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VANGUARD(R)
MASSACHUSETTS
TAX-EXEMPT FUND
Annual Report
November 30, 1999
[SHIP GRAPHIC]
[A MEMBER OF THE VANGUARD GROUP LOGO]
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[PHOTO OF JOHN C. BOGLE]
JOHN C. BOGLE
DEAR SHAREHOLDERS:
TWO ROADS DIVERGED IN A WOOD, AND I--I TOOK THE ONE LESS TRAVELED BY, AND THAT
HAS MADE ALL THE DIFFERENCE.
I can think of no better words than those of Robert Frost to begin this special
letter to our shareholders, who have placed such extraordinary trust in me and
in Vanguard over the past quarter century. When the firm was founded 25 years
ago, we deliberately took a new road to managing a mutual fund enterprise.
Instead of having the funds controlled by an outside management company with its
own financial interests, the Vanguard funds--there were only 11 of them
then--would be controlled by their own shareholders and operate solely in their
financial interests. The outcome of our unprecedented decision was by no means
certain. We described it then as "The Vanguard Experiment."
Well, I guess it's fair to say it's an experiment no more. During the past
25 years, the assets we hold in stewardship for investors have grown from $1
billion to more than $500 billion, and I believe that our reputation for
integrity, fair-dealing, and sound investment principles is second to none in
this industry. Our staggering growth--which I never sought--has come in
important part as a result of the simple investment ideas and basic human values
that are the foundation of my personal philosophy. I have every confidence that
they will long endure at Vanguard, for they are the right ideas and right
values, unshakable and eternal.
While Emerson believed that "an institution is the lengthened shadow of one
man," Vanguard today is far greater than any individual. The Vanguard crew has
splendidly implemented and enthusiastically supported our founding ideas and
values, and deserves the credit for a vital role in forging our success over the
years. It is a dedicated crew of fine human beings, working together in an
organization that is well prepared to press on regardless long after I am gone.
Creating and leading this enterprise has been an exhilarating run. Through it
all, I've taken the kudos and the blows alike, enjoying every moment to the
fullest, and even getting a second chance at life with a heart transplant three
years ago. What more could a man ask?
While I shall no longer be serving on the Vanguard Board, I want to assure
you that I will remain vigorous and active in a newly created Vanguard unit,
researching the financial markets, writing, and speaking. I'll continue to focus
whatever intellectual power and ethical strength I possess on my mission to
assure that mutual fund investors everywhere receive a fair shake. In the spirit
of Robert Frost:
BUT I HAVE PROMISES TO KEEP, AND MILES TO GO BEFORE I SLEEP, AND MILES TO
GO BEFORE I SLEEP.
You have given me your loyalty and friendship over these long years, and I
deeply appreciate your thousands of letters of support. For my part, I will
continue to keep an eagle eye on your interests, for you deserve no less. May
God bless you all, always.
/S/
JCB
CONTENTS
REPORT FROM THE CHAIRMAN .................1
THE MARKETS IN PERSPECTIVE ...............5
REPORT FROM THE ADVISER ..................7
PERFORMANCE SUMMARY ......................9
FUND PROFILE ............................10
FINANCIAL STATEMENTS ....................12
REPORT OF INDEPENDENT ACCOUNTANTS .......20
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[PHOTO OF JOHN J. BRENNAN]
JOHN J. BRENNAN
REPORT FROM THE CHAIRMAN
Concerns about higher inflation took hold of the bond market during the early
months of Vanguard Massachusetts Tax-Exempt Fund's 1999 fiscal year and never
loosened their grip. The resulting decline in prices made the 12 months ended
November 30 a difficult period for fixed-income investors. Our fund, which was
launched nine days into the 12-month period, registered a total return of -3.4%
through November 30, a result that was slightly better than that of its average
peer, but behind that of its unmanaged benchmark index.
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TOTAL RETURNS
DECEMBER 9, 1998, THROUGH
NOVEMBER 30, 1999
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Vanguard Massachusetts
Tax-Exempt Fund -3.4%
Average Massachusetts
Municipal Debt Fund* -3.7
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*Derived from data provided by Lipper Inc.
The table at right presents the fund's total return (capital change plus
reinvested dividends) since its December 1998 inception along with that of our
average mutual fund competitor. Our total return is based on a decrease in net
asset value from $10.00 per share on December 9, 1998, to $9.25 per share on
November 30, 1999, and is adjusted for dividends totaling $0.42 per share paid
from net investment income. At the end of the fiscal year, our fund's yield was
5.17%, up from 4.64% six months earlier.
For Massachusetts residents, income earned by the fund is exempt from
federal and Massachusetts state income taxes, but may be subject to local taxes
and to the alternative minimum tax.
FINANCIAL MARKETS IN REVIEW
The 12 months ended November 30 featured plenty of positive economic news, as
well as a good deal of apprehension over how long the good times can last
without touching off higher inflation. The U.S. economy expanded at an
inflation-adjusted rate of 4.3% from the third quarter of 1998 to the third
quarter of 1999, the nation's unemployment rate hovered near record-low levels,
and inflation barely stirred.
However, the nagging concern that inflation would soon accelerate resulted
in a steady rise in interest rates during the fiscal year. The rate increase
merely restrained the stock market, which managed an impressive advance, but
dealt a heavy blow to bond prices, which suffered their worst year since 1994.
The Federal Reserve Board went along with the uptrend in interest rates, hiking
its target for short-term interest rates by 25 basis points on three separate
occasions in an attempt to head off inflation it believes could result from
strong growth and tight labor markets.
