<PAGE>
This term sheet, taken together with the preliminary prospectus dated
February 5, 1999 (the "Preliminary Prospectus"), pursuant to Rule 434 under
the Securities Act of 1933, as amended, shall be deemed to constitute the
final prospectus for purposes of Section 10(a) of such Act with respect to the
shares of AMPS of MuniHoldings California Insured Fund IV, Inc. offered
hereby. Capitalized terms in this term sheet which are not defined herein will
have the meaning defined in the Preliminary Prospectus.
TERM SHEET
Used pursuant to Rule 434 under the Securities Act of 1933, as amended
(Supplement to preliminary prospectus dated February 5, 1999)
$91,000,000
MuniHoldings California Insured Fund IV, Inc.
Auction Market Preferred Stock ["AMPS(R)"]
1,820 Shares, Series A
1,820 Shares, Series B
Liquidation Preference $25,000 Per Share
----------------
Terms of the Offering
This information appearing on the cover page of the Preliminary Prospectus
is supplemented and restated as follows:
<TABLE>
<CAPTION>
Per Share Total
--------- -----
<S> <C> <C>
Public Offering Price............................. $25,000.00 $91,000,000
Sales Load........................................ $187.50 $682,500
Proceeds, before expenses, to Fund................ $24,812.50 $90,317,500
</TABLE>
The public offering price per share will be increased by the amount of
accumulated dividends, if any, from the date the shares are first issued.
----------------
One certificate for each series of the AMPS will be ready for delivery to
the nominee of The Depository Trust Company on or about February 22, 1999.
----------------
The information appearing in the section captioned "Offering Summary--
Dividends and Dividend Periods" on page 3 of the Preliminary Prospectus is
supplemented and restated as follows:
Dividends on the Series A AMPS and Series B AMPS will be cumulative from the
date the shares are first issued and payable beginning on March 3, 1999 in the
case of Series A AMPS and March 2, 1999 in the case of Series B AMPS.
Thereafter, in the case of dividend periods that are not special dividend
periods, dividends generally will be payable on each succeeding Wednesday in
the case of Series A AMPS and each succeeding Tuesday in the case of Series B
AMPS. After the initial dividend period, each dividend period for each series
of AMPS will generally consist of seven days; provided, however, that before
any auction, the Fund may decide, subject to certain limitations and only if
it gives notice to holders, to declare a special dividend period of up to five
years.
Dividends for each series of AMPS will be paid through the securities
depository (The Depository Trust Company) on each dividend payment date for
each series.
The cash dividend rate on the shares of Series A AMPS for the initial
dividend period ending March 2, 1999 will be 2.50% per year and the cash
dividend rate on the shares of Series B AMPS for the initial dividend period
ending March 1, 1999 will be 2.50% per year. For each subsequent dividend
period, the auction agent (IBJ Whitehall Bank & Trust Company) will hold an
auction to determine the cash dividend rate on the shares of each series of
AMPS.
- --------
(R) Registered trademark of Merrill Lynch & Co. Inc.
----------------
Merrill Lynch & Co.
----------------
The date of this term sheet is February 17, 1999.
<PAGE>
Underwriting
The text of the second paragraph under "Underwriting" on page 32 of the
Preliminary Prospectus is supplemented and restated as follows:
The Underwriter has advised the Fund that it proposes initially to offer the
shares of AMPS to the public at the public offering price set forth on the
cover page of this prospectus, and to certain dealers at such price less a
concession not in excess of $125.00 per share. The Underwriter may allow, and
such dealers may reallow, a discount not in excess of $31.25 per share to
other dealers. After the initial public offering, the public offering price,
concession and discount may be changed. The sales load of $187.50 per share is
equal to .75% of the initial public offering price. Investors must pay for any
AMPS purchased in the initial public offering on or before February 22, 1999.
Statement of Additional Information
The information appearing in the last sentence on the cover page of the
preliminary statement of additional information dated February 5, 1999 is
supplemented and restated as follows:
The date of this statement of additional information is February 17,
1999.
2
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information contained in this prospectus is not complete and may be +
+changed. We may not sell these securities until the registration statement +
+filed with the Securities and Exchange Commission is effective. This +
+prospectus is not an offer to sell these securities and it is not soliciting +
+an offer to buy these securities in any State where the offer or sale is not +
+permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED FEBRUARY 5, 1999
PROSPECTUS
$91,000,000
MuniHoldings California Insured Fund IV, Inc.
Auction Market Preferred Stock ["AMPS(R)"]
1,820 Shares, Series A
1,820 Shares, Series B
Liquidation Preference $25,000 Per Share
------------
MuniHoldings California Insured Fund IV, Inc. (the "Fund") is a recently
organized, non-diversified, closed-end management investment company that seeks
to provide shareholders with current income exempt from Federal and California
income taxes. The Fund seeks to achieve its objective by investing primarily in
a portfolio of long-term, investment grade municipal obligations the interest
on which, in the opinion of bond counsel to the issuer, is exempt from Federal
and California income taxes. The Fund intends to invest in municipal
obligations that are rated investment grade or, if unrated, are considered by
the Fund's investment adviser to be of comparable quality. Under normal
circumstances, at least 80% of the Fund's assets will be invested in municipal
obligations with remaining maturities of one year or more that are covered by
insurance guaranteeing the timely payment of principal at maturity and
interest.
------------
This prospectus contains information you should know before investing,
including information about risks. Please read it before you invest and keep it
for future reference. This Fund's statement of additional information contains
further information about the Fund and is incorporated by reference (legally
considered to be part of this prospectus). You may request a free copy by
writing or calling the Fund at (800) 637-3863.
------------
Investing in the AMPS involves certain risks, which are described in the
"Risk Factors and Special Considerations" section beginning on page 5 of this
prospectus.
<TABLE>
<CAPTION>
Per Share Total
--------- -----------
<S> <C> <C>
Public Offering Price...................... $25,000 $91,000,000
Sales Load................................. $ $
Proceeds, before expenses, to Fund......... $ $
</TABLE>
The public offering price per share will be increased by the amount of
accumulated dividends, if any, from the date the shares are first issued.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offence.
We expect that one certificate for each series of the AMPS will be ready for
delivery to the nominee of The Depository Trust Company on or about February
, 1999.
- ------
(R) Registered trademark of Merrill Lynch & Co., Inc.
------------
Merrill Lynch & Co.
------------
The date of this prospectus is February , 1999.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Offering Summary........................................................... 3
Risk Factors and Special Considerations.................................... 5
The Fund................................................................... 7
Use of Proceeds............................................................ 7
Capitalization............................................................. 7
Portfolio Composition...................................................... 8
Investment Objective and Policies.......................................... 8
Description of AMPS........................................................ 14
The Auction................................................................ 19
Rating Agency Guidelines................................................... 27
Investment Advisory and Management Arrangements............................ 28
Taxes...................................................................... 29
Description of Capital Stock............................................... 30
Custodian.................................................................. 32
Underwriting............................................................... 32
Transfer Agent, Dividend Disbursing Agent and Registrar.................... 33
Legal Opinions............................................................. 33
Experts.................................................................... 33
Year 2000 Issues........................................................... 33
Table of Contents of Statement of Additional Information................... 34
Glossary................................................................... 35
</TABLE>
----------------
Information about the Fund can be reviewed and copied at the SEC's Public
Reference Room in Washington, D.C. Call 1-800-SEC-0330 for information on the
operation of the public reference room. This information is also available on
the SEC's Internet site at http://www.sec.gov and copies may be obtained upon
payment of a duplicating fee by writing the Public Reference Section of the
SEC, Washington, D.C. 20549-6009.
----------------
You should rely only on the information contained in this prospectus. We have
not, and the underwriter has not, authorized any other person to provide you
with different information. If anyone provides you with different or
inconsistent information, you should not rely on it. We are not, and the
underwriter is not, making an offer to sell these securities in any
jurisdiction where the offer or sale is not permitted. You should assume that
the information appearing in this prospectus is accurate as of the date on the
front cover of this prospectus only. Our business, financial condition, results
of operations and prospects may have changed since that date.
2
<PAGE>
OFFERING SUMMARY
This summary is qualified in its entirety by reference to the detailed
information included in this prospectus and the statement of additional
information.
The Offering
The Fund is offering a total of 1,820 shares of Series A AMPS
and 1,820 shares of Series B AMPS, each at a purchase price of
$25,000 per share plus accumulated dividends, if any, from the
date the shares are first issued. The shares of AMPS are being
offered by Merrill Lynch, Pierce, Fenner & Smith Incorporated,
as underwriter.
The AMPS of each series will be shares of preferred stock of
the Fund that entitle their holders to receive cash dividends
at an annual rate that may vary for the successive dividend
periods for each series. In general, except as described below,
each dividend period for each series of AMPS following the
initial dividend period will be seven days. The applicable
dividend for a particular dividend period will be determined by
an auction conducted on the business day next preceding the
start of that dividend period.
Investors and potential investors in shares of AMPS of each
series may participate in auctions for the AMPS through their
broker-dealers.
Generally, AMPS investors will not receive certificates
representing ownership of their shares. Ownership of AMPS will
be maintained in book-entry form by the securities depository
(The Depository Trust Company) or its nominee for the account
of the investor's agent member (generally the investor's
broker-dealer). The investor's agent member, in turn, will
maintain records of such investor's beneficial ownership of
AMPS.
Dividends and
Dividend Dividends on the Series A AMPS and Series B AMPS will be
Periods cumulative from the date the shares are first issued and
payable beginning on , 1999 in the case of Series A AMPS
and , 1999 in the case of Series B AMPS. Thereafter, in
the case of dividend periods that are not special dividend
periods, dividends generally will be payable on each succeeding
Wednesday in the case of Series A AMPS and each succeeding
Tuesday in the case of Series B AMPS. After the initial
dividend period, each dividend period for each series of AMPS
will generally consist of seven days; provided, however, that
before any auction, the Fund may decide, subject to certain
limitations and only if it gives notice to holders, to declare
a special dividend period of up to five years.
Dividends for each series of AMPS will be paid through the
securities depository (The Depository Trust Company) on each
dividend payment date for each series.
The cash dividend rate on the shares of Series A AMPS for the
initial dividend period ending , 1999 will be % per
year and the cash dividend rate on the shares of Series B AMPS
for the initial dividend period ending , 1999 will be %
per year. For each subsequent dividend period, the auction
agent (IBJ Whitehall Bank & Trust Company) will hold an auction
to determine the cash dividend rate on the shares of each
series of AMPS.
Determination Generally, the applicable dividend rate for any dividend period
of Maximum for shares of AMPS of each series will be subject to a maximum
Dividend applicable rate. The maximum applicable rate for shares of AMPS
Rates will depend on the credit rating assigned to the shares and on
the length of the dividend period. There is no minimum
applicable dividend rate for any dividend period.
3
<PAGE>
ASSET Under the Fund's Articles Supplementary creating the AMPS, the
MAINTENANCE Fund must maintain
. asset coverage of the AMPS as required by the rating agencies
rating the AMPS, and
. asset coverage of the AMPS of at least 200% as required by
the Investment Company Act of 1940.
The Fund estimates that, based on the composition of its
portfolio at February 1, 1999, asset coverage of the AMPS as
required by the Investment Company Act of 1940 would be
approximately 241% immediately after the Fund issues the shares
of AMPS offered by this prospectus representing approximately
41% of the Fund's capital.
MANDATORY
REDEMPTION If the required asset coverage is not maintained or, when
necessary, restored, the Fund must redeem shares of AMPS at the
price of $25,000 per share plus accumulated but unpaid
dividends thereon (whether or not earned or declared). The
provisions of the Investment Company Act of 1940 may restrict
the Fund's ability to make such a mandatory redemption.
OPTIONAL The Fund may, at its option, choose to redeem all or a portion
REDEMPTION of the shares of AMPS of each series on any dividend payment
date at the price of $25,000 per share, plus accumulated but
unpaid dividends thereon (whether or not earned or declared)
plus any applicable premium.
LIQUIDATION
PREFERENCE The liquidation preference (that is, the amount the Fund must
pay to AMPS shareholders if the Fund is liquidated) of each
share of AMPS will be $25,000, plus an amount equal to
accumulated but unpaid dividends (whether or not earned or
declared).
RATINGS The AMPS will be issued with a rating of "aaa" from Moody's
Investors Service, Inc. and AAA from Standard & Poor's.
VOTING RIGHTS
The Investment Company Act of 1940 requires that the holders of
AMPS and any other preferred stock, voting as a separate class,
have the right to elect at least two directors at all times and
to elect a majority of the directors at any time when dividends
on the AMPS or any other preferred stock are unpaid for two
full years. The Fund's charter and the Investment Company Act
of 1940 require holders of AMPS and any other preferred stock
to vote as a separate class on certain other matters.
4
<PAGE>
RISK FACTORS AND SPECIAL CONSIDERATIONS
California Municipal Bonds. The Fund intends to invest the majority of its
portfolio in California municipal bonds. As a result, the Fund is more exposed
to risks affecting issuers of California municipal bonds than is a municipal
bond fund that invests more widely.
Interest Rate and Credit Risk. The Fund invests in municipal bonds, which are
subject to interest rate and credit risk. Interest rate risk is the risk that
prices of municipal bonds generally increase when interest rates decline and
decrease when interest rates increase. Prices of longer term securities
generally change more in response to interest rate changes than prices of
shorter term securities. Credit risk is the risk that the issuer will be unable
to pay the interest or principal when due. The degree of credit risk depends on
both the financial condition of the issuer and the terms of the obligation.
Non-diversification. The Fund is registered as a "non-diversified" investment
company. This means that the Fund may invest a greater percentage of its assets
in a single issuer than a diversified investment company. Even as a non-
diversified fund, the Fund must still meet the diversification requirements of
applicable Federal income tax laws. Since the Fund may invest a relatively high
percentage of its assets in a limited number of issuers, the Fund may be more
exposed to any single economic, political or regulatory occurrence than a more
widely-diversified fund.
Rating Categories. The Fund intends to invest in municipal bonds that are
rated investment grade by Standard & Poor's, Moody's Investors Service, Inc. or
Fitch IBCA, Inc. It may also invest in unrated municipal bonds that the Fund's
investment adviser believes are of comparable quality. Obligations rated in the
lowest investment grade category have certain speculative characteristics.
Private Activity Bonds. The Fund may invest in certain tax-exempt securities
classified as "private activity bonds." These bonds may subject certain
investors in the Fund to the alternative minimum tax.
Portfolio Insurance. The Fund will be subject to certain restrictions on
investments imposed by guidelines of the insurance companies issuing the
portfolio insurance. The Fund does not expect these guidelines to prevent the
Fund's investment adviser from managing the Fund's portfolio in accordance with
the Fund's investment objective and policies.
Indexed and Inverse Floating Rate Securities. The Fund may invest in
securities whose potential returns are directly related to changes in an
underlying index or interest rate, known as indexed securities. The return on
indexed securities will rise when the underlying index or interest rate rises
and fall when the index or interest rate falls. The Fund may also invest in
securities whose return is inversely related to changes in an interest rate
(inverse floaters). In general, income on inverse floaters will decrease when
short term interest rates increase and increase when short term interest rates
decrease. Investments in inverse floaters may subject the Fund to the risks of
reduced or eliminated interest payments and losses of principal. In addition,
certain indexed securities and inverse floaters may increase or decrease in
value at a greater rate than the underlying interest rate, which effectively
leverages the Fund's investment. As a result, the market value of such
securities will generally be more volatile than that of fixed rate, tax exempt
securities. Both indexed securities and inverse floaters are derivative
securities and can be considered speculative.
Options and Futures Transactions. The Fund may seek to hedge its portfolio
against changes in interest rates using options and financial futures
contracts. The Fund's hedging transactions are designed to reduce volatility,
but come at some cost. For example, the Fund may try to limit its risk of loss
from a decline in price of a portfolio security by purchasing a put option.
However, the Fund must pay for the option, and the price of the security may
not in fact drop. In large part, the success of the Fund's hedging activities
depends on its ability to forecast movements in securities prices and interest
rates. The Fund does not, however, intend to
5
<PAGE>
enter into options and futures transactions for speculative purposes. The Fund
is not required to hedge its portfolio and may not do so.
Antitakeover Provisions. The Fund's charter includes provisions that could
limit the ability of other entities or persons to acquire control of the Fund
or to change the composition of its Board of Directors. Such provisions could
discourage a third party from seeking to obtain control of the Fund.
Investment Considerations. Investors in AMPS should consider the following
factors:
. The credit ratings of the AMPS could be reduced while an investor holds
the AMPS.
. Neither broker-dealers nor the Fund are obligated to purchase shares of
AMPS in an auction or otherwise nor is the Fund required to redeem shares
of AMPS in the event of a failed auction.
. If sufficient bids do not exist in an auction, the applicable dividend
rate will be the maximum applicable dividend rate, and in such event,
owners of AMPS wishing to sell will not be able to sell all, and may not
be able to sell any, AMPS in the auction. As a result, investors may not
have liquidity of investment.
Secondary Market. The broker-dealers intend to maintain a secondary trading
market in the AMPS outside of auctions; however, they have no obligation to do
so and there can be no assurance that a secondary market for the AMPS will
develop or, if it does develop, that it will provide holders with a liquid
trading market. The AMPS will not be registered on any stock exchange or on any
automated quotation system. An increase in the level of interest rates likely
will have an adverse effect on the secondary market price of the AMPS, and a
selling shareholder may have to sell AMPS between auctions at a price per share
of less than $25,000.
6
<PAGE>
THE FUND
MuniHoldings California Insured Fund IV, Inc. (the "Fund") is a recently
organized, non-diversified, closed-end management investment company. The Fund
was incorporated under the laws of the State of Maryland on November 23, 1998,
and has registered under the 1940 Act. The Fund's principal office is located
at 800 Scudders Mill Road, Plainsboro, New Jersey 08536, and its telephone
number is (609) 282-2800.
The Fund commenced operations on January 29, 1999 upon the closing of an
initial public offering of shares of its common stock. The proceeds of such
offering were approximately $128,730,000 after the payment of offering
expenses. In connection with the initial public offering of the Fund's common
stock, the underwriter was granted an option to purchase up to an additional
1,290,000 shares of common stock to cover overallotments.
USE OF PROCEEDS
The estimated net proceeds of this offering will be $90,147,500 after the
payment of offering expenses (estimated to be $170,000) and the sales load.
The net proceeds of the offering will be invested in accordance with the
Fund's investment objective and policies during a period estimated not to
exceed three months from the offer and sale of such shares of AMPS depending on
market conditions and the availability of appropriate securities. Pending such
investment, it is anticipated that the proceeds will be invested in short-term
tax-exempt securities. See "Investment Objective and Policies."
CAPITALIZATION
The following table sets forth the unaudited capitalization of the Fund as of
February 1, 1999 and as adjusted to give effect to the issuance of the shares
of AMPS offered hereby.
<TABLE>
<CAPTION>
ACTUAL AS ADJUSTED
------------ ------------
<S> <C> <C>
Shareholders' equity:
Capital Stock (200,000,000 shares authorized)
Preferred Stock, par value $.10 per share (no
shares issued; 3,640 shares of AMPS issued and
outstanding, as adjusted, at $25,000 per share
liquidation preference)........................... -- $ 91,000,000
Common Stock, par value $.10 per share (8,606,667
shares issued and outstanding).................... $ 860,667 860,667
Capital in excess of par value attributable to
Common Stock...................................... 127,976,461 127,123,961
Undistributed investment income--net............... 64,606 64,606
Unrealized appreciation on investments--net........ 284,915 284,915
------------ ------------
Net assets......................................... $129,186,649 $219,334,149
============ ============
</TABLE>
7
<PAGE>
PORTFOLIO COMPOSITION
As of February 1, 1999, approximately 83.7% of the market value of the Fund's
portfolio was invested in long-term municipal obligations and approximately
16.3% of the market value of the Fund's portfolio was invested in short-term
municipal obligations. The following table sets forth certain information with
respect to the composition of the Fund's investment portfolio as of February 1,
1999.
<TABLE>
<CAPTION>
Number of Value
S&P* Moody's* Issues (in thousands) Percent
---- -------- --------- -------------- -------
<S> <C> <C> <C> <C>
AAA Aaa 27 $131,090 76.6%
AA VMIG1 7 27,841 16.3
A A 2 12,245 7.1
--- -------- -----
Total............. 36 $171,176 100.0%
=== ======== =====
</TABLE>
- --------
* Ratings: Using the higher of Standard & Poor's ("S&P") or Moody's Investors
Service, Inc. ("Moody's") ratings on the Fund's municipal obligations. See
"Schedule of Investments." S&P rating categories may be modified further by a
plus (+) or minus (-) in AA, A, BBB, BB, B and C ratings. Moody's rating
categories may be modified further by a 1, 2 or 3 in Aa, A, Baa, Ba and B
ratings.
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to provide shareholders with current
income exempt from Federal and California income taxes. The Fund seeks to
achieve its investment objective by investing primarily in a portfolio of long-
term, investment grade municipal obligations issued by or on behalf of the
State of California, its political subdivisions, agencies and
instrumentalities, and other qualifying issuers, each of which pays interest
which, in the opinion of bond counsel to the issuer, is exempt from Federal and
California income taxes ("California Municipal Bonds"). The Fund intends to
invest substantially all (at least 80%) of its assets in California Municipal
Bonds, except at times when the Fund's investment adviser, Fund Asset
Management, L.P. (the "Investment Adviser"), considers that California
Municipal Bonds of sufficient quality and quantity are unavailable for
investment at suitable prices by the Fund. To the extent the Investment Adviser
considers that suitable California Municipal Bonds are not available for
investment, the Fund may purchase other long-term municipal obligations exempt
from Federal but not California income taxes ("Municipal Bonds"). The Fund will
maintain at least 65% of its assets in California Municipal Bonds and at least
80% of its assets in California Municipal Bonds and Municipal Bonds, except
during interim periods pending investment of the net proceeds of public
offerings of the Fund's securities and during temporary defensive periods.
Under normal circumstances, at least 80% of the Fund's assets will be invested
in municipal obligations with remaining maturities of one year or more that are
covered by insurance guaranteeing the timely payment of principal at maturity
and interest. The Fund's investment objective is a fundamental policy that may
not be changed without a vote of a majority of the Fund's outstanding voting
securities, as defined in the statement of additional information under
"Investment Restrictions." There can be no assurance that the investment
objective of the Fund will be realized. At times the Fund may seek to hedge its
portfolio through the use of options and futures transactions to reduce
volatility in the net asset value of its shares of common stock.
The Fund ordinarily does not intend to realize significant investment income
that is subject to Federal and California income taxes. The Fund may invest all
or a portion of its assets in certain tax-exempt securities classified as
"private activity bonds" (in general, bonds that benefit non-governmental
entities) that may subject certain investors in the Fund to an alternative
minimum tax.
The Fund also may invest in securities not issued by or on behalf of a state
or territory or by an agency or instrumentality thereof, if the Fund
nevertheless believes such securities pay interest or distributions that are
exempt from Federal income taxation ("Non-Municipal Tax-Exempt Securities").
Non-Municipal Tax-Exempt Securities may include securities issued by other
investment companies that invest in California Municipal Bonds and Municipal
Bonds, to the extent such investments are permitted by the Investment Company
Act of 1940, as amended (the "1940 Act"). Other Non-Municipal Tax-Exempt
Securities could include trust
8
<PAGE>
certificates or other instruments evidencing interests in one or more long-term
California Municipal Bonds or Municipal Bonds. Certain Non-Municipal Tax-Exempt
Securities may be characterized as derivative instruments. Non-Municipal Tax-
Exempt Securities are considered "California Municipal Bonds" or "Municipal
Bonds" for purposes of the Fund's investment objective and policies.
The investment grade California Municipal Bonds and Municipal Bonds in which
the Fund will primarily invest are those California Municipal Bonds and
Municipal Bonds that are rated at the date of purchase in the four highest
rating categories of S&P, Moody's or Fitch IBCA, Inc. ("Fitch") or, if unrated,
are considered to be of comparable quality by the Investment Adviser. In the
case of long-term debt, the investment grade rating categories are AAA through
BBB for S&P, Aaa through Baa for Moody's and AAA through BBB for Fitch. In the
case of short-term notes, the investment grade rating categories are SP-l+
through SP-3 for S&P, MIG-1 through MIG-3 for Moody's and F-1+ through F-3 for
Fitch. In the case of tax-exempt commercial paper, the investment grade rating
categories are A-1+ through A-3 for S&P, Prime-1 through Prime-3 for Moody's
and F-l+ through F-3 for Fitch. Obligations ranked in the lowest investment
grade rating category (BBB, SP-3 and A-3 for S&P; Baa, MIG-3 and Prime-3 for
Moody's; and BBB and F-3 for Fitch), while considered "investment grade," may
have certain speculative characteristics. There may be sub-categories or
gradations indicating relative standing within the rating categories set forth
above. Appendix B to the statement of additional information contains a
description of S&P's, Moody's and Fitch's ratings of California Municipal Bonds
and Municipal Bonds. In assessing the quality of California Municipal Bonds and
Municipal Bonds with respect to the foregoing requirements, the Investment
Adviser will take into account the portfolio insurance as well as the nature of
any letters of credit or similar credit enhancement to which particular
Municipal Bonds are entitled and the creditworthiness of the insurance company
or financial institution that provided such insurance or credit enhancement.
Consequently, if California Municipal Bonds or Municipal Bonds are covered by
insurance policies issued by insurers whose claims-paying ability is rated AAA
by S&P or Fitch or Aaa by Moody's, the Investment Adviser may consider such
municipal obligations to be equivalent to AAA- or Aaa- rated securities, as the
case may be, even though such California Municipal Bonds or Municipal Bonds
would generally be assigned a lower rating if the rating were based primarily
upon the credit characteristics of the issuers without regard to the insurance
feature. The insured California Municipal Bonds and Municipal Bonds must also
comply with the standards applied by the insurance carriers in determining
eligibility for portfolio insurance.
The Fund's investments may also include variable rate demand obligations
("VRDOs") and VRDOs in the form of participation interests ("Participating
VRDOs") in variable rate tax-exempt obligations held by a financial
institution, typically a commercial bank. The VRDOs in which the Fund will
invest are tax-exempt obligations, in the opinion of counsel to the issuer,
that contain a floating or variable interest rate adjustment formula and an
unconditional right of demand on the part of the holder thereof to receive
payment of the unpaid principal balance plus accrued interest on a short notice
period not to exceed seven days. Participating VRDOs provide the Fund with a
specified undivided interest (up to 100%) in the underlying obligation and the
right to demand payment of the unpaid principal balance plus accrued interest
on the Participating VRDOs from the financial institution on a specified number
of days' notice, not to exceed seven days. There is, however, the possibility
that because of default or insolvency, the demand feature of VRDOs or
Participating VRDOs may not be honored. The Fund has been advised by its
counsel that the Fund should be entitled to treat the income received on
Participating VRDOs as interest from tax-exempt obligations for Federal income
tax purposes.
The average maturity of the Fund's portfolio securities will vary based upon
the Investment Adviser's assessment of economic and market conditions. The net
asset value of the shares of common stock of a closed-end investment company,
such as the Fund, which invests primarily in fixed-income securities, changes
as the general levels of interest rates fluctuate. When interest rates decline,
the value of a fixed-income portfolio can be expected to rise. Conversely, when
interest rates rise, the value of a fixed-income portfolio can be expected to
decline. Prices of longer-term securities generally fluctuate more in response
to interest rate changes than do short-term or medium-term securities. These
changes in net asset value are likely to be greater in the case of a fund
having a leveraged capital structure, such as that used by the Fund.
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The Fund intends to invest primarily in long-term California Municipal Bonds
and Municipal Bonds with a maturity of more than ten years. Also, the Fund may
invest in intermediate-term California Municipal Bonds and Municipal Bonds with
a maturity of between three years and ten years. The Fund may invest in short-
term, tax-exempt securities, short-term U.S. Government securities, repurchase
agreements or cash. Such short-term securities or cash will not exceed 20% of
its total assets except during interim periods pending investment of the net
proceeds of public offerings of the Fund's securities or in anticipation of the
repurchase or redemption of the Fund's securities and temporary periods when,
in the opinion of the Investment Adviser, prevailing market or economic
conditions warrant. The Fund does not ordinarily intend to realize significant
interest income that is subject to Federal and California income taxes. For a
more complete description of California Municipal Bonds and Municipal Bonds,
see "Investment Objectives and Policies" in the statement of additional
information.
The Fund is classified as non-diversified within the meaning of the 1940 Act,
which means that the Fund is not limited by the 1940 Act in the proportion of
its assets that it may invest in securities of a single issuer. However, the
Fund's investments will be limited so as to qualify the Fund for special tax
treatment afforded regulated investment companies under the Federal tax laws.
See "Taxes" herein and in the statement of additional information. To qualify,
among other requirements, the Fund will limit its investments so that, at the
close of each quarter of the taxable year, (i) not more than 25% of the market
value of the Fund's total assets will be invested in the securities (other than
U.S. Government securities) of a single issuer, and (ii) with respect to 50% of
the market value of its total assets, not more than 5% of the market value of
its total assets will be invested in the securities (other than U.S. Government
securities) of a single issuer. A fund that elects to be classified as
"diversified" under the 1940 Act must satisfy the foregoing 5% requirement with
respect to 75% of its total assets. To the extent that the Fund assumes large
positions in the securities of a small number of issuers, the Fund's yield may
fluctuate to a greater extent than that of a diversified company as a result of
changes in the financial condition or in the market's assessment of the
issuers.
Portfolio Insurance
Under normal circumstances, at least 80% of the Fund's assets will be
invested in California Municipal Bonds and Municipal Bonds either (i) insured
under an insurance policy purchased by the Fund or (ii) insured under an
insurance policy obtained by the issuer thereof or any other party. The Fund
will seek to limit its investments to municipal obligations insured under
insurance policies issued by insurance carriers that have total admitted assets
(unaudited) of at least $75,000,000 and capital and surplus (unaudited) of at
least $50,000,000 and insurance claims-paying ability ratings of AAA from S&P
or Fitch or Aaa from Moody's. There can be no assurance that insurance from
insurance carriers meeting these criteria will be available. See Appendix C to
the statement of additional information for a brief description of S&P's,
Fitch's and Moody's insurance claims--paying ability ratings. Currently, it is
anticipated that a majority of the insured California Municipal Bonds and
Municipal Bonds in the Fund's portfolio will be insured by the following
insurance companies that satisfy the foregoing criteria: AMBAC Indemnity
Corporation, Financial Guaranty Insurance Company, Financial Security Assurance
and Municipal Bond Investors Assurance Corporation. The Fund also may purchase
California Municipal Bonds and Municipal Bonds covered by insurance issued by
any other insurance company that satisfies the foregoing criteria. It is
anticipated that initially a majority of insured California Municipal Bonds and
Municipal Bonds held by the Fund will be insured under policies obtained by
parties other than the Fund.
The Fund may purchase, but has no obligation to purchase, separate insurance
policies (the "Policies") from insurance companies meeting the criteria set
forth above that guarantee the payment of principal and interest on specified
eligible California Municipal Bonds and Municipal Bonds purchased by the Fund.
A California Municipal Bond or a Municipal Bond will be eligible for coverage
if it meets certain requirements of the insurance company set forth in a
Policy. In the event interest or principal on an insured California Municipal
Bond or Municipal Bond is not paid when due, the insurer will be obligated
under its Policy to make such payment not later than 30 days after it has been
notified by, and provided with documentation from, the Fund that such
nonpayment has occurred.
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The Policies will be effective only as to insured California Municipal Bonds
and Municipal Bonds beneficially owned by the Fund. In the event of a sale of
any California Municipal Bonds and Municipal Bonds held by the Fund, the issuer
of the relevant Policy will be liable only for those payments of interest and
principal that are then due and owing. The Policies will not guarantee the
market value of the insured California Municipal Bonds and Municipal Bonds or
the value of the shares of the Fund.
The insurer will not have the right to withdraw coverage on securities
insured by their Policies and held by the Fund so long as such securities
remain in the Fund's portfolio. In addition, the insurer may not cancel its
Policies for any reason except failure to pay premiums when due. The Board of
Directors of the Fund will reserve the right to terminate any of the Policies
if it determines that the benefits to the Fund of having its portfolio insured
under such policy are not justified by the expense involved.
The premiums for the Policies are paid by the Fund and the yield on the
Fund's portfolio is reduced thereby. The Investment Adviser estimates that the
cost of the annual premiums for the Policies currently ranges from
approximately .02 of 1% to .15 of 1% of the principal amount of the California
Municipal Bonds and Municipal Bonds covered by such Policies. The estimate is
based on the expected composition of the Fund's portfolio of California
Municipal Bonds and Municipal Bonds. In instances in which the Fund purchases
California Municipal Bonds and Municipal Bonds insured under policies obtained
by parties other than the Fund, the Fund does not pay the premiums for such
policies; rather, the cost of such policies may be reflected in the purchase
price of the California Municipal Bonds and Municipal Bonds.
It is the intention of the Investment Adviser to retain any insured
securities that are in default or in significant risk of default and to place a
value on the insurance, which ordinarily will be the difference between the
market value of the defaulted security and the market value of similar
securities which are not in default. In certain circumstances, however, the
Investment Adviser may determine that an alternative value for the insurance,
such as the difference between the market value of the defaulted security and
its par value, is more appropriate. The Investment Adviser will be unable to
manage the portfolio to the extent it holds defaulted securities, which may
limit its ability in certain circumstances to purchase other California
Municipal Bonds and Municipal Bonds. See "Net Asset Value" in the statement of
additional information for a more complete description of the Fund's method of
valuing defaulted securities and securities that have a significant risk of
default.
There can be no assurance that insurance with the terms and issued by
insurance carriers meeting the criteria described above will continue to be
available to the Fund. In the event the Board of Directors determines that such
insurance is unavailable or that the cost of such insurance outweighs the
benefits to the Fund, the Fund may modify the criteria for insurance carriers
or the terms of the insurance, or may discontinue its policy of maintaining
insurance for all or any of the California Municipal Bonds and Municipal Bonds
held in the Fund's portfolio. Although the Investment Adviser periodically
reviews the financial condition of each insurer, there can be no assurance that
the insurers will be able to honor their obligations under the circumstances.
The portfolio insurance reduces financial or credit risk (i.e., the
possibility that the owners of the insured California Municipal Bonds or
Municipal Bonds will not receive timely scheduled payments of principal or
interest). However, the insured California Municipal Bonds or Municipal Bonds
are subject to market risk (i.e., fluctuations in market value as a result of
changes in prevailing interest rates).
Special Considerations Relating to California Municipal Bonds
The Fund ordinarily will invest at least 80% of its total assets in
California Municipal Bonds, and therefore it is more susceptible to factors
adversely affecting issuers of California Municipal Bonds than is a municipal
bond mutual fund that is not concentrated in issuers of California Municipal
Bonds to this degree. Beginning in the 1990-91 fiscal year, the State of
California faced the worst economic, fiscal and budget conditions since the
1930s. On July 5, 1994, all three of the rating agencies rating the State of
California's
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long-term debt lowered their ratings of the State of California's general
obligation bonds. Moody's lowered its rating from "Aa" to "A1," S&P lowered its
rating from "A+" to "A" and Fitch lowered its rating from "AA" to "A." Although
a steady upturn has been underway since 1994, pre-recession job levels are not
expected to be reached until later in the decade. As of the date of this
Prospectus, S&P and Fitch have upgraded their ratings to A+ and AA-,
respectively. No assurance can be given that such ratings will not be lowered
in the future. The Investment Adviser does not believe that the current
economic conditions in California will have a significant adverse effect on the
Fund's ability to invest prudently in California Municipal Bonds. For a
discussion of economic and other conditions in the State of California, see
Appendix A, "Economic and Other Conditions in California" to the statement of
additional information.
Other Investment Policies
The Fund has adopted certain other policies as set forth below:
Borrowings. The Fund is authorized to borrow money in amounts of up to 5% of
the value of its total assets at the time of such borrowings; provided,
however, that the Fund is authorized to borrow moneys in amounts of up to 33
1/3% of the value of its total assets at the time of such borrowings to finance
the repurchase of its own common stock pursuant to tender offers or otherwise
to redeem or repurchase shares of preferred stock or for temporary,
extraordinary or emergency purposes. Borrowings by the Fund (commonly known, as
with the issuance of preferred stock, as "leveraging") create an opportunity
for greater total return since the Fund will not be required to sell portfolio
securities to repurchase or redeem shares but, at the same time, increase
exposure to capital risk. In addition, borrowed funds are subject to interest
costs that may offset or exceed the return earned on the borrowed funds.
When-Issued Securities and Delayed Delivery Transactions. The Fund may
purchase or sell California Municipal Bonds and Municipal Bonds on a delayed
delivery basis or on a when-issued basis at fixed purchase or sale terms. These
transactions arise when securities are purchased or sold by the Fund with
payment and delivery taking place in the future. The purchase will be recorded
on the date the Fund enters into the commitment, and the value of the
obligation will thereafter be reflected in the calculation of the Fund's net
asset value. The value of the obligation on the delivery day may be more or
less than its purchase price. A separate account of the Fund will be
established with its custodian consisting of cash, cash equivalents or liquid
securities having a market value at all times at least equal to the amount of
the commitment.
Indexed and Inverse Floating Obligations. The Fund may invest in California
Municipal Bonds and Municipal Bonds yielding a return based on a particular
index of value or interest rates. For example, the Fund may invest in
California Municipal Bonds and Municipal Bonds that pay interest based on an
index of Municipal Bond interest rates. The principal amount payable upon
maturity of certain California Municipal Bonds and Municipal Bonds also may be
based on the value of an index. To the extent the Fund invests in these types
of Municipal Bonds, the Fund's return on such California Municipal Bonds and
Municipal Bonds will be subject to risk with respect to the value of the
particular index. Also, the Fund may invest in so-called "inverse floating
obligations" or "residual interest bonds" on which the interest rates typically
vary inversely with a short-term floating rate (which may be reset periodically
by a dutch auction, a remarketing agent, or by reference to a short-term tax-
exempt interest rate index). The Fund may purchase in the secondary market
synthetically-created inverse floating rate bonds evidenced by custodial or
trust receipts. Generally, income on inverse floating rate bonds will decrease
when short-term interest rates increase, and will increase when short-term
interest rates decrease. Such securities have the effect of providing a degree
of investment leverage, since they may increase or decrease in value in
response to changes, as an illustration, in market interest rates at a rate
that is a multiple (typically two) of the rate at which fixed-rate, long-term,
tax-exempt securities increase or decrease in response to such changes. As a
result, the market values of such securities generally will be more volatile
than the market values of fixed-rate tax-exempt securities. To seek to limit
the volatility of these securities, the Fund may purchase inverse floating
obligations with shorter-term maturities or limitations on the extent to which
the interest rate may vary. The Investment Adviser believes that indexed and
inverse floating
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<PAGE>
obligations represent a flexible portfolio management instrument for the Fund
that allows the Investment Adviser to vary the degree of investment leverage
relatively efficiently under different market conditions.
Call Rights. The Fund may purchase a California Municipal Bond or Municipal
Bond issuer's right to call all or a portion of such California Municipal Bond
or Municipal Bond for mandatory tender for purchase (a "Call Right"). A holder
of a Call Right may exercise such right to require a mandatory tender for the
purchase of related California Municipal Bonds or Municipal Bonds, subject to
certain conditions. A Call Right that is not exercised prior to the maturity of
the related California Municipal Bond or Municipal Bond will expire without
value. The economic effect of holding both the Call Right and the related
California Municipal Bond or Municipal Bond is identical to holding a
California Municipal Bond or Municipal Bond as a non-callable security.
Repurchase Agreements. The Fund may invest in California Municipal Bonds,
Municipal Bonds and U.S. Government securities pursuant to repurchase
agreements. Repurchase agreements may be entered into only with a member bank
of the Federal Reserve System or a primary dealer in U.S. Government securities
or an affiliate thereof. Under such agreements, the seller agrees, upon
entering into the contract, to repurchase the security at a mutually agreed-
upon time and price, thereby determining the yield during the term of the
agreement. The Fund may not invest in repurchase agreements maturing in more
than seven days if such investments, together with all other illiquid
investments, would exceed 15% of the Fund's net assets. In the event of default
by the seller under a repurchase agreement, the Fund may suffer time delays and
incur costs or possible losses in connection with the disposition of the
underlying securities.
In general, for Federal and California income tax purposes, repurchase
agreements are treated as collateralized loans secured by the securities
"sold." Therefore, amounts earned under such agreements will not be considered
tax-exempt interest.
Options and Futures Transactions
The Fund may hedge all or a portion of its portfolio investments against
fluctuations in interest rates through the use of options and certain financial
futures contracts and options thereon. While the Fund's use of hedging
strategies is intended to reduce the volatility of the net asset value of the
common stock, the net asset value of the common stock will fluctuate. There can
be no assurance that the Fund's hedging transactions will be effective. For so
long as the AMPS are rated by Moody's and S&P, the Fund's use of options and
financial futures contracts will be subject to the limitations described under
"Rating Agency Guidelines" herein and in the statement of additional
information. Furthermore, the Fund may only engage in hedging activities from
time to time and may not necessarily be engaging in hedging activities when
movements in interest rates occur. The Fund has no obligation to enter into
hedging transactions and may not do so.
Certain Federal income tax requirements may limit the Fund's ability to
engage in hedging transactions. Gains from transactions in options and futures
contracts distributed to shareholders will be taxable as ordinary income or, in
certain circumstances, as long-term capital gains to shareholders. See "Taxes--
Tax Treatment of Options and Futures Transactions" in the statement of
additional information. In addition, in order to obtain ratings of the
preferred stock from one or more nationally recognized statistical rating
organizations ("NRSROs"), the Fund may be required to limit its use of hedging
techniques in accordance with the specified guidelines of such rating
organizations.
For a description of the options and futures transactions in which the Fund
may engage, limitations on the Fund's use of such transactions and risks
associated with these transactions, see "Investment Objective and Policies--
Options and Futures Transactions" in the statement of additional information.
The investment policies with respect to the hedging transactions of the Fund
are not fundamental policies and may be modified by the Board of Directors of
the Fund without the approval of the Fund's shareholders.
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DESCRIPTION OF AMPS
General
Certain of the capitalized terms used herein are defined in the Glossary that
appears at the back of this prospectus.
The AMPS of each series will be shares of preferred stock that entitle their
holders to receive dividends when, as and if declared by the Board of
Directors, out of funds legally available therefor, at a rate per annum that
may vary for the successive Dividend Periods for each such series. After the
Initial Dividend Period, each Subsequent Dividend Period for each series of
AMPS generally will be a 7-Day Dividend Period; provided, however, that prior
to any Auction, the Fund may elect, subject to certain limitations described
herein, upon giving notice to holders thereof, a Special Dividend Period. The
Applicable Rate for a particular Dividend Period will be determined by an
Auction conducted on the Business Day before the start of such Dividend Period.
Beneficial Owners and Potential Beneficial Owners of shares of AMPS may
participate in Auctions therefor, although, except in the case of a Special
Dividend Period, Beneficial Owners desiring to continue to hold all of their
shares of AMPS regardless of the Applicable Rate resulting from Auctions need
not participate. For an explanation of Auctions and the method of determining
the Applicable Rate, see "The Auction" herein and in the statement of
additional information.
The following is a brief description of the terms of the shares of AMPS. This
description does not purport to be complete and is subject to and qualified in
its entirety by reference to the Fund's Articles of Incorporation and Articles
Supplementary, including the provisions thereof establishing the AMPS. The
Fund's Articles of Incorporation and the form of Articles Supplementary
establishing the terms of the AMPS have been filed as exhibits to the
Registration Statement of which this prospectus is a part.
Dividends
General. The holders of shares of each series of AMPS will be entitled to
receive, when, as and if declared by the Board of Directors of the Fund, out of
funds legally available therefor, cumulative cash dividends on their shares, at
the Applicable Rate determined as set forth below under "Determination of
Dividend Rate," payable on the respective dates set forth below. Dividends on
the shares of AMPS so declared and payable shall be paid (i) in preference to
and in priority over any dividends so declared and payable on the Common Stock,
and (ii) to the extent permitted under the Code and to the extent available,
out of net tax-exempt income earned on the Fund's investments. Generally,
dividends on shares of AMPS, to the extent that they are derived from interest
paid on Municipal Bonds, will be exempt from Federal income taxes, subject to
possible application of the alternative minimum tax. See "Taxes" in the
statement of additional information.
Dividends on the shares of AMPS will accumulate from the date on which the
Fund originally issues the shares of AMPS (the "Date of Original Issue") and
will be payable on each series of AMPS on the dates described below. Dividends
on shares of each series of AMPS with respect to the Initial Dividend Period
shall be payable on the Initial Dividend Payment Date with respect to each
series of AMPS. Following the Initial Dividend Payment Date for each series of
AMPS, dividends on each series of AMPS will be payable, at the option of the
Fund, either (i) with respect to any 7-Day Dividend Period and any Short Term
Dividend Period of 35 or fewer days, on the day next succeeding the last day
thereof or (ii) with respect to any Short Term Dividend Period of more than 35
days and with respect to any Long Term Dividend Period, monthly on the first
Business Day of each calendar month during such Short Term Dividend Period or
Long Term Dividend Period and on the day next succeeding the last day thereof
(each such date referred to in clause (i) or (ii) being referred to herein as a
"Normal Dividend Payment Date"), except that if such Normal Dividend Payment
Date is not a Business Day, the Dividend Payment Date shall be the first
Business Day next succeeding such Normal Dividend Payment Date. Thus, following
the Initial Dividend Payment Date for each series of AMPS, dividends generally
will be payable (in the case of Dividend Periods which are not Special Dividend
Periods) on each succeeding Wednesday in the case of Series A AMPS and on each
succeeding Tuesday in the case of Series B AMPS. Although any particular
Dividend Payment Date may not occur on the originally scheduled
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date because of the exceptions discussed above, the next succeeding Dividend
Payment Date, subject to such exceptions, will occur on the next following
originally scheduled date. If for any reason a Dividend Payment Date cannot be
fixed as described above, then the Board of Directors shall fix the Dividend
Payment Date. The Board of Directors by resolution prior to authorization of a
dividend by the Board of Directors may change a Dividend Payment Date if such
change does not adversely affect the contract rights of the holders of shares
of AMPS set forth in the Charter. The Initial Dividend Period, 7-Day Dividend
Periods and Special Dividend Periods are hereinafter sometimes referred to as
"Dividend Periods." Each dividend payment date determined as provided above is
hereinafter referred to as a "Dividend Payment Date."
