As filed with the Securities and Exchange Commission
on May 9, 2000
Registration No. 811-09347
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM N-1A
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
Amendment No. 5 [X]
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NATIONS MASTER INVESTMENT TRUST
(Exact Name of Registrant as specified in Charter)
111 Center Street
Little Rock, Arkansas 72201
(Address of Principal Executive Offices, including Zip Code)
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Registrant's Telephone Number, including Area Code: (800) 643-9691
Richard H. Blank, Jr.
c/o Stephens Inc.
111 Center Street
Little Rock, Arkansas 72201
(Name and Address of Agent for Service)
With a copy to:
Robert M. Kurucza, Esq.
Marco E. Adelfio, Esq.
Morrison & Foerster LLP
2000 Pennsylvania Ave., N.W.
Washington, D.C. 20006
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EXPLANATORY NOTE
This Registration Statement has been filed by the Registrant
pursuant to Section 8(b) of the Investment Company Act of 1940, as amended in
order to file the updated Statement of Additional Information. However,
beneficial interests in the Registrant are not being registered under the
Securities Act of 1933, as amended (the "1933 Act"), since such interests will
be issued solely in private placement transactions which do not involve any
"public offering" within the meaning of Section 4(2) of the 1933 Act.
Investments in the Registrant may only be made by the investment companies or
certain other entities which are "accredited investors" within the meaning of
Regulation D under the 1933 Act. This Registration Statement does not constitute
an offer to sell, or the solicitation of an offer to buy, any beneficial
interests in the Registrant.
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NATIONS MASTER INVESTMENT TRUST
Part B
Nations Intermediate Bond Master Portfolio
Nations Blue Chip Master Portfolio
Nations International Equity Master Portfolio
Nations International Value Master Portfolio
Nations Marsico Growth & Income Master Portfolio
Nations Marsico Focused Equities Master Portfolio
Nations Marsico 21st Century Master Portfolio
Nations High Yield Bond Master Portfolio
ITEM 10. COVER PAGE AND TABLE OF CONTENTS.
This Part B is not a prospectus. It is intended to provide additional
information regarding the eight Master Portfolios of Nations Master Investment
Trust (the "Trust") and should be read in conjunction with the Trust's Part A
dated Marcy 30, 2000. All terms used in Part B that are defined in Part A will
have the same meanings assigned in Part A. Copies of Part A may be obtained
without charge by writing Nations Funds c/o the Distributor, Stephens Inc., One
Bank of America Plaza, 33rd Floor, Charlotte, North Carolina 28255, or by
calling Nations Funds at (800) 321-7854.
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TABLE OF CONTENTS
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TRUST HISTORY.....................................................................................................4
DESCRIPTION OF THE TRUST, MASTER PORTFOLIOS, INVESTMENT AND RISKS.................................................4
INVESTMENT LIMITATIONS............................................................................................4
FUNDAMENTAL INVESTMENT LIMITATIONS................................................................................4
NON-FUNDAMENTAL INVESTMENT LIMITATIONS............................................................................5
INVESTMENT RISKS..................................................................................................7
ADDITIONAL INFORMATION ON MASTER PORTFOLIO INVESTMENTS............................................................9
PERMISSIBLE FUND INVESTMENTS..................................................................................10
ASSET-BACKED SECURITIES.......................................................................................11
BANK INSTRUMENTS..............................................................................................14
BORROWINGS....................................................................................................14
COMMERCIAL INSTRUMENTS........................................................................................14
CONVERTIBLE SECURITIES........................................................................................15
CORPORATE DEBT SECURITIES.....................................................................................16
CUSTODIAL RECEIPTS............................................................................................16
CURRENCY SWAPS................................................................................................17
DELAYED DELIVERY TRANSACTIONS.................................................................................17
DOLLAR ROLL TRANSACTIONS......................................................................................17
EQUITY SWAP CONTRACTS.........................................................................................17
FOREIGN CURRENCY TRANSACTIONS.................................................................................18
FUTURES, OPTIONS AND OTHER DERIVATIVE INSTRUMENTS.............................................................20
RISK FACTORS ASSOCIATED WITH FUTURES AND OPTIONS TRANSACTIONS.................................................26
GUARANTEED INVESTMENT CONTRACTS...............................................................................28
INSURED MUNICIPAL SECURITIES..................................................................................28
INTEREST RATE TRANSACTIONS....................................................................................28
LOWER RATED (OR HIGH YIELD) DEBT SECURITIES...................................................................29
MUNICIPAL SECURITIES..........................................................................................30
OPTIONS ON CURRENCIES.........................................................................................33
OTHER INVESTMENT COMPANIES....................................................................................33
REAL ESTATE INVESTMENT TRUSTS.................................................................................33
REPURCHASE AGREEMENTS.........................................................................................33
RESTRICTED SECURITIES.........................................................................................34
REVERSE REPURCHASE AGREEMENTS.................................................................................34
SECURITIES LENDING............................................................................................34
SHORT SALES...................................................................................................35
SPECIAL SITUATIONS............................................................................................35
STAND-BY COMMITMENTS..........................................................................................35
STRIPPED SECURITIES...........................................................................................36
TAX-EXEMPT INSTRUMENTS........................................................................................37
U.S. AND FOREIGN BANK OBLIGATIONS.............................................................................37
U.S. GOVERNMENT OBLIGATIONS...................................................................................38
USE OF SEGREGATED AND OTHER SPECIAL ACCOUNTS..................................................................38
VARIABLE AMOUNT MASTER DEMAND NOTES...........................................................................39
VARIABLE- AND FLOATING-RATE INSTRUMENTS.......................................................................39
WARRANTS......................................................................................................40
WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS.................................................................40
PORTFOLIO TURNOVER............................................................................................40
MANAGEMENT OF THE TRUST..........................................................................................41
NATIONS FUNDS RETIREMENT PLAN.................................................................................46
NATIONS FUNDS DEFERRED COMPENSATION PLAN......................................................................46
COMPENSATION TABLE...............................................................................................47
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES..............................................................48
INVESTMENT ADVISORY AND OTHER SERVICES...........................................................................48
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BROKERAGE ALLOCATION AND OTHER PRACTICES.........................................................................50
SECTION 28(E) STANDARDS.......................................................................................52
CAPITAL STOCK AND OTHER SECURITIES...............................................................................53
DESCRIPTION OF SHARES............................................................................................53
PURCHASE, REDEMPTION, AND PRICING OF SHARES......................................................................54
DETERMINATION OF NET ASSET VALUE.................................................................................55
TAXATION.........................................................................................................56
UNDERWRITERS.....................................................................................................56
CALCULATION OF PERFORMANCE DATA..................................................................................56
FINANCIAL STATEMENTS.............................................................................................56
SCHEDULE A - DESCRIPTION OF RATINGS.............................................................................A-1
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ITEM 11. TRUST HISTORY
The Trust is registered as an open-end management investment company
under the Investment Company Act of 1940, as amended (the "1940 Act"). The Trust
was organized as a Delaware business trust. The Trust's Declaration of Trust
authorizes the Board of Trustees to issue an unlimited number of beneficial
interests ("Beneficial Interests") and to establish and designate such
Beneficial Interests into one or more master portfolios. Beneficial Interests
may be purchased only by institutional investors which are "accredited
investors" within the meaning of Regulation D under the Securities Act of 1933,
as amended (the "1933 Act"), and may not be purchased by individuals, S
corporations, partnerships or grantor trusts. The number of investors for each
master portfolio may not exceed 100.
The Trust is a member of the Nations Funds family (`Nations Funds"), a
fund complex consisting of the Trust, Nations Fund, Inc., Nations Fund Trust,
Nations Annuity Trust, Nations Reserves and Nations LifeGoal Funds, Inc. Nations
Funds currently have more than 70 distinct investment portfolios and total
assets in excess of $70 billion.
ITEM 12. DESCRIPTION OF THE TRUST, MASTER PORTFOLIOS, INVESTMENTS AND RISKS
The Trust is currently comprised of eight separate series of master
portfolios (each a "Master Portfolio" and collectively the "Master Portfolios"):
Nations Intermediate Bond Master Portfolio, Nations Blue Chip Master Portfolio,
Nations International Equity Master Portfolio, Nations International Value
Master Portfolio, Nations Marsico Focused Equities Master Portfolio, Nations
Marsico Growth & Income Master Portfolio, Nations Marsico 21st Century Master
Portfolio and Nations High Yield Bond Master Portfolio. Each Master Portfolio
(except for Nations Marsico Focused Equities Master Portfolio) is "diversified"
as defined in the 1940 Act.
Each Master Portfolio is a separate series of the Trust. An investor
does not purchase an interest in the Master Portfolio, but instead, purchases
shares in a corresponding "feeder" fund which invests all of its assets in a
Master Portfolio series. The feeder funds related to each respective Master
Portfolio are Nations Intermediate Bond Fund, Nations Blue Chip Fund, Nations
International Equity Fund, Nations International Value Fund, Nations Marsico
Focused Equities Fund, Nations Marsico Growth & Income Fund, Nations Marsico
21st Century Fund and Nations High Yield Bond Fund (each, a "Fund", and
collectively, the "Funds"), which in turn invest all of their assets in,
respectively, the Nations Intermediate Bond Master Portfolio, Nations Blue Chip
Master Portfolio, Nations International Equity Master Portfolio, Nations
International Value Master Portfolio, Nations Marsico Focused Equities Master
Portfolio, Nations Marsico Growth & Income Master Portfolio, Nations Marsico
21st Century Master Portfolio and Nations High Yield Bond Master Portfolio. Each
corresponding Master Portfolio, which has the same investment objective,
policies, and limitations as the Fund, invests in the actual securities.
Other investors may also be permitted to invest in a Master Portfolio.
All other investors will invest in a Master Portfolio on the same terms and
conditions as a Fund, although there may be different administrative and other
expenses. Therefore, the Private Master Portfolio may have different returns
than other investors of the same Master Portfolio.
INVESTMENT LIMITATIONS
Information concerning each Master Portfolio's investment objective is
set forth in Part A. There can be no assurance that the Master Portfolios will
achieve their objectives. The principal features of the Master Portfolios'
investment programs and the primary risks associated with those investment
programs are discussed in Part A. The values of the securities in which the
Master Portfolios invest fluctuate based upon interest rates, foreign currency
rates, the financial stability of the issuer and market factors.
FUNDAMENTAL INVESTMENT LIMITATIONS:
As a matter of fundamental policy which may not be changed without a
majority vote of a Master Portfolio's Beneficial Interest holders, each Master
Portfolio will not:
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1. Underwrite any issue of securities within the meaning of the 1933
Act except when it might technically be deemed to be an underwriter either (a)
in connection with the disposition of a portfolio security, or (b) in connection
with the purchase of securities directly from the issuer thereof in accordance
with its investment objective.
2. Purchase or sell real estate, except a Master Portfolio may purchase
securities of issuers which deal or invest in real estate and may purchase
securities which are secured by real estate or interests in real estate.
3. Purchase or sell commodities, except that a Master Portfolio may to
the extent consistent with its investment objective, invest in securities of
companies that purchase or sell commodities or which invest in such programs,
and purchase and sell options, forward contracts, futures contracts, and options
on futures contracts. This limitation does not apply to foreign currency
transactions including without limitation forward currency contracts.
4. Purchase any securities which would cause 25% or more of the value
of its total assets at the time of purchase to be invested in the securities of
one or more issuers conducting their principal business activities in the same
industry, provided that: (a) there is no limitation with respect to obligations
issued or guaranteed by the U.S. government, any state or territory of the
United States, or any of their agencies, instrumentalities or political
subdivisions, and (b) notwithstanding this limitation or any other fundamental
investment limitation, assets may be invested in the securities of one or more
management investment companies to the extent permitted by the 1940 Act, the
rules and regulations thereunder and any exemptive relief obtained by the Funds.
5. Make loans, except to the extent permitted by the 1940 Act, the
rules and regulations thereunder and any exemptive relief obtained by the Funds.
6. Borrow money, issue senior securities or mortgage, pledge or
hypothecate its assets except to the extent permitted under the 1940 Act, the
rules and regulations thereunder and any exemptive relief obtained by the Funds.
7. Purchase securities (except securities issued or guaranteed by the
U.S. Government, its agencies or instrumentalities) of any one issuer if, as a
result, more than 5% of its total assets will be invested in the securities of
such issuer or it would own more than 10% of the voting securities of such
issuer, except that (a) up to 25% of its total assets may be invested without
regard to these limitations and (b) a Fund's assets may be invested in the
securities of one or more diversified management investment companies to the
extent permitted by the 1940 Act, the rules and regulations thereunder and any
exemptive relief obtained by the Funds.
NON-FUNDAMENTAL INVESTMENT LIMITATIONS:
Nations Intermediate Bond Master Portfolio and Nations Blue Chip Master
Portfolio may not:
1. Sell securities short, maintain a short position, or purchase
securities on margin, except for such short-term credits as are necessary for
the clearance of transactions. For this purpose, a deposit or payment by a Fund
for initial or maintenance margin in connection with future contracts is not
considered to be the purchase or sale of a security on margin.
2. Purchase securities of other investment companies except as
permitted by the 1940 Act.
3. Write or sell puts, calls, straddles, spreads or combinations
thereof except that a Fund may acquire standby commitments and may enter into
futures contracts and options in accordance with their investment objectives.
Pursuant to a fundamental investment restriction , the Master
Portfolios do not have authority to purchase any securities which would cause
more than 25% of the value of any Master Portfolio's total assets at the time of
such purchase to be invested in the securities of one or more issuers conducting
their principal business activities in the same industry, provided that, there
is no limitation with respect to investments in obligations issued or guaranteed
by the U.S. Government, its agencies or instrumentalities.
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Nations High Yield Bond Master Portfolio and Nations Marsico 21st Century Master
Portfolio may:
1. Invest in shares of other open-end management investment companies,
subject to the limitations of the 1940 Act, the rules thereunder, and any orders
obtained thereunder now or in the future.
2. Not invest or hold more than 15% of the Master Portfolio's net
assets in illiquid securities. For this purpose, illiquid securities include,
among others, (a) securities that are illiquid by virtue of the absence of a
readily available market or legal or contractual restrictions on resale, (b)
fixed time deposits that are subject to withdrawal penalties and that have
maturities of more than seven days, and (c) repurchase agreements not terminable
within seven days.
3. Invest in futures or options contracts regulated by the CFTC for (i)
bona fide hedging purposes within the meaning of the rules of the CFTC and (ii)
for other purposes if, as a result, no more than 5% of a Master Portfolio's net
assets would be invested in initial margin and premiums (excluding amounts
"in-the-money") required to establish the contracts.
A Master Portfolio (i) will not hedge more than 50% of its total assets by
selling futures contracts, buying put options, and writing call options (so
called "short positions"), (ii) will not buy futures contracts or write put
options whose underlying value exceeds 25% of the Master Portfolio's total
assets, and (iii) will not buy call options with a value exceeding 5% of the
Master Portfolio's total assets.
4. Lend securities from its portfolio to brokers, dealers and financial
institutions, in amounts not to exceed (in the aggregate) one-third of the
Master Portfolio's total assets. Any such loans of portfolio securities will be
fully collateralized based on values that are marked to market daily.
5. Not make investments for the purpose of exercising control of
management. (Investments by the Master Portfolio in entities created under the
laws of foreign countries solely to facilitate investment in securities in that
country will not be deemed the making of investments for the purpose of
exercising control.)
6. Not sell securities short, unless it owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short (short
sales "against the box"), and provided that transactions in futures contracts
and options are not deemed to constitute selling securities short.
Each of the Nations Marsico Focused Equities Master Portfolio, Nations Marsico
Growth & Income Master Portfolio, International Equity Master Portfolio,
International Value Master Portfolio and Emerging Markets Master Portfolio may:
1. Not invest in shares of other open-end management investment
companies, subject to the limitations of the 1940 Act, the rules thereunder, and
any orders obtained thereunder now or in the future.
2. Invest or hold more than 15% of the Master Portfolio's net assets in
illiquid securities. For this purpose, illiquid securities include, among
others, (a) securities that are illiquid by virtue of the absence of a readily
available market or legal or contractual restrictions on resale, (b) fixed time
deposits that are subject to withdrawal penalties and that have maturities of
more than seven days, and (c) repurchase agreements not terminable within seven
days.
3. Not hedge more than 50% of its total assets by selling futures
contracts, buying put options, and writing call options (so called "short
positions"), not buy futures contracts or write put options whose underlying
value exceeds 25% of the Fund's total assets, and not buy call options with a
value exceeding 5% of the Master Portfolio's total assets.
4. Lend securities from its portfolio to brokers, dealers and financial
institutions, in amounts not to exceed (in the aggregate) one-third of the
Master Portfolio's total assets. Any such loans of portfolio securities will be
fully collateralized based on values that are marked to market daily. The Master
Portfolio will not enter into any portfolio security lending arrangement having
a duration of longer than one year.
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5. Not make investments for the purpose of exercising control or
management. (Investments by the Master Portfolio in entities created under the
laws of foreign countries solely to facilitate investment in securities in that
country will not be deemed the making of investments for the purpose of
exercising control.)
6. Not purchase securities on margin (except for short-term credits
necessary for the clearance of transactions).
7. Not sell securities short, unless it owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short (short
sales "against the box"), and provided that transactions in futures contracts
and options are not deemed to constitute selling securities short.
8. Not purchase interests, leases, or limited partnership interests in
oil, gas, or other mineral exploration or development programs.
INVESTMENT RISKS
In addition to the investment risks and considerations identified in
certain of the securities descriptions below, there are additional investment
risks and considerations associated with an investment in certain of the Funds.
Investments by a Master Portfolio in common stocks and other equity
securities are subject to stock market risks. The value of the stocks that the
Master Portfolio holds, like the broader stock market, may decline over short or
even extended periods. The U.S. stock market tends to be cyclical, with periods
when stock prices generally rise and periods when prices generally decline. As
of the date of this SAI, the stock market, as measured by the S&P 500 Index and
other commonly used indexes, was trading at or close to record levels. There can
be no guarantee that these levels will continue.
Nations Marsico Focused Equities Master Portfolio is a non-diversified
portfolio, which means that it typically invests in fewer issuers than
diversified portfolios. Therefore, appreciation or depreciation of an investment
in a single issuer could have a greater impact on this Master Portfolio's net
asset value. Nations Marsico Focused Equities Master Portfolio reserves the
right to become a diversified portfolio by limiting the investments in which
more than 5% of its total assets are invested.
The value of a Master Portfolio's investments in debt securities,
including U.S. Government Obligations, will tend to decrease when interest rates
rise and increase when interest rates fall. In general, longer-term debt
instruments tend to fluctuate in value more than shorter-term debt instruments
in response to interest rate movements. In addition, debt securities that are
not backed by the United States Government are subject to credit risk, which is
the risk that the issuer may not be able to pay principal and/or interest when
due. In addition, obligations with the lowest investment grade rating (E.G.,
"BBB" by Standard & Poor's Corporation ("S&P") or "Baa" by Moody's Investors
Service, Inc. ("Moody's")) have speculative characteristics and changes in
economic conditions or other circumstances are more likely to lead to a weakened
capacity to make principal and interest payments than is the case with higher
grade debt obligations. Subsequent to its purchase by the Master Portfolio, an
issue of securities may cease to be rated or its rating may be reduced below the
minimum rating required for purchase by the Master Portfolio. The Adviser will
consider such an event in determining whether the Master Portfolio should
continue to hold the obligation. Unrated obligations may be acquired by the
Master Portfolio if they are determined by the Adviser to be of comparable
quality at the time of purchase to rated obligations that may be acquired.
Certain of the Master Portfolios' investments constitute derivative
securities, which are securities whose value is derived, at least in part, from
an underlying index or reference rate. There are certain types of derivative
securities that can, under certain circumstances, significantly increase a
purchaser's exposure to market or other risks. The Adviser, however, only
purchases derivative securities in circumstances where it believes such
purchases are consistent with such Master Portfolio's investment objective and
do not unduly increase the Master Portfolio's exposure to market or other risks.
For additional risk information regarding the Master Portfolios' investments in
particular instruments.
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Certain of the Master Portfolios may invest in securities of smaller
and newer issuers. Investments in such companies may present greater
opportunities for capital appreciation because of high potential earnings
growth, but also present greater risks than investments in more established
companies with longer operating histories and greater financial capacity.
Master Feeder Structure. The Funds are open-end mutual funds that seek
to achieve their investment objectives by investing all of its investable assets
in corresponding Master Portfolios which have the same investment objectives.
The Funds may withdraw their investment in the Master Portfolios at any time if
the Board of Directors of appropriate Company determines that it is in the best
interest of such Fund to do so. Upon such withdrawal, the Board of Directors
would consider what action might be taken, including the investment of all of
the assets of the Fund in another pooled investment entity having the same
investment objective as the Fund or the hiring of an investment adviser to
manage the Fund's assets in accordance with its investment policies.
The Master Portfolios are separate series of Nations Master Investment
Trust (the "Master Trust"), which is organized as a business trust under the
laws of Delaware. The Fund and other entities that may invest in the Master
Portfolios from time to time (E.G., other investment companies and commingled
trust funds) will each be liable for all obligations of the Master Portfolios.
However, the risk of the Fund's incurring financial loss on account of such
liability is limited to circumstances in which both inadequate insurance exists
and a Portfolio itself is unable to meet its obligations. Accordingly, the
Companies' Boards of Directors believe that neither a Fund nor its shareholders
will be adversely affected by reason of a Fund's investing in a Master
Portfolio. As with any mutual fund, other investors in the Master Portfolios
could control the results of voting at the Master Portfolio level in certain
instances (E.G., a change in fundamental policies by the Master Portfolio which
was not approved by the Fund's shareholders). This could result in a Fund's
withdrawal of its investment in the Master Portfolio. Further, the withdrawal of
other entities that may from time to time invest in the Master Portfolios could
have an adverse effect on the performance of such Master Portfolios and the
corresponding Fund, such as decreased economies of scale, and increased per
share operating expenses. In addition, the total withdrawal by another
investment company as an investor in a Master Portfolio will cause the such
Master Portfolio to terminate automatically in 120 days unless a Fund and any
other investors in the Master Portfolio unanimously agree to continue the
business of the Master Portfolio. If unanimous agreement is not reached to
continue the Master Portfolio, the Board of Directors of a Company would need to
consider alternative arrangements for the Fund, such as those described above.
When the Fund is required to vote as an interestholder of the Master Portfolio,
current regulations provide that in those circumstances the Fund may either seek
instructions from its security holders with regard to voting such proxies and
vote such proxies in accordance with such instructions or the Fund may vote its
shares in the Master Portfolio in the same proportion of all other security
holders in the Master Portfolio.
There may also be other investment companies through which you can
invest in the Master Portfolio which may have higher or lower fees and expenses
than those of its corresponding Fund and which may therefore have different
performance results than the Fund.