Technology companies propelled the U.S. stock market higher, and the
Standard & Poor's 500 Index, which is dominated by large-capitalization stocks,
returned 20.9%--the index's fifth straight year of returns higher than 20%. The
broad market, as represented by the Wilshire 5000 Total Market Index, advanced
an even higher 22.4%, but a large portion of the gain was concentrated in a
relatively small number of stocks. Many value-oriented stocks were left far
behind.
1
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The yield of the 30-year U.S. Treasury bond ended the fiscal year at 6.29%,
up 123 basis points (1.23 percentage points) from its starting point of 5.06% on
November 30, 1998. The yield of 3-month U.S. Treasury bills climbed to 5.30% on
balance, from 4.48%. Yields of high-quality, long-term municipal bonds climbed
nearly a full percentage point, from 4.89% when the period began to 5.87% on
November 30, 1999. Yields of top-grade (MIG-1) 3-month notes, which react more
quickly to changes in short-term interest rates, rose from 2.95% to 3.80%.
The Lehman Brothers 10 Year Municipal Bond Index, a good measure of the
long-term municipal market, recorded a return of -0.4% during our fiscal year.
Long-term bonds suffer more when interest rates are rising, just as they benefit
more from a decline in interest rates.
Municipal bonds performed well early in the 1999 fiscal year as new
issuance dropped off from 1998's near-record levels and yields remained high
relative to Treasuries. But their relative performance faltered later in the
period because many investors were attracted to corporate bonds.
At the end of the fiscal year, the spread between yields of long-term
Treasuries and long-term munis stood at just 42 basis points (0.42 percentage
point). This is an extremely narrow gap, given that the income from Treasuries
is subject to federal income taxes (but not state taxes), while income from a
state-specific municipal bond fund is fully exempt from federal and state taxes.
On November 30, the yield of a top-quality, long-term municipal bond was equal
to about 93% of the yield of the 30-year U.S. Treasury bond. Historically, the
ratio has been about 84%.
FISCAL 1999 PERFORMANCE OVERVIEW
The -3.4% return of Vanguard Massachusetts Tax-Exempt Fund was slightly better
than the -3.7% return of the average Massachusetts municipal bond fund, which
has lower average credit quality than our fund but a similar average maturity.
Our return, however, was 2 percentage points behind that of the unmanaged Lehman
Municipal Bond Index.
Though our fund earned an income return of 4.1%, a price decline of -7.5%
engendered by the rise in interest rates pulled our total return into negative
territory for the year. Our performance advantage over our average peer was
primarily the result of our lower costs. The Lehman Index, which includes
municipal bonds from across the country, is a notoriously tough competitor
because it does not incur the "real world" operating expenses and transaction
costs that all mutual funds must bear. The index also has a slightly lower
average duration than your fund, making it slightly less sensitive to interest
rate changes--an advantage during fiscal 1999.
Though the rise in interest rates during the past 12 months was to blame
for the poor bond returns, a slide in rates just one year ago provided a boost
to bond prices and returns. The simple lesson is that interest rates rise and
fall, sometimes gradually and sometimes sharply. All bond investors should know
that over long periods, the ups and downs in interest rates tend to offset each
other, leaving a bond fund's interest income as the chief source of return. And
considering that interest paid on munis today is considerably higher than a year
ago, it would seem that tax-exempt securities have become more attractive. At a
yield of about 5.1% compounded annually, money doubles in a little more than 14
years, or more than two years sooner than at 4.3%.
2
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Our fund has an expense ratio (annual expenses as a percentage of average
net assets) of 0.20%, a fraction of the 1.16% charged by the average
Massachusetts tax-exempt fund. Because fund operating costs are deducted
directly from the income earned by a bond fund, our fund has a significant edge
in its quest to provide returns that are superior to those of similar funds. The
combination of our cost advantage and skillful management by Vanguard's Fixed
Income Group has benefited our shareholders over the fund's brief life span and
we expect it to continue to do so in the future.
THE MUNICIPAL BOND TAX ADVANTAGE
For Massachusetts residents, the income earned by our fund is exempt from
federal, state, and, in most cases, local income taxes. At current yields,
investors in long-term municipal bonds who are taxed at the highest marginal tax
rate (39.6%) can earn an astounding 55% more after-tax income than they could in
comparable long-term U.S. Treasury bonds. For Massachusetts taxpayers subject to
the highest tax rates, a yield of 5.9% on a tax-exempt long-term bond is the
equivalent of a 9.8% taxable yield.
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ILLUSTRATION OF INCOME FROM
A HYPOTHETICAL $100,000 INVESTMENT
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Taxable gross income $6,300
Less taxes (39.6%) (2,500)
Net after-tax income 3,800
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Tax-exempt income $5,900
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Tax-exempt income advantage $2,100
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Percentage advantage 55%
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This illustration assumes current yields (as of November 30, 1999) of 6.3% for
long-term U.S. Treasury bonds and 5.9% for long-term municipals. The tax
adjustment assumes a typical itemized tax return based on a federal tax rate of
39.6%. Income from U.S. Treasuries is not subject to state taxes; local taxes
are not considered. The illustration is not intended to represent future
results.
This remarkable advantage is illustrated in the table at left, which
compares the annual net income earned on U.S. Treasury and tax-exempt securities
as of November 30, 1999, assuming a $100,000 investment.
There is an important distinction between state-specific municipal bond
funds and U.S. Treasury bonds. Treasury securities are backed by the full faith
and credit of the U.S. government and therefore have unmatched credit quality.
Also, municipal bond funds that confine their investments to a single state lack
the diversification that comes from spreading investments among various states,
which may be subject to different economic conditions and different risks.
