) 3,150 3,176
Massachusetts Turnpike Auth. Rev. (Metro. Highway System) 0.00% 1/1/2020(1) 3,000 920
Massachusetts Turnpike Auth. Rev. (Metro. Highway System) 5.00% 1/1/2027(1) 2,500 2,135
Massachusetts Turnpike Auth. Rev. (Metro. Highway System) 5.00% 1/1/2037(1) 4,500 3,733
Massachusetts Turnpike Auth. Rev. (Metro. Highway System) 5.125% 1/1/2023(1) 500 441
Massachusetts Turnpike Auth. Rev. (Metro. Highway System) 5.25% 1/1/2029(1) 60 53
Massachusetts Water Resources Auth. Rev. 5.50% 11/1/2006(3)(Prere.) 120 123
Massachusetts Water Resources Auth. Rev. 5.50% 8/1/2014(4) 3,250 3,218
Massachusetts Water Resources Auth. Rev. VRDO 4.00% 6/7/2000(2) 2,400 2,400
Methuen MA GO 4.875% 5/15/2017(3) 2,080 1,817
Methuen MA GO 5.00% 11/1/2014(3) 450 415
Narragansett MA Regional School Dist. 6.50% 6/1/2013(2)+ 1,210 1,300
Plymouth County MA COP (Correctional Fac.) 5.00% 10/1/2015(2) 1,000 912
Westfield MA GO 5.00% 5/1/2020(3) 1,715 1,523
Worcester MA GO 5.00% 8/1/2017(1) 1,920 1,720
Worcester MA GO 5.75% 4/1/2015(4) 1,000 1,001
OUTSIDE MASSACHUSETTS:
Puerto Rico Govt. Dev. Bank VRDO 3.40% 6/7/2000(1) 210 210
Puerto Rico Highway and Transp. Auth. Rev. 5.875% 7/1/2035(1)+ 2,500 2,476
Puerto Rico Public Buildings Auth. Public Educ. & Health Fac. 5.75% 7/1/2010(2) 2,000 2,085
-------
79,979
-------
NONINSURED (43.3%)
Boston MA GO 5.75% 2/1/2017 2,460 2,439
Boston MA GO 5.75% 2/1/2018 1,955 1,927
Boston MA Water & Sewer Comm. Rev. 5.75% 11/1/2013 540 549
Massachusetts Bay Transp. Auth. 5.125% 3/1/2014 80 75
Massachusetts Bay Transp. Auth. 7.00% 3/1/2009 2,000 2,224
Massachusetts Dev. Finance Agency (Smith College) 5.75% 7/1/2014 1,195 1,204
Massachusetts Dev. Finance Agency (Suffolk Univ.) 5.85% 7/1/2029 2,000 1,783
Massachusetts Dev. Finance Agency (Waste Management Inc.) 6.90% 12/1/2009 2,000 1,996
Massachusetts Dev. Finance Agency
(Xaverian Brothers High School) 5.55% 7/1/2019 1,000 885
Massachusetts Dev. Finance Agency
(Xaverian Brothers High School) 5.65% 7/1/2029 1,500 1,301
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FACE MARKET
MATURITY AMOUNT VALUE*
COUPON DATE (000) (000)
-----------------------------------------------------------------------------------------------------------------------------------
Massachusetts GO 5.25% 9/1/2008 1,850 $ 1,847
Massachusetts GO 7.00% 12/1/2000(Prere.) 1,315 1,331
Massachusetts Grant Anticipation Notes 5.125% 12/15/2010 1,480 1,435
Massachusetts Grant Anticipation Notes 5.125% 6/15/2014 300 280
Massachusetts Grant Anticipation Notes 5.25% 12/15/2011 180 175
Massachusetts Health & Educ. Fac. Auth. Rev. (Amherst College) 5.00% 11/1/2023 1,500 1,292
Massachusetts Health & Educ. Fac. Auth. Rev. (Boston College) 5.00% 6/1/2018 200 177
Massachusetts Health & Educ. Fac. Auth. Rev.
(Caritas Christi Obligated Group) 5.70% 7/1/2015 6,165 5,109
Massachusetts Health & Educ. Fac. Auth. Rev.
(Partners Healthcare System) 5.25% 7/1/2011 2,080 1,912
Massachusetts Health & Educ. Fac. Auth. Rev.
