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PROSPECTUS - MARCH 31, 2000
Mercury V.I. U.S. Large Cap Fund
OF MERCURY ASSET MANAGEMENT V.I. FUNDS, INC.
[MERCURY ASSET MANAGEMENT GLOBE LOGO]
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.
THE SECURITIES AND EXCHANGE COMMISSION HAS NOT
APPROVED OR DISAPPROVED THESE SECURITIES OR
PASSED UPON THE ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
[MERCURY ASSET MANAGEMENT LOGO]
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FUND FACTS LOGO
ABOUT THE DETAILS LOGO
THE MANAGEMENT TEAM LOGO
ACCOUNT CHOICES LOGO
TO LEARN MORE LOGO
Table of Contents
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FUND FACTS
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About the Mercury V.I. U.S. Large Cap Fund.................. 2
ABOUT THE DETAILS
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How the Mercury V.I. U.S. Large Cap Fund Invests............ 4
Investment Risks............................................ 5
Appendix and Statement of Additional Information............ 10
THE MANAGEMENT TEAM
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Management of the Mercury V.I. U.S. Large Cap Fund.......... 11
Financial Highlights........................................ 13
APPENDIX
ACCOUNT CHOICES
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Fund Shares................................................. A-2
How to Buy and Sell Shares.................................. A-2
How Shares are Priced....................................... A-3
Dividends and Taxes......................................... A-4
TO LEARN MORE
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Shareholder Reports....................................Back Cover
Statement of Additional Information....................Back Cover
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MERCURY V.I. U.S. LARGE CAP FUND
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IN AN EFFORT TO HELP YOU BETTER UNDERSTAND THE MANY CONCEPTS INVOLVED IN MAKING
AN INVESTMENT DECISION, WE HAVE DEFINED THE HIGHLIGHTED TERMS IN THIS PROSPECTUS
IN THE SIDEBAR.
LARGE CAP COMPANIES -- companies whose market capitalization is at least $5
billion under current market conditions. The Fund's definition of large cap
companies may be increased in response to changes in the market.
COMMON STOCK -- securities representing shares of ownership of a corporation.
PREFERRED STOCK -- class of stock that often pays dividends at a specified rate
and has preference over common stock in dividend payments and liquidation of
assets. Preferred stock may also be convertible into common stock.
CONVERTIBLE SECURITIES -- fixed-income securities, such as bonds or preferred
stocks, that are exchangeable for shares of common stocks of the issuer or
another company.
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FUND Fund Facts
FACTS
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ABOUT THE MERCURY V.I. U.S. LARGE CAP FUND
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WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
The investment objective of the Fund is long-term capital growth. In other
words, the Fund tries to choose investments that will increase in value. Current
income from dividends and interest will not be an important consideration in
selecting portfolio securities.
WHAT ARE THE FUND'S MAIN INVESTMENT STRATEGIES?
The Fund invests primarily in a diversified portfolio of equity securities of
LARGE CAP COMPANIES located in the U.S. that Fund management believes are
undervalued or have good prospects for earnings growth. The Fund may also invest
up to 10% of its assets in stocks of companies located in Canada. A company's
stock is considered to be undervalued when its price is less than Fund
management believes it is worth. A company whose earnings per share grow faster
than inflation and the economy in general usually has a higher stock price over
time than a company with slower earnings growth. The Fund's evaluation of the
prospects for a company's industry or market sector is an important factor in
evaluating a particular company's earnings prospects. The Fund may purchase
COMMON STOCK, PREFERRED STOCK, CONVERTIBLE SECURITIES and other instruments.
We cannot guarantee that the Fund will achieve its objective.
WHAT ARE THE MAIN RISKS OF INVESTING IN THE FUND?
As with any mutual fund, the value of the Fund's investments -- and, therefore,
the value of Fund shares -- may fluctuate. These changes may occur because a
particular stock market is rising or falling. At other times, there are specific
factors that may affect the value of a particular investment. The Fund is also
subject to the risk that the stocks the Fund's adviser selects will underperform
the stock markets or other funds with similar investment objectives and
investment strategies. If the value of the Fund's investments goes down, you may
lose money.
2
MERCURY V.I. U.S. LARGE CAP FUND
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CONTRACT -- The Fund offers its shares only to participating insurance
companies. These insurance companies write variable annuity and/or variable life
insurance contracts that allow the contract owner to choose the Fund as an
investment option. The contract owner does not become a Fund shareholder.
Fund Facts
FUND FACTS LOGO
In addition, because the Fund invests up to 10% of its assets in securities of
Canadian companies, the Fund is subject to additional risks. For example, the
Fund's securities may go up or down in value depending on changes in the
Canadian stock market, on the relative exchange rates of the U.S. dollar and the
Canadian dollar, U.S. and Canadian political and economic developments, and U.S.
and Canadian laws relating to investments in Canada. Canadian securities may
also be less liquid, more volatile and harder to value than U.S. securities.
WHO SHOULD INVEST?
The Fund may be an appropriate investment to fund a portion of a CONTRACT owned
by contract owners who:
- Have long-term goals in mind
- Want a professionally managed and diversified portfolio
- Are willing to accept the risk of short-term fluctuations in
exchange for the potential of higher long-term returns
MERCURY V.I. U.S. LARGE CAP FUND 3
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ABOUT THE PORTFOLIO MANAGEMENT TEAM -- The Fund is managed by members of a team
of 17 investment professionals who participate in the team's research process
and stock selection. The senior investment professionals in this group include
Garrett Fish and Michael Morony. Michael Morony is primarily responsible for the
day-to-day management of the Fund.
ABOUT THE INVESTMENT ADVISER -- Mercury Asset Management International Ltd. is
the Investment Adviser.
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ABOUT THE About the Details
DETAILS
LOGO
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HOW THE MERCURY V.I. U.S. LARGE CAP FUND INVESTS
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The Fund's main objective is long-term capital growth. The Fund tries to achieve
its objective by investing primarily in a diversified portfolio of equity
securities of large cap companies located in the U.S. The Fund may also invest
up to 10% of its assets in equity securities of companies located in Canada. In
selecting securities, the Fund emphasizes those securities that Fund management
believes are undervalued or have good prospects for earnings growth.
The Fund will, under normal circumstances, invest at least 65% of its total
assets in equity securities of large cap companies located in the U.S. The Fund
may also invest in equity securities of companies of any market capitalization
located in Canada and of small or medium capitalization companies located in the
U.S. Normally, Canadian investments will represent 10% or less of the Fund's
assets. A company's market capitalization may go up or down due to market
fluctuations. The Fund will not sell a company's securities because that
company's market capitalization drops below $5 billion or another amount set by
the Fund. Equity securities consist of:
- Common Stock
- Preferred Stock
- Securities Convertible into Common Stock
- Derivative securities such as options (including warrants)
and futures, the value of which is based on a common stock or
group of common stocks
The Fund considers a company to be "located" in the U.S. or Canada if:
- It is legally organized in the U.S. or Canada, or
- The primary trading market for its securities is located in the
U.S. or Canada, or
- At least 50% of the company's (and its subsidiaries') non-current
assets, capitalization, gross revenues or profits have been
located in the U.S. or Canada during one of the last two fiscal
years.
Under this definition a "foreign" company (a company organized or trading
outside the U.S. or Canada, or with substantial operations outside the U.S. or
Canada) may be considered to be "located" in the U.S. or Canada.
A company's stock is considered to be undervalued when the stock's current price
is less than what Fund management believes a share of the company is worth. Fund
management feels a company's worth can be assessed by several factors, such as:
- financial resources
4
MERCURY V.I. U.S. LARGE CAP FUND
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About the Details
ABOUT THE DETAILS LOGO
- value of assets
- sales and earnings growth
- product development
- quality of management
- overall business prospects
A company's stock may become undervalued when most investors fail to perceive
the company's strengths in one or more of these areas. A company whose earnings
per share grow faster than inflation and the economy in general usually has a
higher stock price over time than a company with slower earnings growth. The
Fund's evaluation of the prospects for a company's industry or market sector is
an important factor in evaluating a particular company's earnings prospects.
Current income from dividends and interest will not be an important
consideration in selecting portfolio securities. The Fund may invest in debt
securities that are issued together with a particular equity security. The Fund
may invest in derivatives to hedge (protect against price movements) or to
enable it to reallocate its investments more quickly than it could by buying and
selling the underlying securities. The Fund is not required to hedge and may
choose not to do so.
The Fund has no stated minimum holding period for investments, and will buy or
sell securities whenever Fund management sees an appropriate opportunity.
The Fund will normally invest almost all of its assets as described above. The
Fund may, however, invest in short-term instruments, such as money market
securities and repurchase agreements, to meet redemptions. The Fund may also,
without limit, make short-term investments, purchase high quality bonds or buy
or sell derivatives to reduce exposure to equity securities, when the Fund
believes it is advisable to do so (on a temporary defensive basis). Short-term
investments and temporary defensive positions may limit the potential for growth
in the value of your shares and the Fund may, therefore, not achieve its
investment objective.
The Fund may use many different strategies and it has certain investment
restrictions, all of which are explained in the Fund's Statement of Additional
Information.
INVESTMENT RISKS
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This section contains a summary discussion of the general risks of investing in
the Fund. As with any mutual fund, there can be no guarantee that the Fund will
meet its goals, or that the Fund's performance will be positive over any period
of time.
MERCURY V.I. U.S. LARGE CAP FUND 5
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About the Details
ABOUT THE DETAILS LOGO
MARKET AND SELECTION RISK
Market risk is the risk that the U.S. or Canadian stock markets in which the
Fund invests will go down in value, including the possibility that the U.S. or
Canadian stock markets will go down sharply and unpredictably. Selection risk
is the risk that the investments that Fund management selects will underperform
the stock markets or other funds with similar investment objectives and
investment strategies.
CANADIAN INVESTMENT RISK
Canadian investment risk is the risk that the Fund's Canadian securities may go
up or down in value depending on the fluctuations in the relative exchange rates
of the U.S. dollar and the Canadian dollar, U.S. and Canadian political and
economic developments, and changes in U.S. and Canadian laws relating to
investments in Canada.
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in illiquid securities that it
cannot easily resell within seven days at current value or that have contractual
or legal restrictions on resale. If the Fund buys illiquid securities it may be
unable to quickly resell them or may be able to sell them only at a price below
current value.
RESTRICTED SECURITIES
Restricted securities have contractual or legal restrictions on their resale.
They include private placement securities that the Fund buys directly from the
issuer. Private placement and other restricted securities may not be listed on
an exchange and may have no active trading market.
Restricted securities may be illiquid. The Fund may be unable to sell them on
short notice or may be able to sell them only at a price below current value.
The Fund may get only limited information about the issuer, so it may be less
able to predict a loss. In addition, if Fund management receives material
adverse nonpublic information about the issuer, the Fund will not be able to
sell the security.
RULE 144A SECURITIES
Rule 144A securities are restricted securities that can be resold to qualified
institutional buyers but not to the general public. Rule 144A securities may
6
MERCURY V.I. U.S. LARGE CAP FUND
<PAGE> 8
About the Details
ABOUT THE DETAILS LOGO
have an active trading market, but carry the risk that the active trading market
may not continue.
OTHER CANADIAN SECURITIES RISKS
Canadian securities are sensitive to conditions within Canada, but also tend to
follow the U.S. market. Canada's economy depends heavily on exports to the U.S.,
Canada's largest trading partner. The Canadian economy relies strongly on the
production and processing of natural resources. Historically, natural resource
prices have been volatile. Demand by many citizens of the Province of Quebec for
secession from Canada may significantly impact the Canadian economy.
- The costs of Canadian securities transactions tend to be higher
than those of U.S. transactions.
- The Canadian securities market has different clearance and
settlement procedures, which may cause delays. This means that the
Fund's assets may be uninvested and not earning returns. The Fund
may miss investment opportunities or be unable to dispose of a
security because of these delays.
FOREIGN SECURITIES RISKS
The Fund defines companies located in the U.S. or Canada broadly. As a result,
the Fund's investments may include companies organized, traded or having
substantial operations outside the U.S. or Canada. This may expose the Fund to
risks associated with foreign investments.
- The value of holdings traded outside the U.S. (and hedging
transactions in foreign currencies) will be affected by changes in
currency exchange rates.
- The costs of non-U.S. securities transactions tend to be higher
than those of U.S. transactions.
- The Fund's holdings may be adversely affected by U.S. or non-U.S.
government action.
- International trade barriers or economic sanctions against certain
non-U.S. countries may adversely affect the Fund's holdings.
MERCURY V.I. U.S. LARGE CAP FUND 7
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About the Details
ABOUT THE DETAILS LOGO
BORROWING AND LEVERAGE
The use of borrowing can create leverage. Leverage increases the Fund's exposure
to risk by increasing its total investments. If the Fund borrows money to make
more investments than it otherwise could or to meet redemptions, and the Fund's
investments go down in value, the Fund's losses will be magnified. Borrowing
will cost the Fund interest expense and other fees.
Certain securities that the Fund buys may create leverage, including, for
example, derivative securities. Like borrowing, these investments may increase
the Fund's exposure to risk.
DERIVATIVES
The Fund may use derivative instruments, including futures, forwards, options,
indexed and inverse securities and swaps. Derivatives may allow the Fund to
increase or decrease its risk exposure more quickly and efficiently than other
types of instruments. Derivatives are volatile and involve significant risks,
including:
- Credit risk -- the risk that the counterparty (the party on the
other side of the transaction) on a derivative transaction will be
unable to honor its financial obligation to the Fund.
- Currency risk -- the risk that changes in the exchange rate
between currencies will adversely affect the value (in U.S. dollar
terms) of an investment.
- Leverage risk -- the risk associated with certain types of
investments or trading strategies (such as borrowing money to
increase the amount of investment) that relatively small market
movements may result in large changes in the value of an
investment. Certain investments or trading strategies that involve
leverage can result in losses that greatly exceed the amount
originally invested.
- Liquidity risk -- the risk that certain securities may be
difficult or impossible to sell at the time that the seller would
like or at the price that the seller believes the security is
currently worth.
- Index risk -- If the derivative is linked to the performance of an
index, it will be subject to the risks associated with changes in
that index. If the index changes, the Fund could receive lower
8
MERCURY V.I. U.S. LARGE CAP FUND
<PAGE> 10
About the Details
ABOUT THE DETAILS LOGO
interest payments or experience a reduction in the value of the
derivative to below what the Fund paid. Certain indexed
securities, including inverse securities (which move in an
opposite direction to the index), may create leverage, to the
extent that they increase or decrease in value at a rate that is a
multiple of the changes in the applicable index.
The Fund may use derivatives for hedging purposes, including anticipatory
hedges. Hedging is a strategy in which the Fund uses a derivative to offset the
risk that other Fund holdings may decrease in value. While hedging can reduce
losses, it can also reduce or eliminate gains if the market moves in a different
manner than anticipated by the Fund or if the cost of the derivative outweighs
the benefit of the hedge. Hedging also involves the risk that changes in the
value of the derivative will not match those of the holdings being hedged as
expected by the Fund, in which case any losses on the holdings being hedged may
not be reduced. There can be no assurance that the Fund's hedging strategy will
reduce risk or that hedging transactions will be either available or cost
effective. The Fund is not required to use hedging and may choose not to do so.
CONVERTIBLES
Convertibles are generally debt securities or preferred stocks that may be
converted into common stock. Convertibles typically pay current income as either
interest (debt security convertibles) or dividends (preferred stocks). A
convertible's value usually reflects both the stream of current income payments
and the value of the underlying common stock. The market value of a convertible
performs like that of a regular debt security; that is, if market interest rates
rise, the value of a convertible usually falls. Since it is convertible into
common stock, the convertible also has the same types of market and issuer risk
as the underlying common stock.
DEBT SECURITIES
Debt securities, such as bonds, involve credit risk. This is the risk that the
borrower will not make timely payments of principal and interest. The degree of
credit risk depends on the issuer's financial condition and on the terms of the
bonds. These securities are also subject to interest rate risk. This is the risk
that the value of the security may fall when interest rates rise. In general,
the market price of debt securities with longer maturities will go up or down
more
MERCURY V.I. U.S. LARGE CAP FUND 9
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About the Details
ABOUT THE DETAILS LOGO
in response to changes in interest rates than the market price of shorter term
securities.
APPENDIX AND STATEMENT OF ADDITIONAL INFORMATION
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Additional information about the Fund is discussed in the Appendix which is a
part of this Prospectus.
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
10
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The Management Team
THE MANAGEMENT TEAM ICON
MANAGEMENT OF THE
MERCURY V.I. U.S. LARGE CAP FUND
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Mercury Asset Management International Ltd. manages the Fund's investments under
the overall supervision of the Fund's Board of Directors. The Investment Adviser
and its affiliates have the responsibility for making all investment decisions
for the Fund.
The senior investment professionals in the group that have managed the Fund's
portfolio since the Fund started operations include:
Garrett Fish, Associate Director of Mercury Asset Management, has been employed
as an investment professional by the Investment Adviser or its Mercury
affiliates since 1997. Mr. Fish was employed at Jardine Fleming Hong Kong as a
U.S. fund manager from 1994 to 1997. From 1991 to 1993 Mr. Fish was an account
manager at Aetna Capital Management in the U.S.
Michael Morony, Director of Mercury Asset Management, has been employed as an
investment professional by the Investment Adviser or its Mercury affiliates
since 1997. Mr. Morony worked for Threadneedle Investment Managers from 1992 to
1997. Mr. Morony is primarily responsible for the day-to-day management of the
Fund.
Mercury and its affiliates manage portfolios with over $559 billion in assets
(as of February 2000) for individuals and institutions seeking investments
worldwide. This amount includes assets managed for its affiliates. The advisory
agreement between the Fund and the Investment Adviser gives the Investment
Adviser the responsibility for making all investment decisions.
The Investment Adviser is paid at the rate of 0.65% of the Fund's average daily
net assets.
Fund Asset Management, L.P., an affiliate of Mercury, may manage all or a
portion of the Fund's daily cash assets, to the extent not managed by Mercury.
The Fund does not pay any incremental fee for this service, although Mercury may
make payments to Fund Asset Management, L.P.
MERCURY V.I. U.S. LARGE CAP FUND 11
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The Management Team
THE MANAGEMENT TEAM ICON
The Fund may in the future invest all of its assets in another mutual fund that
has the same investment objective and fundamental policies as the Fund. All
portfolio investments would then be made at the level of the underlying mutual
fund and the Fund's investment results would correspond directly to that fund's
investment results. This type of mutual fund structure is sometimes referred to
as a "master/feeder" structure. If other entities also invest in the underlying
fund, this could enable the Fund to realize economies of scale by investing
through an entity with more assets (the underlying fund). However, there are
additional costs involved in operating a "master/feeder" structure. If these
additional costs are not offset as a result of economies of scale, it is
possible that the Fund's expenses would increase rather than decrease if it
converts to this structure. The directors of the Fund have the authority to make
the change to a "master/feeder" structure without first holding a vote of the
Fund's shareholders if they believe it is in the best interests of the Fund to
do so.
12
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FINANCIAL HIGHLIGHTS
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The Financial Highlights table is intended to help you understand the Fund's
performance for the period April 30, 1999 (commencement of operations) to
December 31, 1999. Certain information reflects financial results for a single
Fund share. The total returns in the table represent the rate that an investor
would have earned on an investment in the Fund (assuming reinvestment of all
dividends). This information has been audited by Deloitte & Touche LLP, whose
report, along with the Fund's financial statements, is included in the Fund's
annual report to shareholders, which is available upon request.