IN SUMMARY
During a period when the stock market seems invulnerable, it's easy to overlook
the merits of bonds. However, bond funds must not be judged by how well their
returns stack up against those of stock funds in a particular period, but by
what they can add to a balanced investment program, namely, current income and
relative stability. Vanguard Massachusetts Tax-Exempt Fund can provide a high
level of after-tax income, particularly for those in high income tax brackets,
and especially compared to the income available from the stock market, whose
average dividend yield is less than 1.5%. And because the performance of bonds
often differs from that of equities, a commitment to bonds is a useful
diversifier that can help smooth the sometimes-volatile returns of stocks.
3
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We advise investors to hold balanced portfolios of stock funds, bond funds,
and short-term reserves in proportions suitable to their own investment goals,
time horizon, and tolerance for risk. Once you have such a plan in place, we
advise you to stick with it through good times and bad.
John J. Brennan
Chairman and Chief Executive Officer
December 27, 1999
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A Note of Thanks to Our Founder
As you may have read on the inside cover of our report, our founder, John C.
Bogle, is retiring December 31, 1999, as Senior Chairman of our Board after
nearly 25 years of devoted service to Vanguard and our shareholders. Vanguard
investors have Jack to thank for creating a truly mutual mutual fund company
that operates solely in the interest of its fund shareholders. And mutual fund
investors everywhere have benefited from his energetic efforts to improve this
industry. Finally, on a personal note, I am forever grateful to Jack for giving
me the opportunity to join this great company in 1982.
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4
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THE MARKETS IN PERSPECTIVE
YEAR ENDED NOVEMBER 30, 1999
Strong economic expansion sent global stock markets charging higher but dealt a
blow to bond prices during the fiscal year ended November 30, 1999. The
powerhouse U.S. economy led the global growth parade, joined by Asian, European,
and Latin American economies that had slumped or stagnated in 1998.
Interest rates rose sharply as investors and monetary policymakers grew
increasingly worried that such strong economic growth would cause inflation to
surge. Although the rise in rates caused bond prices to fall, it only tempered
the stock market's advance.
U.S. STOCK MARKETS
Against the backdrop of a booming economy, U.S. companies reported solid
increases in earnings during the fiscal year. The nation's economic output
increased at an inflation-adjusted rate of 4.3%--a very rapid pace for such a
large, mature economy. Consumer spending, which accounts for roughly two-thirds
of economic activity, powered the expansion. Americans spent freely, encouraged
by rising wealth from a long bull market, a hot job market, and climbing
incomes.
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AVERAGE ANNUAL RETURNS
PERIODS ENDED NOVEMBER 30, 1999
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1 Year 3 Years 5 Years
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STOCKS
S&P 500 Index 20.9% 24.3% 27.5%
Russell 2000 Index 15.7 10.1 14.8
Wilshire 5000 Index 22.4 22.6 25.6
MSCI EAFE Index 21.4 12.3 11.4
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BONDS
Lehman Aggregate Bond Index 0.0% 5.6% 8.0%
Lehman 10 Year Municipal Bond Index -0.4 4.8 7.6
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 4.7 5.0 5.2
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OTHER
Consumer Price Index 2.6% 2.0% 2.4%
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The stock market, as measured by the Wilshire 5000 Index, gained 22.4%
overall. For a change, mid-capitalization and small-cap stocks outpaced their
large-cap brethren. The large-cap S&P 500 Index, which accounts for more than
75% of the U.S. stock market's total value, gained 20.9% during the year; the
rest of the market (as measured by the Wilshire 4500 Index) gained 29.0%.
Increasingly optimistic expectations for future corporate earnings more
than offset the negative effects of rising interest rates during fiscal 1999.
Higher rates often hurt stock prices because many investors use current rates to
discount the value of a stock's projected earnings and dividends. The higher the
interest rate, the more future earnings are discounted, and the less investors
will pay for the stock now.
Because of a remarkable surge in prices for technology stocks, growth
stocks again outperformed value stocks during the past year. Within the S&P 500
Index, growth stocks--characterized by high prices in relation to earnings, book
value, and dividends--recorded a 28.5% return, 16 percentage points above the
12.5% return for value stocks. The disparity was even greater in the small-cap
segment of the market; growth stocks within the small-cap Russell 2000 Index
gained 32.7%, while value stocks posted a -1.4% return.
Technology stocks within the S&P 500 Index gained 66%. QUALCOMM posted an
eye-popping 1,200% return, and a number of computer-related stocks doubled or
tripled in
5
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price, including Sun Microsystems (+257%), Apple Computer (+206%), Oracle
(+197%), Gateway (+172%), Texas Instruments (+152%), and Cisco Systems (+136%).
Big gains for wireless telecommunications and cable-TV stocks powered the
utilities category to an overall gain of nearly 28%. The producer-durables
group, which includes some technology-related manufacturers as well as aircraft
and equipment makers, gained 27%. Oil exploration and service firms in the
"other energy" category posted a 26% return, assisted by a jump in prices for
oil and natural gas.
The year's worst-performing sector was consumer staples (down nearly -12%).
This group suffered as severe price competition and a stronger dollar in Europe
crimped profits for many food and beverage makers, and the specter of litigation
costs caused tobacco stocks to slump. The auto & transportation group declined
- -2% overall, with airline stocks hurt by rising prices for jet fuel.
U.S. BOND MARKETS
Stock investors may cheer a fast-growing economy, but rapid growth tends to
worry bond investors. Early in the fiscal year, inflation seemed
dormant--plunging oil prices had taken commodity price indexes to the lowest
point in a quarter-century. But as the world economy began hitting on all
cylinders, the bond market feared that a minuscule U.S. unemployment rate,
rising commodity prices, and capacity constraints would cause inflation to
accelerate. Although oil prices were up nearly 150% during the fiscal year, the
overall price level, as measured by the Consumer Price Index, increased by a
moderate 2.6%.