SPECIAL RISK RELATING TO THE HIGH YIELD BOND MASTER PORTFOLIO. High
yield bonds may be more susceptible to real or perceived adverse economic and
competitive industry conditions than higher grade bonds. The prices of high
yield bonds have been found to be less sensitive to interest-rate changes than
more highly rated investments, but more sensitive to adverse economic downturns
or individual corporate developments. A projection of an economic downturn or of
a period of rising interest rates, for example, could cause a decline in high
yield bond prices because the advent of a recession could lessen the ability of
a highly leveraged company to make principal and interest payments on its debt
securities. Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of high yield bonds,
especially in a thinly traded market. Legislation designed to limit the use of
high yield bonds in corporate transactions may have a material adverse effect on
the Master Portfolio's net asset value and investment practices. In addition,
there may be special tax considerations associated with investing in high yield
bonds structured as zero coupon or payment-in-kind securities. The Master
Portfolio records the interest on these securities annually as income even
though it receives no cash interest until the security's maturity or payment
date. Also, distributions on account of such interest generally will be taxable
to shareholders even if the Master Portfolio does not distribute cash to them.
Therefore, in order to pay taxes on this interest, shareholders may have to
redeem some of their shares to pay the tax or the Master Portfolio may have to
sell some of its assets to reduce the Master Portfolio's assets and may thereby
increase its expense ratio and decrease its
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rate of return. The Sub-Adviser seeks to reduce risk through diversification,
credit analysis and attention to current developments and trends in both the
economy and financial markets. In addition, investments in foreign securities
may serve to provide further diversification.
Because certain high yield debt instruments that the High Yield Bond
Master Portfolio purchases may be instruments issued by foreign governments,
agencies, corporations or other entities of countries, some of which may be
considered emerging markets countries, there are certain additional risks
associated with such investments.
Investors should also understand and consider carefully the special
risks involved in foreign investing. Such risks include, but are not limited to:
(1) restrictions on foreign investment and repatriation of capital; (2)
fluctuations in currency exchange rates, which can significantly affect a Master
Portfolio's share price; (3) costs of converting foreign currency into U.S.
dollars and U.S. dollars into foreign currencies; (4) greater price volatility
and less liquidity; (5) settlement practices, including delays, which may differ
from those customary in U.S. markets; (6) exposure to political and economic
risks, including the risk of nationalization, expropriation of assets and war;
(7) possible impositions of foreign taxes and exchange control and currency
restrictions; (8) lack of uniform accounting, auditing and financial reporting
standards; (9) less governmental supervision of securities markets, brokers and
issuers of securities; (10) less financial information available to investors;
and (11) difficulty in enforcing legal rights outside the United States.
Certain of the risks associated with investments by the High Yield Bond
Master Portfolio in foreign securities are heightened with respect to investment
in emerging markets countries. Political and economic structures in many
emerging market countries, especially those in Eastern Europe, the Pacific
Basin, and the Far East, may be undergoing significant evolution and rapid
development, and may lack the social, political and economic stability
characteristic of more developed countries. Investing in emerging markets
securities also involves risks which are in addition to the usual risks inherent
in foreign investments. For example, some emerging market countries may have
fixed or managed currencies that are not free-floating against the U.S. dollar.
Further, certain currencies may not be traded internationally and some countries
with emerging securities markets have sustained long periods of substantially
high inflation or rapid fluctuation in inflation rates which can have negative
effects on a country's economy or securities markets.
SPECIAL RISK RELATING TO THE INTERNATIONAL EQUITY MASTER PORTFOLIO AND
THE INTERNATIONAL VALUE MASTER PORTFOLIO. Investors should also understand and
consider carefully the special risks involved in foreign investing. Such risks
include, but are not limited to: (1) restrictions on foreign investment and
repatriation of capital; (2) fluctuations in currency exchange rates, which can
significantly affect a Master Portfolio's share price; (3) costs of converting
foreign currency into U.S. dollars and U.S. dollars into foreign currencies; (4)
greater price volatility and less liquidity; (5) settlement practices, including
delays, which may differ from those customary in U.S. markets; (6) exposure to
political and economic risks, including the risk of nationalization,
expropriation of assets and war; (7) possible impositions of foreign taxes and
exchange control and currency restrictions; (8) lack of uniform accounting,
auditing and financial reporting standards; (9) less governmental supervision of
securities markets, brokers and issuers of securities; (10) less financial
information available to investors; and (11) difficulty in enforcing legal
rights outside the United States.
Certain of the risks associated with investments by the Master
Portfolios in foreign securities are heightened with respect to investment in
emerging markets countries. Political and economic structures in many emerging
market countries, especially those in Eastern Europe, the Pacific Basin, and the
Far East, may be undergoing significant evolution and rapid development, and may
lack the social, political and economic stability characteristic of more
developed countries. Investing in emerging markets securities also involves
risks which are in addition to the usual risks inherent in foreign investments.
For example, some emerging market countries may have fixed or managed currencies
that are not free-floating against the U.S. dollar. Further, certain currencies
may not be traded internationally and some countries with emerging securities
markets have sustained long periods of substantially high inflation or rapid
fluctuation in inflation rates which can have negative effects on a country's
economy or securities markets.
ADDITIONAL INFORMATION ON MASTER PORTFOLIO INVESTMENTS
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PERMISSIBLE FUND INVESTMENTS
In addition to the principal investment strategies for each Master
Portfolio, which are outlined in Part A, each Fund also may invest in other
types of securities in percentages of less than 10% of its total assets (unless
otherwise indicated, E.G., most Funds may invest in money market instruments
without limit during temporary defensive periods). These types of securities are
listed below for each portfolio and then are described in more detail after this
sub-section.
Nations Marsico Focused Equities Master Portfolio, Nations Marsico Growth &
Income Master Portfolio and Nations Marsico 21st Century Master Portfolio: In
addition to the types of securities described in Part A, the Master Portfolios
may invest in: preferred stock, warrants, convertible securities and debt
securities; zero coupon, pay-in-kind and step coupon securities, and may invest
without limit in indexed/structured securities. The Master Portfolios also may
invest its assets in high-yield/high-risk securities, such as lower grade debt
securities, high-grade commercial paper, certificates of deposit, and repurchase
agreements, and may invest in short-term debt securities as a means of receiving
a return on idle cash.
The Master Portfolios may hold cash or cash equivalents and invest
without limit in U.S. Government Obligations and short-term debt securities or
money market instruments when the Adviser: (i) believes that the market
conditions are not favorable for profitable investing, (ii) is unable to locate
favorable investment opportunities, or (iii) determines that a temporary
defensive position is advisable or necessary to meet anticipated redemption
request. In other words, the Master Portfolios do not always stay fully invested
in stocks and bonds. The Master Portfolios also may use options, futures,
forward currency contracts and other types of derivatives for hedging purposes
or for non-hedging purposes such as seeking to enhance return. The Master
Portfolios also may purchase securities on a when-issued, delayed delivery or
forward commitment basis.
In addition, each Nations Marsico Master Portfolio also may invest in
certain specified derivative securities including: exchange-traded options;
over-the-counter options executed with primary dealers, including long calls and
puts and covered calls to enhance return; and U.S. and foreign exchange-traded
financial futures approved by the Commodity Futures Trading Commission ("CFTC")
and options thereon for market exposure risk management. Each Nations Marsico
Master Portfolio may lend its portfolio securities to qualified institutional
investors and may invest in repurchase agreements, restricted, private placement
and other illiquid securities and forward foreign exchange contracts. Each
Nations Marsico Master Portfolio also may invest in real estate investment trust
securities. In addition, each Nations Marsico Master Portfolio may invest in
securities issued by other investment companies, consistent with the each
Nations Marsico Master Portfolio's investment objective and policies and
repurchase agreements.
Nations Blue Chip Master Portfolio: In addition to the types of securities
described in Part A, Nations Blue Chip Master Portfolio may invest in cash
equivalents, which include the following short-term interest rate bearing
instruments--obligations issued or guaranteed by the U.S. Government, its
agencies and instrumentalities (some of which may be subject to repurchase
agreements), certificates of deposit, bankers' acceptances, time deposits and
other interest-bearing deposits issued by domestic and foreign banks and foreign
branches of U.S. banks, foreign government securities and commercial papers
issued by U.S. and foreign issuers which is rated at the time of purchase at
least Prime-2 by Moody's or A-2 by S&P, Duff & Phelps and Fitch IBCA. For a
description of ratings, see Appendix A to this SAI. The Master Portfolio also
may invest in certain specified derivative securities including: exchange-traded
options, over-the-counter options executed with primary dealers, including long
calls and puts and covered calls to enhance return; and CFTC-approved U.S. and
foreign exchange-traded financial futures and options thereon for market
exposure risk-management. The Master Portfolio also may lend its portfolios
securities to qualified institutional investors and may invest in repurchase
agreements, restricted, private placement and other illiquid securities. It also
may invest in real estate investment trust securities, securities issued by
other investment companies, consistent with the Master Portfolio's investment
objective and policies.
Nations International Equity Master Portfolio: In addition to the types of
securities described in Part A, the Master Portfolio may invest in: real estate
investment trust securities and, for temporary defensive purposes, substantially
all of its assets in U.S. financial markets or U.S. dollar-denominated
instruments. The Master Portfolio also may invest
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in convertible securities, preferred stocks, bonds, notes and other fixed-income
securities, including Eurodollar and foreign government securities.
International Value Master Portfolio: In addition to the types of securities
described in Part A, the Master Portfolio may invest in: short-term debt
instruments; purchase and write covered call options on specific portfolio
securities and may purchase and write put and call options on foreign stock
indices listed on foreign and domestic exchanges options and futures contracts
on securities, securities lending, forward foreign exchange contracts and
repurchase agreements. The Master Portfolio also may invest in ADRs, GDRs, EDRs
and ADSs and invest in foreign currency exchange contracts to convert foreign
currencies to and from the U.S. dollar, and to hedge against changes in foreign
currency exchange rates.
General: Each of the Nations International Equity Master Portfolio and Nations
International Value Master Portfolio also may invest in certain specified
derivative securities including: exchange-traded options; over-the-counter
options executed with primary dealers, including long calls and puts and covered
calls to enhance return; and U.S. and foreign exchange-traded financial futures
approved by the CFTC and options thereon for market exposure risk management.
Each International Master Portfolio may lend its portfolio securities to
qualified institutional investors and may invest in repurchase agreements,
restricted, private placement and other illiquid securities. Each International
Master Portfolio also may invest in real estate investment trust securities. In
addition, each International Fund may invest in securities issued by other
investment companies, consistent with the Fund's investment objective and
policies and repurchase agreements. Each Fund also may invest in forward foreign
exchange contracts.
Intermediate Bond Master Portfolio: In addition to the types of securities
described in Part A, the Master Portfolio (in which the Fund invests all of its
assets) may invest in: municipal securities, cash equivalents, certain specified
derivative securities, including: interest rate swaps, caps and floors for
hedging purposes; exchange-traded options; over-the-counter options executed
with primary dealers, including long calls and puts and covered calls to enhance
return; and CFTC-approved U.S. and foreign exchange-traded financial futures and
options thereon for market exposure risk-management. The Master Portfolio may
lend its securities to qualified institutional investors and may invest in
repurchase agreements, restricted, private placement and other illiquid
securities. The Master Portfolio may engage in reverse repurchase agreements and
dollar roll transactions. Additionally, the Master Portfolio may purchase
securities issued by other investment companies, consistent with its investment
objective and policies. The Master Portfolio also may invest in instruments
issued by trusts or certain partnerships including pass-through certificates
representing participations in, or debt investments backed by, the securities
and other assets owned by such trusts and partnerships.
High Yield Bond Master Portfolio: In addition to the types of securities
described in its Prospectuses, the Master Portfolio (in which the Fund invests
all of its assets) may invest in: debt securities, which include all types of
debt obligations of both domestic and foreign issuers, such as bonds,
debentures, notes, equipment lease certificates, equipment trust certificates,
conditional sales contracts, commercial paper and U.S. government securities
(including obligations, such as repurchase agreements, secured by such
instruments). The debt securities in which the Master Portfolio invests may be
in non-dollar denominated foreign currency and may include debt issued by
countries or corporations located in emerging market countries. The Master
Portfolio may invest in participation interests in loans. Such participation
interests, which may take the form of interests in, or assignments of, loans,
are acquired from banks which have made loans or are members of lending
syndicates. The Master Portfolio's investments in loan participation interests
will be subject to its limitation on investments in illiquid securities and, to
the extent applicable, its limitation on investments in securities rated below
investment grade.
Additional information on the particular types of securities in which
certain Funds may invest in is set forth below.
ASSET-BACKED SECURITIES
IN GENERAL. Asset-backed securities arise through the grouping by governmental,
government-related, and private organizations of loans, receivables, or other
assets originated by various lenders. Asset-backed securities consist of both
mortgage- and non-mortgage-backed securities. Interests in pools of these assets
may differ from other forms of debt securities, which normally provide for
periodic payment of interest in fixed amounts with principal paid at
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maturity or specified call dates. Conversely, asset-backed securities provide
periodic payments which may consist of both interest and principal payments.
The life of an asset-backed security varies depending upon rate of the
prepayment of the underlying debt instruments. The rate of such prepayments will
be a function of current market interest rates, and other economic and
demographic factors. For example, falling interest rates generally result in an
increase in the rate of prepayments of mortgage loans while rising interest
rates generally decrease the rate of prepayments. An acceleration in prepayments
in response to sharply falling interest rates will shorten the security's
average maturity and limit the potential appreciation in the security's value
relative to a conventional debt security. Consequently, asset-backed securities
may not be as effective in locking in high, long-term yields. Conversely, in
periods of sharply rising rates, prepayments are generally slow, increasing the
security's average life and its potential for price depreciation.
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities represent an ownership
interest in a pool of mortgage loans.
Mortgage pass-through securities may represent participation interests
in pools of residential mortgage loans originated by U.S. governmental or
private lenders and guaranteed, to the extent provided in such securities, by
the U.S. Government or one of its agencies, authorities or instrumentalities.
Such securities, which are ownership interests in the underlying mortgage loans,
differ from conventional debt securities, which provide for periodic payment of
interest in fixed amounts (usually semi-annually) and principal payments at
maturity or on specified call dates. Mortgage pass-through securities provide
for monthly payments that are a "pass-through" of the monthly interest and
principal payments (including any prepayments) made by the individual borrowers
on the pooled mortgage loans, net of any fees paid to the guarantor of such
securities and the servicer of the underlying mortgage loans.
The guaranteed mortgage pass-through securities in which a Master
Portfolio may invest may include those issued or guaranteed by GNMA, FNMA, or
"Freddie Mac" (see Schedule C). Such Certificates are mortgage-backed securities
which represent a partial ownership interest in a pool of mortgage loans issued
by lenders such as mortgage bankers, commercial banks and savings and loan
associations. Such mortgage loans may have fixed or adjustable rates of
interest.
The average life of a mortgage-backed security is likely to be
substantially less than the original maturity of the mortgage pools underlying
the securities. Prepayments of principal by mortgagors and mortgage foreclosures
will usually result in the return of the greater part of principal invested far
in advance of the maturity of the mortgages in the pool.
The yield which will be earned on mortgage-backed securities may vary
from their coupon rates for the following reasons: (i) Certificates may be
issued at a premium or discount, rather than at par; (ii) Certificates may trade
in the secondary market at a premium or discount after issuance; (iii) interest
is earned and compounded monthly, which has the effect of raising the effective
yield earned on the Certificates; and (iv) the actual yield of each Certificate
is affected by the prepayment of mortgages included in the mortgage pool
underlying the Certificates and the rate at which principal so prepaid is
reinvested. In addition, prepayment of mortgages included in the mortgage pool
underlying a GNMA Certificate purchased at a premium may result in a loss to the
Master Portfolio.
Mortgage-backed securities issued by private issuers, whether or not
such obligations are subject to guarantees by the private issuer, may entail
greater risk than obligations directly or indirectly guaranteed by the U.S.
Government.
Collateralized mortgage obligations ("CMOs") are debt obligations
collateralized by mortgage loans or mortgage pass-through securities (collateral
collectively hereinafter referred to as "Mortgage Assets"). Multi-class
pass-through securities are interests in a trust composed of Mortgage Assets and
all references herein to CMOs will include multi-class pass-through securities.
Payments of principal of and interest on the Mortgage Assets, and any
reinvestment income thereon, provide the Master Portfolios to pay debt service
on the CMOs or make scheduled distribution on the multi-class pass-through
securities.
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Moreover, principal prepayments on the Mortgage Assets may cause the
CMOs to be retired substantially earlier than their stated maturities or final
distribution dates, resulting in a loss of all or part of the premium if any has
been paid. Interest is paid or accrues on all classes of the CMOs on a monthly,
quarterly or semiannual basis.
The principal and interest payments on the Mortgage Assets may be
allocated among the various classes of CMOs in several ways. Typically, payments
of principal, including any prepayments, on the underlying mortgages are applied
to the classes in the order of their respective stated maturities or final
distribution dates, so that no payment of principal is made on CMOs of a class
until all CMOs of other classes having earlier stated maturities or final
distribution dates have been paid in full.
Stripped mortgage-backed securities ("SMBS") are derivative multi-class
mortgage securities. A Master Portfolio will only invest in SMBS that are
obligations backed by the full faith and credit of the U.S. Government. SMBS are
usually structured with two classes that receive different proportions of the
interest and principal distributions from a pool of mortgage assets. A Master
Portfolio will only invest in SMBS whose mortgage assets are U.S. Government
obligations.
A common type of SMBS will be structured so that one class receives
some of the interest and most of the principal from the mortgage assets, while
the other class receives most of the interest and the remainder of the
principal. If the underlying mortgage assets experience greater than anticipated
prepayments of principal, a Master Portfolio may fail to fully recoup its
initial investment in these securities. The market value of any class which
consists primarily or entirely of principal payments generally is unusually
volatile in response to changes in interest rates.
The average life of mortgage-backed securities varies with the
maturities of the underlying mortgage instruments. The average life is likely to
be substantially less than the original maturity of the mortgage pools
underlying the securities as the result of mortgage prepayments, mortgage
refinancings, or foreclosures. The rate of mortgage prepayments, and hence the
average life of the certificates, will be a function of the level of interest
rates, general economic conditions, the location and age of the mortgage and
other social and demographic conditions. Such prepayments are passed through to
the registered holder with the regular monthly payments of principal and
interest and have the effect of reducing future payments. Estimated average life
will be determined by the investment adviser and used for the purpose of
determining the average weighted maturity and duration of the Master Portfolios.
NON-MORTGAGE ASSET-BACKED SECURITIES. Non-mortgage asset-backed securities
include interests in pools of receivables, such as motor vehicle installment
purchase obligations and credit card receivables. Such securities are generally
issued as pass-through certificates, which represent undivided fractional
ownership interests in the underlying pools of assets. Such securities also may
be debt instruments, which are also known as collateralized obligations and are
generally issued as the debt of a special purpose entity organized solely for
the purpose of owning such assets and issuing such debt. Such securities also
may include instruments issued by certain trusts, partnerships or other special
purpose issuers, including pass-through certificates representing participations
in, or debt instruments backed by, the securities and other assets owned by such
issuers.
Non-mortgage-backed securities are not issued or guaranteed by the U.S.
Government or its agencies or instrumentalities; however, the payment of
principal and interest on such obligations may be guaranteed up to certain
amounts and for a certain time period by a letter of credit issued by a
financial institution (such as a bank or insurance company) unaffiliated with
the issuers of such securities.
The purchase of non-mortgage-backed securities raises considerations
peculiar to the financing of the instruments underlying such securities. For
example, most organizations that issue asset-backed securities relating to motor
vehicle installment purchase obligations perfect their interests in their
respective obligations only by filing a financing statement and by having the
servicer of the obligations, which is usually the originator, take custody
thereof. In such circumstances, if the servicer were to sell the same
obligations to another party, in violation of its duty not to do so, there is a
risk that such party could acquire an interest in the obligations superior to
that of the holders of the asset-backed securities. Also, although most such
obligations grant a security interest in the motor vehicle being financed, in
most states the security interest in a motor vehicle must be noted on the
certificate of title
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to perfect such security interest against competing claims of other parties. Due
to the larger number of vehicles involved, however, the certificate of title to
each vehicle financed, pursuant to the obligations underlying the asset-backed
securities, usually is not amended to reflect the assignment of the seller's
security interest for the benefit of the holders of the asset-backed securities.
Therefore, there is the possibility that recoveries on repossessed collateral
may not, in some cases, be available to support payments on those securities. In
addition, various state and Federal laws give the motor vehicle owner the right
to assert against the holder of the owner's obligation certain defenses such
owner would have against the seller of the motor vehicle. The assertion of such
defenses could reduce payments on the related asset-backed securities. Insofar
as credit card receivables are concerned, credit card holders are entitled to
the protection of a number of state and Federal consumer credit laws, many of
which give such holders the right to set off certain amounts against balances
owed on the credit card, thereby reducing the amounts paid on such receivables.
In addition, unlike most other asset-backed securities, credit card receivables
are unsecured obligations of the card holder.
While the market for asset-backed securities is becoming increasingly
liquid, the market for mortgage-backed securities issued by certain private
organizations and non-mortgage-backed securities is not as well developed. As
stated above, the Adviser intends to limit its purchases of mortgage-backed
securities issued by certain private organizations and non-mortgage-backed
securities to securities that are readily marketable at the time of purchase.
BANK INSTRUMENTS
Obligations of U.S. commercial banks include certificates of deposit,
time deposits and bankers' acceptances. Certificates of deposit are negotiable
interest-bearing instruments with a specific maturity. Certificates of deposit
are issued by banks and savings and loan institutions in exchange for the
deposit of funds and normally can be traded in the secondary market, prior to
maturity. Time deposits are non-negotiable receipts issued by a bank in exchange
for the deposit of funds. Time deposits earn a specified rate of interest over a
definite period of time; however, time deposits cannot be traded in the
secondary market. Bankers' acceptances are bills of exchange or time drafts
drawn on and accepted by a commercial bank. Bankers' acceptances are used by
corporations to finance the shipment and storage of goods and furnish dollar
exchanges. Maturities are generally six months or less.
BORROWINGS
The Trust participates in an uncommitted line of credit provided by The
Bank of New York ("BNY") under a line of credit agreement (the "Agreement").
Advances under the Agreement are taken primarily for temporary or emergency
purposes, including the meeting of redemption requests that otherwise might
require the untimely disposition of securities. Interest on borrowings is
payable at the federal funds rate plus .50% on an annualized basis. The
Agreement requires, among other things, that each participating Master Portfolio
maintain a ratio of no less than 4 to 1 net assets (not including funds borrowed
pursuant to the Agreement) to the aggregate amount of indebtedness pursuant to
the Agreement. Specific borrowings by a Master Portfolio under the Agreement for
each fiscal year, if any, will be described in the Master Portfolios' Annual
Report. The Master Portfolios may lend portfolio securities and participate in a
interfund lending program with other members of the Nations Funds Family after
obtaining permission from the Commission.
COMMERCIAL INSTRUMENTS
Commercial Instruments consist of short-term U.S. dollar-denominated
obligations issued by domestic corporations or issued in the U.S. by foreign
corporations and foreign commercial banks. Investments by a Master Portfolio in
commercial paper will consist of issues rated in a manner consistent with such
Master Portfolio's investment policies and objectives. In addition, the Master
Portfolios may acquire unrated commercial paper and corporate bonds that are
determined by the investment adviser at the time of purchase to be of comparable
quality to rated instruments that may be acquired by such Master Portfolios as
previously described.