(Partners Healthcare System) 5.25% 7/1/2014 1,000 885
Massachusetts Health & Educ. Fac. Auth. Rev.
(Partners Healthcare System) 5.25% 7/1/2015 3,000 2,630
Massachusetts Health & Educ. Fac. Auth. Rev. VRDO
(Univ. of Massachusetts) 3.95% 6/7/2000 2,000 2,000
Massachusetts Health & Educ. Fac. Auth. Rev. VRDO (Harvard Univ.) 4.05% 6/8/2000 1,355 1,355
Massachusetts Ind. Finance Agency Resource Recovery Rev.
(Refusetech Inc. Project) 6.15% 7/1/2002 480 484
Massachusetts Ind. Finance Agency Resource Recovery Rev.
(Refusetech Inc. Project) 6.30% 7/1/2005 2,000 2,041
Massachusetts Ind. Finance Agency Rev. (BioMed Research Corp.) 0.00% 8/1/2004 520 414
Massachusetts Muni. Wholesale Electric Co.
Power Supply System Rev. 6.75% 7/1/2002(Prere.) 1,570 1,654
Massachusetts Port Auth. Rev. 5.00% 7/1/2018 500 442
Massachusetts Port Auth. Rev. 5.00% 7/1/2027 2,500 2,124
Massachusetts Port Auth. Rev. (United Airlines) 5.75% 10/1/2007 4,450 4,310
Massachusetts Water Pollution Abatement Trust 5.125% 8/1/2014 500 473
Massachusetts Water Pollution Abatement Trust 5.375% 8/1/2027 3,000 2,737
Massachusetts Water Pollution Abatement Trust 5.50% 8/1/2029 1,000 926
Massachusetts Water Pollution Abatement Trust 5.75% 8/1/2029 3,105 2,970
Massachusetts Water Resources Auth. Rev. 4.00% 6/7/2000 1,300 1,300
Massachusetts Water Resources Auth. Rev. 5.50% 7/15/2002 (Prere.) 80 81
Rail Connections Inc. MA Rev. 5.30% 7/1/2009 1,045 986
Rail Connections Inc. MA Rev. 5.40% 7/1/2010 520 489
Rail Connections Inc. MA Rev. 5.50% 7/1/2011 1,175 1,102
Rail Connections Inc. MA Rev. 6.00% 7/1/2012 570 558
Rail Connections Inc. MA Rev. 6.00% 7/1/2014 1,030 994
Univ. of Massachusetts Building Auth. Rev. 6.875% 5/1/2014 1,000 1,123
Weston MA BAN 4.50% 9/14/2000 2,170 2,167
-------
62,186
-------
-----------------------------------------------------------------------------------------------------------------------------------
TOTAL MUNICIPAL BONDS
(COST $149,397) 142,165
-----------------------------------------------------------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (1.1%)
-----------------------------------------------------------------------------------------------------------------------------------
Other Assets--Note B 5,656
Liabilities (4,080)
-------
1,576
-----------------------------------------------------------------------------------------------------------------------------------
NET ASSETS (100%)
-----------------------------------------------------------------------------------------------------------------------------------
Applicable to 15,794,558 outstanding $.001 par value shares of beneficial
interest
(unlimited authorization) $143,741
===================================================================================================================================
NET ASSET VALUE PER SHARE $9.10
===================================================================================================================================
*See Note A in Notes to Financial Statements.
**Security segregated as initial margin for open futures contracts.
+Security purchased on a when-issued or delivery basis for which the
fund has not taken delivery as of May 31, 2000. For key to abbreviations and
other references, see page 14.
</TABLE>
13
<PAGE>
AMOUNT PER
MASSACHUSETTS TAX-EXEMPT FUND (000) SHARE
--------------------------------------------------------------------------------
AT MAY 31, 2000, NET ASSETS CONSISTED OF:
--------------------------------------------------------------------------------
Paid in Capital $152,861 $9.68
Undistributed Net Investment Income -- --
Accumulated Net Realized Losses (1,952) (.12)
Unrealized Appreciation (Depreciation)--Note F
Investment Securities (7,232) (.46)
Futures Contracts 64 --
--------------------------------------------------------------------------------
NET ASSETS $143,741 $9.10
================================================================================
KEY TO ABBREVIATIONS
BAN--Bond Anticipation Note.
COP--Certificate of Participation.
GO--General Obligation Bond.