Prior to each Dividend Payment Date, the Fund is required to deposit with the
Auction Agent sufficient funds for the payment of declared dividends. The Fund
does not intend to establish any reserves for the payment of dividends.
Each dividend will be paid to the record holder of the AMPS, which holder is
expected to be the nominee of the Securities Depository. See "The Auction--
Securities Depository." The Securities Depository will credit the accounts of
the Agent Members of the Existing Holders in accordance with the Securities
Depository's normal procedures which provide for payment in same-day funds. The
Agent Member of an Existing Holder will be responsible for holding or
disbursing such payments on the applicable Dividend Payment Date to such
Existing Holder in accordance with the instructions of such Existing Holder.
Dividends in arrears for any past Dividend Period may be declared and paid at
any time, without reference to any regular Dividend Payment Date, to the
nominee of the Securities Depository. Any dividend payment made on shares of
AMPS first shall be credited against the earliest declared but unpaid dividends
accumulated with respect to such series.
Holders of shares of AMPS will not be entitled to any dividends, whether
payable in cash, property or stock, in excess of full cumulative dividends
except as described under "Additional Dividends" and "Non-Payment Period; Late
Charge." No interest will be payable in respect of any dividend payment or
payments on the shares of AMPS which may be in arrears.
The amount of cash dividends per share of any series of AMPS payable (if
declared) on the Initial Dividend Payment Date, each 7-Day Dividend Period and
each Dividend Payment Date of each Short Term Dividend Period shall be computed
by multiplying the Applicable Rate for such Dividend Period by a fraction, the
numerator of which will be the number of days in such Dividend Period or part
thereof that such share was outstanding and for which dividends are payable on
such Dividend Payment Date and the denominator of which will be 365,
multiplying the amount so obtained by $25,000, and rounding the amount so
obtained to the nearest cent. During any Long Term Dividend Period, the amount
of cash dividends per share of AMPS payable (if declared) on any Dividend
Payment Date shall be computed by multiplying the Applicable Rate for such
Dividend Period by a fraction, the numerator of which will be such number of
days in such part of such Dividend Period that such share was outstanding and
for which dividends are payable on such Dividend Payment Date and the
denominator of which will be 360, multiplying the amount so obtained by
$25,000, and rounding the amount so obtained to the nearest cent.
Notification of Dividend Period. With respect to each Dividend Period that is
a Special Dividend Period, the Fund, at its sole option and to the extent
permitted by law, by telephonic and written notice (a "Request for Special
Dividend Period") to the Auction Agent and to each Broker-Dealer, may request
that the next succeeding Dividend Period for a series of AMPS will be a number
of days (other than seven), evenly divisible by seven, and not fewer than seven
nor more than 364 in the case of a Short Term Dividend Period or one whole year
or more but not greater than five years in the case of a Long Term Dividend
Period, specified in such notice, provided that the Fund may not give a Request
for Special Dividend Period (and any such request shall be null and void)
unless, for any Auction occurring after the initial Auction, Sufficient
Clearing Bids were made in the last occurring Auction and unless full
cumulative dividends, any amounts due with respect to redemptions, and any
Additional Dividends payable prior to such date have been paid in full. Such
Request for Special Dividend Period, in the case of a Short Term Dividend
Period, shall be given on or prior to the second
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Business Day but not more than seven Business Days prior to an Auction Date for
the AMPS and, in the case of a Long Term Dividend Period, shall be given on or
prior to the second Business Day but not more than 28 days prior to an Auction
Date for the AMPS. Upon receiving such Request for Special Dividend Period, the
Broker-Dealers jointly shall determine whether, given the factors set forth
below, it is advisable that the Fund issue a Notice of Special Dividend Period
for a series of AMPS as contemplated by such Request for Special Dividend
Period and the Optional Redemption Price of the AMPS during such Special
Dividend Period and the Specific Redemption Provisions and shall give the Fund
and the Auction Agent written notice (a "Response") of such determination by no
later than the second Business Day prior to such Auction Date. In the event the
Response indicates that it is advisable that the Fund give a notice of a
Special Dividend Period for the AMPS, the Fund, by no later than the second
Business Day prior to such Auction Date may give a notice (a "Notice of Special
Dividend Period") to the Auction Agent, the Securities Depository and each
Broker-Dealer. See "Description of AMPS--Dividends-- Notification of Dividend
Period" in the statement of additional information for a detailed description
of these procedures.
Determination of Dividend Rate. The dividend rate on shares of each series of
AMPS during the period from and including the Date of Original Issue for each
series of AMPS to but excluding the Initial Dividend Payment Date for each
series of AMPS (the "Initial Dividend Period") will be the rate per annum set
forth above under "Offering Summary." Commencing on the Initial Dividend
Payment Date for each series of AMPS, the Applicable Rate on the shares of such
series of AMPS for each Subsequent Dividend Period, which Subsequent Dividend
Period shall be a period commencing on and including a Dividend Payment Date
and ending on and including the calendar day prior to the next Dividend Payment
Date (or last Dividend Payment Date in a Dividend Period if there is more than
one Dividend Payment Date), shall be equal to the rate per annum that results
from the Auction with respect to such Subsequent Dividend Period. The Initial
Dividend Period and Subsequent Dividend Period for each series of AMPS is
referred to herein as a "Dividend Period." Cash dividends shall be calculated
as set forth above under "Dividends--General."
Restrictions on Dividends and Other Payments. Under the 1940 Act, the Fund
may not declare dividends or make other distributions on shares of Common Stock
or purchase any such shares if, at the time of the declaration, distribution or
purchase, as applicable (and after giving effect thereto), asset coverage (as
defined in the 1940 Act) with respect to the outstanding shares of AMPS would
be less than 200% (or such other percentage as in the future may be required by
law). The Fund estimates that, based on the composition of its portfolio at
February 1, 1999, asset coverage with respect to shares of AMPS would be
approximately 241% immediately after the issuance of the shares of AMPS offered
hereby. Under the Code, the Fund, among other things, must distribute at least
90% of its investment company taxable income each year in order to maintain its
qualification for tax treatment as a regulated investment company. The
foregoing limitations on dividends, distributions and purchases under certain
circumstances may impair the Fund's ability to maintain such qualification. See
"Taxes" in the statement of additional information.
Upon any failure to pay dividends on shares of AMPS for two years or more,
the holders of the shares of AMPS will acquire certain additional voting
rights. See "Voting Rights" below. Such rights shall be the exclusive remedy of
the holders of shares of AMPS upon any failure to pay dividends on shares of
the Fund.
Additional Dividends. If the Fund retroactively allocates any net capital
gains or other income subject to regular Federal income taxes to shares of AMPS
without having given advance notice thereof to the Auction Agent as described
under "The Auction--Auction Date; Advance Notice of Allocation of Taxable
Income; Inclusion of Taxable Income in Dividends" below, which may only happen
when such allocation is made as a result of the redemption of all or a portion
of the outstanding shares of AMPS or the liquidation of the Fund (the amount of
such allocation referred to herein as a "Retroactive Taxable Allocation"), the
Fund, within 90 days (and generally within 60 days) after the end of the Fund's
fiscal year for which a Retroactive Taxable Allocation is made, will provide
notice thereof to the Auction Agent and to each holder of shares (initially
Cede as nominee of the Securities Depository) during such fiscal year at such
holder's address as the same appears or last appeared on the stock books of the
Fund. The Fund, within 30 days after such notice is given to the Auction Agent,
will pay to the Auction Agent (who then will distribute to such holders of
shares of
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AMPS), out of funds legally available therefor, an amount equal to the
aggregate Additional Dividend (as defined below) with respect to all
Retroactive Taxable Allocations made to such holders during the fiscal year in
question. See "Taxes" in the statement of additional information.
An "Additional Dividend" means payment to a present or former holder of
shares of AMPS of an amount which, when taken together with the aggregate
amount of Retroactive Taxable Allocations made to such holder with respect to
the fiscal year in question, would cause such holder's dividends in dollars
(after Federal and California income tax consequences) from the aggregate of
both the Retroactive Taxable Allocations and the Additional Dividend to be
equal to the dollar amount of the dividends which would have been received by
such holder if the amount of the aggregate Retroactive Taxable Allocations had
been excludable from the gross income of such holder. Such Additional Dividend
shall be calculated (i) without consideration being given to the time value of
money; (ii) assuming that no holder of shares of AMPS is subject to the Federal
alternative minimum tax with respect to dividends received from the Fund; and
(iii) assuming that each Retroactive Taxable Allocation would be taxable in the
hands of each holder of shares of AMPS at the greater of: (a) the maximum
combined marginal regular Federal and California individual income tax rate
applicable to ordinary income or capital gains depending on the taxable
character of the distribution (including any surtax); or (b) the maximum
combined marginal regular Federal and California corporate income tax rate
applicable to ordinary income or capital gains depending on the taxable
character of the distribution (taking into account in both (a) and (b) the
Federal income tax deductibility of state taxes paid or incurred but not any
phase out of, or provision limiting, personal exemptions, itemized deductions,
or the benefit of lower tax brackets and assuming the taxability of Federally
tax-exempt dividends for corporations for California state franchise tax
purposes). Although the Fund generally intends to designate any Additional
Dividend as an exempt-interest dividend to the extent permitted by applicable
law, it is possible that all or a portion of any Additional Dividend will be
taxable to the recipient thereof. See "Taxes--Tax Treatment of Additional
Dividends" in the statement of additional information. The Fund will not pay a
further Additional Dividend with respect to any taxable portion of an
Additional Dividend.
If the Fund does not give advance notice of the amount of taxable income to
be included in a dividend on shares of AMPS in the related Auction, the Fund
may include such taxable income in a dividend on shares of AMPS if it increases
the dividend by an additional amount calculated as if such income were a
Retroactive Taxable Allocation and the additional amount were an Additional
Dividend and notifies the Auction Agent of such inclusion at least five days
prior to the applicable Dividend Payment Date. See "The Auction--Auction
Procedures--Auction Date; Advance Notice of Allocation of Taxable Income;
Inclusion of Taxable Income in Dividends" below.
Asset Maintenance
The Fund will be required to satisfy two separate asset maintenance
requirements under the terms of the Articles Supplementary. These requirements
are summarized below.
1940 Act AMPS Asset Coverage. The Fund will be required under the Articles
Supplementary to maintain, with respect to shares of AMPS, as of the last
Business Day of each month in which any shares of AMPS are outstanding, asset
coverage of at least 200% with respect to senior securities which are stock,
including the shares of AMPS (or such other asset coverage as in the future may
be specified in or under the 1940 Act as the minimum asset coverage for senior
securities which are stock of a closed-end investment company as a condition of
paying dividends on its common stock) ("1940 Act AMPS Asset Coverage"). If the
Fund fails to maintain 1940 Act AMPS Asset Coverage and such failure is not
cured as of the last Business Day of the following month (the "1940 Act Cure
Date"), the Fund will be required under certain circumstances to redeem certain
of the shares of AMPS. See "Redemption" below.
17
<PAGE>
The 1940 Act AMPS Asset Coverage immediately following the issuance of AMPS
offered hereby (after giving effect to the deduction of the sales load and
offering expenses for the shares of AMPS) will be computed as follows:
<TABLE>
<S> <C> <C> <C> <C>
Value of Fund assets
less
liabilities not
constituting
senior securities = $ 219,334,149 = 241%
------------------------ -------------
Senior securities $ 91,000,000
representing
indebtedness
plus liquidation value
of the
shares of AMPS
</TABLE>
AMPS Basic Maintenance Amount. So long as shares of AMPS are outstanding, the
Fund will be required under the Articles Supplementary to maintain as of each
Business Day (a "Valuation Date") S&P Eligible Assets and Moody's Eligible
Assets each having in the aggregate a Discounted Value at least equal to the
AMPS Basic Maintenance Amount. The AMPS Basic Maintenance Amount includes the
sum of (i) the aggregate liquidation value of AMPS then outstanding and (ii)
certain accrued and projected payment obligations of the Fund. See "Description
of AMPS--Asset Maintenance--AMPS Basic Maintenance Amount" in the statement of
additional information. If the Fund fails to meet such requirement as of any
Valuation Date and such failure is not cured on or before the sixth Business
Day after such Valuation Date (the "AMPS Basic Maintenance Cure Date"), the
Fund will be required under certain circumstances to redeem certain of the
shares of AMPS. Upon any failure to maintain the required Discounted Value, the
Fund will use its best efforts to alter the composition of its portfolio to
reattain a Discounted Value at least equal to the AMPS Basic Maintenance Amount
on or prior to the AMPS Basic Maintenance Cure Date. See "Redemption" herein
and in the statement of additional information.
Redemption
Optional Redemption. To the extent permitted under the 1940 Act and under
Maryland law, upon giving a Notice of Redemption, as provided in the statement
of additional information, the Fund, at its option, may redeem shares of AMPS
of any series, in whole or in part, out of funds legally available therefor, at
the Optional Redemption Price per share on any Dividend Payment Date; provided
that no share of AMPS may be redeemed at the option of the Fund during (a) the
Initial Dividend Period with respect to a series of shares or (b) a Non-Call
Period to which such share is subject. "Optional Redemption Price" means
$25,000 per share of AMPS plus an amount equal to accumulated but unpaid
dividends (whether or not earned or declared) to the date fixed for redemption
plus any applicable redemption premium, if any, attributable to the designation
of a Premium Call Period. In addition, holders of AMPS may be entitled to
receive Additional Dividends in the event of redemption of such AMPS to the
extent provided herein. See "Dividends--Additional Dividends" above. The Fund
has the authority to redeem the AMPS for any reason and may redeem all or part
of the outstanding shares of AMPS if it anticipates that the Fund's leveraged
capital structure will result in a lower rate of return to holders of common
stock for any significant period of time than that obtainable if the Common
Stock were unleveraged.
Mandatory Redemption. The Fund will be required to redeem, out of funds
legally available therefor, at the Mandatory Redemption Price per share, shares
of AMPS to the extent permitted under the 1940 Act and Maryland law, on a date
fixed by the Board of Directors, if the Fund fails to maintain S&P Eligible
Assets and Moody's Eligible Assets each with an aggregate Discounted Value
equal to or greater than the AMPS Basic Maintenance Amount or to satisfy the
1940 Act AMPS Asset Coverage and such failure is not cured on or before the
AMPS Basic Maintenance Cure Date or the 1940 Act Cure Date (herein collectively
referred to as a "Cure Date"), as the case may be. "Mandatory Redemption Price"
means $25,000 per share of AMPS plus an amount equal to accumulated but unpaid
dividends (whether or not earned or declared) to the date fixed for redemption.
In addition, holders of AMPS may be entitled to receive Additional Dividends in
the event of redemption of such AMPS to the extent provided herein. See
"Dividends--Additional Dividends" above.
18
<PAGE>
For a discussion of the allocation procedures to be used if fewer than all of
the outstanding AMPS of either series are to be redeemed and for a discussion
of other redemption procedures, see "Description of AMPS--Redemption" in the
statement of additional information.
Liquidation Rights
Upon any liquidation, dissolution or winding up of the Fund, whether
voluntary or involuntary, the holders of shares of all series of AMPS will be
entitled to receive, out of the assets of the Fund available for distribution
to shareholders, before any distribution or payment is made upon any shares of
common stock or any other capital stock of the Fund ranking junior in right of
payment upon liquidation of AMPS, $25,000 per share together with the amount of
any dividends accumulated but unpaid (whether or not earned or declared)
thereon to the date of distribution, and after such payment the holders of AMPS
will be entitled to no other payments except for any Additional Dividends. If
such assets of the Fund shall be insufficient to make the full liquidation
payment on each outstanding series of AMPS and liquidation payments on any
other outstanding class or series of preferred stock of the Fund ranking on a
parity with the AMPS as to payment upon liquidation, then such assets will be
distributed among the holders of each such series of AMPS and the holders of
shares of such other class or series ratably in proportion to the respective
preferential amounts to which they are entitled. After payment of the full
amount of liquidation distribution to which they are entitled, the holders of
AMPS will not be entitled to any further participation in any distribution of
assets by the Fund except for any Additional Dividends. A consolidation, merger
or share exchange of the Fund with or into any other entity or entities or a
sale, whether for cash, shares of stock, securities or properties, of all or
substantially all or any part of the assets of the Fund shall not be deemed or
construed to be a liquidation, dissolution or winding up of the Fund.
Voting Rights
Except as otherwise indicated in this prospectus and the statement of
additional information and except as otherwise required by applicable law,
holders of shares of AMPS will be entitled to one vote per share on each matter
submitted to a vote of stockholders and will vote together with holders of
shares of common stock as a single class.
The 1940 Act and the Articles Supplementary require that the holders of
preferred stock, including the AMPS, voting as a separate class, have the
rights to elect two of the Fund's Directors at all times and to elect a
majority of the Directors at any time that two full years' dividends on the
AMPS are unpaid. The holders of AMPS will vote as a separate class or classes
on certain other matters as required under the Articles Supplementary, the 1940
Act and Maryland law. In addition, each series of AMPS may vote as a separate
series under certain circumstances. See "Description of AMPS--Voting Rights" in
the statement of additional information.
THE AUCTION
General
Holders of the shares of AMPS of each series will be entitled to receive
cumulative cash dividends on their shares when, as and if declared by the Board
of Directors of the Fund, out of funds legally available therefor, on the
Initial Dividend Payment Date with respect to the Initial Dividend Period and,
thereafter, on each Dividend Payment Date with respect to a Subsequent Dividend
Period (generally a period of seven days subject to certain exceptions set
forth under "Description of AMPS--Dividends--General") at the rate per annum
equal to the Applicable Rate for each such Dividend Period.
The provisions of the Articles Supplementary establishing the terms of the
shares of AMPS offered hereby will provide that the Applicable Rate for each
series of AMPS for each Dividend Period after the Initial Dividend Period
therefor will be equal to the rate per annum that the Auction Agent advises has
resulted on the Business Day preceding the first day of such Dividend Period
due to implementation of the auction procedures set forth in the Articles
Supplementary (the "Auction Procedures") in which persons determine to hold or
offer to purchase or sell shares of AMPS of such series. The Auction Procedures
are attached as Appendix E to the statement of additional information.
19
<PAGE>
Each periodic operation of such procedures with respect to the shares of AMPS
is referred to hereinafter as an "Auction." If, however, the Fund should fail
to pay or duly provide for the full amount of any dividend on shares of AMPS of
any series or the redemption price of shares of AMPS of such series called for
redemption, the Applicable Rate for shares of AMPS will be determined as set
forth under "Description of AMPS--Dividends--Non-Payment Period; Late Charge"
in the statement of additional information.
Auction Agent Agreement. The Fund will enter into an agreement (the "Auction
Agent Agreement") with IBJ Schroder Bank & Trust Company (together with any
successor bank or trust company or other entity entering into a similar
agreement with this Fund, the "Auction Agent"), which provides, among other
things, that the Auction Agent will follow the Auction Procedures for the
purpose of determining the Applicable Rate for the AMPS. The Fund will pay the
Auction Agent compensation for its services under the Auction Agent Agreement.
Broker-Dealer Agreements. The Auction Agent will enter into agreements with
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch"), Goldman,
Sachs & Co., Lehman Government Securities Incorporated and Salomon Smith Barney
Inc. and may enter into similar agreements (collectively, the "Broker-Dealer
Agreements") with one or more other broker-dealers (collectively, the "Broker-
Dealers") selected by the Fund, which provide for the participation of such
Broker-Dealers in Auctions. Merrill Lynch is an affiliate of the Investment
Adviser in that they share a common parent, ML & Co.
Securities Depository. The Depository Trust Company initially will act as the
Securities Depository for the Agent Members with respect to the shares of AMPS
of each series. One or more registered certificates for all of the shares of
each series of AMPS initially will be registered in the name of Cede, as
nominee of the Securities Depository. The certificate will bear a legend to the
effect that such certificate is issued subject to the provisions restricting
transfers of shares of AMPS of the series to which it relates contained in the
Articles Supplementary. Cede initially will be the holder of record of all
shares of AMPS, and Beneficial Owners will not be entitled to receive
certificates representing their ownership interest in such shares. The
Securities Depository will maintain lists of its participants and will maintain
the positions (ownership interests) of shares of AMPS held by each Agent
Member, whether as the Beneficial Owner thereof for its own account or as
nominee for the Beneficial Owner thereof. Payments made by the Fund to holders
of AMPS will be duly made by making payments to the nominee of the Securities
Depository.
AUCTION PROCEDURES
The following is a brief discussion of the procedures to be used in
conducting Auctions. Separate auctions will be conducted for each series of
AMPS. This summary is qualified by reference to the Auction Procedures set
forth in Appendix E to the statement of additional information. The Settlement
Procedures to be used with respect to Auctions are set forth in Appendix D to
the statement of additional information.
Auction Date; Advance Notice of Allocation of Taxable Income; Inclusion of
Taxable Income in Dividends. An Auction to determine the Applicable Rate for
each series of AMPS offered hereby for each Dividend Period for such series
(other than the Initial Dividend Period therefor) will be held on the first
Business Day (as hereinafter defined) preceding the first day of such Dividend
Period, which first day is also the Dividend Payment Date for the preceding
Dividend Period (the date of each Auction being referred to herein as an
"Auction Date"). "Business Day" means a day on which the New York Stock
Exchange is open for trading and which is not a Saturday, Sunday or other day
on which banks in the City of New York are authorized or obligated by law to
close. Auctions for shares of Series A AMPS for Dividend Periods after the
Initial Dividend Period normally will be held every Tuesday after the preceding
Dividend Payment Date, and each subsequent Dividend Period normally will begin
on the following Wednesday (also a Dividend Payment Date). Auctions for shares
of Series B AMPS for Dividend Periods after the Initial Dividend Period
normally will be held every Monday after the preceding Dividend Payment Date,
and each subsequent Dividend Period normally will begin on the following
Tuesday (also a Dividend Payment Date). The Auction Date and the first day of
the related Dividend Period (both of which must be Business Days) need not be
consecutive calendar days. For example, in most cases, if the Tuesday that
normally would be an Auction Date for Series A AMPS
20
<PAGE>
is not a Business Day, then such Auction Date will be the preceding Monday and
the first day of the related Dividend Period will continue to be the following
Wednesday. See "Description of AMPS--Dividends" for information concerning the
circumstances under which a Dividend Payment Date may fall on a date other than
the days specified above, which may affect the Auction Date.
Except as noted below, whenever the Fund intends to include any net capital
gains or other income subject to regular Federal income taxes in any dividend
on shares of AMPS, the Fund will notify the Auction Agent of the amount to be
so included at least five Business Days prior to the Auction Date on which the
Applicable Rate for such dividend is to be established. Whenever the Auction
Agent receives such notice from the Fund, in turn it will notify each Broker-
Dealer, who, on or prior to such Auction Date, in accordance with its Broker-
Dealer Agreement, will notify its customers who are Beneficial Owners and
Potential Beneficial Owners believed to be interested in submitting an Order in
the Auction to be held on such Auction Date. The Fund also may include such
income in a dividend on shares of AMPS without giving advance notice thereof if
it increases the dividend by an additional amount calculated as if such income
were a Retroactive Taxable Allocation and the additional amount were an
Additional Dividend; provided that the Fund will notify the Auction Agent of
the additional amounts to be included in such dividend at least five Business
Days prior to the applicable Dividend Payment Date. See "Description of AMPS--
Dividends--Additional Dividends" above.
Orders by Beneficial Owners, Potential Beneficial Owners, Existing Holders
and Potential Holders. On or prior to each Auction Date:
(a) each Beneficial Owner may submit to its Broker-Dealer by telephone a:
(i) Hold Order--indicating the number of outstanding shares, if any,
of AMPS that such Beneficial Owner desires to continue to hold without
regard to the Applicable Rate for the next Dividend Period for such
shares;
(ii) Bid--indicating the number of outstanding shares, if any, of
AMPS that such Beneficial Owner desires to continue to hold, provided
that the Applicable Rate for the next Dividend Period for such shares
is not less than the rate per annum then specified by such Beneficial
Owner; and/or
(iii) Sell Order--indicating the number of outstanding shares, if
any, of AMPS that such Beneficial Owner offers to sell without regard
to the Applicable Rate for the next Dividend Period for such shares;
and
(b) Broker-Dealers will contact customers who are Potential Beneficial
Owners of shares of AMPS to determine whether such Potential Beneficial
Owners desire to submit Bids indicating the number of shares of AMPS which
they offer to purchase provided that the Applicable Rate for the next
Dividend Period for such shares is not less than the rates per annum
specified in such Bids.
The communication by a Beneficial Owner or Potential Beneficial Owner to a
Broker-Dealer and the communication by a Broker-Dealer, whether or not acting
for its own account, to the Auction Agent of the foregoing information is
hereinafter referred to as an "Order" and collectively as "Orders." A
Beneficial Owner or a Potential Beneficial Owner placing an Order, including a
Broker-Dealer acting in such capacity for its own account, is hereinafter
referred to as a "Bidder" and collectively as "Bidders." Any Order submitted by
a Beneficial Owner or a Potential Beneficial Owner to its Broker-Dealer, or by
a Broker-Dealer to the Auction Agent, prior to the Submission Deadline on any
Auction Date shall be irrevocable.
In an Auction, a Beneficial Owner may submit different types of Orders with
respect to shares of AMPS then held by such Beneficial Owner, as well as Bids
for additional shares of AMPS. For information concerning the priority given to
different types of Orders placed by Beneficial Owners, see "Submission of
Orders by Broker-Dealers to Auction Agent" below.
The Maximum Applicable Rate for shares of AMPS will be the Applicable
Percentage of the Reference Rate. The Auction Agent will round each applicable
Maximum Applicable Rate to the nearest one-thousandth (0.001) of one percent
per annum, with any such number ending in five ten-thousandths of one percent
being
21
<PAGE>
rounded upwards to the nearest one-thousandth (0.001) of one percent. The
Auction Agent will not round the applicable Reference Rate as part of its
calculation of the Maximum Applicable Rate.
The Maximum Applicable Rate for shares of AMPS will depend on the credit
rating or ratings assigned to such shares. The Applicable Percentage will be
determined based on (i) the lower of the credit rating or ratings assigned on
such date to such shares by Moody's and S&P (or if Moody's or S&P or both shall
not make such rating available, the equivalent of either or both of such
ratings by a Substitute Rating Agency or two Substitute Rating Agencies or, in
the event that only one such rating shall be available, such rating) and (ii)
whether the Fund has provided notification to the Auction Agent prior to the
Auction establishing the Applicable Rate for any dividend that net capital
gains or other taxable income will be included in such dividend on shares of
AMPS as follows:
<TABLE>
<CAPTION>
Applicable Applicable
Credit Ratings Percentage of Percentage of
---------------------------------- Reference Rate-- Reference Rate--
Moody's S&P No Notification Notification
---------------- ------------- ---------------- ----------------
<S> <C> <C> <C>
"aa3" or higher AA- or Higher 110% 150%
"a3" or "a1" A- to A 125% 160%
"baa3" to "baa1" BBB- to BBB+ 150% 250%
Below "baa3" Below BBB- 200% 275%
</TABLE>
There is no minimum Applicable Rate in respect of any Dividend Period.
The Fund will take all reasonable action necessary to enable S&P and Moody's
to provide a rating for the AMPS. If either S&P or Moody's, or both, shall not
make such a rating available, the Underwriter or its affiliates and successors,
after consultation with the Fund, will select another nationally recognized
statistical rating organization (a "Substitute Rating Agency") or two other
nationally recognized statistical rating organizations ("Substitute Rating
Agencies") to act as a Substitute Rating Agency or Substitute Rating Agencies,
as the case may be.
Any Bid by a Beneficial Owner specifying a rate per annum higher than the
Maximum Applicable Rate will be treated as a Sell Order, and any Bid by a
Potential Beneficial Owner specifying a rate per annum higher than the Maximum
Applicable Rate will not be considered. See "Determination of Sufficient
Clearing Bids, Winning Bid Rate and Applicable Rate" and "Acceptance and
Rejection of Submitted Bids and Submitted Sell Orders and Allocation of
Shares."
Neither the Fund nor the Auction Agent will be responsible for a Broker-
Dealer's failure to comply with the foregoing.
A Broker-Dealer also may hold AMPS in its own account as a Beneficial Owner.
A Broker-Dealer thus may submit Orders to the Auction Agent as a Beneficial
Owner or a Potential Beneficial Owner and therefore participate in an Auction
as an Existing Holder or Potential Holder on behalf of both itself and its
customers. Any Order placed with the Auction Agent by a Broker-Dealer as or on
behalf of a Beneficial Owner or a Potential Beneficial Owner will be treated in
the same manner as an Order placed with a Broker-Dealer by a Beneficial Owner
or a Potential Beneficial Owner. Similarly, any failure by a Broker-Dealer to
submit to the Auction Agent an Order in respect of any AMPS held by it or its
customers who are Beneficial Owners will be treated in the same manner as a
Beneficial Owner's failure to submit to its Broker-Dealer an Order in respect
of AMPS held by it, as described in the next paragraph. Inasmuch as a Broker-
Dealer participates in an Auction as an Existing Holder or a Potential Holder
only to represent the interests of a Beneficial Owner or Potential Beneficial
Owner, whether it be its customers or itself, all discussion herein relating to
the consequences of an Auction for Existing Holders and Potential Holders also
applies to the underlying beneficial ownership interests represented thereby.
For information concerning the priority given to different types of Orders
placed by Existing Holders, see "Submission of Orders by Broker-Dealers to
Auction Agent." Each purchase or sale in an Auction will be settled on the
Business Day next succeeding the Auction Date at a price per share equal to
$25,000. See "Notification of Results; Settlement" below.
22
<PAGE>
If one or more Orders covering in the aggregate all of the outstanding shares
of AMPS held by a Beneficial Owner are not submitted to the Auction Agent prior
to the Submission Deadline, either because a Broker-Dealer failed to contact
such Beneficial Owner or otherwise, the Auction Agent shall deem a Hold Order
(in the case of an Auction relating to a Dividend Period which is not a Special
Dividend Period) and a Sell Order (in the case of an Auction relating to a
Special Dividend Period) to have been submitted on behalf of such Beneficial
Owner covering the number of outstanding shares of AMPS held by such Beneficial
Owner and not subject to Orders submitted to the Auction Agent.
If all of the outstanding shares of AMPS are subject to Submitted Hold
Orders, the Dividend Period next succeeding the Auction automatically shall be
the same length as the immediately preceding Dividend Period, and the
Applicable Rate for the next Dividend Period for all shares of AMPS will be 40%
of the Reference Rate on the date of the applicable Auction (or 60% of such
rate if the Fund has provided notification to the Auction Agent prior to the
Auction establishing the Applicable Rate for any dividend that net capital
gains or other taxable income will be included in such dividend on shares of
AMPS).
For the purposes of an Auction, shares of AMPS for which the Fund shall have
given notice of redemption and deposited moneys therefor with the Auction Agent
in trust or segregated in an account at the Fund's custodian bank for the
benefit of the Auction Agent, as set forth under "Description of AMPS--
Redemption" in the statement of additional information, will not be considered
as outstanding and will not be included in such Auction. Pursuant to the
Articles Supplementary of the Fund, the Fund will be prohibited from reissuing
and its affiliates (other than the Underwriter) will be prohibited from
transferring (other than to the Fund) any shares of AMPS they may acquire.
Neither the Fund nor any affiliate of the Fund (other than the Underwriter) may
submit an Order in any Auction, except that an affiliate of the Fund that is a
Broker-Dealer may submit an Order.
Submission of Orders by Broker-Dealers to Auction Agent. Prior to 1:00 p.m.,
New York City time, on each Auction Date, or such other time on the Auction
Date as may be specified by the Auction Agent (the "Submission Deadline"), each
Broker-Dealer will submit to the Auction Agent in writing all Orders obtained
by it for the Auction to be conducted on such Auction Date, designating itself
(unless otherwise permitted by the Fund) as the Existing Holder or Potential
Holder in respect of the shares of AMPS subject to such Orders. Any Order
submitted by a Beneficial Owner or a Potential Beneficial Owner to its Broker-
Dealer, or by a Broker-Dealer to the Auction Agent, prior to the Submission
Deadline on any Auction Date, shall be irrevocable.
If the rate per annum specified in any Bid contains more than three figures
to the right of the decimal point, the Auction Agent will round such rate per
annum up to the next highest one-thousandth (.001) of 1%.
If one or more Orders of an Existing Holder are submitted to the Auction
Agent and such Orders cover in the aggregate more than the number of
outstanding shares of AMPS held by such Existing Holder, such Orders will be
considered valid in the following order of priority:
(i) any Hold Order will be considered valid up to and including the
number of outstanding shares of AMPS held by such Existing Holder, provided
that if more than one Hold Order is submitted by such Existing Holder and
the number of shares of AMPS subject to such Hold Orders exceeds the number
of outstanding shares of AMPS held by such Existing Holder, the number of
shares of AMPS subject to each of such Hold Orders will be reduced pro rata
so that such Hold Orders, in the aggregate, will cover exactly the number
of outstanding shares of AMPS held by such Existing Holder;
(ii) any Bids will be considered valid, in the ascending order of their
respective rates per annum if more than one Bid is submitted by such
Existing Holder, up to and including the excess of the number of
outstanding shares of AMPS held by such Existing Holder over the number of
outstanding shares of AMPS subject to any Hold Order referred to in clause
(i) above (and if more than one Bid submitted by such Existing Holder
specifies the same rate per annum and together they cover more than the
remaining number of shares that can be the subject of valid Bids after
application of clause (i) above and of the
23
<PAGE>
foregoing portion of this clause (ii) to any Bid or Bids specifying a lower
rate or rates per annum, the number of shares subject to each of such Bids
will be reduced pro rata so that such Bids, in the aggregate, cover exactly
such remaining number of outstanding shares); and the number of outstanding
shares, if any, subject to Bids not valid under this clause (ii) shall be
treated as the subject of a Bid by a Potential Holder; and
(iii) any Sell Order will be considered valid up to and including the
excess of the number of outstanding shares of AMPS held by such Existing
Holder over the sum of the number of shares of AMPS subject to Hold Orders
referred to in clause (i) above and the number of shares of AMPS subject to
valid Bids by such Existing Holder referred to in clause (ii) above;
provided that, if more than one Sell Order is submitted by any Existing
Holder and the number of shares of AMPS subject to such Sell Orders is
greater than such excess, the number of shares of AMPS subject to each of
such Sell Orders will be reduced pro rata so that such Sell Orders, in the
aggregate, will cover exactly the number of shares of AMPS equal to such
excess.
If more than one Bid of any Potential Holder is submitted in any Auction,
each Bid submitted in such Auction will be considered a separate Bid with the
rate per annum and number of shares of AMPS therein specified.
Determination of Sufficient Clearing Bids, Winning Bid Rate and Applicable
Rate. Not earlier than the Submission Deadline for each Auction, the Auction
Agent will assemble all Orders submitted or deemed submitted to it by the
Broker-Dealers (each such "Hold Order," "Bid" or "Sell Order" as submitted or
deemed submitted by a Broker-Dealer hereinafter being referred to as a
"Submitted Hold Order," a "Submitted Bid" or a "Submitted Sell Order," as the
case may be, or as a "Submitted Order") and will determine the excess of the
number of outstanding shares of AMPS over the number of outstanding shares of
AMPS subject to Submitted Hold Orders (such excess being referred to as the
"Available AMPS") and whether Sufficient Clearing Bids have been made in such
Auction. Sufficient Clearing Bids will have been made if the number of
outstanding shares of AMPS that are the subject of Submitted Bids of Potential
Holders with rates per annum not higher than the Maximum Applicable Rate equals
or exceeds the number of outstanding shares that are the subject of Submitted
Sell Orders (including the number of shares subject to Bids of Existing Holders
specifying rates per annum higher than the Maximum Applicable Rate).
If Sufficient Clearing Bids have been made, the Auction Agent will determine
the lowest rate per annum specified in the Submitted Bids (the "Winning Bid
Rate") which would result in the number of shares subject to Submitted Bids
specifying such rate per annum or a lower rate per annum being at least equal
to the Available AMPS. If Sufficient Clearing Bids have been made, the Winning
Bid Rate will be the Applicable Rate for the next Dividend Period for all
shares of AMPS then outstanding.
If Sufficient Clearing Bids have not been made (other than because all
outstanding shares of AMPS are the subject of Submitted Hold Orders), the
Dividend Period next following the Auction automatically will be a 7-Day
Dividend Period, and the Applicable Rate for such Dividend Period will be equal
to the Maximum Applicable Rate. If Sufficient Clearing Bids have not been made,
Beneficial Owners that have Submitted Sell Orders will not be able to sell in
the Auction all, and may not be able to sell any, shares of AMPS subject to
such Submitted Sell Orders. See "Acceptance and Rejection of Submitted Bids and
Submitted Sell Orders and Allocation of Shares." Thus, under some
circumstances, Beneficial Owners may not have liquidity of investment.
Acceptance and Rejection of Submitted Bids and Submitted Sell Orders and
Allocation of Shares. Based on the determinations described under
"Determination of Sufficient Clearing Bids, Winning Bid Rate and Applicable
Rate" and subject to the discretion of the Auction Agent to round as described
below, Submitted Bids and Submitted Sell Orders will be accepted or rejected in
the order of priority set forth in the Auction Procedures with the result that
Existing Holders and Potential Holders of AMPS will sell, continue to hold
and/or purchase shares of AMPS as set forth below. Existing Holders that submit
or are deemed to have submitted Hold Orders will continue to hold the shares of
AMPS subject to such Hold Orders.
24
<PAGE>
If Sufficient Clearing Bids have been made:
(a) each Existing Holder that placed a Submitted Bid specifying a rate
per annum higher than the Winning Bid Rate or a Submitted Sell Order will
sell the outstanding shares of AMPS subject to such Submitted Bid or
Submitted Sell Order;
(b) each Existing Holder that placed a Submitted Bid specifying a rate
per annum lower than the Winning Bid Rate will continue to hold the
outstanding shares of AMPS subject to such Submitted Bid;
(c) each Potential Holder that placed a Submitted Bid specifying a rate
per annum lower than the Winning Bid Rate will purchase the number of
shares of AMPS subject to such Submitted Bid;
(d) each Existing Holder that placed a Submitted Bid specifying a rate
per annum equal to the Winning Bid Rate will continue to hold the
outstanding shares of AMPS subject to such Submitted Bids, unless the
number of outstanding shares of AMPS subject to all such Submitted Bids of
Existing Holders is greater than the excess of the Available AMPS over the
number of shares of AMPS accounted for in clauses (b) and (c) above, in
which event each Existing Holder with such a Submitted Bid will sell a
number of outstanding shares of AMPS determined on a pro rata basis based
on the number of outstanding shares of AMPS subject to all such Submitted
Bids of such Existing Holders; and
(e) each Potential Holder that placed a Submitted Bid specifying a rate
per annum equal to the Winning Bid Rate will purchase any Available AMPS
not accounted for in clause (b), (c) or (d) above on a pro rata basis based
on the shares of AMPS subject to all such Submitted Bids of Potential
Holders.
If Sufficient Clearing Bids have not been made (other than because all
outstanding shares of AMPS are the subject of Submitted Hold Orders):
(a) each Existing Holder that placed a Submitted Bid specifying a rate
per annum equal to or lower than the Maximum Applicable Rate will continue
to hold the outstanding shares of AMPS subject to such Submitted Bid;
(b) each Potential Holder that placed a Submitted Bid specifying a rate
per annum equal to or lower than the Maximum Applicable Rate will purchase
the number of shares of AMPS subject to such Submitted Bid; and
(c) each Existing Holder that placed a Submitted Bid specifying a rate
per annum higher than the Maximum Applicable Rate or a Submitted Sell Order
will sell a number of outstanding shares of AMPS determined on a pro rata
basis based on the outstanding shares of AMPS subject to all such Submitted
Bids and Submitted Sell Orders.
If as a result of the Auction Procedures described above any Existing Holder
would be entitled or required to sell, or any Potential Holder would be
entitled or required to purchase, a fraction of a share of AMPS, the Auction
Agent, in such manner as, in its sole discretion, it shall determine, will
round up or down the number of shares of AMPS being sold or purchased on such
Auction Date so that each share sold or purchased by each Existing Holder or
Potential Holder will be a whole share of AMPS. If any Potential Holder would
be entitled or required to purchase less than a whole share of AMPS, the
Auction Agent, in such manner as, in its sole discretion, it shall determine,
will allocate shares of AMPS for purchase among Potential Holders so that only
whole shares of AMPS are purchased by any such Potential Holder, even if such
allocation results in one or more of such Potential Holders not purchasing any
shares of AMPS.
Notification of Results; Settlement. The Auction Agent will advise each
Broker-Dealer who submitted a Bid or Sell Order in an Auction whether such Bid
or Sell Order was accepted or rejected in whole or in part and of the
Applicable Rate for the next Dividend Period for the related shares of AMPS by
telephone at approximately 3:00 P.M., Eastern time, on the Auction Date for
such Auction. Each such Broker-Dealer that submitted an Order for the account
of a customer then will advise such customer whether such Bid or Sell Order was
accepted or rejected, will confirm purchases and sales with each customer
purchasing or selling shares of AMPS as a result of the Auction and will advise
each customer purchasing or selling shares of AMPS to give instructions to its
Agent Member of the Securities Depository to pay the purchase price against
delivery
25
<PAGE>
of such shares or to deliver such shares against payment therefor as
appropriate. If a customer selling shares of AMPS as a result of an Auction
shall fail to instruct its Agent Member to deliver such shares, the Broker-
Dealer that submitted such customer's Bid or Sell Order will instruct such
Agent Member to deliver such shares against payment therefor. Each Broker-
Dealer that submitted a Hold Order in an Auction on behalf of a customer also
will advise such customer of the Applicable Rate for the next Dividend Period
for the AMPS. The Auction Agent will record each transfer of shares of AMPS on
the record book of Existing Holders to be maintained by the Auction Agent.
In accordance with the Securities Depository's normal procedures, on the day
after each Auction Date, the transactions described above will be executed
through the Securities Depository, and the accounts of the respective Agent
Members at the Securities Depository will be debited and credited as necessary
to effect the purchases and sales of shares of AMPS as determined in such
Auction. Purchasers will make payment through their Agent Members in same-day
funds to the Securities Depository against delivery through their Agent
Members; the Securities Depository will make payment in accordance with its
normal procedures, which now provide for payment in same-day funds. If the
procedures of the Securities Depository applicable to AMPS shall be changed to
provide for payment in next-day funds, then purchasers may be required to make
payment in next-day funds. If the certificates for shares of AMPS are not held
by the Securities Depository or its nominee, payment will be made in same-day
funds to the Auction Agent against delivery of such certificates.
If any Existing Holder selling shares of AMPS in an Auction fails to deliver
such shares, the Broker-Dealer of any person that was to have purchased shares
of AMPS in such Auction may deliver to such person a number of whole shares of
AMPS that is less than the number of shares that otherwise was to be purchased
by such person. In such event, the number of shares of AMPS to be so delivered
will be determined by such Broker-Dealer. Delivery of such lesser number of
shares will constitute good delivery. Each Broker-Dealer Agreement also will
provide that neither the Fund nor the Auction Agent will have responsibility or
liability with respect to the failure of a Potential Beneficial Owner,
Beneficial Owner or their respective Agent Members to deliver shares of AMPS or
to pay for shares of AMPS purchased or sold pursuant to an Auction or
otherwise.
Broker-Dealers
General. The Broker-Dealer Agreements provide that a Broker-Dealer may submit
Orders in Auctions for its own account, unless the Fund notifies all Broker-
Dealers that they no longer may do so; provided that Broker-Dealers may
continue to submit Hold Orders and Sell Orders. If a Broker-Dealer submits an
Order for its own account in any Auction of any series of AMPS, it may have
knowledge of Orders placed through it in that Auction and therefore have an
advantage over other Bidders, but such Broker-Dealer would not have knowledge
of Orders submitted by other Broker-Dealers in that Auction.
Fees. The Auction Agent after each Auction will pay a service charge from
funds provided by the Fund to each Broker-Dealer on the basis of the purchase
price of shares of AMPS placed by such Broker-Dealer at such Auction. The
service charge (i) for any 7-Day Dividend Period shall be payable at the annual
rate of 0.25% of the purchase price of the shares of AMPS placed by such
Broker-Dealer in any such Auction and (ii) for any Special Dividend Period
shall be determined by mutual consent of the Fund and any such Broker-Dealer or
Broker-Dealers and shall be based upon a selling concession that would be
applicable to an underwriting of fixed or variable rate preferred shares with a
similar final maturity or variable rate dividend period, respectively, at the
commencement of the Dividend Period with respect to such Auction. For the
purposes of the preceding sentence, shares of AMPS will be placed by a Broker-
Dealer if such shares were (i) the subject of Hold Orders deemed to have been
made by Beneficial Owners that were acquired by such Beneficial Owners through
such Broker-Dealer or (ii) the subject of the following Orders submitted by
such Broker-Dealer: (A) a Submitted Bid of a Beneficial Owner that resulted in
such Beneficial Owner continuing to hold such shares as a result of the
Auction, (B) a Submitted Bid of a Potential Beneficial Owner that resulted in
such Potential Beneficial Owner purchasing such shares as a result of the
Auction or (C) a Submitted Hold Order.