Variable-rate master demand notes are unsecured instruments that permit
the indebtedness thereunder to vary and provide for periodic adjustments in the
interest rate. While some of these notes are not rated by credit rating
agencies, issuers of variable rate master demand notes must satisfy the
investment advisor that they are:
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(i) comparable in priority and security to a class of short-term instruments of
the same issuer that has such rating(s), or (ii) of comparable quality to such
instruments as determined by the Board of Trustees on the advice of the
investment adviser. Variable-rate instruments acquired by a Master Portfolio
will be rated at a level consistent with such Master Portfolio's investment
objective and policies of high quality as determined by a major rating agency
or, if not rated, will be of comparable quality as determined by the investment
adviser. See also the discussion of variable- and floating-rate instruments in
this Part B.
Variable- and floating-rate instruments are unsecured instruments that
permit the indebtedness thereunder to vary. While there may be no active
secondary market with respect to a particular variable or floating rate
instrument purchased by a Master Portfolio, a Master Portfolio may, from time to
time as specified in the instrument, demand payment of the principal or may
resell the instrument to a third party. The absence of an active secondary
market, however, could make it difficult for a Master Portfolio to dispose of an
instrument if the issuer defaulted on its payment obligation or during periods
when a Master Portfolio is not entitled to exercise its demand rights, and a
Master Portfolio could, for these or other reasons, suffer a loss. A Master
Portfolio may invest in variable and floating rate instruments only when the
investment adviser deems the investment to involve minimal credit risk. If such
instruments are not rated, the investment adviser will consider the earning
power, cash flows, and other liquidity ratios of the issuers of such instruments
and will continuously monitor their financial status to meet payment on demand.
In determining average weighted portfolio maturity, an instrument will be deemed
to have a maturity equal to the longer of the period remaining to the next
interest rate adjustment or the demand notice period specified in the
instrument.
Certain Master Portfolios also may purchase short-term participation
interests in loans extended by banks to companies, provided that both such banks
and such companies meet the quality standards set forth above. In purchasing a
loan participation or assignment, the Master Portfolio acquires some or all of
the interest of a bank or other lending institution in a loan to a corporate
borrower. Many such loans are secured and most impose restrictive covenants
which must be met by the borrower and which are generally more stringent than
the covenants available in publicly traded debt securities. However, interests
in some loans may not be secured, and the Master Portfolio will be exposed to a
risk of loss if the borrower defaults. Loan participations also may be purchased
by the Master Portfolio when the borrowing company is already in default. In
purchasing a loan participation, the Master Portfolio may have less protection
under the federal securities laws than it has in purchasing traditional types of
securities. The Master Portfolio's ability to assert its rights against the
borrower will also depend on the particular terms of the loan agreement among
the parties.
CONVERTIBLE SECURITIES
Certain Master Portfolios may invest in convertible securities, such as
bonds, notes, debentures, preferred stocks and other securities that may be
converted into common stock. All convertible securities purchased by the Master
Portfolio will be rated in the top two categories by an NRSRO or, if unrated,
determined by the investment adviser to be of comparable quality. Investments in
convertible securities can provide income through interest and dividend
payments, as well as, an opportunity for capital appreciation by virtue of their
conversion or exchange features.
The convertible securities in which a Master Portfolio may invest
include fixed-income and zero coupon debt securities, and preferred stock that
may be converted or exchanged at a stated or determinable exchange ratio into
underlying shares of common stock. The exchange ratio for any particular
convertible security may be adjusted from time to time due to stock splits,
dividends, spin-offs, other corporate distributions or scheduled changes in the
exchange ratio. Convertible debt securities and convertible preferred stocks,
until converted, have general characteristics similar to both debt and equity
securities. Although to a lesser extent than with debt securities, generally,
the market value of convertible securities tends to decline as interest rates
increase and, conversely, tends to increase as interest rates decline. In
addition, because of the conversion exchange feature, the market value of
convertible securities typically changes as the market value of the underlying
common stock changes, and, therefore, also tends to follow movements in the
general market for equity securities. A unique feature of convertible securities
is that as the market price of the underlying common stock declines, convertible
securities tend to trade increasingly on a yield basis, and so may not
experience market value declines to the same extent as the underlying common
stock. When the market price of the underlying common stock increases, the price
of a convertible security tends to
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rise as a reflection of the value of the underlying common stock, although
typically not as much as the price of the underlying common stock. While no
securities investments are without risk, investments in convertible securities
generally entail less risk than investments in common stock of the same issuer.
As debt securities, convertible securities are investments which
provide for a stream of income or, in the case of zero coupon securities,
accretion of income with generally higher yields than common stocks. Of course,
like all debt securities, there can be no assurance of income or principal
payments because the issuers of the convertible securities may default on their
obligations. Convertible securities generally offer lower yields than
non-convertible securities of similar quality because of their conversion
exchange features. Convertible securities generally are subordinated to other
similar debt securities but not to non-convertible securities of the same
issuer. Convertible bonds, as corporate debt obligations, are senior in right of
payment to all equity securities, and convertible preferred stock is senior to
common stock, of the same issuer. However, convertible bonds and convertible
preferred stock typically have lower coupon rates than similar non-convertible
securities. Convertible securities may be issued as fixed income obligations
that pay current income or as zero coupon notes and bonds, including Liquid
Yield Option Notes ("LYONs"). Zero coupon securities pay no cash income and are
sold at substantial discounts from their value at maturity. When held to
maturity, their entire income, which consists of accretion of discount, comes
from the difference between the issue price and their value at maturity. Zero
coupon convertible securities offer the opportunity for capital appreciation
because increases (or decreases) in the market value of such securities closely
follow the movements in the market value of the underlying common stock. Zero
coupon convertible securities generally are expected to be less volatile than
the underlying common stocks because they usually are issued with short
maturities (15 years or less) and are issued with options and/or redemption
features exercisable by the holder of the obligation entitling the holder to
redeem the obligation and receive a defined cash payment.
CORPORATE DEBT SECURITIES
Certain Master Portfolios may invest in corporate debt securities of
domestic issuers of all types and maturities, such as bonds, debentures, notes
and commercial paper. Corporate debt securities may involve equity features,
such as conversion or exchange rights or warrants for the acquisition of stock
of the same or a different issuer, participation based on revenue, sales or
profit, or the purchase of common stock or warrants in a unit transaction (where
corporate debt obligations and common stock are offered as a unit). Each may
also invest in corporate debt securities of foreign issuers.
The corporate debt securities in which the High Yield Master Portfolio
will invest will be rated BB or lower by Standard & Poor's Corporation ("S&P")
or Ba or below by Moody's Investors Services, Inc. ("Moody's"). The corporate
debt securities in which the other Master Portfolios will invest will be rated
investment grade by at least one NRSRO (E.G., BBB or above by Standard & Poor's
Corporation ("S&P") or Baa or above by Moody's Investors Services, Inc.
("Moody's")). Commercial paper purchased by the Master Portfolios (other than
Nations High Yield Bond Master Portfolio) will be rated in the top two
categories by a NRSRO. Corporate debt securities that are not rated may be
purchased by such Master Portfolios if they are determined by the Adviser to be
of comparable quality under the direction of the Board of Trustees of the Trust.
If the rating of any corporate debt security held by a Master Portfolio falls
below such ratings or if the investment adviser determines that an unrated
corporate debt security is no longer of comparable quality, then such security
shall be disposed of in an orderly manner as quickly as possible. A description
of these ratings is attached as Schedule A to this Part B.
CUSTODIAL RECEIPTS
Certain Master Portfolios may also acquire custodial receipts that
evidence ownership of future interest payments, principal payments or both on
certain U.S. Government notes or bonds. Such notes and bonds are held in custody
by a bank on behalf of the owners. These custodial receipts are known by various
names, including "Treasury Receipts," "Treasury Investors Growth Receipts" and
"Certificates of Accrual on Treasury Securities." Although custodial receipts
are not considered U.S. Government securities, they are indirectly issued or
guaranteed as to principal and interest by the U.S. Government, its agencies,
authorities or instrumentalities. Custodial receipts will be treated as illiquid
securities.
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CURRENCY SWAPS
Certain Master Portfolios also may enter into currency swaps for
hedging purposes and to seek to increase total return. In as much as swaps are
entered into for good faith hedging purposes or are offset by a segregated
account as described below, the Master Portfolio and the investment adviser
believe that swaps do not constitute senior securities as defined in the 1940
Act and, accordingly, will not treat them as being subject to the Master
Portfolio's borrowing restrictions. The net amount of the excess, if any, of the
Master Portfolio's obligations over its entitlement with respect to each
currency swap will be accrued on a daily basis and an amount of cash or liquid
high grade debt securities (i.e., securities rated in one of the top three
ratings categories by an NRSRO, or, if unrated, deemed by the investment adviser
to be of comparable credit quality) having an aggregate net asset value at least
equal to such accrued excess will be maintained in a segregated account by the
Master Portfolio's custodian. The Master Portfolio will not enter into any
currency swap unless the credit quality of the unsecured senior debt or the
claims-paying ability of the other party thereto is considered to be investment
grade by the investment adviser.
DELAYED DELIVERY TRANSACTIONS
In a delayed delivery transaction, the Master Portfolio relies on the
other party to complete the transaction. If the transaction is not completed,
the Master Portfolio may miss a price or yield considered to be advantageous. In
delayed delivery transactions, delivery of the securities occurs beyond normal
settlement periods, but a Master Portfolio would not pay for such securities or
start earning interest on them until they are delivered. However, when a Master
Portfolio purchases securities on such a delayed delivery basis, it immediately
assumes the risk of ownership, including the risk of price fluctuation. Failure
by a counterparty to deliver a security purchased on a delayed delivery basis
may result in a loss or missed opportunity to make an alternative investment.
Depending upon market conditions, a Master Portfolio's delayed delivery purchase
commitments could cause its net asset value to be more volatile, because such
securities may increase the amount by which the Master Portfolio's total assets,
including the value of when-issued and delayed delivery securities held by the
Master Portfolio, exceed its net assets.
DOLLAR ROLL TRANSACTIONS
Certain Master Portfolios may enter into "dollar roll" transactions,
which consist of the sale by a Master Portfolio to a bank or broker/dealer (the
"counterparty") of GNMA certificates or other mortgage-backed securities
together with a commitment to purchase from the counterparty similar, but not
identical, securities at a future date, at the same price. The counterparty
receives all principal and interest payments, including prepayments, made on the
security while it is the holder. A Master Portfolio receives a fee from the
counterparty as consideration for entering into the commitment to purchase.
Dollar rolls may be renewed over a period of several months with a different
repurchase price and a cash settlement made at each renewal without physical
delivery of securities. Moreover, the transaction may be preceded by a firm
commitment agreement pursuant to which the Master Portfolio agrees to buy a
security on a future date. If the broker/dealer to whom a Master Portfolio sells
the security becomes insolvent, the Master Portfolio's right to purchase or
repurchase the security may be restricted; the value of the security may change
adversely over the term of the dollar roll; the security that the Master
Portfolio is required to repurchase may be worth less than the security that the
Master Portfolio originally held, and the return earned by the Master Portfolio
with the proceeds of a dollar roll may not exceed transaction costs.
The entry into dollar rolls involves potential risks of loss that are
different from those related to the securities underlying the transactions. For
example, if the counterparty becomes insolvent, the Master Portfolio's right to
purchase from the counterparty might be restricted. Additionally, the value of
such securities may change adversely before the Master Portfolio is able to
purchase them. Similarly, the Master Portfolio may be required to purchase
securities in connection with a dollar roll at a higher price than may otherwise
be available on the open market. Since, as noted above, the counterparty is
required to deliver a similar but not identical security to the Master
Portfolio, the security that the Master Portfolio is required to buy under the
dollar roll may be worth less than an identical security. Finally, there can be
no assurance that the Master Portfolio's use of the cash that it receives from a
dollar roll will provide a return that exceeds borrowing costs.
EQUITY SWAP CONTRACTS
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Certain Master Portfolios may from time to time enter into equity swap
contracts. The counterparty to an equity swap contract will typically be a bank,
investment banking firm or broker/dealer. For example, the counterparty will
generally agree to pay a Master Portfolio the amount, if any, by which the
notional amount of the Equity Swap Contract would have increased in value had it
been invested in the stocks comprising the S&P 500 Index in proportion to the
composition of the Index, plus the dividends that would have been received on
those stocks. A Master Portfolio will agree to pay to the counterparty a
floating rate of interest (typically the London Inter Bank Offered Rate) on the
notional amount of the Equity Swap Contract plus the amount, if any, by which
that notional amount would have decreased in value had it been invested in such
stocks. Therefore, the return to a Master Portfolio on any Equity Swap Contract
should be the gain or loss on the notional amount plus dividends on the stocks
comprising the S&P 500 Index less the interest paid by the Master Portfolio on
the notional amount. A Master Portfolio will only enter into Equity Swap
Contracts on a net basis, i.e., the two parties' obligations are netted out,
with the Master Portfolio paying or receiving, as the case may be, only the net
amount of any payments. Payments under the Equity Swap Contracts may be made at
the conclusion of the contract or periodically during its term.
If there is a default by the counterparty to an Equity Swap Contract, a
Master Portfolio will be limited to contractual remedies pursuant to the
agreements related to the transaction. There is no assurance that Equity Swap
Contract counterparties will be able to meet their obligations pursuant to
Equity Swap Contracts or that, in the event of default, a Master Portfolio will
succeed in pursuing contractual remedies. A Master Portfolio thus assumes the
risk that it may be delayed in or prevented from obtaining payments owed to it
pursuant to Equity Swap Contracts. A Master Portfolio will closely monitor the
credit of Equity Swap Contract counterparties in order to minimize this risk.
Certain Master Portfolios may from time to time enter into the opposite
side of Equity Swap Contracts (i.e., where a Master Portfolio is obligated to
pay the increase (net of interest) or receive the decrease (plus interest) on
the contract to reduce the amount of the Master Portfolio's equity market
exposure consistent with the Master Portfolio's objective. These positions are
sometimes referred to as Reverse Equity Swap Contracts.
Equity Swap Contracts will not be used to leverage a Master Portfolio.
A Master Portfolio will not enter into any Equity Swap Contract or Reverse
Equity Swap Contract unless, at the time of entering into such transaction, the
unsecured senior debt of the counterparty is rated at least A by Moody's or S&P.
Since the SEC considers Equity Swap Contracts and Reverse Equity Swap Contracts
to be illiquid securities, a Master Portfolio will not invest in Equity Swap
Contracts or Reverse Equity Swap Contracts if the total value of such
investments together with that of all other illiquid securities which a Master
Portfolio owns would exceed 15% of the Master Portfolio's net assets.
The investment adviser does not believe that a Master Portfolio's
obligations under Equity Swap Contracts or Reverse Equity Swap Contracts are
senior securities and, accordingly, the Master Portfolio will not treat them as
being subject to its borrowing restrictions. However, the net amount of the
excess, if any, of a Master Portfolio's obligations over its respective
entitlements with respect to each Equity Swap Contract and each Reverse Equity
Swap Contract will be accrued on a daily basis and an amount of cash, U.S.
Government securities or other liquid high quality debt securities having an
aggregate market value at least equal to the accrued excess will be maintained
in a segregated account by the Master Portfolio's custodian.
FOREIGN CURRENCY TRANSACTIONS
Certain Master Portfolios may invest in foreign currency transactions.
Foreign securities involve currency risks. The U.S. dollar value of a foreign
security tends to decrease when the value of the U.S. dollar rises against the
foreign currency in which the security is denominated, and tends to increase
when the value of the U.S. dollar falls against such currency. A Master
Portfolio may purchase or sell forward foreign currency exchange contracts
("forward contracts") to attempt to minimize the risk to the Master Portfolio
from adverse changes in the relationship between the U.S. dollar and foreign
currencies. A Master Portfolio may also purchase and sell foreign currency
futures contracts and related options (see "Purchase and Sale of Currency
Futures Contracts and Related Options"). A forward contract is an obligation to
purchase or sell a specific currency for an agreed price at a future date that
is individually negotiated and privately traded by currency traders and their
customers.
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Forward foreign currency exchange contracts establish an exchange rate
at a future date. These contracts are transferable in the interbank market
conducted directly between currency traders (usually large commercial banks) and
their customers. A forward foreign currency exchange contract generally has no
deposit requirement, and is traded at a net price without commission. A Master
Portfolio will direct its custodian to segregate high grade liquid assets in an
amount at least equal to its obligations under each forward foreign currency
exchange contract. Neither spot transactions nor forward foreign currency
exchange contracts eliminate fluctuations in the prices of a Master Portfolio's
portfolio securities or in foreign exchange rates, or prevent loss if the prices
of these securities should decline.
A Master Portfolio may enter into a forward contract, for example, when
it enters into a contract for the purchase or sale of a security denominated in
a foreign currency in order to "lock in" the U.S. dollar price of the security
(a "transaction hedge"). In addition, when the investment advisor believes that
a foreign currency may suffer a substantial decline against the U.S. dollar, it
may enter into a forward sale contract to sell an amount of that foreign
currency approximating the value of some or all of the Master Portfolio's
securities denominated in such foreign currency, or when the investment advisor
believes that the U.S. dollar may suffer a substantial decline against the
foreign currency, it may enter into a forward purchase contract to buy that
foreign currency for a fixed dollar amount (a "position hedge").
A Master Portfolio may, however, enter into a forward contract to sell
a different foreign currency for a fixed U.S. dollar amount where the investment
advisor believes that the U.S. dollar value of the currency to be sold pursuant
to the forward contract will fall whenever there is a decline in the U.S. dollar
value of the currency in which the Master Portfolio securities are denominated
(a "cross-hedge").
Foreign currency hedging transactions are an attempt to protect a
Master Portfolio against changes in foreign currency exchange rates between the
trade and settlement dates of specific securities transactions or changes in
foreign currency exchange rates that would adversely affect a portfolio position
or an anticipated portfolio position. Although these transactions tend to
minimize the risk of loss due to a decline in the value of the hedged currency,
at the same time they tend to limit any potential gain that might be realized
should the value of the hedged currency increase. The precise matching of the
forward contract amount and the value of the securities involved will not
generally be possible because the future value of these securities in foreign
currencies will change as a consequence of market movements in the value of
those securities between the date the forward contract is entered into and date
it matures.
The Master Portfolio's custodian will segregate cash, U.S. Government
securities or other high-quality debt securities having a value equal to the
aggregate amount of the Master Portfolio's commitments under forward contracts
entered into with respect to position hedges and cross-hedges. If the value of
the segregated securities declines, additional cash or securities will be
segregated on a daily basis so that the value of the segregated securities will
equal the amount of the Master Portfolio's commitments with respect to such
contracts. As an alternative to segregating all or part of such securities, the
Master Portfolio may purchase a call option permitting the Master Portfolio to
purchase the amount of foreign currency being hedged by a forward sale contract
at a price no higher than the forward contract price or the Master Portfolio may
purchase a put option permitting the Master Portfolio to sell the amount of
foreign currency subject to a forward purchase contract at a price as high or
higher than the forward contract price.
The Master Portfolios are dollar-denominated mutual Master Portfolios
and therefore consideration is given to hedging part or all of the portfolio
back to U.S. dollars from international currencies. All decisions to hedge are
based upon an analysis of the relative value of the U.S. dollar on an
international purchasing power parity basis (purchasing power parity is a method
for determining the relative purchasing power of different currencies by
comparing the amount of each currency required to purchase a typical bundle of
goods and services to domestic markets) and an estimation of short-term interest
rate differentials (which affect both the direction of currency movements and
also the cost of hedging).
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FUTURES, OPTIONS AND OTHER DERIVATIVE INSTRUMENTS
FUTURES CONTRACTS IN GENERAL. A futures contract is an agreement
between two parties for the future delivery of fixed income securities or equity
securities or for the payment or acceptance of a cash settlement in the case of
futures contracts on an index of fixed income or equity securities. A "sale" of
a futures contract means the contractual obligation to deliver the securities at
a specified price on a specified date, or to make the cash settlement called for
by the contract. Futures contracts have been designed by exchanges which have
been designated "contract markets" by the Commodity Futures Trading Commission
("CFTC") and must be executed through a brokerage firm, known as a futures
commission merchant, which is a member of the relevant contract market. Futures
contracts trade on these markets, and the exchanges, through their clearing
organizations, guarantee that the contracts will be performed as between the
clearing members of the exchange. Presently, futures contracts are based on such
debt securities as long-term U.S. Treasury Bonds, Treasury Notes, GNMA modified
pass-through mortgage-backed securities, three-month U.S. Treasury Bills, bank
certificates of deposit, and on indices of municipal, corporate and government
bonds.
While futures contracts based on securities do provide for the delivery
and acceptance of securities, such deliveries and acceptances are seldom made.
Generally, a futures contract is terminated by entering into an offsetting
transaction. A Master Portfolio will incur brokerage fees when it purchases and
sells futures contracts. At the time such a purchase or sale is made, a Master
Portfolio must provide cash or money market securities as a deposit known as
"margin." The initial deposit required will vary, but may be as low as 2% or
less of a contract's face value. Daily thereafter, the futures contract is
valued through a process known as "marking to market," and a Master Portfolio
that engages in futures transactions may receive or be required to pay
"variation margin" as the futures contract becomes more or less valuable. At the
time of delivery of securities pursuant to a futures contract based on
securities, adjustments are made to recognize differences in value arising from
the delivery of securities with a different interest rate than the specific
security that provides the standard for the contract. In some (but not many)
cases, securities called for by a futures contract may not have been issued when
the contract was written.
Futures contracts on indices of securities are settled through the
making and acceptance of cash settlements based on changes in value of the
underlying rate or index between the time the contract is entered into and the
time it is liquidated.
FUTURES CONTRACTS ON FIXED INCOME SECURITIES AND RELATED INDICES.
Certain Master Portfolios may enter into transactions in futures contracts for
the purpose of hedging a relevant portion of their portfolios. A Master
Portfolio may enter into transactions in futures contracts that are based on
U.S. Government obligations, including any index of government obligations that
may be available for trading. Such transactions will be entered into where
movements in the value of the securities or index underlying a futures contract
can be expected to correlate closely with movements in the value of securities
held in a Master Portfolio. For example, a Master Portfolio may sell futures
contracts in anticipation of a general rise in the level of interest rates,
which would result in a decline in the value of its fixed income securities. If
the expected rise in interest rates occurs, the Master Portfolio may realize
gains on its futures position, which should offset all or part of the decline in
value of fixed income Master Portfolio securities. A Master Portfolio could
protect against such decline by selling fixed income securities, but such a
strategy would involve higher transaction costs than the sale of futures
contracts and, if interest rates again declined, the Master Portfolio would be
unable to take advantage of the resulting market advance without purchases of
additional securities.