The Federal Reserve Board, anticipating price pressures, abandoned its bias
toward easier monetary policy, and by mid-year was boosting interest rates to
try to throttle back the economic engines. The bond market was ahead of the
Fed--interest rates began rising sharply in February. By fiscal year-end, the
yield of 30-year U.S. Treasury bonds had risen 1.23 percentage points (123 basis
points) to 6.29%. The 10-year Treasury note's yield rose 148 basis points, from
4.71% to 6.19%. The rise in short-term rates was more restrained; 3-month
Treasury bill yields were up 82 basis points to 5.30% at fiscal year-end.
Bond prices fall when interest rates rise, and long-term bond prices are
most sensitive to changing rates. Long-term Treasury bond prices fell by more
than -13%, resulting in total returns of -8%. The Lehman Aggregate Bond Index, a
measure of the overall taxable bond market, which has an intermediate-term
structure on average, broke even on the year, as interest income of 6.2% was
offset by price declines. The damage to municipal bond prices was not as severe
as for Treasuries, and the intermediate-term Lehman 7 Year Municipal Bond Index
recorded a price decline of -3.7% and a total return of 0.5%.
INTERNATIONAL STOCK MARKETS
International markets had a strong year, with European stocks gaining 21.9% in
local-currency terms and Pacific-region stocks advancing 30.2%. However,
currency effects significantly altered the returns to U.S.-based investors. The
U.S. dollar rose in value against most European currencies but fell sharply
against the Japanese yen. As a result, returns from Europe plunged to 9.8% in
dollar terms while returns from the Pacific soared to 51.0%.
Overall, U.S. investors earned 21.4% in the major developed international
markets, as measured by the Morgan Stanley Capital International Europe,
Australasia, Far East (EAFE) Index. The bull markets in most nations stemmed
from renewed optimism that economic growth would continue to accelerate. Japan
and the rest of Asia, which were hit hardest by currency and economic crises in
1997 and 1998, saw the biggest stock gains.
Emerging markets, as measured by the Select Emerging Markets Free Index,
gained 37.1% in U.S.-dollar terms, as investors regained an appetite for the
considerable risks of smaller markets.
6
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REPORT FROM THE ADVISER
Interest rates rose during the 12 months ended November 30, 1999, the fiscal
year for Vanguard Massachusetts Tax-Exempt Fund. The rise was principally due to
investors' fears about the impact of the strong economy and the low unemployment
rate on inflation. In the past, these factors have caused inflation to increase,
and many investors expect that history will repeat itself at some point. So far,
employment costs and consumer price indexes have not risen substantially, but
each number is being closely watched for any upsurge. A desire to head off
inflation and concerns about the booming stock market led the Federal Reserve
Board to increase interest rates three times during the fiscal year, raising the
federal funds rate by a total of 0.75 percentage point.
As you might expect, yields of insured long-term municipal bonds rose along
with yields on U.S. Treasury bonds during fiscal 1999. During the first half of
the year, long-term insured municipals performed better than Treasury
securities; municipal yields increased by less than half as much as those for
long-term Treasuries. But the relative performance flip-flopped during the
second half, when yields on long-term municipals increased almost 11/2 times as
much as those on long Treasuries. Over the full fiscal year, the yield on the
benchmark 30-year U.S. Treasury bond rose by 1.23 percentage points (from 5.06%
to 6.29%), while the yield of a similar AAA-rated municipal bond rose by nearly
1 percentage point (from 4.89% to 5.87%).
Two factors account for the first-half outperformance of insured municipal
bonds and for their later underperformance. First, as the fiscal year began in
December 1998, insured municipal bonds were especially attractive to investors,
because the AAA-rated insured municipal's tax-exempt yield of 4.9% was equal to
97% of the yield of a 30-year Treasury. For an investor in the top marginal tax
bracket of 39.6%, that 4.9% yield was equivalent to an 8.1% yield on a taxable
bond. By May 31, the middle of our fiscal year, the long-term insured
municipal's yield was about 89% as high as the 30-year Treasury's yield, making
insured municipal bonds somewhat less alluring. The second factor was that in
the second half of the fiscal year, corporate bond yields had become quite
attractive, providing stiff competition for the bond investor's dollar. During
this period the corporate bond market encountered the same type of supply
imbalance that the municipal market had seen in fiscal 1998, as corporations
rushed bond issues to market to complete their financing before the end of the
century. The result was attractively high yields on corporate debt, which
enticed some large institutional buyers away from the municipal market. At
year-end, yields on long-term insured municipal bonds had risen in relation to
those on Treasuries, and 30-year munis offered yields equal to 94% of yields on
30-year Treasuries.
The municipal market was aided by the fact that the supply of new issues
was lower during 1999 than in 1998. Through November, issuance of municipal
securities in 1999 amounted to $207 billion, down more than 20% from the same
period in 1998. The main reason for the decline was a 53% decrease in the
issuance of refunding bonds, whose proceeds are used to pay off older,
higher-coupon bonds. Because of the rise in
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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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7
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interest rates, refunding issues generally did not make fiscal sense during
1999. As the economy continued to expand, the supply of bonds issued for new
projects was unchanged from 1998.
THE FUND'S FISCAL-YEAR PERFORMANCE
Long-term bonds typically are hurt most by rising interest rates. As a result,
the Massachusetts Tax-Exempt Fund suffered a price decline of -7.5% and posted a
total return of -3.4%. A negative return is not good news, but our result was
moderately ahead of the -3.7% total return for the average Massachusetts
municipal bond fund.