MERCURY V.I. U.S. LARGE CAP FUND
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CLASS A
FOR THE PERIOD
APRIL 30, 1999+ TO
INCREASE (DECREASE) IN NET ASSET VALUE: DECEMBER 31, 1999
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Per Share Operating Performance:
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Net asset value, beginning of period $10.00
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Investment loss -- net --++
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Realized and unrealized gain on investments -- net 2.10
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Total from investment operations 2.10
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Less dividends and distributions:
In excess of investment income -- net (.04)
In excess of realized gain on investments -- net (.03)
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Total dividends and distributions (.07)
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Net asset value, end of period $12.03
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Total Investment Return:**
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Based on net asset value per share 20.94%#
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Ratios to Average Net Assets:
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Expenses, net of reimbursement 1.25%*
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Expenses 2.83%*
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Investment income -- net (.07%)*
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Supplemental Data:
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Net assets, end of period (in thousands) $24,014
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Portfolio turnover 37.25%
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* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of operations.
++ Amount is less than $.01 per share.
# Aggregate total investment return.
MERCURY V.I. U.S. LARGE CAP FUND 13
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[THE MANAGEMENT TEAM ICON] The Management Team
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INVESTMENT ADVISER
Mercury Asset Management International Ltd.
33 King William Street
London EC4R 9AS
England
SUB-ADVISER
Fund Asset Management, L.P.
800 Scudders Mill Road
Plainsboro, New Jersey 08536
TRANSFER AGENT
Financial Data Services, Inc.
Administrative Offices:
4800 Deer Lake Drive East
Jacksonville, Florida 32246-6484
(888-763-2260)
Mailing Address:
P.O. Box 45289
Jacksonville, Florida 32232-5289
INDEPENDENT AUDITORS
Deloitte & Touche LLP
Princeton Forrestal Village
116-300 Village Boulevard
Princeton, New Jersey 08540-6400
DISTRIBUTOR
Mercury Funds Distributor, a division of Princeton Funds Distributor,
Inc.
P.O. Box 9081
Princeton, New Jersey 08543-9081
CUSTODIAN
Brown Brothers Harriman & Co.
40 Water Street
Boston, Massachusetts 02109
COUNSEL
Swidler Berlin Shereff Friedman, LLP
The Chrysler Building
405 Lexington Avenue
New York, New York 10174
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14 MERCURY V.I. U.S. LARGE CAP FUND
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[TO LEARN To Learn More
MORE
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SHAREHOLDER REPORTS
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Additional information about a Fund's investments is available in that Fund's
annual and semi-annual reports to shareholders. In a Fund's annual report you
will find a discussion of the relevant market conditions and investment
strategies that significantly affected that Fund's performance during its last
fiscal year. You may obtain these reports at no cost by calling 1-888-763-2260.
STATEMENT OF ADDITIONAL INFORMATION
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Each Fund's Statement of Additional Information contains further information
about that Fund and is incorporated by reference (legally considered to be part
of that Fund's Prospectus). You may request a free copy by writing or calling
the Transfer Agent at Financial Data Services, Inc., P.O. Box 45289,
Jacksonville, Florida 32232-5289 or by calling 1-888-763-2260.
Each Fund's shares are sold to insurance company separate accounts to support
variable annuity and/or variable life insurance contracts. For copies of each
Fund's shareholder reports or Statement of Additional Information, contract
owners may also contact the insurance company that issued their contract.
You may contact the Fund at 1-888-763-2260 if you have any questions.
Information about each Fund (including the Statement of Additional Information)
can be reviewed and copied at the SEC's Public Reference Room in Washington,
D.C. Call 1-202-942-8090 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 electronic request at the following e-mail address: [email protected], or
writing the Public Reference Section of the SEC, Washington, D.C. 20549-0102.
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. NO ONE IS
AUTHORIZED TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT FROM THE
INFORMATION CONTAINED IN THIS PROSPECTUS.
Investment Company Act File #811-09159.
(C) Mercury Asset Management International Ltd.
<PAGE> 17
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MERCURY ASSET MANAGEMENT V.I. FUNDS, INC.
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APPENDIX
This Appendix constitutes a part of the Prospectus for Class A shares of Mercury
V.I. U.S. Large Cap Fund. For simplicity, this Appendix uses the term "Fund" to
refer to Mercury V.I. U.S. Large Cap Fund and any future series of Mercury Asset
Management V.I. Funds.
TABLE OF CONTENTS
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ACCOUNT CHOICES
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Fund Shares................................................. A-2
How to Buy and Sell Shares.................................. A-2
How Shares are Priced....................................... A-3
Dividends and Taxes......................................... A-4
TO LEARN MORE
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Shareholder Reports.....................................Back Cover
Statement of Additional Information.....................Back Cover
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ACCOUNT CHOICES ICON
TO LEARN MORE ICON
Appendix--Class A Shares
24
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ACCOUNT Account Choices
CHOICES
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FUND SHARES
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Each Fund offers two classes of shares, Class A and Class B. This Prospectus
describes the Class A shares only. The participating insurance company decides
which share class will support a contract. Each share class represents an
ownership interest in the same investment portfolio.
Each Fund's shares are distributed by Mercury Funds Distributor, a division of
Princeton Funds Distributor, Inc.
The Fund's Investment Adviser has agreed to cap the annual operating expenses of
the Mercury V.I. U.S. Large Cap Fund to 1.25% of the average net assets of the
Fund's Class A shares. This expense cap will be in place through April 2001.
HOW TO BUY AND SELL SHARES
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The Funds do not offer their shares to the general public. Only separate
accounts established by participating insurance companies can buy Fund shares.
Each Fund's Investment Adviser is affiliated with two participating insurance
companies. Participating insurance companies issue variable annuity and/or
variable life insurance contracts and use Fund shares to support these
contracts. When this Prospectus refers to Fund shareholders, it is referring to
the participating insurance companies.
More than one participating insurance company may invest in each Fund to support
either variable life insurance or variable annuity contracts, or both. It is
possible that a difference may arise among the interests of the holders of
different types of contracts--for example, if different tax laws apply, or if
applicable state insurance law or contract owner instructions prevent a
participating insurance company from continuing to invest in a Fund following a
change in the Fund's investment policies. The Fund and the participating
insurance companies will attempt to monitor events to prevent such differences
from arising. If a conflict between participating insurance companies occurs,
however, the Fund may be required to take actions that are adverse to the
interests of a particular participating insurance company and its contract
owners.
Contract owners have certain rights under their contract, but do not have any
direct interest in Fund shares. A separate prospectus describes the contract and
its additional fees and charges. That prospectus also describes how changes in a
A- 2
MERCURY ASSET MANAGEMENT V.I. FUNDS
<PAGE> 3
Account Choices
ACCOUNT CHOICES ICON
NET ASSET VALUE -- the market value of the Fund's total assets after deducting
liabilities, divided by the number of shares outstanding.
Fund's net asset value and distributions on Fund shares affect benefits under a
contract.
HOW SHARES ARE PRICED
- --------------------------------------------------------------------------------
Shares are sold and redeemed at their NET ASSET VALUE. A Fund calculates its net
asset value (generally by using market quotations) each day the New York Stock
Exchange is open after the close of business on the Exchange, based on prices at
the time of closing. The Exchange generally closes at 4:00 p.m. Eastern time.
The net asset value used in determining share price is the next one calculated
after a purchase or redemption order is placed. Net asset value is generally
calculated by valuing each security at its closing price for the day. Securities
and assets for which market quotations are not readily available are generally
valued at fair value as determined in good faith by or under the direction of
the Board of Directors.
MERCURY ASSET MANAGEMENT V.I. FUNDS A- 3
<PAGE> 4
DIVIDENDS -- ordinary income and capital gains paid to shareholders. Dividends
may be reinvested in additional Fund shares as they are paid.
Account Choices
ACCOUNT CHOICES ICON
DIVIDENDS AND TAXES
- --------------------------------------------------------------------------------
A Fund will distribute at least annually any net investment income and any net
realized long or short-term capital gains. A Fund may also pay a special
distribution at the end of the calendar year to comply with Federal tax
requirements. DIVIDENDS from a Fund are reinvested automatically in shares of
that Fund at net asset value.
Each Fund intends to continue to qualify as a regulated investment company under
the Internal Revenue Code of 1986, as amended, which requires it to satisfy
certain conditions relating to the diversification of its assets and the nature
and distribution of its income. As long as each Fund is qualified as a regulated
investment company, it will not be subject to Federal income tax on the earnings
that it distributes to its shareholders. In addition, each Fund intends to limit
the type of its shareholders and to meet the standards for diversification of
assets as necessary to satisfy the tax rules that apply to the separate accounts
that invest in that Fund.
For information regarding the Federal income tax treatment of a contract and
distributions to the separate accounts of the participating insurance companies,
see the separate prospectus for the contracts.
A NOTE ABOUT YEAR 2000
As the year 2000 began, there were few problems caused by the inability of
certain computer systems to tell the difference between the year 2000 and the
year 1900 (commonly known as the "Year 2000 Problem"). It is still possible that
some computer systems could malfunction in the future because of the Year 2000
Problem or as a result of actions taken to address the Year 2000 Problem. Fund
management does not anticipate that its services or those of other Fund service
providers will be adversely affected, but Fund management will continue to
monitor the situation. If malfunctions related to the Year 2000 Problem do
arise, each Fund and its investments could be negatively affected.
The Year 2000 Problem may also adversely affect the participating insurance
companies and the contracts that they offer. For more information, see the
separate contract prospectus.
A- 4
MERCURY ASSET MANAGEMENT V.I. FUNDS
<PAGE> 18
STATEMENT OF ADDITIONAL INFORMATION
MERCURY V.I. U.S. LARGE CAP FUND
of Mercury Asset Management V.I. Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011
Phone No. (888) 763-2260
------------------------
Mercury V.I. U.S. Large Cap Fund (the "Mercury V.I. U.S. Large Cap Fund" or
a "Fund") is a series of Mercury Asset Management V.I. Funds, Inc. (the
"Corporation" or "Mercury"). The Mercury V.I. U.S. Large Cap Fund is an open-end
diversified management investment company (commonly known as a mutual fund). The
investment objective of the Mercury V.I. U.S. Large Cap Fund is long-term
capital growth. The Mercury V.I. U.S. Large Cap Fund seeks to achieve this
objective through investments primarily in a diversified portfolio of equity
securities of large cap companies located in the U.S. The Mercury V.I. U.S.
Large Cap Fund may also invest up to 10% of its assets in equity securities of
companies located in Canada. There can be no assurance that the investment
objective of the Mercury V.I. U.S. Large Cap Fund will be realized.
The Mercury V.I. U.S. Large Cap Fund does not offer its shares to the
general public. Shares are sold only to separate accounts established by
participating insurance companies (the "Participating Insurance Companies") to
fund benefits under variable annuity and/or variable life insurance contracts
(the "Contracts"). Certain Participating Insurance Companies may be affiliates
of Mercury Asset Management International Ltd. ("Mercury International" or the
"Investment Adviser"). The rights of Participating Insurance Companies as
shareholders of the Mercury V.I. U.S. Large Cap Fund should be distinguished
from the rights of a Contract owner, which are set forth in the Contract. A
Contract owner has an interest solely in the Contract and not in the shares of
the Mercury V.I. U.S. Large Cap Fund. The relevant Contract is described in the
prospectus of the Participating Insurance Company that issues the Contract. The
prospectus of the Participating Insurance Company that issues the Contract
describes the various fees and charges in connection with the separate account
and the Contract, and the benefits provided by the Contract. That prospectus
also describes the relationship between the Contract and increases or decreases
in the net asset value of shares of the Mercury V.I. U.S. Large Cap Fund and any
distributions on such shares. The Participating Insurance Companies will redeem
shares to the extent necessary to provide benefits under the respective
Contracts or for such other purposes as consistent with the respective
Contracts. The Mercury V.I. U.S. Large Cap Fund's distributor is Mercury Funds
Distributor, a division of Princeton Funds Distributor, Inc.
------------------------
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Prospectus of the Mercury V.I. U.S. Large Cap Fund,
dated March 31, 2000 (the "Prospectus"), which has been filed with the
Securities and Exchange Commission (the "Commission"), and can be obtained,
without charge, by calling the Mercury V.I. U.S. Large Cap Fund at
1-888-763-2260 or writing to the Fund at the address listed above. The
Prospectus may also be obtained from the Participating Insurance Company that
issued your Contract. For information on obtaining the Prospectus from the
Participating Insurance Company that issued your Contract, see the separate
prospectus describing the Contract. The Prospectus is incorporated by reference
into this Statement of Additional Information, and this Statement of Additional
Information has been incorporated by reference into the Prospectus. The Fund's
audited financial statements are incorporated in this Statement of Additional
Information by reference to its 1999 annual report to shareholders. You may
request a copy of the annual report at no charge by calling 1-888-763-2260
between 8:00 a.m. and 8:00 p.m. on any business day.
MERCURY ASSET MANAGEMENT INTERNATIONAL LTD. -- INVESTMENT ADVISER
MERCURY FUNDS DISTRIBUTOR -- DISTRIBUTOR
------------------------
The date of this Statement of Additional Information is March 31, 2000.
<PAGE> 19
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objectives and Policies.......................... 2
Insurance Law Restrictions................................ 14
Other Considerations...................................... 15
Investment Restrictions................................... 15
Portfolio Turnover........................................ 17
General Information Relating to the Mercury V.I. U.S. Large
Cap Fund.................................................. 17
Description of Shares..................................... 17
Appendix.................................................... A-1
Management of the Funds..................................... A-2
Directors and Officers.................................... A-2
Compensation of Directors................................. A-3
Management and Advisory Arrangements...................... A-3
Code of Ethics............................................ A-5
Purchase of Shares.......................................... A-5
Distribution Agreements................................... A-6
Distribution Plans........................................ A-6
Redemption of Shares........................................ A-7
Portfolio Transactions and Brokerage........................ A-7
Pricing of Shares........................................... A-9
Determination of Net Asset Value.......................... A-9
Dividends and Taxes......................................... A-10
Dividends................................................. A-10
Taxes..................................................... A-10
Performance Data............................................ A-11
General Information......................................... A-13
Independent Auditors...................................... A-13
Custodian................................................. A-13
Transfer Agent............................................ A-13
Legal Counsel............................................. A-13
Reports to Shareholders................................... A-13
Additional Information.................................... A-13
Financial Statements........................................ A-14
Annex A -- Ratings of Fixed Income Securities............... Annex A-1
</TABLE>
(C) Mercury Asset Management International Ltd.
<PAGE> 20
INVESTMENT OBJECTIVES AND POLICIES
The investment objective of the Mercury V.I. U.S. Large Cap Fund is
long-term capital growth. This is a fundamental policy and cannot be changed
without shareholder approval. The Mercury V.I. U.S. Large Cap Fund tries to
achieve its objective by investing primarily in a diversified portfolio of
equity securities of large cap companies located in the U.S. The Mercury V.I.
U.S. Large Cap Fund may also invest up to 10% of its assets in equity securities
of companies of any market capitalization located in Canada. Reference is made
to "How the Mercury V.I. U.S. Large Cap Fund Invests" and "About the
Details -- Investment Risks" in the Prospectus for a discussion of the
investment objective and policies of, and the risks associated with, an
investment in the Mercury V.I. U.S. Large Cap Fund. There can be no guarantee
that the Mercury V.I. U.S. Large Cap Fund's investment objective will be
realized.
The Mercury V.I. U.S. Large Cap Fund may in the future invest all of its
assets in another mutual fund that has the same investment objective and
fundamental policies as the Mercury V.I. U.S. Large Cap Fund. All portfolio
investments would then be made at the level of the underlying mutual fund and
the Mercury V.I. U.S. Large Cap Fund's investment results would correspond
directly to that fund's investment results. This type of mutual fund structure
is sometimes referred to as a "master/feeder" structure. If other entities also
invest in the underlying fund, this could enable the Mercury V.I. U.S. Large Cap
Fund to realize economies of scale by investing through an entity with more
assets (the underlying fund). However, there are additional costs involved in
operating a "master/feeder" structure. If these additional costs are not offset
as a result of economies of scale, it is possible that the Mercury V.I. U.S.
Large Cap Fund's expenses would increase rather than decrease if it converts to
this structure. The Directors of the Mercury V.I. U.S. Large Cap Fund have the
authority to make the change to a "master/feeder" structure without first
holding a vote of the Fund's shareholders if they believe it is in the best
interests of the Mercury V.I. U.S. Large Cap Fund to do so.
For purposes of the Mercury V.I. U.S. Large Cap Fund's investment policies,
an issuer ordinarily will be considered to be located in the country under the
laws of which it is organized or where the primary trading market of its
securities is located. The Mercury V.I. U.S. Large Cap Fund, however, may also
consider a company to be located in a country, without reference to its domicile
or to the primary trading market of its securities, when at least 50% of its
non-current assets, capitalization, gross revenues or profits in any one of the
two most recent fiscal years represents (directly or indirectly through
subsidiaries) assets or activities located in such country. The Mercury V.I.
U.S. Large Cap Fund also may consider closed-end investment companies to be
located in the country or countries in which they primarily make their portfolio
investments.
While it is the policy of the Mercury V.I. U.S. Large Cap Fund generally
not to engage in trading for short-term gains, the Investment Adviser will
effect portfolio transactions without regard to holding period if, in its
judgment, such transactions are advisable in light of a change in circumstances
of a particular company or within a particular industry or in general market,
economic or financial conditions.
The U.S. Government has from time to time in the past imposed restrictions,
through taxation and otherwise, on non-U.S. investments by U.S. investors such
as the Mercury V.I. U.S. Large Cap Fund. If such restrictions should be
reinstituted, it might become necessary for the Mercury V.I. U.S. Large Cap Fund
to invest all or substantially all of its assets in U.S. securities. In such
event, the Mercury V.I. U.S. Large Cap Fund would review its investment
objective or fundamental policies to determine whether changes are appropriate.
Any changes in the investment objective or fundamental policies set forth under
"Investment Restrictions" below would require the approval of the holders of a
majority of the Mercury V.I. U.S. Large Cap Fund's outstanding voting
securities.
The Mercury V.I. U.S. Large Cap Fund's ability and decisions to purchase or
sell portfolio securities may be affected by laws or regulations relating to the
convertibility and repatriation of assets. Under present conditions, the
Investment Adviser does not believe that these considerations will have any
significant effect on its portfolio strategy, although there can be no assurance
in this regard.
The Mercury V.I. U.S. Large Cap Fund may invest in the securities of
non-U.S. issuers in the form of American Depositary Receipts ("ADRs"), European
Depositary Receipts ("EDRs"), Global Depositary Receipts ("GDRs") or other
securities convertible into securities of non-U.S. issuers. These securities may
2
<PAGE> 21
not necessarily be denominated in the same currency as the securities into which
they may be converted. However, they would generally be subject to the same
risks as the securities into which they may be converted (as more fully
described in the Prospectus and below). ADRs are receipts typically issued by a
U.S. bank or trust company that evidence ownership of underlying securities
issued by a non-U.S. corporation. EDRs are receipts issued in Europe that
evidence a similar ownership arrangement. GDRs are receipts issued throughout
the world that evidence a similar ownership arrangement. Generally, ADRs, in
registered form, are designed for use in the U.S. securities markets, and EDRs,
in bearer form, are designed for use in European securities markets. GDRs are
tradeable both in the United States and Europe and are designed for use
throughout the world. The Mercury V.I. U.S. Large Cap Fund may invest in
unsponsored ADRs, EDRs and GDRs. The issuers of unsponsored ADRs, EDRs and GDRs
are not obligated to disclose material information in the United States, and
therefore, there may be no correlation between such information and the market
value of such securities.