The purpose of the purchase or sale of a futures contract on government
securities and indices of government securities, in the case of certain Master
Portfolios, which hold or intend to acquire long-term debt securities, is to
protect a Master Portfolio from fluctuations in interest rates without actually
buying or selling long-term debt securities. For example, if long-term bonds are
held by a Master Portfolio, and interest rates were expected to increase, the
Master Portfolio might enter into futures contracts for the sale of debt
securities. Such a sale would have much the same effect as selling an equivalent
value of the long-term bonds held by the Master Portfolio. If interest rates did
increase, the value of the debt securities in the Master Portfolio would
decline, but the value of the futures contracts to the Master Portfolio would
increase at approximately the same rate thereby keeping the net asset value of
the Master Portfolio from declining as much as it otherwise would have. When a
Master
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Portfolio is not fully invested and a decline in interest rates is anticipated,
which would increase the cost of fixed income securities that the Master
Portfolio intends to acquire, it may purchase futures contracts. In the event
that the projected decline in interest rates occurs, the increased cost of the
securities acquired by the Master Portfolio should be offset, in whole or part,
by gains on the futures contracts by entering into offsetting transactions on
the contract market on which the initial purchase was effected. In a substantial
majority of transactions involving futures contracts on fixed income securities,
a Master Portfolio will purchase the securities upon termination of the long
futures positions, but under unusual market conditions, a long futures position
may be terminated without a corresponding purchase of securities.
Similarly, when it is expected that interest rates may decline, futures
contracts on fixed income securities and indices of government securities may be
purchased for the purpose of hedging against anticipated purchases of long-term
bonds at higher prices. Since the fluctuations in the value of such futures
contracts should be similar to that of long-term bonds, a Master Portfolio could
take advantage of the anticipated rise in the value of long-term bonds without
actually buying them until the market had stabilized. At that time, the futures
contracts could be liquidated and the Master Portfolio's cash reserves could
then be used to buy long-term bonds in the cash market. Similar results could be
accomplished by selling bonds with long maturities and investing in bonds with
short maturities when interest rates are expected to increase. However, since
the futures market is more liquid than the cash market, the use of these futures
contracts as an investment technique allows a Master Portfolio to act in
anticipation of such an interest rate decline without having to sell its
portfolio securities. To the extent a Master Portfolio enters into futures
contracts for this purpose, the segregated assets maintained by a Master
Portfolio will consist of cash, cash equivalents or high quality debt securities
of the Master Portfolio in an amount equal to the difference between the
fluctuating market value of such futures contract and the aggregate value of the
initial deposit and variation margin payments made by the Master Portfolio with
respect to such futures contracts.
STOCK INDEX FUTURES CONTRACTS. Certain Master Portfolios may sell stock
index futures contracts in order to offset a decrease in market value of its
securities that might otherwise result from a market decline. A Master Portfolio
may do so either to hedge the value of its portfolio as a whole, or to protect
against declines, occurring prior to sales of securities, in the value of
securities to be sold. Conversely, a Master Portfolio may purchase stock index
futures contracts in order to protect against anticipated increases in the cost
of securities to be acquired.
In addition, a Master Portfolio may utilize stock index futures
contracts in anticipation of changes in the composition of its portfolio. For
example, in the event that a Master Portfolio expects to narrow the range of
industry groups represented in its portfolio, it may, prior to making purchases
of the actual securities, establish a long futures position based on a more
restricted index, such as an index comprised of securities of a particular
industry group. As such securities are acquired, a Master Portfolio's futures
positions would be closed out. A Master Portfolio may also sell futures
contracts in connection with this strategy, in order to protect against the
possibility that the value of the securities to be sold as part of the
restructuring of its portfolio will decline prior to the time of sale.
OPTIONS ON FUTURES CONTRACTS. An option on a futures contract gives the
purchaser (the "holder") the right, but not the obligation, to purchase a
position in the underlying futures contract (i.e., a purchase of such futures
contract) in the case of an option to purchase (a "call" option), or a "short"
position in the underlying futures contract (i.e., a sale of such futures
contract) in the case of an option to sell (a "put" option), at a fixed price
(the "strike price") up to a stated expiration date. The holder pays a
non-refundable purchase price for the option, known as the "premium." The
maximum amount of risk the purchase of the option assumes is equal to the
premium plus related transaction costs, although this entire amount may be lost.
Upon exercise of the option by the holder, the exchange clearing corporation
establishes a corresponding long position in the case of a put option. In the
event that an option is exercised, the parties will be subject to all the risks
associated with the trading of futures contracts, such as payment of variation
margin deposits. In addition, the writer of an option on a futures contract,
unlike the holder, is subject to initial and variation margin requirements on
the option position.
OPTIONS ON FUTURES CONTRACTS ON FIXED INCOME SECURITIES AND RELATED
INDICES. Certain Master Portfolios may purchase put options on futures contracts
in which such Master Portfolios are permitted to invest for the purpose of
hedging a relevant portion of their portfolios against an anticipated decline in
the values of portfolio securities resulting from increases in interest rates,
and may purchase call options on such futures contracts as a hedge against
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an interest rate decline when they are not fully invested. A Master Portfolio
would write options on these futures contracts primarily for the purpose of
terminating existing positions.
OPTIONS ON STOCK INDEX FUTURES CONTRACTS, OPTIONS ON STOCK INDICES AND
OPTIONS ON EQUITY SECURITIES. Certain Master Portfolios may purchase put options
on stock index futures contracts, stock indices or equity securities for the
purpose of hedging the relevant portion of their portfolio securities against an
anticipated market-wide decline or against declines in the values of individual
portfolio securities, and they may purchase call options on such futures
contracts as a hedge against a market advance when they are not fully invested.
A Master Portfolio would write options on such futures contracts primarily for
the purpose of terminating existing positions. In general, options on stock
indices will be employed in lieu of options on stock index futures contracts
only where they present an opportunity to hedge at lower cost. With respect to
options on equity securities, a Master Portfolio may, under certain
circumstances, purchase a combination of call options on such securities and
U.S. Treasury bills. The Adviser believes that such a combination may more
closely parallel movements in the value of the security underlying the call
option than would the option itself.
Further, while a Master Portfolio generally would not write options on
individual portfolio securities, it may do so under limited circumstances known
as "targeted sales" and "targeted buys," which involve the writing of call or
put options in an attempt to purchase or sell portfolio securities at specific
desired prices. A Master Portfolio would receive a fee, or a "premium," for the
writing of the option. For example, where the Master Portfolio seeks to sell
portfolio securities at a "targeted" price, it may write a call option at that
price. In the event that the market rises above the exercise price, it would
receive its "targeted" price, upon the exercise of the option, as well as the
premium income. Also, where it seeks to buy portfolio securities at a "targeted"
price, it may write a put option at that price for which it will receive the
premium income. In the event that the market declines below the exercise price,
a Master Portfolio would pay its "targeted" price upon the exercise of the
option. In the event that the market does not move in the direction or to the
extent anticipated, however, the targeted sale or buy might not be successful
and a Master Portfolio could sustain a loss on the transaction that may not be
offset by the premium received. In addition, a Master Portfolio may be required
to forego the benefit of an intervening increase or decline in value of the
underlying security.
OPTIONS AND FUTURES STRATEGIES. The investment advisor may seek to
increase the current return of certain Master Portfolios by writing covered call
or put options. In addition, through the writing and purchase of options and the
purchase and sale of U.S. and certain foreign stock index futures contracts,
interest rate futures contracts, foreign currency futures contracts and related
options on such futures contracts, the investment advisor may at times seek to
hedge against a decline in the value of securities included in the Master
Portfolio or an increase in the price of securities that it plans to purchase
for the Master Portfolio. Expenses and losses incurred as a result of such
hedging strategies will reduce the Master Portfolio's current return. A Master
Portfolio's investment in foreign stock index futures contracts and foreign
interest rate futures contracts, and related options on such futures contracts,
are limited to only those contracts and related options that have been approved
by the CFTC for investment by U.S. investors. Additionally, with respect to a
Master Portfolio's investment in foreign options, unless such options are
specifically authorized for investment by order of the CFTC or meet the
definition of trade options as set forth in CFTC Rule 32.4, a Master Portfolio
will not make these investments.
The ability of a Master Portfolio to engage in the options and futures
strategies described below will depend on the availability of liquid markets in
such instruments. Markets in options and futures with respect to stock indices,
foreign government securities and foreign currencies are relatively new and
still developing. It is impossible to predict the amount of trading interest
that may exist in various types of options or futures. Therefore, no assurance
can be given that a Master Portfolio will be able to utilize these instruments
effectively for the purposes stated below. Furthermore, a Master Portfolio's
ability to engage in options and futures transactions may be limited by tax
considerations. Although a Master Portfolio will only engage in options and
futures transactions for limited purposes, these activities will involve certain
risks which are described below under "Risk Factors Associated with Futures and
Options Transactions." A Master Portfolio will not engage in options and futures
transactions for leveraging purposes.
WRITING COVERED OPTIONS ON SECURITIES. Certain Master Portfolios may
write covered call options and covered put options on securities in which it is
permitted to invest from time to time as the investment advisor
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determines is appropriate in seeking to attain its objective. Call options
written by a Master Portfolio give the holder the right to buy the underlying
securities from a Master Portfolio at a stated exercise price; put options give
the holder the right to sell the underlying security to the Master Portfolio at
a stated price.
A Master Portfolio may write only covered options, which means that, so
long as the Master Portfolio is obligated as the writer of a call option, it
will own the underlying securities subject to the option (or comparable
securities satisfying the cover requirements of securities exchanges). In the
case of put options, a Master Portfolio will maintain in a separate account cash
or short-term U.S. Government securities with a value equal to or greater than
the exercise price of the underlying securities. A Master Portfolio may also
write combinations of covered puts and calls on the same underlying security.
A Master Portfolio will receive a premium from writing a put or call
option, which increases the Master Portfolio's return in the event the option
expires unexercised or is closed out at a profit. The amount of the premium will
reflect, among other things, the relationship of the market price of the
underlying security to the exercise price of the option, the term of the option
and the volatility of the market price of the underlying security. By writing a
call option, a Master Portfolio limits its opportunity to profit from any
increase in the market value of the underlying security above the exercise price
of the option. By writing a put option, the Master Portfolio assumes the risk
that it may be required to purchase the underlying security for an exercise
price higher than its then current market value, resulting in a potential
capital loss if the purchase price exceeds the market value plus the amount of
the premium received, unless the security subsequently appreciates in value.
A Master Portfolio may terminate an option that it has written prior to
its expiration by entering into a closing purchase transaction in which it
purchases an option having the same terms as the option written. A Master
Portfolio will realize a profit or loss from such transaction if the cost of
such transaction is less or more than the premium received from the writing of
the option. In the case of a put option, any loss so incurred may be partially
or entirely offset by the premium received from a simultaneous or subsequent
sale of a different put option. Because increases in the market price of a call
option will generally reflect increases in the market price of the underlying
security, any loss resulting from the repurchase of a call option is likely to
be offset in whole or in part by unrealized appreciation of the underlying
security owned by a Master Portfolio.
PURCHASING PUT AND CALL OPTIONS ON SECURITIES. A Master Portfolio may
purchase put options to protect its portfolio holdings in an underlying security
against a decline in market value. Such hedge protection is provided during the
life of the put option since a Master Portfolio, as holder of the put option, is
able to sell the underlying security at the put exercise price regardless of any
decline in the underlying security's market price. In order for a put option to
be profitable, the market price of the underlying security must decline
sufficiently below the exercise price to cover the premium and transaction
costs. By using put options in this manner, a Master Portfolio will reduce any
profit it might otherwise have realized in its underlying security by the
premium paid for the put option and by transaction costs.
A Master Portfolio may also purchase call options to hedge against an
increase in prices of securities that it wants ultimately to buy. Such hedge
protection is provided during the life of the call option since the Master
Portfolio, as holder of the call option, is able to buy the underlying security
at the exercise price regardless of any increase in the underlying security's
market price. In order for a call option to be profitable, the market price of
the underlying security must rise sufficiently above the exercise price to cover
the premium and transaction costs. By using call options in this manner, a
Master Portfolio will reduce any profit it might have realized had it bought the
underlying security at the time it purchased the call option by the premium paid
for the call option and by transaction costs.
PURCHASE AND SALE OF OPTIONS AND FUTURES ON STOCK INDICES. A Master
Portfolio may purchase and sell options on non-U.S. stock indices and stock
index futures as a hedge against movements in the equity markets.
Options on stock indices are similar to options on specific securities
except that, rather than the right to take or make delivery of the specific
security at a specific price, an option on a stock index gives the holder the
right to receive, upon exercise of the option, an amount of cash if the closing
level of that stock index is greater than, in the case of a call, or less than,
in the case of a put, the exercise price of the option. This amount of cash is
equal to such
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difference between the closing price of the index and the exercise price of the
option expressed in dollars multiplied by a specified multiple. The writer of
the option is obligated, in return for the premium received, to make delivery of
this amount. Unlike options on specific securities, all settlements of options
on stock indices are in cash and gain or loss depends on general movements in
the stocks included in the index rather than price movements in particular
stocks. A stock index futures contract is an agreement in which one party agrees
to deliver to the other an amount of cash equal to a specific amount multiplied
by the difference between the value of a specific stock index at the close of
the last trading day of the contract and the price at which the agreement is
made. No physical delivery of securities is made.
If the investment adviser expects general stock market prices to rise,
a Master Portfolio might purchase a call option on a stock index or a futures
contract on that index as a hedge against an increase in prices of particular
equity securities it wants ultimately to buy. If in fact the stock index does
rise, the price of the particular equity securities intended to be purchased may
also increase, but that increase would be offset in part by the increase in the
value of a Master Portfolio's index option or futures contract resulting from
the increase in the index. If, on the other hand, the Investment adviser expects
general stock market prices to decline, a Master Portfolio might purchase a put
option or sell a futures contract on the index. If that index does in fact
decline, the value of some or all of the equity securities in a Master Portfolio
may also be expected to decline, but that decrease would be offset in part by
the increase in the value of the Master Portfolio's position in such put option
or futures contract.
PURCHASE AND SALE OF INTEREST RATE FUTURES. A Master Portfolio may
purchase and sell interest rate futures contracts on foreign government
securities including, but not limited to, debt securities of the governments and
central banks of France, Germany, Denmark and Japan for the purpose of hedging
fixed income and interest sensitive securities against the adverse effects of
anticipated movements in interest rates.
A Master Portfolio may sell interest rate futures contracts in
anticipation of an increase in the general level of interest rates. Generally,
as interest rates rise, the market value of the fixed income securities held by
a Master Portfolio will fall, thus reducing the net asset value of the Master
Portfolio. This interest rate risk can be reduced without employing futures as a
hedge by selling long-term fixed income securities and either reinvesting the
proceeds in securities with shorter maturities or by holding assets in cash.
This strategy, however, entails increased transaction costs to a Master
Portfolio in the form of dealer spreads and brokerage commissions.
The sale of interest rate futures contracts provides an alternative
means of hedging against rising interest rates. As rates increase, the value of
a Master Portfolio's short position in the futures contracts will also tend to
increase, thus offsetting all or a portion of the depreciation in the market
value of a Master Portfolio's investments that are being hedged. While a Master
Portfolio will incur commission expenses in selling and closing out futures
positions (which is done by taking an opposite position which operates to
terminate the position in the futures contract), commissions on futures
transactions are lower than transaction costs incurred in the purchase and sale
of portfolio securities.
OPTIONS ON STOCK INDEX FUTURES CONTRACTS AND INTEREST RATE FUTURES
CONTRACTS. A Master Portfolio may purchase and write call and put options on
non-U.S. stock index and interest rate futures contracts. A Master Portfolio may
use such options on futures contracts in connection with its hedging strategies
in lieu of purchasing and writing options directly on the underlying securities
or stock indices or purchasing and selling the underlying futures. For example,
a Master Portfolio may purchase put options or write call options on stock index
futures, or interest rate futures, rather than selling futures contracts, in
anticipation of a decline in general stock market prices or rise in interest
rates, respectively, or purchase call options or write put options on stock
index or interest rate futures, rather than purchasing such futures, to hedge
against possible increases in the price of equity securities or debt securities,
respectively, which the Master Portfolio intends to purchase.
PURCHASE AND SALE OF CURRENCY FUTURES CONTRACTS AND RELATED OPTIONS. In
order to hedge its portfolio and to protect it against possible variations in
foreign exchange rates pending the settlement of securities transactions, a
Master Portfolio may buy or sell currency futures contracts and related options.
If a fall in exchange rates for a particular currency is anticipated, a Master
Portfolio may sell a currency futures contract or a call option thereon or
purchase a put option on such futures contract as a hedge. If it is anticipated
that exchange rates will rise, a Master Portfolio may purchase a currency
futures contract or a call option thereon or sell (write) a put option to
protect
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against an increase in the price of securities denominated in a particular
currency a Master Portfolio intends to purchase. These futures contracts and
related options thereon will be used only as a hedge against anticipated
currency rate changes, and all options on currency futures written by a Master
Portfolio will be covered.
A currency futures contract sale creates an obligation by a Master
Portfolio, as seller, to deliver the amount of currency called for in the
contract at a specified future time for a special price. A currency futures
contract purchase creates an obligation by a Master Portfolio, as purchaser, to
take delivery of an amount of currency at a specified future time at a specified
price. Although the terms of currency futures contracts specify actual delivery
or receipt, in most instances the contracts are closed out before the settlement
date without the making or taking of delivery of the currency. Closing out of a
currency futures contract is effected by entering into an offsetting purchase or
sale transaction. Unlike a currency futures contract, which requires the parties
to buy and sell currency on a set date, an option on a currency futures contract
entitles its holder to decide on or before a future date whether to enter into
such a contract. If the holder decides not to enter into the contract, the
premium paid for the option is fixed at the point of sale.
The Master Portfolio will write (sell) only covered put and call
options on currency futures. This means that a Master Portfolio will provide for
its obligations upon exercise of the option by segregating sufficient cash or
short-term obligations or by holding an offsetting position in the option or
underlying currency future, or a combination of the foregoing. A Master
Portfolio will, so long as it is obligated as the writer of a call option on
currency futures, own on a contract-for-contract basis an equal long position in
currency futures with the same delivery date or a call option on stock index
futures with the difference, if any, between the market value of the call
written and the market value of the call or long currency futures purchased
maintained by a Master Portfolio in cash, Treasury bills, or other high grade
short-term obligations in a segregated account with its custodian. If at the
close of business on any day the market value of the call purchased by a Master
Portfolio falls below 100% of the market value of the call written by the Master
Portfolio, a Master Portfolio will so segregate an amount of cash, Treasury
bills or other high grade short-term obligations equal in value to the
difference. Alternatively, a Master Portfolio may cover the call option through
segregating with the custodian an amount of the particular foreign currency
equal to the amount of foreign currency per futures contract option times the
number of options written by a Master Portfolio. In the case of put options on
currency futures written by the Master Portfolio, the Master Portfolio will hold
the aggregate exercise price in cash, Treasury bills, or other high grade
short-term obligations in a segregated account with its custodian, or own put
options on currency futures or short currency futures, with the difference, if
any, between the market value of the put written and the market value of the
puts purchased or the currency futures sold maintained by a Master Portfolio in
cash, Treasury bills or other high grade short-term obligations in a segregated
account with its custodian. If at the close of business on any day the market
value of the put options purchased or the currency futures by a Master Portfolio
falls below 100% of the market value of the put options written by the Master
Portfolio, a Master Portfolio will so segregate an amount of cash, Treasury
bills or other high grade short-term obligations equal in value to the
difference.
If other methods of providing appropriate cover are developed, a Master
Portfolio reserves the right to employ them to the extent consistent with
applicable regulatory and exchange requirements. In connection with transactions
in stock index options, stock index futures, interest rate futures, foreign
currency futures and related options on such futures, a Master Portfolio will be
required to deposit as "initial margin" an amount of cash or short-term
government securities equal to from 5% to 8% of the contract amount. Thereafter,
subsequent payments (referred to as "variation margin") are made to and from the
broker to reflect changes in the value of the futures contract.
LIMITATIONS ON PURCHASE OF OPTIONS. The staff of the Securities and
Exchange Commission ("SEC") has taken the position that purchased
over-the-counter options and assets used to cover written over-the-counter
options are illiquid and, therefore, together with other illiquid securities,
cannot exceed 15% of a Master Portfolio's net assets. The Investment adviser
intends to limit a Master Portfolio's writing of over-the-counter options in
accordance with the following procedure. Each Master Portfolio intends to write
over-the-counter options only with primary U.S. Government securities dealers
recognized by the Federal Reserve Bank of New York. Also, the contracts which a
Master Portfolio has in place with such primary dealers will provide that the
Master Portfolio has the absolute right to repurchase an option it writes at any
time at a price which represents the fair market value, as determined in good
faith through negotiation between the parties, but which in no event will exceed
a price
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determined pursuant to a formula in the contract. Although the specific formula
may vary between contracts with different primary dealers, the formula will
generally be based on a multiple of the premium received by a Master Portfolio
for writing the option, plus the amount, if any, of the option's intrinsic value
(i.e., the amount that the option is in-the-money). The formula also may include
a factor to account for the difference between the price of the security and the
strike price of the option if the option is written out-of-the-money. A Master
Portfolio will treat all or a part of the formula price as illiquid for purposes
of any limitation on illiquid securities imposed by the SEC staff.
RISK FACTORS ASSOCIATED WITH FUTURES AND OPTIONS TRANSACTIONS
The effective use of options and futures strategies depends on, among
other things, a Master Portfolio's ability to terminate options and futures
positions at times when its the investment adviser deems it desirable to do so.
Although a Master Portfolio will not enter into an option or futures position
unless the investment adviser believes that a liquid secondary market exists for
such option or future, there is no assurance that a Master Portfolio will be
able to effect closing transactions at any particular time or at an acceptable
price. A Master Portfolio generally expects that its options and futures
transactions will be conducted on recognized U.S. and foreign securities and
commodity exchanges. In certain instances, however, a Master Portfolio may
purchase and sell options in the over-the-counter market. A Master Portfolio's
ability to terminate option positions established in the over-the-counter market
may be more limited than in the case of exchange-traded options and may also
involve the risk that securities dealers participating in such transactions
would fail to meet their obligations to the Master Portfolio.
Options and futures markets can be highly volatile and transactions of
this type carry a high risk of loss. Moreover, a relatively small adverse market
movement with respect to these types of transactions may result not only in loss
of the original investment but also in unquantifiable further loss exceeding any
margin deposited.
The use of options and futures involves the risk of imperfect
correlation between movements in options and futures prices and movements in the
price of securities which are the subject of the hedge. Such correlation,
particularly with respect to options on stock indices and stock index futures,
is imperfect, and such risk increases as the composition of a Master Portfolio
diverges from the composition of the relevant index. The successful use of these
strategies also depends on the ability of the investment adviser to correctly
forecast interest rate movements, currency rate movements and general stock
market price movements.
In addition to certain risk factors described above, the following sets
forth certain information regarding the potential risks associated with the
Master Portfolios' futures and options transactions.