We scrutinize various bond maturities to find the best values for each
level of interest rate risk. Our focus on keeping expenses low is always helpful
and is critical in delivering above-average tax-exempt income, since expenses
are deducted directly from a bond fund's interest income. Our emphasis on
keeping the fund invested in high-quality securities benefits our shareholders
by reducing credit risk. The overall effect of combining low costs and high
quality is to provide to our shareholders both superior yields and low credit
risk, the ingredients of excellent risk-adjusted returns.
Ian A. MacKinnon, Managing Director
Christopher M. Ryon, Principal
Pamela Wisehaupt Tynan, Principal
Daniel S. Solender, Manager
Vanguard Fixed Income Group
December 18, 1999
8
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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.
TOTAL INVESTMENT RETURNS:
DECEMBER 9, 1998-NOVEMBER 30, 1999
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MASSACHUSETTS TAX-EXEMPT FUND LEHMAN*
FISCAL CAPITAL INCOME TOTAL TOTAL
PERIOD RETURN RETURN RETURN RETURN
- ---------------------------------------------
1999 -7.5% 4.1% -3.4% -1.4%
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*Lehman Municipal Bond Index.
See Financial Highlights table on page 17 for dividend
information since the fund's inception.
CUMULATIVE PERFORMANCE: DECEMBER 9, 1998-NOVEMBER 30, 1999
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[GRAPH]
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TOTAL RETURNS PERIOD
ENDED NOVEMBER 30, 1999
----------------------- FINAL VALUE OF A
SINCE INCEPTION $10,000 INVESTMENT
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Massachusetts Tax-Exempt Fund -3.38% $9,662
Average Massachusetts Municipal Fund* -3.73 9,627
Lehman Municipal Bond Index -1.39 9,861
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*Derived from data provided by Lipper Inc.
TOTAL RETURN: PERIOD ENDED SEPTEMBER 30, 1999*
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SINCE INCEPTION
INCEPTION -----------------------------
DATE CAPITAL INCOME TOTAL
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Massachusetts Tax-Exempt Fund 12/9/1998 -6.60% 3.36% -3.24%
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*SEC rules require that we provide this total return information through the
latest calendar quarter.
9
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FUND PROFILE
MASSACHUSETTS TAX-EXEMPT FUND
This Profile provides a snapshot of the fund's characteristics as of November
30, 1999, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on page 11.
FINANCIAL ATTRIBUTES
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MASSACHUSETTS LEHMAN
TAX-EXEMPT INDEX*
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Number of Issues 90 52,144
Yield 5.2% --
Yield to Maturity 5.4% --
Average Coupon 5.1% 5.5%
Average Maturity 13.9 years 13.0 years
Average Quality AA AA+
Average Duration 8.6 years 7.5 years
Expense Ratio 0.20%** --
Cash Reserves 1.5% --
*Lehman Municipal Bond Index.
**Annualized
INVESTMENT FOCUS
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[GRID]
AVERAGER MATURITY Long
CREDIT QUALITY High
DISTRIBUTION BY CREDIT QUALITY
(% OF PORTFOLIO)
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AAA 68.1%
AA 18.1
A 0.9
BBB 12.9
BB 0.0
B 0.0
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Total 100.0%
DISTRIBUTION BY MATURITY
(% OF PORTFOLIO)
- -----------------------------------------------
Under 1 Year 8.9%
1-5 Years 2.8
5-10 Years 21.5
10-20 Years 49.3
20-30 Years 16.0
Over 30 Years 1.5
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Total 100.0%
10
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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.
11
<PAGE>
FINANCIAL STATEMENTS
NOVEMBER 30, 1999
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>
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FACE MARKET
MATURITY AMOUNT VALUE*
MASSACHUSETTS TAX-EXEMPT FUND COUPON DATE (000) (000)
- ----------------------------------------------------------------------------------------------------------------------------
MUNICIPAL BONDS (98.5%)
- ----------------------------------------------------------------------------------------------------------------------------
ISSUER INSURED (63.6%)
Beverly MA GO 4.75% 9/1/2016 (2) $ 1,025 $ 904
Beverly MA GO 4.80% 9/1/2017 (2) 1,080 950
Boston MA GO 4.50% 1/1/2000 (3) 2,000 2,001
Chelsea MA GO 5.50% 6/15/2009 (2) 90 92
Easton MA GO 5.00% 10/1/2017 (1) 1,205 1,095
Haverhill MA GO 5.00% 6/1/2016 (3) 1,420 1,303
Lynn MA GO 5.25% 2/15/2008 (1) 2,270 2,305
Lynn MA GO 5.25% 6/1/2013 (2) 1,530 1,492
Lynn MA Water & Sewer Rev. 5.125% 12/1/2017 (4) 2,000 1,846
Malden MA GO 5.00% 10/1/2015 (2) 500 461
Marlborough MA GO 6.75% 6/15/2008 (3) 1,400 1,568
Massachusetts Dev. Finance Agency Rev. (Brooks School) 5.125% 7/1/2015 (1) 560 527
Massachusetts Dev. Finance Agency Rev. (Brooks School) 5.125% 7/1/2016 (1) 585 545
Massachusetts Dev. Finance Agency Rev. (Emerson College) 5.25% 1/1/2007 (2) 2,000 2,035
Massachusetts Dev. Finance Agency Rev. VRDO (Brooks School) 3.80% 12/2/1999 (1) 3,700 3,700
Massachusetts Educ. Financing Auth. Educ. Loan Rev. 4.55% 7/1/2009 (2) 2,000 1,869
Massachusetts Educ. Financing Auth. Educ. Loan Rev. 4.65% 7/1/2010 (2) 1,500 1,398
Massachusetts Frontier Regional School Dist. GO 5.00% 6/15/2017 (2) 1,000 909
Massachusetts GO 5.25% 6/1/2014 (3) 80 77
Massachusetts Health & Educ. Fac. Auth. Rev. (Bentley College) 5.00% 7/1/2023 (1) 2,500 2,181
Massachusetts Health & Educ. Fac. Auth. Rev.