26
<PAGE>
Secondary Trading Market. The Broker-Dealers intend to maintain a secondary
trading market in the AMPS outside of Auctions; however, they have no
obligation to do so and there can be no assurance that a secondary market for
the AMPS will develop or, if it does develop, that it will provide holders with
a liquid trading market (i.e., trading will depend on the presence of willing
buyers and sellers and the trading price is subject to variables to be
determined at the time of the trade by the Broker-Dealers). The AMPS will not
be registered on any stock exchange or on any automated quotation system. An
increase in the level of interest rates, particularly during any Long-Term
Dividend Period, likely will have an adverse effect on the secondary market
price of the AMPS, and a selling shareholder may sell AMPS between Auctions at
a price per share of less than $25,000.
RATING AGENCY GUIDELINES
Certain of the capitalized terms used herein are defined in the Glossary that
appears at the end of this prospectus.
The Fund intends that, so long as shares of AMPS are outstanding, the
composition of its portfolio will reflect guidelines established by Moody's and
S&P in connection with the Fund's receipt of a rating for such shares on or
prior to their Date of Original Issue of at least "aaa" from Moody's and AAA
from S&P. Moody's and S&P, which are NRSROs, issue ratings for various
securities reflecting the perceived creditworthiness of such securities. The
guidelines described below have been developed by Moody's and S&P in connection
with issuances of asset-backed and similar securities, including debt
obligations and variable rate preferred stock, generally on a case-by-case
basis through discussions with the issuers of these securities. The guidelines
are designed to ensure that assets underlying outstanding debt or preferred
stock will be varied sufficiently and will be of sufficient quality and amount
to justify investment-grade ratings. The guidelines do not have the force of
law but have been adopted by the Fund in order to satisfy current requirements
necessary for Moody's and S&P to issue the above-described ratings for shares
of AMPS, which ratings generally are relied upon by institutional investors in
purchasing such securities. The guidelines provide a set of tests for portfolio
composition and asset coverage that supplement (and in some cases are more
restrictive than) the applicable requirements under the 1940 Act. See
"Description of AMPS--Asset Maintenance" herein and in the statement of
additional information.
The Fund intends to maintain a Discounted Value for its portfolio at least
equal to the AMPS Basic Maintenance Amount. Moody's and S&P each has
established separate guidelines for determining Discounted Value. To the extent
any particular portfolio holding does not satisfy the applicable rating
agency's guidelines, all or a portion of such holding's value will not be
included in the calculation of Discounted Value (as defined by such rating
agency). The Moody's and S&P guidelines do not impose any limitations on the
percentage of Fund assets that may be invested in holdings not eligible for
inclusion in the calculation of the Discounted Value of the Fund's portfolio.
Upon any failure to maintain the required Discounted Value, the Fund will
seek to alter the composition of its portfolio to reattain a Discounted Value
at least equal to the AMPS Basic Maintenance Amount on or prior to the AMPS
Basic Maintenance Cure Date, thereby incurring additional transaction costs and
possible losses and/or gains on dispositions of portfolio securities. To the
extent any such failure is not cured in a timely manner, shares of AMPS will be
subject to redemption. See "Description of AMPS--Asset Maintenance" and
"Description of AMPS--Redemption" herein and in the statement of additional
information.
The Fund may, but is not required to, adopt any modifications to these
guidelines that hereafter may be established by Moody's or S&P. Failure to
adopt any such modifications, however, may result in a change in the ratings
described above or a withdrawal of ratings altogether. In addition, any rating
agency providing a rating for the shares of AMPS, at any time, may change or
withdraw any such rating. As set forth in the Articles Supplementary, the Board
of Directors, without shareholder approval, may modify certain definitions or
restrictions that have been adopted by the Fund pursuant to the rating agency
guidelines, provided the Board
27
<PAGE>
of Directors has obtained written confirmation from Moody's and S&P that any
such change would not impair the ratings then assigned by Moody's and S&P to
the AMPS.
As described by Moody's and S&P, a preferred stock rating is an assessment of
the capacity and willingness of an issuer to pay preferred stock obligations.
The ratings on the AMPS are not recommendations to purchase, hold or sell
shares of AMPS, inasmuch as the ratings do not comment as to market price or
suitability for a particular investor, nor do the rating agency guidelines
described above address the likelihood that a holder of shares of AMPS will be
able to sell such shares in an Auction. The ratings are based on current
information furnished to Moody's and S&P by the Fund and the Investment Adviser
and information obtained from other sources. The ratings may be changed,
suspended or withdrawn as a result of changes in, or the unavailability of,
such information. The Common Stock has not been rated by a nationally
recognized statistical rating organization.
For additional information concerning the Moody's and S&P ratings guidelines,
see "Rating Agency Guidelines" in the statement of additional information.
INVESTMENT ADVISORY AND MANAGEMENT ARRANGEMENTS
The Investment Adviser, which is owned and controlled by ML & Co., a
financial services holding company and the parent of Merrill Lynch, provides
the Fund with investment advisory and management services. The Merrill Lynch
Asset Management Group (which includes the Investment Adviser) acts as the
investment adviser to more than 100 other registered investment companies and
offers investment advisory services to individuals and institutional accounts.
As of December 1998, the Merrill Lynch Asset Management Group had a total of
approximately $501 billion in investment company and other portfolio assets
under management (approximately $38 billion of which were invested in municipal
securities). This amount includes assets managed for certain affiliates of the
Investment Adviser. The Investment Adviser is a limited partnership, the
partners of which are ML & Co. and Princeton Services. The principal business
address of the Investment Adviser is 800 Scudders Mill Road, Plainsboro, New
Jersey 08536.
The Investment Advisory Agreement provides that, subject to the supervision
of the Board of Directors of the Fund, the Investment Adviser is responsible
for the actual management of the Fund's portfolio. The responsibility for
making decisions to buy, sell or hold a particular security rests with the
Investment Adviser, subject to review by the Board of Directors.
The Investment Adviser provides the portfolio management for the Fund. Such
portfolio management will consider analyses from various sources (including
brokerage firms with which the Fund does business), make the necessary
investment decisions, and place orders for transactions accordingly. The
Investment Adviser will also be responsible for the performance of certain
administrative and management services for the Fund. Walter O'Connor and
Robert A. DiMella are the portfolio managers of the Fund and are primarily
responsible for the Fund's day-to-day management.
For the services provided by the Investment Adviser under the Investment
Advisory Agreement, the Fund will pay a monthly fee at an annual rate of 0.55
of 1% of the Fund's average weekly net assets (i.e., the average weekly value
of the total assets of the Fund, including proceeds from the issuance of shares
of preferred stock, minus the sum of accrued liabilities of the Fund and
accumulated dividends on the shares of preferred stock). For purposes of this
calculation, average weekly net assets are determined at the end of each month
on the basis of the average net assets of the Fund for each week during the
month. The assets for each weekly period are determined by averaging the net
assets at the last business day of a week with the net assets at the last
business day of the prior week.
The Investment Advisory Agreement obligates the Investment Adviser to provide
investment advisory services and to pay all compensation of and furnish office
space for officers and employees of the Fund
28
<PAGE>
connected with investment and economic research, trading and investment
management of the Fund, as well as the compensation of all Directors of the
Fund who are affiliated persons of the Investment Adviser or any of its
affiliates. The Fund pays all other expenses incurred in the operation of the
Fund, including, among other things, expenses for legal and auditing services,
taxes, costs of printing proxies, listing fees, if any, stock certificates and
shareholder reports, charges of the custodian and the transfer and dividend
disbursing agent and registrar, fees and expenses with respect to the issuance
of preferred stock, Securities and Exchange Commission fees, fees and expenses
of non-interested Directors, accounting and pricing costs, insurance, interest,
brokerage costs, litigation and other extraordinary or non-recurring expenses,
mailing and other expenses properly payable by the Fund. Accounting services
are provided to the Fund by the Investment Adviser, and the Fund reimburses the
Investment Adviser for its costs in connection with such services.
TAXES
In general, dividends on the AMPS will be exempt from Federal income tax in
the hands of holders of such AMPS, subject to the possible application of the
Federal alternative minimum tax. However, the Fund is required to allocate net
capital gains and other taxable income, if any, proportionately among the
common stock and each series of AMPS in accordance with the current position of
the Internal Revenue Service ("IRS") described under the heading "Taxes" in the
statement of additional information. The Fund may notify the Auction Agent of
the amount of any net capital gains or other anticipated taxable income to be
included in any dividend on the AMPS prior to the Auction establishing the
Applicable Dividend Rate for such dividend. The Auction Agent will in turn
notify holders of the AMPS and prospective purchasers. The amount of taxable
income allocable to each series of AMPS will depend upon the amount of such
income realized by the Fund and cannot be determined with certainty prior to
the end of the Fund's fiscal year, but it is not generally expected to be
significant.
The portion of exempt-interest dividends paid from interest received by the
Fund from California Municipal Bonds also will be exempt from California income
tax. However, exempt-interest dividends paid to a corporate shareholder subject
to California state franchise tax will not be exempt from California taxation.
Shareholders subject to income taxation by states other than California will
realize a lower after-tax rate of return than California shareholders since the
dividends distributed by the Fund generally will not be exempt, to any
significant degree, from income taxation by such other states.
Generally, within 60 days after the end of the Fund's taxable year, the Fund
will tell you the amount of exempt-interest dividends, ordinary income
dividends or capital gain dividends you received that year. Capital gain
dividends are taxable as long-term capital gains to you regardless of how long
you have held your shares. The tax treatment of distributions from the Fund is
the same whether you choose to receive distributions in cash or to have them
reinvested in shares of the Fund.
If the Fund makes a Retroactive Taxable Allocation, it will pay Additional
Dividends to holders of AMPS who are subject to the Retroactive Taxable
Allocation. See "Description of AMPS--Dividends--Additional Dividends." The
Federal income tax consequences of Additional Dividends under existing law are
uncertain. The Fund intends to treat a holder as receiving a dividend
distribution in the amount of any Additional Dividend only as and when such
Additional Dividend is paid. An Additional Dividend generally will be
designated by the Fund as an exempt-interest dividend except as otherwise
required by applicable law. However, the IRS may assert that all or part of an
Additional Dividend is a taxable dividend either in the taxable year for which
the Retroactive Taxable Allocation is made or in the taxable year in which the
Additional Dividend is paid.
Because the Fund may from time to time invest a substantial portion of its
portfolio in municipal securities bearing income that is taxable under the
Federal alternative minimum tax, the Fund would not ordinarily be a suitable
investment for investors who are subject to the alternative minimum tax.
29
<PAGE>
If at any time when AMPS are outstanding the Fund does not meet the asset
coverage requirements of the 1940 Act, the Fund will be required to suspend
distributions to holders of common stock until the asset coverage is restored.
See "Description of AMPS--Restrictions on Dividends and Other Payments." This
may prevent the Fund from meeting certain distribution requirements for
qualification as a regulated investment company ("RIC"). Upon any failure to
meet the asset coverage requirements of the 1940 Act, the Fund, in its sole
discretion, may, and under certain circumstances will be required to, redeem
AMPS in order to maintain or restore the requisite asset coverage and avoid the
adverse consequences to the Fund and its shareholders of failing to qualify as
a RIC. See "Description of AMPS--Redemption." There can be no assurance,
however, that any such action would achieve such objectives.
By law, the Fund must withhold 31% of your distributions and proceeds if you
have not provided a taxpayer identification number or social security number.
For more information regarding the tax treatment of an investment in AMPS, see
"Taxes" in the statement of additional information.
Shareholders are urged to consult their tax advisers regarding the
availability of any exemptions from state or local taxes and with specific
questions as to Federal, foreign, state or local taxes.
DESCRIPTION OF CAPITAL STOCK
The Fund is authorized to issue 200,000,000 shares of capital stock, par
value $.10 per share, all of which shares were initially classified as common
stock. The Board of Directors is authorized, however, to classify or reclassify
any unissued shares of capital stock by setting or changing the preferences,
conversion or other rights, voting powers, restrictions, limitations as to
dividends, qualifications, or terms or conditions of redemption. In this
regard, the Board of Directors has reclassified 3,640 shares of unissued common
stock as AMPS. For a description of the shares of AMPS, see "Description of
AMPS" herein and in the statement of additional information.
The following table shows the amount of (i) capital stock authorized, (ii)
capital stock held by the Fund for its own account and (iii) capital stock
outstanding for each class of authorized securities of the Fund as of February
1, 1999.
<TABLE>
<CAPTION>
Amount
Outstanding
Amount held (exclusive of
by Fund amount held
Amount for its own by Fund for its
Title of Class Authorized account own account)
-------------- ----------- ----------- ---------------
<S> <C> <C> <C>
Common Stock........................ 199,996,360 -0- 8,606,667
Auction Market Preferred Stock...... 3,640 -0- -0-
</TABLE>
Common Stock
Holders of common stock are entitled to share equally in dividends declared
by the Board of Directors payable to holders of common stock and in the net
assets of the Fund available for distribution to holders of common stock after
payment of the preferential amounts payable to holders of any outstanding
preferred stock. Neither holders of common stock nor holders of preferred stock
have pre-emptive or conversion rights and shares of common stock are not
redeemable. The outstanding shares of common stock are fully paid and non-
assessable.
Holders of common stock are entitled to one vote for each share held and will
vote with the holders of any outstanding shares of AMPS or other preferred
stock on each matter submitted to a vote of holders of common stock, except as
described under "Description of AMPS--Voting Rights" herein and in the
statement of additional information.
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<PAGE>
Shareholders are entitled to one vote for each share held. The shares of
common stock, AMPS and any other preferred stock do not have cumulative voting
rights, which means that the holders of more than 50% of the shares of common
stock, AMPS and any other preferred stock voting for the election of Directors
can elect all of the Directors standing for election by such holders, and, in
such event, the holders of the remaining shares of common stock, AMPS and any
other preferred stock will not be able to elect any of such Directors.
So long as any shares of AMPS or any other preferred stock are outstanding,
holders of common stock will not be entitled to receive any dividends of or
other distributions from the Fund unless all accumulated dividends on
outstanding shares of AMPS and any other preferred stock have been paid, and
unless asset coverage (as defined in the 1940 Act) with respect to such AMPS
and any other preferred stock would be at least 200% after giving effect to
such distributions. See "Description of AMPS--Restrictions on Dividends and
Other Payments" herein and in the statement of additional information.
The Fund will send unaudited reports at least semi-annually and audited
financial statements annually to all of its shareholders.
The shares of common stock will commence trading on the NYSE on February 8,
1999. At February 1, 1999, the net asset value per share of common stock was
$15.01.
Preferred Stock
Under the Articles Supplementary, the Fund is authorized to issue an
aggregate of 3,640 shares of AMPS. See "Description of AMPS." Under the 1940
Act, the Fund is permitted to have outstanding more than one series of
preferred stock as long as no single series has priority over another series
as to the distribution of assets of the Fund or the payment of dividends.
Neither holders of common stock nor holders of preferred stock have pre-
emptive rights to purchase any shares of AMPS or any other preferred stock
that might be issued. It is anticipated that the net asset value per share of
the AMPS will equal its original purchase price per share plus accumulated
dividends per share.
Certain Provisions of the Charter
The Fund's Charter includes provisions that could have the effect of
limiting the ability of other entities or persons to acquire control of the
Fund or to change the composition of its Board of Directors and could have the
effect of depriving shareholders of an opportunity to sell their shares at a
premium over prevailing market prices by discouraging a third party from
seeking to obtain control of the Fund. A director may be removed from office
with or without cause but only by vote of the holders of at least 66 2/3% of
the votes entitled to be voted on the matter. A director elected by all of the
holders of capital stock may be removed only by action of such holders, and a
director elected by the holders of AMPS and any other preferred stock may be
removed only by action of AMPS and any other preferred stock.
In addition, the Charter requires the favorable vote of the holders of at
least 66 2/3% of the Fund's shares of capital stock, then entitled to be
voted, voting as a single class, to approve, adopt or authorize the following:
. a merger or consolidation or statutory share exchange of the Fund with
any other corporation,
. a sale of all or substantially all of the Fund's assets (other than in
the regular course of the Fund's investment activities), or
. a liquidation or dissolution of the Fund,
unless such action has been approved, adopted or authorized by the affirmative
vote of at least two-thirds of the total number of Directors fixed in
accordance with the by-laws, in which case the affirmative vote of a majority
of all of the votes entitled to be cast by shareholders of the Fund, voting as
a single class, is required. Such approval, adoption or authorization of the
foregoing would also require the favorable vote of at least a majority of the
Fund's shares of preferred stock then entitled to be voted, including the
AMPS, voting as a separate class.
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<PAGE>
In addition, conversion of the Fund to an open-end investment company would
require an amendment to the Fund's Charter. The amendment would have to be
declared advisable by the Board of Directors prior to its submission to
shareholders. Such an amendment would require the favorable vote of the holders
of at least 66 2/3% of the Fund's outstanding shares of capital stock
(including the AMPS and any other preferred stock) entitled to be voted on the
matter, voting as a single class (or a majority of such shares if the amendment
was previously approved, adopted or authorized by at least two-thirds of the
total number of Directors fixed in accordance with the by-laws), and, the
affirmative vote of at least a majority of outstanding shares of preferred
stock of the Fund (including the AMPS), voting as a separate class. Such a vote
also would satisfy a separate requirement in the 1940 Act that the change be
approved by the shareholders. Shareholders of an open-end investment company
may require the company to redeem their shares of common stock at any time
(except in certain circumstances as authorized by or under the 1940 Act) at
their net asset value, less such redemption charge, if any, as might be in
effect at the time of a redemption. All redemptions will be made in cash. If
the Fund is converted to an open-end investment company, it could be required
to liquidate portfolio securities to meet requests for redemption. Conversion
to an open-end investment company would also require redemption of all
outstanding shares of preferred stock (including the AMPS) and would require
changes in certain of the Fund's investment policies and restrictions, such as
those relating to the issuance of senior securities, the borrowing of money and
the purchase of illiquid securities.
The Board of Directors has determined that the 66 2/3% voting requirements
described above, which are greater than the minimum requirements under Maryland
law or the 1940 Act, are in the best interests of shareholders generally.
Reference should be made to the Charter on file with the Commission for the
full text of these provisions.
CUSTODIAN
The Fund's securities and cash are held under a custody agreement with State
Street Bank and Trust Company, 225 Franklin Street, Boston, Massachusetts
02110.
UNDERWRITING
Merrill Lynch, Pierce, Fenner & Smith Incorporated (the "Underwriter") has
agreed, subject to the terms and conditions of a Purchase Agreement with the
Fund and the Investment Adviser, to purchase from the Fund all of the shares of
AMPS of each series offered hereby. The Underwriter is committed to purchase
all of such shares if any are purchased.
The Underwriter has advised the Fund that it proposes initially to offer the
shares of AMPS to the public at the public offering price set forth on the
cover page of this prospectus, and to certain dealers at such price less a
concession not in excess of $ per share. The Underwriter may allow, and such
dealers may reallow, a discount not in excess of $ per share to other
dealers. After the initial public offering, the public offering price,
concession and discount may be changed. The sales load of $ per share is
equal to % of the initial public offering price. Investors must pay for any
AMPS purchased in the initial public offering on or before February , 1999.
The Underwriter will act in Auctions as a Broker-Dealer as set forth under
"The Auction--General--Broker-Dealer Agreements" and will be entitled to fees
for services as a Broker-Dealer as set forth under "The Auction--Broker-
Dealers". The Underwriter also may provide information to be used in
ascertaining the Reference Rate.
The Fund anticipates that the Underwriter from time to time may act as a
broker in connection with the execution of the Fund's portfolio transactions.
The Fund has obtained exemptive orders permitting it to engage
32
<PAGE>
in certain principal transactions with the Underwriter involving high quality,
short-term, tax-exempt securities, subject to certain conditions. See
"Investment Restrictions" and "Portfolio Transactions" in the statement of
additional information.
The Underwriter is an affiliate of the Investment Adviser.
The Fund and the Investment Adviser have agreed to indemnify the Underwriter
against certain liabilities including liabilities under the Securities Act of
1933, as amended.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR
The transfer agent, dividend disbursing agent and registrar for the shares of
AMPS will be IBJ Whitehall Bank & Trust Company, One State Street, New York,
New York 10004. The transfer agent, dividend disbursing agent and shareholder
servicing agent for the shares of Common Stock is State Street Bank and Trust
Company, 225 Franklin Street, Boston, Massachusetts 02110.
LEGAL OPINIONS
Certain legal matters in connection with the AMPS offered hereby will be
passed upon for the Fund and the Underwriter by Brown & Wood LLP, One World
Trade Center, New York, New York 10048-0557.
EXPERTS
The statement of assets, liabilities and capital of the Fund as of January
13, 1999 included in the statement of additional information has been so
included in reliance on the report of Deloitte & Touche LLP, independent
auditors, and on their authority as experts in auditing and accounting. The
selection of independent auditors is subject to ratification by shareholders of
the Fund.
YEAR 2000 ISSUES
Many computer systems were designed using only two digits to designate years.
These systems may not be able to distinguish the Year 2000 from the Year 1900
(commonly known as the "Year 2000 Problem"). The Fund could be adversely
affected if the computer systems used by the Investment Adviser or other Fund
service providers do not properly address this problem before January 1, 2000.
The Investment Adviser expects to have addressed this problem before then, and
does not anticipate that the services it provides will be adversely affected.
The Fund's other service providers have told the Investment Adviser that they
also expect to resolve the Year 2000 Problem, and the Investment Adviser will
continue to monitor the situation as the Year 2000 approaches. However, if the
problem has not been fully addressed, the Fund could be negatively affected.
The Year 2000 Problem could also have a negative impact on the issuers of
securities in which the Fund invests, and this could hurt the Fund's investment
returns.
The State of California relies on information technology in every aspect of
its operation and the risks posed by the Year 2000 Problem are not confined to
computer systems. They also include problems presented by embedded microchips
(products or systems that contain microchips to perform functions such as
traffic control, controlling instruments used in hospitals, and monitoring of
the California Aquaduct). Although the State reports it is making substantial
progress overall, the State cannot predict whether all critical systems will be
ready and tested by late 1999 or what impact failure of any information
technology system might have. The State Treasurer's Office (which operates the
system responsible for debt service payments on State debt) has reported that
it is scheduled to complete its remediation efforts by December 31, 1999.
However, there is no centralized mechanism for reporting on the Year 2000
Problem remediation efforts of the over 1,200 other public agencies in
California.
33
<PAGE>
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
<TABLE>
<S> <C>
Investment Objective and Policies........................................... 3
Investment Restrictions..................................................... 7
Description of AMPS......................................................... 9
The Auction................................................................. 16
Rating Agency Guidelines.................................................... 17
Directors and Officers...................................................... 25
Investment Advisory and Management Arrangements............................. 27
Portfolio Transactions...................................................... 28
Taxes....................................................................... 29
Net Asset Value............................................................. 33
Additional Information...................................................... 34
Independent Auditors' Report................................................ 35
Statement of Assets, Liabilities and Capital................................ 36
Financial Statements (Unaudited)............................................ 37
Appendix A--Economic and Other Conditions in California..................... A-1
Appendix B--Ratings of Municipal Bonds...................................... B-1
Appendix C--Portfolio Insurance............................................. C-1
Appendix D--Settlement Procedures........................................... D-1
Appendix E--Auction Procedures.............................................. E-1
</TABLE>
34
<PAGE>
GLOSSARY
"AA' (AA) Composite Commercial Paper Rate," on any Valuation Date, means (i)
the Interest Equivalent of the rate on commercial paper placed on behalf of
issuers whose corporate bonds are rated "AA" by S&P or "Aa" by Moody's or the
equivalent of such rating by another nationally recognized statistical rating
organization, as such rate is made available on a discount basis or otherwise
by the Federal Reserve Bank of New York for the Business Day immediately
preceding such date, or (ii) in the event that the Federal Reserve Bank of New
York does not make available such a rate, then the arithmetic average of the
Interest Equivalent of the rate on commercial paper placed on behalf of such
issuers, as quoted on a discount basis or otherwise by Merrill Lynch, Pierce,
Fenner & Smith Incorporated or its successors that are Commercial Paper
Dealers, to the Auction Agent for the close of business on the Business Day
immediately preceding such date. If one of the Commercial Paper Dealers does
not quote a rate required to determine the "AA" Composite Commercial Paper
Rate, the "AA" Composite Commercial Paper Rate will be determined on the basis
of the quotation or quotations furnished by any Substitute Commercial Paper
Dealer or Substitute Commercial Paper Dealers selected by the Fund to provide
such rate or rates not being supplied by the Commercial Paper Dealer. If the
number of Dividend Period days shall be (i) 7 or more but fewer than 49 days,
such rate shall be the Interest Equivalent of the 30-day rate on such
commercial paper; (ii) 49 or more but fewer than 70 days, such rate shall be
the Interest Equivalent of the 60-day rate on such commercial paper; (iii) 70
or more days but fewer than 85 days, such rate shall be the arithmetic average
of the Interest Equivalent of the 60-day and 90-day rates on such commercial
paper; (iv) 85 or more days but fewer than 99 days, such rate shall be the
Interest Equivalent of the 90-day rate on such commercial paper; (v) 99 or more
days but fewer than 120 days, such rate shall be the arithmetic average of the
Interest Equivalent of the 90-day and 120-day rates on such commercial paper;
(vi) 120 or more days but fewer than 141 days, such rate shall be the Interest
Equivalent of the 120-day rate on such commercial paper; (vii) 141 or more days
but fewer than 162 days, such rate shall be the arithmetic average of the
Interest Equivalent of the 120-day and 180-day rates on such commercial paper;
and (viii) 162 or more days but fewer than 183 days, such rate shall be the
Interest Equivalent of the 180-day rate on such commercial paper.
"Additional Dividend" has the meaning set forth on page 17 of this
prospectus.
"Agent Member" means the member of the Securities Depository that will act on
behalf of a Beneficial Owner of one or more shares of AMPS or on behalf of a
Potential Beneficial Owner.
"AMPS" means the Auction Market Preferred Stock, Series A and the Auction
Market Preferred Stock, Series B, each with a par value of $.10 per share and a
liquidation preference of $25,000 per share plus an amount equal to accumulated
but unpaid dividends thereon (whether or not earned or declared), of the Fund.
"AMPS Basic Maintenance Amount" has the meaning set forth on page 18 of this
prospectus.
"AMPS Basic Maintenance Cure Date" has the meaning set forth on page 18 of
this prospectus.
"AMPS Basic Maintenance Report" has the meaning set forth on page 13 of the
statement of additional information.
"Anticipation Notes" means the following California Municipal Bonds: revenue
anticipation notes, tax anticipation notes, tax and revenue anticipation notes,
grant anticipation notes and bond anticipation notes.
"Applicable Percentage" has the meaning set forth on page 22 of this
prospectus.
"Applicable Rate" means the rate per annum at which cash dividends are
payable on shares of AMPS for any Dividend Period.
"Articles Supplementary" means the Articles Supplementary of the Fund
specifying the powers, preferences and rights of the shares of AMPS.
35
<PAGE>
"Auction" means a periodic operation of the Auction Procedures.
"Auction Agent" means IBJ Whitehall Bank & Trust Company unless and until
another commercial bank, trust company or other financial institution appointed
by a resolution of the Board of Directors of the Fund or a duly authorized
committee thereof enters into an agreement with the Fund to follow the Auction
Procedures for the purpose of determining the Applicable Rate and to act as
transfer agent, registrar, dividend disbursing agent and redemption agent for
the AMPS.
"Auction Agent Agreement" means the agreement entered into between the Fund
and the Auction Agent which provides, among other things, that the Auction
Agent will follow the Auction Procedures for the purpose of determining the
Applicable Rate.
"Auction Date" has the meaning set forth on page 20 of this prospectus.
"Auction Procedures" means the procedures for conducting Auctions set forth
in Appendix E to the statement of additional information.
"Available AMPS" has the meaning set forth on page 24 of this prospectus.
"Beneficial Owner" means a customer of a Broker-Dealer who is listed on the
records of that Broker-Dealer (or if applicable, the Auction Agent) as a holder
of shares of AMPS or a Broker-Dealer that holds AMPS for its own account.
"Bid" has the meaning set forth on page 21 of this prospectus.
"Bidder" has the meaning set forth on page 21 of this prospectus.
"Board of Directors" or "Board" means the Board of Directors of the Fund.
"Broker-Dealer" means any broker-dealer, or other entity permitted by law to
perform the functions required of a Broker-Dealer in the Auction Procedures,
that has been selected by the Fund and has entered into a Broker-Dealer
Agreement with the Auction Agent that remains effective.
"Broker-Dealer Agreement" means an agreement entered into between the Auction
Agent and a Broker-Dealer, including Merrill Lynch, Pierce, Fenner & Smith
Incorporated, pursuant to which such Broker-Dealer agrees to follow the Auction
Procedures.
"Business Day" means a day on which the New York Stock Exchange is open for
trading and which is not a Saturday, Sunday or other day on which banks in The
City of New York are authorized or obligated by law to close.
"California Municipal Bonds" has the meaning set forth on page 8 of this
prospectus.
"Cede" means Cede & Co., the nominee of DTC, and in whose name the shares of
AMPS initially will be registered.
"Charter" means the Articles of Incorporation, as amended and supplemented
(including the Articles Supplementary), of the Fund.
"Code" means the Internal Revenue Code of 1986, as amended.
"Commercial Paper Dealers" means Merrill Lynch, Pierce, Fenner & Smith
Incorporated and such other commercial paper dealer or dealers as the Fund from
time to time may appoint or, in lieu thereof, their respective affiliates and
successors.
"Common stock" means the common stock, par value $.10 per share, of the Fund.
36
<PAGE>
"Date of Original Issue" means, with respect to each share of AMPS, the date
on which such share first is issued by the Fund.
"Deposit Securities" means cash and California Municipal Bonds and Municipal
Bonds rated at least A2 (having a remaining maturity of 12 months or less), P-
1, VMIG-1 or MIG-1 by Moody's or A (having a remaining maturity of 12 months or
less), A-1+ or SP-1+ by S&P.
"Discount Factor" means a Moody's Discount Factor or an S&P Discount Factor,
as the case may be.
"Discounted Value" of any asset of the Fund means (i) with respect to an S&P
Eligible Asset, the quotient of the market value thereof divided by the
applicable S&P Discount Factor and (ii) with respect to a Moody's Eligible
Asset, the lower of par and the quotient of the market value thereof divided by
the applicable Moody's Discount Factor.
"Dividend Payment Date" has the meaning set forth on page 15 of this
prospectus.
"Dividend Period" has the meaning set forth on page 15 of this prospectus.
"DTC" means The Depository Trust Company.
"Eligible Assets" means Moody's Eligible Assets or S&P Eligible Assets, as
the case may be.
"Existing Holder" means a Broker-Dealer or any such other person as may be
permitted by the Fund that is listed as the holder of record of shares of AMPS
in the records of the Auction Agent.
"Fitch" means Fitch IBCA, Inc. or its successors.
"Forward Commitment" has the meaning set forth on page 24 of the statement of
additional information.
"Fund" means MuniHoldings California Insured Fund IV, Inc., a Maryland
corporation that is the issuer of the AMPS.
"Hold Order" has the meaning set forth on page 24 of this prospectus.
"Initial Dividend Payment Date" means with respect to each series of AMPS,
the first Dividend Payment Date for the AMPS as set forth on page 14 of this
prospectus.
"Initial Dividend Period" means, with respect to the AMPS, the period from
and including the Date of Original Issue to but excluding the Initial Dividend
Payment Date for each series of AMPS.
"Initial Margin" means the amount of cash or securities deposited with a
broker as a margin payment at the time of purchase or sale of a financial
futures contract.
"Interest Equivalent" means a yield on a 360-day basis of a discount basis
security which is equal to the yield on an equivalent interest-bearing
security.
"Investment Adviser" means Fund Asset Management, L.P.
"IRS" means the United States Internal Revenue Service.
"Long Term Dividend Period" means a dividend period of one year or more but
not greater than five years.
"Mandatory Redemption Price" has the meaning set forth on page 18 of this
prospectus.
37
<PAGE>
"Marginal Tax Rate" means the maximum marginal regular Federal individual
income tax rate applicable to ordinary income or the maximum marginal regular
Federal corporate income tax rate, whichever is greater.
"Maximum Applicable Rate" has the meaning set forth on page 22 of this
prospectus.
"Maximum Potential Additional Dividend Liability" has the meaning set forth
on page 13 of the statement of additional information.
"Moody's" means Moody's Investors Service, Inc. or its successors.
"Moody's Discount Factor" has the meaning set forth on page 21 of the
statement of additional information.
"Moody's Eligible Assets" has the meaning set forth on page 22 of the
statement of additional information.
"Moody's Exposure Period" means a period that is the same length or longer
than the number of days used in calculating the cash dividend component of the
AMPS Basic Maintenance Amount and initially shall be the period commencing on
and including a given Valuation Date and ending 48 days thereafter.
"Moody's Hedging Transactions" has the meaning set forth on page 23 of the
statement of additional information.
"Moody's Volatility Factor" means 272% as long as there has been no increase
enacted to the Marginal Tax Rate. If such an increase is enacted but not yet
implemented, the Moody's Volatility Factor shall be as follows:
<TABLE>
<CAPTION>
% CHANGE IN MOODY'S
MARGINAL TAX RATE VOLATILITY FACTOR
----------------- -----------------
<S> <C>
less than or equal to 5%....................................... 292%
greater than 5% but less than or equal to 10%....................................... 313%
greater than 10% but less than or equal to 15%....................................... 338%
greater than 15% but less than or equal to 20%....................................... 364%
greater than 20% but less than or equal to 25%....................................... 396%
greater than 25% but less than or equal to 30%....................................... 432%
greater than 30% but less than or equal to 35%....................................... 472%
greater than 35% but less than or equal to 40%....................................... 520%
</TABLE>
Notwithstanding the foregoing, the Moody's Volatility Factor may mean such
other potential dividend rate increase factor as Moody's advises the Fund in
writing is applicable.
"Municipal Bonds" has the meaning set forth on page 8 of this prospectus.
"Municipal Index" has the meaning set forth on pages 19 and 20 of the
statement of additional information.
"1940 Act" means the Investment Company Act of 1940, as amended from time to
time.
"1940 Act AMPS Asset Coverage" has the meaning set forth on page 17 of this
prospectus.
"1940 Act Cure Date" has the meaning set forth on page 17 of this prospectus.
"Non-Call Period" has the meaning set forth under "Specific Redemption
Provisions" below.
"Non-Payment Period" has the meaning set forth on page 11 of the statement of
additional information.
38
<PAGE>
"Non-Payment Period Rate" has the meaning set forth on page 11 of the
statement of additional information.
"Notice of Revocation" has the meaning set forth on page 10 of the statement
of additional information.
"Notice of Special Dividend Period" has the meaning set forth on page 16 of
this prospectus.
"Optional Redemption Price" has the meaning set forth on page 18 of this
prospectus.
"Order" has the meaning set forth on page 21 of this prospectus.
"Policy" means an insurance policy purchased by the Fund which guarantees the
payment of principal and interest on specified California Municipal Bonds or
Municipal Bonds during the period in which such California Municipal Bonds or
Municipal Bonds are owned by the Fund; provided, however, that, as long as the
AMPS are rated by Moody's and S&P, the Fund will not obtain any Policy unless
Moody's and S&P advise the Fund in writing that the purchase of such Policy
will not adversely affect their then-current rating on the AMPS.
"Potential Beneficial Owner" means a customer of a Broker-Dealer or a Broker-
Dealer that is not a Beneficial Owner of shares of AMPS but that wishes to
purchase such shares, or that is a Beneficial Owner that wishes to purchase
additional shares of AMPS.
"Potential Holder" means any Broker-Dealer or any such other person as may be
permitted by the Fund, including any Existing Holder, who may be interested in
acquiring shares of AMPS (or, in the case of an Existing Holder, additional
shares of AMPS).
"Preferred stock" means preferred stock, par value $.10 per share, of the
Fund.
"Premium Call Period" has the meaning set forth under "Specific Redemption
Provisions" below.
"Receivables for California Municipal Bonds Sold," for purposes of
determining S&P Eligible Assets, has the meaning set forth on page 18 of the
statement of additional information.
"Receivables for California Municipal Bonds or Municipal Bonds Sold," for
purposes of determining Moody's Eligible Assets, has the meaning set forth on
page 21 of the statement of additional information.
"Reference Rate" means: (i) with respect to a Dividend Period or a Short Term
Dividend Period having 28 or fewer days, the higher of the applicable "AA"
Composite Commercial Paper Rate and the Taxable Equivalent of the Short Term
Municipal Bond Rate, (ii) with respect to any Short Term Dividend Period,
having more than 28 but fewer than 183 days, the applicable "AA" Composite
Commercial Paper Rate, (iii) with respect to any Short Term Dividend Period
having 183 or more but fewer than 364 days, the applicable U.S. Treasury Bill
Rate and (iv) with respect to any Long Term Dividend Period, the applicable
U.S. Treasury Note Rate.
"Request for Special Dividend Period" has the meaning set forth on page 15 of
this prospectus.
"Response" has the meaning set forth on page 16 of this prospectus.
"Retroactive Taxable Allocation" has the meaning set forth on page 16 of this
prospectus.
"Series A AMPS" means the Auction Market Preferred Stock, Series A, with a
par value of $.10 per share and a liquidation preference of $25,000 per share
plus an amount equal to accumulated but unpaid dividends thereon (whether or
not earned or declared), of the Fund.
"Series B AMPS" means the Auction Market Preferred Stock, Series B, with a
par value of $.10 per share and a liquidation preference of $25,000 per share
plus an amount equal to accumulated but unpaid dividends thereon (whether or
not earned or declared), of the Fund.
39
<PAGE>
"S&P" means Standard & Poor's, a division of The McGraw-Hill Companies, Inc.,
or its successors.
"S&P Discount Factor" has the meaning set forth on page 17 of the statement
of additional information.
"S&P Eligible Assets" has the meaning set forth on page 17 of the statement
of additional information.
"S&P Exposure Period" means the maximum period of time following a Valuation
Date, including the Valuation Date and the AMPS Basic Maintenance Cure Date,
that the Fund has under the Articles Supplementary to cure any failure to
maintain, as of such Valuation Date, a Discounted Value for its portfolio at
least equal to the AMPS Basic Maintenance Amount.
"S&P Hedging Transactions" has the meaning set forth on page 20 of the
statement of additional information.
"S&P Volatility Factor" means 277% or such other potential dividend rate
increase factor as S&P advises the Fund in writing is applicable.
"Securities Depository" means The Depository Trust Company and its successors
and assigns or any successor securities depository selected by the Fund that
agrees to follow the procedures required to be followed by such securities
depository in connection with shares of AMPS.
"Sell Order" has the meaning specified in Subsection 10(b)(i) of the Auction
Procedures.
"7-Day Dividend Period" means a Dividend Period consisting of seven days.
"Short Term Dividend Period" means a dividend period the number of days in
which are evenly divisible by seven, and not fewer than seven days nor more
than 364 days.
"Special Dividend Period" has the meaning set forth on page 15 of this
prospectus.
"Specific Redemption Provisions" means, with respect to a Special Dividend
Period, either, or any combination of, (i) a period (a "Non-Call Period")
determined by the Board of Directors of the Fund, after consultation with the
Auction Agent and the Broker-Dealers, during which the shares of AMPS subject
to such Dividend Period shall not be subject to redemption at the option of the
Fund and (ii) a period (a "Premium Call Period"), consisting of a number of
whole years and determined by the Board of Directors of the Fund, after
consultation with the Auction Agent and the Broker-Dealers, during each year of
which the shares of AMPS subject to such Dividend Period shall be redeemable at
the Fund's option at a price per share equal to $25,000 plus accumulated but
unpaid dividends plus a premium expressed as a percentage of $25,000, as
determined by the Board of Directors of the Fund after consultation with the
Auction Agent and the Broker-Dealers.
"Submission Deadline" has the meaning set forth on page 23 of this
prospectus.
"Submitted Bid" has the meaning set forth on page 24 of this prospectus.
"Submitted Hold Order" has the meaning set forth on page 24 of this
prospectus.
"Submitted Order" has the meaning set forth on page 24 of this prospectus.
"Submitted Sell Order" has the meaning set forth on page 24 of this
prospectus.
"Subsequent Dividend Period" means each Dividend Period after the Initial
Dividend Period.
"Substitute Rating Agency" and "Substitute Rating Agencies" shall mean a
nationally recognized statistical rating organization or two nationally
recognized statistical rating organizations, respectively, selected by Merrill
Lynch, Pierce, Fenner & Smith Incorporated, or its respective affiliates and
successors, after consultation with the Fund, to act as a substitute rating
agency or substitute rating agencies, as the case may be, to determine the
credit ratings of the AMPS.
40
<PAGE>
"Sufficient Clearing Bids" has the meaning set forth on page 24 of this
prospectus.
"Taxable Equivalent of the Short-Term Municipal Bond Rate" on any date means
90% of the quotient of (A) the per annum rate expressed on an interest
equivalent basis equal to the Kenny S&P 30-day High Grade Index (the "Kenny
Index"), or any successor index made available for the Business Day immediately
preceding such date but in any event not later than 8:30 A.M., Eastern time, on
such date by Kenny Information Systems Inc. or any successor thereto, based
upon 30-day yield evaluations at par of bonds the interest on which is
excludable for regular Federal income tax purposes under the Code of "high
grade" component issuers selected by Kenny Information Systems Inc. or any such
successor from time to time in its discretion, which component issuers shall
include, without limitation, issuers of general obligation bonds but shall
exclude any bonds the interest on which constitutes an item of tax preference
under Section 57(a) (5) of the Code, or successor provisions, for purposes of
the "alternative minimum tax," divided by (B) 1.00 minus the Marginal Tax Rate
(expressed as a decimal); provided, however, that if the Kenny Index is not
made so available by 8:30 A.M., New York City time, on such date by Kenny
Information Systems Inc. or any successor, the Taxable Equivalent of the Short-
Term Municipal Bond Rate shall mean the quotient of (A) the per annum rate
expressed on an interest equivalent basis equal to the most recent Kenny Index
so made available for any preceding Business Day, divided by (B) 1.00 minus the
Marginal Tax Rate (expressed as a decimal). The Fund may not utilize a
successor index to the Kenny Index unless Moody's and S&P provide the Fund with
written confirmation that the use of such successor index will not adversely
affect the then-current respective Moody's and S&P ratings of the AMPS.
"Treasury Bonds" has the meaning set forth on page 20 of the statement of
additional information.
"U.S. Treasury Bill Rate" on any date means (i) the Interest Equivalent of
the rate on the actively traded Treasury Bill with a maturity most nearly
comparable to the length of the related Dividend Period, as such rate is made
available on a discount basis or otherwise by the Federal Reserve Bank of New
York in its Composite 3:30 P.M. Quotations for U.S. Government Securities
report for such Business Day, or (ii) if such yield as so calculated is not
available, the Alternate Treasury Bill Rate on such date. "Alternate Treasury
Bill Rate" on any date means the Interest Equivalent of the yield as calculated
by reference to the arithmetic average of the bid price quotations of the
actively traded Treasury Bill with a maturity most nearly comparable to the
length of the related Dividend Period, as determined by bid price quotations as
of any time on the Business Day immediately preceding such date, obtained from
at least three recognized primary U.S. Government securities dealers selected
by the Auction Agent.
"U.S. Treasury Note Rate" on any date means (i) the yield as calculated by
reference to the bid price quotation of the actively traded, current coupon
Treasury Note with a maturity most nearly comparable to the length of the
related Dividend Period, as such bid price quotation is published on the
Business Day immediately preceding such date by the Federal Reserve Bank of New
York in its Composite 3:30 P.M. Quotations for U.S. Government Securities
report for such Business Day, or (ii) if such yield as so calculated is not
available, the Alternate Treasury Note Rate on such date. "Alternate Treasury
Note Rate" on any date means the yield as calculated by reference to the
arithmetic average of the bid price quotations of the actively traded, current
coupon Treasury Note with a maturity most nearly comparable to the length of
the related Dividend Period, as determined by the bid price quotations as of
any time on the Business Day immediately preceding such date, obtained from at
least three recognized primary U.S. Government securities dealers selected by
the Auction Agent.
"Valuation Date" has the meaning set forth on page 18 of this prospectus.
"Variation Margin" means, in connection with an outstanding financial futures
contract owned or sold by the Fund, the amount of cash or securities paid to or
received from a broker (subsequent to the Initial Margin payment) from time to
time as the price of such financial futures contract fluctuates.
"Winning Bid Rate" has the meaning set forth on page 24 of this prospectus.
41
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
$91,000,000
MUNIHOLDINGS CALIFORNIA INSURED FUND IV, INC.
AUCTION MARKET PREFERRED STOCK(R) ["AMPS(R)"]
1,820 SHARES, SERIES A
1,820 SHARES, SERIES B
----------------
PROSPECTUS
----------------
MERRILL LYNCH & CO.