The Mercury V.I. U.S. Large Cap Fund's investment objective and policies
are described in "About the Details -- How the Mercury V.I. U.S. Large Cap Fund
Invests" in the Prospectus. Certain types of securities in which the Mercury
V.I. U.S. Large Cap Fund may invest and certain investment practices that the
Fund may employ are discussed more fully below.
Investing in Canada. While the Mercury V.I. U.S. Large Cap Fund will
invest at least 65% of its total assets in large cap companies located in the
United States, it may invest up to 10% of its assets in Canada. Canadian
securities are sensitive to conditions within Canada, but also tend to follow
the U.S. market. The country's economy relies strongly on the production and
processing of natural resources and foreign trade. The Canadian government has
attempted to reduce restrictions against foreign investment, and its recent
trade agreements with the United States and Mexico are expected to increase
trade; however, these reforms could be reversed. Demand by many citizens in the
Province of Quebec for secession from Canada may significantly impact the
Canadian economy.
Foreign Security Risks. The Mercury V.I. U.S. Large Cap Fund defines
companies located in the U.S. or Canada broadly. As a result, the Mercury V.I.
U.S. Large Cap Fund's investments may include companies organized, traded or
having substantial operations outside the U.S. or Canada. This may expose the
Mercury V.I. U.S. Large Cap Fund to risks associated with foreign investments.
Foreign investments involve certain risks not typically involved in domestic
investments, including fluctuations in foreign exchange rates, future political
and economic developments, different legal systems and the existence or possible
imposition of exchange controls or other U.S. or non-U.S. governmental laws or
restrictions applicable to such investments. Securities prices in different
countries are subject to different economic, financial and social factors.
Because the Mercury V.I. U.S. Large Cap Fund may invest in securities
denominated or quoted in currencies other than the U.S. dollar, changes in
foreign currency exchange rates may affect the value of securities in the
portfolio and the unrealized appreciation or depreciation of investments insofar
as U.S. investors are concerned. Foreign currency exchange rates are determined
by forces of supply and demand in the foreign exchange markets. These forces
are, in turn, affected by international balance of payments and other economic
and financial conditions, government intervention, speculation and other
factors. With respect to certain countries, there may be the possibility of
expropriation of assets, confiscatory taxation, high rates of inflation,
political or social instability or diplomatic developments that could affect
investment in those countries. In addition, certain investments may be subject
to non-U.S. withholding taxes.
Debt Securities. The Mercury V.I. U.S. Large Cap Fund may hold convertible
and non-convertible debt securities, and preferred securities. The Mercury V.I.
U.S. Large Cap Fund has established no rating criteria for the debt securities
in which it may invest and such securities may not be rated at all for
creditworthiness. In purchasing such securities, the Mercury V.I. U.S. Large Cap
Fund will rely on the Investment Adviser's judgment, analysis and experience in
evaluating the creditworthiness of an issuer of such securities. The Investment
Adviser will take into consideration, among other things, the issuer's financial
resources, its sensitivity to economic conditions and trends, its operating
history, the quality of the issuer's management and regulatory matters.
3
<PAGE> 22
Junk Bonds. Junk bonds are debt securities that are rated below investment
grade by the major rating agencies or are unrated securities that Fund
management believes are of comparable quality. Although junk bonds generally pay
higher rates of interest than investment grade bonds, they are high risk
investments that may cause income and principal losses for the Mercury V.I. U.S.
Large Cap Fund. The major risks in junk bond investments include the following:
Junk bonds may be issued by less creditworthy companies. These securities
are vulnerable to adverse changes in the issuer's industry and to general
economic conditions. Issuers of junk bonds may be unable to meet their interest
or principal payment obligations because of an economic downturn, specific
issuer developments or the unavailability of additional financing.
The issuers of junk bonds may have a larger amount of outstanding debt
relative to their assets than issuers of investment grade bonds. If the issuer
experiences financial stress, it may be unable to meet its debt obligations. The
issuer's ability to pay its debt obligations also may be lessened by specific
issuer developments, or the unavailability of additional financing.
Junk bonds are frequently ranked junior to claims by other creditors. If
the issuer cannot meet its obligations, the senior obligations are generally
paid off before the junior obligations.
Junk bonds frequently have redemption features that permit an issuer to
repurchase the security from the Mercury V.I. U.S. Large Cap Fund before it
matures. If an issuer redeems the junk bonds, the Mercury V.I. U.S. Large Cap
Fund may have to invest the proceeds in bonds with lower yields and may lose
income.
Prices of junk bonds are subject to extreme price fluctuations. Negative
economic developments may have a greater impact on the prices of junk bonds than
on other higher rated fixed income securities.
Junk bonds may be less liquid than higher rated fixed income securities
even under normal economic conditions. There are fewer dealers in the junk bond
market, and there may be significant differences in the prices quoted for junk
bonds by the dealers. Because they are less liquid, judgment may play a greater
role in valuing certain of the Mercury V.I. U.S. Large Cap Fund's portfolio
securities than in the case of securities trading in a more liquid market.
The Mercury V.I. U.S. Large Cap Fund may incur expenses to the extent
necessary to seek recovery upon default or to negotiate new terms with a
defaulting issuer.
Convertible Securities. Convertible securities entitle the holder to
receive interest payments paid on corporate debt securities or the dividend
preference on a preferred stock until such time as the convertible security
matures or is redeemed or until the holder elects to exercise the conversion
privilege.
The characteristics of convertible securities include the potential for
capital appreciation as the value of the underlying common stock increases, the
relatively high yield received from dividend or interest payments as compared to
common stock dividends and decreased risks of decline in value relative to the
underlying common stock due to their fixed-income nature. As a result of the
conversion feature, however, the interest rate or dividend preference on a
convertible security is generally less than would be the case if the securities
were issued in non-convertible form.
In analyzing convertible securities, the Investment Adviser will consider
both the yield on the convertible security relative to its credit quality and
the potential capital appreciation that is offered by the underlying common
stock, among other things.
Convertible securities are issued and traded in a number of securities
markets. Even in cases where a substantial portion of the convertible securities
held by the Mercury V.I. U.S. Large Cap Fund are denominated in United States
dollars, the underlying equity securities may be quoted in the currency of the
country where the issuer is domiciled. With respect to convertible securities
denominated in a currency different from that of the underlying equity
securities, the conversion price may be based on a fixed exchange rate
established at the time the security is issued. As a result, fluctuations in the
exchange rate between the currency in which the debt security is denominated and
the currency in which the share price is quoted will affect the value of the
convertible security.
4
<PAGE> 23
Apart from currency considerations, the value of convertible securities is
influenced by both the yield of nonconvertible securities of comparable issuers
and by the value of the underlying common stock. The value of a convertible
security viewed without regard to its conversion feature (i.e., strictly on the
basis of its yield) is sometimes referred to as its "investment value." To the
extent interest rates change, the investment value of the convertible security
typically will fluctuate. However, at the same time, the value of the
convertible security will be influenced by its "conversion value," which is the
market value of the underlying common stock that would be obtained if the
convertible security were converted. Conversion value fluctuates directly with
the price of the underlying common stock. If, because of a low price of the
common stock the conversion value is substantially below the investment value of
the convertible security, the price of the convertible security is governed
principally by its investment value.
To the extent the conversion value of a convertible security increases to a
point that approximates or exceeds its investment value, the price of the
convertible security will be influenced principally by its conversion value. A
convertible security will sell at a premium over the conversion value to the
extent investors place value on the right to acquire the underlying common stock
while holding a fixed-income security.
Holders of convertible securities generally have a claim on the assets of
the issuer prior to the common stockholders but may be subordinated to other
debt securities of the same issuer. A convertible security may be subject to
redemption at the option of the issuer at a price established in the charter
provision, indenture or other governing instrument pursuant to which the
convertible security was issued. If a convertible security held by the Mercury
V.I. U.S. Large Cap Fund is called for redemption, the Mercury V.I. U.S. Large
Cap Fund will be required to redeem the security, convert it into the underlying
common stock or sell it to a third party. Certain convertible debt securities
may provide a put option to the holder which entitles the holder to cause the
security to be redeemed by the issuer at a premium over the stated principal
amount of the debt security under certain circumstances.
Borrowing and Leverage. The Mercury V.I. U.S. Large Cap Fund may borrow
from banks (as defined in the Investment Company Act) in amounts up to 33 1/3%
of its total assets (including the amount borrowed) and may borrow up to an
additional 5% of its total assets for temporary purposes. The Mercury V.I. U.S.
Large Cap Fund may obtain such short-term credit as may be necessary for the
clearance of purchases and sales of portfolio securities and may purchase
securities on margin to the extent permitted by applicable law, and may use
borrowing to enable it to meet redemptions.
The use of leverage by the Mercury V.I. U.S. Large Cap Fund creates an
opportunity for greater total return, but, at the same time, creates special
risks. For example, leveraging may exaggerate changes in the net asset value of
Mercury V.I. U.S. Large Cap Fund shares and in the yield on the Mercury V.I.
U.S. Large Cap Fund's portfolio. Although the principal of such borrowings will
be fixed, the Mercury V.I. U.S. Large Cap Fund's assets may change in value
during the time the borrowings are outstanding. Borrowings will create interest
expenses for the Mercury V.I. U.S. Large Cap Fund which can exceed the income
from the assets purchased with the borrowings. To the extent the income or
capital appreciation derived from securities purchased with borrowed funds
exceeds the interest the Mercury V.I. U.S. Large Cap Fund will have to pay on
the borrowings, the Mercury V.I. U.S. Large Cap Fund's return will be greater
than if leverage had not been used. Conversely, if the income or capital
appreciation from the securities purchased with such borrowed funds is not
sufficient to cover the cost of borrowing, the return to the Mercury V.I. U.S.
Large Cap Fund will be less than if leverage had not been used, and therefore
the amount available for distribution to shareholders as dividends and other
distributions will be reduced. In the latter case, the Investment Adviser in its
best judgment nevertheless may determine to maintain the Mercury V.I. U.S. Large
Cap Fund's leveraged position if it expects that the benefits to the Fund's
shareholders of maintaining the leveraged position will outweigh the current
reduced return.
Certain types of borrowings by the Mercury V.I. U.S. Large Cap Fund may
result in the Mercury V.I. U.S. Large Cap Fund being subject to covenants in
credit agreements relating to asset coverage, portfolio composition requirements
and other matters. It is not anticipated that observance of such covenants would
impede the Investment Adviser from managing the Mercury V.I. U.S. Large Cap
Fund's portfolio in accordance with the Mercury V.I. U.S. Large Cap Fund's
investment objectives and policies. However, a
5
<PAGE> 24
breach of any such covenants not cured within the specified cure period may
result in acceleration of outstanding indebtedness and require the Mercury V.I.
U.S. Large Cap Fund to dispose of portfolio investments at a time when it may be
disadvantageous to do so.
The Mercury V.I. U.S. Large Cap Fund at times may borrow from affiliates of
the Investment Adviser, provided that the terms of such borrowings are no less
favorable than those available from comparable sources of funds in the
marketplace.
Illiquid or Restricted Securities. The Mercury V.I. U.S. Large Cap Fund
may invest up to 15% of its net assets in securities that lack an established
secondary trading market or otherwise are considered illiquid. Liquidity of a
security relates to the ability to dispose easily of the security and the price
to be obtained upon disposition of the security, which may be less than would be
obtained for a comparable more liquid security. Illiquid securities may trade at
a discount from comparable, more liquid investments. Investment of the Mercury
V.I. U.S. Large Cap Fund's assets in illiquid securities may restrict the
ability of the Mercury V.I. U.S. Large Cap Fund to dispose of its investments in
a timely fashion and for a fair price as well as its ability to take advantage
of market opportunities. The risks associated with illiquidity will be
particularly acute where the Mercury V.I. U.S. Large Cap Fund's operations
require cash, such as when the Mercury V.I. U.S. Large Cap Fund redeems shares
or pays dividends, and could result in the Mercury V.I. U.S. Large Cap Fund
borrowing to meet short term cash requirements or incurring capital losses on
the sale of illiquid investments.
The Mercury V.I. U.S. Large Cap Fund may invest in securities that are not
registered ("restricted securities") under the Securities Act of 1933, as
amended (the "Securities Act"). Restricted securities may be sold in private
placement transactions between the issuers and their purchasers and may be
neither listed on an exchange nor traded in other established markets. In many
cases, privately placed securities may not be freely transferable under the laws
of the applicable jurisdiction or due to contractual restrictions on resale. As
a result of the absence of a public trading market, privately placed securities
may be less liquid and more difficult to value than publicly traded securities.
To the extent that privately placed securities may be resold in privately
negotiated transactions, the prices realized from the sales, due to illiquidity,
could be less than those originally paid by the Mercury V.I. U.S. Large Cap Fund
or less than their fair market value. In addition, issuers whose securities are
not publicly traded may not be subject to the disclosure and other investor
protection requirements that may be applicable if their securities were publicly
traded. If any privately placed securities held by the Mercury V.I. U.S. Large
Cap Fund are required to be registered under the securities laws of one or more
jurisdictions before being resold, the Mercury V.I. U.S. Large Cap Fund may be
required to bear the expenses of registration. Certain of the Mercury V.I. U.S.
Large Cap Fund's investments in private placements may consist of direct
investments and may include investments in smaller, less seasoned issuers, which
may involve greater risks. These issuers may have limited product lines, markets
or financial resources, or they may be dependent on a limited management group.
In making investments in such securities, the Mercury V.I. U.S. Large Cap Fund
may obtain access to material nonpublic information which may restrict the
Fund's ability to conduct portfolio transactions in such securities.
144A Securities. The Mercury V.I. U.S. Large Cap Fund may purchase
restricted securities that can be offered and sold to "qualified institutional
buyers" under Rule 144A under the Securities Act. The Board of Directors has
determined to treat as liquid Rule 144A securities that are either freely
tradeable in their primary markets offshore or have been determined to be liquid
in accordance with the policies and procedures adopted by the Mercury V.I. U.S.
Large Cap Fund's Board. The Board of Directors has adopted guidelines and
delegated to the Investment Adviser the daily function of determining and
monitoring liquidity of restricted securities. The Board of Directors, however,
will retain sufficient oversight and be ultimately responsible for the
determinations. Since it is not possible to predict with assurance exactly how
this market for restricted securities sold and offered under Rule 144A will
continue to develop, the Board of Directors will carefully monitor the Mercury
V.I. U.S. Large Cap Fund's investments in these securities. This investment
practice could have the effect of increasing the level of illiquidity in the
Mercury V.I. U.S. Large Cap Fund to the extent that qualified institutional
buyers become for a time uninterested in purchasing these securities.
Sovereign Debt. The Mercury V.I. U.S. Large Cap Fund may invest more than
5% of its assets in debt obligations ("sovereign debt") issued or guaranteed by
non-U.S. governments or their agencies and
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instrumentalities ("governmental entities"). Investment in sovereign debt
involves a high degree of risk. The governmental entity that controls the
repayment of sovereign debt may not be able or willing to repay the principal
and/or interest when due in accordance with the terms of such debt. A
governmental entity's willingness or ability to repay principal and interest due
in a timely manner may be affected by, among other factors, its cash flow
situation, the extent of its foreign reserves, the availability of sufficient
foreign exchange on the date a payment is due, the relative size of the debt
service burden to the economy as a whole.
Holders of sovereign debt may be requested to participate in the
rescheduling of such debt and to extend further loans to governmental entities.
In the event of a default by the issuer, the Mercury V.I. U.S. Large Cap Fund
may have few or no effective legal remedies for collecting on such debt.
Securities Lending. The Mercury V.I. U.S. Large Cap Fund may lend
securities with a value not exceeding 33 1/3% of its total assets to banks,
brokers and other financial institutions. In return, the Mercury V.I. U.S. Large
Cap Fund receives collateral in cash or securities issued or guaranteed by the
U.S. Government which will be maintained at all times in an amount equal to at
least 100% of the current market value of the loaned securities. During the
period of such a loan, the Mercury V.I. U.S. Large Cap Fund typically receives
the income on both the loaned securities and the collateral and thereby
increases its yield. In certain circumstances, the Mercury V.I. U.S. Large Cap
Fund may receive a flat fee for its loans. Such loans are terminable at any time
and the borrower, after notice, is required to return borrowed securities within
five business days. The Mercury V.I. U.S. Large Cap Fund may pay reasonable
finder's, administrative and custodial fees in connection with its loans. In the
event that the borrower defaults on its obligation to return borrowed securities
because of insolvency or for any other reason, the Mercury V.I. U.S. Large Cap
Fund could experience delays and costs in gaining access to the collateral and
could suffer a loss to the extent the value of the collateral falls below the
market value of the borrowed securities.
Repurchase Agreements. The Mercury V.I. U.S. Large Cap Fund may invest in
securities pursuant to repurchase agreements. Repurchase agreements may be
entered into only with a member bank of the Federal Reserve System or primary
dealer in U.S. Government securities or an affiliate thereof. Under such
agreements, the bank or primary dealer or an affiliate thereof 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.
This insulates the Mercury V.I. U.S. Large Cap Fund from fluctuations in the
market value of the underlying security during such period, although, to the
extent the repurchase agreement is not denominated in U.S. dollars, the Mercury
V.I. U.S. Large Cap Fund's return may be affected by currency fluctuations. The
Mercury V.I. U.S. Large Cap Fund may not invest more than 15% of its net assets
in repurchase agreements maturing in more than seven days (together with other
illiquid securities). Repurchase agreements may be construed to be
collateralized loans by the purchaser to the seller secured by the securities
transferred to the purchaser. The Mercury V.I. U.S. Large Cap Fund will require
the seller to provide additional collateral if the market value of the
securities falls below the repurchase price at any time during the term of the
repurchase agreement. In the event of default by the seller under a repurchase
agreement construed to be a collateralized loan, the underlying securities are
not owned by the Mercury V.I. U.S. Large Cap Fund but only constitute collateral
for the seller's obligation to pay the repurchase price. Therefore, the Mercury
V.I. U.S. Large Cap Fund may suffer time delays and incur costs or possible
losses in connection with the disposition of the collateral. In the event of a
default under such a repurchase agreement, instead of the contractual fixed rate
of return, the rate of return to the Mercury V.I. U.S. Large Cap Fund shall be
dependent upon intervening fluctuations of the market value of such security and
the accrued interest on the security. In such event, the Mercury V.I. U.S. Large
Cap Fund would have rights against the seller for breach of contract with
respect to any losses arising from market fluctuations following the failure of
the seller to perform.
Warrants. The Mercury V.I. U.S. Large Cap Fund may invest in warrants,
which are securities permitting, but not obligating, the warrant holder to
subscribe for other securities. Buying a warrant does not make the Mercury V.I.
U.S. Large Cap Fund a shareholder of the underlying stock. The warrant holder
has no right to dividends or votes on the underlying stock. A warrant does not
carry any right to assets of the issuer, and for this reason investment in
warrants may be more speculative than other equity-based investments.