RISK OF IMPERFECT CORRELATION. A Master Portfolio's ability effectively
to hedge all or a portion of its portfolio through transactions in futures,
options on futures or options on stock indices depends on the degree to which
movements in the value of the securities or index underlying such hedging
instrument correlate with movements in the value of the relevant portion of the
Master Portfolio's securities. If the values of the securities being hedged do
not move in the same amount or direction as the underlying security or index,
the hedging strategy for a Master Portfolio might not be successful and the
Master Portfolio could sustain losses on its hedging transactions which would
not be offset by gains on its portfolio. It is also possible that there may be a
negative correlation between the security or index underlying a futures or
option contract and the portfolio securities being hedged, which could result in
losses both on the hedging transaction and the Master Portfolio securities. In
such instances, a Master Portfolio's overall return could be less than if the
hedging transactions had not been undertaken. Stock index futures or options
based on a narrower index of securities may present greater risk than options or
futures based on a broad market index, as a narrower index is more susceptible
to rapid and extreme fluctuations resulting from changes in the value of a small
number of securities. A Master Portfolio would, however, effect transactions in
such futures or options only for hedging purposes.
The trading of futures and options on indices involves the additional
risk of imperfect correlation between movements in the futures or option price
and the value of the underlying index. The anticipated spread between the prices
may be distorted due to differences in the nature of the markets, such as
differences in margin requirements, the liquidity of such markets and the
participation of speculators in the futures and options market. The purchase of
an option on a futures contract also involves the risk that changes in the value
of underlying futures contract will not
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be fully reflected in the value of the option purchased. The risk of imperfect
correlation, however, generally tends to diminish as the maturity date of the
futures contract or termination date of the option approaches. The risk incurred
in purchasing an option on a futures contract is limited to the amount of the
premium plus related transaction costs, although it may be necessary under
certain circumstances to exercise the option and enter into the underlying
futures contract in order to realize a profit. Under certain extreme market
conditions, it is possible that a Master Portfolio will not be able to establish
hedging positions, or that any hedging strategy adopted will be insufficient to
completely protect the Master Portfolio.
A Master Portfolio will purchase or sell futures contracts or options
only if, in the investment adviser's judgment, there is expected to be a
sufficient degree of correlation between movements in the value of such
instruments and changes in the value of the relevant portion of the Master
Portfolio for the hedge to be effective. There can be no assurance that the
investment adviser's judgment will be accurate.
POTENTIAL LACK OF A LIQUID SECONDARY MARKET. The ordinary spreads
between prices in the cash and futures markets, due to differences in the
natures of those markets, are subject to distortions. First, all participants in
the futures market are subject to initial deposit and variation margin
requirements. This could require a Master Portfolio to post additional cash or
cash equivalents as the value of the position fluctuates. Further, rather than
meeting additional variation margin requirements, investors may close futures
contracts through offsetting transactions which could distort the normal
relationship between the cash and futures markets. Second, the liquidity of the
futures or options market may be lacking. Prior to exercise or expiration, a
futures or option position may be terminated only by entering into a closing
purchase or sale transaction, which requires a secondary market on the exchange
on which the position was originally established. While a Master Portfolio will
establish a futures or option position only if there appears to be a liquid
secondary market therefor, there can be no assurance that such a market will
exist for any particular futures or option contract at any specific time. In
such event, it may not be possible to close out a position held by a Master
Portfolio, which could require the Master Portfolio to purchase or sell the
instrument underlying the position, make or receive a cash settlement, or meet
ongoing variation margin requirements. The inability to close out futures or
option positions also could have an adverse impact on a Master Portfolio's
ability effectively to hedge its securities, or the relevant portion thereof.
The liquidity of a secondary market in a futures contract or an option
on a futures contract may be adversely affected by "daily price fluctuation
limits" established by the exchanges, which limit the amount of fluctuation in
the price of a contract during a single trading day and prohibit trading beyond
such limits once they have been reached. The trading of futures and options
contracts also is subject to the risk of trading halts, suspensions, exchange or
clearing house equipment failures, government intervention, insolvency of the
brokerage firm or clearing house or other disruptions of normal trading
activity, which could at times make it difficult or impossible to liquidate
existing positions or to recover excess variation margin payments.
RISK OF PREDICTING INTEREST RATE MOVEMENTS. Investments in futures
contracts on fixed income securities and related indices involve the risk that
if the investment adviser's investment judgment concerning the general direction
of interest rates is incorrect, a Master Portfolio's overall performance may be
poorer than if it had not entered into any such contract. For example, if a
Master Portfolio has been hedged against the possibility of an increase in
interest rates which would adversely affect the price of bonds held in its
portfolio and interest rates decrease instead, the Master Portfolio will lose
part or all of the benefit of the increased value of its bonds which have been
hedged because it will have offsetting losses in its futures positions. In
addition, in such situations, if a Master Portfolio has insufficient cash, it
may have to sell bonds from its portfolio to meet daily variation margin
requirements, possibly at a time when it may be disadvantageous to do so. Such
sale of bonds may be, but will not necessarily be, at increased prices which
reflect the rising market.
TRADING AND POSITION LIMITS. Each contract market on which futures and
option contracts are traded has established a number of limitations governing
the maximum number of positions which may be held by a trader, whether acting
alone or in concert with others. The investment adviser does not believe that
these trading and position limits will have an adverse impact on the hedging
strategies regarding the Master Portfolios' investments.
REGULATIONS ON THE USE OF FUTURES AND OPTIONS CONTRACTS. Regulations of
the CFTC require that the Master Portfolios enter into transactions in futures
contracts and options thereon for hedging purposes only, in order to
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assure that they are not deemed to be a "commodity pool" under such regulations.
In particular, CFTC regulations require that all short futures positions be
entered into for the purpose of hedging the value of investment securities held
by a Master Portfolio, and that all long futures positions either constitute
bona fide hedging transactions, as defined in such regulations, or have a total
value not in excess of an amount determined by reference to certain cash and
securities positions maintained for the Master Portfolio, and accrued profits on
such positions. In addition, a Master Portfolio may not purchase or sell such
instruments if, immediately thereafter, the sum of the amount of initial margin
deposits on its existing futures positions and premiums paid for options on
futures contracts would exceed 5% of the market value of the Master Portfolio's
total assets.
When a Master Portfolio purchases a futures contract, an amount of cash
or cash equivalents or high quality debt securities will be segregated with the
Master Portfolio's custodian so that the amount so segregated, plus the initial
deposit and variation margin held in the account of its broker, will at all
times equal the value of the futures contract, thereby insuring that the use of
such futures is unleveraged.
The Master Portfolios' ability to engage in the hedging transactions
described herein may be limited by the current federal income tax requirement
that a Master Portfolio derive less than 30% of its gross income from the sale
or other disposition of stock or securities held for less than three months. The
Master Portfolios may also further limit their ability to engage in such
transactions in response to the policies and concerns of various Federal and
state regulatory agencies. Such policies may be changed by vote of the Board of
Trustees.
GUARANTEED INVESTMENT CONTRACTS
Guaranteed investment contracts, investment contracts or funding
agreements (each referred to as a "GIC") are investment instruments issued by
highly rated insurance companies. Pursuant to such contracts, a Master Portfolio
may make cash contributions to a deposit fund of the insurance company's general
or separate accounts. The insurance company then credits to a Master Portfolio
guaranteed interest. The insurance company may assess periodic charges against a
GIC for expense and service costs allocable to it, and the charges will be
deducted from the value of the deposit fund. The purchase price paid for a GIC
generally becomes part of the general assets of the issuer, and the contract is
paid from the general assets of the issuer.
A Master Portfolio will only purchase GICs from issuers which, at the
time of purchase, meet quality and credit standards established by the
investment adviser. Generally, GICs are not assignable or transferable without
the permission of the issuing insurance companies, and an active secondary
market in GICs does not currently exist. Also, a Master Portfolio may not
receive the principal amount of a GIC from the insurance company on seven days'
notice or less, at which point the GIC may be considered to be an illiquid
investment.
INSURED MUNICIPAL SECURITIES
Certain of the Municipal Securities held by the Master Portfolios may
be insured at the time of issuance as to the timely payment of principal and
interest. The insurance policies will usually be obtained by the issuer of the
Municipal Securities at the time of its original issuance. In the event that the
issuer defaults with respect to interest or principal payments, the insurer will
be notified and will be required to make payment to the bondholders. There is,
however, no guarantee that the insurer will meet its obligations. In addition,
such insurance will not protect against market fluctuations caused by changes in
interest rates and other factors.
INTEREST RATE TRANSACTIONS
Among the strategic transactions into which certain Master Portfolios
may enter are interest rate swaps and the purchase or sale of related caps and
floors. The Master Portfolios expect to enter into these transactions primarily
to preserve a return or spread on a particular investment or portion of its
portfolio, to protect against currency fluctuations, as a duration management
technique or to protect against any increase in the price of securities the
Master Portfolio anticipates purchasing at a later date. A Master Portfolio
intends to use these transactions as hedges and not as speculative investments
and will not sell interest rate caps or floors where it does not own securities
or other instruments providing the income stream the Master Portfolio may be
obligated to pay. Interest rate swaps involve the exchange by a Master Portfolio
with another party of their respective commitments to pay or
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receive interest, e.g. an exchange of floating rate payments for fixed rate
payments with respect to a notional amount of principal. A currency swap is an
agreement to exchange cash flows on a notional amount of two or more currencies
based on the relative value differential among them and an index swap is an
agreement to swap cash flows on a notional amount based on changes in the values
of the reference indices. The purchase of a cap entitles the purchaser to
receive payments on a notional principal amount from the party selling such
floor to the extent that a specified index falls below a predetermined interest
rate or amount.
A Master Portfolio will usually enter into swaps on a net basis, i.e.,
the two payment streams are netted out in a cash settlement on the payment date
or dates specified in the instrument, with the Master Portfolio receiving or
paying, as the case may be, only the net amount of the two payments. In as much
as these swaps, caps and floors are entered into for good faith hedging
purposes, the investment adviser and the Master Portfolio believe such
obligations do not constitute senior securities under the 1940 Act and,
accordingly, will not treat them as being subject to its borrowing restrictions.
A Master Portfolio will not enter into any swap, cap and floor transaction
unless, at the time of entering into such transaction, the unsecured long-term
debt of the counterparty, combined with any credit enhancements, is rated at
least "A" by Standard & Poor's Corporation or Moody's Investors Service, Inc. or
has an equivalent rating from a NRSRO, or is determined to be of equivalent
credit quality by the Investment adviser. If there is a default by the
counterparty, the Master Portfolio may have contractual remedies pursuant to the
agreements related to the transaction. The swap market has grown substantially
in recent years with a large number of banks and investment banking firms acting
both as principals and as agents utilizing standardized swap documentation. As a
result, the swap market has become relatively liquid. Caps and floors are more
recent innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than swaps.
With respect to swaps, a Master Portfolio will accrue the net amount of
the excess, if any, of its obligations over its entitlements with respect to
each swap on a daily basis and will segregate an amount of cash or liquid high
grade securities having a value equal to the accrued excess. Caps and floors
require segregation of assets with a value equal to the Master Portfolio's net
obligation, if any.
LOWER RATED (OR HIGH YIELD) DEBT SECURITIES
The yields on lower rated debt and comparable unrated fixed-income
securities generally are higher than the yields available on higher-rated
securities. However, investments in lower rated debt and comparable unrated
securities generally involve greater volatility of price and risk of loss of
income and principal, including the probability of default by or bankruptcy of
the issuers of such securities. Lower rated debt and comparable unrated
securities (a) will likely have some quality and protective characteristics
that, in the judgment of the rating organization, are outweighed by large
uncertainties or major risk exposures to adverse conditions and (b) are
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. Accordingly,
it is possible that these types of factors could, in certain instances, reduce
the value of securities held in a Master Portfolio's portfolio, with a
commensurate effect on the value of the Master Portfolio's shares. Therefore, an
investment in the Master Portfolio should not be considered as a complete
investment program and may not be appropriate for all investors.
The market prices of lower rated securities may fluctuate more than
higher rated securities and may decline significantly in periods of general
economic difficulty which may follow periods of rising interest rates. During an
economic downturn or a prolonged period of rising interest rates, the ability of
issuers of lower quality debt to service their payment obligations, meet
projected goals, or obtain additional financing may be impaired.
Since the risk of default is higher for lower rated securities, the
investment adviser will try to minimize the risks inherent in investing in lower
rated debt securities by engaging in credit analysis, diversification, and
attention to current developments and trends affecting interest rates and
economic conditions. The Investment adviser will attempt to identify those
issuers of high-yielding securities whose financial condition is adequate to
meet future obligations, have improved, or are expected to improve in the
future.
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Unrated securities are not necessarily of lower quality than rated
securities, but they may not be attractive to as may buyers. Each Master
Portfolio's policies regarding lower rated debt securities is not fundamental
and may be changed at any time without shareholder approval.
While the market values of lower rated debt and comparable unrated
securities tend to react less to fluctuations in interest rate levels than the
market values of higher-rated securities, the market values of certain lower
rated debt and comparable unrated securities also tend to be more sensitive to
individual corporate developments and changes in economic conditions than
higher-rated securities. In addition, lower rated debt securities and comparable
unrated securities generally present a higher degree of credit risk. Issuers of
lower rated debt and comparable unrated securities often are highly leveraged
and may not have more traditional methods of financing available to them so that
their ability to service their debt obligations during an economic downturn or
during sustained periods of rising interest rates may be impaired. The risk of
loss due to default by such issuers is significantly greater because lower rated
debt and comparable unrated securities generally are unsecured and frequently
are subordinated to the prior payment of senior indebtedness. A Master Portfolio
may incur additional expenses to the extent that it is required to seek recovery
upon a default in the payment of principal or interest on its portfolio
holdings. The existence of limited markets for lower rated debt and comparable
unrated securities may diminish a Master Portfolio's ability to (a) obtain
accurate market quotations for purposes of valuing such securities and
calculating its net asset value and (b) sell the securities at fair value either
to meet redemption requests or to respond to changes in the economy or in
financial markets.
Fixed-income securities, including lower rated debt securities and
comparable unrated securities, frequently have call or buy-back features that
permit their issuers to call or repurchase the securities from their holders,
such as a Master Portfolio. If an issuer exercises these rights during periods
of declining interest rates, a Master Portfolio may have to replace the security
with a lower yielding security, thus resulting in a decreased return to a Master
Portfolio.
The market for certain lower rated debt and comparable unrated
securities is relatively new and has not weathered a major economic recession.
The effect that such a recession might have on such securities is not known. Any
such recession, however, could disrupt severely the market for such securities
and adversely affect the value of such securities. Any such economic downturn
also could adversely affect the ability of the issuers of such securities to
repay principal and pay interest thereon.
MUNICIPAL SECURITIES
GENERAL. The two principal classifications of municipal securities are
"general obligation" securities and "revenue" securities. General obligation
securities are secured by the issuer's pledge of its full faith, credit, and
taxing power for the payment of principal and interest. Revenue securities are
payable only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise tax or other
specific revenue source such as the user of the facility being financed. Private
activity bonds held by a Master Portfolio are in most cases revenue securities
and are not payable from the unrestricted revenues of the issuer. Consequently,
the credit quality of private activity bonds is usually directly related to the
credit standing of the corporate user of the facility involved.
Municipal securities may include "moral obligation" bonds, which are
normally issued by special purpose public authorities. If the issuer of moral
obligation bonds is unable to meet its debt service obligations from current
revenues, it may draw on a reserve fund, the restoration of which is a moral
commitment but not a legal obligation of the state or municipality which created
the issuer.
Municipal securities may include variable- or floating- rate
instruments issued by industrial development authorities and other governmental
entities. While there may not be an active secondary market with respect to a
particular instrument purchased by a Master Portfolio, a Master Portfolio may
demand payment of the principal and accrued interest on the instrument or may
resell it to a third party as specified in the instruments. The absence of an
active secondary market, however, could make it difficult for a Master Portfolio
to dispose of the instrument if the issuer defaulted on its payment obligation
or during periods the Master Portfolio is not entitled to exercise its demand
rights, and the Master Portfolio could, for these or other reasons, suffer a
loss.
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Some of these instruments may be unrated, but unrated instruments
purchased by a Master Portfolio will be determined by the investment adviser to
be of comparable quality at the time of purchase to instruments rated "high
quality" by any major rating service. Where necessary to ensure that an
instrument is of comparable "high quality," a Master Portfolio will require that
an issuer's obligation to pay the principal of the note may be backed by an
unconditional bank letter or line of credit, guarantee, or commitment to lend.
Municipal securities may include participations in privately arranged
loans to municipal borrowers, some of which may be referred to as "municipal
leases." Generally such loans are unrated, in which case they will be determined
by the investment adviser to be of comparable quality at the time of purchase to
rated instruments that may be acquired by a Master Portfolio. Frequently,
privately arranged loans have variable interest rates and may be backed by a
bank letter of credit. In other cases, they may be unsecured or may be secured
by assets not easily liquidated. Moreover, such loans in most cases are not
backed by the taxing authority of the issuers and may have limited marketability
or may be marketable only by virtue of a provision requiring repayment following
demand by the lender. Such loans made by a Master Portfolio may have a demand
provision permitting the Master Portfolio to require payment within seven days.
Participations in such loans, however, may not have such a demand provision and
may not be otherwise marketable.
Although lease obligations do not constitute general obligations of the
municipality for which the municipality's taxing power is pledged, a lease
obligation is ordinarily backed by the municipality's covenant to budget for,
appropriate, and make the payments due under the lease obligation. However,
certain lease obligations contain "non-appropriation" clauses which provide that
the municipality has no obligation to make lease or installment purchase
payments in future years unless money is appropriated for such purpose on a
yearly basis. In addition to the "non-appropriation" risk, these securities
represent a relatively new type of financing that has not yet developed the
depth of marketability associated with more conventional bonds. In the case of a
"non-appropriation" lease, the Master Portfolios' ability to recover under the
lease in the event of non-appropriation or default will be limited solely to the
repossession of the leased property in the event foreclosure might prove
difficult.
The Master Portfolios will not invest more than 5% of their total
investment assets in lease obligations that contain "non-appropriation" clauses
where (1) the nature of the leased equipment or property is such that its
ownership or use is essential to a governmental function of the municipality,
(2) the lease payments will commence amortization of principal at an early date
resulting in an average life of seven years or less for the lease obligation,
(3) appropriate covenants will be obtained from the municipal obligor
prohibiting the substitution or purchase of similar equipment if lease payments
are not appropriated, (4) the lease obligor has maintained good market
acceptability in the past, (5) the investment is of a size that will be
attractive to institutional investors, and (6) the underlying leased equipment
has elements of probability and/or use that enhance its marketability in the
event foreclosure on the underlying equipment were ever required. The Master
Portfolios have not imposed any percentage limitations with respect to their
investment in lease obligations not subject to the "non-appropriation" risk. To
the extent municipal leases are illiquid, they will be subject to each Master
Portfolio's limitation on investments in illiquid securities. Recovery of an
investment in any such loan that is illiquid and payable on demand may depend on
the ability of the municipal borrower to meet an obligation for full repayment
of principal and payment of accrued interest within the demand period, normally
seven days or less (unless a Master Portfolio determines that a particular loan
issue, unlike most such loans, has a readily available market). As it deems
appropriate, the investment adviser will establish procedures to monitor the
credit standing of each such municipal borrower, including its ability to meet
contractual payment obligations.
In evaluating the credit quality of a municipal lease obligation and
determining whether such lease obligation will be considered "liquid," the
investment adviser for each Master Portfolio will consider: (1) whether the
lease can be canceled; (2) what assurance there is that the assets represented
by the lease can be sold; (3) the strength of the lessee's general credit (e.g.,
its debt, administrative, economic, and financial characteristics); (4) the
likelihood that the municipality will discontinue appropriating funding for the
leased property because the property is no longer deemed essential to the
operations of the municipality (e.g., the potential for an "event of
non-appropriation"); and (5) the legal recourse in the event of failure to
appropriate.
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Municipal securities may include units of participation in trusts
holding pools of tax-exempt leases. Municipal participation interests may be
purchased from financial institutions, and give the purchaser an undivided
interest in one or more underlying municipal security. To the extent that
municipal participation interests are considered to be "illiquid securities,"
such instruments are subject to each Master Portfolio's limitation on the
purchase of illiquid securities. Municipal leases and participating interests
therein, which may take the form of a lease or an installment sales contract,
are issued by state and local governments and authorities to acquire a wide
variety of equipment and facilities. Interest payments on qualifying leases are
exempt from Federal income taxes.
In addition, certain of the Master Portfolios may acquire "stand-by
commitments" from banks or broker/dealers with respect to municipal securities
held in their portfolios. Under a stand-by commitment, a dealer would agree to
purchase at a Master Portfolio's option specified Municipal Securities at a
specified price. The Master Portfolios will acquire stand-by commitments solely
to facilitate portfolio liquidity and do not intend to exercise their rights
thereunder for trading purposes.
Although the Master Portfolios do not presently intend to do so on a
regular basis, each may invest more than 25% of its total assets in municipal
securities the interest on which is paid solely from revenues of similar
projects if such investment is deemed necessary or appropriate by the investment
adviser. To the extent that more than 25% of a Master Portfolio's total assets
are invested in Municipal Securities that are payable from the revenues of
similar projects, a Master Portfolio will be subject to the peculiar risks
presented by such projects to a greater extent than it would be if its assets
were not so concentrated.
There are, of course, variations in the quality of Municipal
Securities, both within a particular classification and between classifications,
and the yields on Municipal Securities depend upon a variety of factors,
including general money market conditions, the financial condition of the
issuer, general conditions of the municipal bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of nationally recognized statistical rating organizations
represent their opinions as to the quality of Municipal Securities. It should be
emphasized, however, that these ratings are general and are not absolute
standards of quality, and Municipal Securities with the same maturity, interest
rate, and rating may have different yields while Municipal Securities of the
same maturity and interest rate with different ratings may have the same yield.
Subsequent to its purchase by a Master Portfolio, an issue of Municipal
Securities may cease to be rated, or its rating may be reduced below the minimum
rating required for purchase by that Master Portfolio. The investment adviser
will consider such an event in determining whether a Master Portfolio should
continue to hold the obligation.
Opinions relating to the validity of Municipal Securities and to the
exemption of interest thereon from regular Federal income tax or state income
tax are rendered by counsel to the issuer or bond counsel at the time of
issuance. Neither the Master Portfolios nor the investment adviser will review
the proceedings relating to the issuance of Municipal Securities or the bases
for opinions relating to the validity of such issuance.
The payment of principal and interest on most securities purchased by a
Master Portfolio will depend upon the ability of the issuers to meet their
obligations. Each state, each of their political subdivisions, municipalities,
and public authorities, as well as the District of Columbia, Puerto Rico, Guam,
and the Virgin Islands are a separate "issuer" as that term is used in Part A
and Part B. The non-governmental user of facilities financed by private activity
bonds is also considered to be an "issuer." An issuer's obligations under its
Municipal Securities are subject to the provisions of bankruptcy, insolvency,
and other laws affecting the rights and remedies of creditors, such as the
Federal Bankruptcy Code, and laws, if any, which may be enacted by Federal or
state legislatures extending the time for payment of principal or interest, or
both, or imposing other constraints upon enforcement of such obligations or upon
the ability of municipalities to levy taxes. The power or ability of an issuer
to meet its obligations for the payment of interest on and principal of its
Municipal Securities may be materially adversely affected by litigation or other
conditions.