FEBRUARY , 1999
(R) Registered trademarks of Merrill Lynch & Co. Inc.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+ +
+The information contained in this statement of additional information is not +
+complete and may be changed. We may not sell these securities until the +
+registration statement filed with the Securities and Exchange Commission is +
+effective. This statement of additional information is not a prospectus. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION
PRELIMINARY STATEMENT OF ADDITIONAL INFORMATION DATED FEBRUARY 5, 1999
STATEMENT OF ADDITIONAL INFORMATION
$91,000,000
MuniHoldings California Insured Fund IV, Inc.
Auction Market Preferred Stock ["AMPS(R)"]
1,820 Shares, Series A
1,820 Shares, Series B
Liquidation Preference $25,000 Per Share
------------
MuniHoldings California Insured Fund IV, Inc. (the "Fund") is a recently
organized, non-diversified, closed-end management investment company that seeks
to provide shareholders with current income exempt from Federal and California
income taxes. The Fund seeks to achieve its objective by investing primarily in
a portfolio of long-term, investment grade municipal obligations the interest
on which, in the opinion of bond counsel to the issuer, is exempt from Federal
and California income taxes. The Fund intends to invest in municipal
obligations that are rated investment grade or, if unrated, are considered by
the Fund's investment adviser to be of comparable quality. Under normal
circumstances, at least 80% of the Fund's assets will be invested in municipal
obligations with remaining maturities of one year or more that are covered by
insurance guaranteeing the timely payment of principal at maturity and
interest. There can be no assurance that the Fund's investment objective will
be realized. For more information on the Fund's investment objective and
policies, see "Investment Objective and Policies."
------------
Certain capitalized terms not otherwise defined in this statement of
additional information have the meaning provided in the Glossary included as
part of the prospectus.
This statement of additional information is not a prospectus, but should be
read in conjunction with the prospectus of the Fund, which has been filed with
the Securities and Exchange Commission (the "Commission") and can be obtained,
without charge, by calling (800) 637-3863. The prospectus is incorporated by
reference into this statement of additional information, and this statement of
additional information is incorporated by reference into the prospectus.
- ------
(R) Registered trademark of Merrill Lynch & Co., Inc.
------------
Merrill Lynch & Co.
------------
The date of this statement of additional information is February , 1999.
<PAGE>
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
<TABLE>
<S> <C>
Investment Objective and Policies........................................... 3
Investment Restrictions..................................................... 7
Description of AMPS......................................................... 9
The Auction................................................................. 16
Rating Agency Guidelines.................................................... 17
Directors and Officers...................................................... 25
Investment Advisory and Management Arrangements............................. 27
Portfolio Transactions...................................................... 28
Taxes....................................................................... 29
Net Asset Value............................................................. 33
Additional Information...................................................... 34
Independent Auditors' Report................................................ 35
Statement of Assets, Liabilities and Capital................................ 36
Financial Statements (Unaudited)............................................ 37
Appendix A--Economic and Other Conditions in California..................... A-1
Appendix B--Ratings of Municipal Bonds...................................... B-1
Appendix C--Portfolio Insurance............................................. C-1
Appendix D--Settlement Procedures........................................... D-1
Appendix E--Auction Procedures.............................................. E-1
</TABLE>
2
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to provide shareholders with current
income exempt from Federal and California income taxes. The Fund seeks to
achieve its investment objective by investing primarily in a portfolio of long-
term, investment grade municipal obligations issued by or on behalf of the
State of California, its political subdivisions, agencies and instrumentalities
and by other qualifying issuers that pay interest which, in the opinion of bond
counsel to the issuer, is exempt from Federal and California income taxes
("California Municipal Bonds"). The Fund intends to invest substantially all
(at least 80%) of its assets in California Municipal Bonds, except at times
when the Fund's investment adviser, Fund Asset Management, L.P. (the
"Investment Adviser"), considers that California Municipal Bonds of sufficient
quality and quantity are unavailable for investment at suitable prices by the
Fund. To the extent the Investment Adviser considers that suitable California
Municipal Bonds are not available for investment, the Fund may purchase other
long-term municipal obligations exempt from Federal but not California income
taxes ("Municipal Bonds"). The Fund will maintain at least 65% of its assets in
California Municipal Bonds and at least 80% of its assets in California
Municipal Bonds and Municipal Bonds, except during interim periods pending
investment of the net proceeds of public offerings of the Fund's securities and
during temporary defensive periods. Under normal circumstances, at least 80% of
the Fund's assets will be invested in municipal obligations with remaining
maturities of one year or more that are covered by insurance guaranteeing the
timely payment of principal at maturity and interest. The Fund's investment
objective is a fundamental policy that may not be changed without a vote of a
majority of the Fund's outstanding voting securities, as defined below under
"Investment Restrictions." There can be no assurance that the investment
objective of the Fund will be realized. At times the Fund may seek to hedge its
portfolio through the use of options and futures transactions to reduce
volatility in the net asset value of its shares of common stock.
The Fund ordinarily does not intend to realize significant investment income
that is subject to Federal and California income taxes. The Fund may invest all
or a portion of its assets in certain tax-exempt securities classified as
"private activity bonds" (in general, bonds that benefit non-governmental
entities) that may subject certain investors in the Fund to the alternative
minimum tax.
The Fund also may invest in securities not issued by or on behalf of a state
or territory or by an agency or instrumentality thereof, if the Fund
nevertheless believes such securities pay interest or distributions that are
exempt from Federal income taxation ("Non-Municipal Tax-Exempt Securities").
Non-Municipal Tax-Exempt Securities may include securities issued by other
investment companies that invest in California Municipal Bonds and Municipal
Bonds, to the extent such investments are permitted by the Investment Company
Act of 1940, as amended (the "1940 Act"). Other Non-Municipal Tax-Exempt
Securities could include trust certificates or other instruments evidencing
interests in one or more long-term California Municipal Bonds or Municipal
Bonds. Certain Non-Municipal Tax-Exempt Securities may be characterized as
derivative instruments. Non-Municipal Tax-Exempt Securities are considered
"California Municipal Bonds" or "Municipal Bonds" for purposes of the Fund's
investment objective and policies.
Description of California Municipal Bonds and Municipal Bonds
California Municipal Bonds and Municipal Bonds include debt obligations
issued to obtain funds for various public purposes, including construction of a
wide range of public facilities, refunding of outstanding obligations and
obtaining funds for general operating expenses and loans to other public
institutions and facilities. In addition, certain types of industrial
development bonds ("IDBs") are issued by or on behalf of public authorities to
finance various privately operated facilities, including certain local
facilities for water supply, gas, electricity, sewage or solid waste disposal.
For purposes of this statement of additional information, such obligations are
considered Municipal Bonds if the interest paid thereon is exempt from Federal
income tax and as California Municipal Bonds if the interest thereon is exempt
from Federal and California income taxes, even though such bonds may be IDBs or
"private activity bonds" as discussed below. Also, for purposes of this
statement of additional information, Non-Municipal Tax-Exempt Securities as
discussed above will be considered California Municipal Bonds or Municipal
Bonds.
3
<PAGE>
The two principal classifications of California Municipal Bonds and Municipal
Bonds are "general obligation" bonds and "revenue" bonds, which latter category
includes IDBs and, for bonds issued after August 15, 1986, private activity
bonds. General obligation bonds (other than those of the State of California,
which has limited taxing powers) are typically secured by the issuer's pledge
of faith, credit and taxing power for the repayment of principal and the
payment of interest. Revenue or special obligation bonds are typically payable
only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise tax or
other specific revenue source such as from the user of the facility being
financed. IDBs are in most cases revenue bonds and do not generally constitute
the pledge of the credit or taxing power of the issuer of such bonds. The
repayment of principal and the payment of interest on such industrial
development bonds depends solely on the ability of the user of the facility
financed by the bonds to meet its financial obligations and the pledge, if any,
of real and personal property so financed as security for such payment.
California Municipal Bonds and Municipal Bonds may also include "moral
obligation" bonds, which are normally issued by special purpose public
authorities. If an issuer of moral obligation bonds is unable to meet its
obligations, the repayment of such bonds becomes a moral commitment but not a
legal obligation of the state or municipality in question.
The Fund may purchase California Municipal Bonds and Municipal Bonds
classified as "private activity bonds" (in general, bonds that benefit non-
governmental entities). Interest received on certain tax-exempt securities that
are classified as "private activity bonds" may subject certain investors in the
Fund to an alternative minimum tax. There is no limitation on the percentage of
the Fund's assets that may be invested in California Municipal Bonds and
Municipal Bonds that may subject certain investors to an alternative minimum
tax. See "Taxes--General." Also included within the general category of
California Municipal Bonds and/or Municipal Bonds are participation
certificates issued by government authorities or entities to finance the
acquisition or construction of equipment, land and/or facilities. The
certificates represent participations in a lease, an installment purchase
contract or a conditional sales contract (hereinafter collectively referred to
as "lease obligations") relating to such equipment, land or facilities.
Although lease obligations typically do not constitute general obligations of
the issuer for which the issuer's unlimited taxing power is pledged, a lease
obligation frequently is backed by the issuer's covenant to budget for,
appropriate and make the payments due under the lease obligation. However,
certain lease obligations contain "non-appropriation" clauses which provide
that the issuer has no obligation to make lease or installment purchase
payments in future years unless money is appropriated for such purpose on a
yearly basis. Although "non-appropriation" lease obligations are secured by the
lease property, disposition of the property in the event of foreclosure might
prove difficult. These securities represent a relatively new type of financing
that has not yet developed the depth of marketability associated with more
conventional securities.
Federal tax legislation has limited the types and volume of bonds the
interest on which qualifies for a Federal income tax exemption. As a result,
this legislation and legislation that may be enacted in the future may affect
the availability of California Municipal Bonds and Municipal Bonds for
investment by the Fund.
Options and Futures Transactions
The following is a description of the options and futures transactions in
which the Fund may engage, limitations on the Fund's use of such transactions
and risks associated with these transactions. The investment policies with
respect to the hedging transactions of the Fund are not fundamental policies
and may be modified by the Board of Directors of the Fund without the approval
of the Fund's shareholders.
Writing Covered Call Options. The Fund may write (i.e., sell) covered call
options with respect to California Municipal Bonds and Municipal Bonds it owns,
thereby giving the holder of the option the right to buy the underlying
security covered by the option from the Fund at the stated exercise price until
the option expires. The Fund writes only covered call options, which means that
so long as the Fund is obligated as the writer of a call option, it will own
the underlying securities subject to the option. The Fund may not write covered
call options on underlying securities in an amount exceeding 15% of the market
value of its total assets.
4
<PAGE>
The Fund will receive a premium from writing a call option, which increases
the Fund's return on the underlying security in the event the option expires
unexercised or is closed out at a profit. By writing a call, the Fund limits
its opportunity to profit from an increase in the market value of the
underlying security above the exercise price of the option for as long as the
Fund's obligation as a writer continues. Covered call options may serve as a
partial hedge against a decline in the price of the underlying security. The
Fund may engage in closing transactions in order to terminate outstanding
options that it has written.
Purchase of Options. The Fund may purchase put options in connection with its
hedging activities. By buying a put the Fund has a right to sell the underlying
security at the exercise price, thus limiting the Fund's risk of loss through a
decline in the market value of the security until the put expires. The amount
of any appreciation in the value of the underlying security will be partially
offset by the amount of the premium paid for the put option and any related
transaction costs. Prior to its expiration, a put option may be sold in a
closing sale transaction; profit or loss from the sale will depend on whether
the amount received is more or less than the premium paid for the put option
plus the related transaction costs. A closing sale transaction cancels out the
Fund's position as the purchaser of an option by means of an offsetting sale of
an identical option prior to the expiration of the option it has purchased. In
certain circumstances, the Fund may purchase call options on securities held in
its portfolio on which it has written call options or on securities that it
intends to purchase. The Fund will not purchase options on securities if, as a
result of such purchase, the aggregate cost of all outstanding options on
securities held by the Fund would exceed 5% of the market value of the Fund's
total assets.
Financial Futures Contracts and Options. The Fund is authorized to purchase
and sell certain financial futures contracts and options thereon solely for the
purpose of hedging its investments in California Municipal Bonds and Municipal
Bonds against declines in value and hedging against increases in the cost of
securities it intends to purchase. A financial futures contract obligates the
seller of a contract to deliver and the purchaser of a contract to take
delivery of the type of financial instrument covered by the contract or, in the
case of index-based financial futures contracts, to make and accept a cash
settlement, at a specific future time for a specified price. A sale of
financial futures contracts may provide a hedge against a decline in the value
of portfolio securities because such depreciation may be offset, in whole or in
part, by an increase in the value of the position in the financial futures
contracts. A purchase of financial futures contracts may provide a hedge
against an increase in the cost of securities intended to be purchased because
such appreciation may be offset, in whole or in part, by an increase in the
value of the position in the financial futures contracts.
The purchase or sale of a financial futures contract differs from the
purchase or sale of a security in that no price or premium is paid or received.
Instead, an amount of cash or securities acceptable to the broker equal to
approximately 5% of the contract amount must be deposited with the broker. This
amount is known as initial margin. Subsequent payments to and from the broker,
called variation margin, are made on a daily basis as the price of the
financial futures contract fluctuates making the long and short positions in
the financial futures contract more or less valuable.
The Fund may purchase and sell financial futures contracts based on The Bond
Buyer Municipal Bond Index, a price-weighted measure of the market value of 40
large tax-exempt issues, and purchase and sell put and call options on such
financial futures contracts for the purpose of hedging California Municipal
Bonds and Municipal Bonds which the Fund holds or anticipates purchasing
against adverse changes in interest rates. The Fund also may purchase and sell
financial futures contracts on U.S. Government securities and purchase and sell
put and call options on such financial futures contracts for such hedging
purposes. With respect to U.S. Government securities, currently there are
financial futures contracts based on long-term U.S. Treasury bonds, U.S.
Treasury notes, GNMA Certificates and three-month U.S. Treasury bills.
Subject to policies adopted by the Board of Directors, the Fund also may
engage in transactions in other financial futures contracts, such as financial
futures contracts on other municipal bond indices that may become available, if
the Investment Adviser should determine that there is normally sufficient
correlation between the prices of such financial futures contracts and the
California Municipal Bonds and Municipal Bonds in which the Fund invests to
make such hedging appropriate.
5
<PAGE>
Over-the-Counter Options. The Fund may engage in options and futures
transactions on exchanges and in the over-the-counter markets. In general,
exchange-traded contracts are third-party contracts (i.e., performance of the
parties' obligations is guaranteed by an exchange or clearing corporation)
with standardized strike prices and expiration dates. Over-the-counter options
transactions ("OTC options") are two-party contracts with prices and terms
negotiated by the buyer and seller. See "Restrictions on OTC Options" below
for information as to restrictions on the use of OTC options.
Restrictions on OTC Options. The Fund will engage in transactions in OTC
options only with banks or dealers that have capital of at least $50 million
or whose obligations are guaranteed by an entity having capital of at least
$50 million. Certain OTC options and assets used to cover OTC options written
by the Fund may be considered to be illiquid. The illiquidity of such options
or assets may prevent a successful sale of such options or assets, result in a
delay of sale, or reduce the amount of proceeds that might otherwise be
realized.
Risk Factors in Options and Futures Transactions. Utilization of futures
transactions involves the risk of imperfect correlation in movements in the
price of financial futures contracts and movements in the price of the
security that is the subject of the hedge. If the price of the financial
futures contract moves more or less than the price of the security that is the
subject of the hedge, the Fund will experience a gain or loss that will not be
completely offset by movements in the price of such security. There is a risk
of imperfect correlation where the securities underlying financial futures
contracts have different maturities, ratings, geographic compositions or other
characteristics than the security being hedged. In addition, the correlation
may be affected by additions to or deletions from the index that serves as a
basis for a financial futures contract. Finally, in the case of financial
futures contracts on U.S. Government securities and options on such financial
futures contracts, the anticipated correlation of price movements between the
U.S. Government securities underlying the futures or options and California
Municipal Bonds and Municipal Bonds may be adversely affected by economic,
political, legislative or other developments which have a disparate impact on
the respective markets for such securities.
Under regulations of the Commodity Futures Trading Commission (the "CFTC"),
the futures trading activities described herein will not result in the Fund
being deemed a "commodity pool," as defined under such regulations, provided
that the Fund adheres to certain restrictions. In particular, the Fund may
purchase and sell financial futures contracts and options thereon (i) for bona
fide hedging purposes, without regard to the percentage of the Fund's assets
committed to margin and option premiums, and (ii) for non-hedging purposes if,
immediately thereafter, the sum of the amount of initial margin deposits on
the Fund's existing futures positions and option premiums entered into for
non-hedging purposes does not exceed 5% of the market value of the liquidation
value of the Fund's portfolio, after taking into account unrealized profits
and unrealized losses on any such transactions. Margin deposits may consist of
cash or securities acceptable to the broker and the relevant contract market.
When the Fund purchases a financial futures contract, or writes a put option
or purchases a call option thereon, it will maintain an amount of cash, cash
equivalents (e.g., commercial paper and daily tender adjustable notes) or
liquid securities in a segregated account with the Fund's custodian so that
the amount so segregated plus the amount of initial and variation margin held
in the account of its broker equals the market value of the financial futures
contract, thereby ensuring that the use of such financial futures contract is
unleveraged.
Certain risks are involved in options and futures transactions. The
Investment Adviser believes, however, that, because the Fund will engage in
options and futures transactions only for hedging purposes, the Fund's options
and futures portfolio strategies will not subject the Fund to those risks
associated with speculation in options and futures transactions.
The volume of trading in the exchange markets with respect to California
Municipal Bond or Municipal Bond options may be limited, and it is impossible
to predict the amount of trading interest that may exist in such options. In
addition, there can be no assurance that viable exchange markets will continue
to be available.
6
<PAGE>
The Fund intends to enter into options and futures transactions, on an
exchange or in the over-the-counter market, only if there appears to be a
liquid secondary market for such options or futures. There can be no assurance,
however, that a liquid secondary market will exist at any specific time. Thus,
it may not be possible to close an options or futures transaction. The
inability to close options and futures positions also could have an adverse
impact on the Fund's ability to effectively hedge its portfolio. There is also
the risk of loss by the Fund of margin deposits or collateral in the event of
bankruptcy of a broker with which the Fund has an open position in an option or
financial futures contract.
The liquidity of a secondary market in a financial futures contract may be
adversely affected by "daily price fluctuation limits" established by commodity
exchanges that limit the amount of fluctuation in a financial futures contract
price during a single trading day. Once the daily limit has been reached in the
contract, no trades may be entered into at a price beyond the limit, thus
preventing the liquidation of open futures positions. Prices have in the past
reached or exceeded the daily limit on a number of consecutive trading days.
If it is not possible to close a financial futures position entered into by
the Fund, the Fund would continue to be required to make daily cash payments of
variation margin in the event of adverse price movements. In such a situation,
if the Fund has insufficient cash, it may have to sell portfolio securities to
meet daily variation margin requirements at a time when it may be
disadvantageous to do so.
The successful use of these transactions also depends on the ability of the
Investment Adviser to forecast correctly the direction and extent of interest
rate movements within a given time frame. To the extent these rates remain
stable during the period in which a financial futures contract is held by the
Fund or move in a direction opposite to that anticipated, the Fund may realize
a loss on the hedging transaction that is not fully or partially offset by an
increase in the value of portfolio securities. As a result, the Fund's total
return for such period may be less than if it had not engaged in the hedging
transaction. Furthermore, the Fund will only engage in hedging transactions
from time to time and may not necessarily be engaging in hedging transactions
when movements in interest rates occur. The Fund is not required to enter into
hedging transactions and may not do so.
INVESTMENT RESTRICTIONS
The following are fundamental investment restrictions of the Fund and may not
be changed without the approval of the holders of a majority of the Fund's
outstanding shares of common stock and outstanding shares of AMPS and any other
preferred stock, voting as a single class, and the majority of the outstanding
shares of AMPS and any other preferred stock, voting as a separate class (which
for this purpose and under the 1940 Act means the lesser of (i) 67% of the
shares of each class of capital stock represented at a meeting at which more
than 50% of the outstanding shares of each class of capital stock are
represented or (ii) more than 50% of the outstanding shares of each class of
capital stock). The Fund may not:
1. Make investments for the purpose of exercising control or management.
2. Purchase or sell real estate, commodities or commodity contracts;
provided that the Fund may invest in securities secured by real estate or
interests therein or issued by entities that invest in real estate or
interest therein, and the Fund may purchase and sell financial futures
contracts and options thereon.
3. Issue senior securities or borrow money except as permitted by Section
18 of the 1940 Act.
4. Underwrite securities of other issuers except insofar as the Fund may
be deemed an underwriter under the Securities Act of 1933, as amended, in
selling portfolio securities.
5. Make loans to other persons, except that the Fund may purchase
California Municipal Bonds, Municipal Bonds and other debt securities and
enter into repurchase agreements in accordance with its investment
objective, policies and limitations.
6. Invest more than 25% of its total assets (taken at market value at the
time of each investment) in securities of issuers in a single industry;
provided that, for purposes of this restriction, states, municipalities and
their political subdivisions are not considered to be part of any industry.
7
<PAGE>
Additional investment restrictions adopted by the Fund, which may be changed
by the Board of Directors without shareholder approval, provide that the Fund
may not:
a. Purchase securities of other investment companies, except to the
extent that such purchases are permitted by applicable law. Applicable law
currently prohibits the Fund from purchasing the securities of other
investment companies except if immediately thereafter not more than (i) 3%
of the total outstanding voting stock of such company is owned by the Fund,
(ii) 5% of the Fund's total assets, taken at market value, would be
invested in any one such company, (iii) 10% of the Fund's total assets,
taken at market value, would be invested in such securities, and (iv) the
Fund, together with other investment companies having the same investment
adviser and companies controlled by such companies, owns not more than 10%
of the total outstanding stock of any one closed-end investment company.
b. Mortgage, pledge, hypothecate or in any manner transfer, as security
for indebtedness, any securities owned or held by the Fund except as may be
necessary in connection with borrowings mentioned in investment restriction
(3) above or except as may be necessary in connection with transactions in
financial futures contracts and options thereon.
c. Purchase any securities on margin, except that the Fund may obtain
such short-term credit as may be necessary for the clearance of purchases
and sales of portfolio securities (the deposit or payment by the Fund of
initial or variation margin in connection with financial futures contracts
and options thereon is not considered the purchase of a security on
margin).
d. Make short sales of securities or maintain a short position or invest
in put, call, straddle or spread options, except that the Fund may write,
purchase and sell options and futures on California Municipal Bonds,
Municipal Bonds, U.S. Government obligations and related indices or
otherwise in connection with bona fide hedging activities and may purchase
and sell Call Rights to require mandatory tender for the purchase of
related California Municipal Bonds and Municipal Bonds.
If a percentage restriction on the investment or use of assets set forth
above is adhered to at the time a transaction is effected, later changes in
percentages resulting from changing values will not be considered a violation.
For so long as shares of AMPS are rated by Moody's, the Fund will not change
these additional investment restrictions unless it receives written
confirmation from Moody's that engaging in such transactions would not impair
the rating then assigned to the shares of AMPS by Moody's.
The Fund has no intention to file a voluntary application for relief under
Federal bankruptcy law or any similar application under state law for so long
as the Fund is solvent and does not foresee becoming insolvent.
The Investment Adviser of the Fund and Merrill Lynch are owned and controlled
by Merrill Lynch & Co. ("ML & Co."). Because of the affiliation of Merrill
Lynch with the Investment Adviser, the Fund is prohibited from engaging in
certain transactions involving Merrill Lynch except pursuant to an exemptive
order or otherwise in compliance with the provisions of the 1940 Act and the
rules and regulations thereunder. Included among such restricted transactions
will be purchases from or sales to Merrill Lynch of securities in transactions
in which it acts as principal. An exemptive order has been obtained that
permits the Fund to effect principal transactions with Merrill Lynch in high
quality, short-term, tax-exempt securities subject to conditions set forth in
such order. The Fund may consider in the future requesting an order permitting
other principal transactions with Merrill Lynch, but there can be no assurance
that such application will be made and, if made, that such order would be
granted.
8
<PAGE>
DESCRIPTION OF AMPS
Certain of the capitalized terms used herein are defined in the Glossary that
appears at the back of the prospectus.
The AMPS of each series will be shares of preferred stock that entitle their
holders to receive dividends when, as and if declared by the Board of
Directors, out of funds legally available therefor, at a rate per year that may
vary for the successive Dividend Periods for each such series. After the
Initial Dividend Period, each Subsequent Dividend Period for each series of
AMPS generally will be a 7-Day Dividend Period; provided, however, that prior
to any Auction, the Fund may elect, subject to certain limitations described
herein, upon giving notice to holders thereof, a Special Dividend Period. The
Applicable Rate for a particular Dividend Period will be determined by an
Auction conducted on the Business Day before the start of such Dividend Period.
Beneficial Owners and Potential Beneficial Owners of shares of AMPS may
participate in Auctions therefor, although, except in the case of a Special
Dividend Period, Beneficial Owners desiring to continue to hold all of their
shares of AMPS regardless of the Applicable Rate resulting from Auctions need
not participate. For an explanation of Auctions and the method of determining
the Applicable Rate, see Appendix E--"Auction Procedures."
Except as otherwise required by law or unless there is no Securities
Depository, all outstanding shares of AMPS of each series will be represented
by one or more certificates registered in the name of the nominee of the
Securities Depository (initially expected to be Cede), and no person acquiring
shares of AMPS will be entitled to receive a certificate representing such
shares. See Appendix E--"Auction Procedures." As a result, the nominee of the
Securities Depository is expected to be the sole holder of record of the shares
of AMPS. Accordingly, each purchaser of AMPS must rely on (i) the procedures of
the Securities Depository and, if such purchaser is not a member of the
Securities Depository, such purchaser's Agent Member, to receive dividends,
distributions and notices and to exercise voting rights (if and when
applicable) and (ii) the records of the Securities Depository and, if such
purchaser is not a member of the Securities Depository, such purchaser's Agent
Member, to evidence its beneficial ownership of shares of AMPS.
When issued and sold, the shares of AMPS will have a liquidation preference
of $25,000 per share plus an amount equal to accumulated but unpaid dividends
(whether or not earned or declared) and will be fully paid and non-assessable.
See "Description of AMPS--Liquidation Rights" in the prospectus. The shares of
AMPS will not be convertible into shares of common stock or other capital stock
of the Fund, and the holders thereof will have no preemptive rights. The shares
of AMPS of each series will not be subject to any sinking fund but will be
subject to redemption at the option of the Fund at the Optional Redemption
Price on any Dividend Payment Date for such series (except during the Initial
Dividend Period and during a Non-Call Period) and, under certain circumstances,
will be subject to mandatory redemption by the Fund at the Mandatory Redemption
Price stated in the prospectus. See "Description of AMPS--Redemption" in the
prospectus.
In addition to serving as the Auction Agent in connection with the Auction
Procedures described in the prospectus, IBJ Whitehall Bank & Trust Company will
be the transfer agent, registrar, dividend disbursing agent and redemption
agent for the shares of AMPS. The Auction Agent, however, will serve merely as
the agent of the Fund, acting in accordance with the Fund's instructions, and
will not be responsible for any evaluation or verification of any matters
certified to it.
Except in an Auction, the Fund will have the right (to the extent permitted
by applicable law) to purchase or otherwise acquire any shares of AMPS so long
as the Fund is current in the payment of dividends on AMPS and on any other
capital stock of the Fund ranking on a parity with the AMPS with respect to the
payment of dividends or upon liquidation.
The following supplements the description of the terms of the shares of AMPS
set forth in the prospectus. This description does not purport to be complete
and is subject to and qualified in its entirety by reference to the Fund's
Charter and Articles Supplementary, including the provisions thereof
establishing the AMPS. The
9
<PAGE>
Fund's Charter and the form of Articles Supplementary establishing the terms of
the AMPS have been filed as exhibits to the Registration Statement of which
this statement of additional information is a part.
Dividends
General. The holders of shares of each series of AMPS will be entitled to
receive, when, as and if declared by the Board of Directors of the Fund, out of
funds legally available therefor, cumulative cash dividends on their shares, at
the Applicable Rate determined as set forth below under "Determination of
Dividend Rate," payable on the respective dates set forth below. Dividends on
the shares of AMPS so declared and payable shall be paid (i) in preference to
and in priority over any dividends so declared and payable on the common stock,
and (ii) to the extent permitted under the Code and to the extent available,
out of net tax-exempt income earned on the Fund's investments. Generally,
dividends on shares of AMPS, to the extent that they are derived from interest
paid on Municipal Bonds, will be exempt from Federal income taxes, subject to
possible application of the alternative minimum tax. See "Taxes."
Notification of Dividend Period. In determining whether the Fund should issue
a Notice of Special Dividend for a series of AMPS, the Broker-Dealers will
consider (i) existing short-term and long-term market rates and indices of such
short-term and long-term rates, (ii) existing market supply and demand for
short-term and long-term securities, (iii) existing yield curves for short-term
and long-term securities comparable to the AMPS, (iv) industry and financial
conditions which may affect the AMPS, (v) the investment objective of the Fund
and (vi) the Dividend Periods and dividend rates at which current and potential
beneficial holders of the AMPS would remain or become beneficial holders. If
the Broker-Dealers shall not give the Fund and the Auction Agent a Response by
such second Business Day or if the Response states that given the factors set
forth above it is not advisable that the Fund give a Notice of Special Dividend
Period for the AMPS, the Fund may not give a Notice of Special Dividend Period
in respect of such Request for Special Dividend Period. In the event the
Response indicates that it is advisable that the Fund give a Notice of Special
Dividend Period for the AMPS, the Fund, by no later than the second Business
Day prior to such Auction Date, may give a notice (a "Notice of Special
Dividend Period") to the Auction Agent, the Securities Depository and each
Broker-Dealer, which notice will specify (i) the duration of the Special
Dividend Period, (ii) the Optional Redemption Price as specified in the related
Response and (iii) the Specific Redemption Provisions, if any, as specified in
the related Response. The Fund also shall provide a copy of such Notice of
Special Dividend Period to Moody's and S&P. The Fund shall not give a Notice of
Special Dividend Period, and, if such Notice of Special Dividend Period shall
have been given already, shall give telephonic and written notice of its
revocation (a "Notice of Revocation") to the Auction Agent, each Broker-Dealer,
and the Securities Depository on or prior to the Business Day prior to the
relevant Auction Date if (x) either the 1940 Act AMPS Asset Coverage is not
satisfied or the Fund shall fail to maintain S&P Eligible Assets and Moody's
Eligible Assets each with an aggregate Discounted Value at least equal to the
AMPS Basic Maintenance Amount, in each case on each of the two Valuation Dates
immediately preceding the Business Day prior to the relevant Auction Date on an
actual basis and on a pro forma basis giving effect to the proposed Special
Dividend Period (using as a pro forma dividend rate with respect to such
Special Dividend Period the dividend rate which the Broker-Dealers shall advise
the Fund is an approximately equal rate for securities similar to the AMPS with
an equal dividend period), provided that, in calculating the aggregate
Discounted Value of Moody's Eligible Assets for this purpose, the Moody's
Exposure Period shall be deemed to be one week longer, (y) sufficient funds for
the payment of dividends payable on the immediately succeeding Dividend Payment
Date have not been irrevocably deposited with the Auction Agent by the close of
business on the third Business Day preceding the related Auction Date or (z)
the Broker-Dealers jointly advise the Fund that, after consideration of the
factors listed above, they have concluded that it is advisable to give a Notice
of Revocation. The Fund also shall provide a copy of such Notice of Revocation
to Moody's and S&P. If the Fund is prohibited from giving a Notice of Special
Dividend Period as a result of the factors enumerated in clause (x), (y) or (z)
above or if the Fund gives a Notice of Revocation with respect to a Notice of
Special Dividend Period, the next succeeding Dividend Period for that series
will be a 7-Day Dividend Period. In addition, in the event Sufficient Clearing
Bids are not made in any Auction or an Auction is not held for any reason, the
next succeeding Dividend
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Period will be a 7-Day Dividend Period, and the Fund may not again give a
Notice of Special Dividend Period (and any such attempted notice shall be null
and void) until Sufficient Clearing Bids have been made in an Auction with
respect to a 7-Day Dividend Period.
Non-Payment Period; Late Charge. A Non-Payment Period will commence if the
Fund fails to (i) declare, prior to the close of business on the second
Business Day preceding any Dividend Payment Date, for payment on or (to the
extent permitted as described below) within three Business Days after such
Dividend Payment Date to the persons who held such shares as of 12:00 noon, New
York City time, on the Business Day preceding such Dividend Payment Date, the
full amount of any dividend on shares of AMPS payable on such Dividend Payment
Date or (ii) deposit, irrevocably in trust, in same-day funds, with the Auction
Agent by 12:00 noon, Eastern time, (A) on such Dividend Payment Date the full
amount of any cash dividend on such shares (if declared) payable on such
Dividend Payment Date or (B) on any redemption date for shares of AMPS called
for redemption, the Mandatory Redemption Price per share of such AMPS or, in
the case of an optional redemption, the Optional Redemption Price per share.
Such Non-Payment Period will consist of the period commencing on and including
the aforementioned Dividend Payment Date or redemption date, as the case may
be, and ending on and including the Business Day on which, by 12:00 noon,
Eastern time, all unpaid cash dividends and unpaid redemption prices shall have
been so deposited or otherwise shall have been made available to the applicable
holders in same-day funds, provided that a Non-Payment Period for any series of
AMPS will not end unless the Fund shall have given at least five days' but no
more than 30 days' written notice of such deposit or availability to the
Auction Agent, the Securities Depository and all holders of shares of AMPS of
such series. Notwithstanding the foregoing, the failure by the Fund to deposit
funds as provided for by clause (ii) (A) or (ii) (B) above within three
Business Days after any Dividend Payment Date or redemption date, as the case
may be, in each case to the extent contemplated below, shall not constitute a
"Non-Payment Period."
The Applicable Rate for each Dividend Period for shares of AMPS of any
series, commencing during a Non-Payment Period, will be equal to the Non-
Payment Period Rate; and each Dividend Period commencing after the first day
of, and during, a Non-Payment Period shall be a 7-Day Dividend Period. Any
dividend on shares of AMPS due on any Dividend Payment Date for such shares
(if, prior to the close of business on the second Business Day preceding such
Dividend Payment Date, the Fund has declared such dividend payable on such
Dividend Payment Date to the persons who held such shares as of 12:00 noon,
Eastern time, on the Business Day preceding such Dividend Payment Date) or
redemption price with respect to such shares not paid to such persons when due
may be paid to such persons in the same form of funds by 12:00 noon, Eastern
time, on any of the first three Business Days after such Dividend Payment Date
or due date, as the case may be, provided that such amount is accompanied by a
late charge calculated for such period of non-payment at the Non-Payment Period
Rate applied to the amount of such non-payment based on the actual number of
days comprising such period divided by 365. In the case of a willful failure of
the Fund to pay a dividend on a Dividend Payment Date or to redeem any shares
of AMPS on the date set for such redemption, the preceding sentence shall not
apply and the Applicable Rate for the Dividend Period commencing during the
Non-Payment Period resulting from such failure shall be the Non-Payment Period
Rate. For the purposes of the foregoing, payment to a person in same-day funds
on any Business Day at any time will be considered equivalent to payment to
that person in New York Clearing House (next-day) funds at the same time on the
preceding Business Day, and any payment made after 12:00 noon, Eastern time, on
any Business Day shall be considered to have been made instead in the same form
of funds and to the same person before 12:00 noon, Eastern time, on the next
Business Day.
The Non-Payment Period Rate initially will be 200% of the applicable
Reference Rate (or 275% of such rate if the Fund has provided notification to
the Auction Agent prior to the Auction establishing the Applicable Rate for any
dividend that net capital gains or other taxable income will be included in
such dividend on shares of AMPS), provided that the Board of Directors of the
Fund shall have the authority to adjust, modify, alter or change from time to
time the initial Non-Payment Period Rate if the Board of Directors of the Fund
determines and Moody's and S&P (and any Substitute Rating Agency in lieu of
Moody's or S&P in the event either of
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such parties shall not rate the AMPS) advise the Fund in writing that such
adjustment, modification, alteration or change will not adversely affect their
then-current ratings on the AMPS.
Restrictions on Dividends and Other Payments. For so long as any shares of
AMPS are outstanding, the Fund will not declare, pay or set apart for payment
any dividend or other distribution (other than a dividend or distribution paid
in shares of, or options, warrants or rights to subscribe for or purchase,
common stock or other stock, if any, ranking junior to shares of AMPS as to
dividends or upon liquidation) in respect of common stock or any other stock of
the Fund ranking junior to or on a parity with shares of AMPS as to dividends
or upon liquidation, or call for redemption, redeem, purchase or otherwise
acquire for consideration any shares of common stock or any other such junior
stock (except by conversion into or exchange for stock of the Fund ranking
junior to AMPS as to dividends and upon liquidation) or any such parity stock
(except by conversion into or exchange for stock of the Fund ranking junior to
or on a parity with AMPS as to dividends and upon liquidation), unless (A)
immediately after such transaction, the Fund would have S&P Eligible Assets and
Moody's Eligible Assets each with an aggregate Discounted Value equal to or
greater than the AMPS Basic Maintenance Amount, and the 1940 Act AMPS Asset
Coverage (see "Asset Maintenance" and "Redemption" below) would be satisfied,
(B) full cumulative dividends on shares of AMPS due on or prior to the date of
the transaction have been declared and paid or shall have been declared and
sufficient funds for the payment thereof deposited with the Auction Agent, (C)
any Additional Dividend required to be paid on or before the date of such
declaration or payment has been paid and (D) the Fund has redeemed the full
number of shares of AMPS required to be redeemed by any provision for mandatory
redemption contained in the Articles Supplementary.
Asset Maintenance
1940 Act AMPS Asset Coverage. The Fund will be required under the Articles
Supplementary to maintain, with respect to shares of AMPS, as of the last
Business Day of each month in which any shares of AMPS are outstanding, asset
coverage of at least 200% with respect to senior securities which are stock,
including the shares of AMPS (or such other asset coverage as in the future may
be specified in or under the 1940 Act as the minimum asset coverage for senior
securities which are stock of a closed-end investment company as a condition of
paying dividends on its common stock) ("1940 Act AMPS Asset Coverage"). If the
Fund fails to maintain 1940 Act AMPS Asset Coverage and such failure is not
cured as of the last Business Day of the following month (the "1940 Act Cure
Date"), the Fund will be required under certain circumstances to redeem certain
of the shares of AMPS. See "Redemption" in the prospectus and below.
AMPS Basic Maintenance Amount. So long as shares of AMPS are outstanding,
the Fund will be required under the Articles Supplementary to maintain as of
each Business Day (a "Valuation Date") S&P Eligible Assets and Moody's Eligible
Assets each having in the aggregate a Discounted Value at least equal to the
AMPS Basic Maintenance Amount. If the Fund fails to meet such requirement as of
any Valuation Date and such failure is not cured on or before the sixth
Business Day after such Valuation Date (the "AMPS Basic Maintenance Cure
Date"), the Fund will be required under certain circumstances to redeem certain
of the shares of AMPS. Upon any failure to maintain the required Discounted
Value, the Fund will use its best efforts to alter the composition of its
portfolio to reattain a Discounted Value at least equal to the AMPS Basic
Maintenance Amount on or prior to the AMPS Basic Maintenance Cure Date. See
"Redemption" in the prospectus and below.
The AMPS Basic Maintenance Amount as of any Valuation Date is defined as the
dollar amount equal to (i) the sum of (A) the product of the number of shares
of AMPS outstanding on such Valuation Date multiplied by the sum of $25,000 and
any applicable redemption premium attributable to the designation of a Premium
Call Period; (B) the aggregate amount of cash dividends (whether or not earned
or declared) that will have accumulated for each share of AMPS outstanding to
(but not including) the end of the current Dividend Period that follows such
Valuation Date in the event the then-current Dividend Period will end within 49
calendar days of such Valuation Date or through the 49th day after such
Valuation Date in the event the then-current
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Dividend Period for each series of AMPS will not end within 49 calendar days of
such Valuation Date; (C) in the event the then-current Dividend Period will end
within 49 calendar days of such Valuation Date, the aggregate amount of cash
dividends that would accumulate at the Maximum Applicable Rate applicable to a
Dividend Period of 28 or fewer days on any shares of AMPS outstanding from the
end of such Dividend Period through the 49th day after such Valuation Date,
multiplied by the larger of the Moody's Volatility Factor and the S&P
Volatility Factor determined from time to time by Moody's and S&P, respectively
(except that if such Valuation Date occurs during a Non-Payment Period, the
cash dividend for purposes of calculation would accumulate at the then-current
Non-Payment Period Rate); (D) the amount of anticipated Fund expenses for the
90 days subsequent to such Valuation Date (including any premiums payable with
respect to a Policy); (E) the amount of the Fund's Maximum Potential Additional
Dividend Liability as of such Valuation Date; and (F) any current liabilities
as of such Valuation Date to the extent not reflected in any of (i) (A) through
(i) (E) (including, without limitation, and immediately upon determination, any
amounts due and payable by the Fund pursuant to repurchase agreements, any
amounts payable for California Municipal Bonds or Municipal Bonds purchased as
of such Valuation Date) less (ii) either (A) the Discounted Value of any Fund
assets, or (B) the face value of any of the Fund's assets if such assets mature
prior to or on the date of redemption of AMPS or payment of a liability and are
either securities issued or guaranteed by the United States Government or
Deposit Securities, in both cases irrevocably deposited by the Fund for the
payment of the amount needed to redeem shares of AMPS subject to redemption or
to satisfy any of (i) (B) through (i) (F). For Moody's and S&P the Fund shall
include as a liability an amount calculated semi-annually equal to 150% of the
estimated cost of obtaining other insurance guaranteeing the timely payment of
interest on a Moody's Eligible Asset or S&P Eligible Asset and principal
thereof to maturity with respect to Moody's Eligible Assets and S&P Eligible
Assets that (i) are covered by a Policy which provides the Fund with the option
to obtain such other insurance and (ii) are discounted by a Moody's Discount
Factor or S&P Discount Factor, as the case may be, determined by reference to
the insurance claims-paying ability rating of the issuer of such Policy. For
purposes of the foregoing, "Maximum Potential Additional Dividend Liability,"
as of any Valuation Date, means the aggregate amount of Additional Dividends
that would be due if the Fund were to make Retroactive Taxable Allocations,
with respect to any fiscal year, estimated based upon dividends paid and the
amount of undistributed realized net capital gains and other taxable income
earned by the Fund, as of the end of the calendar month immediately preceding
such Valuation Date and assuming such Additional Dividends are fully taxable.
The Discount Factors and guidelines for determining the market value of the
Fund's portfolio holdings have been based on criteria established in connection
with rating the AMPS. These factors include, but are not limited to, the
sensitivity of the market value of the relevant asset to changes in interest
rates, the liquidity and depth of the market for the relevant asset, the credit
quality of the relevant asset (for example, the lower the rating of a debt
obligation, the higher the related discount factor) and the frequency with
which the relevant asset is marked to market. In no event shall the Discounted
Value of any asset of the Fund exceed its unpaid principal balance or face
amount as of the date of calculation. The Discount Factor relating to any asset
of the Fund and the AMPS Basic Maintenance Amount, the assets eligible for
inclusion in the calculation of the Discounted Value of the Fund's portfolio
and certain definitions and methods of calculation relating thereto may be
changed from time to time by the Fund, without shareholder approval, but only
in the event the Fund receives written confirmation from S&P, Moody's and any
Substitute Rating Agency that any such changes would not impair the ratings
then assigned to the shares of AMPS by S&P or Moody's or any Substitute Rating
Agency.
On or before the third Business Day after a Valuation Date on which the Fund
fails to maintain S&P Eligible Assets and Moody's Eligible Assets each with an
aggregate Discounted Value equal to or greater than the AMPS Basic Maintenance
Amount, the Fund is required to deliver to the Auction Agent, Moody's and S&P a
report with respect to the calculation of the AMPS Basic Maintenance Amount and
the value of its portfolio holdings as of the date of such failure (an "AMPS
Basic Maintenance Report"). Additionally, on or before the third Business Day
after the first day of a Special Dividend Period, the Fund will deliver an AMPS
Basic Maintenance Report to S&P and the Auction Agent. The Fund also will
deliver an AMPS Basic
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Maintenance Report as of the twenty-first day of the last month of each fiscal
quarter of the Fund (or, if such day is not a Business Day, the next succeeding
Business Day) on or before the third Business Day after such day. Within ten
Business Days after delivery of such report relating to the twenty-first day of
the last month of each fiscal quarter of the Fund, the Fund will deliver a
letter prepared by the Fund's independent accountants regarding the accuracy of
the calculations made by the Fund in its most recent AMPS Basic Maintenance
Report. Also, on or before 5:00 p.m., Eastern time, on the first Business Day
after shares of common stock are repurchased by the Fund, the Fund will
complete and deliver to S&P and Moody's an AMPS Basic Maintenance Report as of
the close of business on such date that common stock is repurchased. If any
such letter prepared by the Fund's independent accountants shows that an error
was made in the most recent AMPS Basic Maintenance Report, the calculation or
determination made by the Fund's independent accountants will be conclusive and
binding on the Fund.