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When Issued Securities, Delayed Delivery Securities and Forward
Commitments. The Mercury V.I. U.S. Large Cap Fund may purchase or sell
securities that it is entitled to receive on a when issued basis. The Mercury
V.I. U.S. Large Cap Fund may also purchase or sell securities on a delayed
delivery basis. The Mercury V.I. U.S. Large Cap Fund may also purchase or sell
securities through a forward commitment. These transactions involve the purchase
or sale of securities by the Mercury V.I. U.S. Large Cap Fund at an established
price with payment and delivery taking place in the future. The Mercury V.I.
U.S. Large Cap Fund enters into these transactions to obtain what is considered
an advantageous price to the Mercury V.I. U.S. Large Cap Fund at the time of
entering into the transaction. The Mercury V.I. U.S. Large Cap Fund has not
established any limit on the percentage of its assets that may be committed in
connection with these transactions. When the Mercury V.I. U.S. Large Cap Fund
purchases securities in these transactions, the Mercury V.I. U.S. Large Cap Fund
segregates liquid securities in an amount equal to the amount of its purchase
commitments.
There can be no assurance that a security purchased on a when issued basis
will be issued, or that a security purchased or sold through a forward
commitment will be delivered. The value of securities in these transactions on
the delivery date may be more or less than the Mercury V.I. U.S. Large Cap
Fund's purchase price. The Mercury V.I. U.S. Large Cap Fund may bear the risk of
a decline in the value of the security in these transactions and may not benefit
from an appreciation in the value of the security during the commitment period.
Standby Commitment Agreements. The Mercury V.I. U.S. Large Cap Fund may
enter into standby commitment agreements. These agreements commit the Mercury
V.I. U.S. Large Cap Fund, for a stated period of time, to purchase a stated
amount of securities which may be issued and sold to the Mercury V.I. U.S. Large
Cap Fund at the option of the issuer. The price of the security is fixed at the
time of the commitment. At the time of entering into the agreement the Mercury
V.I. U.S. Large Cap Fund is paid a commitment fee, regardless of whether or not
the security is ultimately issued. The Mercury V.I. U.S. Large Cap Fund will
enter into such agreements for the purpose of investing in the security
underlying the commitment at a price that is considered advantageous to the
Mercury V.I. U.S. Large Cap Fund. The Mercury V.I. U.S. Large Cap Fund will not
enter into a standby commitment with a remaining term in excess of 45 days and
will limit its investment in such commitments so that the aggregate purchase
price of securities subject to such commitments, together with the value of
portfolio securities subject to legal restrictions on resale that affect their
marketability, will not exceed 15% of its net assets taken at the time of the
commitment. The Mercury V.I. U.S. Large Cap Fund segregates liquid assets in an
aggregate amount equal to the purchase price of the securities underlying the
commitment.
There can be no assurance that the securities subject to a standby
commitment will be issued, and the value of the security, if issued, on the
delivery date may be more or less than its purchase price. Since the issuance of
the security underlying the commitment is at the option of the issuer, the
Mercury V.I. U.S. Large Cap Fund may bear the risk of a decline in the value of
such security and may not benefit from an appreciation in the value of the
security during the commitment period.
The purchase of a security subject to a standby commitment agreement and
the related commitment fee will be recorded on the date on which the security
can reasonably be expected to be issued, and the value of the security
thereafter will be reflected in the calculation of the Mercury V.I. U.S. Large
Cap Fund's net asset value. The cost basis of the security will be adjusted by
the amount of the commitment fee. In the event the security is not issued, the
commitment fee will be recorded as income on the expiration date of the standby
commitment.
Derivatives.
The Mercury V.I. U.S. Large Cap Fund may use instruments referred to as
Derivatives. Derivatives are financial instruments the value of which is derived
from another security, a commodity (such as gold or oil) or an index (a measure
of value or rates, such as the Standard & Poor's 500 Index or the prime lending
rate). Derivatives allow the Mercury V.I. U.S. Large Cap Fund to increase or
decrease the level of risk to which the Mercury V.I. U.S. Large Cap Fund is
exposed more quickly and efficiently than transactions in other types of
instruments.
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Hedging. The Mercury V.I. U.S. Large Cap Fund may use Derivatives for
hedging purposes. Hedging is a strategy in which a Derivative is used to offset
the risk that other fund holdings may decrease in value. Losses on the other
investment may be substantially reduced by gains on a Derivative that reacts in
an opposite manner to market movements. While hedging can reduce losses, it can
also reduce or eliminate gains if the market moves in a different manner than
anticipated by the Mercury V.I. U.S. Large Cap Fund or if the cost of the
Derivative outweighs the benefit of the hedge. Hedging also involves the risk
that changes in the value of the Derivative will not match those of the holdings
being hedged as expected by the Mercury V.I. U.S. Large Cap Fund, in which case
any losses on the holdings being hedged may not be reduced.
The Mercury V.I. U.S. Large Cap Fund may use Derivative instruments and
trading strategies including the following:
Indexed and Inverse Securities. The Mercury V.I. U.S. Large Cap Fund may
invest in securities the potential return of which is based on an index. As an
illustration, the Mercury V.I. U.S. Large Cap Fund may invest in a debt security
that pays interest based on the current value of an interest rate index, such as
the prime rate. The Mercury V.I. U.S. Large Cap Fund may also invest in a debt
security which returns principal at maturity based on the level of a securities
index or a basket of securities, or based on the relative changes of two
indices. In addition, the Mercury V.I. U.S. Large Cap Fund may invest in
securities the potential return of which is based inversely on the change in an
index (that is, a security the value of which will move in the opposite
direction of changes to an index). For example, the Mercury V.I. U.S. Large Cap
Fund may invest in securities that pay a higher rate of interest when a
particular index decreases and pay a lower rate of interest (or do not fully
return principal) when the value of the index increases. If the Mercury V.I.
U.S. Large Cap Fund invests in such securities, it may be subject to reduced or
eliminated interest payments or loss of principal in the event of an adverse
movement in the relevant index or indices. Indexed and inverse securities
involve credit risk, and certain indexed and inverse securities may involve
currency risk, leverage risk and liquidity risk. The Mercury V.I. U.S. Large Cap
Fund may invest in indexed and inverse securities for hedging purposes only.
When used for hedging purposes, indexed and inverse securities involve
correlation risk.
Options on Securities and Securities Indices
Purchasing Put Options. The Mercury V.I. U.S. Large Cap Fund may purchase
put options on securities held in its portfolio or on securities or interest
rate indices which are correlated with securities held in its portfolio. When
the Mercury V.I. U.S. Large Cap Fund purchases a put option, in consideration
for an up front payment (the "option premium") that Fund acquires a right to
sell to another party specified securities owned by the Mercury V.I. U.S. Large
Cap Fund at a specified price (the "exercise price") on or before a specified
date (the "expiration date"), in the case of an option on securities, or to
receive from another party a payment based on the amount a specified securities
index declines below a specified level on or before the expiration date, in the
case of an option on a securities index. The purchase of a put option limits the
Mercury V.I. U.S. Large Cap Fund's risk of loss in the event of a decline in the
market value of the portfolio holdings underlying the put option prior to the
option's expiration date. If the market value of the portfolio holdings
associated with the put option increases rather than decreases, however, the
Mercury V.I. U.S. Large Cap Fund will lose the option premium and will
consequently realize a lower return on the portfolio holdings than would have
been realized without the purchase of the put. Purchasing a put option may
involve correlation risk, and may also involve liquidity and credit risk.
Purchasing Call Options. The Mercury V.I. U.S. Large Cap Fund may also
purchase call options on securities it intends to purchase or securities or
interest rate indices, which are correlated with the types of securities it
intends to purchase. When the Mercury V.I. U.S. Large Cap Fund purchases a call
option, in consideration for the option premium the Mercury V.I. U.S. Large Cap
Fund acquires a right to purchase from another party specified securities at the
exercise price on or before the expiration date, in the case of an option on
securities, or to receive from another party a payment based on the amount a
specified securities index increases beyond a specified level on or before the
expiration date, in the case of an option on a securities index. The purchase of
a call option may protect the Mercury V.I. U.S. Large Cap Fund from having to
pay more for a security as a consequence of increases in the market value for
the security during a period when the Mercury V.I. U.S. Large Cap Fund is
contemplating its purchase, in the case of an option on a security, or
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attempting to identify specific securities in which to invest in a market the
Mercury V.I. U.S. Large Cap Fund believes to be attractive, in the case of an
option on an index (an "anticipatory hedge"). In the event the Mercury V.I. U.S.
Large Cap Fund determines not to purchase a security underlying a call option,
however, the Mercury V.I. U.S. Large Cap Fund may lose the entire option
premium. Purchasing a call option involves correlation risk, and may also
involve liquidity and credit risk.
The Mercury V.I. U.S. Large Cap Fund is also authorized to purchase put or
call options in connection with closing out put or call options it has
previously sold.
Writing Call Options. The Mercury V.I. U.S. Large Cap Fund may write
(i.e., sell) call options on securities held in its portfolio or securities
indices the performance of which correlates with securities held in its
portfolio. When the Mercury V.I. U.S. Large Cap Fund writes a call option, in
return for an option premium, the Mercury V.I. U.S. Large Cap Fund gives another
party the right to buy specified securities owned by the Mercury V.I. U.S. Large
Cap Fund at the exercise price on or before the expiration date, in the case of
an option on securities, or agrees to pay to another party an amount based on
any gain in a specified securities index beyond a specified level on or before
the expiration date, in the case of an option on a securities index. In the
event the party to which the Mercury V.I. U.S. Large Cap Fund has written an
option fails to exercise its rights under the option because the value of the
underlying securities is less than the exercise price, the Mercury V.I. U.S.
Large Cap Fund will partially offset any decline in the value of the underlying
securities through the receipt of the option premium. By writing a call option,
however, the Mercury V.I. U.S. Large Cap Fund limits its ability to sell the
underlying securities, and gives up the opportunity to profit from any increase
in the value of the underlying securities beyond the exercise price, while the
option remains outstanding. Writing a call option may involve correlation risk.
Writing Put Options. The Mercury V.I. U.S. Large Cap Fund may also write
put options on securities or securities indices. When the Mercury V.I. U.S.
Large Cap Fund writes a put option, in return for an option premium the Mercury
V.I. U.S. Large Cap Fund gives another party the right to sell to the Mercury
V.I. U.S. Large Cap Fund a specified security at the exercise price on or before
the expiration date, in the case of an option on a security, or agrees to pay to
another party an amount based on any decline in a specified securities index
below a specified level on or before the expiration date, in the case of an
option on a securities index. In the event the party to which the Mercury V.I.
U.S. Large Cap Fund has written an option fails to exercise its rights under the
option because the value of the underlying securities is greater than the
exercise price, the Mercury V.I. U.S. Large Cap Fund will profit by the amount
of the option premium. By writing a put option, however, the Mercury V.I. U.S.
Large Cap Fund will be obligated to purchase the underlying security at a price
that may be higher than the market value of the security at the time of exercise
as long as the put option is outstanding, in the case of an option on a
security, or make a cash payment reflecting any decline in the index, in the
case of an option on an index. Accordingly, when the Mercury V.I. U.S. Large Cap
Fund writes a put option it is exposed to a risk of loss in the event the value
of the underlying securities falls below the exercise price, which loss
potentially may substantially exceed the amount of option premium received by
the Mercury V.I. U.S. Large Cap Fund for writing the put option. The Mercury
V.I. U.S. Large Cap Fund will write a put option on a security or a securities
index only if the Mercury V.I. U.S. Large Cap Fund would be willing to purchase
the security at the exercise price for investment purposes (in the case of an
option on a security) or is writing the put in connection with trading
strategies involving combinations of options -- for example, the sale and
purchase of options with identical expiration dates on the same security or
index but different exercise prices (a technique called a "spread"). Writing a
put option may involve substantial leverage risk.
The Mercury V.I. U.S. Large Cap Fund is also authorized to sell put or call
options in connection with closing out call or put options it has previously
purchased.
Other than with respect to closing transactions, the Mercury V.I. U.S.
Large Cap Fund will write only call or put options that are "covered." A call or
put option will be considered covered if the Mercury V.I. U.S. Large Cap Fund
has segregated assets with respect to such option in the manner described in
"Risk Factors in Derivatives" below. A call option will also be considered
covered if the Mercury V.I. U.S. Large Cap Fund owns the securities it would be
required to deliver upon exercise of the option (or, in the case of an option on
a
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securities index, securities that substantially correlate with the performance
of such index) or owns a call option, warrant or convertible instrument which is
immediately exercisable for, or convertible into, such security.
Types of Options. The Mercury V.I. U.S. Large Cap Fund may engage in
transactions in options on securities or securities indices on exchanges and in
the over-the-counter ("OTC") markets. In general, exchange-traded options have
standardized exercise prices and expiration dates and require the parties to
post margin against their obligations, and the performance of the parties'
obligations in connection with such options is guaranteed by the exchange or a
related clearing corporation. OTC options have more flexible terms negotiated
between the buyer and the seller, but generally do not require the parties to
post margin and are subject to greater credit risk. OTC options also involve
greater liquidity risk. See "Additional Risk Factors of OTC Transactions;
Limitations on the Use of OTC Derivatives" below.
Futures
The Mercury V.I. U.S. Large Cap Fund may engage in transactions in futures
and options thereon. Futures are standardized, exchange-traded contracts which
obligate a purchaser to take delivery, and a seller to make delivery, of a
specific amount of an asset at a specified future date at a specified price. No
price is paid upon entering into a futures contract. Rather, upon purchasing or
selling a futures contract the Mercury V.I. U.S. Large Cap Fund is required to
deposit collateral ("margin") equal to a percentage (generally less than 10%) of
the contract value. Each day thereafter until the futures position is closed,
the Mercury V.I. U.S. Large Cap Fund will pay additional margin representing any
loss experienced as a result of the futures position the prior day or be
entitled to a payment representing any profit experienced as a result of the
futures position the prior day. Futures involve substantial leverage risk.
The sale of a futures contract limits the Mercury V.I. U.S. Large Cap
Fund's risk of loss through a decline in the market value of portfolio holdings
correlated with the futures contract prior to the futures contract's expiration
date. In the event the market value of the portfolio holdings correlated with
the futures contract increases rather than decreases, however, the Mercury V.I.
U.S. Large Cap Fund will realize a loss on the futures position and a lower
return on the portfolio holdings than would have been realized without the
purchase of the futures contract.
The purchase of a futures contract may protect the Mercury V.I. U.S. Large
Cap Fund from having to pay more for securities as a consequence of increases in
the market value for such securities during a period when the Mercury V.I. U.S.
Large Cap Fund was attempting to identify specific securities in which to invest
in a market the Mercury V.I. U.S. Large Cap Fund believes to be attractive. In
the event that such securities decline in value or the Mercury V.I. U.S. Large
Cap Fund determines not to complete an anticipatory hedge transaction relating
to a futures contract, however, the Mercury V.I. U.S. Large Cap Fund may realize
a loss relating to the futures position.
The Mercury V.I. U.S. Large Cap Fund will limit transactions in futures and
options on futures to financial futures contracts (i.e., contracts for which the
underlying commodity is a currency or securities or interest rate index)
purchased or sold for hedging purposes (including anticipatory hedges). The
Mercury V.I. U.S. Large Cap Fund will further limit transactions in futures and
options on futures to the extent necessary to prevent that Fund from being
deemed a "commodity pool" under regulations of the Commodity Futures Trading
Commission.
Swaps
The Mercury V.I. U.S. Large Cap Fund is authorized to enter into equity
swap agreements, which are OTC contracts in which one party agrees to make
periodic payments based on the change in market value of a specified equity
security, basket of equity securities or equity index in return for periodic
payments based on a fixed or variable interest rate or the change in market
value of a different equity security, basket of equity securities or equity
index. Swap agreements may be used to obtain exposure to an equity or market
without owning or taking physical custody of securities in circumstances in
which direct investment is restricted by local law or is otherwise impractical.
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The Mercury V.I. U.S. Large Cap Fund will enter into an equity swap
transaction only if, immediately following the time the Mercury V.I. U.S. Large
Cap Fund enters into the transaction, the aggregate notional principal amount of
equity swap transactions to which the Mercury V.I. U.S. Large Cap Fund is a
party would not exceed 5% of the Mercury V.I. U.S. Large Cap Fund's net assets.
Swap agreements entail the risk that a party will default on its payment
obligations to the Mercury V.I. U.S. Large Cap Fund thereunder. The Mercury V.I.
U.S. Large Cap Fund will seek to lessen the risk to some extent by entering into
a transaction only if the counterparty meets the current credit requirement for
OTC option counterparties. Swap agreements also bear the risk that the Mercury
V.I. U.S. Large Cap Fund will not be able to meet its obligations to the
counterparty. The Mercury V.I. U.S. Large Cap Fund, however, will deposit in a
segregated account with its custodian, liquid securities or cash or cash
equivalents or other assets permitted to be so segregated by the Commission in
an amount equal to or greater than the market value of the liabilities under the
swap agreement or the amount it would cost the Mercury V.I. U.S. Large Cap Fund
initially to make an equivalent direct investment, plus or minus any amount the
Mercury V.I. U.S. Large Cap Fund is obligated to pay or is to receive under the
swap agreement.
Foreign Exchange Transactions
The Mercury V.I. U.S. Large Cap Fund may engage in spot and forward foreign
exchange transactions and currency swaps, purchase and sell options on
currencies and purchase and sell currency futures and related options thereon
(collectively, "Currency Instruments") for purposes of hedging against the
decline in the value of currencies in which its portfolio holdings are
denominated against the U.S. dollar.
Forward Foreign Exchange Transactions. Forward foreign exchange
transactions are OTC contracts to purchase or sell a specified amount of a
specified currency or multinational currency unit at a price and future date set
at the time of the contract. Spot foreign exchange transactions are similar but
require current, rather than future, settlement. The Mercury V.I. U.S. Large Cap
Fund will enter into foreign exchange transactions only for purposes of hedging
either a specific transaction or a portfolio position. The Mercury V.I. U.S.
Large Cap Fund may enter into a forward foreign exchange transaction for
purposes of hedging a specific transaction by, for example, purchasing a
currency needed to settle a security transaction at a future date or selling a
currency in which the Mercury V.I. U.S. Large Cap Fund has received or
anticipates receiving a dividend or distribution. The Mercury V.I. U.S. Large
Cap Fund may enter into a foreign exchange transaction for purposes of hedging a
portfolio position by selling forward a currency in which a portfolio position
of that Fund is denominated or by purchasing a currency in which the Mercury
V.I. U.S. Large Cap Fund anticipates acquiring a portfolio position in the near
future. The Mercury V.I. U.S. Large Cap Fund may also hedge portfolio positions
through currency swaps, which are transactions in which one currency is
simultaneously bought for a second currency on a spot basis and sold for the
second currency on a forward basis. Forward foreign exchange transactions
involve substantial currency risk, and also involve credit and liquidity risk.
Currency Futures. The Mercury V.I. U.S. Large Cap Fund may also hedge
against the decline in the value of a currency against the U.S. dollar through
use of currency futures or options thereon. Currency futures are similar to
forward foreign exchange transactions except that futures are standardized,
exchange-traded contracts. See "Futures" above. Currency futures involve
substantial currency risk, and also involve leverage risk.
Currency Options. The Mercury V.I. U.S. Large Cap Fund may also hedge
against the decline in the value of a currency against the U.S. dollar through
the use of currency options. Currency options are similar to options on
securities, but in consideration for an option premium the writer of a currency
option is obligated to sell (in the case of a call option) or purchase (in the
case of a put option) a specified amount of a specified currency on or before
the expiration date for a specified amount of another currency. The Mercury V.I.