Certain types of Municipal Securities (private activity bonds) have
been or are issued to obtain funds to provide, among other things, privately
operated housing facilities, pollution control facilities, convention or trade
show facilities, mass transit, airport, port or parking facilities, and certain
local facilities for water supply, gas, electricity, or sewage or solid waste
disposal. Private activity bonds are also issued for privately held or publicly
owned corporations in the financing of commercial or industrial facilities. Most
governments are authorized to issue
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private activity bonds for such purposes in order to encourage corporations to
locate within their communities. The principal and interest on these obligations
may be payable from the general revenues of the users of such facilities.
From time to time, proposals have been introduced before Congress for
the purpose of restricting or eliminating the Federal income tax exemption for
interest on Municipal Securities. Such proposals, while pending or if enacted,
might materially and adversely affect the availability of Municipal Securities
for investment by one of these Master Portfolios and the liquidity and value of
such portfolios. In such an event, a Master Portfolio impacted would re-evaluate
its investment objective and policies and consider possible changes in its
structure or possible dissolution.
OPTIONS ON CURRENCIES
Certain Master Portfolios may purchase and sell options on currencies
to hedge the value of securities the Master Portfolio holds or intends to buy.
Options on foreign currencies may be traded on U.S. and foreign exchanges or
over-the-counter.
OTHER INVESTMENT COMPANIES
In seeking to attain their investment objectives, certain Master
Portfolios may invest in securities issued by other investment companies within
the limits prescribed by the 1940 Act. Each Master Portfolio currently intends
to limit its investments so that, as determined immediately after a securities
purchase is made: (a) not more than 5% of the value of its total assets will be
invested in the securities of any one investment company; (b) not more than 10%
of the value of its total assets will be invested in the aggregate in securities
of investment companies as a group; and (c) not more than 3% of the outstanding
voting stock of any one investment company will be owned by the Master Portfolio
or by the Trust as a whole. As a shareholder of another investment company, a
Master Portfolio would bear, along with other shareholders, its pro rata portion
of the other investment company's expenses, including investment advisory fees.
These expenses would be in addition to the investment advisory and other
expenses that a Master Portfolio bears in connection with its own operations.
The investment adviser has agreed to remit to the respective investing Master
Portfolio fees payable to it under its respective Investment Advisory Agreement
with an affiliated money market fund to the extent such fees are based upon the
investing Master Portfolio's assets invested in shares of the affiliated money
market fund.
REAL ESTATE INVESTMENT TRUSTS
A real estate investment trust ("REIT") is a managed portfolio of real
estate investments which may include office buildings, apartment complexes,
hotels and shopping malls. An equity REIT holds equity positions in real estate,
and it seeks to provide its shareholders with income from the leasing of its
properties, and with capital gains from any sales of properties. A mortgage REIT
specializes in lending money to developers of properties, and passes any
interest income it may earn to its shareholders.
REITs may be affected by changes in the value of the underlying
property owned or financed by the REIT, while Mortgage REITs also may be
affected by the quality of credit extended. Both equity and mortgage REITs are
dependent upon management skill and may not be diversified. REITs also may be
subject to heavy cash flow dependency, defaults by borrowers, self-liquidation,
and the possibility of failing to qualify for tax-free pass-through of income
under the Internal Revenue Code of 1986, as amended.
REPURCHASE AGREEMENTS
Repurchase agreements are agreements by which a person (E.G., a Master
Portfolio) obtains a security and simultaneously commits to return the security
to the seller (a member bank of the Federal Reserve System or recognized
securities dealer) at an agreed upon price (including principal and interest) on
an agreed upon date within a number of days (usually not more than seven) from
the date of purchase. The resale price reflects the purchase price plus an
agreed upon market rate of interest which is unrelated to the coupon rate or
maturity of the underlying security. A repurchase agreement involves the
obligation of the seller to pay the agreed upon price, which obligation is in
effect secured by the value of the underlying security.
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The repurchase agreements entered into by the Master Portfolios will
provide that the underlying security at all times shall have a value at least
equal to 102% of the resale price stated in the agreement (the investment
adviser, the Custodian or an agent of either such party monitors compliance with
this requirement). Under all repurchase agreements entered into by the Master
Portfolios, the Master Portfolios' custodian or its agent must take possession
of the underlying collateral. However, if the seller defaults, the Master
Portfolios could realize a loss on the sale of the underlying security to the
extent that the proceeds of sale including accrued interest are less than the
resale price provided in the agreement including interest. In addition, even
though the Bankruptcy Code provides protection for most repurchase agreements,
if the seller should be involved in bankruptcy or insolvency proceedings, the
Master Portfolios may incur delay and costs in selling the underlying security
or may suffer a loss of principal and interest if the Master Portfolios are
treated as an unsecured creditor and required to return the underlying security
to the seller's estate. Repurchase agreements are a permissible investment for
all Master Portfolios.
RESTRICTED SECURITIES
Restricted securities are securities that may not be sold to the public
without registration under the Securities Act of 1933, as amended (the "1933
Act") absent an exemption from registration. Certain of the permitted
investments of the Master Portfolios may be restricted securities and the
investment adviser may invest in restricted securities based on guidelines which
are the responsibility of and are periodically reviewed by the Board of
Trustees. Under these guidelines, the investment adviser will consider the
frequency of trades and quotes for the security, the number of dealers in, and
potential purchasers for, the securities, dealer undertakings to make a market
in the security, and the nature of the security and of the marketplace trades.
In purchasing such restricted securities, the investment adviser intends to
purchase securities that are exempt from registration under Rule 144A and
Section 4(2) promulgated under the 1933 Act. The Master Portfolios may purchase
liquid and illiquid restricted securities.
REVERSE REPURCHASE AGREEMENTS
At the time a Master Portfolio enters into a reverse repurchase
agreement, it may establish a segregated account with its custodian bank in
which it will maintain cash, U.S. Government securities or other liquid high
grade debt obligations equal in value to its obligations in respect of reverse
repurchase agreements. Reverse repurchase agreements involve the risk that the
market value of the securities the Master Portfolios are obligated to repurchase
under the agreement may decline below the repurchase price. In the event the
buyer of securities under a reverse repurchase agreement files for bankruptcy or
becomes insolvent, the Master Portfolios' use of proceeds of the agreement may
be restricted pending a determination by the other party, or its trustee or
receiver, whether to enforce the Master Portfolios' obligation to repurchase the
securities. Reverse repurchase agreements are speculative techniques involving
leverage, and are subject to asset coverage requirements if the Master
Portfolios do not establish and maintain a segregated account (as described
above). In addition, some or all of the proceeds received by a Master Portfolio
from the sale of a portfolio instrument may be applied to the purchase of a
repurchase agreement. To the extent the proceeds are used in this fashion and a
common broker/dealer is the counterparty on both the reverse repurchase
agreement and the repurchase agreement, the arrangement might be recharacterized
as a swap transaction. Under the requirements of the 1940 Act, the Master
Portfolios are required to maintain an asset coverage (including the proceeds of
the borrowings) of at least 300% of all borrowings. Depending on market
conditions, the Master Portfolios' asset coverage and other factors at the time
of a reverse repurchase, the Master Portfolios may not establish a segregated
account when the investment adviser believes it is not in the best interests of
the Master Portfolios to do so. In this case, such reverse repurchase agreements
will be considered borrowings subject to the asset coverage described above.
SECURITIES LENDING
To increase return on portfolio securities, all the Master Portfolios
may lend their portfolio securities to broker/dealers and other institutional
investors pursuant to agreements requiring that the loans be continuously
secured by collateral equal at all times in value to at least the market value
of the securities loaned. Collateral for such loans may include cash, securities
of the U.S. Government, its agencies or instrumentalities, an irrevocable letter
of credit issued by (i) a U.S. bank that has total assets exceeding $1 billion
and that is a member of the Federal Deposit Insurance Corporation, or (ii) a
foreign bank that is one of the 75 largest foreign commercial banks in terms
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of total assets, or any combination thereof. Such loans will not be made if, as
a result, the aggregate of all outstanding loans of the Master Portfolio
involved exceeds one-third of the value of its total assets taken at fair market
value. A Master Portfolio will continue to receive interest on the securities
lent while simultaneously earning interest on the investment of the cash
collateral in U.S. government securities, including cash collateral received for
securities loans. However, a Master Portfolio will normally pay lending fees to
such broker/dealers and related expenses from the interest earned on investment
collateral. Any loan may be terminated by either party upon reasonable notice to
the other party.
There may be risks of delay in receiving additional collateral or in
recovering the securities loaned or even a loss of rights in the collateral
should the borrower of the securities fail financially. However, loans are made
only to borrowers deemed by the investment adviser to be of good standing and
when, in its judgment, the income to be earned from the loan justifies the
attendant risks. Pursuant to the securities loan agreement a Master Portfolio is
able to terminate the securities loan upon notice of not more than five business
days and thereby secure the return to the Master Portfolio of securities
identical to the transferred securities upon termination of the loan.
SHORT SALES
Certain Master Portfolios may from time to time enter into short sales
transactions. A Master Portfolio will not make short sales of securities nor
maintain a short position unless at all times when a short position is open,
such Master Portfolio owns an equal amount of such securities or securities
convertible into or exchangeable, without payment of any further consideration,
for securities of the same issue as, and equal in amount to, the securities sold
short. This is a technique known as selling short "against the box." Such short
sales will be used by a Master Portfolio for the purpose of deferring
recognition of gain or loss for federal income tax purposes.
SPECIAL SITUATIONS
Certain Master Portfolios may invest in "special situations." A special
situation arises when, in the opinion of the investment adviser, the securities
of a particular company will, within a reasonably estimable period of time, be
accorded market recognition at an appreciated value solely by reason of a
development applicable to that company, and regardless of general business
conditions or movements of the market as a whole. Developments creating special
situations might include, among others: liquidations, reorganizations,
recapitalizations, mergers, material litigation, technical breakthroughs and new
management or management policies. Although large and well known companies may
be involved, special situations more often involve comparatively small or
unseasoned companies. Investments in unseasoned companies and special situations
often involve much greater risk than is inherent in ordinary investment
securities.
STAND-BY COMMITMENTS
Certain Master Portfolios may acquire "stand-by commitments" with
respect to Municipal Securities held in their portfolios. Under a "stand-by
commitment," a dealer agrees to purchase from a Master Portfolio, at a Master
Portfolio's option, specified Municipal Securities at a specified price.
Stand-by commitments are exercisable by a Master Portfolio at any time before
the maturity of the underlying Municipal Securities, and may be sold,
transferred, or assigned by a Master Portfolio only with the underlying
instruments.
The amount payable to a Master Portfolio upon its exercise of a
stand-by commitment will normally be (i) the Master Portfolio's acquisition cost
of the Municipal Securities (excluding any accrued interest which a Master
Portfolio paid on their acquisition), less any amortized market premium or plus
any amortized market or original issue discount during the period a Master
Portfolio owned the securities, plus (ii) all interest accrued on the securities
since the last interest payment date during that period. Under normal market
conditions, in determining net asset value a Master Portfolio values the
underlying Municipal Securities on an amortized cost basis. Accordingly, the
amount payable by a dealer upon exercise of a stand-by commitment will normally
be substantially the same as the portfolio value of the underlying Municipal
Securities.
A Master Portfolio's right to exercise stand-by commitments will be
unconditional and unqualified. A stand-by commitment will not be transferable by
a Master Portfolio, although the Master Portfolio could sell the
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underlying Municipal Securities to a third party at any time. Until a Master
Portfolio exercises its stand-by commitment, it owns the securities in its
portfolio which are subject to the stand-by commitment.
The Master Portfolios expect that stand-by commitments will generally
be available without the payment of any direct or indirect consideration.
However, if necessary or advisable, a Master Portfolio may pay for a stand-by
commitment either separately in cash or by paying a higher price for the
security being acquired which will be subject to the commitment (thus reducing
the yield to maturity otherwise available for the same security). When a Master
Portfolio pays any consideration directly or indirectly for a stand-by
commitment, its cost will be reflected as unrealized depreciation for the period
during which the commitment is held by that Master Portfolio.
The Master Portfolios will not acquire a stand-by commitment unless
immediately after the acquisition not more than 5% of the Master Portfolios'
total assets will be subject to a demand feature, or in stand-by commitments,
with the same institution.
Each Master Portfolio intends to enter into stand-by commitments only
with banks and broker/dealers which, in the investment adviser's opinion,
present minimal credit risks. In evaluating the credit worthiness of the issuer
of a stand-by commitment, the investment adviser will review periodically the
issuer's assets, liabilities, contingent claims, and other relevant financial
information.
The Master Portfolios would acquire stand-by commitments solely to
facilitate portfolio liquidity and do not intend to exercise their rights
thereunder for trading purposes. Stand-by commitments acquired by a Master
Portfolio will be valued at zero in determining net asset value. A Master
Portfolio's reliance upon the credit of these dealers, banks, and broker/dealers
will be secured by the value of the underlying Municipal Securities that are
subject to the commitment. Thus, the risk of loss to the Master Portfolio in
connection with a "stand-by commitment" will not be qualitatively different from
the risk of loss faced by a person that is holding securities pending settlement
after having agreed to sell the securities in the ordinary course of business.
STRIPPED SECURITIES
Certain Master Portfolios may purchase stripped securities issued or
guaranteed by the U.S. Government, where the principal and interest components
are traded independently under the Separate Trading of Registered Interest and
Principal of Securities program ("STRIPS"). Under STRIPS, the principal and
interest components are individually numbered and separately issued by the U.S.
Treasury at the request of depository financial institutions, which then trade
the component parts independently.
In addition, the Master Portfolio may purchase stripped mortgage-backed
securities ("SMBS") issued by the U.S. Government (or a U.S. Government agency
or instrumentality) or by private issuers such as banks and other institutions.
If the underlying obligations experience greater than anticipated prepayments of
principal, the Master Portfolio may fail to fully recover its initial
investment. The market value of the class consisting entirely of principal
payments can be extremely volatile in response to changes in interest rates. The
yields on a class of SMBS that receives all or most of the interest are
generally higher than prevailing market yields on other mortgage-backed
obligations because their cash flow patterns are also volatile and there is a
greater risk that the initial investment will not be full recovered. SMBS issued
by the U.S. Government (or a U.S. Government agency or instrumentality) may be
considered liquid under guidelines established by the Trust's Board of Trustees
if they can be disposed of promptly in the ordinary course of business at a
value reasonably close to that used in the calculation of the Master Portfolio's
net asset value.
Although stripped securities may not pay interest to holders prior to
maturity, Federal income tax regulations require a Master Portfolio to recognize
as interest income a portion of the bond's discount each year. This income must
then be distributed to interestholders along with other income earned by the
Master Portfolio. To the extent that any interestholders in the Master Portfolio
elect to receive their dividends in cash rather than reinvest such dividends in
additional Master Portfolio interests, cash to make these distributions will
have to be provided from the assets of the Master Portfolio or other sources
such as proceeds of sales of Master Portfolio interests and/or sales of
portfolio securities. In such cases, the Master Portfolio will not be able to
purchase additional income producing securities with cash used to make such
distributions and its current income may ultimately be reduced as a result.
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TAX-EXEMPT INSTRUMENTS
Tax-exempt instruments which are permissible investments include
floating-rate notes. Investments in such floating-rate instruments will normally
involve industrial development or revenue bonds which provide that the rate of
interest is set as a specific percentage of a designated base rate (such as the
prime rate at a major commercial bank), and that the Master Portfolio can demand
payment of the obligation at all times or at stipulated dates on short notice
(not to exceed 30 days) at par plus accrued interest. Such obligations are
frequently secured by letters of credit or other credit support arrangements
provided by banks. The quality of the underlying credit or of the bank, as the
case may be, must, in the investment adviser's opinion be comparable to the
long-term bond or commercial paper ratings discussed in Part A. The investment
adviser will monitor the earnings power, cash flow and liquidity ratios of the
issuers of such instruments and the ability of an issuer of a demand instrument
to pay principal and interest on demand. The investment adviser may purchase
other types of tax-exempt instruments as long as they are of a quality
equivalent to the long-term bond or commercial paper ratings discussed in Part
A, including municipal lease obligations and participation interests in
municipal securities (such as industrial development bonds and municipal lease
purchase payments).
U.S. AND FOREIGN BANK OBLIGATIONS
These obligations include negotiable certificates of deposit, banker's
acceptances and fixed time deposits. Each Master Portfolio limits its
investments in domestic bank obligations to banks having total assets in excess
of $1 billion and subject to regulation by the U.S. Government. Each Master
Portfolio may also invest in certificates of deposit issued by members of the
Federal Deposit Insurance Corporation ("FDIC") having total assets of less than
$1 billion, provided that the Master Portfolio will at no time own more than
$100,000 principal amount of certificates of deposit (or any higher principal
amount which in the future may be fully covered by FDIC insurance) of any one of
those issuers. Fixed time deposits are obligations which are payable at a stated
maturity date and bear a fixed rate of interest. Generally, fixed time deposits
may be withdrawn on demand by a Master Portfolio, but they may be subject to
early withdrawal penalties which vary depending upon market conditions and the
remaining maturity of the obligation. Although fixed time deposits do not have a
market, there are no contractual restrictions on a Master Portfolio's right to
transfer a beneficial interest in the deposit to a third party.
Each Master Portfolio limits its investments in foreign bank
obligations (i.e., obligations of foreign branches and subsidiaries of domestic
banks, and domestic and foreign branches and agencies of foreign banks) to
obligations of banks which at the time of investment are branches or
subsidiaries of domestic banks which meet the criteria in the preceding
paragraphs or are branches or agencies of foreign banks which (i) have more than
$10 billion, or the equivalent in other currencies, in total assets; (ii) in
terms of assets are among the 75 largest foreign banks in the world; (iii) have
branches or agencies in the United States; and (iv) in the opinion of the
investment adviser, pursuant to the established by the Board of Trustees of the
Trust, are of an investment quality comparable to obligations of domestic banks
which may be purchased by a Master Portfolio. These obligations may be general
obligations of the parent bank in addition to the issuing branch or subsidiary,
but the parent bank's obligations may be limited by the terms of the specific
obligation or by governmental regulation. Each Master Portfolio also limits its
investments in foreign bank obligations to banks, branches and subsidiaries
located in Western Europe (United Kingdom, France, Germany, Belgium, The
Netherlands, Italy and Switzerland), Scandinavia (Denmark and Sweden),
Australia, Japan, the Cayman Islands, the Bahamas and Canada. Each Master
Portfolio will limit its investment in securities of foreign banks to not more
than 20% of total assets at the time of investment.
Each Master Portfolio may also make interest-bearing savings deposits
in commercial and savings banks in amounts not in excess of 5% of the total
assets of the Master Portfolio.
U.S. GOVERNMENT OBLIGATIONS
Each Master Portfolio may invest in U.S. Government obligations.
Examples of the types of U.S. Government obligations that may be held by the
Master Portfolios include, in addition to U.S. Treasury bonds, notes and bills,
the obligations of the Federal Home Loan Banks, Federal Farm Credit Banks,
Federal Land Banks, Federal
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Housing Administration, Farmers Home Administration, Export-Import Bank of the
United States, Small Business Administration, Government National Mortgage
Association, Federal National Mortgage Association, General Services
Administration, Student Loan Marketing Association, Central Bank for
Cooperatives, Federal Home Loan Mortgage Corporation, Federal Intermediate
Credit Banks, Tennessee Valley Authority, Resolution Funding Corporation and
Maritime Administration. Obligations guaranteed as to principal or interest by
the U.S. Government, its agencies, authorities or instrumentalities are deemed
to include: (a) securities for which the payment of principal and interest is
backed by an irrevocable letter of credit issued by the U.S. Government, its
agencies, authorities or instrumentalities and (b) participations in loans made
to foreign governments or their agencies that are so guaranteed. The secondary
market for certain of these participations is limited. If such participations
are illiquid they will not be purchased.
U.S. Government obligations include principal and interest components
of securities issued or guaranteed by the U.S. Treasury if the components are
traded independently under the Separate Trading of Registered Interest and
Principal of Securities program. Obligations issued or guaranteed as to
principal or interest by the U.S. Government, its agencies, authorities or
instrumentalities may also be acquired in the form of custodial receipts. These
receipts evidence ownership of future interest payments, principal payments or
both on certain notes or bonds issued by the U.S. Government, its agencies,
authorities or instrumentalities.
USE OF SEGREGATED AND OTHER SPECIAL ACCOUNTS
Options, futures and forward foreign currency contracts that obligate a
Master Portfolio to provide cash, securities or currencies to complete such
transactions will entail that Master Portfolio to either segregate assets in an
account with, or on the books of, the Trust's custodian, or otherwise "covering"
the transaction as described below. For example, a call option written by a
Master Portfolio will require the Master Portfolio to hold the securities
subject to the call (or securities convertible into the needed securities
without additional consideration) or liquid assets sufficient to meet the
obligation by purchasing and delivering the securities if the call is exercised.
A call option written on an index will require that Master Portfolio to have
portfolio securities that correlate with the index. A put option written by a
Master Portfolio also will require that Master Portfolio to have available
assets sufficient to purchase the securities the Master Portfolio would be
obligated to buy if the put is exercised.
A forward foreign currency contract that obligates a Master Portfolio
to provide currencies will require the Master Portfolio to hold currencies or
liquid securities denominated in a foreign currency which will equal the Master
Portfolio's obligations. Such a contract requiring the purchase of currencies
also requires segregation.
Unless a segregated account consists of the securities, cash or
currencies that are the subject of the obligation, a Master Portfolio will hold
cash, U.S. Government securities and other high grade liquid debt obligations in
a segregated account. These assets cannot be transferred while the obligation is
outstanding unless replaced with other suitable assets. In the case of an
index-based transaction, a Master Portfolio could own securities substantially
replicating the movement of the particular index.
In the case of a futures contract, a Master Portfolio must deposit
initial margin and variation margin, as often as daily, if the position moves
adversely, sufficient to meet its obligation to purchase or provide securities
or currencies, or to pay the amount owed at the expiration of an index-based
futures contract. Similarly, options on futures contracts require a Master
Portfolio to deposit margin to the extent necessary to meet the Master
Portfolio's commitments.
In lieu of such assets, such transactions may be covered by other means
consistent with applicable regulatory policies. A Master Portfolio may enter
into off-setting transactions so that its combined position, coupled with any
segregated assets, equals its net outstanding obligation in related options and
hedging transactions. For example, a Master Portfolio could purchase a put
option if the strike price of that option is the same or higher than the strike
price of a put option sold by that Master Portfolio. Moreover, instead of
segregating assets if a Master Portfolio held a futures or forward contract, it
could purchase a put option on the same futures or forward contract with a
strike price as high or higher than the price of the contract held. Of course,
the off-setting transaction must terminate at the time of or after the primary
transaction.