VRDO--Variable Rate Demand Obligation.
(Prere.)--Prerefunded.
Scheduled principal and interest payments are guaranteed by:
(1) MBIA (Municipal Bond Insurance Association).
(2) AMBAC (Ambac Assurance Corporation).
(3) FGIC (Financial Guaranty Insurance Company).
(4) FSA (Financial Security Assurance).
The insurance does not guarantee the market value of the municipal bonds.
14
<PAGE>
STATEMENT OF OPERATIONS
This Statement shows interest earned by the fund during the reporting
period, and details the operating expenses charged to the fund. These expenses
directly reduce the amount of investment income available to pay to shareholders
as tax-exempt income dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period. If a
fund invested in futures contracts during the period, the results of these
investments are shown separately.
--------------------------------------------------------------------------------
MASSACHUSETTS TAX-EXEMPT FUND
SIX MONTHS ENDED MAY 31, 2000
(000)
--------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Interest 3,530
-------
Total Income 3,530
-------
EXPENSES
The Vanguard Group--Note B
Investment Advisory Services 7
Management and Administrative 89
Marketing and Distribution 12
Custodian Fees 1
Auditing Fees 4
Shareholders' Reports 14
-------
Total Expenses 127
Expenses Paid Indirectly--Note C (1)
-------
Net Expenses 126
--------------------------------------------------------------------------------
NET INVESTMENT INCOME 3,404
--------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS)
Investment Securities Sold (904)
Futures Contracts 22
--------------------------------------------------------------------------------
REALIZED NET LOSS (882)
--------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities (1,030)
Futures Contracts 64
--------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (966)
--------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 1,556
================================================================================
15
<PAGE>
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information detailed
in the Statement of Operations. Because the fund distributes its income to
shareholders each day, the amounts of Distributions--Net Investment Income
generally equal the net income earned under the Operations section. The amounts
of Distributions--Realized Capital Gain may not match the capital gains shown in
the Operations section, because distributions are determined on a tax basis and
may be made in a period different from the one in which the gains were realized
on the financial statements. The Capital Share Transactions section shows the
amount shareholders invested in the fund, either by purchasing shares or by
reinvesting distributions, and the amounts redeemed. The corresponding numbers
of Shares Issued and Redeemed are shown at the end of the Statement.
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------
MASSACHUSETTS
TAX-EXEMPT FUND
--------------------------------
SIX MONTHS
ENDED DEC. 9, 1998* TO
MAY 31, 2000 NOV. 30, 1999
(000) (000)
----------------------------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
<S> <C> <C>
Net Investment Income 3,404 3,623
Realized Net Loss (882) (1,070)
Change in Unrealized Appreciation (Depreciation) (966) (6,202)
----------------------------
Net Increase (Decrease) in Net Assets Resulting from Operations 1,556 (3,649)
----------------------------
DISTRIBUTIONS
Net Investment Income (3,404) (3,623)
Realized Capital Gain -- --
----------------------------
Total Distributions (3,404) (3,623)
----------------------------
CAPITAL SHARE TRANSACTIONS1
Issued 61,360 148,562
Issued in Lieu of Cash Distributions 2,412 2,870
Redeemed (32,024) (30,464)
----------------------------
Net Increase from Capital Share Transactions 31,748 120,968
----------------------------------------------------------------------------------------------------
Total Increase 29,900 113,69
----------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Period--Note G 113,841 145
----------------------------
End of Period $143,741 $113,841
====================================================================================================
1Shares Issued (Redeemed)
Issued 6,716 15,185
Issued in Lieu of Cash Distributions 264 301
Redeemed (3,490) (3,195)
----------------------------
Net Increase in Shares Outstanding 3,490 12,291
====================================================================================================
*Commencement of operations.
</TABLE>
16
<PAGE>
FINANCIAL HIGHLIGHTS
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis. It also presents the fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the fund's total return; how much it costs to operate the fund;
and the extent to which the fund tends to distribute capital gains. The table
also shows the Portfolio Turnover Rate, a measure of trading activity. A
turnover rate of 100% means that the average security is held in the fund for
one year.