U.S. Large Cap Fund may engage in transactions in options on currencies either
on exchanges or OTC markets. See "Types of Options" above and "Additional Risk
Factors of OTC Transactions; Limitations on the Use of OTC Derivatives" below.
Currency options involve substantial currency risk, and may also involve credit,
leverage or liquidity risk.
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Limitations on Currency Hedging. The Mercury V.I. U.S. Large Cap Fund will
not speculate in Currency Instruments. Accordingly, the Mercury V.I. U.S. Large
Cap Fund will not hedge a currency in excess of the aggregate market value of
the securities which it owns (including receivables for unsettled securities
sales), or has committed to or anticipates purchasing, which are denominated in
such currency. The Mercury V.I. U.S. Large Cap Fund may, however, hedge a
currency by entering into a transaction in a Currency Instrument denominated in
a currency other than the currency being hedged (a "cross-hedge"). The Mercury
V.I. U.S. Large Cap Fund will only enter into a cross-hedge if the Investment
Adviser believes that (i) there is a demonstrable high correlation between the
currency in which the cross-hedge is denominated and the currency being hedged,
and (ii) executing a cross-hedge through the currency in which the cross-hedge
is denominated will be significantly more cost-effective or provide
substantially greater liquidity than executing a similar hedging transaction by
means of the currency being hedged.
Risk Factors in Hedging Foreign Currency. Hedging transactions involving
Currency Instruments involve substantial risks, including correlation risk.
While the Mercury V.I. U.S. Large Cap Fund's use of Currency Instruments to
effect hedging strategies is intended to reduce the volatility of the net asset
value of the Mercury V.I. U.S. Large Cap Fund's shares, the net asset value of
the Mercury V.I. U.S. Large Cap Fund's shares will fluctuate. Moreover, although
Currency Instruments will be used with the intention of hedging against adverse
currency movements, transactions in Currency Instruments involve the risk that
anticipated currency movements will not be accurately predicted and that the
Mercury V.I. U.S. Large Cap Fund's hedging strategies will be ineffective. To
the extent that the Mercury V.I. U.S. Large Cap Fund hedges against anticipated
currency movements which do not occur, the Mercury V.I. U.S. Large Cap Fund may
realize losses, and decrease its total return, as the result of its hedging
transactions. Furthermore, the Mercury V.I. U.S. Large Cap Fund will only engage
in hedging activities from time to time and may not be engaging in hedging
activities when movements in currency exchange rates occur.
It may not be possible for the Mercury V.I. U.S. Large Cap Fund to hedge
against currency exchange rate movements, even if correctly anticipated, in the
event that (i) the currency exchange rate movement is so generally anticipated
that the Mercury V.I. U.S. Large Cap Fund is not able to enter into a hedging
transaction at an effective price, or (ii) the currency exchange rate movement
relates to a market with respect to which Currency Instruments are not available
and it is not possible to engage in effective foreign currency hedging.
Risk Factors in Derivatives
Derivatives are volatile and involve significant risks, including:
- Credit risk -- the risk that the counterparty on a Derivative transaction
will be unable to honor its financial obligation to the Mercury V.I. U.S.
Large Cap Fund.
- Currency risk -- the risk that changes in the exchange rate between two
currencies will adversely affect the value (in U.S. dollar terms) of an
investment.
- Leverage risk -- the risk associated with certain types of investments or
trading strategies (such as borrowing money to increase the amount of
investments) that relatively small market movements may result in large
changes in the value of an investment. Certain investments or trading
strategies that involve leverage can result in losses that greatly exceed
the amount originally invested.
- Liquidity risk -- the risk that certain securities may be difficult or
impossible to sell at the time that the seller would like or at the price
that the seller believes the security is currently worth.
Use of Derivatives for hedging purposes involves correlation risk. If the
value of the Derivatives moves more or less than the value of the hedged
instruments, the Mercury V.I. U.S. Large Cap Fund will experience a gain or loss
which will not be completely offset by movements in the value of the hedged
instruments.
The Mercury V.I. U.S. Large Cap Fund intends to enter into transactions
involving Derivatives only if there appears to be a liquid secondary market for
such instruments or, in the case of illiquid instruments traded in OTC
transactions, such instruments satisfy the criteria set forth below under
"Additional Risk Factors of OTC Transactions; Limitations on the Use of OTC
Derivatives." However, there can be no
13
<PAGE> 32
assurance that, at any specific time, either a liquid secondary market will
exist for a Derivative or the Mercury V.I. U.S. Large Cap Fund will otherwise be
able to sell such instrument at an acceptable price. It may therefore not be
possible to close a position in a Derivative without incurring substantial
losses, if at all.
Certain transactions in Derivatives (such as futures transactions or sales
of put options) involve substantial leverage risk and may expose the Mercury
V.I. U.S. Large Cap Fund to potential losses, which exceed the amount originally
invested by the Mercury V.I. U.S. Large Cap Fund. When the Mercury V.I. U.S.
Large Cap Fund engages in such a transaction, the Mercury V.I. U.S. Large Cap
Fund will deposit in a segregated account at its custodian liquid securities
with a value at least equal to the Mercury V.I. U.S. Large Cap Fund's exposure,
on a marked-to-market basis, to the transaction (as calculated pursuant to
requirements of the Commission). Such segregation will ensure that the Mercury
V.I. U.S. Large Cap Fund has assets available to satisfy its obligations with
respect to the transaction, but will not limit the Mercury V.I. U.S. Large Cap
Fund's exposure to loss.
Additional Risk Factors of OTC Transactions; Limitations on the Use of OTC
Derivatives
Certain Derivatives traded in OTC markets, including indexed securities,
swaps and OTC options, involve substantial liquidity risk. The absence of
liquidity may make it difficult or impossible for the Mercury V.I. U.S. Large
Cap Fund to sell such instruments promptly at an acceptable price. The absence
of liquidity may also make it more difficult for the Mercury V.I. U.S. Large Cap
Fund to ascertain a market value for such instruments. The Mercury V.I. U.S.
Large Cap Fund will therefore acquire illiquid OTC instruments (i) if the
agreement pursuant to which the instrument is purchased contains a formula price
at which the instrument may be terminated or sold, or (ii) for which the
Investment Adviser anticipates the Mercury V.I. U.S. Large Cap Fund can receive
on each business day at least two independent bids or offers, unless a quotation
from only one dealer is available, in which case that dealer's quotation may be
used.
Because Derivatives traded in OTC markets are not guaranteed by an exchange
or clearing corporation and generally do not require payment of margin, to the
extent that the Mercury V.I. U.S. Large Cap Fund has unrealized gains in such
instruments or has deposited collateral with its counterparty, the Mercury V.I.
U.S. Large Cap Fund is at risk that its counterparty will become bankrupt or
otherwise fail to honor its obligations. The Mercury V.I. U.S. Large Cap Fund
will attempt to minimize the risk that a counterparty, will become bankrupt or
otherwise fail to honor its obligations by engaging in transactions in
Derivatives traded in OTC markets only with financial institutions which have
substantial capital or which have provided the Mercury V.I. U.S. Large Cap Fund
with a third-party guaranty or other credit enhancement.
Additional Limitations on the Use of Derivatives
The Mercury V.I. U.S. Large Cap Fund may not use any Derivative to gain
exposure to an asset or class of assets that it would be prohibited by its
investment restrictions from purchasing directly.
Other Special Considerations. The Mercury V.I. U.S. Large Cap Fund may
invest, without limit, in short-term investments, high quality bonds or
derivatives, to reduce exposure to equity securities when the Mercury V.I. U.S.
Large Cap Fund believes it is advisable to do so (on a temporary defensive
basis). Short-term investments and temporary defensive positions may limit the
potential for growth in the value of shares of the Mercury V.I. U.S. Large Cap
Fund and may reduce the level of current income.
INSURANCE LAW RESTRICTIONS
In order for shares of the Mercury V.I. U.S. Large Cap Fund to remain
eligible investments for the separate accounts of Participating Insurance
Companies, it may be necessary, from time to time, for the Fund to limit its
investments in certain types of securities in accordance with the insurance laws
or regulations of the various states in which the Contracts are sold.
The New York insurance law requires that investments of the Mercury V.I.
U.S. Large Cap Fund be made with the degree of care of an "ordinarily prudent
person." The Investment Adviser believes that
14
<PAGE> 33
compliance with this standard will not have any negative impact on the
performance of the Mercury V.I. U.S. Large Cap Fund.
OTHER CONSIDERATIONS
The Investment Adviser will use its best efforts to assure that the Mercury
V.I. U.S. Large Cap Fund complies with certain investment limitations of the
Internal Revenue Service to assure favorable income tax treatment for the
Contracts. It is not expected that such investment limitations will materially
affect the ability of the Mercury V.I. U.S. Large Cap Fund to achieve its
investment objective.
INVESTMENT RESTRICTIONS
The Corporation has adopted the following restrictions and policies
relating to the investment of the Mercury V.I. U.S. Large Cap Fund's assets and
its activities. The fundamental restrictions set forth below may not be changed
with respect to the Mercury V.I. U.S. Large Cap Fund without the approval of the
holders of a majority of the Fund's outstanding voting securities (which for
this purpose and under the Investment Company Act of 1940, as amended, (the
"Investment Company Act") means the lesser of (i) 67% of the shares represented
at a meeting at which more than 50% of the outstanding shares are represented or
(ii) more than 50% of the outstanding shares). Provided that none of the
following restrictions shall prevent the Mercury V.I. U.S. Large Cap Fund from
investing all of its assets in shares of another registered investment company
with the same investment objective (in a master/feeder structure), the Mercury
V.I. U.S. Large Cap Fund may not:
1. Make any investment inconsistent with the Mercury V.I. U.S. Large
Cap Fund's classification as a diversified company under the Investment
Company Act.
2. Invest more than 25% of its total assets, taken at market value, in
the securities of issuers in any particular industry (excluding the U.S.
Government and its agencies and instrumentalities).
3. Make investments for the purpose of exercising control or
management. Investments by the Mercury V.I. U.S. Large Cap Fund in
wholly-owned investment entities created under the laws of certain
countries will not be deemed the making of investments for the purpose of
exercising control or management.
4. Purchase or sell real estate, except that, to the extent permitted
by applicable law, the Mercury V.I. U.S. Large Cap Fund may invest in
securities directly or indirectly secured by real estate or interests
therein or issued by companies that invest in real estate or interests
therein.
5. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in
governmental obligations, commercial paper, pass-through instruments,
certificates of deposit, bankers' acceptances, repurchase agreements or any
similar instruments shall not be deemed to be the making of a loan, and
except further that the Mercury V.I. U.S. Large Cap Fund may lend its
portfolio securities, provided that the lending of portfolio securities may
be made only in accordance with applicable law and the guidelines set forth
in the Mercury V.I. U.S. Large Cap Fund's Prospectus and Statement of
Additional Information, as they may be amended from time to time.
6. Issue senior securities to the extent such issuance would violate
applicable law.
7. Borrow money, except that (i) the Mercury V.I. U.S. Large Cap Fund
may borrow from banks (as defined in the Investment Company Act) in amounts
up to 33 1/3% of its total assets (including the amount borrowed), (ii) the
Mercury V.I. U.S. Large Cap Fund may borrow up to an additional 5% of its
total assets for temporary purposes, (iii) the Mercury V.I. U.S. Large Cap
Fund may obtain such short-term credit as may be necessary for the
clearance of purchases and sales of portfolio securities and (iv) the
Mercury V.I. U.S. Large Cap Fund may purchase securities on margin to the
extent permitted by applicable law. The Mercury V.I. U.S. Large Cap Fund
may not pledge its assets other than to secure such borrowings or, to the
extent permitted by the Mercury V.I. U.S. Large Cap Fund's investment
policies as set forth in its Prospectus and Statement of Additional
Information, as they may be amended from time to time, in connection with
hedging transactions, short sales, when-issued and forward commitment
transactions and similar investment strategies.
15
<PAGE> 34
8. Underwrite securities of other issuers except insofar as the
Mercury V.I. U.S. Large Cap Fund technically may be deemed an underwriter
under the Securities Act of 1933 in selling portfolio securities.
9. Purchase or sell commodities or contracts on commodities, except to
the extent that the Mercury V.I. U.S. Large Cap Fund may do so in
accordance with applicable law and the Mercury V.I. U.S. Large Cap Fund's
Prospectus and Statement of Additional Information, as they may be amended
from time to time, and without registering as a commodity pool operator
under the Commodity Exchange Act.
In addition, the Corporation has adopted non-fundamental restrictions that
may be changed by the Board of Directors without shareholder approval. Like the
fundamental restrictions, none of the non-fundamental restrictions, including
but not limited to restriction (a) below, shall prevent the Mercury V.I. U.S.
Large Cap Fund from investing all of its assets in shares of another registered
investment company with the same investment objective (in a master/feeder
structure). Under the non-fundamental investment restrictions, the Mercury V.I.
U.S. Large Cap Fund may not:
(a) Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law. As a matter of
policy, however, the Mercury V.I. U.S. Large Cap Fund will not purchase
shares of any registered open-end investment company or registered unit
investment trust, in reliance on Section 12(d)(1)(F) or (G) (the "fund of
funds" provisions) of the Investment Company Act, at any time the Mercury
V.I. U.S. Large Cap Fund's shares are owned by another investment company
that is part of the same group of investment companies as the Mercury V.I.
U.S. Large Cap Fund.
(b) Make short sales of securities or maintain a short position,
except to the extent permitted by applicable law. The Mercury V.I. U.S.
Large Cap Fund currently does not intend to engage in short sales, except
short sales "against the box."
(c) Invest in securities that cannot be readily resold because of
legal or contractual restrictions or that cannot otherwise be marketed,
redeemed or put to the issuer or a third party, if at the time of
acquisition more than 15% of its net assets would be invested in such
securities. This restriction shall not apply to securities that mature
within seven days or securities that the Directors of the Corporation have
otherwise determined to be liquid pursuant to applicable law. Securities
purchased in accordance with Rule 144A under the Securities Act (which are
restricted securities that can be resold to qualified institutional buyers,
but not to the general public) and determined to be liquid by the Directors
of the Corporation are not subject to the limitations set forth in this
investment restriction.
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.
The staff of the Commission has taken the position that purchased
over-the-counter ("OTC") options and the assets used as cover for written OTC
options are illiquid securities. Therefore, the Corporation has adopted an
investment policy pursuant to which the Mercury V.I. U.S. Large Cap Fund will
not purchase or sell OTC options (including OTC options on futures contracts)
if, as a result of such transactions, the sum of the market value of OTC options
currently outstanding which are held by the Mercury V.I. U.S. Large Cap Fund,
the market value of the underlying securities covered by OTC call options
currently outstanding which were sold by the Fund and margin deposits on the
Mercury V.I. U.S. Large Cap Fund's existing OTC options on futures contracts
exceed 15% of the net assets of the Fund, taken at market value, together with
all other assets of the Mercury V.I. U.S. Large Cap Fund which are illiquid or
are not otherwise readily marketable. However, if an OTC option is sold by the
Mercury V.I. U.S. Large Cap Fund to a primary U.S. Government securities dealer
recognized by the Federal Reserve Bank of New York and if the Fund has the
unconditional contractual right to repurchase such OTC option from the dealer at
a predetermined price, then the Mercury V.I. U.S. Large Cap Fund will treat as
illiquid such amount of the underlying securities as is equal to the repurchase
price less the amount by which the option is "in-the-money" (i.e., current
market value of the underlying securities minus the option's strike price). The
repurchase price with the primary dealers is typically a formula price that is
generally based on a multiple of the premium received for the option, plus the
amount by which the option is "in-the-money." This policy as to OTC options is
not a fundamental policy of the Mercury V.I. U.S. Large Cap Fund
16
<PAGE> 35
and may be amended by the Directors without the approval of the shareholders.
However, the Directors will not change or modify this policy prior to the change
or modification by the Commission staff of its position.
Portfolio securities of the Mercury V.I. U.S. Large Cap Fund generally may
not be purchased from, sold or loaned to the Investment Adviser or its
affiliates or any of their directors, general partners, officers or employees,
acting as principal, unless pursuant to a rule or exemptive order under the
Investment Company Act.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Investment Adviser and Fund Asset
Management, L.P. ("FAM"), the Mercury V.I. U.S. Large Cap Fund is prohibited
from engaging in certain transactions involving Merrill Lynch, the Investment
Adviser, or any of its affiliates, except for brokerage transactions permitted
under the Investment Company Act involving only usual and customary commissions
or transactions pursuant to an exemptive order under the Investment Company Act.
See "Portfolio Transactions and Brokerage" in the Appendix to this Statement of
Additional Information. Rule 10f-3 under the Investment Company Act sets forth
conditions under which the Mercury V.I. U.S. Large Cap Fund may purchase from an
underwriting syndicate of which Merrill Lynch is a member.
PORTFOLIO TURNOVER
The portfolio turnover rate is calculated by dividing the lesser of the
Mercury V.I. U.S. Large Cap Fund's annual sales or purchases of portfolio
securities (exclusive of purchases or sales of securities whose maturities at
the time of acquisition were one year or less) by the monthly average value of
the securities in the portfolio during the year. Although the Fund anticipates
that its annual portfolio turnover rates should not exceed 100%, the turnover
rate may vary greatly from year to year or during periods within a year. A high
rate of portfolio turnover results in correspondingly higher brokerage
commission expenses.
GENERAL INFORMATION RELATING TO THE MERCURY V.I. U.S. LARGE CAP FUND
DESCRIPTION OF SHARES
The Corporation is a Maryland corporation incorporated on December 7, 1998.
It has authorized capital of 800,000,000 shares of Common Stock, par value
$.0001, divided into 200,000,000 shares of each of Class A and Class B shares
for each of its series.
Shareholders are entitled to one vote for each full share held and
fractional votes for fractional shares held in the election of Directors of the
Corporation (to the extent hereinafter provided) and on other matters submitted
to the vote of shareholders, except that Class B shareholders, whose shares bear
distribution expenses as provided below, shall have exclusive voting rights with
respect to matters relating to such distribution expenditures. Voting rights are
not cumulative, so that the holders of more than 50% of the shares voting in the
election of Directors can, if they choose to do so, elect all the Directors of
the Corporation, in which event the holders of the remaining shares would be
unable to elect any person as a Director.
There normally will be no meeting of shareholders for the purpose of
electing Directors unless and until such time as less than a majority of the
Directors holding office have been elected by the shareholders, at which time
the Directors then in office will call a shareholders' meeting for the election
of Directors. Shareholders may, in accordance with the terms of the Articles of
Incorporation, cause a meeting of shareholders to be held for the purpose of
voting on the removal of Directors. Also, the Corporation will be required to
call a special meeting of shareholders in accordance with the requirements of
the Investment Company Act to seek approval of new management and advisory
arrangements, of a material increase in distribution fees or of a change in
fundamental policies, objectives or restrictions. Except as set forth above, the
Directors shall continue to hold office and appoint successor Directors. Each
issued and outstanding share is entitled to participate equally in dividends and
distributions declared and in net assets upon liquidation or dissolution
remaining after satisfaction of outstanding liabilities, except for any expenses
which may be attributable to only one class. Shares issued are fully-paid and
non-assessable by the Corporation or the Mercury V.I. U.S. Large Cap Fund.