(Berklee College of Music) 5.00% 10/1/2017 (1) 1,250 1,136
Massachusetts Health & Educ. Fac. Auth. Rev.
(Boston Medical Center) 5.00% 7/1/2019 (1) 50 44
Massachusetts Health & Educ. Fac. Auth. Rev.
(Boston Medical Center) 5.25% 7/1/2012 (1) 150 146
Massachusetts Health & Educ. Fac. Auth. Rev. (Brandeis Univ.) 5.25% 10/1/2016 (1) 550 519
Massachusetts Health & Educ. Fac. Auth. Rev.
(Harvard Pilgrim Health) 4.75% 7/1/2022 (4) 1,000 823
</TABLE>
12
<PAGE>
<TABLE>
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FACE MARKET
MATURITY AMOUNT VALUE*
COUPON DATE (000) (000)
- ----------------------------------------------------------------------------------------------------------------------------
Massachusetts Health & Educ. Fac. Auth. Rev.
(Harvard Pilgrim Health) 5.00% 7/1/2018 (4) $ 80 $ 70
Massachusetts Health & Educ. Fac. Auth. Rev. (Lahey Clinic) 7.85% 7/1/2003 (1) 360 397
Massachusetts Health & Educ. Fac. Auth. Rev.
(Massachusetts General Hosp.) 6.25% 7/1/2012 (2) 500 543
Massachusetts Health & Educ. Fac. Auth. Rev.
(Northeastern Univ.) 5.00% 10/1/2017 (1) 970 880
Massachusetts Health & Educ. Fac. Auth. Rev.
(Northeastern Univ.) 5.00% 10/1/2022 (1) 1,750 1,534
Massachusetts Health & Educ. Fac. Auth. Rev.
(Partners Healthcare System) 5.25% 7/1/2003 (4) 80 82
Massachusetts Health & Educ. Fac. Auth. Rev.
(Partners Healthcare System) 5.25% 7/1/2015 (1) 390 367
Massachusetts Health & Educ. Fac. Auth. Rev.
(Univ. of Massachusetts Memorial) 5.00% 7/1/2018 (2) 550 484
Massachusetts Health & Educ. Finance Auth.
(Catholic Healthcare East) 5.00% 11/15/2028 (2) 3,250 2,744
Massachusetts Housing Finance Agency Single Family Housing Rev. 5.15% 12/1/2012 (2) 3,300 3,089
Massachusetts Ind. Finance Agency Rev.
(College of the Holy Cross) 5.00% 9/1/2023 (1) 1,575 1,373
Massachusetts Port Auth. Rev. 5.25% 7/1/2008 (4) 2,000 2,008
Massachusetts Port Auth. Rev. (US Airways Project) 5.25% 9/1/2010 (1) 1,380 1,372
Massachusetts Port Auth. Rev. (US Airways Project) 5.25% 9/1/2011 (1) 1,480 1,461
Massachusetts Port Auth. Rev. (US Airways Project) 5.25% 9/1/2012 (1) 1,535 1,499
Massachusetts Port Auth. Rev. (US Airways Project) 5.25% 9/1/2013 (1) 1,610 1,552
Massachusetts Special Obligation Rev. 5.50% 6/1/2010 (2) 3,150 3,219
Massachusetts Turnpike Auth. Rev. (Metro. Highway System) 5.00% 1/1/2027 (1) 2,500 2,152
Massachusetts Turnpike Auth. Rev. (Metro. Highway System) 5.00% 1/1/2037 (1) 2,000 1,672
Massachusetts Turnpike Auth. Rev. (Metro. Highway System) 5.125% 1/1/2023 (1) 500 445
Massachusetts Turnpike Auth. Rev. (Metro. Highway System) 5.25% 1/1/2029 (1) 60 54
Massachusetts Water Resources Auth. Rev. 5.50% 11/1/2006 (3)(Prere.) 120 126
Massachusetts Water Resources Auth. Rev. 5.50% 8/1/2014 (4) 3,250 3,256
Methuen MA GO 4.875% 5/15/2017 (3) 2,080 1,847
Methuen MA GO 5.00% 11/1/2014 (3) 450 422
Plymouth County MA COP (Correctional Fac.) 5.00% 10/1/2007 (2) 1,595 1,600
Plymouth County MA COP (Correctional Fac.) 5.00% 10/1/2015 (2) 1,000 927
Worcester MA GO 5.00% 8/1/2017 (1) 1,920 1,744
Worcester MA Muni. Purpose Loan 5.75% 4/1/2015 (4) 1,000 1,006
OUTSIDE MASSACHUSETTS
Puerto Rico Govt. Dev. Bank VRDO 3.60% 12/8/1999 (1) 2,400 2,400
Puerto Rico Public Buildings Auth. Public Educ. & Health Fac. 5.75% 7/1/2010 (2) 2,000 2,119
---------
72,370
---------
NONINSURED (34.9%)
Boston MA Water & Sewer Comm. Rev. 5.75% 11/1/2013 540 557
Massachusetts Bay Transp. Auth. 5.125% 3/1/2014 80 76
Massachusetts Bay Transp. Auth. 7.00% 3/1/2009 2,000 2,274
Massachusetts Dev. Finance Agency (Suffolk Univ.) 5.85% 7/1/2029 2,000 1,855
Massachusetts Dev. Finance Agency
(Xaverian Brothers High School) 5.55% 7/1/2019 1,000 919
Massachusetts Dev. Finance Agency
(Xaverian Brothers High School) 5.65% 7/1/2029 1,500 1,358
Massachusetts GO 5.25% 9/1/2008 2,850 2,894
Massachusetts GO 5.25% 4/1/2011 80 80
Massachusetts GO 5.25% 4/1/2012 80 79
Massachusetts Grant Anticipation Notes 5.125% 12/15/2010 1,480 1,472
Massachusetts Grant Anticipation Notes 5.125% 6/15/2014 300 286
Massachusetts Grant Anticipation Notes 5.25% 12/15/2008 2,000 2,033
Massachusetts Grant Anticipation Notes 5.25% 12/15/2011 180 179
Massachusetts Health & Educ. Fac. Auth. Rev.