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
MASSACHUSETTS TAX-EXEMPT FUND
SIX MONTHS ENDED DEC. 9, 1998* TO
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD MAY 31, 2000 NOV. 30, 1999
----------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $9.25 $10.00
----------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .237 .420
Net Realized and Unrealized Gain (Loss) on Investments (.150) (.750)
--------------------------------
Total from Investment Operations .087 (.330)
--------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.237) (.420)
Distributions from Realized Capital Gains -- --
--------------------------------
Total Distributions (.237) (.420)
----------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $9.10 $ 9.25
================================================================================================================
TOTAL RETURN 0.95% -3.38%
================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $144 $114
Ratio of Total Expenses to Average Net Assets 0.19%** 0.20%**
Ratio of Net Investment Income to Average Net Assets 5.12%** 4.57%**
Portfolio Turnover Rate 29%** 39%
================================================================================================================
*Commencement of operations.
**Annualized.
</TABLE>
17
<PAGE>
NOTES TO FINANCIAL STATEMENTS
Vanguard Massachusetts Tax-Exempt Fund is registered under the Investment
Company Act of 1940 as an open-end investment company, or mutual fund. The fund
invests in debt instruments of municipal issuers whose ability to meet their
obligations may be affected by economic and political developments in the state
of Massachusetts.
A. The following significant accounting policies conform to generally
accepted accounting principles for mutual funds. The fund consistently follows
such policies in preparing its financial statements.
1. SECURITY VALUATION: Bonds, and temporary cash investments acquired over
60 days to maturity, are valued using the latest bid prices or using valuations
based on a matrix system (which considers such factors as security prices,
yields, maturities, and ratings), both as furnished by independent pricing
services. Other temporary cash investments are valued at amortized cost, which
approximates market value. Securities for which market quotations are not
readily available are valued by methods deemed by the board of trustees to
represent fair value.
2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a
regulated investment company and distribute all of its income. Accordingly, no
provision for federal income taxes is required in the financial statements.
3. FUTURES CONTRACTS: The fund may use Municipal Bond Index, U.S. Treasury
Bond, and U.S. Treasury Note futures contracts, with the objectives of enhancing
returns, managing interest rate risk, maintaining liquidity, diversifying credit
risk, and minimizing transaction costs. The fund may purchase or sell futures
contracts instead of bonds to take advantage of pricing differentials between
the futures contracts and the underlying bonds. The fund may also seek to take
advantage of price differences among bond market sectors by simultaneously
buying futures (or bonds) of one market sector and selling futures (or bonds) of
another sector. Futures contracts may also be used to simulate a fully invested
position in the underlying bonds while maintaining a cash balance for liquidity.
The primary risks associated with the use of futures contracts are imperfect
correlation between changes in market values of bonds held by the fund and the
prices of futures contracts, and the possibility of an illiquid market.
Futures contracts are valued based upon their quoted daily settlement
prices. The aggregate principal amounts of the contracts are not recorded in the
financial statements. Fluctuations in the value of the contracts are recorded in
the Statement of Net Assets as an asset (liability) and in the Statement of
Operations as unrealized appreciation (depreciation) until the contracts are
closed, when they are recorded as realized futures gains (losses).
4. DISTRIBUTIONS: Distributions from net investment income are declared
daily and paid on the first business day of the following month. Annual
distributions from realized capital gains, if any, are recorded on the
ex-dividend date.
5. OTHER: Security transactions are accounted for on the date securities
are bought or sold. costs used to determine realized gains (losses) on the sale
of investment securities are those of the specific securities sold. premiums and
original issue discounts are amortized and accreted, respectively, to interest
income over the lives of the respective securities.
B. The Vanguard Group furnishes at cost investment advisory, corporate
management, administrative, marketing, and distribution services. The costs of
such services are allocated to the fund under methods approved by the board of
trustees. The fund has committed to provide up to 0.40% of its net assets in
capital contributions to Vanguard. At May 31, 2000, the fund had contributed
capital of $27,000 to Vanguard (included in Other Assets), representing 0.02% of
the fund's net assets and 0.03% of Vanguard's capitalization. The fund's
trustees and officers are also directors and officers of Vanguard.
18
<PAGE>
C. The fund's custodian bank has agreed to reduce its fees when the fund
maintains cash on deposit in the non-interest-bearing custody account. For the
six months ended May 31, 2000, custodian fee offset arrangements reduced
expenses by $1,000.
D. During the six months ended May 31, 2000, the fund purchased $47,078,000 of
investment securities and sold $17,637,000 of investment securities, other than
temporary cash investments.