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VARIABLE AMOUNT MASTER DEMAND NOTES
Commercial paper which may be purchased by the Master Portfolios
includes variable-amount master demand notes which may or may not be backed by
bank letters of credit. These notes permit the investment of fluctuating amounts
at varying market rates of interest pursuant to direct arrangements between the
Trust, as lender, and the borrower. Such notes provide that the interest rate on
the amount outstanding varies on a periodic basis (E.G. daily, weekly or
monthly) depending upon a stated short-term interest rate index. Both the lender
and the borrower may have the right to reduce the amount of outstanding
indebtedness at any time. There is no secondary market for the notes. It is not
generally contemplated that such instruments will be traded. The holder of an
instrument with a demand feature may tender the instrument back to the issuer at
par prior to maturity. A variable-amount master demand note is issued pursuant
to a written agreement between the issuer and the holder, its amount may be
increased by the holder or decreased by the holder or issuer, it is payable on
demand, and the rate of interest varies based upon an agreed formula. The
investment adviser will monitor on an ongoing basis the earnings power, cash
flow, and liquidity ratios of the issuers of such instruments and will similarly
monitor the ability of an issuer of a demand instrument to pay principal and
interest on demand. In addition, variable-amount master demand notes must meet
the demand feature ratings and notice requirements set forth above.
VARIABLE- AND FLOATING-RATE INSTRUMENTS
Certain Master Portfolios may purchase variable-rate and floating rate
obligations. If such instrument is not rated, the investment adviser will
consider the earning power, cash flows, and other liquidity ratios of the
issuers and guarantors of such obligations and, if the obligation is subject to
a demand feature, will monitor their financial status to meet payment on demand.
In determining average weighted portfolio maturity, a variable-rate demand
instrument issued or guaranteed by the U.S. Government or an agency or
instrumentality thereof will be deemed to have a maturity equal to the period
remaining until the obligations next interest rate adjustment. Other
variable-rate obligations will be deemed to have a maturity equal to the longer
of the period remaining to the next interest rate adjustment or the time a
Master Portfolio can recover payment of principal as specified in the
instrument.
The variable- and-floating rate demand instruments that the Master
Portfolios may purchase include participations in Municipal Securities purchased
from and owned by financial institutions, primarily banks. Participation
interests provide a Master Portfolio with a specified undivided interest (up to
100%) in the underlying obligation and the right to demand payment of the unpaid
principal balance plus accrued interest on the participation interest from the
institution upon a specified number of days' notice, not to exceed 30 days. Each
participation interest is backed by an irrevocable letter of credit or guarantee
of a bank that the investment adviser has determined meets the prescribed
quality standards for the Master Portfolios. The bank typically retains fees out
of the interest paid on the obligation for servicing the obligation, providing
the letter of credit, and issuing the repurchase commitment.
WARRANTS
Certain Master Portfolios are permitted to invest in warrants. Warrants
are privileges issued by corporations enabling the owner to subscribe to and
purchase a specified number of shares of the corporation at a specified price
during a specified period of time. The prices of warrants do not necessarily
correlate with the prices of the underlying securities. The purchase of warrants
involves the risk that the purchaser could lose the purchase value of the
warrant if the right to subscribe to additional shares is not exercised prior to
the warrant's expiration. Also, the purchase of warrants involves the risk that
the effective price paid for the warrant added to the subscription price of the
related security may exceed the value of the subscribed security's market price
such as when there is no movement in the level of the underlying security.
39
<PAGE>
WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS
A Master Portfolio may agree to purchase securities on a when-issued
basis or enter into a forward commitment to purchase securities. When a Master
Portfolio engages in these transactions, its custodian will segregate cash, U.S.
government securities or other high quality debt obligations equal to the amount
of the commitment. Normally, the custodian will segregate portfolio securities
to satisfy a purchase commitment, and in such a case a Master Portfolio may be
required subsequently to segregate additional assets in order to ensure that the
value of the segregated assets remains equal to the amount of the Master
Portfolio's commitment. Because a Master Portfolio will segregate cash or liquid
assets to satisfy its purchase commitments in the manner described, the Master
Portfolio's liquidity and ability to manage its portfolio might be adversely
affected in the event its commitments to purchase when-issued securities ever
exceeded 25% of the value of its assets. In the case of a forward commitment to
sell portfolio securities, the Master Portfolio's custodian will hold the
portfolio securities themselves in a segregated account while the commitment is
outstanding.
A Master Portfolio will make commitments to purchase securities on a
when-issued basis or to purchase or sell securities on a forward commitment
basis only with the intention of completing the transaction and actually
purchasing or selling the securities. If deemed advisable as a matter of
investment strategy, however, a Master Portfolio may dispose of or renegotiate a
commitment after it is entered into, and may sell securities it has committed to
purchase before those securities are delivered to the Master Portfolio on the
settlement date. In these cases the Master Portfolio may realize a capital gain
or loss.
When a Master Portfolio engages in when-issued and forward commitment
transactions, it relies on the other party to consummate the trade. Failure of
such party to do so may result in the Master Portfolio's incurring a loss or
missing an opportunity to obtain a price considered to be advantageous.
The value of the securities underlying a when-issued purchase or a
forward commitment to purchase securities, and any subsequent fluctuations in
their value, is taken into account when determining the net asset value of a
Master Portfolio starting on the date the Master Portfolio agrees to purchase
the securities. The Master Portfolio does not earn dividends on the securities
it has committed to purchase until they are paid for and delivered on the
settlement date. When the Master Portfolio makes a forward commitment to sell
securities it owns, the proceeds to be received upon settlement are included in
the Master Portfolio's assets. Fluctuations in the value of the underlying
securities are not reflected in the Master Portfolio's net asset value as long
as the commitment remains in effect.
PORTFOLIO TURNOVER
Generally, the Master Portfolios will purchase portfolio securities for
capital appreciation or investment income, or both, and not for short-term
trading profits. If a Master Portfolio's annual portfolio turnover rate exceeds
100%, it may result in higher brokerage costs and possible tax consequences for
the interestholders.
ITEM 13. MANAGEMENT OF THE TRUST
The management and affairs of the Trust are supervised by the Trustees under the
laws governing business trusts in the state of Delaware. The Trustees and the
officers of the Trust and their principal occupations for the last five years
are set forth below.
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATIONS
DURING PAST 5 YEARS
POSITION WITH AND CURRENT
NAME, ADDRESS, AND AGE THE TRUST DIRECTORSHIPS
- ---------------------- --------- -------------
<S> <C> <C>
Edmund L. Benson, III, 63 Trustee Director, President and Treasurer,
Saunders & Benson, Inc. Saunders & Benson, Inc. (Insurance);
728 East Main Street Trustee, Nations Institutional
Suite 400 Reserves, Nations Fund Trust,
Richmond, VA 23219 Nations Annuity Trust and Nations
Master Investment Trust; Director,
</TABLE>
40
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATIONS
DURING PAST 5 YEARS
POSITION WITH AND CURRENT
NAME, ADDRESS, AND AGE THE TRUST DIRECTORSHIPS
- ---------------------- --------- -------------
<S> <C> <C>
Nations Fund, Inc., Nations Fund
Portfolios, Inc. and Nations
LifeGoal Fund, Inc.
William P. Carmichael, 56 Trustee Trustee - 231 Funds (investment
Succession Fund company) from 1993 to 1995, Time
The Wrigley Building Horizon Fund (investment company)
400 North Michigan Avenue from 1995 to 1999, Pacific
Suite 1016 Innovations Trust (investment
Chicago, IL 60611 company) from 1997 to 1999, Nations
Annuity Trust (investment company)
since December 1999, Nations Master
Investment Trust (investment
company) since December 1999 and
Nations Funds Trust (investment
company) since December 1999;
Director- The Hain Food Group, Inc.
(specialty food products
distributor) until December 1998,
Cobra Electronics Corporation
(electronic equipment manufacturer),
Opta Food Ingredients, Inc. (food
ingredients manufacturer), Golden
Rule Insurance Company, Nations
LifeGoal Funds, Inc. (investment
company) since December 1999.
James Ermer, 57 Trustee Retired; Formerly, (Senior Vice
13705 Hickory Nut Point President- Finance, CSX Corporation
Midlothian, VA 23112 (transportation and natural
resources); Director, National Mine
Service; Director, Lawyers Title
Corporation; Trustee, Nations
Institutional Reserves, Nations Fund
Trust, Nations Annuity Trust and
Nations Master Investment Trust;
Director, Nations Fund, Inc.,
Nations Fund Portfolios, Inc. and
Nations LifeGoal Funds, Inc.
William H. Grigg, 67 Trustee Since June 1997, Chairman Emeritus;
Duke Power Co. June 1997 to April 1994, Chairman
422 South Church Street and Chief Executive Officer;
PB04G November 1991 to April 1994, Vice
Charlotte, NC 28242-0001 Chairman, Duke Power Co.; from April
1988 to November 1991, Executive
Vice President Customer Group, Duke
Power Co.; Director, Hatteras Income
Securities, Inc., Nations
Government Income Term Trust 2003,
Inc., Nations Government Income Term
Trust 2004, Inc.,
</TABLE>
41
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATIONS
DURING PAST 5 YEARS
POSITION WITH AND CURRENT
NAME, ADDRESS, AND AGE THE TRUST DIRECTORSHIPS
- ---------------------- --------- -------------
<S> <C> <C>
Nations Balanced Target Maturity
Fund, Inc., Nations Fund, Inc.,
Nations Fund Portfolios, Inc. and
Nations LifeGoal Funds, Inc.;
Trustee, Nations Institutional
Reserves, Nations Fund Trust,
Nations Annuity Trust and Nations
Master Investment Trust.
Thomas F. Keller, 68 Trustee R.J. Reynolds Industries Professor
Fuqua School of Business of Business Administration and Dean,
Duke University Fuqua School of Business, Duke
Durham, NC 27706 University; Director, LADD
Furniture, Inc.; Director, Wendy's
and Mentor Funds; Director, Hatteras
Income Securities, Inc., Nations
Government Income Term Trust 2003,
Inc., Nations Government Income Term
Trust 2004, Inc., Nations Balanced
Target Maturity Fund, Inc., Nations
Fund, Inc., Nations Fund Portfolios,
Inc. and Nations LifeGoal Funds,
Inc.; Trustee, Nations Institutional
Reserves, Nations Fund Trust,
Nations Annuity Trust and Nations
Master Investment Trust.
Carl E. Mundy, Jr., 64 Trustee Commandant, United States Marine
9308 Ludgate Drive Corps, from July 1991 to July 1995;
Alexandria, VA 23309 Commanding General, Marine Forces
Atlantic, from June 1990 to June
1991; Director, Nations Fund, Inc.,
Nations Fund Portfolios, Inc. and
Nations LifeGoal Funds, Inc.;
Trustee, Nations Institutional
Reserves, Nations Master Portfolio
Trust, Nations Annuity Trust and
Nations Master Investment Trust.
Dr. Cornelius J. Pings, 71* Trustee President - Association of American
480 S. Orange Grove Blvd. Universities from February 1993 to
Pasadena, CA 91105 June 1998; Director - Farmers Group,
Inc. (insurance company), Nations
Fund, Inc. and Nations LifeGoal
Funds, Inc.; Trustee, Master
Investment Trust, Series I from 1995
to 1999, Master Investment Trust,
Series II from 1995 to 1997, Nations
Reserves, Nations Fund Trust,
Nations Annuity Trust and Nations
</TABLE>
42
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATIONS
DURING PAST 5 YEARS
POSITION WITH AND CURRENT
NAME, ADDRESS, AND AGE THE TRUST DIRECTORSHIPS
- ---------------------- --------- -------------
<S> <C> <C>
Master Investment Trust.;
Director/Trustee and Chairman -
Pacific Horizon Funds, Inc. and
Master Investment Trust, Series I,
from inception to May 1999;
Director - Time Horizon Funds and
Pacific Innovations Trust; Director,
Nations Fund Portfolios, Inc.
through August, 1999.
James B. Sommers, 61* Trustee President, NationsBank Trust, from
237 Cherokee Road January 1992 to September 1996;
Charlotte, NC 28207 Executive Vice President,
NationsBank Corporation, from
January 1992 to May 1997; Principal,
Bainbridge & Associates; Partner,
Villa LLC; Chairman, Central
Piedmont Community College
Foundation; Trustee, Central
Piedmont Community College; Board of
Commissioners, Charlotte/Mecklenberg
Hospital Authority; Director,
Nations Fund, Inc., Nations Fund
Portfolios, Inc. and Nations
LifeGoal Funds, Inc.; Trustee,
Nations Institutional Reserves,
Nations Master Portfolio Trust,
Nations Annuity Trust and Nations
Master Investment Trust.
</TABLE>
43
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATIONS
DURING PAST 5 YEARS
POSITION WITH AND CURRENT
NAME, ADDRESS, AND AGE THE TRUST DIRECTORSHIPS
- ---------------------- --------- -------------
<S> <C> <C>
A. Max Walker, 78* President, Trustee and Chairman Financial consultant; Formerly,
4580 Windsor Gate Court of the Board President, A. Max Walker, Inc.;
Atlanta, GA 30342 Director and Chairman of the Board,
Hatteras Income Securities, Inc.,
Nations Government Income Term Trust
2003, Inc., Nations Government
Income Term Trust 2004, Inc.,
Nations Balanced Target Maturity
Fund, Inc., Nations Fund, Inc.,
Nations Fund Portfolios, Inc. and
Nations LifeGoal Funds, Inc.;
President and Chairman of the Board
of Trustees, Nations Institutional
Reserves, Nations Fund Trust,
Nations Annuity Trust and Nations
Master Investment Trust.
Charles B. Walker, 61 Trustee Since 1989, Director, Executive Vice
Ethyl Corporation President, Chief Financial Officer
P.O. Box 2189 and Treasurer, Ethyl Corporation
330 South Fourth Street (chemicals, plastics, and aluminum
Richmond, VA 23217 manufacturing); since 1994, Vice
Chairman, Ethyl Corporation and Vice
Chairman, Chief Financial Officer
and Treasurer, Albemarle
Corporation, Director, Nations Fund,
Inc., Nations Fund Portfolios, Inc.
and Nations LifeGoal Funds, Inc.;
Trustee, Nations Institutional
Reserves, Nations Fund Trust,
Nations Annuity Trust and Nations
Master Investment Trust.
Thomas S. Word, Jr., 60* Trustee Partner, McGuire Woods Battle &
McGuire, Woods, Battle Boothe (law); Director, Vaughan
& Boothe Bassett Furniture Company, Director
One James Center VB Williams Furniture Company, Inc.;
Richmond, VA 23219 Director, Nations Fund, Inc.,
Nations Fund Portfolios, Inc. and
Nations LifeGoal Funds, Inc.;
Trustee, Nations Institutional
Reserves, Nations Fund Trust,
Nations Annuity Trust and Nations
Master Investment Trust.
</TABLE>
44
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATIONS
DURING PAST 5 YEARS
POSITION WITH AND CURRENT
NAME, ADDRESS, AND AGE THE TRUST DIRECTORSHIPS
- ---------------------- --------- -------------
<S> <C> <C>
Richard H. Blank, Jr., 42 Secretary and Treasurer Since 1999, Senior Vice President of
Stephens Inc. Stephens; 1994 to 1999, Vice
111 Center Street President of Mutual Fund Services,
Suite 300 Stephens Inc.; 1990 to 1994, Manager
Little Rock, AR 72201 Mutual Fund Services, Stephens Inc.;
1983 to 1990, Associate in Corporate
Finance Department, Stephens Inc.;
Secretary and Treasurer, Nations
Institutional Reserves, Nations Fund
Trust, Nations Fund, Inc., Nations
Fund Portfolios, Inc., Nations
Annuity Trust, Nations Master
Investment Trust and Nations
LifeGoal Funds, Inc.
Michael W. Nolte, 39 Assistant Secretary Associate, Financial Services
Stephens Inc. Group of Stephens Inc.
111 Center Street
Suite 300
Little Rock, AR 72201
Carolyn Wyse, 37 Assistant Secretary and Assistant Secretary and Assistant
Stephens Inc. Assistant Treasurer Treasurer since August 1999- Nations
Fund Trust, Nations Fund, Inc.,
Nations Reserves, Nations LifeGoal
Funds, Inc., Nations Annuity Trust,
Nations Master Investment Trust and
Nations Funds Trust.
</TABLE>
- --------------------
* James P. Sommers, A. Max Walker, Thomas S. Word, Jr. and Cornelius J. Pings
are considered "interested persons" of the Trust for purposes of the 1940 Act.
Each Trustee of the Trust is also a Director of Nations Fund, Inc.,
Nations Fund Portfolios, Inc. and Nations LifeGoal Master Portfolios, Inc. and a
Trustee of Nations Fund Trust, Nations Funds Trust, Nations Annuity Trust and
Nations Institutional Reserves, each a registered investment company that is
part of the Nations Funds Family, except William P. Carmichael, who is only a
board member of Nations Funds Trust, Nations Annuity Trust, the Trust and
Nations LifeGoal Funds, Inc. Richard H. Blank, Jr., Michael W. Nolte, and
Carolyn Wyse also are officers of Nations Funds Trust, Nations Fund Trust,
Nations Fund, Inc., Nations Reserves, Nations Annuity Trust, the Trust and
Nations LifeGoal Funds, Inc.
45
<PAGE>
Each Trustee receives (i) an annual retainer of $1,000 ($3,000 for the
Chairman of the Board) plus $500 for each Master Portfolio of the Trust, plus
(ii) a fee of $1,000 for attendance at each "in-person" meeting of the Board of
Trustees (or committee thereof) and $500 for each telephonic Board meeting
attended. All Trustees receive reimbursements for expenses related to their
attendance at meetings of the Board of Trustees. Officers receive no direct
remuneration in such capacity from the Trust. No person who is an officer,
director, or employee of Bank of America or its affiliates serves as an officer,
Trustee, or employee of the Trust. The Trustees and officers of the Nations
Funds own less than 1% of the shares of the Trust.
The Trust has adopted a Code of Ethics which, among other things,
prohibits each access person of the Trust from purchasing or selling securities
when such person knows or should have known that, at the time of the
transaction, the security (i) was being considered for purchase or sale by a
Master Portfolio or (ii) was being purchased or sold by a Master Portfolio. For
purposes of the Code of Ethics, an access person means (i) a Trustee or officer
of the Trust, (ii) any employee of the Trust (or any company in a control
relationship with the Trust) who, in the course of his/her regular duties,
obtains information about, or makes recommendations with respect to, the
purchase or sale of securities by the Trust, and (iii) any natural person in a
control relationship with the Trust who obtains information concerning
recommendations made to the Trust regarding the purchase or sale of securities.
Portfolio managers and other persons who assist in the investment process are
subject to additional restrictions, including a requirement that they disgorge
to the Trust any profits realized on short-term trading (i.e., the purchase/sale
or sale/purchase of securities within any 60-day period). The above restrictions
do not apply to purchases or sales of certain types of securities, including
mutual fund shares, money market instruments and certain U.S. Government
securities. To facilitate enforcement, the Code of Ethics generally requires
that the Trust's access persons, other than its "disinterested" Trustees, submit
reports to the Trust's designated compliance person regarding transactions
involving securities which are eligible for purchase by a Master Portfolio.
NATIONS FUNDS RETIREMENT PLAN
Under the terms of the Nations Funds Retirement Plan for Eligible
Trustees (the "Retirement Plan"), each Trustee may be entitled to certain
benefits upon retirement from the Board of Trustees. Pursuant to the Retirement
Plan, the normal retirement date is the date on which the eligible Trustee has
attained age 65 and has completed at least five years of continuous service with
one or more of the open-end investment companies advised by the Investment
adviser. If a Trustee retires before reaching age 65, no benefits are payable.
Each eligible Trustee is entitled to receive an annual benefit from the Master
Portfolios commencing on the first day of the calendar quarter coincident with
or next following his date of retirement equal to 5% of the aggregate Trustee's
fees payable by the Master Portfolios during the calendar year in which the
Trustee's retirement occurs multiplied by the number of years of service (not in
excess of ten years of service) completed with respect to any of the Master
Portfolios. Such benefit is payable to each eligible Trustee in quarterly
installments for a period of no more than five years. If an eligible Trustee
dies after attaining age 65, the Trustee's surviving spouse (if any) will be
entitled to receive 50% of the benefits that would have been paid (or would have
continued to have been paid) to the Trustee if he or she had not died. The
Retirement Plan is unfunded. The benefits owed to each Trustee are unsecured and
subject to the general creditors of the Master Portfolios.
NATIONS FUNDS DEFERRED COMPENSATION PLAN
Under the terms of the Nations Funds Deferred Compensation Plan for
Eligible Trustees (the "Deferred Compensation Plan"), each Trustee may elect, on
an annual basis, to defer all or any portion of the annual board fees (including
the annual retainer and all attendance fees) payable to the Trustee for that
calendar year. Distributions from the deferring Trustees' deferral accounts will
be paid in cash, in generally equal quarterly installments over a period of five
years beginning on the date the deferring Trustee's retirement benefits commence
under the Retirement Plan. The Board of Trustees, in its sole discretion, may
accelerate or extend such payments after a Trustee's termination of service. If
a deferring Trustee dies prior to the commencement of the distribution of
amounts in his or her deferral account, the balance of the deferral account will
be distributed to his or her designated beneficiary in a lump sum as soon as
practicable after the Trustee's death. If a deferring Trustee dies after the
commencement of such distribution, but prior to the complete distribution of his
or her deferral account, the balance of the amounts credited to his or her
deferral account will be distributed to his or her designated beneficiary over
the remaining period during which such amounts were distributable to the
Trustee. Amounts payable under the Deferred
46
<PAGE>
Compensation Plan are not funded or secured in any way and deferring Trustees
have the status of unsecured creditors of the Master Portfolios from which they
are deferring compensation.
COMPENSATION TABLE
<TABLE>
<CAPTION>
PENSION OR
RETIREMENT
AGGREGATE BENEFITS ESTIMATED ANNUAL
COMPENSATION ACCRUED AS PART BENEFITS UPON TOTAL COMPENSATION
NAME OF PERSON FROM OF FUND RETIREMENT FROM REGISTRANT
POSITION (1) REGISTRANT (2) EXPENSES PLAN & FUND COMPLEX (3) (4)
- ------------ --------------- --------------- ----------------- ----------------------
<S> <C> <C> <C> <C> <C>
Edmund L. Benson, III $9,500 $11,111.11 $35,000 $75,376 (50% Def'd)
Trustee
William P. Carmichael $0 $0 $0 $0
Trustee
James Ermer $7,500 $11,111.11 $35,000 $62,625
Trustee
William H. Grigg $9,500 $11,111.11 $35,000 $89,625 (100% Def'd)
Trustee
Thomas F. Keller $9,500 $11,111.11 $35,000 $93,625 (100% Def'd)
Trustee
Cornelius J. Pings $0 $0 $0 $0
Trustee
A. Max Walker $11,500 $11,111.11 $40,000 $108,125
Chairman of the Board
Charles B. Walker $9,500 $11,111.11 $35,000 $74,625
Trustee
Thomas S. Word $9,500 $11,111.11 $35,000 $76,125 (100% Def'd)
Trustee
James P. Sommers $9,500 $11,111.11 $40,000 $70,625
Trustee
Carl E. Mundy, Jr. $9,000 $11,111.11 $35,000 $70,127
------ ---------- ------- -------
Trustee
$85,000 $100,000 $320,000 $720,878
======= ======== ======== ========
</TABLE>
(1) All Trustees receive reimbursements for expenses related to their
attendance at meetings of the Board of Trustees. Officers of the Trust
receive no direct remuneration in such capacity from the Trust.