Redemption
Mandatory Redemption. The number of shares of AMPS to be redeemed will be
equal to the lesser of (a) the minimum number of shares of AMPS the redemption
of which, if deemed to have occurred immediately prior to the opening of
business on the Cure Date, together with all other shares of the preferred
stock subject to redemption or retirement, would result in the Fund having S&P
Eligible Assets and Moody's Eligible Assets each with an aggregate Discounted
Value equal to or greater than the AMPS Basic Maintenance Amount or
satisfaction of the 1940 Act AMPS Asset Coverage, as the case may be, on such
Cure Date (provided that, if there is no such minimum number of shares the
redemption of which would have such result, all shares of AMPS then outstanding
will be redeemed), and (b) the maximum number of shares of AMPS, together with
all other shares of preferred stock subject to redemption or retirement, that
can be redeemed out of funds expected to be legally available therefor on such
redemption date. In determining the number of shares of AMPS required to be
redeemed in accordance with the foregoing, the Fund shall allocate the number
required to be redeemed which would result in the Fund having S&P Eligible
Assets and Moody's Eligible Assets each with an aggregate Discounted Value
equal to or greater than the AMPS Basic Maintenance Amount or satisfaction of
the 1940 Act AMPS Asset Coverage, as the case may be, pro rata among shares of
AMPS and other preferred stock subject to redemption pursuant to provisions
similar to those set forth below; provided that, shares of AMPS which may not
be redeemed at the option of the Fund due to the designation of a Non-Call
Period applicable to such shares (A) will be subject to mandatory redemption
only to the extent that other shares are not available to satisfy the number of
shares required to be redeemed and (B) will be selected for redemption in an
ascending order of outstanding number of days in the Non-Call Period (with
shares with the lowest number of days to be redeemed first) and by lot in the
event of shares having an equal number of days in such Non-Call Period. The
Fund is required to effect such a mandatory redemption not later than 35 days
after such Cure Date, except that if the Fund does not have funds legally
available for the redemption of all of the required number of shares of AMPS
which are subject to mandatory redemption or the Fund otherwise is unable to
effect such redemption on or prior to 35 days after such Cure Date, the Fund
will redeem those shares of AMPS which it was unable to redeem on the earliest
practicable date on which it is able to effect such redemption.
Notice of Redemption. If shares of AMPS of any series are to be redeemed, a
notice of redemption will be mailed to each record holder of such shares of
AMPS (initially Cede as nominee of the Securities Depository) and to the
Auction Agent not less than 17 nor more than 30 days prior to the date fixed
for the redemption thereof. Each notice of redemption will include a statement
setting forth: (i) the redemption date, (ii) the aggregate number of shares of
AMPS of such series to be redeemed, (iii) the redemption price, (iv) the place
or places where shares of AMPS of such series are to be surrendered for payment
of the redemption price, (v) a statement that dividends on the shares to be
redeemed will cease to accumulate on such redemption date (except that holders
may be entitled to Additional Dividends) and (vi) the provision of the Articles
Supplementary pursuant to which such shares are being redeemed. The notice also
will be published in The Wall Street Journal. No defect in the notice of
redemption or in the mailing or publication thereof will affect the validity of
the redemption proceedings, except as required by applicable law.
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In the event that less than all of the outstanding shares of any series of
AMPS are to be redeemed, the shares to be redeemed will be selected by lot or
such other method as the Fund shall deem fair and equitable, and the results
thereof will be communicated to the Auction Agent. The Auction Agent will give
notice to the Securities Depository, whose nominee will be the record holder of
all shares of AMPS, and the Securities Depository will determine the number of
shares to be redeemed from the account of the Agent Member of each Existing
Holder. Each Agent Member will determine the number of shares to be redeemed
from the account of each Existing Holder for which it acts as agent. An Agent
Member may select for redemption shares from the accounts of some Existing
Holders without selecting for redemption any shares from the accounts of other
Existing Holders. Notwithstanding the foregoing, if neither the Securities
Depository nor its nominee is the record holder of all of the shares of such
series, the particular shares to be redeemed shall be selected by the Fund by
lot or by such other method as the Fund shall deem fair and equitable.
If the Fund gives notice of redemption, and concurrently or thereafter
deposits in trust with the Auction Agent, or segregates in an account at the
Fund's custodian bank for the benefit of the Auction Agent, Deposit
Securities(with a right of substitution) having an aggregate Discounted Value
(utilizing in the case of S&P and S&P Exposure Period of 22 Business Days)
equal to the redemption payment for the shares of AMPS as to which notice of
redemption has been given, with irrevocable instructions and authority to pay
the redemption price to the record holders thereof, then upon the date of such
deposit or, if no such deposit is made, upon such date fixed for redemption
(unless the Fund shall default in making payment of the redemption price), all
rights of the holders of such shares called for redemption will cease and
terminate, except the right of such holders to receive the redemption price
thereof and any Additional Dividends, but without interest, and such shares no
longer will be deemed to be outstanding. The Fund will be entitled to receive,
from time to time, the interest, if any, earned on such Deposit Securities
deposited with the Auction Agent, and the holders of any shares so redeemed
will have no claim to any such interest. Any funds so deposited which are
unclaimed at the end of one year from such redemption date will be repaid, upon
demand, to the Fund, after which the holders of the shares of AMPS of such
series so called for redemption may look only to the Fund for payment thereof.
So long as any shares of AMPS are held of record by the nominee of the
Securities Depository (initially Cede), the redemption price for such shares
will be paid on the redemption date to the nominee of the Securities
Depository. The Securities Depository's normal procedures now provide for it to
distribute the amount of the redemption price to Agent Members who, in turn,
are expected to distribute such funds to the persons for whom they are acting
as agent.
Notwithstanding the provisions for redemption described above, no shares of
AMPS shall be subject to optional redemption (i) unless all dividends in
arrears on the outstanding shares of AMPS, and all capital stock of the Fund
ranking on a parity with the AMPS with respect to the payment of dividends or
upon liquidation, have been or are being contemporaneously paid or declared and
set aside for payment and (ii) if redemption thereof would result in the Fund's
failure to maintain Moody's Eligible Assets or S&P Eligible Assets with an
aggregate Discounted Value equal to or greater than the AMPS Basic Maintenance
Amount.
Voting Rights
In connection with the election of the Fund's directors, holders of shares of
AMPS and any other preferred stock, voting as a separate class, shall be
entitled at all times to elect two of the Fund's directors, and the remaining
directors will be elected by holders of shares of common stock and shares of
AMPS and any other preferred stock, voting together as a single class. In
addition, if at any time dividends on outstanding shares of AMPS shall be
unpaid in an amount equal to at least two full years' dividends thereon or if
at any time holders of any shares of preferred stock are entitled, together
with the holders of AMPS, to elect a majority of the directors of the Fund
under the 1940 Act, then the number of directors constituting the Board of
Directors automatically shall be increased by the smallest number that, when
added to the two directors elected exclusively by the holders of shares of AMPS
and any other preferred stock as described above, would constitute a majority
of the Board of Directors as so increased by such smallest number, and at a
special meeting of shareholders which will be called and held as soon as
practicable, and at all subsequent meetings at
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which directors are to be elected, the holders of shares of AMPS and any other
preferred stock, voting as a separate class, will be entitled to elect the
smallest number of additional directors that, together with the two directors
which such holders in any event will be entitled to elect, constitutes a
majority of the total number of directors of the Fund as so increased. The
terms of office of the persons who are directors at the time of that election
will continue. If the Fund thereafter shall pay, or declare and set apart for
payment in full, all dividends payable on all outstanding shares of AMPS and
any other preferred stock for all past Dividend Periods, the additional voting
rights of the holders of shares of AMPS and any other preferred stock as
described above shall cease, and the terms of office of all of the additional
directors elected by the holders of shares of AMPS and any other preferred
stock (but not of the directors with respect to whose election the holders of
common stock were entitled to vote or the two directors the holders of shares
of AMPS and any other preferred stock have the right to elect in any event)
will terminate automatically.
The affirmative vote of a majority of the votes entitled to be cast by
holders of outstanding shares of AMPS and any other preferred stock, voting as
a separate class, will be required to (i) authorize, create or issue any class
or series of stock ranking prior to the AMPS or any other series of preferred
stock with respect to the payment of dividends or the distribution of assets on
liquidation, or (ii) amend, alter or repeal the provisions of the Articles of
Incorporation, whether by merger, consolidation or otherwise, so as to
adversely affect any of the contract rights expressly set forth in the Articles
of Incorporation of holders of shares of AMPS or any other preferred stock. To
the extent permitted under the 1940 Act, in the event shares of more than one
series of AMPS are outstanding, the Fund shall not approve any of the actions
set forth in clause (i) or (ii) which adversely affects the contract rights
expressly set forth in the Articles of Incorporation of a holder of shares of a
series of AMPS differently than those of a holder of shares of any other series
of AMPS without the affirmative vote of at least a majority of votes entitled
to be cast by holders of the shares of AMPS of each series adversely affected
and outstanding at such time (each such adversely affected series voting
separately as a class). The Board of Directors, however, without shareholder
approval, may amend, alter or repeal any or all of the various rating agency
guidelines described herein in the event the Fund receives confirmation from
the rating agencies that any such amendment, alteration or repeal would not
impair the ratings then assigned to shares of AMPS. Unless a higher percentage
is provided for under "Description of Capital Stock--Certain Provisions of the
Charter" in the prospectus, the affirmative vote of a majority of the votes
entitled to be cast by holders of outstanding shares of AMPS and any other
preferred stock, voting as a separate class, will be required to approve any
plan of reorganization (including bankruptcy proceedings) adversely affecting
such shares or any action requiring a vote of security holders under Section
13(a) of the 1940 Act including, among other things, changes in the Fund's
investment objective or changes in the investment restrictions described as
fundamental policies under "Investment Objective and Policies." The class vote
of holders of shares of AMPS and any other preferred stock described above in
each case will be in addition to a separate vote of the requisite percentage of
shares of common stock and shares of AMPS and any other preferred stock, voting
together as a single class, necessary to authorize the action in question.
The foregoing voting provisions will not apply to any series of AMPS if, at
or prior to the time when the act with respect to which such vote otherwise
would be required shall be effected, such shares shall have been (i) redeemed
or (ii) called for redemption and sufficient funds shall have been deposited in
trust to effect such redemption.
THE AUCTION
Auction Agent Agreement
The Auction Agent will act as agent for the Fund in connection with Auctions.
In the absence of bad faith or negligence on its part, the Auction Agent will
not be liable for any action taken, suffered or omitted, or for any error of
judgment made, by it in the performance of its duties under the Auction Agent
Agreement, and will not be liable for any error of judgment made in good faith
unless the Auction Agent shall have been negligent in ascertaining the
pertinent facts. Pursuant to the Auction Agent Agreement, the Fund is required
to indemnify the Auction Agent for certain losses and liabilities incurred by
the Auction Agent without negligence or bad faith on its part in connection
with the performance of its duties under such agreement.
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The Auction Agent may terminate the Auction Agent Agreement upon notice to
the Fund, which termination may be no earlier than 60 days following delivery
of such notice. If the Auction Agent resigns, the Fund will use its best
efforts to enter into an agreement with a successor Auction Agent containing
substantially the same terms and conditions as the Auction Agent Agreement. The
Fund may terminate the Auction Agent Agreement, provided that prior to such
termination the Fund shall have entered into such an agreement with respect
thereto with a successor Auction Agent.
Broker-Dealer Agreements
The Auctions require the participation of one or more broker-dealers. A
Broker-Dealer Agreement may be terminated by the Auction Agent or a Broker-
Dealer on five days' notice to the other party, provided that the Broker-Dealer
Agreement with Merrill Lynch may not be terminated without the prior written
consent of the Fund, which consent may not be unreasonably withheld.
Auction Procedures
Separate auctions will be conducted for each series of AMPS. The Auction
Procedures are set forth in Appendix E to this statement of additional
information. The Settlement Procedures to be used with respect to Auctions are
set forth in Appendix D to this statement of additional information.
RATING AGENCY GUIDELINES
S&P AAA Rating Guidelines
The Discounted Value of the Fund's S&P Eligible Assets is calculated on each
Valuation Date. See "Description of AMPS--Asset Maintenance--AMPS Basic
Maintenance Amount." S&P Eligible Assets include cash, Receivables for
California Municipal Bonds Sold (as defined below) and California Municipal
Bonds or Municipal Bonds eligible for consideration under S&P's current
guidelines. For purposes of calculating the Discounted Value of the Fund's
portfolio under current S&P guidelines, the fair market value of California
Municipal Bonds or Municipal Bonds eligible for consideration under such
guidelines must be discounted by the applicable S&P Discount Factor set forth
in the table below. The Discounted Value of a California Municipal Bond or
Municipal Bond eligible for consideration under S&P guidelines is the fair
market value thereof divided by the S&P Discount Factor. The S&P Discount
Factor used to discount a particular California Municipal Bond or Municipal
Bond will be determined by reference to (a)(i) the rating by S&P, Moody's or
Fitch on such Bond or (ii) in the event the California Municipal Bond is
insured under a Policy and the terms of the Policy permit the Fund, at its
option, to obtain other permanent insurance guaranteeing the timely payment of
interest on such California Municipal Bond and principal thereof to maturity,
the S&P insurance claims-paying ability rating of the issuer of the Policy or
(iii) in the event the California Municipal Bond is insured under an insurance
policy which guarantees the timely payment of interest on such California
Municipal Bond and principal thereof to maturity, the S&P insurance claims-
paying ability rating of the issuer of the insurance policy and (b) the S&P
Exposure Period. The S&P Exposure Period is the maximum period of time
following a Valuation Date, including the Valuation Date and the AMPS Basic
Maintenance Cure Date, that the Fund has to cure any failure to maintain, as of
such Valuation Date, a Discounted Value for its portfolio at least equal to the
AMPS Basic Maintenance Amount.
S&P Discount Factors applicable to California Municipal Bonds for a range of
S&P Exposure Periods are set forth below:
<TABLE>
<CAPTION>
S&P Discount
Factors Rating
Category
------------------
Exposure Period AAA AA A BBB
--------------- --- --- --- ---
<S> <C> <C> <C> <C>
40 Business Days....................................... 200% 205% 220% 260%
22 Business Days....................................... 180 185 200 240
10 Business Days....................................... 165 170 185 225
7 Business Days....................................... 160 165 180 220
3 Business Days....................................... 140 145 160 200
</TABLE>
17
<PAGE>
Since the S&P Exposure Period currently applicable to the Fund is seven
Business Days, the S&P Discount Factors currently applicable to Municipal Bonds
eligible for consideration under S&P guidelines will be determined by reference
to the factors set forth opposite the exposure period line entitled "7 Business
Days." Notwithstanding the foregoing, (i) the S&P Discount Factor for short-
term California Municipal Bonds will be 115%, so long as such California
Municipal Bonds are rated A-1+ or SP-1+ by S&P and mature or have a demand
feature exercisable in 30 days or less, or 120% so long as such California
Municipal Bonds are rated A-1 or SP-1 by S&P and mature or have a demand
feature exercisable in 30 days or less, or 125% if such California Municipal
Bonds are not rated by S&P but are rated VMIG-1, P-1 or MIG-1 by Moody's or F-
1+ by Fitch; provided, however, such short-term California Municipal Bonds
rated by Moody's or Fitch but not rated by S&P having a demand feature
exercisable in 30 days or less must be backed by a letter of credit, liquidity
facility or guarantee from a bank or other financial institution having a
short-term rating of at least A-1+ from S&P; and further provided that such
short-term California Municipal Bonds rated by Moody's or Fitch but not rated
by S&P may comprise no more than 50% of short-term California Municipal Bonds
that qualify as S&P Eligible Assets, (ii) the S&P Discount Factor for
Receivables for California Municipal Bonds Sold that are due in more than five
Business Days from such Valuation Date will be the S&P Discount Factor
applicable to the California Municipal Bonds sold, and (iii) no S&P Discount
Factor will be applied to cash or to Receivables for California Municipal Bonds
Sold if such receivables are due within five Business Days of such Valuation
Date. "Receivables for California Municipal Bonds Sold," for purposes of
calculating S&P Eligible Assets as of any Valuation Date, means the book value
of receivables for California Municipal Bonds sold as of or prior to such
Valuation Date. The Fund may adopt S&P Discount Factors for Municipal Bonds
other than California Municipal Bonds provided that S&P advises the Fund in
writing that such action will not adversely affect its then current rating on
the AMPS. For purposes of the foregoing, Anticipation Notes rated SP-1 or, if
not rated by S&P, rated VMIG-1 by Moody's or F-1+ by Fitch, which do not mature
or have a demand feature exercisable in 30 days and which do not have a long-
term rating, shall be considered to be short-term California Municipal Bonds.
The S&P guidelines require certain minimum issue size and geographical
diversification and impose other requirements for purposes of determining S&P
Eligible Assets. In order to be considered S&P Eligible Assets, Municipal Bonds
must:
(i) be interest bearing and pay interest at least semi-annually;
(ii) be payable with respect to principal and interest in U.S. dollars;
(iii) be publicly rated BBB or higher by S&P or, except in the case of
Anticipation Notes that are grant anticipation notes or bond anticipation
notes, which must be rated by S&P to be included in S&P Eligible Assets, if
not rated by S&P but rated by Moody's or Fitch, be rated at least A by
Moody's or Fitch (provided that such Moody's-rated or Fitch-rated
California Municipal Bonds will be included in S&P Eligible Assets only to
the extent the fair market value of such California Municipal Bonds does
not exceed 50% of the aggregate fair market value of the S&P Eligible
Assets. For purposes of determining the S&P Discount Factors applicable to
any such Moody's-rated or Fitch-rated Municipal Bonds, such California
Municipal Bonds will be deemed to have an S&P rating that is one full
rating category lower than its Moody's rating or Fitch rating);
(iv) not be subject to a covered call or covered put option written by
the Fund;
(v) except for inverse floating obligations, not be part of a private
placement of Municipal Bonds; and
(vi) except for inverse floating obligations, be part of an issue with an
original issue size of at least $20 million or, if of an issue with an
original issue size below $20 million (but in no event below $10 million),
be issued by an issuer with a total of at least $50 million of securities
outstanding.
Notwithstanding the foregoing:
(i) California Municipal Bonds of any one issuer or guarantor (excluding
bond insurers) will be considered S&P Eligible Assets only to the extent
the fair market value of such Bonds does not exceed
18
<PAGE>
10% of the aggregate fair market value of the S&P Eligible Assets, provided
that 2% is added to the applicable S&P Discount Factor for every 1% by
which the fair market value of such California Municipal Bonds exceeds 5%
of the aggregate fair market value of the S&P Eligible Assets;
(ii) California Municipal Bonds of any one issue type category (as
described below) will be considered S&P Eligible Assets only to the extent
the market value of such California Municipal Bonds does not exceed 25% of
the aggregate market value of S&P Eligible Assets, except that California
Municipal Bonds falling within the utility issue type category will be
broken down into three sub-categories (as described below) and such
California Municipal Bonds will be considered S&P Eligible Assets to the
extent the market value of such California Municipal Bonds in each such
sub-category does not exceed 25% of the aggregate market value of S&P
Eligible Assets, except that California Municipal Bonds falling within the
transportation issue type category will be broken down into two sub-
categories (as described below) and such California Municipal Bonds will be
considered S&P Eligible Assets to the extent the market value of such Bonds
in both sub-categories combined (as described below) does not exceed 40% of
the aggregate market value of S&P Eligible Assets and except that
California Municipal Bonds falling within the general obligation issue type
category will be considered S&P Eligible Assets to the extent the market
value of such California Municipal Bonds does not exceed 50% of the
aggregate market value of S&P Eligible Assets. For purposes of the issue
type category requirement described above, California Municipal Bonds will
be classified within one of the following categories: health care issues,
housing issues, educational facilities issues, student loan issues,
transportation issues, industrial development bond issues, utility issues,
general obligation issues, lease obligations, escrowed bonds and other
issues not falling within one of the aforementioned categories. The general
obligation issue type category includes any issuer that is directly or
indirectly guaranteed by the State of California or its political
subdivisions. Utility issuers are included in the general obligation issue
type category if the issuer is directly or indirectly guaranteed by the
State of California or its political subdivisions. For purposes of the
issue type category requirement described above, California Municipal Bonds
in the utility issue type category will be classified within one of the
three following sub-categories: (1) electric, gas and combination issues
(if the combination issue includes an electric issue), (2) water and sewer
utilities and combination issues (if the combination issue does not include
an electric issue), and (3) irrigation, resource recovery, solid waste and
other utilities, provided that California Municipal Bonds included in this
sub-category (3) must be rated by S&P in order to be included in S&P
Eligible Assets. For purposes of the issue type category requirement
described above, California Municipal Bonds in the transportation issue
type category will be classified within one of the two following sub-
categories: (i) streets and highways, toll roads, bridges and tunnels,
airports and multi-purpose port authorities (multiple revenue streams
generated by toll roads, airports, real estate, bridges) or (ii) mass
transit, parking, seaports and others. Exposure to transportation sub-
category (i) in the preceding sentence is limited to 25% of the aggregate
market value of S&P Eligible Assets, provided, however, exposure to
transportation sub-category (ii) in the preceding sentence can exceed the
25% limit to the extent that exposure to transportation sub-category (ii)
is reduced, for a total exposure up to and not exceeding 40% of the
aggregate market value of S&P Eligible Assets for the transportation issue
type category; and
(iii) California Municipal Bonds which are escrow bonds or defeased bonds
may compose up to 100% of the aggregate market value of S&P Eligible Assets
if such California Municipal Bonds initially are assigned a rating by S&P
in accordance with S&P's legal defeasance criteria or rerated by S&P as
economic defeased escrow bonds and assigned an AAA rating. California
Municipal Bonds may be rated as escrow bonds by another nationally
recognized rating agency or rerated as an escrow bond and assigned the
equivalent of an S&P AAA rating, provided that such equivalent rated
California Municipal Bonds are limited to 50% of the aggregate market value
of S&P Eligible Assets and are deemed to have an AA S&P rating for purposes
of determining the S&P Discount Factor applicable to such California
Municipal Bonds. The limitations on California Municipal Bonds of any one
issuer in clause (i) above is not applicable to escrow bonds, however,
economically defeased bonds that are either initially rated or rerated by
S&P or another nationally recognized rating agency and assigned the same
rating level as the issuer of the California Municipal Bonds will remain in
its original issue type category set forth in clause (ii) above.
19
<PAGE>
California Municipal Bonds that are legally defeased and secured by
securities issued or guaranteed by the United States Government are not
required to meet the minimum issuance size requirement set forth above.
As discussed in the prospectus, the Fund may engage in options or futures
transactions. For so long as any shares of AMPS are rated by S&P, the Fund will
not purchase or sell financial futures contracts, write, purchase or sell
options on financial futures contracts or write put options (except covered put
options) or call options (except covered call options) on portfolio securities
unless it receives written confirmation from S&P that engaging in such
transactions will not impair the ratings then assigned to the shares of AMPS by
S&P, except that the Fund may purchase or sell financial futures contracts
based on the Bond Buyer Municipal Bond Index (the "Municipal Index") or United
States Treasury Bonds or Notes ("Treasury Bonds") and write, purchase or sell
put and call options on such contracts (collectively "S&P Hedging
Transactions"), subject to the following limitations:
(i) the Fund will not engage in any S&P Hedging Transaction based on the
Municipal Index (other than transactions that terminate a financial futures
contract or option held by the Fund by the Fund's taking an opposite
position thereto ("Closing Transactions")), that would cause the Fund at
the time of such transaction to own or have sold the least of (A) more than
1,000 outstanding financial futures contracts based on the Municipal Index,
(B) outstanding financial futures contracts based on the Municipal Index
exceeding in number 25% of the quotient of the fair market value of the
Fund's total assets divided by $1,000 or (C) outstanding financial futures
contracts based on the Municipal Index exceeding in number 10% of the
average number of daily traded financial futures contracts based on the
Municipal Index in the 30 days preceding the time of effecting such
transaction as reported by The Wall Street Journal;
(ii) the Fund will not engage in any S&P Hedging Transaction based on
Treasury Bonds (other than Closing Transactions) that would cause the Fund
at the time of such transaction to own or have sold the lesser of (A)
outstanding financial futures contracts based on Treasury Bonds and on the
Municipal Index exceeding in number 25% of the quotient of the fair market
value of the Fund's total assets divided by $100,000 ($200,000 in the case
of the two-year United States Treasury Note) or (B) outstanding financial
futures contracts based on Treasury Bonds exceeding in number 10% of the
average number of daily traded financial futures contracts based on
Treasury Bonds in the 30 days preceding the time of effecting such
transaction as reported by The Wall Street Journal;
(iii) the Fund will engage in Closing Transactions to close out any
outstanding financial futures contract that the Fund owns or has sold or
any outstanding option thereon owned by the Fund in the event (A) the Fund
does not have S&P Eligible Assets with an aggregate Discounted Value equal
to or greater than the AMPS Basic Maintenance Amount on two consecutive
Valuation Dates and (B) the Fund is required to pay Variation Margin on the
second such Valuation Date;
(iv) the Fund will engage in a Closing Transaction to close out any
outstanding financial futures contract or option thereon in the month prior
to the delivery month under the terms of such financial futures contract or
option thereon unless the Fund holds the securities deliverable under such
terms; and
(v) when the Fund writes a financial futures contract or an option
thereon, it will either maintain an amount of cash, cash equivalents or
high grade (rated A or better by S&P) fixed-income securities in a
segregated account with the Fund's custodian, so that the amount so
segregated plus the amount of Initial Margin and Variation Margin held in
the account of or on behalf of the Fund's broker with respect to such
financial futures contract or option equals the fair market value of the
financial futures contract or option, or, in the event the Fund writes a
financial futures contract or option thereon that requires delivery of an
underlying security, it shall hold such underlying security in its
portfolio.
For purposes of determining whether the Fund has S&P Eligible Assets with a
Discounted Value that equals or exceeds the AMPS Basic Maintenance Amount, the
Discounted Value of cash or securities held for the payment of Initial Margin
or Variation Margin shall be zero and the aggregate Discounted Value of S&P
Eligible Assets shall be reduced by an amount equal to (i) 30% of the aggregate
settlement value, as marked to
20
<PAGE>
market, of any outstanding financial futures contracts based on the Municipal
Index that are owned by the Fund plus (ii) 25% of the aggregate settlement
value, as marked to market, of any outstanding financial futures contracts
based on Treasury Bonds which contracts are owned by the Fund.
Moody's "aaa" Rating Guidelines
The Discounted Value of the Fund's Moody's Eligible Assets is calculated on
each Valuation Date. See "Description of AMPS--Asset Maintenance--AMPS Basic
Maintenance Amount" herein. Moody's Eligible Assets include cash, Receivables
for California Municipal Bonds or Municipal Bonds (as defined below), and
California Municipal Bonds or Municipal Bonds eligible for consideration under
Moody's guidelines. For purposes of calculating the Discounted Value of the
Fund's portfolio under current Moody's guidelines, the fair market value of
Municipal Bonds eligible for consideration under such guidelines must be
discounted by the applicable Moody's Discount Factor set forth in the table
below. The Discounted Value of a Municipal Bond eligible for consideration
under Moody's guidelines is the lower of par and the quotient of the fair
market value thereof divided by the Moody's Discount Factor. The Moody's
Discount Factor used to discount a particular California Municipal Bond or
Municipal Bond will be determined by reference to (a) (i) the rating by Moody's
or S&P on such Bond or (ii) in the event the Moody's Eligible Asset is insured
under a Policy and the terms of the Policy permit the Fund, at its option, to
obtain other insurance guaranteeing the timely payment of interest on such
Moody's Eligible Asset and principal thereof to maturity, the Moody's insurance
claims-paying ability rating of the issuer of the Policy or (iii) in the event
the Moody's Eligible Asset is insured under an insurance policy which
guarantees the timely payment of interest on such Moody's Eligible Asset and
principal thereof to maturity, the Moody's insurance claims-paying ability
rating of the issuer of the insurance policy (provided that for purposes of
clauses (ii) and (iii) if the insurance claims-paying ability of an issuer of a
Policy or insurance policy is not rated by Moody's but is rated by S&P, such
issuer shall be deemed to have a Moody's insurance claims-paying ability rating
which is two full categories lower than the S&P insurance claims-paying ability
rating) and (b) the Moody's Exposure Period. Moody's Discount Factors for a
range of Moody's Exposure Periods are set forth below:
<TABLE>
<CAPTION>
Moody's Discount Factors Rating Category
-----------------------------------------------------
Moody's Exposure Period Aaa(1) Aa(1) A(1) Baa(1) Other(2) VMIG-1(3) SP-1+(3)
----------------------- ------ ----- ---- ------ -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
7 weeks or less......... 151% 159% 168% 202% 229% 136% 148%
8 weeks or less but
greater than seven
weeks.................. 154 164 173 205 235 137 149
9 weeks or less but
greater than eight
weeks.................. 158 169 179 209 242 138 150
</TABLE>
- --------
(1) Moody's rating.
(2) California Municipal Bonds and Municipal Bonds not rated by Moody's but
rated BBB or BBB+ by S&P.
(3) California Municipal Bonds and Municipal Bonds rated MIG-1, VMIG-1 or P-1
or, if not rated by Moody's, rated SP-1+ or A-1+ by S&P which do not mature
or have a demand feature at par exercisable within the Moody's Exposure
Period and which do not have a long-term rating. For the purposes of the
definition of Moody's Eligible Assets, these securities will have an
assumed rating of A by Moody's.
provided, however, in the event a Moody's Discount Factor applicable to a
Moody's Eligible Asset is determined by reference to an insurance claims-paying
ability rating in accordance with clause (a)(ii) or (a)(iii), such Moody's
Discount Factor shall be increased by an amount equal to 50% of the difference
between (a) the percentage set forth in the foregoing table under the
applicable rating category and (b) the percentage set forth in the foregoing
table under the rating category which is one category lower than the applicable
rating category.
Since the Moody's Exposure Period currently is 49 days, the Moody's Discount
Factors currently applicable to Municipal Bonds eligible for consideration
under Moody's guidelines will be determined by reference to the factors set
forth opposite the exposure period line entitled "7 weeks or less."
Notwithstanding the foregoing, (i) no Moody's Discount Factor will be applied
to short-term California Municipal Bonds and short-term Municipal Bonds, so
long as such California Municipal Bonds and Municipal Bonds are rated at
21
<PAGE>
least MIG-1, VMIG-1 or P-1 by Moody's and mature or have a demand feature at
par exercisable within the Moody's Exposure Period, and the Moody's Discount
Factor for such Bonds will be 125% if such Bonds are not rated by Moody's but
are rated A-1+, SP-1+ or AA by S&P and mature or have a demand feature at par
exercisable within the Moody's Exposure Period, and (ii) no Moody's Discount
Factor will be applied to cash or to Receivables for California Municipal Bonds
or Municipal Bonds Sold. "Receivables for California Municipal Bonds or
Municipal Bonds Sold," for purposes of calculating Moody's Eligible Assets as
of any Valuation Date, means no more than the aggregate of the following: (i)
the book value of receivables for California Municipal Bonds or Municipal Bonds
sold as of or prior to such Valuation Date if such receivables are due within
five Business Days of such Valuation Date, and if the trades which generated
such receivables are (A) settled through clearing house firms with respect to
which the Fund has received prior written authorization from Moody's or (B)
with counterparties having a Moody's long-term debt rating of at least Baa3;
and (ii) the Moody's Discounted Value of California Municipal Bonds or
Municipal Bonds sold as of or prior to such Valuation Date that generated
receivables, if such receivables are due within five Business Days of such
Valuation Date but do not comply with either of conditions (A) or (B) of the
preceding clause (i).
The Moody's guidelines impose certain requirements as to minimum issue size,
issuer diversification and geographical concentration, as well as other
requirements for purposes of determining whether California Municipal Bonds or
Municipal Bonds constitute Moody's Eligible Assets, as set forth in the table
below:
<TABLE>
<CAPTION>
Maximum Maximum State
Minimum Maximum Issue Type Maximum County or Territory
Issue Size Underlying Concentration Concentration Concentration
Rating ($ Millions) Obligor (%)(1) (%)(1)(3) (%)(1)(4) (%)(1)(5)
- ------ ------------ -------------- ------------- -------------- -------------
<S> <C> <C> <C> <C> <C>
Aaa..................... 10 100 100 100 100
Aa...................... 10 20 60 60 60
A....................... 10 10 40 40 40
Baa..................... 10 6 20 20 20
Other(2)................ 10 4 10 10 10
</TABLE>
- --------
(1) The referenced percentages represent maximum cumulative totals for the
related rating category and each lower rating category.
(2) California Municipal Bonds and Municipal Bonds not rated by Moody's but
rated BBB or BBB+ by S&P.
(3) Does not apply to general obligation bonds.
(4) Applicable to general obligation bonds only.
(5) Does not apply to California Municipal Bonds. Territorial bonds (other than
those issued by Puerto Rico and counted collectively) are each limited to
10% of Moody's Eligible Assets. For diversification purposes, Puerto Rico
will be treated as a state.
For purposes of the maximum underlying obligor requirement described above,
any California Municipal Bond or Municipal Bond backed by the guaranty, letter
of credit or insurance issued by a third party will be deemed to be issued by
such third party if the issuance of such third party credit is the sole
determinant of the rating on such Bond. For purposes of the issue type
concentration requirement described above, California Municipal Bonds and
Municipal Bonds will be classified within one of the following categories:
health care issues (teaching and non-teaching hospitals, public and private),
housing issues (single- and multi-family), educational facilities issues
(public and private schools), student loan issues, resource recovery issues,
transportation issues (mass transit, airport and highway bonds), industrial
revenue/pollution control bond issues, utility issues (including water, sewer
and electricity), general obligation issues, lease obligations/certificates of
participation, escrowed bonds and other issues ("Other Issues") not falling
within one of the aforementioned categories (includes special obligations to
crossover, excise and sales tax revenue, recreation revenue, special assessment
and telephone revenue bonds). In no event shall (a) more than 10% of Moody's
Eligible Assets consist of student loan issues, (b) more than 10% of Moody's
Eligible Assets consist of recovery issues or (c) more than 10% of Moody's
Eligible Assets consist of Other Issues.
22
<PAGE>
Current Moody's guidelines also require that California Municipal Bonds or
Municipal Bonds constituting Moody's Eligible Assets pay interest in cash, be
publicly rated Baa or higher by Moody's or, if not rated by Moody's but rated
by S&P, that they be rated at least BBB by S&P, not have suspended ratings by
Moody's and be part of an issue of California Municipal Bonds or Municipal
Bonds of at least $10,000,000. For purposes of determining the Moody's Discount
Factors applicable to any such S&P-rated California Municipal Bonds or S&P-
rated Municipal Bonds, such California Municipal Bonds or Municipal Bonds
(excluding any short-term Municipal Bonds) will be deemed to have a Moody's
rating that is one full rating category lower than its S&P rating. When the
Fund sells a California Municipal Bond or Municipal Bond and agrees to
repurchase it at a future date, the Discounted Value of such Municipal Bond
will constitute a Moody's Eligible Asset and the amount the Fund is required to
pay upon repurchase of such bond will count as a liability for purposes of
calculating the AMPS Basic Maintenance Amount. When the Fund purchases a
California Municipal Bond or Municipal Bond and agrees to sell it at a future
date to another party, cash receivable by the Fund thereby will constitute a
Moody's Eligible Asset if the long-term debt of such other party is rated at
least A2 by Moody's and such agreement has a term of 30 days or less; otherwise
the Discounted Value of such Bond will constitute a Moody's Eligible Asset.
Notwithstanding the foregoing, an asset will not be considered a Moody's
Eligible Asset if it is (i) held in a margin account, (ii) subject to any
material lien, mortgage, pledge, security interest or security agreement of any
kind, (iii) held for the purchase of a security pursuant to a Forward
Commitment or (iv) irrevocably deposited by the Fund for the payment of
dividends or redemption.
For so long as shares of AMPS are rated by Moody's, in managing the Fund's
portfolio, the Investment Adviser will not alter the composition of the Fund's
portfolio if, in the reasonable belief of the Investment Adviser, the effect of
any such alteration would be to cause the Fund to have Moody's Eligible Assets
with an aggregate Discounted Value, as of the immediately preceding Valuation
Date, less than the AMPS Basic Maintenance Amount as of such Valuation Date;
provided, however, that in the event that, as of the immediately preceding
Valuation Date, the aggregate Discounted Value of Moody's Eligible Assets
exceeded the AMPS Basic Maintenance Amount by five percent or less, the
Investment Adviser will not alter the composition of the Fund's portfolio in a
manner reasonably expected to reduce the aggregate Discounted Value of Moody's
Eligible Assets unless the Fund shall have confirmed that, after giving effect
to such alteration, the aggregate Discounted Value of Moody's Eligible Assets
would exceed the AMPS Basic Maintenance Amount.
For so long as any shares of AMPS are rated by Moody's, the Fund will not buy
or sell financial futures contracts, write, purchase or sell call options on
financial futures contracts or purchase put options on financial futures
contracts or write call options (except covered call options) on portfolio
securities unless it receives written confirmation from Moody's that engaging
in such transactions would not impair the ratings then assigned to the shares
of AMPS by Moody's, except that the Fund may purchase or sell exchange-traded
financial futures contracts based on the Municipal Index or Treasury Bonds, and
purchase, write or sell exchange-traded put options on such financial futures
contracts, and purchase, write or sell exchange-traded call options on such
financial futures contracts (collectively "Moody's Hedging Transactions"),
subject to the following limitations:
(i) the Fund will not engage in any Moody's Hedging Transaction based on
the Municipal Index (other than Closing Transactions) that would cause the
Fund at the time of such transaction to own or have sold (A) outstanding
financial futures contracts based on the Municipal Index exceeding in
number 10% of the average number of daily traded financial futures
contracts based on the Municipal Index in the 30 days preceding the time of
effecting such transaction as reported by The Wall Street Journal or (B)
outstanding financial futures contracts based on the Municipal Index having
a Market Value exceeding 50% of the Market Value of all Municipal Bonds
constituting Moody's Eligible Assets owned by the Fund (other than Moody's
Eligible Assets already subject to a Moody's Hedging Transaction);
(ii) the Fund will not engage in any Moody's Hedging Transaction based on
Treasury Bonds (other than Closing Transactions) that would cause the Fund
at the time of such transaction to own or have sold (A) outstanding
financial futures contracts based on Treasury Bonds having an aggregate
Market Value
23
<PAGE>
exceeding 20% of the aggregate Market Value of Moody's Eligible Assets
owned by the Fund and rated Aa by Moody's (or, if not rated by Moody's but
rated by S&P, rated AAA by S&P) or (B) outstanding financial futures
contracts based on Treasury Bonds having an aggregate fair market value
exceeding 40% of the aggregate fair market value of all Municipal Bonds
constituting Moody's Eligible Assets owned by the Fund (other than Moody's
Eligible Assets already subject to a Moody's Hedging Transaction) and rated
Baa or A by Moody's (or, if not rated by Moody's but rated by S&P, rated A
or AA by S&P) (for purposes of the foregoing clauses (i) and (ii), the Fund
shall be deemed to own the number of financial futures contracts that
underlie any outstanding options written by the Fund);
(iii) the Fund will engage in Closing Transactions to close out any
outstanding financial futures contract based on the Municipal Index if the
amount of open interest in the Municipal Index as reported by The Wall
Street Journal is less than 5,000;
(iv) the Fund will engage in a Closing Transaction to close out any
outstanding financial futures contract by no later than the fifth Business
Day of the month in which such contract expires and will engage in a
Closing Transaction to close out any outstanding option on a financial
futures contract by no later than the first Business Day of the month in
which such option expires;
(v) the Fund will engage in Moody's Hedging Transactions only with
respect to financial futures contracts or options thereon having the next
settlement date or the settlement date immediately thereafter;
(vi) the Fund will not engage in options and futures transactions for
leveraging or speculative purposes and will not write any call options or
sell any financial futures contracts for the purpose of hedging the
anticipated purchase of an asset prior to completion of such purchase; and
(vii) the Fund will not enter into an option or futures transaction
unless, after giving effect thereto, the Fund would continue to have
Moody's Eligible Assets with an aggregate Discounted Value equal to or
greater than the AMPS Basic Maintenance Amount.
For purposes of determining whether the Fund has Moody's Eligible Assets with
an aggregate Discounted Value that equals or exceeds the AMPS Basic Maintenance
Amount, the Discounted Value of Moody's Eligible Assets that the Fund is
obligated to deliver or receive pursuant to an outstanding futures contract or
option shall be as follows: (i) assets subject to call options written by the
Fund that are either exchange-traded and "readily reversible" or that expire
within 49 days after the date as of which such valuation is made shall be
valued at the lesser of (A) Discounted Value and (B) the exercise price of the
call option written by the Fund; (ii) assets subject to call options written by
the Fund not meeting the requirements of clause (i) of this sentence shall have
no value; (iii) assets subject to put options written by the Fund shall be
valued at the lesser of (A) the exercise price and (B) the Discounted Value of
the subject security; (iv) futures contracts shall be valued at the lesser of
(A) settlement price and (B) the Discounted Value of the subject security,
provided that, if a contract matures within 49 days after the date as of which
such valuation is made, where the Fund is the seller the contract may be valued
at the settlement price and where the Fund is the buyer the contract may be
valued at the Discounted Value of the subject securities; and (v) where
delivery may be made to the Fund with any security of a class of securities,
the Fund shall assume that it will take delivery of the security with the
lowest Discounted Value.
For purposes of determining whether the Fund has Moody's Eligible Assets with
an aggregate Discounted Value that equals or exceeds the AMPS Basic Maintenance
Amount, the following amounts shall be subtracted from the aggregate Discounted
Value of the Moody's Eligible Assets held by the Fund: 10% of the exercise
price of a written call option; (ii) the exercise price of any written put
option; (iii) where the Fund is the seller under a financial futures contract,
10% of the settlement price of the financial futures contract; (iv) where the
Fund is the purchaser under a financial futures contract, the settlement price
of assets purchased under such financial futures contract; (v) the settlement
price of the underlying financial futures contract if the Fund writes put
options on a financial futures contract; and (vi) 105% of the fair market value
of the underlying financial futures contracts if the Fund writes call options
on a financial futures contract and does not own the underlying contract.
24
<PAGE>
For so long as any shares of AMPS are rated by Moody's, the Fund will not
enter into any contract to purchase securities for a fixed price at a future
date beyond customary settlement time (other than such contracts that
constitute Moody's Hedging Transactions), except that the Fund may enter into
such contracts to purchase newly-issued securities on the date such securities
are issued ("Forward Commitments"), subject to the following limitations:
(i) the Fund will maintain in a segregated account with its custodian
cash, cash equivalents or short term, fixed-income securities rated P-1,
MIG-1 or VMIG-1 by Moody's and maturing prior to the date of the Forward
Commitment with a fair market value that equals or exceeds the amount of
the Fund's obligations under any Forward Commitments to which it is from
time to time a party or long-term, fixed income securities with a
Discounted Value that equals or exceeds the amount of the Fund's
obligations under any Forward Commitment to which it is from time to time a
party, and
(ii) the Fund will not enter into a Forward Commitment unless, after
giving effect thereto, the Fund would continue to have Moody's Eligible
Assets with an aggregate Discounted Value equal to or greater than the AMPS
Basic Maintenance Amount.
For purposes of determining whether the Fund has Moody's Eligible Assets with
an aggregate Discounted Value that equals or exceeds the AMPS Basic Maintenance
Amount, the Discounted Value of all Forward Commitments to which the Fund is a
party and of all securities deliverable to the Fund pursuant to such Forward
Commitments shall be zero.
For so long as shares of AMPS are rated by S&P or Moody's, the Fund, unless
it has received written confirmation from S&P and/or Moody's, as the case may
be, that such action would not impair the ratings then assigned to the AMPS by
S&P and/or Moody's, as the case may be, will not (i) borrow money except for
the purpose of clearing transactions in portfolio securities (which borrowings
under any circumstances shall be limited to the lesser of $10 million and an
amount equal to 5% of the fair market value of the Fund's assets at the time of
such borrowings and which borrowings shall be repaid within 60 days and not be
extended or renewed and shall not cause the aggregate Discounted Value of
Moody's Eligible Assets and S&P Eligible Assets to be less than the AMPS Basic
Maintenance Amount), (ii) engage in short sales of securities, (iii) lend any
securities, (iv) issue any class or series of stock ranking prior to or on a
parity with the AMPS with respect to the payment of dividends or the
distribution of assets upon dissolution, liquidation or winding up of the Fund,
(v) reissue any AMPS previously purchased or redeemed by the Fund, (vi) merge
or consolidate into or with any other corporation or entity, (vii) change the
Fund's pricing service or (viii) engage in reverse repurchase agreements.
DIRECTORS AND OFFICERS
Information about the Directors, executive officers and the portfolio
managers of the Fund, including their ages and their principal occupations
during the last five years is set forth below. Unless otherwise noted, the
address of each Director, executive officer and the portfolio manager is 800
Scudders Mill Road, Plainsboro, New Jersey 08536.
Arthur Zeikel (66)--President and Director (1)(2)--Chairman of the Investment
Adviser and MLAM (which terms, as used herein, include their corporate
predecessors) since 1997; President of the Investment Adviser and MLAM from
1977 to 1997; Chairman of Princeton Services, Inc. ("Princeton Services") since
1997 and Director thereof since 1993; President of Princeton Services from 1993
to 1997; Executive Vice President of ML & Co. since 1990.
Ronald W. Forbes (58)--Director (2)--1400 Washington Avenue, Albany, New York
12222. Professor of Finance, School of Business, State University of New York
at Albany since 1989; Consultant, Urban Institute, Washington, D.C. since 1995.