(Amherst College) 5.00% 11/1/2023 1,500 1,311
Massachusetts Health & Educ. Fac. Auth. Rev.
(Boston College) 5.00% 6/1/2018 200 179
Massachusetts Health & Educ. Fac. Auth. Rev.
(Caritas Christi Obligated Group) 5.70% 7/1/2015 5,000 4,494
Massachusetts Health & Educ. Fac. Auth. Rev.
(Partners Healthcare System) 5.25% 7/1/2014 1,000 928
</TABLE>
13
<PAGE>
<TABLE>
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FACE MARKET
MATURITY AMOUNT VALUE*
MASSACHUSETTS TAX-EXEMPT FUND COUPON DATE (000) (000)
- ----------------------------------------------------------------------------------------------------------------------------
Massachusetts Health & Educ. Fac. Auth. Rev.
(Partners Healthcare System) 5.25% 7/1/2011 $ 2,080 $ 2,005
Massachusetts Health & Educ. Fac. Auth. Rev.
(Partners Healthcare System) 5.25% 7/1/2015 3,000 2,746
Massachusetts Health & Educ. Fac. Auth. Rev. VRDO
(Harvard Univ.) 3.71% 12/2/1999 825 825
Massachusetts Ind. Finance Agency (Refusetech Inc. Project) 6.15% 7/1/2002 480 491
Massachusetts Ind. Finance Agency (Refusetech Inc. Project) 6.30% 7/1/2005 2,000 2,083
Massachusetts Ind. Finance Agency Rev. (BioMed Research Corp.) 0.00% 8/1/2004 520 412
Massachusetts Muni. Wholesale Electric Co. Power Supply
System Rev. 6.75% 7/1/2002 (Prere.) 1,570 1,687
Massachusetts Port Auth. Rev. 5.00% 7/1/2018 500 450
Massachusetts Port Auth. Rev. 5.00% 7/1/2027 2,500 2,149
Massachusetts Water Pollution Abatement Trust 5.125% 8/1/2014 500 478
Massachusetts Water Resources Auth. Rev. 5.50% 7/15/2002 (Prere.) 80 82
Massachusetts Water Resources Auth. Rev. 7.50% 4/1/2000 (Prere.) 1,000 1,031
Rail Connections Inc. MA Rev. 5.40% 7/1/2010 520 504
Rail Connections Inc. MA Rev. 5.50% 7/1/2011 1,175 1,135
Rail Connections Inc. MA Rev. 6.00% 7/1/2012 570 565
Rail Connections Inc. MA Rev. 6.00% 7/1/2014 1,030 1,009
Univ. of Massachusetts Building Auth. Refunding Rev. 6.875% 5/1/2014 1,000 1,123
---------
39,749
---------
- ----------------------------------------------------------------------------------------------------------------------------
TOTAL MUNICIPAL BONDS
(COST $118,321) 112,119
- ----------------------------------------------------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (1.5%)
- ----------------------------------------------------------------------------------------------------------------------------
Other Assets--Note B 2,244
Liabilities (522)
---------
1,722
- ----------------------------------------------------------------------------------------------------------------------------
NET ASSETS (100%)
- ----------------------------------------------------------------------------------------------------------------------------
Applicable to 12,304,505 outstanding $.001 par value shares of beneficial interest
(unlimited authorization) $113,841
============================================================================================================================
NET ASSET VALUE PER SHARE $9.25
============================================================================================================================
*See Note A in Notes to Financial Statements.
For key to abbreviations and other references, see below.
- ----------------------------------------------------------------------------------------------------------------------------
AT NOVEMBER 30, 1999, NET ASSETS CONSISTED OF:
- ----------------------------------------------------------------------------------------------------------------------------
Amount Per
(000) Share
- ----------------------------------------------------------------------------------------------------------------------------
Paid in Capital $121,113 $9.84
Undistributed Net Investment Income -- --
Accumulated Net Realized Losses--Note E (1,070) (.09)
Unrealized Depreciation--Note F (6,202) (.50)
- ----------------------------------------------------------------------------------------------------------------------------
NET ASSETS $113,841 $9.25
============================================================================================================================
</TABLE>
KEY TO ABBREVIATIONS
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
DEC. 9, 1998* TO
NOV. 30, 1999
(000)
- --------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Interest $ 3,773
-------------
Total Income 3,773
-------------
EXPENSES
The Vanguard Group--Note B
Investment Advisory Services 6
Management and Administrative 129
Marketing and Distribution 10
Custodian Fees 4
Auditing Fees 7
Shareholders' Reports 3
-------------
Total Expenses 159
Expenses Paid Indirectly--Note C (9)
-------------
Net Expenses 150
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 3,623
- --------------------------------------------------------------------------------
REALIZED NET (GAIN) LOSS
Investment Securities Sold (1,250)
Futures Contracts 180
- --------------------------------------------------------------------------------
REALIZED NET LOSS (1,070)
- --------------------------------------------------------------------------------
UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities (6,202)
Futures Contracts --
- --------------------------------------------------------------------------------
UNREALIZED DEPRECIATION (6,202)
================================================================================
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $(3,649)
================================================================================
*Commencement of operations.