E. At November 30, 1999, the fund had available a capital loss carryforward of
$1,070,000 to offset future net capital gains through November 30, 2007.
F. At May 31, 2000, net unrealized depreciation of investment securities for
federal income tax purposes was $7,232,000, consisting of unrealized gains of
$318,000 on securities that had risen in value since their purchase and
$7,550,000 in unrealized losses on securities that had fallen in value since
their purchase.
At May 31, 2000, the aggregate settlement value of open futures contracts
expiring in June 2000 and the related unrealized appreciation were:
---------------------------------------------------------------------------
(000)
-----------------------------------
AGGREGATE
NUMBER OF SETTLEMENT UNREALIZED
FUTURES CONTRACTS LONG CONTRACTS VALUE APPRECIATION
---------------------------------------------------------------------------
Municipal Bond Index 28 $2,622 $64
---------------------------------------------------------------------------
G. The fund was organized on August 17, 1998, and its operations up to December
9, 1998, were limited to the sale and issuance of 14,479 shares of its common
stock, at $10 per share, to a family member of an officer of the fund.
19
<PAGE>
THE VANGUARD(R) FAMILY OF FUNDS
STOCK FUNDS
--------------------------------------------------------------------------------
500 Index Fund
Aggressive Growth Fund
Calvert Social Index(TM) Fund*
Capital Opportunity Fund
Convertible Securities Fund
Developed Markets Index Fund
Emerging Markets Stock Index Fund*
Energy Fund
Equity Income Fund
European Stock Index Fund*
Explorer(TM)Fund
Extended Market Index Fund*
Global Equity Fund Gold and Precious Metals Fund
Growth and Income Fund Growth
Equity Fund Growth Index Fund*
Health Care Fund
Institutional Developed Markets
Index Fund
Institutional Index Fund*
International Growth Fund
International Value Fund
Mid-Cap Index Fund*
Morgan(TM) Growth Fund Pacific Stock Index Fund*
PRIMECAP Fund
REIT Index Fund
Selected Value Fund Small-Cap Growth Index Fund*
Small-Cap Index Fund*
Small-Cap Value Index Fund*
Tax-Managed Capital
Appreciation Fund*
Tax-Managed Growth and
Income Fund*
Tax-Managed International Fund*
Tax-Managed Small-Cap Fund*
Total International Stock Index Fund
Total Stock Market Index Fund*
U.S. Growth Fund
U.S. Value Fund
Utilities Income Fund
Value Index Fund*
Windsor(TM) Fund
Windsor(TM) II Fund
BALANCED FUNDS
--------------------------------------------------------------------------------
Asset Allocation Fund
Balanced Index Fund
Global Asset Allocation Fund
LifeStrategy(R)Conservative
Growth Fund
LifeStrategy(R) Growth Fund
LifeStrategy(R) Income Fund
LifeStrategy(R) Moderate
Growth Fund
STAR(TM) Fund
Tax-Managed Balanced Fund
Wellesley(R) Income Fund
Wellington(TM) Fund
BOND FUNDS
--------------------------------------------------------------------------------
Admiral(TM)Intermediate-Term
Treasury Fund
Admiral(TM)Long-Term Treasury
Fund
Admiral(TM)Short-Term Treasury
Fund
GNMA Fund
High-Yield Corporate Fund
High-Yield Tax-Exempt Fund
Inflation-Protected Securities Fund
Insured Long-Term Tax-Exempt
Fund
Intermediate-Term Bond
Index Fund
Intermediate-Term Corporate Fund
Intermediate-Term Tax-Exempt
Fund
Intermediate-Term Treasury Fund
Limited-Term Tax-Exempt Fund
Long-Term Bond Index Fund
Long-Term Corporate Fund
Long-Term Tax-Exempt Fund
Long-Term Treasury Fund
Preferred Stock Fund
Short-Term Bond Index Fund
Short-Term Corporate Fund*
Short-Term Federal Fund
Short-Term Tax-Exempt Fund
Short-Term Treasury Fund
State Tax-Exempt Bond Funds
(California, Florida,
Massachusetts, New Jersey,
New York, Ohio, Pennsylvania)
Total Bond Market Index Fund*
MONEY MARKET FUNDS
--------------------------------------------------------------------------------
Admiral(TM) Treasury Money
Market Fund
Federal Money Market Fund
Prime Money Market Fund*
State Tax-Exempt Money Market
Funds (California, New Jersey,
New York, Ohio, Pennsylvania)
Tax-Exempt Money Market Fund
Treasury Money Market Fund
VARIABLE ANNUITY PLAN
--------------------------------------------------------------------------------
Balanced Portfolio
Diversified Value Portfolio
Equity Income Portfolio
Equity Index Portfolio
Growth Portfolio High-Grade Bond
Portfolio High Yield Bond Portfolio
International Portfolio
Mid-Cap Index Portfolio
Money Market Portfolio
REIT Index Portfolio
Short-Term Corporate Portfolio
Small Company Growth Portfolio
*Offers Institutional Shares.