25
<PAGE>
Cynthia A. Montgomery (46)--Director (2)--Harvard Business School, Soldiers
Field Road, Boston, Massachusetts 02163. Professor, Harvard Business School
since 1989; Associate Professor, J.L. Kellogg Graduate School of Management,
Northwestern University from 1985 to 1989; Assistant Professor, Graduate School
of Business Administration, The University of Michigan from 1979 to 1985;
Director, UNUM Corporation since 1990 and Director of Newell Co. since 1995.
Charles C. Reilly (67)--Director (2)--9 Hampton Harbor Road, Hampton Bays,
New York 11946. Self-employed financial consultant since 1990; President and
Chief Investment Officer of Verus Capital, Inc. from 1979 to 1990; Senior Vice
President of Arnold and S. Bleichroeder, Inc. from 1973 to 1990; Adjunct
Professor, Columbia University Graduate School of Business from 1990 to 1991;
Adjunct Professor, Wharton School, The University of Pennsylvania from 1989 to
1990.
Kevin A. Ryan (66)--Director (2)--127 Commonwealth Avenue, Chestnut Hill,
Massachusetts 02167. Founder and current Director of The Boston University
Center for the Advancement of Ethics and Character; Professor of Education at
Boston University since 1982; Formerly taught on the faculties of The
University of Chicago, Stanford University and Ohio State University.
Richard R. West (60)--Director (2)--Box 604, Genoa, Nevada 89411, Professor
of Finance since 1984, and Dean from 1984 to 1993, and currently Dean Emeritus
of New York University, Leonard N. Stern School of Business Administration;
Director of Bowne & Co., Inc., Vornado Realty Trust, Inc., Vornado Operating
Company and Alexander's Inc.
Terry K. Glenn (58)--Executive Vice President (1)(2)--Executive Vice
President of the Investment Adviser and MLAM since 1983; Executive Vice
President and Director of Princeton Services since 1993; President of Princeton
Funds Distributor, Inc. since 1986 and Director thereof since 1991; President
of Princeton Administrators, L.P. since 1988.
Vincent R. Giordano (54)--Senior Vice President (1)(2)--Senior Vice President
of the Investment Adviser and MLAM since 1984; Senior Vice President of
Princeton Services since 1993.
Kenneth A. Jacob (47)--Vice President (1)(2)--First Vice President of MLAM
since 1997; Vice President of MLAM from 1984 to 1997; Vice President of the
Investment Adviser since 1984.
Robert A. DiMella, CFA (32)--Vice President and Portfolio Manager (1)(2)--
Vice President of MLAM since 1997; Assistant Vice President of MLAM from 1995
to 1997; Assistant Portfolio Manager of MLAM from 1993 to 1995.
Walter O'Connor (36)--Vice President and Portfolio Manager(1)(2)--Director
(Municipal Tax Exempt) of MLAM since 1997; Vice President of MLAM from 1993 to
1997.
Donald C. Burke (38)--Vice President and Treasurer (1)(2)--Senior Vice
President and Treasurer of the Investment Adviser and MLAM since 1999; First
Vice President of MLAM from 1997 to 1999; Vice President of MLAM from 1990 to
1997; Director of Taxation of MLAM since 1990.
Alice A. Pellegrino (38)--Secretary (1)(2)--Vice President of MLAM since
1999; Attorney with MLAM since 1997; Associate with Kirkpatrick & Lockhart LLP
from 1992 to 1997.
- --------
(1) Interested person, as defined in the 1940 Act, of the Fund.
(2) Such Director or officer is a director, trustee or officer of one or more
additional investment companies for which the Investment Adviser or its
affiliate, MLAM, acts as investment adviser or manager.
In connection with the election of the Fund's Directors, holders of shares of
AMPS and other preferred stock, voting as a separate class, are entitled to
elect two of the Fund's Directors, and the remaining Directors will be elected
by holders of common stock and preferred stock voting together as a single
class. Messrs. Reilly and West have been designated as the Directors to be
elected by holders of the preferred stock. See "Description of Capital Stock"
in the prospectus.
26
<PAGE>
Compensation of Directors
Pursuant to an Investment Advisory Agreement with the Fund, the Investment
Adviser pays all compensation of officers and employees of the Fund as well as
the fees of all Directors who are affiliated persons of ML & Co. or its
subsidiaries.
The Fund pays each Director not affiliated with the Investment Adviser (each
a "non-affiliated Director") a fee of $2,000 per year plus $200 per meeting
attended, and pays all Director's out-of-pocket expenses relating to attendance
at meetings. The Fund also pays members of the Board's audit and nominating
committee (the "Committee"), which consists of all the non-affiliated
Directors, an annual fee of $800. The Chairman of the Committee receives an
additional annual fee of $1,000.
The following table sets forth compensation to be paid by the Fund to the
non-affiliated Directors projected through the end of the Fund's first full
fiscal year and for the calendar year ended December 31, 1998 the aggregate
compensation paid by all investment companies advised by the Investment Adviser
and its affiliate, MLAM ("FAM/MLAM Advised Funds"), to the non-affiliated
Directors.
<TABLE>
<CAPTION>
Total Compensation
Pension or from Fund and
Aggregate Retirement Benefits FAM/MLAM Advised
Compensation Accrued as part of Funds Paid to
Name of Director from Fund Fund Expense Directors
---------------- ------------ ------------------- ------------------
<S> <C> <C> <C>
Ronald W. Forbes(1)........ $3,600 None $192,567
Cynthia A. Montgomery(1)... $3,600 None $192,567
Charles C. Reilly(1)....... $4,600 None $362,858
Kevin A. Ryan(1)........... $3,600 None $192,567
Richard R. West(1)......... $3,600 None $334,125
</TABLE>
- --------
(1) The Directors serve on the boards of MLAM/FAM Advised Funds as follows: Mr.
Forbes (35 registered investment companies consisting of 48 portfolios);
Ms. Montgomery (35 registered investment companies consisting of 48
portfolios); Mr. Reilly (54 registered investment companies consisting of
67 portfolios); Mr. Ryan (35 registered investment companies consisting of
46 portfolios); and Mr. West (56 registered investment companies consisting
of 81 portfolios).
INVESTMENT ADVISORY AND MANAGEMENT ARRANGEMENTS
The Fund has entered into an Investment Advisory Agreement with the
Investment Adviser. The Fund pays the Investment Adviser a monthly fee at an
annual rate of 0.55 of 1% of the Fund's average weekly net assets (i.e., the
average weekly value of the total assets of the Fund, including proceeds from
the issuance of shares of preferred stock, minus the sum of accrued liabilities
of the Fund and accumulated dividends on the shares of preferred stock).
The Investment Advisory Agreement obligates the Investment Adviser to provide
investment advisory services and to pay all compensation of and furnish office
space for officers and employees of the Fund connected with investment and
economic research, trading and investment management of the Fund, as well as
the compensation of all Directors of the Fund who are affiliated persons of the
Investment Adviser or any of its affiliates. The Fund pays all other expenses
incurred in the operation of the Fund, including, among other things, expenses
for legal and auditing services, taxes, costs of printing proxies, listing
fees, if any, stock certificates and shareholder reports, charges of the
custodian and the transfer and dividend disbursing agent and registrar, fees
and expenses with respect to the issuance of preferred stock, Securities and
Exchange Commission fees, fees and expenses of non-interested Directors,
accounting and pricing costs, insurance, interest, brokerage costs, litigation
and other extraordinary or non-recurring expenses, mailing and other expenses
properly payable by the Fund. Accounting services are provided to the Fund by
the Investment Adviser, and the Fund reimburses the Investment Adviser for its
costs in connection with such services.
27
<PAGE>
Unless earlier terminated as described below, the Investment Advisory
Agreement will remain in effect for a period of two years from the date of
execution and will remain in effect from year to year thereafter if approved
annually (a) by the Board of Directors of the Fund or by a majority of the
outstanding shares of the Fund and (b) by a majority of the Directors who are
not parties to such contract or interested persons (as defined in the 1940 Act)
of any such party. Such contract is not assignable and may be terminated
without penalty on 60 days' written notice at the option of either party
thereto or by the vote of the shareholders of the Fund.
Securities held by the Fund may also be held by, or be appropriate
investments for, other funds or investment advisory clients for which the
Investment Adviser or its affiliates act as an adviser. Because of different
objectives or other factors, a particular security may be bought for an
advisory client when other clients are selling the same security. If purchases
or sales of securities by the Investment Adviser for the Fund or other funds
for which it acts as investment adviser or for other advisory clients arise for
consideration at or about the same time, transactions in such securities will
be made, insofar as feasible, for the respective funds and clients in a manner
deemed equitable to all. Transactions effected by the Investment Adviser (or
its affiliates) on behalf of more than one of its clients during the same
period may increase the demand for securities being purchased or the supply of
securities being sold, causing an adverse effect on price.
Code of Ethics
The Board of Directors of the Fund has adopted a Code of Ethics pursuant to
Rule 17j-1 under the 1940 Act that incorporates the Code of Ethics of the
Investment Adviser (together, the "Codes"). The Codes significantly restrict
the personal investing activities of all employees of the Investment Adviser
and, as described below, impose additional, more onerous, restrictions on Fund
investment personnel.
The Codes require that all employees of the Investment Adviser preclear any
personal securities investment (with limited exceptions, such as U.S.
Government securities). The preclearance requirement and associated procedures
are designed to identify any substantive prohibition or limitation applicable
to the proposed investment. The substantive restrictions applicable to all
employees of the Investment Adviser include a ban on acquiring any securities
in a "hot" initial public offering and a prohibition from profiting on short-
term trading securities. In addition, no employee may purchase or sell any
security that at the time is being purchased or sold (as the case may be), or
to the knowledge of the employee is being considered for purchase or sale, by
any fund advised by the Investment Adviser. Furthermore, the Codes provide for
trading "blackout periods" that prohibit trading by investment personnel of the
Fund within periods of trading by the Fund in the same (or equivalent) security
(15 or 30 days depending upon the transaction).
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Directors of the Fund, the
Investment Adviser is primarily responsible for the execution of the Fund's
portfolio transactions. In executing such transactions, the Investment Adviser
seeks to obtain the best results for the Fund, taking into account such factors
as price (including the applicable brokerage commission or dealer spread), size
of order, difficulty of execution and operational facilities of the firm
involved and the firm's risk in positioning a block of securities. While the
Investment Adviser generally seeks reasonably competitive commission rates, the
Fund does not necessarily pay the lowest commission or spread available.
The Fund has no obligation to deal with any broker or dealer in the execution
of transactions in portfolio securities. Subject to providing the best price
and execution, securities firms that provide investment research to the
Investment Adviser, including Merrill Lynch, may receive orders for
transactions by the Fund. Research information provided to the Investment
Adviser by securities firms is supplemental. It does not replace or reduce the
level of service performed by the Investment Adviser and the expenses of the
Investment Adviser will not necessarily be reduced because it receives
supplemental research information.
28
<PAGE>
The Fund invests in securities traded in the over-the-counter markets, and
the Fund intends to deal directly with dealers who make markets in the
securities involved, except in those circumstances where better prices and
execution are available elsewhere. Under the 1940 Act, except as permitted by
exemptive order, persons affiliated with the Fund, including Merrill Lynch, are
prohibited from dealing with the Fund as principal in the purchase and sale of
securities. Since transactions in the over-the-counter market usually involve
transactions with dealers acting as principals for their own accounts, the Fund
does not deal with Merrill Lynch and its affiliates in connection with such
transactions except that, pursuant to exemptive orders obtained by the
Investment Adviser, the Fund may engage in principal transactions with the
Underwriter in high quality, short-term, tax-exempt securities. See "Investment
Restrictions." However, affiliated persons of the Fund, including Merrill
Lynch, may serve as its brokers in certain over-the-counter transactions
conducted on an agency basis.
The Fund also may purchase tax-exempt debt instruments in individually
negotiated transactions with the issuer. Because an active trading market may
not exist for such securities, the prices that the Fund may pay for these
securities or receive on their resale may be lower than that for similar
securities with a more liquid market.
Portfolio Turnover
The Fund may dispose of securities without regard to the time they have been
held when such action, for defensive or other reasons, appears advisable to the
Investment Adviser. While it is not possible to predict turnover rates with any
certainty, presently it is anticipated that the Fund's annual portfolio
turnover rate, under normal circumstances should be less than 100%. (The
portfolio turnover rate is calculated by dividing the lesser of purchases or
sales of portfolio securities for the particular fiscal year by the monthly
average of the value of the portfolio securities owned by the Fund during the
particular fiscal year. For purposes of determining this rate, all securities
whose maturities at the time of acquisition are one year or less are excluded.)
A high portfolio turnover rate has certain tax consequences and results in
greater transaction costs, which are borne directly by the Fund.
TAXES
General
The Fund intends to elect and to qualify for the special tax treatment
afforded regulated investment companies ("RICs") under the Internal Revenue
Code of 1986, as amended (the "Code"). As long as it so qualifies, in any
taxable year in which it distributes at least 90% of its taxable net income and
90% of its tax-exempt net income (see below), the Fund (but not its
shareholders) will not be subject to Federal income tax to the extent that it
distributes its net investment income and net realized capital gains. The Fund
intends to distribute substantially all of such income.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year-end, plus certain undistributed
amounts from previous years. The required distributions, however, are based
only on the taxable income of a RIC. The excise tax, therefore, generally will
not apply to the tax-exempt income of a RIC, such as the Fund, that pays
exempt-interest dividends.
The Internal Revenue Service (the "IRS"), in a revenue ruling, held that
certain auction rate preferred stock would be treated as stock for Federal
income tax purposes. The terms of the AMPS are substantially similar, but not
identical, to the auction rate preferred stock discussed in the revenue ruling,
and in the opinion of Brown & Wood LLP, counsel to the Fund, the shares of AMPS
will constitute stock of the Fund and distributions with respect to shares of
AMPS (other than distributions in redemption of shares of AMPS subject to
Section 302(b) of the Code) will constitute dividends to the extent of the
Fund's current and accumulated earnings and profits as calculated for Federal
income tax purposes. Nevertheless, it is possible that the IRS
29
<PAGE>
might take a contrary position, asserting, for example, that the shares of AMPS
constitute debt of the Fund. If this position were upheld, the discussion of
the treatment of distributions below would not apply. Instead, distributions by
the Fund to holders of shares of AMPS would constitute interest, whether or not
they exceeded the earnings and profits of the Fund, would be included in full
in the income of the recipient and would be taxed as ordinary income. Counsel
believes that such a position, if asserted by the IRS, would be unlikely to
prevail.
The Fund intends to qualify to pay "exempt-interest dividends" as defined in
Section 852(b)(5) of the Code. Under such section if, at the close of each
quarter of its taxable year, at least 50% of the value of its total assets
consists of obligations exempt from Federal income tax ("tax-exempt
obligations") under Section 103(a) of the Code (relating generally to
obligations of a state or local governmental unit), the Fund shall be qualified
to pay exempt-interest dividends to its shareholders. Exempt-interest dividends
are dividends or any part thereof paid by the Fund which are attributable to
interest on tax-exempt obligations and designated by the Fund as exempt-
interest dividends in a written notice mailed to the Fund's shareholders within
60 days after the close of its taxable year. To the extent that the dividends
distributed to the Fund's shareholders are derived from interest income exempt
from tax under Code Section 103(a) and are properly designated as exempt-
interest dividends, they will be excludable from a shareholder's gross income
for Federal tax purposes. Exempt-interest dividends are included, however, in
determining the portion, if any, of a person's social security and railroad
retirement benefits subject to Federal income taxes. Each shareholder is
advised to consult a tax adviser with respect to whether exempt-interest
dividends retain the exclusion under Code Section 103(a) if such shareholder
would be treated as a "substantial user" or "related person" under Code Section
147(a) with respect to property financed with the proceeds of an issue of
"industrial development bonds" or "private activity bonds," if any, held by the
Fund.
The portion of exempt-interest dividends paid from interest received by the
Fund from California Municipal Bonds also will be exempt from California income
tax. However, exempt-interest dividends paid to a corporate shareholder subject
to California state franchise tax will not be exempt from California taxation.
Shareholders subject to income taxation by states other than California will
realize a lower after-tax rate of return than California shareholders since the
dividends distributed by the Fund generally will not be exempt, to any
significant degree, from income taxation by such other states. The Fund will
inform shareholders annually as to the portion of the Fund's distributions
which constitutes exempt-interest dividends and the portion which is exempt
from California income taxes. Interest on indebtedness incurred or continued to
purchase or carry Fund shares is not deductible for Federal or California
income tax purposes to the extent attributable to exempt-interest dividends.
To the extent that the Fund's distributions are derived from interest on its
taxable investments or from an excess of net short-term capital gains over net
long-term capital losses ("ordinary income dividends"), such distributions are
considered ordinary income for Federal income tax purposes. Distributions, if
any, from an excess of net long-term capital gains over net short-term capital
losses derived from the sale of securities or from certain transactions in
futures or options ("capital gain dividends") are taxable as long-term capital
gains for Federal income tax purposes, regardless of the length of time the
shareholder has owned Fund shares and, for California income tax purposes, are
treated as capital gains which are taxed at ordinary income tax rates. Certain
categories of capital gains are taxable at different rates. Generally not later
than 60 days after the close of its taxable year, the Fund will provide its
shareholders with a written notice designating the amounts of any exempt-
interest dividends, ordinary income dividends or capital gain dividends, as
well as any amount of capital gain dividends in the different categories of
capital gain referred to above. Distributions by the Fund, whether from exempt-
interest income, ordinary income or capital gains, are not eligible for the
dividends received deduction allowed to corporations under the Code.
All or a portion of the Fund's gain from the sale or redemption of tax-exempt
obligations purchased at a market discount will be treated for Federal income
tax purposes as ordinary income rather than capital gain. This rule may
increase the amount of ordinary income dividends received by shareholders.
Distributions in excess of the Fund's earnings and profits will first reduce
the adjusted tax basis of a holder's shares and, after
30
<PAGE>
such adjusted tax basis is reduced to zero, will constitute capital gains to
such holder (assuming the shares are held as a capital asset). Any loss upon
the sale or exchange of Fund shares held for six months or less will be
disallowed to the extent of any exempt-interest dividends received by the
shareholder. In addition, any such loss that is not disallowed under the rule
stated above will be treated as long-term capital loss to the extent of any
capital gain dividends received by the shareholder. If the Fund pays a dividend
in January which was declared in the previous October, November or December to
shareholders of record on a specified date in one of such months, then such
dividend will be treated for tax purposes as being paid by the Fund and
received by its shareholders on December 31 of the year in which such dividend
was declared.
The IRS has taken the position in a revenue ruling that if a RIC has two or
more classes of shares, it may designate distributions made to each class in
any year as consisting of no more than such class's proportionate share of
particular types of income, including exempt interest and net long-term capital
gains. A class's proportionate share of a particular type of income is
determined according to the percentage of total dividends paid by the RIC
during such year that was paid to such class. Thus, the Fund is required to
allocate a portion of its net capital gains and other taxable income to the
shares of AMPS of each series. The Fund generally will notify the Auction Agent
of the amount of any net capital gains and other taxable income to be included
in any dividend on shares of AMPS prior to the Auction establishing the
Applicable Rate for such dividend. Except for the portion of any dividend that
it informs the Auction Agent will be treated as capital gains or other taxable
income, the Fund anticipates that the dividends paid on the shares of AMPS will
constitute exempt-interest dividends. The amount of net capital gains and
ordinary income allocable to shares of AMPS (the "taxable distribution") will
depend upon the amount of such gains and income realized by the Fund and the
total dividends paid by the Fund on shares of Common Stock and shares of the
two series of AMPS during a taxable year, but the taxable distribution
generally is not expected to be significant.
In the opinion of Brown & Wood LLP, counsel to the Fund, under current law
the manner in which the Fund intends to allocate items of tax-exempt income,
net capital gains (including additional categories of capital gains), and other
taxable income, if any, among shares of Common Stock and shares of the two
series of AMPS will be respected for Federal income tax purposes. However, the
tax treatment of Additional Dividends may affect the Fund's calculation of each
class' allocable share of capital gains and other taxable income. See "Tax
Treatment of Additional Dividends." In addition, there is currently no direct
guidance from the IRS or other sources specifically addressing whether the
Fund's method for allocating tax-exempt income, net capital gains (including
additional categories of capital gain), and other taxable income among shares
of common stock and shares of the two series of AMPS will be respected for
Federal income tax purposes, and it is possible that the IRS could disagree
with counsel's opinion and attempt to reallocate the Fund's net capital gains
or other taxable income. In the event of a reallocation, some of the dividends
identified by the Fund as exempt-interest dividends to holders of shares of
AMPS may be recharacterized as additional capital gains or other taxable
income. In the event of such recharacterization, the Fund would not be required
to make payments to such shareholders to offset the tax effect of such
reallocation. In addition, a reallocation may cause the Fund to be liable for
income tax and excise tax on any reallocated taxable income. Brown & Wood LLP
has advised the Fund that, in its opinion, if the IRS were to challenge in
court the Fund's allocations of income and gain, the IRS would be unlikely to
prevail. A holder should be aware, however, that the opinion of Brown & Wood
LLP represents only its best legal judgment and is not binding on the IRS or
the courts.
The Code subjects interest received on certain otherwise tax-exempt
securities to an alternative minimum tax. The alternative minimum tax will
apply to interest received on "private activity bonds" issued after August 7,
1986. Private activity bonds are bonds which, although tax-exempt, are used for
purposes other than those generally performed by governmental units and which
benefit non-governmental entities (e.g., bonds used for industrial development
or housing purposes). Income received on such bonds is classified as an item of
"tax preference" which could subject certain investors in such bonds, including
shareholders of the Fund, to an alternative minimum tax. The Fund intends to
purchase such "private activity bonds" and will report to shareholders within
60 days after calendar year-end the portion of its dividends declared during
the year which constitutes an item of tax preference for alternative minimum
tax purposes. The Code further provides that
31
<PAGE>
corporations are subject to an alternative minimum tax based, in part, on
certain differences between taxable income as adjusted for other tax
preferences and the corporation's "adjusted current earnings", which more
closely reflect a corporation's economic income. Because an exempt-interest
dividend paid by the Fund will be included in adjusted current earnings, a
corporate shareholder may be required to pay an alternative minimum tax on
exempt-interest dividends paid by the Fund.
The Fund may invest in instruments the return on which includes
nontraditional features such as indexed principal or interest payments
("nontraditional instruments"). These instruments may be subject to special tax
rules under which the Fund may be required to accrue and distribute income
before amounts due under the obligations are paid. In addition, it is possible
that all or a portion of the interest payments on such nontraditional
instruments could be recharacterized as taxable ordinary income.
If at any time when shares of AMPS are outstanding the Fund does not meet the
asset coverage requirements of the 1940 Act, the Fund will be required to
suspend distributions to holders of Common Stock until the asset coverage is
restored. See "Description of AMPS--Dividends--Restrictions on Dividends and
Other Payments." This may prevent the Fund from distributing at least 90% of
its net income, and may, therefore, jeopardize the Fund's qualification for
taxation as a RIC. If the Fund were to fail to qualify as a RIC, some or all of
the distributions paid by the Fund would be fully taxable for Federal and
California income tax purposes. Upon any failure to meet the asset coverage
requirements of the 1940 Act, the Fund, in its sole discretion, may, and under
certain circumstances will be required to, redeem shares of AMPS in order to
maintain or restore the requisite asset coverage and avoid the adverse
consequences to the Fund and its shareholders of failing to qualify as a RIC.
See "Description of AMPS--Redemption." There can be no assurance, however, that
any such action would achieve such objectives.
As noted above, the Fund must distribute annually at least 90% of its net
taxable and tax-exempt interest income. A distribution will only be counted for
this purpose if it qualifies for the dividends paid deduction under the Code.
Some types of preferred stock that the Fund currently contemplates issuing may
raise an issue as to whether distributions on such preferred stock are
"preferential" under the Code and therefore not eligible for the dividends paid
deduction. The Fund intends to issue preferred stock that counsel advises will
not result in the payment of a preferential dividend and may seek a private
letter ruling from the IRS to that effect. If the Fund ultimately relies solely
on a legal opinion when it issues such preferred stock, there is no assurance
that the IRS would agree that dividends on the preferred stock are not
preferential. If the IRS successfully disallowed the dividends paid deduction
for dividends on the preferred stock, the Fund could lose the benefit of the
special treatment afforded RICs under the Code. In this case, dividends paid by
the Fund would not be exempt from Federal income taxes. Additionally, the Fund
would be subject to the alternative minimum tax.
Under certain Code provisions, some taxpayers may be subject to a 31%
withholding tax on certain ordinary income dividends and on capital gain
dividends and redemption payments ("backup withholding"). Generally,
shareholders subject to backup withholding will be those for whom no certified
taxpayer identification number is on file with the Fund or who, to the Fund's
knowledge, have furnished an incorrect number. When establishing an account, an
investor must certify under penalty of perjury that such number is correct and
that such investor is not otherwise subject to backup withholding.
Ordinary income dividends paid to shareholders who are nonresident aliens or
foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult
their own tax advisers concerning the applicability of the United States
withholding tax.
The Code provides that every shareholder required to file a tax return must
include for information purposes on such return the amount of exempt-interest
dividends received from all sources (including the Fund) during the taxable
year.
32
<PAGE>
Tax Treatment of Additional Dividends
If the Fund makes a Retroactive Taxable Allocation, it will pay Additional
Dividends to holders of shares of AMPS who are subject to the Retroactive
Taxable Allocation. See "Description of AMPS--Dividends--Additional Dividends"
in the prospectus. The Federal income tax consequences of Additional Dividends
under existing law are uncertain. The Fund intends to treat a holder as
receiving a dividend distribution in the amount of any Additional Dividend only
as and when such Additional Dividend is paid. An Additional Dividend generally
will be designated by the Fund as an exempt-interest divided except as
otherwise required by applicable law. However, the IRS may assert that all or
part of an Additional Dividend is a taxable dividend either in the taxable year
for which the Retroactive Taxable Allocation is made or in the taxable year in
which the Additional Dividend is paid.
Tax Treatment of Options and Futures Transactions
The Fund may purchase or sell municipal bond index financial futures
contracts and interest rate financial futures contracts on U.S. Government
securities. The Fund may also purchase and write call and put options on such
financial futures contracts. In general, unless an election is available to the
Fund or an exception applies, such options and financial futures contracts that
are "Section 1256 contracts" will be "marked to market" for Federal income tax
purposes at the end of each taxable year, i.e., each such option or financial
futures contract will be treated as sold for its fair market value on the last
day of the taxable year, and any gain or loss attributable to Section 1256
contracts will be 60% long-term and 40% short-term capital gain or loss.
Application of these rules to Section 1256 contracts held by the Fund may alter
the timing and character of distributions to shareholders. The mark-to-market
rules outlined above, however, will not apply to certain transactions entered
into by the Fund solely to reduce the risk of changes in price or interest
rates with respect to its investments.
Code Section 1092, which applies to certain "straddles," may affect the
taxation of the Fund's sales of securities and transactions in financial
futures contracts and related options. Under Section 1092, the Fund may be
required to postpone recognition for tax purposes of losses incurred in certain
sales of securities and certain closing transactions in financial futures
contracts or the related options.
----------------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury Regulations and California income and
corporate franchise tax laws presently in effect. For the complete provisions,
reference should be made to the pertinent Code sections, the Treasury
Regulations promulgated thereunder and California income and corporate
franchise tax laws. The Code and the Treasury Regulations, as well as the
California tax laws, are subject to change by legislative, judicial or
administrative action either prospectively or retroactively.
Shareholders are urged to consult their tax advisers regarding specific
questions as to Federal, foreign, state or local taxes.
NET ASSET VALUE
Net asset value per share of common stock is determined as of 15 minutes
after the close of business on the New York Stock Exchange (the "NYSE")
(generally, the NYSE closes at 4:00 p.m. Eastern time) on the last Business Day
of each week. For purposes of determining the net asset value of a share of
common stock, the value of the securities held by the Fund plus any cash or
other assets (including interest accrued but not yet received) minus all
liabilities (including accrued expenses) and the aggregate liquidation value of
the outstanding shares of AMPS is divided by the total number of shares of
common stock outstanding at such time. Expenses, including the fees payable to
the Investment Adviser, are accrued daily.
33
<PAGE>
The California Municipal Bonds and Municipal Bonds in which the Fund invests
are traded primarily in the over-the-counter markets. In determining net asset
value, the Fund utilizes the valuations of portfolio securities furnished by a
pricing service approved by the Board of Directors. The pricing service
typically values portfolio securities at the bid price or the yield equivalent
when quotations are readily available. California Municipal Bonds and Municipal
Bonds for which quotations are not readily available are valued at fair market
value on a consistent basis as determined by the pricing service using a matrix
system to determine valuations. The procedures of the pricing service and its
valuations are reviewed by the officers of the Fund under the general
supervision of the Board of Directors. The Board of Directors has determined in
good faith that the use of a pricing service is a fair method of determining
the valuation of portfolio securities. Positions in futures contracts are
valued at closing prices for such contracts established by the exchange on
which they are traded, or if market quotations are not readily available, are
valued at fair value on a consistent basis using methods determined in good
faith by the Board of Directors.
The Fund determines and makes available for publication the net asset value
of its common stock weekly. Currently, the net asset values of shares of
publicly traded closed-end investment companies investing in debt securities
are published in Barron's, the Monday edition of The Wall Street Journal, and
the Monday and Saturday editions of The New York Times.
ADDITIONAL INFORMATION
The Fund is subject to the informational requirements of the Securities
Exchange Act of 1934 and the 1940 Act and in accordance therewith is required
to file reports, proxy statements and other information with the Commission.
Any such reports, proxy statements and other information can be inspected and
copied at the public reference facilities of the Commission at Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
following regional offices of the Commission: Regional Office, at Seven World
Trade Center, Suite 1300, New York, New York 10048; Pacific Regional Office, at
5670 Wilshire Boulevard, 11th Floor, Los Angeles, California 90036; and Midwest
Regional Office, at Northwestern Atrium Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661-2511. Copies of such materials can be obtained
from the public reference section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, at prescribed rates. The Commission maintains a Web
site at http://www.sec.gov containing reports, proxy and information statements
and other information regarding registrants, including the Fund, that file
electronically with the Commission. Reports, proxy statements and other
information concerning the Fund can also be inspected at the offices of the New
York Stock Exchange, 20 Broad Street, New York, New York 10005.
Additional information regarding the Fund and the shares of AMPS is contained
in the Registration Statement on Form N-2, including amendments, exhibits and
schedules thereto, relating to such shares filed by the Fund with the
Commission in Washington, D.C. This statement of additional information does
not contain all of the information set forth in the Registration Statement,
including any amendments, exhibits and schedules thereto. For further
information with respect to the Fund and the shares offered hereby, reference
is made to the Registration Statement. Statements contained in this statement
of additional information as to the contents of any contract or other document
referred to are not necessarily complete and in each instance reference is made
to the copy of such contract or other document filed as an exhibit to the
Registration Statement, each such statement being qualified in all respects by
such reference. A copy of the Registration Statement may be inspected without
charge at the Commission's principal office in Washington, D.C., and copies of
all or any part thereof may be obtained from the Commission upon the payment of
certain fees prescribed by the Commission.
34
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholder
MuniHoldings California Insured Fund IV, Inc.:
We have audited the accompanying statement of assets, liabilities and capital
of MuniHoldings California Insured Fund IV, Inc. as of January 13, 1999. This
financial statement is the responsibility of the Fund's management. Our
responsibility is to express an opinion on this financial statement based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statement is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statement. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such statement of assets, liabilities and capital presents
fairly, in all material respects, the financial position of MuniHoldings
California Insured Fund IV, Inc. as of January 13, 1999 in conformity with
generally accepted accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
January 22, 1999
35
<PAGE>
MUNIHOLDINGS CALIFORNIA INSURED FUND IV, INC.
Statement of Assets, Liabilities and Capital
January 13, 1999
<TABLE>
<S> <C>
ASSETS
Cash................................................................ $100,005
Offering costs (Note 1)............................................. 257,000
Total assets...................................................... 357,005
--------
LIABILITIES
Liabilities and accrued expenses (Note 1)........................... 257,000
--------
NET ASSETS............................................................ $100,005
========
CAPITAL
Common Stock, par value $.10 per share; 200,000,000 shares
authorized;
6,667 shares issued and outstanding (Note 1)....................... $ 667
Paid-in Capital in excess of par.................................... 99,338
--------
Total Capital-Equivalent to $15.00 net asset value per share of
Common Stock (Note 1).............................................. $100,005
========
</TABLE>
Notes to Statement of Assets, Liabilities and Capital
Note 1. Organization
The Fund was incorporated under the laws of the State of Maryland on November
23, 1998 as a closed-end, non-diversified management investment company and has
had no operations other than the sale to Fund Asset Management, L.P. (the
"Investment Adviser") of an aggregate of 6,667 shares of Common Stock for
$100,005 on January 13, 1999. The General Partner of the Investment Adviser is
an indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc.
The Investment Adviser, on behalf of the Fund, will incur organization costs
estimated at $11,000. Direct costs relating to the public offering of the
Fund's shares will be charged to capital at the time of issuance of shares.
Note 2. Management Arrangements
The Fund has engaged the Investment Adviser to provide investment advisory
and management services to the Fund. The Investment Adviser will receive a
monthly fee for advisory services at an annual rate of 0.55 of 1% of the Fund's
average weekly net assets, including any proceeds from the issuance of
Preferred Stock. The Investment Adviser or an affiliate will pay Merrill Lynch,
Pierce, Fenner & Smith Incorporated a commission in the amount of 2.00% of the
price to the public in connection with the initial public offering of the
Fund's Common Stock.
Note 3. Federal Income Taxes
The Fund intends to qualify as a "regulated investment company" and as such
(and by complying with the applicable provisions of the Internal Revenue Code
of 1986, as amended) will not be subject to Federal income tax on taxable
income (including realized capital gains) that is distributed to shareholders.
36
<PAGE>
MUNIHOLDINGS CALIFORNIA INSURED FUND IV, INC.
SCHEDULE OF INVESTMENTS (Unaudited)
FEBRUARY 1, 1999
(in Thousands)
<TABLE>
- -------------------------------------------------------------------------------
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
- -------------------------------------------------------------------------------
<C> <C> <C> <S> <C>
California--132.5%
- -------------------------------------------------------------------------------
AAA NR* $ 1,000 Anaheim, California, Public Financing
Authority Revenue Bonds, Electric System
District Facilities, 5% due 10/01/2023(d) $ 999
- -------------------------------------------------------------------------------
NR* Aaa 6,700 California Educational Facilities
Authority Revenue Bonds (University of San
Diego), 5% due 10/01/2028(a) 6,669
- -------------------------------------------------------------------------------
California HFA Revenue Bonds, Home
Mortgage, AMT:
AAA Aaa 3,000 Series J-2, 5.30% due 8/01/2016(d) 3,046
AAA Aaa 5,000 Series R, 5.25% due 8/01/2026(a) 5,034
- -------------------------------------------------------------------------------
California Health Facilities Finance
Authority Revenue Bonds:
AAA Aaa 2,000 (Kaiser Permanente), Series A, 5.50% due
6/01/2022(c) 2,098
A1+ VMIG1++ 800 (St. Joseph Health System), VRDN, Series
B, 3% due 7/01/2009(e) 800
- -------------------------------------------------------------------------------
California Health Facilities Finance
Authority Revenue Refunding Bonds:
A1+ VMIG1++ 6,000 (Adventist Health System), VRDN, Series C,
3.10% due 9/01/2015(d)(e) 6,000
A A2 10,000 (Catholic Healthcare West), Series A, 5%
due 7/01/2028 9,744
AAA Aaa 1,045 (Sutter Health), Series A, 5.35% due
8/15/2028(d) 1,075
AA VMIG1++ 7,500 RIB, Series 90, 5.35% due 8/15/2028(f) 7,942
- -------------------------------------------------------------------------------
AA+ NR* 5,600 California Pollution Control Financing
Authority, PCR, Refunding (Pacific Gas and
Electric), VRDN, Series F, 3.10% due
11/01/2026(e) 5,600
- -------------------------------------------------------------------------------
AAA VMIG1++ 1,000 California Pollution Control Financing
Authority, Solid Waste Disposal Revenue
Bonds (Shell Martinez Refining), AMT,
VRDN, Series A, 3% due 10/01/2031(e) 1,000
- -------------------------------------------------------------------------------
AA- VMIG1++ 4,300 California State Economic Development
Financing Authority Revenue Bonds
(California Independent Systems Project),
VRDN, Series C, 3.15% due 4/01/2008(e) 4,300
- -------------------------------------------------------------------------------
AAA Aaa 9,135 California State, GO, Refunding, 5% due
2/01/2023(b) 9,135
- -------------------------------------------------------------------------------
NR* VMIG1++ 2,200 California Statewide Communities
Development Authority, COP (Continuing
Care/Univiersity Project), VRDN, 3.10% due
11/15/2028(e) 2,200
- -------------------------------------------------------------------------------
AAA Aaa 8,000 Central Coast Water Authority, California
Revenue Refunding Bonds (State Water
Project Regional Facilities), Series A, 5%
due 10/01/2022(a) 7,988
- -------------------------------------------------------------------------------
AAA Aaa 6,140 Contra Costa, California, Water District,
Water Revenue Bonds, Series G, 5% due
10/01/2024(d) 6,131
- -------------------------------------------------------------------------------
East Side Union High School District,
California, Santa Clara County GO, Series
E(b):
AAA Aaa 3,205 5% due 9/01/2022 3,214
AAA Aaa 5,655 5% due 9/01/2023 5,668
- -------------------------------------------------------------------------------
</TABLE>
37
<PAGE>
MUNIHOLDINGS CALIFORNIA INSURED FUND IV, INC.
SCHEDULE OF INVESTMENTS (Unaudited)
February 1, 1999 (Continued)
(in Thousands)
<TABLE>
- --------------------------------------------------------------------------------
<CAPTION>
S&P Moody's Face Value
Ratings Ratings Amount Issue (Note 1a)
- --------------------------------------------------------------------------------
<C> <C> <C> <S> <C>
AAA Aaa $ 3,390 Fresno, California, Sewer Revenue Bonds,
Series A, 5% due 9/01/2023(d) $ 3,385
- --------------------------------------------------------------------------------
AAA Aaa 4,600 La Quinta, California, Redevelopment
Agency, Tax Allocation Refunding Bonds
(Redevelopment Project Area Number 1),
5.20% due 9/01/2028(a) 4,686
- --------------------------------------------------------------------------------
AAA Aaa 3,415 Los Angeles, California, Unified School
District, GO, Series B, 5% due 7/01/2023(b) 3,410
- --------------------------------------------------------------------------------
AAA Aaa 4,200 Los Angeles, California, Wastewater System
Revenue Bonds, Series A, 5% due
6/01/2028(b) 4,193
- --------------------------------------------------------------------------------
A+ A2 2,500 Modesto, California, Irrigation District,
COP, Refunding and Capital Improvements,
Series B, 5.30% due 7/01/2022 2,501
- --------------------------------------------------------------------------------
New San Dieguito, California, Public
Facilities Authority Revenue Bonds, Series
A(a):
AAA Aaa 2,650 5% due 8/01/2023 2,646
AAA Aaa 5,250 5% due 8/01/2030 5,242
- --------------------------------------------------------------------------------
AAA NR* 2,250 Northern California Power Agency Multiple
Capital Facilities Revenue Refunding
Bonds, Series A, 5% due 8/01/2025(a) 2,247
- --------------------------------------------------------------------------------
AAA Aaa 1,500 Salinas, California, Sanitation Sewer
System Revenue Bonds, 5% due 8/01/2028(b) 1,498
- --------------------------------------------------------------------------------
AAA Aaa 15,000 San Diego, California, Public Facilities
Financing Authority, Sewer Revenue Bonds,
5% due 5/15/2025(b) 14,977
- --------------------------------------------------------------------------------
AAA NR* 5,825 San Diego County, California, COP,
Refunding (Central Jail), 5% due
10/01/2025(a) 5,808
- --------------------------------------------------------------------------------
AAA Aaa 3,500 San Francisco, California, City and County
Redevelopment Agency, Hotel Tax Revenue
Refunding Bonds, 5% due 7/01/2025(c) 3,495
- --------------------------------------------------------------------------------
San Jose, California, Redevelopment Agency
Tax Allocation (Merged Area Redevelopment
Project)(a):
AAA Aaa 4,845 5% due 8/01/2026 4,838
AAA Aaa 4,000 5% due 8/01/2031 3,968
- --------------------------------------------------------------------------------
AAA Aaa 10,000 Santa Clara, California, Electric Revenue
Refunding Bonds, Sub-Series A, 5% due
7/01/2027(a) 9,984
- --------------------------------------------------------------------------------
AAA Aaa 8,000 Turlock, California, Irrigation District
Revenue Refunding Bonds, Series A, 5% due
1/01/2026(d) 7,988
- --------------------------------------------------------------------------------
AAA Aaa 1,670 West Sacremento, California, Redevelopment
Agency Tax Allocation (West Sacramento
Redevelopment Project), 5% due 9/01/2029(d) 1,667
- --------------------------------------------------------------------------------
Total Investments (Cost - $170,891) - 132.5% 171,176
Liabilities in Excess of Other Assets - (32.5)% (41,989)
--------
Net Assets - 100.0% $129,187
========
</TABLE>
38
<PAGE>
MUNIHOLDINGS CALIFORNIA INSURED FUND IV, INC.
SCHEDULE OF INVESTMENTS (Unaudited)
February 1, 1999 (Concluded)
(in Thousands)
- --------
(a) AMBAC Insured.
(b) FGIC Insured.
(c) FSA Insured.
(d) MBIA Insured.
(e) The interest rate is subject to change periodically based upon prevailing
market rates. The interest rate shown is the rate in effect at February 1,
1999.
(f) The interest rate is subject to change periodically and inversely based
upon prevailing market rates. The interest rate shown is the rate in effect
at February 1, 1999.
* Not Rated.
++ Highest short-term rating by Moody's Investors Service, Inc.
See Notes to Financial Statements.
Portfolio Abbreviations
To simplify the listings of MuniHoldings California Insured Fund IV, Inc.'s
portfolio holdings in the Schedule of Investments, we have abbreviated the
names of many of the securities according to the list below and at right.
AMT Alternative Minimum Tax (Subject To)
COP Certificates of Participation
GO General Obligation Bonds
HFA Housing Finance Agency
PCR Pollution Control Revenue Bonds
RIB Residual Interest Bonds
VRDN Variable Rate Demand Revenue Bonds
39
<PAGE>
MUNIHOLDINGS CALIFORNIA INSURED FUND IV, INC.
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
As of February 1, 1999 (Unaudited)
<TABLE>
<CAPTION>
Assets:
<S> <C> <C>
Investments, at value (identified cost--$170,890,726)
(Note 1a)............................................. $171,175,641
Cash................................................... 28,573,876
Receivables:
Securities sold...................................... $1,700,000
Interest............................................. 1,517,409
Investment adviser (Note 2).......................... 1,716 3,219,125
----------
Other assets........................................... 19,000
------------
Total assets........................................... 202,987,642
------------
Liabilities:
Payable for securities purchased....................... 73,517,400
Accrued expenses and other liabilities................. 283,593
------------
Total liabilities...................................... 73,800,993
------------
Net Assets:
Net Assets:............................................ $129,186,649
============
Capital:
Capital Stock (200,000,000 shares authorized)(Note 4):
Common Stock, par value $.10 per share (8,606,667
shares issued and outstanding)...................... $ 860,667
Paid-in capital in excess of par....................... 127,976,461
Undistributed investment income--net................... 64,606
Unrealized appreciation on investments--net............ 284,915
------------
Total capital--Equivalent to $15.01 net asset value per
Common Stock.......................................... $129,186,649
============
</TABLE>
See Notes to Financial Statements
40
<PAGE>
MUNIHOLDINGS CALIFORNIA INSURED FUND IV, INC.
Notes to Financial Statements (Unaudited)
1. Significant Accounting Policies:
MuniHoldings California Insured Fund IV, Inc. (the "Fund") is registered
under the Investment Company Act of 1940 as a non-diversified, closed-end
management investment company. The Fund's financial statements are prepared in
accordance with generally accepted accounting principles which may require the
use of management accruals and estimates. Prior to commencement of operations
on January 29, 1999, the Fund had no operations other than those relating to
organizational matters and the sale of 6,667 shares of Common Stock on January
13, 1999 to Fund Asset Management, L.P. ("FAM") for $100,005. The Fund
determines and makes available for publication the net asset value of its
Common Stock on a weekly basis. The Fund's Common Stock is listed on the New
York Stock Exchange under the symbol CIL. The following is a summary of
significant accounting policies followed by the Fund.
(a) Valuation of investments--Municipal bonds are traded primarily in the
over-the-counter markets and are valued at the most recent bid price or yield
equivalent as obtained by the Fund's pricing service from dealers that make
markets in such securities. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their closing prices as of the
close of such exchanges. Options written or purchased are valued at the last
sale price in the case of exchange-traded options. In the case of options
traded in the over-the-counter market, valuation is the last asked price
(options written) or the last bid price (options purchased). Securities with
remaining maturities of sixty days or less are valued at amortized cost, which
approximates market value. Securities and assets for which market quotations
are not readily available are valued at fair value as determined in good faith
by or under the direction of the Board of Directors of the Fund, including
valuations furnished by a pricing service retained by the Fund, which may
utilize a matrix system for valuations. The procedures of the pricing service
and its valuations are reviewed by the officers of the Fund under the general
supervision of the Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its portfolio
against adverse movements in the debt markets. Losses may arise due to changes
in the value of the contract or if the counterparty does not perform under the
contract.