15
<PAGE>
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the
reporting period. 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.
- --------------------------------------------------------------------------------
MASSACHUSETTS
TAX-EXEMPT FUND
DEC. 9, 1998* TO
NOV. 30, 1999
(000)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 3,623
Realized Net Loss (1,070)
Unrealized Depreciation (6,202)
-------------
Net Decrease in Net Assets Resulting from Operations (3,649)
-------------
DISTRIBUTIONS
Net Investment Income (3,623)
Realized Capital Gain --
-------------
Total Distributions (3,623)
-------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 148,562
Issued in Lieu of Cash Distributions 2,870
Redeemed (30,464)
-------------
Net Increase from Capital Share Transactions 120,968
- --------------------------------------------------------------------------------
Total Increase 113,696
- --------------------------------------------------------------------------------
NET ASSETS
Beginning of Period--Note G 145
-------------
End of Period $113,841
================================================================================
(1)Shares Issued (Redeemed)
Issued 15,185
Issued in Lieu of Cash Distributions 301
Redeemed (3,195)
-------------
Net Increase in Shares Outstanding 12,291
================================================================================
*Commencement of operations.
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.
- --------------------------------------------------------------------------------
MASSACHUSETTS
TAX-EXEMPT FUND
DEC. 9, 1998* TO
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD NOV. 30, 1999
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $10.00
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .420
Net Realized and Unrealized Gain (Loss) on Investments (.750)
-------------
Total from Investment Operations (.330)
-------------
DISTRIBUTIONS
Dividends from Net Investment Income (.420)
Distributions from Realized Capital Gains --
-------------
Total Distributions (.420)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 9.25
================================================================================
TOTAL RETURN -3.38%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $114
Ratio of Total Expenses to Average Net Assets 0.20%**
Ratio of Net Investment Income to Average Net Assets 4.57%**
Portfolio Turnover Rate 39%
================================================================================
*Commencement of operations.
**Annualized.
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 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 November 30, 1999, the fund had
contributed capital of $22,000 to Vanguard (included in Other Assets),
representing 0.02% of the fund's net assets and 0.02% of Vanguard's
capitalization. The fund's Trustees and officers are also Directors and officers
of Vanguard.
18
<PAGE>
C. The fund's investment adviser may direct new issue purchases, subject to
obtaining the best price and execution, to underwriters who have agreed to
rebate or credit to the fund part of the underwriting fees generated. Such
rebates or credits are used solely to reduce the fund's management and
administrative expenses. The fund's custodian bank has also agreed to reduce its
fees when the fund maintains cash on deposit in the non-interest-bearing custody
account. For the period ended November 30, 1999, these arrangements reduced
expenses by:
- --------------------------------------------------------------------------------
EXPENSE REDUCTION
(000) TOTAL EXPENSE
- ------------------------------------------- REDUCTION AS A
MANAGEMENT AND CUSTODIAN PERCENTAGE OF
ADMINISTRATIVE FEES AVERAGE NET ASSETS
- --------------------------------------------------------------------------------
$5 $4 0.01%*
- --------------------------------------------------------------------------------
*Annualized.
D. During the period ended November 30, 1999, the fund purchased $138,027,000 of
investment securities and sold $27,173,000 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 November 30, 1999, net unrealized depreciation of investment securities
for federal income tax purposes was $6,202,000, consisting of unrealized gains
of $70,000 on securities that had risen in value since their purchase and
$6,272,000 in unrealized losses on securities that had fallen in value since
their purchase.
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>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Trustees of
Vanguard Massachusetts Tax-Exempt Fund
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard Massachusetts Tax-Exempt Fund (the "Fund") at November 30, 1999, the
results of its operations for the period then ended, the changes in its net
assets in the period then ended and the financial highlights in the period then
ended, in conformity with generally accepted accounting principles. These
financial statements and financial highlights (hereafter referred to as
"financial statements") are the responsibility of the Fund's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these financial statements in accordance
with generally accepted auditing standards which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audit, which included confirmation of securities at November
30, 1999 by correspondence with the custodian, provides a reasonable basis for
the opinion expressed above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
January 6, 2000
- --------------------------------------------------------------------------------
SPECIAL 1999 TAX INFORMATION (UNAUDITED) FOR
VANGUARD MASSACHUSETTS TAX-EXEMPT FUND
This information for the fiscal year ended November 30, 1999, is included
pursuant to provisions of the Internal Revenue Code.
The fund designates 100% of its income dividends as exempt-interest
dividends.
- --------------------------------------------------------------------------------
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 C. BOGLE -- (1967) Founder, Senior Chairman of the Board, and
Director/Trustee of The Vanguard Group, Inc., and each of the investment
companies in The Vanguard Group.
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.
JOHN C. SAWHILL -- (1991) President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and
President of New York University; Director of Pacific Gas and Electric Co.,
Procter & Gamble Co., NACCO Industries, and Newfield Exploration 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
Cummins Engine Co. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY -- Secretary; Managing Director and 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 -- Core Management Group.
<PAGE>
ABOUT OUR COVER
Our cover art, depicting HMS Vanguard at sea, is a
reproduction of Leading the Way, a 1984 work created
and copyrighted by noted naval artist Tom Freeman,
of Forest Hill, Maryland.
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 4500" and "Wilshire 5000"
are trademarks of Wilshire Associates.
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This report is intended for the fund's
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Q1680-01/21/2000
(C) 2000 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing
Corporation, Distributor.