17
<PAGE> 36
<PAGE> 1
MERCURY ASSET MANAGEMENT V.I. FUNDS, INC.
APPENDIX
This Appendix constitutes a part of the Statement of Additional Information
for the Class A and Class B shares of Mercury V.I. U.S. Large Cap Fund. This
Appendix uses the term "Fund" to refer to Mercury V.I. U.S. Large Cap Fund and
any future series of Mercury Asset Management V.I. Funds.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Management of the Funds..................................... A-2
Directors and Officers.................................... A-2
Compensation of Directors................................. A-3
Management and Advisory Arrangements...................... A-3
Code of Ethics............................................ A-5
Purchase of Shares.......................................... A-5
Distribution Agreements................................... A-6
Distribution Plans........................................ A-6
Redemption of Shares........................................ A-7
Portfolio Transactions and Brokerage........................ A-7
Pricing of Shares........................................... A-9
Determination of Net Asset Value.......................... A-9
Dividends and Taxes......................................... A-10
Dividends................................................. A-10
Taxes..................................................... A-10
Performance Data............................................ A-11
General Information......................................... A-13
Independent Auditors...................................... A-13
Custodian................................................. A-13
Transfer Agent............................................ A-13
Legal Counsel............................................. A-13
Reports to Shareholders................................... A-13
Additional Information.................................... A-13
Financial Statements........................................ A-14
Annex A -- Ratings of Fixed Income Securities............... Annex A-1
</TABLE>
A-1
<PAGE> 2
MANAGEMENT OF THE FUNDS
DIRECTORS AND OFFICERS
The Directors of the Corporation consist of six individuals, four of whom
are not "interested persons" of the Corporation as defined in the Investment
Company Act. The Directors are responsible for the overall supervision of the
operations of each Fund and perform the various duties imposed on the directors
of investment companies by the Investment Company Act. Information about the
Directors and executive officers of the Corporation, their ages and their
principal occupations for at least the last five years are set forth below.
Unless otherwise noted, the address of each executive officer and Director is
P.O. Box 9011, Princeton, New Jersey 08543-9011.
JEFFREY M. PEEK (53) -- Director and President(1)(2) -- President of
Merrill Lynch Asset Management L.P. ("MLAM") and FAM since 1997; President and
Director of Princeton Services, Inc. ("Princeton Services") since 1997;
Executive Vice President of Merrill Lynch & Co., Inc. ("ML & Co.") since 1997;
Co-Head of Merrill Lynch Investment Banking Division from March 1997 to December
1997; Director of Merrill Lynch Global Securities Research and Economics
Division from 1995 to 1997; Head of Merrill Lynch Global Industries Group from
1993 to 1995.
TERRY K. GLENN (59) -- Director and Executive Vice
President(1)(2) -- Executive Vice President of MLAM and FAM 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.
DAVID O. BEIM (59) -- Director (2)(3) -- 410 Uris Hall, Columbia
University, New York, New York 10027. Professor of Finance and Economics at the
Columbia University Graduate School of Business since 1991; Chairman of Outward
Bound USA since 1997; Chairman of Wave Hill, Inc. since 1980.
JAMES T. FLYNN (60) -- Director(2)(3) -- 340 East 72nd Street, New York,
New York 10021. Chief Financial Officer of J.P. Morgan & Co. Inc. from 1990 to
1995 and an employee of J.P. Morgan in various capacities from 1967 to 1995.
W. CARL KESTER (48) -- Director(2)(3) -- Harvard Business School, Morgan
Hall 393, Soldiers Field, Boston, Massachusetts 02163. Industrial Bank of Japan
Professor of Finance, Senior Associate Dean and Chairman of the MBA Program of
Harvard University Graduate School of Business Administration since 1999; James
R. Williston Professor of Business Administration of Harvard University Graduate
School of Business from 1997 to 1999; MBA Class of 1958 Professor of Business
Administration of Harvard University Graduate School of Business Administration
from 1981 to 1997; Independent Consultant since 1978.
KAREN P. ROBARDS (50) -- Director (2)(3) -- Robards & Company, 173
Riverside Drive, New York, New York 10024. President of Robards & Company, a
financial advisory firm, for more than five years; Director of Enable Medical
Corp. since 1996; Director of Cine Muse Inc. since 1996; Director of the Cooke
Center for Learning and Development, a not-for-profit organization, since 1987.
PETER JOHN GIBBS (42) -- Senior Vice President(1)(2) -- 33 King William
Street, London, EC4R 9AS, England. Chairman and Chief Executive Officer of
Mercury International since 1998; Director of Mercury Asset Management Ltd.
since 1993; Director of Mercury Asset Management International Channel Islands
Ltd. since 1997.
DONALD C. BURKE (39) -- Treasurer and Vice President (1)(2) -- Senior Vice
President and Treasurer of MLAM and FAM since 1999; Senior Vice President and
Treasurer of Princeton Services, Inc. since 1999; Vice President of Princeton
Funds Distributor, Inc. since 1999; First Vice President of MLAM and FAM from
1997 to 1999; Director of Taxation of MLAM since 1990; Vice President of MLAM
and FAM from 1990 to 1997.
A-2
<PAGE> 3
ALLAN J. OSTER (36) -- Secretary (1)(2) -- Vice President (Legal Advisory)
of MLAM since 2000; Consultant (Legal Advisory) of MLAM since 1999; Associate of
Drinker Biddle & Reath LLP from 1996 to 1999; Senior Counsel of U.S. Securities
and Exchange Commission from 1991 to 1996.
- ---------------
(1) Interested person, as defined in the Investment Company Act, of each Fund.
(2) Such Director or officer is a trustee, director or officer of other
investment companies for which the Investment Adviser, or the Funds'
sub-adviser, FAM, or their affiliates, acts as investment adviser.
(3) Member of the Corporation's Audit and Nominating Committee, which is
responsible for the selection of the independent auditors and the selection
and nomination of Directors not affiliated with the Investment Adviser or
FAM or with an affiliate of the Investment Adviser or FAM (each a
"non-interested Director").
As of March 1, 2000, the officers and Directors of the Corporation as a
group (nine persons) owned an aggregate of less than 1% of the outstanding
shares of common stock of ML & Co. and owned an aggregate of less than 1% of the
outstanding shares of any Fund.
COMPENSATION OF DIRECTORS
The Corporation pays each non-interested Director, for service to the
Funds, a fee of $3,000 per year plus $500 per Board meeting attended. The
Corporation also compensates each member of the Audit and Nominating Committee
(the "Committee"), which consists of all of the non-interested Directors, at a
rate of $1,000 per year. The Corporation reimburses each non-interested Director
for his out-of-pocket expenses relating to attendance at Board and Committee
meetings.
The following table sets forth the aggregate compensation the Corporation
expects to pay to the non-interested Directors for their first full fiscal year
and the aggregate compensation paid by all investment companies advised by
Mercury International, FAM, or their affiliates ("Mercury and Affiliates-Advised
Funds") to the non-interested Directors for the calendar year ended December 31,
1999.
<TABLE>
<CAPTION>
TOTAL COMPENSATION FROM
FUNDS AND
PENSION OR RETIREMENT MERCURY AND
BENEFITS ACCRUED AS AFFILIATES-ADVISED
AGGREGATE COMPENSATION PART OF FUNDS' FUNDS PAID TO
NAME OF DIRECTOR FROM FUNDS EXPENSES DIRECTORS(1)
---------------- ---------------------- --------------------- -----------------------
<S> <C> <C> <C>
David O. Beim.................... $6,000 None $35,667
James T. Flynn................... $6,000 None $67,500
W. Carl Kester................... $6,000 None $67,167
Karen P. Robards................. $6,000 None $35,667
</TABLE>
- ---------------
(1) In addition to the Corporation, the Directors served on other Mercury and
Affiliates-Advised Funds as follows: Mr. Beim (2 registered investment
companies consisting of 12 portfolios); Mr. Flynn (4 registered investment
companies consisting of 18 portfolios); Mr. Kester (4 registered investment
companies consisting of 18 portfolios); and Ms. Robards (2 registered
investment companies consisting of 12 portfolios).
MANAGEMENT AND ADVISORY ARRANGEMENTS
The Corporation on behalf of each Fund has entered into an investment
advisory agreement with Mercury International as Investment Adviser (each, an
"Investment Advisory Agreement"). As discussed in "The Management Team" in the
Prospectus, the Investment Adviser receives for its services to the Mercury V.I.
U.S. Large Cap Fund monthly compensation at the annual rate of 0.65% of the
average daily net assets of the Mercury V.I. U.S. Large Cap Fund. The Investment
Adviser has agreed to limit the annual operating expenses of the Mercury V.I.
U.S. Large Cap Fund to 1.25% and 1.40% of the Mercury V.I. U.S. Large Cap Fund's
average net assets with respect to the Class A shares and Class B shares,
respectively. These
A-3
<PAGE> 4
expense limits will be in place through April 2001. For the period April 30,
1999 (commencement of operations) to December 31, 1999, the Mercury V.I. U.S.
Large Cap Fund paid the Investment Adviser a fee of $50,626, all of which was
waived.
Each Investment Advisory Agreement obligates the Investment Adviser to
provide investment advisory services and to pay, or cause an affiliate to pay,
for maintaining its staff and personnel and to provide office space, facilities
and necessary personnel for the Corporation. The Investment Adviser is also
obligated to pay, or cause an affiliate to pay, the fees of all Officers and
Directors who are affiliated persons of the Investment Adviser or any
sub-adviser or of an affiliate of the Investment Adviser or any sub-adviser. The
Corporation pays, or causes to be paid, all other expenses incurred in the
operation of each Fund and the Corporation (except to the extent paid by
Participating Insurance Companies), including, among other things, taxes,
expenses for legal and auditing services, costs of printing proxies, shareholder
reports, copies of the Registration Statement, charges of the custodian, any
sub-custodian and the transfer agent, expenses of portfolio transactions,
expenses of redemption of shares, Commission fees, expenses of registering the
shares under Federal, state or non-U.S. laws, fees and actual out-of-pocket
expenses of non-interested Directors, accounting and pricing costs (including
the daily calculation of net asset value), insurance, interest, brokerage costs,
litigation and other extraordinary or non-recurring expenses, and other expenses
properly payable by the Corporation or any Fund. Accounting services are
provided to the Corporation by the Investment Adviser or an affiliate of the
Investment Adviser, and the Corporation reimburses the Investment Adviser or an
affiliate of the Investment Adviser for its costs in connection with such
services. The Participating Insurance Companies will pay certain of the expenses
of a Fund incurred in connection with the continuous offering of its shares.
Certain expenses will be financed by a Fund pursuant to distribution plans in
compliance with Rule 12b-1 under the Investment Company Act. See "Purchase of
Shares -- Distribution Plans."
Securities held by a Fund of the Corporation 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
one or more clients of the Investment Adviser or an affiliate when one or more
clients of the Investment Adviser or an affiliate are selling the same security.
If purchases or sales of securities arise for consideration at or about the same
time that would involve a Fund or other clients or funds for which the
Investment Adviser or an affiliate acts as manager, transactions in such
securities will be made, insofar as feasible, for the respective funds and
clients in a manner deemed equitable to all. To the extent that transactions on
behalf of more than one client of the Investment Adviser or an affiliate during
the same period may increase the demand for securities being purchased or the
supply of securities being sold, there may be an adverse effect on price.
Mercury International is located at 33 King William Street, London EC4R
9AS, England. Mercury International's intermediate parent company is Mercury
Asset Management Group Ltd., a London-based holding company of a group engaged
in the provision of investment management and advisory services globally. The
ultimate parent of Mercury Asset Management Group Ltd. is ML & Co., a financial
services holding company. ML & Co. is a "controlling person" of Mercury
International as defined under the Investment Company Act because of its power
to exercise a controlling influence over its management or policies.
The Corporation has entered into sub-advisory agreements (each, a
"Sub-Advisory Agreement") with FAM with respect to each Fund, pursuant to which
FAM provides investment advisory services with respect to all or a portion of
each Fund's daily cash assets. The Corporation has agreed to use its reasonable
best efforts to cause the Investment Adviser to pay to FAM a fee in an amount to
be determined from time to time by the Investment Adviser and FAM but in no
event in excess of the amount that the Investment Adviser actually receives for
providing services to the Corporation and the Funds pursuant to the Investment
Advisory Agreements. For the period April 30, 1999 (commencement of operations)
to December 31, 1999, the Investment Adviser paid no fees to FAM pursuant to the
Sub-Advisory Agreement.
The Investment Adviser has entered into administrative services agreements
with certain Participating Insurance Companies, including Participating
Insurance Companies that may be affiliates of the Investment Adviser, pursuant
to which the Investment Adviser compensates such Participating Insurance
Companies for
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administrative responsibilities relating to the Corporation which are performed
by such Participating Insurance Companies.
FAM is located at 800 Scudders Mill Road, Plainsboro, New Jersey 08536.
FAM, an affiliate of Mercury International, is a wholly owned subsidiary of ML &
Co., a financial services holding company and the parent of Merrill Lynch. ML &
Co. and Princeton Services, the partners of FAM, are "controlling persons" of
FAM as defined under the Investment Company Act because of their ownership of
its voting securities or their power to exercise a controlling influence over
its management or policies.
Duration and Termination. Unless earlier terminated as described below,
each Investment Advisory Agreement and Sub-Advisory Agreement will each continue
in effect for two years from its effective date. Thereafter, they will remain in
effect from year to year if approved annually (a) by the Board of Directors of
the Corporation or by a majority of the outstanding shares of a Fund and (b) by
a majority of the Directors of the Corporation who are not parties to such
contract or interested persons (as defined in the Investment Company Act) of any
such party. The Investment Advisory Agreement is not assignable and will
automatically terminate in the event of its assignment. In addition, such
contract may be terminated with respect to any Fund by the vote of a majority of
the outstanding voting securities of such Fund, or by the Investment Adviser
without penalty on 60 days' written notice to the other party.
Transfer Agency Services. Financial Data Services, Inc. (the "Transfer
Agent"), a subsidiary of ML & Co., acts as the Fund's Transfer Agent pursuant to
a Transfer Agency, Dividend Disbursing Agency and Shareholder Servicing Agency
Agreement (the "Transfer Agency Agreement"). Pursuant to the Transfer Agency
Agreement, the Transfer Agent is responsible for the issuance, transfer and
redemption of shares and the opening and maintenance of shareholder accounts.
Pursuant to the Transfer Agency Agreement, the Transfer Agent receives a fee of
$5,000 annually and an amount equal to 0.05% annually of the average daily net
asset value of the assets of a Fund held by separate accounts of Participating
Insurance Companies that are not affiliates of Merrill Lynch & Co. Payment of
this fee is remitted to the Transfer Agent on a monthly basis. The Transfer
Agent is entitled to reimbursement for certain transaction charges and
out-of-pocket expenses incurred by the Transfer Agent under the Transfer Agency
Agreement. For purposes of the Transfer Agency Agreement, the term "account"
includes a shareholder account maintained directly by the Transfer Agent.
CODE OF ETHICS
The Board of Directors of the Corporation, the Investment Adviser, FAM and
Mercury Funds Distributor, a division of Princeton Funds Distributor, Inc.
("MFD" or the "Distributor") have each adopted a Code of Ethics under Rule 17j-1
of the Investment Company Act (together the "Codes"). The Codes significantly
restrict the personal investing activities of all employees of the Investment
Adviser, FAM and the Distributor and, as described below, impose additional,
more onerous, restrictions on fund investment personnel. Among other substantive
restrictions, the Codes contain reporting and preclearance requirements for
employees of the Investment Adviser, FAM and the Distributor and provide for
trading "blackout periods" that prohibit trading by decision making access
persons (those who recommend or determine which securities transactions the
Corporation undertakes) of the Corporation within periods of trading by the
Corporation in the same (or equivalent) security.
PURCHASE OF SHARES
Reference is made to "Account Choices -- Fund Shares" in the Appendix to
the Prospectus.
Each Fund offers two classes of shares: Class A and Class B. The
Participating Insurance Company decides which share class will support a
Contract. Each Class A and Class B share of a Fund represents an identical
interest in the investment portfolio of that Fund, and has the same rights,
except that Class B shares bear the expenses of the ongoing distribution fees
and Class B shares have exclusive voting rights with respect to the Rule 12b-1
distribution plan adopted with respect to such class pursuant to which the
distribution fees are paid.
The Funds do not offer their shares to the general public. Only separate
accounts established by Participating Insurance Companies can buy Fund shares.
Each Fund's Investment Adviser is affiliated with
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two Participating Insurance Companies. Participating Insurance Companies issue
Contracts and use Fund shares to support these Contracts. When this Statement of
Additional Information refers to Fund shareholders, it is referring to the
Participating Insurance Companies.
Contract owners have certain rights under their Contract, but do not have
any direct interest in Fund shares. A separate prospectus describes the Contract
and its additional fees and charges. It also describes how changes in a Fund's
net asset value and distributions on Fund shares affect benefits under a
Contract.
The Distributor, an affiliate of the Investment Adviser and of Merrill
Lynch, with offices at 800 Scudders Mill Road, Plainsboro, New Jersey 08536
(mailing address: P. O. Box 9081, Princeton, New Jersey 08543-9081) acts as
Distributor for each Fund.
DISTRIBUTION AGREEMENTS
The Corporation has entered into distribution agreements (each, a
"Distribution Agreement") with the Distributor with respect to the sale of the
Corporation's shares to the Distributor for resale to Participating Insurance
Companies' separate accounts. Such shares will be sold at their respective net
asset values and therefore will involve no sales charge. The Distributor is an
affiliate of the Investment Adviser.
Each Distribution Agreement is subject to the same renewal requirements and
termination provisions as the Investment Advisory Agreements described above.
The Corporation may suspend the continuous offering of a Fund's shares of
any class at any time in response to conditions in the securities markets or
otherwise and may thereafter resume such offering from time to time. Any order
may be rejected by the Corporation.
DISTRIBUTION PLANS
Reference is made to "Account Choices -- Fund Shares" in the Appendix to
the Prospectus for certain information with respect to the distribution plan for
Class B shares pursuant to Rule 12b-1, under the Investment Company Act, of a
Fund (each a "Distribution Plan") with respect to the distribution fees paid by
each Fund with respect to such class.
Each Distribution Plan permits the Corporation to pay to each Participating
Insurance Company that enters into an agreement with the Corporation to provide
distribution related services to Contract owners, a distribution fee relating to
the Class B shares accrued daily and paid monthly, at the annual rate of 0.15%
of the average daily net assets of the Class B shares of each Fund held by such
Participating Insurance Company. Such services include, but are not limited to,
(a) the printing and mailing of Fund prospectuses, statements of additional
information, any supplements thereto and shareholder reports for prospective
Contract owners, (b) services relating to the development, preparation, printing
and mailing of Corporation advertisements, sales literature and other
promotional materials describing and/or relating to the Corporation and
including materials intended for use within the Participating Insurance Company
or for broker-dealer only use or retail use, (c) holding seminars and sales
meetings designed to promote the distribution of the Class B shares of the
Funds, (d) obtaining information and providing explanations to Contract owners
regarding the investment objectives and policies and other information about the
Corporation and its Funds, including the performance of the Funds, (e) training
sales personnel regarding the Corporation and the Funds, (f) compensating sales
personnel in connection with the allocation of cash values and premiums of the
Contract owners to the Corporation, (g) providing personal services and/or
maintenance of the accounts of the Contract owners with respect to Class B
shares of the Funds attributable to such accounts, and (h) financing any other
activity that the Corporation's Board of Directors determines is primarily
intended to result in the sale of Class B shares.