. Financial futures contracts--The Fund may purchase or sell financial
futures contracts and options on such futures contracts for the purpose of
hedging the market risk on existing securities or the intended purchase of
securities. Futures contracts are contracts for delayed delivery of
securities at a specific future date and at a specific price or yield.
Upon entering into a contract, the Fund deposits and maintains as
collateral such initial margin as required by the exchange on which the
transaction is effected. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in value of the contract. Such receipts or payments are known
as variation margin and are recorded by the Fund as unrealized gains or
losses. When the contract is closed, the Fund records a realized gain or
loss equal to the difference between the value of the contract at the time
it was opened and the value at the time it was closed.
. Options--The Fund is authorized to write covered call options and
purchase put options. When the Fund writes an option, an amount equal to
the premium received by the Fund is reflected as an asset and an
equivalent liability. The amount of the liability is subsequently marked
to market to reflect the current market value of the option written. When
a security is purchased or sold through an exercise of an option, the
related premium paid (or received) is added to (or deducted from) the
basis of the security acquired or deducted from (or added to) the proceeds
of the security sold. When an option expires (or the Fund enters into a
closing transaction), the Fund realizes a gain or loss on the option to
the extent of the premiums received or paid (or gain or loss to the extent
the cost of the closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
41
<PAGE>
MUNIHOLDINGS CALIFORNIA INSURED FUND IV, INC.
Notes to Financial Statements (Unaudited)--(Continued)
(c) Income taxes--It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Interest income is recognized on the accrual basis. Discounts and market
premiums are amortized into interest income. Realized gains and losses on
security transactions are determined on the identified cost basis.
(e) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with FAM. The
general partner of FAM is Princeton Services, Inc. ("PSI"), an indirect wholly-
owned subsidiary of Merrill Lynch & Co., Inc. ("ML & Co."), which is the
limited partner.
FAM is responsible for the management of the Fund's portfolio and provides
the necessary personnel, facilities, equipment and certain other services
necessary to the operations of the Fund. For such services, the Fund pays a
monthly fee at an annual rate of 0.55% of the Fund's average weekly net assets.
For the period ended February 1, 1999, FAM earned fees of $7,797, all of which
was voluntarily waived. FAM also reimbursed the Fund additional expenses of
$1,716.
Accounting services are provided to the Fund by FAM at cost.
Certain officers and/or directors of the Fund are officers and/or directors
of FAM, PSI, and/or ML & Co.
3. Investments:
Purchases of investments, excluding short-term securities, for the period
ended February 1, 1999 were $150,990,726. There were no long term sales.
Net unrealized gains as of February 1, 1999 were as follows:
<TABLE>
<CAPTION>
Unrealized
Gains
----------
<S> <C>
Long-term investments............. $284,915
--------
Total............................. $284,915
========
</TABLE>
As of February 1, 1999, net unrealized appreciation for Federal income tax
purposes aggregated $284,915, of which $314,451 related to appreciated
securities and $29,536 related to depreciated securities. The aggregate cost of
investments at February 1, 1999 for Federal income tax purposes was
$170,890,726.
4. Capital Stock Transactions:
The Fund is authorized to issue 200,000,000 shares of capital stock,
including Preferred Stock, par value $.10 per share, all of which were
initially classified as Common Stock. The Board of Directors is authorized,
however, to reclassify any unissued shares of capital stock without approval of
holders of Common Stock.
42
<PAGE>
MUNIHOLDINGS CALIFORNIA INSURED FUND IV, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)--(CONCLUDED)
Common Stock
Shares issued and outstanding were increased by 8,600,000 during the period
ended February 1, 1999.
5. GENERAL:
As of February 1, 1999, the Fund had only four days of investment operations
and had not yet declared dividends (whereas it will ordinarily do so on a
monthly basis). As a result, the Fund believes that more extensive interim
financial statements would not be indicative of the Fund's current and ongoing
operations. The Fund believes that such financial statements may be misleading
to potential investors and, accordingly, believes that inclusion of such
financial statements would be inappropriate. For the period ended February 1,
1999, the Fund had net investment income of $64,606. FAM voluntarily waived all
expenses.
43
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APPENDIX A
ECONOMIC AND OTHER CONDITIONS IN CALIFORNIA
The following information is a brief summary of factors affecting the economy
of the State of California and does not purport to be a complete description of
such factors. Other factors will affect issuers. The summary is based primarily
upon one or more of the most recent publicly available offering statements
relating to debt offerings of California issuers, however, it has not been
updated. The Fund has not independently verified the information.
General Economic Conditions
The economy of the State of California (sometimes referred to herein as the
"State") is the largest among the 50 states and one of the largest in the
world. This diversified economy has major components in agriculture,
manufacturing, high technology, trade, entertainment, tourism, construction and
services.
California's July 1, 1998 population of over 33.2 million represented over
13% of the total United States population. As of July 1, 1990, the population
of 29,944,000 represented an increase of over 6 million persons, or 26%, during
the decade of the 1980s.
California's population is concentrated in metropolitan areas. As of the
April 1, 1990 census, 96% of the State's population resided in the 23
Metropolitan Statistical Areas in the State. As of July 1, 1997, the five-
county Los Angeles area accounted for 49%, with 16.0 million residents. The 10-
county San Francisco Bay Area represented 21%, with a population of 6.9
million.
From 1990-1993, the State suffered through a severe recession, the worst
since the 1930s, heavily influenced by large cutbacks in defense/aerospace
industries and military base closures and by a major drop in real estate
construction. California's economy has been recovering and growing steadily
since the start of 1994. The current economic expansion is marked by strong
growth in high technology manufacturing and services, including computer
software, electronic manufacturing and motion picture/television production;
growth is also strong in other business services, both nonresidential and
residential construction and local education.
In May 1998, the State Department of Finance projected that the California
economy would continue to show robust growth although at a slightly slower pace
than in 1997. The Asian economic crisis which began in late 1997 was expected
to have some dampening effects on the State's economy. However, during the
summer of 1998, the soaring trade deficit, continuing weakness in Asia, initial
signs of economic weakness in Canada and Latin America, which have been
California's largest trading partners, and the fall in stock prices worldwide
all suggest that the May forecasts were too optimistic, particularly for 1999.
Other impacts of the international situation may help California, such as the
reduction in long-term interest rates.
The State
Fiscal Years Prior to 1995-1996. The State's budget problems in the early
1990s were caused by a combination of external economic conditions and a
structural imbalance in that the largest general fund programs (K-14 education,
health, welfare and corrections) were increasing faster than the revenue base,
driven by the State's rapid population growth. These pressures are expected to
continue as population trends maintain strong demand for health and welfare
services, as the school age population continues to grow, and as the State's
corrections program responds to a "Three Strikes" law enacted in 1994, which
requires mandatory life prison terms for certain third- time felony offenders.
In addition, the State's health and welfare programs are in a transition period
as a result of recent federal and state welfare reform initiatives.
As a result of these factors and others, and especially because the severe
recession between 1990-1994 reduced revenues and increased expenditures for
social welfare programs, from the late 1980s until 1992-93, the State had a
period of budget imbalance. During this period, expenditures exceeded revenues
in four out of
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six years, and the State accumulated and sustained a budget deficit in its
budget reserve, the Special Fund for Economic Uncertainties ("SFEU")
approaching $2.8 billion at its peak at June 30, 1993. Starting in the 1990-91
Fiscal Year and for each fiscal year thereafter, each budget required
multibillion dollar actions to bring projected revenues and expenditures into
balance. The State Legislature and the Governor of the State (the "Governor")
agreed on the following principal steps to produce Budget Acts in the years
1991-92 to 1994-95, although not all these actions were taken in each year.
1. significant cuts in health and welfare program expenditures;
2. transfers of program responsibilities and funding from the State to
local governments (referred to as "realignment"), coupled with some
reduction in mandates on local government;
3. transfer of about $3.6 billion in local property tax revenues from
cities, counties, redevelopment agencies and some other districts to local
school districts, thereby reducing State funding for schools under
Proposition 98 (discussed below);
4. reduction in growth of support for higher education programs, coupled
with increases in student fees, through the 1994-95 Fiscal Year;
5. maintenance of the minimum Proposition 98 funding guarantee for K-14
schools, and the disbursement of additional funds to keep a constant level
of about $4,200 per K-12 pupils through the1993-94 Fiscal Year;
6. revenue increases, most of which were for a short duration;
7. increased reliance on aid from the federal government to offset the
costs of incarcerating, educating and providing health and welfare services
to illegal immigrants, although during this time frame, most of the
additional aid requested by the Administration was not received; and
8. various one-time adjustments and accounting changes.
Despite these budget actions, as noted, the effects of the recession led to
large, unanticipated deficits in the budget reserve, the SFEU, as compared to
projected positive balances. By the 1993-94 Fiscal Year, the accumulated
deficit was so large that it was impractical to budget to retire it in one
year, so a two-year program was implemented, using the issuance of revenue
anticipation warrants to carry a portion of the deficit over the end of the
fiscal year. When the economy failed to recover sufficiently in 1993-94, a
second two-year plan was implemented in 1994-95, again using cross-fiscal year
revenue anticipation warrants to partly finance the deficit into the 1995-96
fiscal year.
Another consequence of the accumulated budget deficits, together with other
factors such as disbursement of funds to local school districts "borrowed" from
future fiscal years and hence not shown in the annual budget, was to
significantly reduce the State's cash resources available to pay its ongoing
obligations. For several years during the recession, the State was forced to
rely increasingly on external debt markets to meet its cash needs, as a
succession of notes and revenue anticipation warrants were issued in the period
from June 1992 to July 1994, often needed to pay previously maturing notes or
warrants. These borrowings were used also in part to spread out the repayment
of the accumulated budget deficit over the end of a fiscal year, as noted
earlier. The last and largest of these borrowings was $4.0 billion of revenue
anticipation warrants which were issued in July 1994 and matured on April 25,
1996. However, the State's improved cash position in 1995-96 allowed it to
repay the $4.0 billion Revenue Anticipation Warrant issue on April 25, 1996,
and to issue only $2.0 billion of revenue anticipation notes during the fiscal
year, which matured on June 28, 1996.
1995-96 through 1997-98 Fiscal Years
The State's financial condition improved markedly during the 1995-96, 1996-97
and 1997-98 fiscal years, with a combination of better than expected revenues,
slowdown in growth of social welfare programs, and continued spending restraint
based on the actions taken in earlier years. The State's cash position also
improved, and no external deficit borrowing has occurred over the end of these
three fiscal years.
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The economy grew strongly during these fiscal years, and as a result, the
General Fund took in substantially greater tax revenues (around $2.2 billion in
1995-96, $1.6 billion in 1996-97 and $2.2 billion in 1997-98) than were
initially planned when the budgets were enacted. These additional funds were
largely directed to school spending as mandated by Proposition 98, and to make
up shortfalls from reduced federal health and welfare aid in 1995-96 and 1996-
97. The accumulated budget deficit from the recession years was finally
eliminated. The Department of Finance estimates that the State's budget reserve
(the SFEU) totaled $639.8 million as of June 30, 1997 and $1.782 billion at
June 30, 1998.
On August 18, 1997, the Governor signed the 1997-98 Budget Act, but vetoed
about $314 million of specific spending items, primarily in health and welfare
and education areas from both the General Fund and Special Funds. The Governor
announced that he was prepared to restore about $200 million of education
spending upon satisfactory completion of legislation on an education testing
program.
The 1997-98 Budget Act anticipated General Fund revenues and transfers of
$52.5 billion (a 6.8% increase over the final 1996-97 amount), and expenditures
of $52.8 billion (an 8.0% increase from the 1996-97 levels). On a budgetary
basis, the SFEU was projected to decrease from $408 million at June 30, 1997 to
$112 million at June 30, 1998. As of January 9, 1998, the State Director of
Finance estimated a reserve of $329 million at June 30, 1998. (The expenditure
figure assumes restoration of $200 million in vetoed funding.) The Budget Act
also included Special Fund expenditures of $14.4 billion (as against estimated
Special Fund revenues of $14.0 billion), and $2.1 billion of expenditures from
various Bond Funds. The State implemented its normal annual cash flow borrowing
program, issuing $3 billion of notes which matured on June 30, 1998.
The following were major features of the 1997-98 Budget Act:
1. The 1997-98 Budget contained a large increase in funding for K-14
education under Proposition 98, reflecting strong revenues which exceeded
initial budgeted amounts. Part of the nearly $1.75 billion in increased
spending was allocated to prior fiscal years. Funds were provided to fully
pay for the cost-of-living increase component of Proposition 98, and to
extend class size reduction and reading initiatives.
2. The 1997-98 Budget Act reflected the $1.235 billion pension case
judgment payment, and brought funding of the State's pension contribution
back to the quarterly basis which existed prior to the deferral actions
which were invalidated by the courts. There was no provision for any
additional payments relating to this court case.
3. Continuing the third year of a four-year "compact" which the
Administration made with higher education units, funding from the General
Fund for the University of California and California State University has
increased by about six percent ($121 million and $107 million,
respectively), and there was no increase in student fees.
4. Because of the effect of the pension payment, most other State
programs were continued at 1996-97 levels.
5. Health and welfare costs were contained, continuing generally the
grant levels from prior years, as part of the initial implementation of the
new CalWORKs program.
6. Unlike prior years, the 1997-98 Budget Act did not depend on federal
budget actions. About $300 million in federal funds, already included in
the federal FY 1997 and 1998 budgets, were included in the 1997-98 Budget
Act, to offset incarceration costs for illegal aliens.
7. The 1997-98 Budget Act contained no tax increases, and no tax
reductions. The Renters Tax Credit was suspended for another year, saving
approximately $500 million.
Federal Welfare Reform. Congress passed and the President signed (on August
22, 1996) the Personal Responsibility and Work Opportunity Act of 1996 (the
"Law") making a fundamental reform of the current welfare system. Among many
provisions, the Law includes: (i) conversion of Aid to Families with Dependent
Children from an entitlement program to a block grant titled Temporary
Assistance for Needy Families
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("TANF"), with lifetime time limits on TANF recipients, work requirements and
other changes; (ii) provisions denying certain federal welfare and public
benefits to legal noncitizens, allowing states to elect to deny additional
benefits (including TANF) to legal noncitizens, and generally denying almost
all benefits to illegal immigrants; and (iii) changes in the Food Stamp
program, including reducing maximum benefits and imposing work requirements.
As part of the 1997-98 Budget Act legislative package, the State Legislature
and Governor agreed on a comprehensive reform of the State's public assistance
programs to implement the new federal Law. The new basic State welfare program
is called California Work Opportunity and Responsibility to Kids Act
("CalWORKs"), which replaces the former Aid to Families with Dependent Children
(AFDC) and Greater Avenues to Independence (GAIN) programs effective January 1,
1998. Consistent with the federal Law, CalWORKs contains new time limits on
receipt of welfare aid, both lifetime as well as for any current time on aid.
Administration of the new Welfare-to-Work programs will be largely at the
county level, and counties are given financial incentives for success in this
program.
Although the longer-term impact of the new federal Law and CalWORKs cannot be
determined until there has been some experience, the State does not presently
anticipate that these new programs will have any adverse financial impact on
its General Fund. Overall TANF grants from the federal government are expected
to equal or exceed the amounts the State would have received under the old AFDC
program.
1998-99 Fiscal Year. When the Governor released his proposed 1998-99 Fiscal
Year Budget on January 9, 1998, he projected General Fund revenues for the
1998-99 Fiscal Year of $55.4 billion, and proposed expenditures in the same
amount. By the time the Governor released the May Revision to the 1998-99
Budget ("May Revision") on May 14, 1998, the Administration projected that
revenues for the 1997-98 and 1998-99 Fiscal Years combined would be more than
$4.2 billion higher than was projected in January. The Governor proposed that
most of this increased revenue be dedicated to fund a 75% cut in the Vehicle
License Fee ("VLF").
Pursuant to Article IV, Section 13(c) of the Constitution of the State of
California, the State Legislature is required to adopt its budget for the
upcoming fiscal year (July 1-June 30) by midnight of June 15th, and in the
absence of which, the Legislature may not send to the Governor for
consideration any bill appropriating funds for expenditure during the fiscal
year for which the budget bill is to be enacted, except emergency bills or
appropriations for the salaries and expenses of the Legislature. For the
current fiscal year, as has been true since the late 1980's, the State
Legislature did not adhere to this deadline. Due to the Legislature's failure
to comply with this constitutional requirement, the Howard Jarvis Taxpayers
Association sought an injunction in a Los Angeles Superior Court to prohibit
the State from making certain types of payments in the absence of an adopted
budget. On July 21, 1998, a preliminary injunction was issued. Under the terms
of the injunction order, until such time as the budget was adopted, the State
was precluded from making any payments from the State treasury for Fiscal Year
1998-99 except for certain enumerated expenditures.
On July 22, 1998, the Legislature unanimously passed an $18.9 billion
emergency-spending bill to cover the costs of, among others, bond payments,
paychecks for state workers, retirement pensions, prisons, school and welfare
payments from July 1st through August 5th. However, before a final resolution
of the legal issues raised by the plaintiff, a budget for Fiscal Year 1998-99
was passed by the Legislature on August 11, 1998, and the Governor signed it on
August 21, 1998.
In signing the 1998-99 Budget Bill, the Governor used his line-item veto
power to reduce expenditures by $1.360 billion from the General Fund, and $160
million from Special Funds. Of this total, the Governor indicated that about
$250 million of vetoed funds were "set aside" to fund programs for education.
Vetoed items included education funds, salary increases and many individual
resources and capital projects.
The 1998-99 Budget Act is based on projected general fund revenues and
transfers of $57.0 billion (after giving effect to various tax reductions
enacted in 1997 and 1998), a 4.2% increase from the revised 1997-98
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figures. Special Fund revenues were estimated at $14.3 billion. The revenue
projections were based on the May Revision. Economic problems overseas since
that time may affect the May Revision projections.
After giving effect to the Governor's vetoes, the 1998-99 Budget Act provides
authority for expenditures of $57.3 billion from the General Fund (a 7.3%
increase from 1997-98), $14.7 billion from Special Funds, and $3.4 billion from
bond funds. The 1998-99 Budget Act projects a balance in the SFEU at June 30,
1999 (but without including the "set aside" veto amount) of $1.255 billion, a
little more than 2% of general fund revenues. The Budget Act assumes the State
will carry out its normal intra-year cash flow borrowing in the amount of $1.7
billion of revenue anticipation notes, which were issued on October 1, 1998.
The most significant feature of the 1998-99 Budget was agreement on a total
of $1.4 billion of tax cuts. The central element is a bill which provides for a
phased-in reduction of the VLF. Since the VLF is currently transferred to
cities and counties, the bill provides for the general fund to replace the lost
revenues. Starting on January 1, 1999, the VLF will be reduced by 25%, at a
cost to the general fund of approximately $500 million in the 1998-99 Fiscal
Year and about $1 billion annually thereafter.
In addition to the cut in VLF, the 1998-99 Budget includes both temporary and
permanent increases in the personal income tax dependent credit ($612 million
General Fund cost in 1998-99, but less in future years), a nonrefundable
renters tax credit ($133 million), and various targeted business tax credits
($106 million).
Other significant elements of the 1998-99 Budget Act are as follows:
1. Proposition 98 funding for K-12 schools is increased by $1.7 billion
in General Fund moneys over revised 1997-98 levels, about $300 million
higher than the minimum Proposition 98 guaranty. An additional $600 million
was appropriated to "settle up" prior years' Proposition 98 entitlements,
and was primarily devoted to one-time uses such as block grants, deferred
maintenance, and computer and laboratory equipment. Of the 1998-99 funds,
major new programs include money for instructional and library materials,
deferred maintenance, support for increasing the school year to 180 days
and reduction of class sizes in Grade 9. The Governor held $250 million of
education funds which were vetoed as set-aside for enactment of additional
reforms. Overall, per-pupil spending for K-12 schools under Proposition 98
is increased to $5,695, more than one-third higher than the level in the
last recession year of 1993-94. The 1998-99 Budget also includes $250
million as repayment of prior years' loans to schools, as part of the
settlement of the CTA v. Gould lawsuit.
2. Funding for higher education increased substantially above the level
called for in the Governor's four-year compact. General Fund support was
increased by $340 million (15.6%) for the University of California and $267
million (14.1%) for the California State University system. In addition,
Community Colleges received a $300 million (6.6%) increase under
Proposition 98.
3. The 1998-99 Budget includes increased funding for health, welfare and
social services programs. A 4.9% grant increase was included in the basic
welfare grants, the first increase in those grants in 9 years. Future
increases will depend on sufficient general fund revenue to trigger the
phased cuts in VLF described above.
4. Funding for the judiciary and criminal justice programs increased by
about 11% over 1997-98, primarily to reflect increased State support for
local trial courts and rising prison population.
5. Various other highlights of the 1998-99 Budget included new funding
for resources projects, dedication of $376 million of general fund moneys
for capital outlay projects, funding of a three percent State employee
salary increase, funding of 2,000 new Department of Transportation
positions to accelerate transportation construction projects, and funding
of the Infrastructure and Economic Development Bank ($50 million).
6. The State of California received approximately $167 million of federal
reimbursements to offset costs related to the incarceration of undocumented
alien felons for federal fiscal year 1997. The State anticipates receiving
approximately $195 million in federal reimbursements for federal fiscal
year 1998.
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After the 1998-99 Budget Act was signed, and prior to the close of the
Legislative session on August 31, 1998, the Legislature passed a variety of
fiscal bills. The Governor had until September 30, 1998 to sign or veto these
bills. The bills with the most significant fiscal impact which the Governor
signed include $235 million for certain water system improvements in Southern
California, $243 million for the State's share of the purchase of
environmentally sensitive forest lands, $178 million for state prisons, $160
million for housing assistance, and $125 million for juvenile facilities. The
Governor also signed bills totaling $223 million for education programs which
were part of the Governor 's $250 million veto "set aside," and $32 million for
local governments' fiscal relief. In addition, he signed a bill reducing by
$577 million the State's obligation to contribute to the State Teachers'
Retirement System in the 1998-99 Fiscal Year.
Based solely on the legislation enacted, on a net basis, the reserve for June
30, 1999 was reduced by $256 million. On the other hand, 1997-98 revenues have
been increased by $160 million. The revised June 30, 1999 reserve is projected
to be $1,159 million or $96 million below the level originally projected by the
1998-99 Budget Act. The reserve projected in the 1998-99 Budget Act was $1,255
million.
Subsequent Events. In November 1998, the State Legislative Analysts Office
(the "LAO") issued a report that projected both a decrease in revenues and an
increase in expenditures from the assumptions on which the 1998-99 Fiscal Year
Budget is based, reducing the estimated year-end reserves to $331 million. The
LAO further estimated a budget shortfall of $1 billion in Fiscal Year 1999-2000
absent corrective actions.
On January 8, 1999, newly-elected Governor Davis released his proposed budget
for the 1999-2000 Fiscal Year (the "Proposed Budget"). The Proposed Budget
estimates general fund revenues and transfers in 1999-2000 of $60.3 billion, a
7.1% increase from revised 1998-99 figures. The Governor proposes expenditures
of $60.5 billion, a 3.8% increase from 1998-99. The Proposed Budget projects a
balance in the SFEU of $414.5 million on June 30, 2000.
Significant features of the Proposed Budget are as follows:
1. Proposition 98 funding for K-12 is proposed to be expanded to $42.8
billion, an increase of $2.8 billion over 1998-99. Proposition 98 per-pupil
spending has increased to $5,944, which is $478 over the 1997-98 level.
$444 million of the Proposition 98 funding will support a package of
initiatives to significantly improve student academic achievement to be
focused in three major areas: improving reading skills ($186 million),
enhancing professional quality ($51.3 million) and increasing school
accountability ($206.7 million).
2. Funding for higher education increased by an average of 3.7 percent,
with General Fund support increased by an average of 3.6 percent. The
Proposed Budget provides the University of California with $119.2 million
in new funding and the California State University system with $110.9
million. The Proposed Budget also incudes an additional $10 million over
the current $100 million allocation to community college districts, to
improve higher education accountability for improvement of student
outcomes.
3. The Proposed Budget incorporates a proposal to obtain federal waiver
and federal funding for the current state-funded family planning program,
titled Family Planning, Access, Care and Treatment (Family PACT). The
federal funding of approximately $122 million will reduce General Fund
expenditures for Medi-Cal by a similar amount, $62 million of which savings
will be used to assist in balancing the 1999-2000 budget.
4. The Proposed Budget recommends an increase in the State's buyout of
county trial court costs in 1999-2000 by $48 million (still less than the
$96 million originally authorized). This increase is due to the increase in
the State's share of local court costs from approximately 30% a decade ago
to 67% in 1998-99 and to an estimated 72% or $1.27 billion in the Proposed
Budget for 1999-2000.
5. The Proposed Budget includes the following augmentations to address
critical housing issues: $2.5 million of redevelopment funds for low-income
housing preservation and creation; $2 million to
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provide farm worker housing grants; an increase of $1 million to expand (to
a total of $2 million) the Self-Help Housing Program for families who build
their own homes; $1 million for temporary housing for the homeless; $5
million to implement legislation to create housing for CalWORKs families
transitioning from welfare to self-sufficiency; and $1 million to the
Department of Mental Health to create a new program for supportive housing,
specifically focused on CalWORKs special needs' populations. In addition,
the Proposed Budget provides $14.6 million to open and operate the Veterans
Home of California.
6. A total of $6.8 billion (a 3.3% increase over the revised 1998-99
budget amount) is proposed for various programs within the Youth and Adult
Correctional Agency, the Department of Justice, Citizens' Option for Public
Safety, Office of Criminal Justice Planning, Commission on Peace Officer
Standards and Training, Office of the Inspector General and the California
Highway Patrol. In addition, $8.6 million General Fund for 1998-99 and $5.7
million General Fund for 1999-2000 are included to reimburse local
governments for costs related to the transport of inmates, the return of
fugitives, and court costs and country charges primarily related to inmate
hearings and trials.
Local Governments
The primary units of local government in California are the counties, ranging
in population from 1,300 (Alpine) to over 9,000,000 (Los Angeles). Counties are
responsible for the provision of many basic services, including indigent
healthcare, welfare, courts, jails and public safety in unincorporated areas.
There are also about 480 incorporated cities and thousands of other special
districts formed for education, utility and other services. The fiscal
condition of local governments has been constrained since the enactment of
"Proposition 13" in 1978, which reduced and limited the future growth of
property taxes and limited the ability of local governments to impose "special
taxes" (those devoted to a specific purpose) without two-thirds voter approval.
Counties, in particular, have had fewer options to raise revenues than many
other local governmental entities, and have been required to maintain many
services.
The entire statewide welfare system has been changed in response to the
change in federal welfare law enacted in 1996 (see "Federal Welfare Reform"
above). Under the CalWORKs program, counties are given flexibility to develop
their own plans, consistent with State law, to implement Welfare-to-Work and to
administer many of its elements and their costs for administrative and support
services are capped at 1996-97 levels. Counties are also given financial
incentives if, at the individual county level or statewide, the CalWORKs
program produces savings associated with specified Welfare-to-Work outcomes;
counties may also suffer penalties for failing to meet federal standards. Under
CalWORKs, counties will still be required to provide "general assistance" aid
to certain persons who cannot obtain welfare from other programs.
Historically, funding for the State's trial court system was divided between
the State and the counties. However, Chapter 850, Statutes of 1997, implements
a restructuring of the State's trial court funding system. Funding for the
courts, with the exception of costs for facilities, local judicial benefits,
and revenue collection, was consolidated at the State level. County
contribution for both their general fund and fine and penalty amounts is capped
at the 1994-95 level and becomes part of the Trial Court Trust Fund, which
supports all trial court operations. The State assumed responsibility for
future growth in trial court funding. The consolidation of funding is intended
to streamline the operation of the courts, provide a dedicated revenue source,
and relieve fiscal pressure on the counties. Beginning in 1998-99, county
general fund contribution for court operations is reduced by $300 million,
including $10.7 million to buy out the contribution of the 20 smallest
counties, and cities will retain $62 million in fine and penalty revenue
previously remitted to the State; the State's general fund backfilled the $362
million revenue loss to the Trial Court Trust Fund. In addition to this general
fund backfill, a $50 million augmentation is included in the 1998 Budget Act
for the trial courts to fund workload increases and high priority issues such
as court security. In 1999-2000, county general fund contributions will be
further reduced by an additional $92 million to buy out the next 17 smallest
counties and reduce by ten percent the general fund contribution of the
remaining 21 counties.
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In the aftermath of Proposition 13, the State provided aid from the general
fund to make up some of the loss of property tax moneys, including taking over
the principal responsibility for funding local K-12 schools and community
colleges. Under the pressure of the recent recession, the Legislature has
eliminated remnants of this post-Proposition 13 aid to entities other than K-
14 education districts, although it has also provided additional funding
sources (such as sales taxes) and reduced mandates for local services. Many
counties continue to be under severe fiscal stress. While such stress has in
recent years most often been experienced by smaller, rural counties, larger
urban counties, such as Los Angeles, have also been affected. Orange County
implemented significant reductions in services and personnel, and continues to
face fiscal constraints in the aftermath of its bankruptcy, which has been
caused by large investment losses in its pooled investment funds.
On November 5, 1996, voters approved Proposition 218, entitled the "Right to
Vote on Taxes Act," which incorporates new Articles XIIIC and XIIID into the
California Constitution. These new provisions enact limitations on the ability
of local government agencies to impose or raise various taxes, fees, charges
and assessments without voter approval. Certain "general taxes" imposed after
January 1, 1995 must be approved by voters in order to remain in effect. In
addition, Article XIIIC clarifies the right of local voters to reduce taxes,
fees, and assessments to changes through local initiatives. There are a number
of ambiguities concerning the Proposition and its impact on local governments
and their bonded debt which will require interpretation by the courts or the
State Legislature. The State Legislature Analyst estimated that enactment of
Proposition 218 would reduce local government revenues statewide by over $100
million a year, and that over time revenues to local government would be
reduced by several hundred million dollars. Proposition 218 does not affect the
State or its ability to levy or collect taxes.
On December 23, 1997, a consortium of California counties filed a test claim
with the Commission on State Mandates (the "Commission") asking the Commission
to determine whether the property tax shift from counties to the Educational
Revenue Augmentation Fund, which is a funding source for schools, is a
reimbursable state mandated cost. On August 11, 1998, the State Department of
Justice, on behalf of the State Department of Finance, filed a rebuttal in
opposition to the counties' claim. The issue is currently scheduled to be heard
by the Commission on October 22, 1998. The fiscal impact to the State general
fund if the Commission determines that the property tax shifts created a
reimbursable state mandate could total approximately $8 billion for the 1996-97
($2.5 billion), 1997-98 ($2.6 billion) and 1998-99 ($2.7 billion) property tax
shifts. Ongoing costs to the State general fund would be approximately $2.7
billion annually.
Constitutional and Statutory Limitations; Recent and Pending Initiatives;
Pending Legislation
Constitutional and Statutory Limitations. Article XIIIA of the California
Constitution (which resulted from the voter-approved Proposition 13 in 1978)
limits the taxing powers of California public agencies, Article XIIIA, provides
that the maximum ad valorem tax on real property cannot exceed 1% of the "full
cash value" of the property and effectively prohibits the levying of any other
ad valorem tax on real property for general purposes. However, on May 3, 1986,
Proposition 46, an amendment to Article XIIIA, was approved by the voters of
the State of California, creating a new exemption under Article XIIIA
permitting an increase in ad valorem taxes on real property in excess of 1% for
bonded indebtedness approved by two-thirds of the voters voting on the proposed
indebtedness, "Full cash value" is defined as "the County Assessor's valuation
of real property as shown on the 1975-76 Fiscal Year tax bill under "full cash
value" or, thereafter, the appraised value of real property when purchased,
newly constructed, or a change in ownership has occurred after the 1975
assessment." The "full cash value" is subject to annual adjustment to reflect
increases (not to exceed 2%) or decreases in the consumer price index or
comparable local data, or to reflect reductions in property value caused by
damage, destruction or other factors.
Article XIIIB of the California Constitution limits the amount of
appropriations of the State and of the local governments to the amount of
appropriations of the entity for the prior year, adjusted for changes in the
cost of living, population and the services that local government has financial
responsibility for providing. To the extent that the revenues of the State
and/or local government exceed its appropriations, the excess revenues
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must be rebated to the public either directly or through a tax decrease.
Expenditures for voter-approved debt services are not included in the
appropriations limit.
At the November 9, 1988 general election, California voters approved an
initiative known as Proposition 98. This initiative amends Article XIIIB to
require that (i) the California Legislature establish a prudent state reserve
fund in an amount it shall deem reasonable and necessary and (ii) revenues in
excess of amounts permitted to be spent and which would otherwise be returned
pursuant to Article XIIIB by revision of tax rates or fee schedules be
transferred and allocated (up to a maximum of 40%) to the State School Fund and
be expended solely for purposes of instructional improvement and
accountability. Proposition 98 also amends Article XVI to require that the
State of California provide a minimum level of funding for public schools and
community colleges. Commencing with the 1988-89 Fiscal Year, money to be
applied by the State for the support of school districts and community college
districts shall not be less than the greater of: (i) the amount which, as a
percentage of the State general fund revenues which may be appropriated
pursuant to Article XIIIB, equals the percentage of such State general fund
revenues appropriated for school districts and community college districts,
respectively, in the 1986-87 Fiscal Year or (ii) the amount required to insure
that the total allocations to school districts and community college districts
from the State general fund proceeds of taxes appropriated pursuant to Article
XIIIB and allocated local proceeds of taxes shall not be less than the total
amount from these sources in the prior year, adjusted for increases in
enrollment and adjusted for changes in the cost of living pursuant to the
provisions of Article XIIIB. The initiative permits the enactment of
legislation, by a two-thirds vote, to suspend the minimum funding requirements
for one year. As a result of Proposition 98, funds that the State might
otherwise make available to its political subdivisions may be allocated instead
to satisfy such minimum funding level.
During the recent recession, general fund revenues for several years were
less than originally projected, so that the original Proposition 98
appropriations turned out to be higher than the minimum percentage provided in
the law. The Legislature responded to these developments by designating the
"extra" Proposition 98 payments in one year as a "loan" from future years'
Proposition 98 entitlements and also intended that the "extra" payments would
not be included in the Proposition 98 "base" for calculating future years'
entitlements. By implementing these actions, per-pupil funding from Proposition
98 sources stayed almost constant at approximately $4,220 from the 1991-92
Fiscal Year to the 1993-94 Fiscal Year.
In 1992, a lawsuit was filed, called California Teachers' Association v.
Gould, which challenged the validity of these off-budget loans. The settlement
of this case, finalized in July, 1996, provides, among other things, that both
the State and K-14 schools share in the repayment of prior years' emergency
loans to schools. Of the total $1.76 billion in loans, the State will repay
$935 million by forgiveness of the amount owed, while schools will repay $825
million. The State share of the repayment will be reflected as an appropriation
above the current Proposition 98 base calculation. The schools' share of the
repayment will count either as appropriations that count toward satisfying the
Proposition 98 guarantee, or as appropriations from "below" the current base.
Repayments are spread over the eight-year period of the 1994-95 Fiscal Year
through the 2001-02 Fiscal Year to mitigate any adverse fiscal impact.
Substantially increased general fund revenues, above initial budget
projections, in the 1994-95, 1995-96 and 1996-97 fiscal years have resulted or
will result in retroactive increases in Proposition 98 appropriations from
subsequent fiscal years' budgets.
On November 8, 1994, the voters approved Proposition 187, an initiative
statute ("Proposition 187"). Proposition 187 specifically prohibits funding by
the State of social services, health care services and public school education
for the benefit of any person not verified as either a United States citizen or
a person legally admitted to the United States. Among the provisions in
Proposition 187 pertaining to public school education, the measure requires,
commencing January 1, 1995, that every school district in the State verify the
legal status of every child enrolling in the district for the first time. By
January 1, 1996, each school district must also verify the legal status of
children already enrolled in the district and of all parents or guardians of
all students. If the district "reasonably suspects" that a student, parent or
guardian is not legally in the United States, that
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district must report the student to the United States Immigration and
Naturalization Service and certain other parties. The measure also prohibits a
school district from providing education to a student it does not verify as
either a United States citizen or a person legally admitted to the United
States. The State Legislative Analyst estimates that verification costs could
be in the tens of millions of dollars on a statewide level (including
verification costs incurred by other local governments), with first-year costs
potentially in excess of $100 million.
The reporting requirements may violate the Family Educational Rights and
Privacy Act ("FERPA"), which generally prohibits schools that receive federal
funds from disclosing information in student records without parental consent.
Compliance with FERPA is a condition of receiving federal education funds,
which total $2.3 billion annually to California school districts. The Secretary
of the United States Department of Education has indicated that the reporting
requirements in Proposition 187 could jeopardize the ability of school
districts to receive these funds.
Opponents of Proposition 187 filed at least eight lawsuits (which were
subsequently consolidated) challenging the constitutionality and validity of
the measure. On March 18, 1998, a United States District Court judge entered as
final judgment in the case, holding key portions of the measure
unconstitutional and permanently enjoining the State from implementing those
sections which would have required law enforcement, teachers and social
services and health care workers to verify a person's immigration status and
subsequently report illegal immigrants to authorities and deny them social
services, health care and education benefits. An appeal by the State Attorney
General was filed with the Ninth Circuit Court of Appeals on March 25, 1998 and
is pending.
Pending Litigation. The State is a party to numerous legal proceedings, many
of which normally occur in governmental operations. Some of the more
significant lawsuits pending against the State are described herein.
The State is involved in a lawsuit, Thomas Hayes v. Commission on State
Mandates, related to the state-mandated costs. The action involves an appeal by
the Director of Finance from a 1984 decision by the State Board of Control (now
succeeded by the Commission on State Mandates). The Board of Control decided in
favor of local school districts' claims for reimbursement for special education
programs for handicapped students. The case was then brought to the trial court
by the State and later remanded to the Commission on State Mandates for
redetermination. The Commission on State Mandates has since expanded the claim
to include supplemental claims filed by seven other educational institutions;
the issuance of a final consolidated decision is anticipated sometime in early
1999. To date, the Legislature has not appropriated funds. The liability to the
State, if all potentially eligible school districts pursue timely claims, has
been estimated by the Department of Finance at more than $1 billion.
The State is involved in a lawsuit related to contamination at the
Stringfellow toxic waste site. In United States, People of the State of
California v. J. B. Stringfellow, Jr., et. al., the State is seeking recovery
for post costs of cleanup of the site, a declaration that the defendants are
jointly and severally liable for future costs, and an injunction ordering
completion of the cleanup. However, the defendants have filed a counterclaim
against the State for alleged negligent acts. Because the State is the present
owner of the site, the State may be found liable. Present estimates of the
cleanup range from $300 million to $800 million.
The State is a defendant in a coordinated action involving 3,000 plaintiffs
seeking recovery for damages caused by the Yuba River flood of February 1986.
The appellate court affirmed the trial court finding of liability in inverse
condemnation and awarded damages of $500,000 to 12 sample plaintiffs. Potential
liability to the remaining 300 plaintiffs, from claims filed, ranges from $800
million to $1.5 billion. An appeal has been filed.
The State is a defendant in Just Say No To Tobacco Dough Campaign v. State of
California, where the petitioners challenge the appropriation of approximately
$166 million of Proposition 99 funds in the Cigarette and Tobacco Products
Surtax Fund for years ended June 30, 1990, through June 30, 1995 for programs
which were allegedly not health education or tobacco-related disease research.
If the State loses, the general fund and funds from other sources would be used
to reimburse the Cigarette and Tobacco Products Surtax Fund for approximately
$166 million.
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The State is a defendant in the case of Kurt Hathaway, et al. v. Wilson, et
al., where the plaintiffs are challenging the legality of various budget action
transfers and appropriations from particular special funds for years ended June
30, 1995 and June 30, 1996. The plaintiffs allege that the transfers and
appropriations are contrary to the substantive law establishing the funds and
providing for interest accruals to the funds, violate the single subject
requirement of the State Constitution, and is an invalid "special law."
Pursuant to a settlement, judgment was entered in August 1998, requiring the
State to return $19,427,000 from the general fund to one special fund.
The State is a defendant in two related cases, Beno v. Sullivan (Beno) and
Welch v. Anderson (Welch), concerning reductions in Aid to Families with
Dependent Children ("AFDC") grant payments. In the Beno case, plaintiffs seek
to invalidate AFDC grant reductions and in the Welch case, plaintiffs contend
that AFDC grant reductions are not authorized by state law. The Beno case
concerns the total grant reductions while the Welch case concerns the period of
time the State did not have a waiver for those reductions. Pursuant to a
settlement, the State has agreed to pay $42 million in return for plaintiff's
agreement to dismiss both actions.
In the case of Board of Administration, California Public Employees'
Retirement System, et al. v. Pete Wilson, Governor, et al., plaintiffs
challenged the constitutionality of legislation which deferred payment of the
State's employer contribution to the Public Employees' Retirement System
("PERS") beginning in the 1992-93 Fiscal Year. On January 11, 1995, the
Sacramento County Superior Court entered a judgment finding that the
legislation unconstitutionally impaired the vested contract rights of PERS
members. The judgment provides for issuance of a writ of mandate directing
State defendants to disregard the provisions of the legislation, to implement
the statute governing employer contributions that existed before the changes in
the legislation were found to be unconstitutional and to transfer to PERS the
contributions that are unpaid to date. On February 19, 1997, the State Court of
Appeals affirmed the decision of the Superior Court, and the Supreme Court
subsequently refused to hear the case, making the Court of Appeals' ruling
final. On July 30, 1997, the Controller transferred $1.235 billion from the
General Fund to PERS in repayment of the principal amount determined to have
been improperly deferred. Subsequent State payments to PERS will be made on a
quarterly basis. On July 7, 1998, pursuant to Chapter 94, Statutes of 1998, the
State paid PERS $332.7 million for the accrued interest on the judgment and
interest on the unpaid accrued interest amount.
On June 24, 1998, plaintiffs in Howard Jarvis Taxpayers Association et al.
v. Kathleen Connell filed a complaint for certain declaratory and injunctive
relief challenging the authority of the State Controller to make payments from
the State Treasury in the absence of a state budget. On July 21, 1998, the
trial court issued a preliminary injunction prohibiting the State Controller
from paying moneys from the State Treasury for fiscal year 1998-99, with
certain limited exceptions, in the absence of a state budget. The preliminary
injunction, among other things, prohibited the State Controller from making any
payments pursuant to any continuing appropriation.
On July 22 and 27, 1998, various employee unions which had intervened in the
case appealed the trial court's preliminary injunction and asked the Court of
Appeal to stay the preliminary injunction. On July 28, 1998, the Court of
Appeal granted the unions' requests and stayed the preliminary injunction
pending the Court of Appeal's decision on the merits of the appeal. On August
5, 1998, the Court of Appeal denied the plaintiffs' request to reconsider the
stay. Also on July 22, 1998, the State Controller asked the California Supreme
Court to immediately stay the trial court's preliminary injunction and to
overrule the order granting the preliminary injunction on the merits. On July
29, 1998, the Supreme Court transferred the State Controller's request to the
Court of Appeal. The matters are now pending before the Court of Appeal.
In Jordan v. Department of Motor Vehicles, plaintiff challenged the validity
and constitutionality of the State's smog impact fee and requested a refund of
the fee. In October 1997, the trial court ruled in favor of the plaintiff and,
in addition, ordered the State to provide refunds to all persons who paid the
smog impact fee from the years before the filing of the lawsuit in 1995 to the
present. The Plaintiff asserts that the total amount required to be refunded
will exceed $350 million. The State has appealed.
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A judgment was entered for the plaintiff in August 1998 in the case of
Ceridian Corporation v. Franchise Tax Board, a suit which challenged the
validity of two sections of the California Tax laws. The first related to
deduction from corporate taxes for dividends received from insurance companies
to the extent the insurance companies have California activities. The second
related to corporate deduction of dividends to the extent the earnings of the
dividend-paying corporation have already been included in the measure of their
California tax. If both sections of the California Tax law are ultimately
invalidated, and all dividends become deductible, then the General Fund can
become liable for approximately $200 to $250 million annually. The State has
appealed the decision.
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APPENDIX B
RATINGS OF MUNICIPAL BONDS
Description of Moody's Investors Service, Inc.'s ("Moody's") Municipal Bond
Ratings
Aaa Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally
referred to as "gilt edge." Interest payments are protected by a large
or by an exceptionally stable margin and principal is secure. While
the various protective elements are likely to change, such changes as
can be visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high grade bonds. They are rated lower than the
best bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater
amplitude or there may be other elements present which make the long-
term risks appear somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate, but
elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payments and principal security appear adequate for the present, but
certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such
bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
of maintenance of other terms of the contract over any long period of
time may be small.
Caa Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other
marked shortcomings.
C Bonds which are rated C are the lowest rated class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: These bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
Al, Baal, Bal and B1.
Short-term Notes: The three ratings of Moody's for short-term notes are MIG
1/VMIG 1, MIG 2/VMIG 2, and MIG 3/VMIG 3; MIG 1/VMIG 1 denotes "best quality,
enjoying strong protection from established cash flows"; MIG 2/VMIG 2 denotes
"high quality" with "ample margins of protection"; MIG 3/VMIG 3 instruments are
of "favorable quality . . . but . . . lacking the undeniable strength of the
preceding grades."
B-1
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Description of Moody's Commercial Paper Ratings
Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
Issuers rated Prime-1 (or supporting institutions) have a superior ability
for repayment of short-term promissory obligations. Prime-l repayment capacity
will often be evidenced by the following characteristics: leading market
positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on
debt and ample asset protection; broad margins in earning coverage of fixed
financial charges and high internal cash generation; and with established
access to a range of financial markets and assured sources of alternate
liquidity.