For information about Vanguard funds and our variable annuity plan, including
charges and expenses, obtain a prospectus from The Vanguard Group, P.O. Box
2600, Valley Forge, PA 19482-2600. Read it carefully before you invest or send
money.
20
<PAGE>
THE PEOPLE WHO GOVERN YOUR FUND
The trustees of your mutual fund are there to see that the fund is operated and
managed in your best interests since, as a shareholder, you are part owner of
the fund. Your fund trustees also serve on the board of directors of The
Vanguard Group, which is owned by the funds and exists solely to provide
services to them on an at-cost basis.
The majority of Vanguard's board members are independent, meaning that they
have no affiliation with Vanguard or the funds they oversee, apart from the
sizable personal investments they have made as private individuals. They bring
distinguished backgrounds in business, academia, and public service to their
task of working with Vanguard officers to establish the policies and oversee the
activities of the funds.
Among board members' responsibilities are selecting investment advisers for
the funds; monitoring fund operations, performance, and costs; reviewing
contracts; nominating and selecting new trustees/directors; and electing
Vanguard officers.
The list below provides a brief description of each trustee's professional
affiliations. Noted in parentheses is the year in which the trustee joined the
Vanguard board.
TRUSTEES
JOHN J. BRENNAN (1987) Chairman of the Board, Chief Executive Officer, and
Director/Trustee of The Vanguard Group, Inc., and each of the investment
companies in The Vanguard Group.
JOANN HEFFERNAN HEISEN (1998) Vice President, Chief Information Officer, and a
member of the Executive Committee of Johnson & Johnson; Director of Johnson &
JohnsonoMerck Consumer Pharmaceuticals Co., The Medical Center at Princeton, and
Women's Research and Education Institute.
BURTON G. MALKIEL (1977) Chemical Bank Chairman's Professor of Economics,
Princeton University; Director of Prudential Insurance Co. of America, Banco
Bilbao Gestinova, Baker Fentress & Co., The Jeffrey Co., and Select Sector SPDR
Trust.
ALFRED M. RANKIN, JR. (1993) Chairman, President, Chief Executive Officer, and
Director of NACCO Industries, Inc.; Director of The BFGoodrich Co.
JAMES O. WELCH, JR. (1971) Retired Chairman of Nabisco Brands, Inc.;
retired Vice Chairman and Director of RJR Nabisco; Director of TECO Energy,
Inc., and Kmart Corp.
J. LAWRENCE WILSON (1985) Retired Chairman of Rohm & Haas Co.; Director of
AmeriSource Health Corporation, Cummins Engine Co., and The Mead Corp.; Trustee
of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY Secretary; Managing Director an Secretary of The Vanguard
Group, Inc.; Secretary of each of the investment companies in The Vanguard
Group.
THOMAS J. HIGGINS Treasurer; Principal of The Vanguard Group, Inc.;
Treasurer of each of the investment companies in The Vanguard
Group.
VANGUARD MANAGING DIRECTORS
R. GREGORY BARTON Legal Department.
ROBERT A. DISTEFANO Information Technology.
JAMES H. GATELY Individual Investor Group.
KATHLEEN C. GUBANICH Human Resources.
IAN A. MACKINNON Fixed Income Group.
F. WILLIAM MCNABB, III Institutional Investor Group.
MICHAEL S. MILLER Planning and Development.
RALPH K. PACKARD Chief Financial Officer.
GEORGE U. SAUTER Quantitative Equity Group.
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of Forest Hill, Maryland.
WORLD WIDE WEB
www.vanguard.com
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
This report is intended for the fund's
shareholders. It may not be distributed
to prospective investors unless it
is preceded or accompanied by the
current fund prospectus.
Q1682 072000
(C)2000 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing
Corporation, Distributor.