A Fund has no obligation with respect to distribution related expenses
incurred by the Distributor or Participating Insurance Companies in connection
with the Class B shares, and there is no assurance that the Board of Directors
of the Corporation will approve the continuance of the Distribution Plans from
year to year. However, the Distributor intends to seek annual continuation of
the Distribution Plans. In their review of the Distribution Plans, the Directors
will be asked to take into consideration expenses incurred in connection with
the distribution of each Fund's Class B shares separately.
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In their consideration of each Distribution Plan, the Directors must
consider all factors they deem relevant, including information as to the
benefits of the Distribution Plan to each Fund and its Class B shareholders.
Each Distribution Plan further provides that, so long as the Distribution Plan
remains in effect, the selection and nomination of the Board Directors of the
Corporation who are not "interested persons" of such Fund, as defined in the
Investment Company Act (the "Independent Directors") shall be committed to the
discretion of the Independent Directors then in office. In approving each
Distribution Plan in accordance with Rule 12b-1, the Independent Directors
concluded that there is reasonable likelihood that such Distribution Plan will
benefit the applicable Fund and its Class B shareholders. Each Distribution Plan
can be terminated at any time, without penalty, by the vote of a majority of the
Independent Directors or by the vote of the holders of a majority of the
outstanding Class B shares of the applicable Fund. A Distribution Plan cannot be
amended to increase materially the amount to be spent by a Fund without the
approval of the related Class B shareholders, and all material amendments are
required to be approved by the vote of the Board Directors of the Corporation,
including a majority of the Independent Directors who have no direct or indirect
financial interest in such Distribution Plan, cast in person at a meeting called
for that purpose. Rule 12b-1 further requires that the Fund preserve copies of
each Distribution Plan and any report made pursuant to such plan for a period of
not less than six years from the date of such Distribution Plan or such report,
the first two years in an easily accessible place.
REDEMPTION OF SHARES
The Corporation is required to redeem for cash all shares of a Fund upon
receipt of a written request in proper form. The redemption price is the net
asset value per share next determined after the initial receipt of proper notice
of redemption.
The right to redeem shares or to receive payment with respect to any such
redemption may be suspended for more than seven days only for periods during
which trading on the New York Stock Exchange (the "NYSE") is restricted as
determined by the Commission or during which the NYSE is closed (other than
customary weekend and holiday closings), for any period during which an
emergency exists, as defined by the Commission, as a result of which disposal of
portfolio securities or determination of the net asset value of a Fund is not
reasonably practicable, and for such other periods as the Commission may by
order permit for the protection of shareholders of that Fund.
The value of shares at the time of redemption may be more or less than
their cost, depending in part on the market value of securities held by a Fund
at such time.
The Mercury V.I. U.S. Large Cap Fund has entered into a joint committed
line of credit with other investment companies advised by the Investment Adviser
and its affiliates and a syndicate of banks that is intended to provide the
Mercury V.I. U.S. Large Cap Fund with a temporary source of cash to be used to
meet redemption requests from Fund shareholders in extraordinary or emergency
circumstances.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to policies established by the Board of Directors, the Investment
Adviser is primarily responsible for the execution of each Fund's portfolio
transactions and the allocation of brokerage. The Corporation has no obligation
to deal with any broker or group of brokers in the execution of transactions in
portfolio securities and does not use any particular broker or dealer. In
executing transactions with brokers and dealers, the Investment Adviser seeks to
obtain the best net results for the Corporation, 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 and the firm's risk in positioning a block of securities. While the
Investment Adviser generally seeks reasonable competitive commission rates, the
Corporation does not necessarily pay the lowest spread or commission available.
In addition, consistent with the Conduct Rules of the NASD and policies
established by the Board of Directors, the Investment Adviser may consider sales
of shares of a Fund as a factor in the selection of brokers or dealers to
execute portfolio transactions for the
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Corporation; however, whether or not a particular broker or dealer sells shares
of a Fund neither qualifies nor disqualifies such broker or dealer to execute
transactions for the Corporation.
Subject to obtaining the best net results, brokers who provide supplemental
investment research services to the Investment Adviser may receive orders for
transactions by the Corporation. Such supplemental research services ordinarily
consist of assessments and analysis of the business or prospects of a company,
industry or economic sector. Information so received will be in addition to and
not in lieu of the services required to be performed by the Investment Adviser
under its Investment Advisory Agreement and the expenses of the Investment
Adviser will not necessarily be reduced as a result of the receipt of such
supplemental information. If in the judgment of the Investment Adviser the
Corporation will benefit from supplemental research services, the Investment
Adviser is authorized to pay brokerage commissions to a broker furnishing such
services that are in excess of commissions that another broker may have charged
for effecting the same transaction. Certain supplemental research services may
primarily benefit one or more other investment companies or other accounts for
which the Investment Adviser exercises investment discretion. Conversely, the
Corporation may be the primary beneficiary of the supplemental research services
received as a result of portfolio transactions effected for such other accounts
or investment companies.
The Corporation anticipates that its brokerage transactions involving
securities of issuers domiciled in countries other than the United States
generally will be conducted primarily on the principal stock exchanges of such
countries. Brokerage commissions and other transaction costs on foreign stock
exchange transactions generally are higher than in the United States, although
the Corporation will endeavor to achieve the best net results in effecting its
portfolio transactions. There generally is less government supervision and
regulation of foreign stock exchanges and brokers than in the United States.
For the period April 30, 1999 to December 31, 1999, aggregate brokerage
commissions paid by the Mercury V.I. U.S. Large Cap Fund were $21,430. There
were no brokerage commissions paid to Merrill Lynch.
The Corporation may invest in certain securities traded in the OTC market
and intends to deal directly with the dealers who make a market in securities
involved, except in those circumstances in which better prices and execution are
available elsewhere. Under the Investment Company Act, persons affiliated with
the Corporation and persons who are affiliated with such affiliated persons are
prohibited from dealing with the Corporation as principal in the purchase and
sale of securities unless a permissive order allowing such transactions is
obtained from the Commission. Since transactions in the OTC market usually
involve transactions with dealers acting as principal for their own accounts,
the Corporation will not deal with affiliated persons, including Merrill Lynch
and its affiliates, in connection with such transactions. However, an affiliated
person of the Corporation may serve as its broker in OTC transactions conducted
on an agency basis provided that, among other things, the fee or commission
received by such affiliated broker is reasonable and fair compared to the fee or
commission received by non-affiliated brokers in connection with comparable
transactions. In addition, the Corporation may not purchase securities during
the existence of any underwriting syndicate for such securities of which Merrill
Lynch is a member or in a private placement in which Merrill Lynch serves a
placement agent except pursuant to procedures adopted by the Board of Directors
of the Corporation that either comply with rules adopted by the Commission or
with interpretations of the Commission staff. See "Investment Objectives and
Policies -- Investment Restrictions."
Section 11(a) of the Exchange Act generally prohibits members of the U.S.
national securities exchanges from executing exchange transactions for their
affiliates and institutional accounts that they manage unless the member (i) has
obtained prior express authorization from the account to effect such
transactions, (ii) at least annually furnishes the account with the aggregate
compensation received by the member in effecting such transactions, and (iii)
complies with any rules the Commission has prescribed with respect to the
requirements of clauses (i) and (ii). To the extent Section 11(a) would apply to
Merrill Lynch acting as a broker for the Corporation in any of its portfolio
transactions executed on any such securities exchange of which it is a member,
appropriate consents have been obtained from the Corporation and annual
statements as to aggregate compensation will be provided to the Corporation.
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The Board of Directors of the Corporation has considered the possibility of
seeking to recapture for the benefit of the Corporation brokerage commissions
and other expenses of portfolio transactions by conducting portfolio
transactions through affiliated entities. For example, brokerage commissions
received by affiliated brokers could be offset against the advisory fee paid by
the Corporation to the Investment Adviser. After considering all factors deemed
relevant, the Board of Directors of the Corporation made a determination not to
seek such recapture. The Directors of the Corporation will reconsider this
matter from time to time.
Because of different objectives or other factors, a particular security may
be bought for one or more clients of the Investment Adviser or an affiliate when
one or more clients of the Investment Adviser or an affiliate are selling the
same security. If purchases or sales of securities arise for consideration at or
about the same time that would involve the Corporation or other clients or funds
for which the Investment Adviser or an affiliate acts as manager, transactions
in such securities will be made, insofar as feasible, for the respective funds
and clients in a manner deemed equitable to all. To the extent that transactions
on behalf of more than one client of the Investment Adviser or an affiliate
during the same period may increase the demand for securities being purchased or
the supply or securities being sold, there may be an adverse effect on price.
PRICING OF SHARES
DETERMINATION OF NET ASSET VALUE
Reference is made to "Account Choices -- How Shares are Priced" in the
Appendix to the Prospectus.
The net asset value of the shares of all classes of a Fund is determined
once daily Monday through Friday after the close of business on the NYSE on each
day the NYSE is open for trading based on prices at the time of closing. The
NYSE generally closes at 4:00 p.m., Eastern time. Any assets or liabilities
initially expressed in terms of non-U.S. dollar currencies are translated into
U.S. dollars at the prevailing market rates as quoted by one or more banks or
dealers on the day of valuation. The NYSE is not open for trading on New Year's
Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
The net asset value is computed by dividing the value of the securities
held by a Fund plus any cash or other assets (including interest and dividends
accrued but not yet received) minus all liabilities (including accrued expenses)
by the total number of shares outstanding at such time. Expenses, including the
fees payable to the Participating Insurance Companies, and the advisory fees
payable by each Fund to the Investment Adviser, are accrued daily.
Portfolio securities that are traded on stock exchanges are valued at the
last sale price on the exchange on which such securities are traded as of the
close of business on the day the securities are being valued or, lacking any
sales, at the last available bid price for long positions, and at the last
available ask price for short positions. In cases where securities are traded on
more than one exchange, the securities are valued on the exchange designated by
or under the authority of the Board of Directors as the primary market. Long
positions in securities traded in the OTC market are valued at the last
available bid price or yield equivalent obtained from one or more dealers or
pricing services approved by the Board of Directors of the Corporation. Short
positions in securities traded on the OTC market are valued at the last
available ask price. Portfolio securities that are traded both in the OTC market
and on a stock exchange are valued according to the broadest and most
representative market. When a Fund writes an option, the amount of the premium
received is recorded on the books of that Fund as an asset and an equivalent
liability. The amount of the liability is subsequently valued to reflect the
current market value of the option written, based upon the last sale price in
the case of exchange-traded options or, in the case of options traded in the OTC
market, the last ask price. Options purchased by a Fund are valued at their last
sale price in the case of exchange-traded options or, in the case of options
traded in the OTC market, the last bid price. The value of swaps, including
interest rate swaps, caps and floors, will be determined by obtaining dealer
quotations. Other investments, including financial futures contracts and related
options, are stated at market value. Obligations with remaining maturities of 60
days or less are valued at amortized cost unless the Investment Adviser believes
that this method no longer produces fair valuations. Repurchase agreements will
be valued at cost plus accrued interest. Securities and assets for
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which market quotations are not readily available are generally valued at fair
value as determined in good faith by or under the direction of the Board of
Directors of the Corporation. Such valuations and procedures will be reviewed
periodically by the Board of Directors of the Corporation.
Generally, trading in non-U.S. securities, as well as U.S. Government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the NYSE. The values of such
securities used in computing the net asset value of each Fund's shares are
determined as of such times. Foreign currency exchange rates are also generally
determined prior to the close of business on the NYSE. Occasionally, events
affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of business on the
NYSE that may not be reflected in the computation of a Fund's net asset value.
DIVIDENDS AND TAXES
DIVIDENDS
Reference is made to "Account Choices -- Dividends and Taxes" in the
Appendix to the Prospectus.
Each Fund intends to distribute all its net investment income, if any.
Dividends from such net investment income will be paid at least annually. All
net realized capital gains, if any, will be distributed to each Fund's
shareholders annually. From time to time, a Fund may declare a special dividend
at or about the end of the calendar year in order to comply with a Federal
income tax requirement that certain percentages of its ordinary income and
capital gains be distributed during the calendar year. Dividends and
distributions of a Fund will be automatically reinvested in shares of that Fund
at net asset value.
TAXES
Each Fund is treated as a separate entity for federal income tax purposes
and intends to qualify for and elect the special tax treatment afforded
regulated investment companies ("RICs") under the Internal Revenue Code of 1986,
as amended (the "Code"). As long as a Fund so qualifies, that Fund (but not its
shareholders) will not be subject to Federal income tax on the part of its net
ordinary income and net realized capital gains that it distributes to
shareholders. Each Fund intends to distribute substantially all of such income.
To qualify for this treatment, each Fund must, among other things, (a) derive at
least 90% of its gross income (without offset for losses from the sale or other
disposition of securities or foreign currencies) from dividends, interest,
payments with respect to securities loans, gains from the sale or other
disposition of securities or foreign currencies and certain financial futures,
options and forward contracts; and (b) diversify its holdings so that, at the
end of each quarter of the taxable year, (i) at least 50% of the value of its
assets is represented by cash, U.S. Government securities and other securities
limited in respect of any one issuer to an amount no greater than 5% of its
assets and 10% of the outstanding voting securities of such issuer, and (ii) not
more than 25% of the value of its assets is invested in the securities of any
one issuer (other than U.S. Government securities). If any Fund should fail to
qualify as a RIC in any year, then that Fund would incur corporate federal
income tax upon its taxable income for that year (with no deduction for
distributions to shareholders), and its distributions will generally be taxable
as ordinary dividend income to its shareholders, and each Participating
Insurance Company separate account invested therein would fail to satisfy the
diversification requirements of section 817(h) of the Code (see below), with the
result that the variable life insurance and/or variable annuity contracts
supported by that account would no longer be eligible for tax deferral.
In addition to satisfying the diversification requirements applicable to
RICs, each Fund intends to diversify its assets as required by section 817(h) of
the Code and the regulations thereunder. These regulations place certain
limitations both on the investments of the Fund and on the type of Fund
shareholders. If a Fund fails to comply with these requirements, Contracts that
invest in the Fund will not be entitled to the favorable treatment granted to
annuity, endowment or life insurance contracts under the Code.
A "passive foreign investment company" ("PFIC") is a foreign corporation
that, in general, meets either of the following tests: (a) at least 75% of its
gross income is passive or (b) an average of at least 50% of its
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assets produce, or are held for the production of, passive income. If a Fund
acquires and holds stock in a PFIC beyond the end of the year of its
acquisition, that Fund will be subject to federal income tax on a portion of any
"excess distribution" received on the stock or of any gain from disposition of
the stock (collectively, the "PFIC income"), plus interest thereon, even if that
Fund distributes the PFIC income as a taxable dividend to its shareholders. The
balance of the PFIC income will be included in that Fund's investment company
taxable income and, accordingly, will not be taxable to it to the extent that
income is distributed to its shareholders. A Fund may make a "mark-to-market"
election with respect to any stock it holds of a PFIC, if such stock is
marketable (as defined by the Code for purposes of such election). If the
election is in effect at the end of the Fund's taxable year, that Fund will
recognize the amount of gains, if any, with respect to PFIC stock. Such
mark-to-market gain will be treated as ordinary income. Alternatively, a Fund
may elect to treat any PFIC in which it invests as a "qualified electing fund,"
in which case, in lieu of the foregoing tax and interest obligation, that Fund
will be required to include in its income each year, its pro rata share of the
qualified electing fund's annual ordinary earnings and net capital gain, even if
they are not distributed to that Fund; those amounts would be subject to the
distribution requirements applicable to that Fund described above. It may be
very difficult, if not impossible, to make this election because of certain
requirements thereof.
Income received by a Fund from sources within foreign countries may be
subject to withholding and other taxes imposed by such countries. Income tax
treaties between certain countries and the United States may reduce or eliminate
such taxes. It is impossible to determine in advance the effective rate of
foreign tax to which a Fund will be subject, since the amount of that Fund's
assets to be invested in various countries is not known. Shareholders are urged
to consult their tax advisors regarding specific questions as to Federal, state
and local taxes.
------------------------
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and the Treasury regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections and
the Treasury regulations promulgated thereunder. The Code and the Treasury
regulations are subject to change by legislative or administrative action either
prospectively or retroactively.
For information regarding the federal income tax treatment of a Contract
and distributions to the separate accounts of the Participating Insurance
Companies, see the separate prospectus for the Contracts.
PERFORMANCE DATA
From time to time a Fund may include its average annual total return and
other total return data in advertisements or information furnished to present or
prospective Contract owners. Total return is based on a Fund's historical
performance and is not intended to indicate future performance. Average annual
total return is determined separately for Class A and Class B shares in
accordance with a formula specified by the Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses. The total return quotations may be of limited use for comparative
purposes because they do not reflect charges imposed on the Contracts by the
Participating Insurance Companies, which, if included, would decrease total
return.
A Fund also may quote annual, average annual and annualized total return
and aggregate total return performance data, both as a percentage and as a
dollar amount based on a hypothetical $1,000 investment, for various periods
other than those noted below. Such data will be computed as described above,
except that as required by the periods of the quotations, actual annual,
annualized or aggregate data, rather than average annual data, may be quoted.
Actual annual or annualized total return data generally will be lower than
average annual total return data since the average rates of return reflect
compounding of return; aggregate total return
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data generally will be higher than average annual total return data since the
aggregate rates of return reflect compounding over a longer period of time.
On occasion, a Fund may compare its performance to various indices
including, the Standard & Poor's 500 Index, the Value Line Composite Index, the
Dow Jones Industrial Average, the MSCI Europe (if applicable) or other published
indices, or to data contained in publications such as Lipper Analytical
Services, Inc., Morningstar Publications, Inc. ("Morningstar"), other competing
universes, Money Magazine, U.S. News & World Report, Business Week, Forbes
Magazine, Fortune Magazine and CDA Investment Technology, Inc. When comparing
its performance to a market index, a Fund may refer to various statistical
measures derived from the historic performance of that Fund and the index, such
as standard deviation and beta. In addition, from time to time, a Fund may
include the Fund's Morningstar risk-adjusted performance rating in
advertisements or supplemental sales literature. A Fund may from time to time
quote in advertisement or other materials other applicable measures of
performance and may also make references to awards that may be given to the
Investment Adviser. As with other performance data, performance comparisons
should not be considered reflective of a Fund's relative performance for any
future period.
Total return figures are based on a Fund's historical performance and are
not intended to indicate future performance. A Fund's total return will vary
depending on market conditions, the securities comprising the Fund's portfolio,
the Fund's operating expenses and the amount of realized and unrealized net
capital gains or losses during the period. The value of an investment in a Fund
will fluctuate and the value of the Fund shares, when redeemed, may be worth
more or less than their original cost.
A Fund may provide information designed to help investors understand how
the Fund is seeking to achieve its investment objectives. This may include
information about past, current or possible economic, market, political, or
other conditions, descriptive information on general principles of investing
such as asset allocation, diversification and risk tolerance, discussion of the
Fund's portfolio composition, investment philosophy, strategy or investment
techniques, comparisons of the Fund's performance or portfolio composition to
that of other funds or types of investments, indices relevant to the comparison
being made, or to a hypothetical or model portfolio. A Fund may also quote
various measures of volatility and benchmark correlation in advertising and
other materials, and may compare these measures to those of other funds or types
of investments.