Issuers rated Prime-2 (or supporting institutions) have a strong ability for
repayment of short-term promissory obligations. This will normally be
evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be
more affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of short-term promissory obligations. The effects of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes to the level
of debt protection measurements and the requirement for relatively high
financial leverage. Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
Description of Standard & Poor's, a Division of the McGraw-Hill Companies,
Inc. ("Standard & Poor's"), Municipal Debt Ratings
A Standard & Poor's municipal debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific financial
obligation, a specific class of financial obligations or a specific program.
It takes into consideration the creditworthiness of guarantors, insurers, or
other forms of credit enhancement on the obligation.
The debt rating is not a recommendation to purchase, sell or hold a
financial obligation, inasmuch as it does not comment as to market price or
suitability for a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by Standard & Poor's from other sources Standard & Poor's considers
reliable. Standard & Poor's does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended or withdrawn as a result of changes in, or
unavailability of, such information, or based on other circumstances.
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of default--capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance
with the terms of the obligation;
II. Nature of and provisions of the obligation;
III. Protection afforded to, and relative position of, the obligation in
the event of bankruptcy, reorganization or other arrangement under the laws
of bankruptcy and other laws affecting creditors' rights.
AAA Debt rated "AAA" has the highest rating assigned by Standard &
Poor's. Capacity of the obligor to meet its financial commitment on
the obligation is extremely strong.
Debt rated "AA" differs from the highest-rated issues only in small
AA degree. The obligor's capacity to meet its financial commitment on
the obligation is very strong.
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A Debt rated "A" is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than debt in
higher-rated categories. However, the obligor's capacity to meet
its financial commitment on the obligation is still strong.
BBB Debt rated "BBB" exhibits adequate protection parameters. However,
adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity of the obligor to meet its
financial commitment on the obligation.
BB Debt rated "BB," "B," "CCC," "CC" and "C" are regarded as having
B significant speculative characteristics. "BB" indicates the least
CCC degree of speculation and "C" the highest degree of speculation.
CC While such debt will likely have some quality and protective
C characteristics, these may be outweighed by large uncertainties or
major risk exposures to adverse conditions.
D Debt rated "D" is in payment default. The "D" rating category is
used when payments on an obligation are not made on the date due
even if the applicable grace period has not expired, unless
Standard & Poor's believes that such payments will be made during
such grace period. The "D" rating also will be used upon the filing
of a bankruptcy petition or the taking of similar action if
payments on an obligation are jeopardized.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Description of Standard & Poor's Commercial Paper Ratings
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more
than 365 days. Ratings are graded into several categories, ranging from "A-l"
for the highest quality obligations to "D" for the lowest. These categories are
as follows:
A-1 This designation indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess
extremely strong safety characteristics are denoted with a plus
sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high
as for issues designated "A-1."
A-3 Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects
of changes in circumstances than obligations carrying the higher
designations.
B Issues rated "B" are regarded as having only speculative capacity
for timely payment.
C This rating is assigned to short-term debt obligations with a
doubtful capacity for payment.
D Debt rated "D" is in payment default. The "D" rating category is
used when interest payments or principal payments are not made on
the date due, even if the applicable grace period has not expired
unless Standard & Poor's believes that such payments will be made
during such grace period.
A commercial paper rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer or obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in, or unavailability of, such information.
A Standard & Poor's note rating reflects the liquidity factors and market
access risks unique to such notes. Notes due in three years or less will likely
receive a note rating. Notes maturing beyond three years will most likely
receive a long-term debt rating. The following criteria will be used in making
that assessment.
--Amortization schedule--the larger the final maturity relative to other
maturities, the more likely it will be treated as a note.
--Source of payment--the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note.
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Note rating symbols are as follows:
SP-1 Strong capacity to pay principal and interest. An issue determined
to possess a very strong capacity to pay debt service is given a
plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest with some
vulnerability to adverse financial and economic changes over the
term of the notes.
SP-3 Speculative capacity to pay principal and interest.
Description of Fitch IBCA, Inc.'s ("Fitch") Investment Grade Bond Ratings
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The rating
represents Fitch's assessment of the issuer's ability to meet the obligations
of a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be provided by
insurance policies or financial guarantees unless otherwise indicated.
Bonds that have the same rating are of similar but not necessarily identical
credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any security.
Ratings do not comment on the adequacy of market price, the suitability of any
security for a particular investor, or the tax-exempt nature or taxability of
payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other obligors,
underwriters, their experts, and other sources Fitch believes to be reliable.
Fitch does not audit or verify the truth or accuracy of such information.
Ratings may be changed, suspended, or withdrawn as a result of changes in, or
the unavailability of, information or for other reasons.
AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated "AAA."
Because bonds rated in the "AAA" and "AA" categories are not
significantly vulnerable to foreseeable future developments, short-
term debt of these issuers is generally rated "F-1+."
A Bonds considered to be investment grade and of high credit quality.
The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes
in economic conditions and circumstances than bonds with higher
ratings.
BBB Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on
these bonds, and therefore impair timely payment. The likelihood that
the ratings of these bonds will fall below investment grade is higher
than for bonds with higher ratings.
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Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "AAA" category.
NR Indicates that Fitch does not rate the specific issue.
Conditional A conditional rating is premised on the successful completion of
a project or the occurrence of a specific event.
Suspended A rating is suspended when Fitch deems the amount of information
available from the issuer to be inadequate for rating purposes.
Withdrawn A rating will be withdrawn when an issue matures or is called or
refinanced and, at Fitch's discretion, when an issuer fails to
furnish proper and timely information.
FitchAlert Ratings are placed on FitchAlert to notify investors of an
occurrence that is likely to result in a rating change and the
likely direction of such change. These are designated as
"Positive," indicating a potential upgrade, "Negative," for
potential downgrade, or "Evolving," where ratings may be raised
or lowered. FitchAlert is relatively short-term, and should be
resolved within three to 12 months.
Ratings An outlook is used to describe the most likely direction of any
Outlook rating change over the intermediate term. It is described as
"Positive" or "Negative." The absence of a designation indicates
a stable outlook.
Description of Fitch's Speculative Grade Bond Ratings
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
("BB" to "C") represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ("DDD" to "D") is an
assessment of the ultimate recovery value through reorganization or
liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength.
Bonds that have the rating are of similar but not necessarily identical
credit quality since rating categories cannot fully reflect the differences in
degrees of credit risk.
BB Bonds are considered speculative. The obligor's ability to pay
interest and repay principal may be affected over time by
adverse economic changes. However, business and financial
alternatives can be identified which could assist the obligor in
satisfying its debt service requirements.
B Bonds are considered highly speculative. While bonds in this
class are currently meeting debt service requirements, the
probability of continued timely payment of principal and
interest reflects the obligor's limited margin of safety and the
need for reasonable business and economic activity throughout
the life of the issue.
CCC Bonds have certain identifiable characteristics which, if not
remedied, may lead to default. The ability to meet obligations
requires an advantageous business and economic environment.
CC Bonds are minimally protected. Default in payment of interest
and/or principal seems probable over time.
C Bonds are in imminent default in payment of interest or
principal.
DDD Bonds are in default on interest and/or principal payments. Such
DD bonds are extremely speculative and should be valued on the
D basis of their ultimate recovery value in liquidation or
reorganization of the obligor. "DDD" represents the highest
potential for recovery on these bonds, and "D" represents the
lowest potential for recovery.
B-5
<PAGE>
Plus (+) or Minus (-): Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "DDD," "DD," or "D" categories.
Description of Fitch's Short-Term Ratings
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
Fitch short-term ratings are as follows:
F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating
are regarded as having the strongest degree of assurance for timely
payment.
F-1 Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than
issues rated "F-1+."
F-2 Good Credit Quality. Issues assigned this rating have a
satisfactory degree of assurance for timely payment, but the margin
of safety is not as great as for issues assigned "F-1+" and "F-1"
ratings.
F-3
Fair Credit Quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause
these securities to be rated below investment grade.
F-S Weak Credit Quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in
financial and economic conditions.
D Default. Issues assigned this rating are in actual or imminent
payment default.
LOC The symbol "LOC" indicates that the rating is based on a letter of
credit issued by a commercial bank.
B-6
<PAGE>
APPENDIX C
PORTFOLIO INSURANCE
Set forth below is further information with respect to the insurance policies
(the "Policies") that the Fund may obtain from several insurance companies with
respect to insured California Municipal Bonds and Municipal Bonds held by the
Fund. The Fund has no obligation to obtain any such Policies, and the terms of
any Policies actually obtained may vary significantly from the terms discussed
below.
In determining eligibility for insurance, insurance companies will apply
their own standards. These standards correspond generally to the standards such
companies normally use in establishing the insurability of new issues of
California Municipal Bonds and Municipal Bonds and are not necessarily the
criteria that would be used in regard to the purchase of such bonds by the
Fund. The Policies do not insure (i) municipal securities ineligible for
insurance and (ii) municipal securities no longer owned by the Fund.
The Policies do not guarantee the market value of the insured California
Municipal Bonds and Municipal Bonds or the value of the shares of the Fund. In
addition, if the provider of an original issuance insurance policy is unable to
meet its obligations under such policy or if the rating assigned to the
insurance claims-paying ability of any such insurer deteriorates, the insurance
company will not have any obligation to insure any issue held by the Fund that
is aversely affected by either of the above described events. In addition to
the payment of premium, the policies may require that the Fund notify the
insurance company as to all California Municipal Bonds and Municipal Bonds in
the Fund's portfolio and permit the insurance company to audit their records.
The insurance premiums will be payable monthly by the Fund in accordance with a
premium schedule to be furnished by the insurance company at the time the
Policies are issued. Premiums are based upon the amounts covered and the
composition of the portfolio.
The Fund will seek to utilize insurance companies that have insurance claims-
paying ability ratings of AAA from Standard & Poor's ("S&P") or Fitch IBCA,
Inc. ("Fitch") or Aaa from Moody's Investors Service ("Moody's"). There can be
no assurance however, that insurance from insurance carriers meeting these
criteria will be at all times available.
An S&P insurance claims-paying ability rating is an assessment of an
operating insurance company's financial capacity to meet obligations under an
insurance policy in accordance with the terms. An insurer with an insurance
claims-paying ability rating of AAA has the highest rating assigned by S&P.
Capacity to honor insurance contracts is considered by S&P to be extremely
strong and highly likely to remain so over a long period of time. A Fitch
insurance claims-paying ability rating provides an assessment of an insurance
company's financial strength and, therefore, its ability to pay policy and
contract claims under the terms indicated. An insurer with an insurance claims-
paying ability rating of AAA has the highest rating assigned by Fitch. The
ability to pay claims is adjudged by Fitch to be extremely strong for insurance
companies with this highest rating. In the opinion of Fitch, foreseeable
business and economic risk factors should not have any material adverse impact
on the ability of these insurers to pay claims. In Fitch's opinion,
profitability, overall balance sheet strength, capitalization and liquidity are
all at very secure levels and are unlikely to be affected by potential adverse
underwriting, investment or cyclical events. A Moody's insurance claims-paying
ability rating is an opinion of the ability of an insurance company to repay
punctually senior policyholder obligations and claims. An insurer with an
insurance claims-paying ability rating of Aaa is considered by Moody's to be of
the best quality. In the opinion of Moody's, the policy obligations of an
insurance company with an insurance claims-paying ability rating of Aaa carry
the smallest degree of credit risk and, while the financial strength of these
companies is likely to change, such changes as can be visualized are most
unlikely to impair the company's fundamentally strong position.
An insurance claims-paying ability rating of S&P, Fitch or Moody's does not
constitute an opinion on any specific contract in that such an opinion can only
be rendered upon the review of the specific insurance contract. Furthermore, an
insurance claims-paying ability rating does not take into account deductibles,
C-1
<PAGE>
surrender or cancellation penalties or the timeliness of payment; nor does it
address the ability of a company to meet nonpolicy obligations (i.e., debt
contracts).
The assignment of ratings by S&P, Fitch or Moody's to debt issues that are
fully or partially supported by insurance policies, contracts or guarantees is
a separate process from the determination of claims-paying ability ratings. The
likelihood of a timely flow of funds from the insurer to the trustee for the
bondholders is a key element in the rating determination for such debt issues.
C-2
<PAGE>
APPENDIX D
SETTLEMENT PROCEDURES
The following summary of Settlement Procedures sets forth the procedures
expected to be followed in connection with the settlement of each Auction and
will be incorporated by reference in the Auction Agent Agreement and each
Broker-Dealer Agreement. Nothing contained in this Appendix C constitutes a
representation by the Fund that in each Auction each party referred to herein
actually will perform the procedures described herein to be performed by such
party. Capitalized terms used herein shall have the respective meanings
specified in the glossary of this Prospectus or Appendix D hereto, as the case
may be.
(a) On each Auction Date, the Auction Agent shall notify by telephone or
through the Auction Agent's Processing System the Broker-Dealers that
participated in the Auction held on such Auction Date and submitted an Order
on behalf of any Beneficial Owner or Potential Beneficial Owner of:
(i) the Applicable Rate fixed for the next succeeding Dividend Period;
(ii) whether Sufficient Clearing Bids existed for the determination of
the Applicable Rate;
(iii) if such Broker-Dealer (a "Seller's Broker-Dealer") submitted a Bid
or a Sell Order on behalf of a Beneficial Owner, the number of shares, if
any, of AMPS to be sold by such Beneficial Owner;
(iv) if such Broker-Dealer (a "Buyer's Broker-Dealer") submitted a Bid on
behalf of a Potential Beneficial Owner, the number of shares, if any, of
AMPS to be purchased by such Potential Beneficial Owner;
(v) if the aggregate number of shares of AMPS to be sold by all
Beneficial Owners on whose behalf such Broker-Dealer submitted a Bid or a
Sell Order exceeds the aggregate number of shares of AMPS to be purchased
by all Potential Beneficial Owners on whose behalf such Broker-Dealer
submitted a Bid, the name or names of one or more Buyer's Broker-Dealers
(and the name of the Agent Member, if any, of each such Buyer's Broker-
Dealer) acting for one or more purchasers of such excess number of shares
of AMPS and the number of such shares to be purchased from one or more
Beneficial Owners on whose behalf such Broker-Dealer acted by one or more
Potential Beneficial Owners on whose behalf each of such Buyer's Broker-
Dealers acted;
(vi) if the aggregate number of shares of AMPS to be purchased by all
Potential Beneficial Owners on whose behalf such Broker-Dealer submitted a
Bid exceeds the aggregate number of shares of AMPS to be sold by all
Beneficial Owners on whose behalf such Broker-Dealer submitted a Bid or a
Sell Order, the name or names of one or more Seller's Broker-Dealers (and
the name of the Agent Member, if any, of each such Seller's Broker-Dealer)
acting for one or more sellers of such excess number of shares of AMPS and
the number of such shares to be sold to one or more Potential Beneficial
Owners on whose behalf such Broker-Dealer acted by one or more Beneficial
Owners on whose behalf each of such Seller's Broker-Dealers acted; and
(vii) the Auction Date of the next succeeding Auction with respect to the
AMPS.
(b) On each Auction Date, each Broker-Dealer that submitted an Order on
behalf of any Beneficial Owner or Potential Beneficial Owner shall:
(i) in the case of a Broker-Dealer that is a Buyer's Broker-Dealer,
instruct each Potential Beneficial Owner on whose behalf such Broker-Dealer
submitted a Bid that was accepted, in whole or in part, to instruct such
Potential Beneficial Owner's Agent Member to pay to such Broker-Dealer (or
its Agent Member) through the Securities Depository the amount necessary to
purchase the number of shares of AMPS to be purchased pursuant to such Bid
against receipt of such shares and advise such Potential Beneficial Owner
of the Applicable Rate for the next succeeding Dividend Period;
(ii) in the case of a Broker-Dealer that is a Seller's Broker-Dealer,
instruct each Beneficial Owner on whose behalf such Broker-Dealer submitted
a Sell Order that was accepted, in whole or in part, or a Bid that was
accepted, in whole or in part, to instruct such Beneficial Owner's Agent
Member to deliver to such Broker-Dealer (or its Agent Member) through the
Securities Depository the number of shares of AMPS to be sold pursuant to
such Order against payment therefor and advise any such Beneficial Owner
that will continue to hold shares of AMPS of the Applicable Rate for the
next succeeding Dividend Period;
D-1
<PAGE>
(iii) advise each Beneficial Owner on whose behalf such Broker-Dealer
submitted a Hold Order of the Applicable Rate for the next succeeding
Dividend Period;
(iv) advise each Beneficial Owner on whose behalf such Broker-Dealer
submitted an Order of the Auction Date for the next succeeding Auction; and
(v) advise each Potential Beneficial Owner on whose behalf such Broker-
Dealer submitted a Bid that was accepted, in whole or in part, of the
Auction Date for the next succeeding Auction.
(c) On the basis of the information provided to it pursuant to (a) above,
each Broker-Dealer that submitted a Bid or a Sell Order on behalf of a
Potential Beneficial Owner or a Beneficial Owner shall, in such manner and at
such time or times as in its sole discretion it may determine, allocate any
funds received by it pursuant to (b)(i) above and any shares of AMPS received
by it pursuant to (b)(ii) above among the Potential Beneficial Owners, if any,
on whose behalf such Broker-Dealer submitted Bids, the Beneficial Owners, if
any, on whose behalf such Broker-Dealer submitted Bids that were accepted or
Sell Orders, and any Broker-Dealer or Broker-Dealers identified to it by the
Auction Agent pursuant to (a)(v) or (a)(vi) above.
(d) On each Auction Date:
(i) each Potential Beneficial Owner and Beneficial Owner shall instruct
its Agent Member as provided in (b)(i) or (ii) above, as the case may be;
(ii) each Seller's Broker-Dealer which is not an Agent Member of the
Securities Depository shall instruct its Agent Member to (A) pay through
the Securities Depository to the Agent Member of the Beneficial Owner
delivering shares to such Broker-Dealer pursuant to (b)(ii) above the
amount necessary to purchase such shares against receipt of such shares,
and (B) deliver such shares through the Securities Depository to a Buyer's
Broker-Dealer (or its Agent Member) identified to such Seller's Broker-
Dealer pursuant to (a)(v) above against payment therefor; and
(iii) each Buyer's Broker-Dealer which is not an Agent Member of the
Securities Depository shall instruct its Agent Member to (A) pay through
the Securities Depository to a Seller's Broker-Dealer (or its Agent Member)
identified pursuant to (a)(vi) above the amount necessary to purchase the
shares to be purchased pursuant to (b)(i) above against receipt of such
shares, and (B) deliver such shares through the Securities Depository to
the Agent Member of the purchaser thereof against payment therefor.
(e) On the day after the Auction Date:
(i) each Bidder's Agent Member referred to in (d)(i) above shall instruct
the Securities Depository to execute the transactions described in (b)(i)
or (ii) above, and the Securities Depository shall execute such
transactions;
(ii) each Seller's Broker-Dealer or its Agent Member shall instruct the
Securities Depository to execute the transactions described in (d)(ii)
above, and the Securities Depository shall execute such transactions; and
(iii) each Buyer's Broker-Dealer or its Agent Member shall instruct the
Securities Depository to execute the transactions described in (d)(iii)
above, and the Securities Depository shall execute such transactions.
(f) If a Beneficial Owner selling shares of AMPS in an Auction fails to
deliver such shares (by authorized book-entry), a Broker-Dealer may deliver
to the Potential Beneficial Owner on behalf of which it submitted a Bid
that was accepted a number of whole shares of AMPS that is less than the
number of shares that otherwise was to be purchased by such Potential
Beneficial Owner. In such event, the number of shares of AMPS to be so
delivered shall be determined solely by such Broker-Dealer. Delivery of
such lesser number of shares shall constitute good delivery.
Notwithstanding the foregoing terms of this paragraph (f), any delivery or
non-delivery of shares which shall represent any departure from the results
of an Auction, as determined by the Auction Agent, shall be of no effect
unless and until the Auction Agent shall have been notified of such
delivery or non-delivery in accordance with the provisions of the Auction
Agent Agreement and the Broker-Dealer Agreements.
D-2
<PAGE>
APPENDIX E
AUCTION PROCEDURES
The following procedures will be set forth in provisions of the Articles
Supplementary relating to the AMPS, and will be incorporated by reference in
the Auction Agent Agreement and each Broker-Dealer Agreement. The terms not
defined below are defined in the forepart of this Prospectus. Nothing contained
in this Appendix E constitutes a representation by the Fund that in each
Auction each party referred to herein actually will perform the procedures
described herein to be performed by such party.
Paragraph 10(a) Certain Definitions.
As used in this Paragraph 10, the following terms shall have the following
meanings, unless the context otherwise requires:
(i) "AMPS" shall mean the shares of AMPS being auctioned pursuant to this
Paragraph 10.
(ii) "Auction Date" shall mean the first Business Day preceding the first
day of a Dividend Period.
(iii) "Available AMPS" shall have the meaning specified in Paragraph
10(d)(i) below.
(iv) "Bid" shall have the meaning specified in Paragraph 10(b)(i) below.
(v) "Bidder" shall have the meaning specified in Paragraph 10(b)(i)
below.
(vi) "Hold Order" shall have the meaning specified in Paragraph 10(b)(i)
below.
(vii) "Maximum Applicable Rate" for any Dividend Period will be the
Applicable Percentage of the Reference Rate. The Applicable Percentage will
be determined based on (i) the lower of the credit rating or ratings
assigned on such date to such shares by Moody's and S&P (or if Moody's or
S&P or both shall not make such rating available, the equivalent of either
or both of such ratings by a Substitute Rating Agency or two Substitute
Rating Agencies or, in the event that only one such rating shall be
available, such rating) and (ii) whether the Fund has provided modification
to the Auction Agent prior to the Auction establishing the Applicable Rate
for any dividend that net capital gains or other taxable income will be
included in such dividend on shares of AMPS as follows:
<TABLE>
<CAPTION>
Applicable
Percentage of Applicable
Credit Ratings Reference Rate-- Percentage of
---------------------------------- No Reference Rate--
Moody's S&P Notification Notification
---------------- ------------- ---------------- ----------------
<S> <C> <C> <C>
"aa3" or higher AA- or Higher 110% 150%
"a3" or "a1" A- to A+ 125% 160%
"baa3" to "baa1" BBB- to BBB+ 150% 250%
Below "baa3" Below BBB- 200% 275%
</TABLE>
The Fund shall take all reasonable action necessary to enable S&P and Moody's
to provide a rating for the AMPS. If either S&P or Moody's shall not make such
a rating available, or if neither S&P nor Moody's shall make such a rating
available, Merrill Lynch, Pierce, Fenner & Smith Incorporated or its affiliates
and successors, after consultation with the Fund, shall select a nationally
recognized statistical rating organization or two nationally recognized
statistical rating organizations to act as a Substitute Rating Agency or
Substitute Rating Agencies, as the case may be.
(viii) "Order" shall have the meaning specified in Paragraph 10(b)(i)
below.
(ix) "Sell Order" shall have the meaning specified in Paragraph 10(b)(i)
below.
(x) "Submission Deadline" shall mean 1:00 p.m., New York City time, on
any Auction Date or such other time on any Auction Date as may be specified
by the Auction Agent from time to time as the time by which each Broker-
Dealer must submit to the Auction Agent in writing all Orders obtained by
it for the Auction to be conducted on such Auction Date.
(xi) "Submitted Bid" shall have the meaning specified in Paragraph
10(d)(i) below.
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<PAGE>
(xii) "Submitted Hold Order" shall have the meaning specified in
Paragraph 10(d)(i) below.
(xiii) "Submitted Order" shall have the meaning specified in Paragraph
10(d)(i) below.
(xiv) "Submitted Sell Order" shall have the meaning specified in
Paragraph 10(d)(i) below.
(xv) "Sufficient Clearing Bids" shall have the meaning specified in
Paragraph 10(d)(i) below.
(xvi) (xvi) "Winning Bid Rate" shall have the meaning specified in
Paragraph 10(d)(i) below.
Paragraph 10(b) Orders by Beneficial Owners, Potential Beneficial Owners,
Existing Holders and Potential Holders.
(i) Unless otherwise permitted by the Fund, Beneficial Owners and Potential
Beneficial Owners may only participate in Auctions through their Broker-
Dealers. Broker-Dealers will submit the Orders of their respective customers
who are Beneficial Owners and Potential Beneficial Owners to the Auction Agent,
designating themselves as Existing Holders in respect of shares subject to
Orders submitted or deemed submitted to them by Beneficial Owners and as
Potential Holders in respect of shares subject to Orders submitted to them by
Potential Beneficial Owners. A Broker-Dealer may also hold shares of AMPS in
its own account as a Beneficial Owner. A Broker-Dealer may thus submit Orders
to the Auction Agent as a Beneficial Owner or a Potential Beneficial Owner and
therefore participate in an Auction as an Existing Holder or Potential Holder
on behalf of both itself and its customers. On or prior to the Submission
Deadline on each Auction Date:
(A) each Beneficial Owner may submit to its Broker-Dealer information as
to:
(1) the number of outstanding shares, if any, of AMPS held by such
Beneficial Owner which such Beneficial Owner desires to continue to
hold without regard to the Applicable Rate for the next succeeding
Dividend Period;
(2) the number of outstanding shares, if any, of AMPS held by such
Beneficial Owner which such Beneficial Owner desires to continue to
hold, provided that the Applicable Rate for the next succeeding
Dividend Period shall not be less than the rate per annum specified by
such Beneficial Owner, and/or
(3) the number of outstanding shares, if any, of AMPS held by such
Beneficial Owner which such Beneficial Owner offers to sell without
regard to the Applicable Rate for the next succeeding Dividend Period;
and
(B) each Broker-Dealer, using a list of Potential Beneficial Owners that
shall be maintained in good faith for the purpose of conducting a
competitive Auction, shall contact Potential Beneficial Owners, including
Persons that are not Beneficial Owners, on such list to determine the
number of outstanding shares, if any, of AMPS which each such Potential
Beneficial Owner offers to purchase, provided that the Applicable Rate for
the next succeeding Dividend Period shall not be less than the rate per
annum specified by such Potential Beneficial Owner.
For the purposes hereof, the communication by a Beneficial Owner or Potential
Beneficial Owner to a Broker-Dealer, or the communication by a Broker-Dealer
acting for its own account to the Auction Agent, of information referred to in
clause (A) or (B) of this Paragraph 10(b)(i) is hereinafter referred to as an
"Order" and each Beneficial Owner and each Potential Beneficial Owner placing
an Order, including a Broker-Dealer acting in such capacity for its own
account, is hereinafter referred to as a "Bidder"; an Order containing the
information referred to in clause (A)(1) of this Paragraph 10(b)(i) is
hereinafter referred to as a "Hold Order"; an Order containing the information
referred to in clause (A)(2) or (B) of this Paragraph 10(b)(i) is hereinafter
referred to as a "Bid"; and an Order containing the information referred to in
clause (A)(3) of this Paragraph 10(b)(i) is hereinafter referred to as a "Sell
Order." Inasmuch as a Broker-Dealer participates in an Auction as an Existing
Holder or a Potential Holder only to represent the interests of a Beneficial
Owner or Potential Beneficial Owner, whether it be its customers or itself, all
discussion herein relating to the consequences of an Auction for Existing
Holders and Potential Holders also applies to the underlying beneficial
ownership interests represented.
E-2
<PAGE>
(ii) (A) A Bid by an Existing Holder shall constitute an irrevocable offer to
sell:
(1) the number of outstanding shares of AMPS specified in such Bid if the
Applicable Rate determined on such Auction Date shall be less than the rate
per annum specified in such Bid; or
(2) such number or a lesser number of outstanding shares of AMPS to be
determined as set forth in Paragraph 10(e)(i)(D) if the Applicable Rate
determined on such Auction Date shall be equal to the rate per annum
specified therein; or
(3) a lesser number of outstanding shares of AMPS to be determined as set
forth in Paragraph 10(e)(ii)(C) if such specified rate per annum shall be
higher than the Maximum Applicable Rate and Sufficient Clearing Bids do not
exist.
(B) A Sell Order by an Existing Holder shall constitute an irrevocable offer
to sell:
(1) the number of outstanding shares of AMPS specified in such Sell
Order, or
(2) such number or a lesser number of outstanding shares of AMPS to be
determined as set forth in Paragraph 10(e)(ii)(C) if Sufficient Clearing
Bids do not exist.
(C) A Bid by a Potential Holder shall constitute an irrevocable offer to
purchase:
(1) the number of outstanding shares of AMPS specified in such Bid if the
Applicable Rate determined on such Auction Date shall be higher than the
rate per annum specified in such Bid; or
(2) such number or a lesser number of outstanding shares of AMPS to be
determined as set forth in Paragraph 10(e)(i)(E) if the Applicable Rate
determined on such Auction Date shall be equal to the rate per annum
specified therein.
Paragraph 10(c) Submission of Orders By Broker-Dealers to Auction Agent.
(i) Each Broker-Dealer shall submit in writing or through the Auction Agent's
Auction Processing System to the Auction Agent prior to the Submission Deadline
on each Auction Date all Orders obtained by such Broker-Dealer, designating
itself (unless otherwise permitted by the Fund) as an Existing Holder in
respect of shares subject to Orders submitted or deemed submitted to it by
Beneficial Owners and as a Potential Holder in respect of shares subject to
Orders submitted to it by Potential Beneficial Owners, and specifying with
respect to each Order:
(A) the name of the Bidder placing such Order (which shall be the Broker-
Dealer unless otherwise permitted by the Fund);
(B) the aggregate number of outstanding shares of AMPS that are the
subject of such Order;
(C) to the extent that such Bidder is an Existing Holder
(1) the number of outstanding shares, if any, of AMPS subject to any
Hold Order placed by such Existing Holder;
(2) the number of outstanding shares, if any, of AMPS subject to any
Bid placed by such Existing Holder and the rate per annum specified in
such Bid; and
(3) the number of outstanding shares, if any, of AMPS subject to any
Sell Order placed by such Existing Holder; and
(D) to the extent such Bidder is a Potential Holder, the rate per annum
specified in such Potential Holder's Bid.
(ii) If any rate per annum specified in any Bid contains more than three
figures to the right of the decimal point, the Auction Agent shall round such
rate up to the next highest one-thousandth (.001) of 1%.
(iii) If an Order or Orders covering all of the outstanding shares of AMPS
held by an Existing Holder are not submitted to the Auction Agent prior to the
Submission Deadline, the Auction Agent shall deem a Hold Order (in the case of
an Auction relating to a Dividend Period which is not a Special Dividend
Period) and a
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<PAGE>
Sell Order (in the case of an Auction relating to a Special Dividend Period) to
have been submitted on behalf of such Existing Holder covering the number of
outstanding shares of AMPS held by such Existing Holder and not subject to
Orders submitted to the Auction Agent.
(iv) If one or more Orders on behalf of an Existing Holder covering in the
aggregate more than the number of outstanding shares of AMPS held by such
Existing Holder are submitted to the Auction Agent, such Orders shall be
considered valid as follows and in the following order of priority:
(A) any Hold Order submitted on behalf of such Existing Holder shall be
considered valid up to and including the number of outstanding shares of
AMPS held by such Existing Holder; provided that if more than one Hold
Order is submitted on behalf of such Existing Holder and the number of
shares of AMPS subject to such Hold Orders exceeds the number of
outstanding shares of AMPS held by such Existing Holder, the number of
shares of AMPS subject to each of such Hold Orders shall be reduced pro
rata so that such Hold Orders, in the aggregate, cover exactly the number
of outstanding shares of AMPS held by such Existing Holder;
(B) any Bids submitted on behalf of such Existing Holder shall be
considered valid, in the ascending order of their respective rates per
annum if more than one Bid is submitted on behalf of such Existing Holder,
up to and including the excess of the number of outstanding shares of AMPS
held by such Existing Holder over the number of shares of AMPS subject to
any Hold Order referred to in Paragraph 10(c)(iv)(A) above (and if more
than one Bid submitted on behalf of such Existing Holder specifies the same
rate per annum and together they cover more than the remaining number of
shares that can be the subject of valid Bids after application of Paragraph
10(c)(iv)(A) above and of the foregoing portion of this Paragraph
10(c)(iv)(B) to any Bid or Bids specifying a lower rate or rates per annum,
the number of shares subject to each of such Bids shall be reduced pro rata
so that such Bids, in the aggregate, cover exactly such remaining number of
shares); and the number of shares, if any, subject to Bids not valid under
this Paragraph 10(c)(iv)(B) shall be treated as the subject of a Bid by a
Potential Holder; and
(C) any Sell Order shall be considered valid up to and including the
excess of the number of outstanding shares of AMPS held by such Existing
Holder over the number of shares of AMPS subject to Hold Orders referred to
in Paragraph 10(c)(iv)(A) and Bids referred to in Paragraph 10(c)(iv)(B);
provided that if more than one Sell Order is submitted on behalf of any
Existing Holder and the number of shares of AMPS subject to such Sell
Orders is greater than such excess, the number of shares of AMPS subject to
each of such Sell Orders shall be reduced pro rata so that such Sell
Orders, in the aggregate, cover exactly the number of shares of AMPS equal
to such excess.
(v) If more than one Bid is submitted on behalf of any Potential Holder, each
Bid submitted shall be a separate Bid with the rate per annum and number of
shares of AMPS therein specified.
(vi) Any Order submitted by a Beneficial Owner or a Potential Beneficial
Owner to its Broker-Dealer, or by a Broker-Dealer to the Auction Agent, prior
to the Submission Deadline on any Auction Date shall be irrevocable.
Paragraph 10(d) Determination of Sufficient Clearing Bids, Winning Bid Rate and
Applicable Rate.
(i) Not earlier than the Submission Deadline on each Auction Date, the
Auction Agent shall assemble all Orders submitted or deemed submitted to it by
the Broker-Dealers (each such Order as submitted or deemed submitted by a
Broker-Dealer being hereinafter referred to individually as a "Submitted Hold
Order," a "Submitted Bid" or a "Submitted Sell Order," as the case may be, or
as a "Submitted Order") and shall determine:
(A) the excess of the total number of outstanding shares of AMPS over the
number of outstanding shares of AMPS that are the subject of Submitted Hold
Orders (such excess being hereinafter referred to as the "Available AMPS");
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(B) from the Submitted Orders whether the number of outstanding shares of
AMPS that are the subject of Submitted Bids by Potential Holders specifying
one or more rates per annum equal to or lower than the Maximum Applicable
Rate exceeds or is equal to the sum of:
(1) the number of outstanding shares of AMPS that are the subject of
Submitted Bids by Existing Holders specifying one or more rates per
annum higher than the Maximum Applicable Rate, and
(2) the number of outstanding shares of AMPS that are subject to
Submitted Sell Orders (if such excess or such equality exists (other
than because the number of outstanding shares of AMPS in clauses (1)
and (2) above are each zero because all of the outstanding shares of
AMPS are the subject of Submitted Hold Orders), such Submitted Bids by
Potential Holders hereinafter being referred to collectively as
"Sufficient Clearing Bids"); and
(C) if Sufficient Clearing Bids exist, the lowest rate per annum
specified in the Submitted Bids (the "Winning Bid Rate") that if:
(1) each Submitted Bid from Existing Holders specifying the Winning
Bid Rate and all other submitted Bids from Existing Holders specifying
lower rates per annum were rejected, thus entitling such Existing
Holders to continue to hold the shares of AMPS that are the subject of
such Submitted Bids, and
(2) each Submitted Bid from Potential Holders specifying the Winning
Bid Rate and all other Submitted Bids from Potential Holders specifying
lower rates per annum were accepted, thus entitling the Potential
Holders to purchase the shares of AMPS that are the subject of such
Submitted Bids, would result in the number of shares subject to all
Submitted Bids specifying the Winning Bid Rate or a lower rate per
annum being at least equal to the Available AMPS.
(ii) Promptly after the Auction Agent has made the determinations pursuant to
Paragraph 10(d)(i), the Auction Agent shall advise the Fund of the Maximum
Applicable Rate and, based on such determinations, the Applicable Rate for the
next succeeding Dividend Period as follows:
(A) if Sufficient Clearing Bids exist, that the Applicable Rate for the
next succeeding Dividend Period shall be equal to the Winning Bid Rate;
(B) if Sufficient Clearing Bids do not exist (other than because all of
the outstanding shares of AMPS are the subject of Submitted Hold Orders),
that the Applicable Rate for the next succeeding Dividend Period shall be
equal to the Maximum Applicable Rate; or
(C) if all of the outstanding shares of AMPS are the subject of Submitted
Hold Orders, that the Dividend Period next succeeding the Auction
automatically shall be the same length as the immediately preceding
Dividend Period and the Applicable Rate for the next succeeding Dividend
Period shall be equal to 40% of the Reference Rate (or 60% of such rate if
the Fund has provided notification to the Auction Agent prior to the
Auction establishing the Applicable Rate for any dividend that net capital
gains or other taxable income will be included in such dividend on shares
of AMPS) on the date of the Auction.
Paragraph 10(e) Acceptance and Rejection of Submitted Bids and Submitted Sell
Orders And Allocation of Shares.
Based on the determinations made pursuant to Paragraph 10(d)(i), the
Submitted Bids and Submitted Sell Orders shall be accepted or rejected and the
Auction Agent shall take such other action as set forth below:
(i) If Sufficient Clearing Bids have been made, subject to the provisions
of Paragraph 10(e)(iii) and Paragraph 10(e)(iv), Submitted Bids and
Submitted Sell Orders shall be accepted or rejected in the following order
of priority and all other Submitted Bids shall be rejected:
(A) the Submitted Sell Orders of Existing Holders shall be accepted
and the Submitted Bid of each of the Existing Holders specifying any
rate per annum that is higher than the Winning Bid Rate shall be
accepted, thus requiring each such Existing Holder to sell the
outstanding shares of AMPS that are the subject of such Submitted Sell
Order or Submitted Bid;
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(B) the Submitted Bid of each of the Existing Holder specifying any
rate per annum that is lower than the Winning Bid Rate shall be
rejected, thus entitling each such Existing Holder to continue to hold
the outstanding shares of AMPS that are the subject of such Submitted
Bid;
(C) the Submitted Bid of each of the Potential Holders specifying any
rate per annum that is lower than the Winning Bid Rate shall be
accepted;
(D) the Submitted Bid of each of the Existing Holders specifying a
rate per annum that is equal to the Winning Bid Rate shall be rejected,
thus entitling each such Existing Holder to continue to hold the
outstanding shares of AMPS that are the subject of such Submitted Bid,
unless the number of outstanding shares of AMPS subject to all such
Submitted Bids shall be greater than the number of outstanding shares
of AMPS ("Remaining Shares") equal to the excess of the Available AMPS
over the number of outstanding shares of AMPS subject to Submitted Bids
described in Paragraph 10(e)(i)(B) and Paragraph 10(e)(i)(C), in which
event the Submitted Bids of each such Existing Holder shall be
accepted, and each such Existing Holder shall be required to sell
outstanding shares of AMPS, but only in an amount equal to the
difference between (1) the number of outstanding shares of AMPS then
held by such Existing Holder subject to such Submitted Bid and (2) the
number of shares of AMPS obtained by multiplying (x) the number of
Remaining Shares by (y) a fraction the numerator of which shall be the
number of outstanding shares of AMPS held by such Existing Holder
subject to such Submitted Bid and the denominator of which shall be the
sum of the numbers of outstanding shares of AMPS subject to such
Submitted Bids made by all such Existing Holders that specified a rate
per annum equal to the Winning Bid Rate; and
(E) the Submitted Bid of each of the Potential Holders specifying a
rate per annum that is equal to the Winning Bid Rate shall be accepted
but only in an amount equal to the number of outstanding shares of AMPS
obtained by multiplying (x) the difference between the Available AMPS
and the number of outstanding shares of AMPS subject to Submitted Bids
described in Paragraph 10(e)(i)(B), Paragraph 10(e)(i)(C) and Paragraph
10(e)(i)(D) by (y) a fraction the numerator of which shall be the
number of outstanding shares of AMPS subject to such Submitted Bid and
the denominator of which shall be the sum of the number of outstanding
shares of AMPS subject to such Submitted Bids made by all such
Potential Holders that specified rates per annum equal to the Winning
Bid Rate.
(ii) If Sufficient Clearing Bids have not been made (other than because
all of the outstanding shares of AMPS are subject to Submitted Hold
Orders), subject to the provisions of Paragraph 10(e)(iii), Submitted
Orders shall be accepted or rejected as follows in the following order of
priority and all other Submitted Bids shall be rejected:
(A) the Submitted Bid of each Existing Holder specifying any rate per
annum that is equal to or lower than the Maximum Applicable Rate shall
be rejected, thus entitling such Existing Holder to continue to hold
the outstanding shares of AMPS that are the subject of such Submitted
Bid;
(B) the Submitted Bid of each Potential Holder specifying any rate
per annum that is equal to or lower than the Maximum Applicable Rate
shall be accepted, thus requiring such Potential Holder to purchase the
outstanding shares of AMPS that are the subject of such Submitted Bid;
and
(C) the Submitted Bids of each Existing Holder specifying any rate
per annum that is higher than the Maximum Applicable Rate shall be
accepted and the Submitted Sell Orders of each Existing Holder shall be
accepted, in both cases only in an amount equal to the difference
between (1) the number of outstanding shares of AMPS then held by such
Existing Holder subject to such Submitted Bid or Submitted Sell Order
and (2) the number of shares of AMPS obtained by multiplying (x) the
difference between the Available AMPS and the aggregate number of
outstanding shares of AMPS subject to Submitted Bids described in
Paragraph 10(e)(ii)(A) and Paragraph 10(e)(ii)(B) by (y) a fraction the
numerator of which shall be the number of outstanding shares of AMPS
held by such Existing Holder subject to such Submitted Bid or Submitted
Sell Order and the denominator of which shall be the number of
outstanding shares of AMPS subject to all such Submitted Bids and
Submitted Sell Orders.
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(iii) If, as a result of the procedures described in Paragraph 10(e)(i)
or Paragraph 10(e)(ii), any Existing Holder would be entitled or required
to sell, or any Potential Holder would be entitled or required to purchase,
a fraction of a share of AMPS on any Auction Date, the Auction Agent shall,
in such manner as in its sole discretion it shall determine, round up or
down the number of shares of AMPS to be purchased or sold by any Existing
Holder or Potential Holder on such Auction Date so that each outstanding
share of AMPS purchased or sold by each Existing Holder or Potential Holder
on such Auction Date shall be a whole share of AMPS.
(iv) If, as a result of the procedures described in Paragraph 10(e)(i),
any Potential Holder would be entitled or required to purchase less than a
whole share of AMPS on any Auction Date, the Auction Agent, in such manner
as in its sole discretion it shall determine, shall allocate shares of AMPS
for purchase among Potential Holders so that only whole shares of AMPS are
purchased on such Auction Date by any Potential Holder, even if such
allocation results in one or more of such Potential Holders not purchasing
any shares of AMPS on such Auction Date.
(v) Based on the results of each Auction, the Auction Agent shall
determine, with respect to each Broker-Dealer that submitted Bids or Sell
Orders on behalf of Existing Holders or Potential Holders, the aggregate
number of the outstanding shares of AMPS to be purchased and the aggregate
number of outstanding shares of AMPS to be sold by such Potential Holders
and Existing Holders and, to the extent that such aggregate number of
outstanding shares to be purchased and such aggregate number of outstanding
shares to be sold differ, the Auction Agent shall determine to which other
Broker-Dealer or Broker-Dealers acting for one or more purchasers such
Broker-Dealer shall deliver, or from which other Broker-Dealer or Broker-
Dealers acting for one or more sellers such Broker-Dealer shall receive, as
the case may be, outstanding shares of AMPS.
Paragraph 10(f) Miscellaneous.
The Fund may interpret the provisions of this Paragraph 10 to resolve any
inconsistency or ambiguity, remedy any formal defect or make any other change
or modification that does not substantially adversely affect the rights of
Beneficial Owners of AMPS. A Beneficial Owner or an Existing Holder (A) may
sell, transfer or otherwise dispose of shares of AMPS only pursuant to a Bid or
Sell Order in accordance with the procedures described in this Paragraph 10 or
to or through a Broker-Dealer, provided that in the case of all transfers other
than pursuant to Auctions such Beneficial Owner or Existing Holder, its Broker-
Dealer, if applicable, or its Agent Member advises the Auction Agent of such
transfer and (B) except as otherwise required by law, shall have the ownership
of the shares of AMPS held by it maintained in book entry form by the
Securities Depository in the account of its Agent Member, which in turn will
maintain records of such Beneficial Owner's beneficial ownership. Neither the
Fund nor any Affiliate (other than Merrill Lynch, Pierce, Fenner & Smith
Incorporated) shall submit an Order in any Auction. Any Beneficial Owner that
is an Affiliate (other than Merrill Lynch, Pierce, Fenner & Smith Incorporated)
shall not sell, transfer or otherwise dispose of shares of AMPS to any Person
other than the Fund. All of the outstanding shares of AMPS of a Series shall be
represented by a single certificate registered in the name of the nominee of
the Securities Depository unless otherwise required by law or unless there is
no Securities Depository. If there is no Securities Depository, at the Fund's
option and upon its receipt of such documents as it deems appropriate, any
shares of AMPS may be registered in the Stock Register in the name of the
Beneficial Owner thereof and such Beneficial Owner thereupon will be entitled
to receive certificates therefor and required to deliver certificates thereof
or upon transfer or exchange thereof.
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