Set forth below is total return information for Class A shares of the
Mercury V.I. U.S. Large Cap Fund for the period indicated. The total return
quotations may be of limited use for comparative purposes because they do not
reflect charges imposed on the contracts by the Participating Insurance
Companies, which, if included, would decrease total return.
<TABLE>
<CAPTION>
CLASS A SHARES
--------------------------------------
EXPRESSED AS REDEEMABLE VALUE
A PERCENTAGE OF A HYPOTHETICAL
BASED ON A $1,000 INVESTMENT
HYPOTHETICAL AT THE END OF
PERIOD $1,000 INVESTMENT THE PERIOD
------ ----------------- -----------------
<S> <C> <C>
AVERAGE ANNUAL TOTAL RETURN
Inception (April 30, 1999) to December 31, 1999............. 32.75% $1,209.40
ANNUAL TOTAL RETURN
Inception (April 30, 1999) to December 31, 1999............. 20.94% $1,209.40
AGGREGATE TOTAL RETURN
Inception (April 30, 1999) to December 31, 1999............. 20.94% $1,209.40
</TABLE>
A-12
<PAGE> 13
GENERAL INFORMATION
INDEPENDENT AUDITORS
Deloitte & Touche LLP, Princeton Forrestal Village, 116-300 Village
Boulevard, Princeton, New Jersey 08540, have been selected as the independent
auditors of each Fund. The independent auditors are responsible for auditing the
annual financial statements of the Fund.
CUSTODIAN
Brown Brothers Harriman & Co., (the "Custodian"), 40 Water Street, Boston,
Massachusetts 02109, acts as the Custodian of each Fund's assets. Under its
contract with the Funds, the Custodian is authorized to establish separate
accounts in foreign currencies and to cause foreign securities owned by each
Fund to be held in its offices outside the United States and with certain
foreign banks and securities depositories. The custodian is responsible for
safeguarding and controlling each Fund's cash and securities, handling the
receipt and delivery of securities and collecting interest and dividends on each
Fund's investments.
TRANSFER AGENT
Financial Data Services, Inc., 4800 Deer Lake Drive East, Jacksonville,
Florida 32246-6484, which is a wholly owned subsidiary of ML & Co., acts as each
Fund's Transfer Agent pursuant to a transfer agency, dividend disbursing agency
and shareholder servicing agency agreement (the "Transfer Agency Agreement").
The Transfer Agent is responsible for the issuance, transfer and redemption of
shares and the opening, maintenance and servicing of shareholder accounts.
LEGAL COUNSEL
Swidler Berlin Shereff Friedman, LLP, The Chrysler Building, 405 Lexington
Avenue, New York, New York 10174, is counsel for the Funds.
REPORTS TO SHAREHOLDERS
Each Fund sends to its shareholders at least semi-annually reports showing
that Fund's portfolio and other information. An annual report, containing
financial statements audited by independent auditors, is sent to shareholders
each year. After the end of each year, shareholders will receive Federal income
tax information regarding dividends and capital gains distributions.
ADDITIONAL INFORMATION
The Prospectus and this Statement of Additional Information do not contain
all the information set forth in the Registration Statement and the exhibits
relating thereto, which the Corporation has filed with the Commission,
Washington, D.C., under the Securities Act and the Investment Company Act, to
which reference is hereby made.
------------------------
A-13
<PAGE> 14
To the knowledge of the Mercury V.I. U.S. Large Cap Fund, the following
Participating Insurance Companies owned of record or beneficially 5% or more of
a class of the Mercury V.I. U.S. Large Cap Fund's shares as of March 1, 2000:
<TABLE>
<CAPTION>
PERCENT OF
NAME/ADDRESS CLASS A
- ------------ ----------
<S> <C>
MLIG MLLIC Retirement Plus.................................. 59%
Attn Doak Foster
310 W Capital Ave
Little Rock AR 72201-3525
MLIGS Mercury............................................... 17%
4804 Deer Lake Drive East
4th Floor
Jacksonville FL 32246
MLVLSC Prime Plan........................................... 10.8%
Attn Doak Foster
310 W Capital Ave
Little Rock AR 72201-3525
MLVLSC Investor Life........................................ 5.9%
Attn Doak Foster
310 W Capital Ave
Little Rock AR 72201-3525
</TABLE>
FINANCIAL STATEMENTS
The Mercury V.I. U.S. Large Cap Fund's audited financial statements are
incorporated into this Statement of Additional Information by reference to its
1999 annual report to shareholders. You may request a copy of the annual report
at no charge by calling 1-888-763-2260 between 8:00 a.m. and 8:00 p.m. on any
business day.
A-14
<PAGE> 15
ANNEX A
RATINGS OF FIXED INCOME SECURITIES
DESCRIPTION OF MOODY'S INVESTORS SERVICES, INC.'S CORPORATE DEBT RATINGS
<TABLE>
<S> <C>
Aaa Bonds that are rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment risk
and are generally referred to as "gilt edge." Interest
payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various
protective elements are likely to change, such changes as
can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa Bonds that are rated Aa are judged to be of high quality by
all standards. Together with the Aaa group they comprise
what are generally known as high grade bonds. They are rated
lower than the best bonds because margins of protection may
not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may
be other elements present that make the long-term risks
appear somewhat larger than in Aaa securities.
A Bonds that are rated A possess many favorable investment
attributes and are to be considered as upper medium grade
obligations. Factors giving security to principal and
interest are considered adequate, but elements may be
present that suggest a susceptibility to impairment sometime
in the future.
Baa Bonds that are rated Baa are considered as medium grade
obligations; i.e., they are neither highly protected nor
poorly secured. Interest payments and principal security
appear adequate for the present but certain protective
elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack
outstanding investment characteristics and in fact have
speculative characteristics as well.
Ba Bonds that are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured.
Often the protection of interest and principal payments may
be very moderate, and therefore not well safeguarded during
both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B Bonds that are rated B generally lack characteristics of
desirable investments. 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 that 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 that are rated Ca represent obligations that are
speculative in a high degree. Such issues are often in
default or have other marked shortcomings.
C Bonds that are rated C are the lowest rated bonds, and
issues so rated can be regarded as having extremely poor
prospects of ever attaining any real investment standing.
</TABLE>
Note: Moody's may apply numerical modifiers 1, 2 and 3 in each generic
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking, and the modifier
3 indicates that the issue ranks in the lower end of its generic category.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
The term "commercial paper" as used by Moody's means promissory obligations
not having an original maturity in excess of nine months. Moody's makes no
representations as to whether such commercial paper is by any other definition
"commercial paper" or is exempt from registration under the Securities Act of
1933, as amended (the "Securities Act").
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 makes no representation that such obligations are
exempt from registration under the Securities Act, nor does it represent that
any specific
Annex A-1
<PAGE> 16
note is a valid obligation of a rated issuer or issued in conformity with any
applicable law. 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 related supporting institutions) have a
superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally 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 earnings coverage of fixed financial charges and
higher internal cash generation
- Well established access to a range of financial markets and assured
sources of alternate liquidity
Issuers rated Prime-2 (or related supporting institutions) have a
strong capacity 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 related supporting institutions) have an
acceptable capacity for repayment of short-term promissory obligations. The
effect of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes
in level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternative liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
If an issuer represents to Moody's that its commercial paper obligations
are supported by the credit of another entity or entities, then the name or
names of such supporting entity or entities are listed within parentheses
beneath the name of the issuer, or there is a footnote referring the reader to
another page for the name or names of the supporting entity or entities. In
assigning ratings to such issuers, Moody's evaluates the financial strength of
the indicated affiliated corporations, commercial banks, insurance companies,
foreign governments or other entities, but only as one factor in the total
rating assessment. Moody's makes no representation and gives no opinion on the
legal validity or enforceability of any support arrangement. You are cautioned
to review with your counsel any questions regarding particular support
arrangements.
DESCRIPTION OF MOODY'S PREFERRED STOCK RATINGS
Because of the fundamental differences between preferred stocks and bonds,
a variation of the bond rating symbols is being used in the quality ranking of
preferred stocks. The symbols, presented below, are designed to avoid comparison
with bond quality in absolute terms. It should always be borne in mind that
preferred stocks occupy a junior position to bonds within a particular capital
structure and that these securities are rated within the universe of preferred
stocks.
Annex A-2
<PAGE> 17
Preferred stock rating symbols and their definitions are as follows:
<TABLE>
<S> <C>
aaa An issue that is rated "aaa" is considered to be a
top-quality preferred stock. This rating indicates good
asset protection and the least risk of dividend impairment
within the universe of preferred stocks.
aa An issue that is rated "aa" is considered a high-grade
preferred stock. This rating indicates that there is
reasonable assurance that earnings and asset protection will
remain relatively well maintained in the foreseeable future.
a An issue that is rated "a" is considered to be an
upper-medium grade preferred stock. While risks are judged
to be somewhat greater than in the "aaa" and "aa"
classifications, earnings and asset protection are,
nevertheless, expected to be maintained at adequate levels.
baa An issue that is rated "baa" is considered to be medium
grade, neither highly protected nor poorly secured. Earnings
and asset protection appear adequate at present but may be
questionable over any great length of time.
ba An issue that is rated "ba" is considered to have
speculative elements and its future cannot be considered
well assured. Earnings and asset protection may be very
moderate and not well safeguarded during adverse periods.
Uncertainty of position characterizes preferred stocks in
this class.
b An issue that is rated "b" generally lacks the
characteristics of a desirable investment. Assurance of
dividend payments and maintenance of other terms of the
issue over any long period of time may be small.
caa An issue that is rated "caa" is likely to be in arrears on
dividend payments. This rating designation does not purport
to indicate the future status of payments.
ca An issue that is rated "ca" is speculative in a high degree
and is likely to be in arrears on dividends with little
likelihood of eventual payment.
c This is the lowest rated class of preferred or preference
stock. Issues so rated can be regarded as having extremely
poor prospects of ever attaining any real investment
standing.
</TABLE>
Note: Moody's may apply numerical modifiers 1, 2 and 3 in each rating
classification from "aa" through "b" in its preferred stock rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
DESCRIPTION OF STANDARD & POOR'S CORPORATE DEBT RATINGS
A Standard & Poor's corporate or municipal rating is a current assessment
of the creditworthiness of an obligor with respect to a specific obligation.
This assessment may take into consideration obligers such as guarantors,
insurers or lessees.
The debt rating is not a recommendation to purchase, sell or hold a
security, 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 it 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 for other reasons.
The ratings are based, in varying degrees, on the following considerations:
(1) 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; (2) nature of and provisions of the obligation; and (3)
protection
Annex A-3
<PAGE> 18
afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization or other arrangement under the laws of bankruptcy and
other laws affecting creditors' rights.
<TABLE>
<S> <C>
AAA Debt rated AAA has the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is
extremely strong.
AA Debt rated AA has a very strong capacity to pay interest and
repay principal and differs from the highest-rated issues
only in small degree.
A Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions than debt in higher-rated categories.
BBB Debt rated BBB is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally
exhibits adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead
to a weakened capacity to pay interest and repay principal
for debt in this category than for debt in higher-rated
categories.
</TABLE>
Debt rated BB, B, CCC and C are regarded as having predominantly
speculative characteristics with respect to capacity to pay interest and repay
principal. BB indicates the least degree of speculation and C the highest degree
of speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
<TABLE>
<S> <C>
BB Debt rated BB has less near-term vulnerability to default
than other speculative grade debt. However, it faces major
ongoing uncertainties or exposure to adverse business,
financial or economic conditions that could lead to
inadequate capacity to meet timely interest and principal
payment. The BB rating category is also used for debt
subordinated to senior debt that is assigned an actual or
implied BBB- rating.
B Debt rated B has a greater vulnerability to default but
presently has the capacity to meet interest payments and
principal repayments. Adverse business, financial or
economic conditions would likely impair capacity or
willingness to pay interest or repay principal. The B rating
category is also used for debt subordinated to senior debt
that is assigned an actual or implied BB or BB- rating.
CCC Debt rated CCC has a current identifiable vulnerability to
default, and is dependent upon favorable business, financial
and economic conditions to meet timely payments of interest
and repayments of principal. In the event of adverse
business, financial or economic conditions, it is not likely
to have the capacity to pay interest and repay principal.
The CCC rating category is also used for debt subordinated
to senior debt that is assigned an actual or implied B or B-
rating.
CC The rating CC is typically applied to debt subordinated to
senior debt that is assigned an actual or implied CCC
rating.
C The rating C is typically applied to debt subordinated to
senior debt that is assigned an actual or implied CCC- debt
rating. The C rating may be used to cover a situation where
a bankruptcy petition has been filed but debt service
payments are continued.
CI The rating CI is reserved for income bonds on which no
interest is being paid.
D Debt rated D is in default. The D rating is assigned on the
day an interest or principal payment is missed. The D rating
also will be used upon the filing of a bankruptcy petition
if debt service payments are jeopardized.
</TABLE>
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
ratings categories.
PROVISIONAL RATINGS: The letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of the
project being financed by the debt being rated and indicates that payment of
debt service requirements is largely or entirely dependent upon the successful
and timely completion of the project. This rating, however, while addressing
credit quality subsequent to completion of the project, makes no
Annex A-4
<PAGE> 19
comment on the likelihood or risk of default upon failure of such completion.
The investor should exercise judgment with respect to such likelihood and risk.
<TABLE>
<S> <C>
L The letter "L" indicates that the rating pertains to the
principal amount of those bonds to the extent that the
underlying deposit collateral is insured by the Federal
Savings & Loan Insurance Corp. or the Federal Deposit
Insurance Corp. and interest is adequately collateralized.
* Continuance of the rating is contingent upon Standard &
Poor's receipt of an executed copy of the escrow agreement
or closing documentation confirming investments and cash
flows.
NR Indicates that no rating has been requested, that there is
insufficient information on which to base a rating or that
Standard & Poor's does not rate a particular type of
obligation as a matter of policy.
</TABLE>
Debt obligations of issuers outside the United States and its territories
are rated on the same basis as domestic corporate and municipal issues. The
ratings measure the creditworthiness of the obligor but do not take into account
currency exchange and related uncertainties.
BOND INVESTMENT QUALITY STANDARDS: Under present commercial bank
regulations issued by the Comptroller of the Currency, bonds rated in the top
four categories ("AAA," "AA," "A," "BBB," commonly known as "investment grade"
ratings) are generally regarded as eligible for bank investment. In addition,
the laws of various states governing legal investments impose certain rating or
other standards for obligations eligible for investment by savings banks, trust
companies, insurance companies and fiduciaries generally.
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 four categories, ranging from "A" for the
highest quality obligations to "D" for the lowest. The four categories are as
follows:
<TABLE>
<S> <C>
A Issues assigned this highest rating are regarded as having
the greatest capacity for timely payment. Issues in this
category are delineated with the numbers 1, 2 and 3 to
indicate the relative degree of safety.
A-1 This designation indicates that the degree of safety
regarding timely payment is either overwhelming or very
strong. Those issues determined to possess overwhelming
safety characteristics are denoted with a plus (+) sign
designation.
A-2 Capacity for timely payment on issues with this designation
is strong. However, the relative degree of safety is not as
high as for issues designated "A-1."
A-3 Issues carrying this designation have a satisfactory
capacity for timely payment. They are, however, somewhat
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 adequate
capacity for timely payment. However, such capacity may be
damaged by changing conditions or short-term adversities.
C This rating is assigned to short-term debt obligations with
a doubtful capacity for payment.
D This rating indicates that the issue is either in default or
is expected to be in default upon maturity.
</TABLE>
The 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 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.
DESCRIPTION OF STANDARD & POOR'S PREFERRED STOCK RATINGS
A Standard & Poor's preferred stock rating is an assessment of the capacity
and willingness of an issuer to pay preferred stock dividends and any applicable
sinking fund obligations. A preferred stock rating differs from a bond rating
inasmuch as it is assigned to an equity issue, which issue is intrinsically
different from, and subordinated to, a debt issue. Therefore, to reflect this
difference, the preferred stock rating symbol will
Annex A-5
<PAGE> 20
normally not be higher than the bond rating symbol assigned to, or that would be
assigned to, the senior debt of the same issuer.
The preferred stock ratings are based on the following considerations:
<TABLE>
<S> <C>
I. Likelihood of payment-capacity and willingness of the issuer
to meet the timely payment of preferred stock dividends and
any applicable sinking fund requirements in accordance with
the terms of the obligation.
II. Nature of, and provisions of, the issue.
III. Relative position of the issue in the event of bankruptcy,
reorganization, or other arrangements affecting creditors'
rights.
AAA This is the highest rating that may be assigned by Standard
& Poor's to a preferred stock issue and indicates an
extremely strong capacity to pay the preferred stock
obligations.
AA A preferred stock issue rated "AA" also qualifies as a
high-quality fixed income security. The capacity to pay
preferred stock obligations is very strong, although not as
overwhelming as for issues rated "AAA."
A An issue rated "A" is backed by a sound capacity to pay the
preferred stock obligations, although it is somewhat more
susceptible to the adverse effects of changes in
circumstances and economic conditions.
BBB An issue rated "BBB" is regarded as backed by an adequate
capacity to pay the preferred stock obligations. Whereas it
normally exhibits adequate protection parameters, adverse
economic conditions or changing circumstances are more
likely to lead to a weakened capacity to make payments for a
preferred stock in this category than for issues in the "A"
category.
BB, Preferred stock rated "BB," "B," and "CCC" are regarded, on
B, balance, as predominantly speculative with respect to the
CCC issuer's capacity to pay preferred stock obligations. "BB"
indicates the lowest degree of speculation and "CCC" the
highest degree of speculation. While such issues will likely
have some quality and protection characteristics, these are
outweighed by large uncertainties or major risk exposures to
adverse conditions.
CC The rating "CC" is reserved for a preferred stock issue in
arrears on dividends or sinking fund payments but that is
currently paying.
C A preferred stock rated "C" is a non-paying issue.
D A preferred stock rated "D" is a non-paying issue in default
on debt instruments.
</TABLE>
NR indicates that no rating has been requested, that there is insufficient
information on which to base a rating, or that S&P does not rate a particular
type of obligation as a matter of policy.
PLUS (+) or MINUS (-): To provide more detailed indications of preferred
stock quality, 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.
The preferred stock ratings are not a recommendation to purchase or sell a
security, inasmuch as market price is not considered in arriving at the rating.
Preferred stock ratings are wholly unrelated to Standard & Poor's earnings and
dividend rankings for common stocks.
The ratings are based on current information furnished to Standard & Poor's
by the issuer, and 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.
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 ratings
represent 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.
Annex A-6
<PAGE> 21
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 of 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 guaranties unless otherwise indicated.
Bonds carrying 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.
<TABLE>
<S> <C>
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 satisfactory
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.
</TABLE>
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.
<TABLE>
<S> <C>
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 12 months.
</TABLE>
Annex A-7
<PAGE> 22
Ratings Outlook: An outlook is used to describe the most likely direction
of any 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 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 same rating are of similar but not necessarily
identical credit quality since rating categories cannot fully reflect the
differences in degrees of credit risk.
<TABLE>
<S> <C>
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.
DD Such bonds are extremely speculative and should be valued on
D the 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.
</TABLE>
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 INVESTMENT GRADE SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally 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:
<TABLE>
<S> <C>
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+."
</TABLE>
Annex A-8
<PAGE> 23
<TABLE>
<S> <C>
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.
</TABLE>
Annex A-9