(2) For the current fiscal year and estimated future payments. Each Trustee
receives (i) an annual retainer of $1,000 ($3,000 for the Chairman of the
Board) plus $500 for each Master Portfolio of the Trust, plus (ii) a fee
of $1,000 for attendance at each in-person board meeting attended and $500
for each telephonic board meeting attended. The Trust also reimburses
expenses incurred by the Trustees in attending such meetings.
(3) Messrs. Grigg, Keller and A.M. Walker receive compensation from ten
investment companies, including Nations Fund, Inc., Nations Fund
Portfolios, Inc., Nations Fund Trust, Nations Annuity Trust, Nations
Master Investment Trust and Nations LifeGoal Funds, Inc., that are deemed
to be part of the Nations Fund "fund complex," as that term
47
<PAGE>
is defined under Rule 14a-101 of the Securities Exchange Act of 1934, as
amended. Messrs. Benson, Ermer, C. Walker, Mundy and Word receive
compensation from six investment companies, including Nations Fund, Inc.,
Nations Fund Portfolios, Inc., Nations Fund Trust, Nations Annuity Trust
and Nations LifeGoal Funds, Inc. deemed to be part of the Nations Funds
complex.
(4) Total compensation amounts include deferred compensation (including
interest) payable to or accrued for the following Trustees: Edmund L.
Benson, III $34,563; William H. Grigg $65,125; Thomas F. Keller $69,125;
and Thomas S. Word $69,125.
ITEM 14. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
As of the date of this SAI, each Fund could be considered a
"controlling person" of its corresponding Master Portfolio for purposes of the
1940 Act. As of the date of commencement of operations of Nations High Yield
Bond Master Portfolio, Stephens Inc. also could be considered a "controlling
person" of that Master Portfolio.
ITEM 15. INVESTMENT ADVISORY AND OTHER SERVICES.
The Adviser and Sub-Advisers: Banc of America Advisors, Inc. ("BAAI")
serves as investment adviser to the Master Portfolios, pursuant to an investment
advisory agreement (the "Investment Advisory Agreement") dated May 21, 1999.
In addition, TradeStreet serves as the investment sub-adviser to the
Nations Intermediate Bond Master Portfolio pursuant to a sub-advisory agreement
dated May 21, 1999. Chicago Equity serves as investment sub-adviser to Nations
Blue Chip Master Portfolio pursuant to a sub-advisory agreement dated May 21,
1999. Marsico Capital Management, LLC ("Marsico Capital") serves as the
investment sub-adviser to Nations Marsico Focused Equities Master Portfolio and
Nations Marsico Growth & Income Master Portfolio pursuant to a sub-advisory
agreement dated May 21, 1999. Gartmore is a co-investment sub-adviser to Nations
International Equity Master Portfolio along with INVESCO Global Asset Management
(N.A.) Inc. ("INVESCO") and Putnam Investment Management, Inc. ("Putnam")
pursuant to a sub-advisory agreement (collectively the "Sub-Advisory
Agreements"). Brandes Investment Partners, L.P. ("Brandes") serves as the
investment sub-advisor to Nations International Value Master Portfolio pursuant
to a sub-advisory agreement dated October 15, 1999. As used herein, "Adviser"
shall mean BAAI, TradeStreet, Chicago Equity, Gartmore, INVESCO, Putnam, Brandes
and/or Marsico Capital as the context may require.
BAAI, TradeStreet and Chicago Equity are each wholly owned subsidiaries
of Bank of America, N.A., which in turn is a wholly owned banking subsidiary of
BankAmerica Corporation, a bank holding company organized as a Delaware
corporation. Prior to April 10, 1996, the predecessor to Gartmore, Nations
Gartmore Investment Management ("Nations Gartmore"), provided sub-advisory
services to BAAI and Nations International Equity Fund. Nations Gartmore was a
joint venture structured as a general partnership between NB Partner Corp. and
Gartmore U.S. Limited, an indirectly wholly owned subsidiary of Gartmore
Investment Management plc ("Gartmore plc"). On April 10, 1996, National
Westminster Bank plc and affiliated parties (collectively, "NatWest") purchased
100% of the equity of Gartmore plc from Compagnie de Suez, S.A. and affiliated
entities (collectively, "Compagnie de Suez") and other shareholders through a
two-part transaction involving (1) the direct purchase from Compagnie de Suez of
its indirect subsidiary Indosuez UK Asset Management Limited, which held 75% of
the outstanding voting shares of Gartmore plc; and (2) the acquisition of the
remaining portion of Gartmore plc's shares held by public shareholders through a
tender offer. This acquisition resulted in the change of control of Nations
Gartmore and the creation of a successor entity, Gartmore.
Thomas F. Marsico is Chairman and Chief Executive Officer of Marsico
Capital. Prior to forming Marsico Capital in September 1997, Mr. Marsico had 18
years of experience as a securities analyst/portfolio manager. Marsico Capital
is an independent subsidiary of Bank of America and its affiliates. The
principal offices of Marsico Captial is 1200 17th Street, Suite 1300, Denver, CO
80202.
MacKay Shields is the investment sub-adviser to the High Yield Bond
Master Portfolio. MacKay Shields is located at 9 West 57th Street, New York, New
York 10019.
48
<PAGE>
The Investment Advisory Agreement provides that in the absence of
willful misfeasance, bad faith, gross negligence or reckless disregard of
obligations or duties thereunder on the part of BAAI or any of its officers,
Trustees, employees or agents, BAAI shall not be subject to liability to the
Trust or to any shareholder of the Trust for any act or omission in the course
of, or connected with, rendering services thereunder or for any losses that may
be sustained in the purchase, holding or sale of any security.
The Investment Advisory Agreement became effective with respect to a
Master Portfolio when approved by the Trustees of the Trust, and thereafter
continues from year to year, provided that such continuation of the Agreement is
specifically approved at least annually by (a) (i) the Trust's Board of Trustees
or (ii) the vote of "a majority of the outstanding voting securities" of a
Master Portfolio (as defined in Section 2(a)(42) of the 1940 Act), and (b) the
affirmative vote of a majority of the Trust's Trustees who are not parties to
such Agreement or "interested persons" (as defined in the 1940 Act) of a party
to such Agreement (other than as Trustees of the Trust), by votes cast in person
at a meeting specifically called for such purpose.
The Investment Advisory Agreement will terminate automatically in the
event of its assignment, and is terminable with respect to a Master Portfolio at
any time without penalty by the Trust (by vote of the Board of Trustees or by
vote of a majority of the outstanding voting securities of the Master Portfolio)
or by BAAI on 60 days' written notice.
The Sub-Advisory Agreements provide that in the absence of willful
misfeasance, bad faith, gross negligence or reckless disregard of obligations or
duties thereunder on the part of TradeStreet, Chicago Equity, Gartmore, INVESCO,
Putnam, Brandes, MacKay Shields and/or Marsico Capital or any of their officers,
Trustees, employees or agents, TradeStreet, Chicago Equity, Gartmore, INVESCO,
Putnam, Brandes and/or Marsico Capital shall not be subject to liability to BAAI
or to the Trust for any act or omission in the course of, or connected with,
rendering services thereunder or for any losses that may be sustained in the
purchase, holding or sale of any security.
The Sub-Advisory Agreements became effective with respect to each
Master Portfolio as of their execution date and, unless sooner terminated,
continue in full force and effect for one year, and may be continued with
respect to each Master Portfolio thereafter, provided that the continuation of
the Agreements are specifically approved at least annually by (a) (i) the
Trust's Board of Trustees or (ii) the vote of "a majority of the outstanding
voting securities" of a Master Portfolio (as defined in Section 2(a)(42) of the
1940 Act), and (b) the affirmative vote of a majority of the Trust's Trustees
who are not parties to such Agreements or "interested persons" (as defined in
the 1940 Act) of a party to such Agreements (other than as Trustees of the
Trust), by votes cast in person at a meeting specifically called for such
purpose.
The Sub-Advisory Agreements will terminate automatically in the event
of their assignment, and are terminable with respect to a Master Portfolio at
any time without penalty by the Trust (by vote of the Board of Trustees or by
vote of a majority of the outstanding voting securities of the Master
Portfolio), or by BAAI, TradeStreet, Chicago Equity, Gartmore, INVESCO, Putnam,
Brandes, MacKay Shields or Marsico Capital on 60 days' written notice.
Administrator, Co-Administrator, and Sub-Administrator. Stephens Inc.
and BAAI (the "Co-Administrators") serve as co-administrators of each Master
Portfolio.
The Co-Administrators serve under a co-administration agreement
("Co-Administration Agreement"), which was approved by the Board of Trustees on
December 2, 1998. The Co-Administrators receive, as compensation for their
services rendered under the Co-Administration Agreement, administration fees,
computed daily and paid monthly.
Pursuant to the Co-Administration Agreement, Stephens has agreed to,
among other things, (i) maintain office facilities for the Master Portfolios,
(ii) furnish statistical and research data, data processing, clerical, and
internal executive and administrative services to the Trust, (iii) furnish
corporate secretarial services to the Trust, including coordinating the
preparation and distribution of materials for Board of Trustees meetings, (iv)
coordinate the provision of legal advice to the Trust with respect to regulatory
matters, (v) coordinate the preparation of reports
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to the Trust's shareholders and the SEC, including annual and semi-annual
reports, (vi) coordinating the provision of services to the Trust by the
Transfer Agent, Sub-Transfer Agent and the Custodian, and (vii) generally assist
in all aspects of the Trust's operations. Stephens bears all expenses incurred
in connection with the performance of its services.
Also, pursuant to the Co-Administration Agreement, BAAI has agreed to,
among other things, (i) provide accounting and bookkeeping services for the
Master Portfolios, (ii) compute each Master Portfolio's net asset value and net
income, (iii) accumulate information required for the Trust's reports to
shareholders and the SEC, (iv) prepare and file the Trust's federal and state
tax returns, (v) perform monthly compliance testing for the Trust, and (vi)
prepare and furnish the Trust monthly broker security transaction summaries and
transaction listings and performance information. BAAI bears all expenses
incurred in connection with the performance of its services.
The Co-Administration Agreement may be terminated by a vote of a
majority of the Board of Trustees, by Stephens or by BAAI on 60 days' written
notice without penalty. The Co-Administration Agreement is not assignable
without the written consent of the other party. Furthermore, the
Co-Administration Agreement provides that Stephens and BAAI shall not be liable
to the Master Portfolios or to their shareholders except in the case of
Stephens' or BAAI's willful misfeasance, bad faith, gross negligence or reckless
disregard of duty.
The Bank of New York ("BNY") serves as sub-administrator for the Master
Portfolios pursuant to a sub-administration agreement. Pursuant to its terms,
BNY assists Stephens and BAAI in supervising, coordinating and monitoring
various aspects of the Master Portfolios' administrative operations. For
providing such services, BNY is entitled to receive a monthly fee from BAAI.
Custodian and Transfer Agent: BNY , 90 Washington Street, New York, New
York 10286, serves as custodian ("Custodian") for the securities and cash of
each Master Portfolio. As custodian, BNY, maintains custody of the Master
Portfolios' securities, cash and other property, delivers securities against
payment upon sale and pays for securities against delivery upon purchase, makes
payments on behalf of the Master Portfolios for payments of dividends,
distributions and redemptions, endorses and collects on behalf of the Master
Portfolios all checks, and receives all dividends and other distributions made
on securities owned by the Master Portfolios.
The Bank of New York ("BONY"), located at Avenue des Arts, 35 1040
Brussels, Belgium, serves as custodian for the assets of the Nations
International Equity Master Portfolio.
The SEC has amended Rule 17f-5 under the 1940 Act to permit boards to
delegate certain foreign custody matters to foreign custody managers and to
modify the criteria applied in the selection process. Accordingly, BONY serves
as Foreign Custody Manager, pursuant to a Foreign Custody Manager Agreement,
under which the Board Trustees retain the responsibility for selecting foreign
compulsory depositories, although BONY agrees to make certain findings with
respect to such depositories and to monitor such depositories.
First Data, which is located at One Exchange Place, Boston,
Massachusetts 02109, serves as transfer agent for the Master Portfolios. Under
the transfer agency agreement, the transfer agent maintains the interestholder
account records for the Trust, handles certain communications between
interestholders and the Trust, and distributes dividends and distributions
payable by the Trust to interestholders, and produces statements with respect to
account activity for the Trust and its interestholders for these services.
Counsel: Morrison & Foerster LLP serves as legal counsel to the Trust
and the Nations Master Portfolios. Their address is 2000 Pennsylvania Avenue,
N.W., Suite 5500, Washington, D.C. 20006-1812.
ITEM 16. BROKERAGE ALLOCATION AND OTHER PRACTICES.
Subject to policies established by the Board of Trustees of the Trust,
the Adviser is responsible for decisions to buy and sell securities for each
Master Portfolio, for the selection of broker/dealers, for the execution of such
Master Portfolio's securities transactions, and for the allocation of brokerage
fees in connection with such transactions. The Adviser's primary consideration
in effecting a security transaction is to obtain the best net price and the most
favorable execution of the order. Purchases and sales of securities on a
securities exchange are effected
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through brokers who charge a negotiated commission for their services. Orders
may be directed to any broker to the extent and in the manner permitted by
applicable law.
In the over-the-counter market, securities are generally traded on a
"net" basis with dealers acting as principal for their own accounts without
stated commissions, although the price of a security usually includes a profit
to the dealer. In underwritten offerings, securities are purchased at a fixed
price that includes an amount of compensation to the underwriter, generally
referred to as the underwriter's concession or discount. On occasion, certain
money market instruments may be purchased directly from an issuer, in which case
no commissions or discounts are paid.
In placing orders for portfolio securities of a Master Portfolio, the
Adviser is required to give primary consideration to obtaining the most
favorable price and efficient execution. This means that the Adviser will seek
to execute each transaction at a price and commission, if any, which provide the
most favorable total cost or proceeds reasonably attainable in the
circumstances. In seeking such execution, the Adviser will use its best judgment
in evaluating the terms of a transaction, and will give consideration to various
relevant factors, including, without limitation, the size and type of the
transaction, the nature and character of the market for the security, the
confidentiality, speed and certainty of effective execution required for the
transaction, the general execution and operational capabilities of the
broker-dealer, the reputation, reliability, experience and financial condition
of the firm, the value and quality of the services rendered by the firm in this
and other transactions and the reasonableness of the spread or commission, if
any. In addition, the Adviser will consider research and investment services
provided by brokers or dealers who effect or are parties to portfolio
transactions of a Master Portfolio, the Adviser or its other clients. Such
research and investment services are those which brokerage houses customarily
provide to institutional investors and include statistical and economic data and
research reports on particular companies and industries. Such services are used
by the Adviser in connection with all of its investment activities, and some of
such services obtained in connection with the execution of transactions for a
Master Portfolio may be used in managing other investment accounts. Conversely,
brokers furnishing such services may be selected for the execution of
transactions of such other accounts, whose aggregate assets are far larger than
those of a Master Portfolio. Services furnished by such brokers may be used by
the Adviser in providing investment advisory and investment management services
for the Trust.
Commission rates are established pursuant to negotiations with the
broker based on the quality and quantity of execution services provided by the
broker in the light of generally prevailing rates. The allocation of orders
among brokers and the commission rates paid are reviewed periodically by the
Trustees of the Trust. On exchanges on which commissions are negotiated, the
cost of transactions may vary among different brokers. Transactions on foreign
stock exchanges involve payment of brokerage commissions which are generally
fixed. Transactions in both foreign and domestic over-the-counter markets are
generally principal transactions with dealers, and the costs of such
transactions involve dealer spreads rather than brokerage commissions. With
respect to over-the-counter transactions, the Adviser, where possible, will deal
directly with dealers who make a market in the securities involved except in
those circumstances in which better prices and execution are available
elsewhere.
In certain instances there may be securities which are suitable for
more than one Master Portfolio as well as for one or more of the other clients
of the Adviser. Investment decisions for each Master Portfolio and for the
Adviser's other clients are made with the goal of achieving their respective
investment objectives. It may happen that a particular security is bought or
sold for only one client even though it may be held by, or bought or sold for,
other clients. Likewise, a particular security may be bought for one or more
clients when one or more other clients are selling that same security. Some
simultaneous transactions are inevitable when several clients receive investment
advice from the same investment adviser, particularly when the same security is
suitable for the investment objectives of more than one client. When two or more
clients are simultaneously engaged in the purchase or sale of the same security,
the securities are allocated among clients in a manner believed to be equitable
to each. It is recognized that in some cases this system could have a
detrimental effect on the price or volume of the security in a particular
transaction as far as a Master Portfolio is concerned. The Trust believes that
over time its ability to participate in volume transactions will produce
superior executions for the Master Portfolios.
The portfolio turnover rate for each Master Portfolio is calculated by
dividing the lesser of purchases or sales of portfolio securities for the
reporting period by the monthly average value of the portfolio securities owned
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during the reporting period. The calculation excludes all securities, including
options, whose maturities or expiration dates at the time of acquisition are one
year or less. Portfolio turnover may vary greatly from year to year as well as
within a particular year, and may be affected by cash requirements for
redemption of shares and by requirements which enable the Master Portfolios to
receive favorable tax treatment.
The Master Portfolios may participate, if and when practicable, in
bidding for the purchase of portfolio securities directly from an issuer in
order to take advantage of the lower purchase price available to members of a
bidding group. A Master Portfolio will engage in this practice, however, only
when the Adviser, in its sole discretion, believes such practice to be otherwise
in the Master Portfolio's interests.
The Trust will not execute portfolio transactions through, or purchase
or sell portfolio securities from or to the distributor, the Adviser, the
administrator, the co-administrator or their affiliates, acting as principal
(including repurchase and reverse repurchase agreements), except to the extent
permitted by applicable law. In addition, the Trust will not give preference to
correspondents of BankAmerica or its affiliates, with respect to such
transactions or securities. (However, the Adviser is authorized to allocate
purchase and sale orders for portfolio securities to certain financial
institutions, including, in the case of agency transactions, financial
institutions which are affiliated with BankAmerica or its affiliates, and to
take into account the sale of Master Portfolio interests if the Adviser believes
that the quality of the transaction and the commission are comparable to what
they would be with other qualified brokerage firms.) In addition, a Master
Portfolio will not purchase securities during the existence of any underwriting
or selling group relating thereto of which the distributor, the Adviser, the
administrator, or the co-administrator, or any of their affiliates, is a member,
except to the extent permitted by the SEC. Under certain circumstances, the
Master Portfolios may be at a disadvantage because of these limitations in
comparison with other investment companies which have similar investment
objectives but are not subject to such limitations.
Under the 1940 Act, persons affiliated with the Trust are prohibited
from dealing with the Trust as a principal in the purchase and sale of
securities unless an exemptive order allowing such transactions is obtained from
the SEC. Each of the Master Portfolios may purchase securities from underwriting
syndicates of which Bank of America or any of its affiliates is a member under
certain conditions, in accordance with the provisions of a rule adopted under
the 1940 Act and any restrictions imposed by the Board of Governors of the
Federal Reserve System.
Investment decisions for each Master Portfolio are made independently
from those for the Trust's other investment portfolios, other investment
companies, and accounts advised or managed by the Adviser. Such other investment
portfolios, investment companies, and accounts may also invest in the same
securities as the Master Portfolios. When a purchase or sale of the same
security is made at substantially the same time on behalf of one or more of the
Master Portfolios and another investment portfolio, investment company, or
account, the transaction will be averaged as to price and available investments
allocated as to amount, in a manner which the Adviser believes to be equitable
to each Master Portfolio and such other investment portfolio, investment company
or account. In some instances, this investment procedure may adversely affect
the price paid or received by a Master Portfolio or the size of the position
obtained or sold by the Master Portfolio. To the extent permitted by law, the
Adviser may aggregate the securities to be sold or purchased for the Master
Portfolios with those to be sold or purchased for other investment portfolios,
investment companies, or accounts in executing transactions.
SECTION 28(E) STANDARDS
Under Section 28(e) of the Securities Exchange Act of 1934, the Adviser
shall not be "deemed to have acted unlawfully or to have breached its fiduciary
duty" solely because under certain circumstances it has caused the account to
pay a higher commission than the lowest available. To obtain the benefit of
Section 28(e), the Adviser must make a good faith determination that the
commissions paid are "reasonable in relation to the value of the brokerage and
research services provided ...viewed in terms of either that particular
transaction or its overall responsibilities with respect to the accounts as to
which it exercises investment discretion and that the services provided by a
broker provide an adviser with lawful and appropriate assistance in the
performance of its investment decision making responsibilities." Accordingly,
the price to a Master Portfolio in any transaction may be less favorable than
that available from another broker/dealer if the difference is reasonably
justified by other aspects of the portfolio execution services offered.
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Broker/dealers utilized by the Adviser may furnish statistical,
research and other information or services which are deemed by the Adviser to be
beneficial to the Master Portfolios' investment programs. Research services
received from brokers supplement the Adviser's own research and may include the
following types of information: statistical and background information on
industry groups and individual companies; forecasts and interpretations with
respect to U.S. and foreign economies, securities, markets, specific industry
groups and individual companies; information on political developments; fund
management strategies; performance information on securities and information
concerning prices of securities; and information supplied by specialized
services to the Adviser and to the Trust's Trustees with respect to the
performance, investment activities and fees and expenses of other mutual funds.
Such information may be communicated electronically, orally or in written form.
Research services may also include the providing of equipment used to
communicate research information, the arranging of meetings with management of
companies and the providing of access to consultants who supply research
information.
The outside research assistance is useful to the Adviser since the
brokers utilized by the Adviser as a group tend to follow a broader universe of
securities and other matters than the Adviser's staff can follow. In addition,
this research provides the Adviser with a diverse perspective on financial
markets. Research services which are provided to the Adviser by brokers are
available for the benefit of all accounts managed or advised by the Adviser. In
some cases, the research services are available only from the broker providing
such services. In other cases, the research services may be obtainable from
alternative sources in return for cash payments. The Adviser is of the opinion
that because the broker research supplements rather than replaces its research,
the receipt of such research does not tend to decrease its expenses, but tends
to improve the quality of its investment advice. However, to the extent that the
Adviser would have purchased any such research services had such services not
been provided by brokers, the expenses of such services to the Adviser could be
considered to have been reduced accordingly. Certain research services furnished
by broker/dealers may be useful to the Adviser with clients other than the
Master Portfolios. Similarly, any research services received by the Adviser
through the placement of Master Portfolio transactions of other clients may be
of value to the Adviser in fulfilling its obligations to the Master Portfolios.
The Adviser is of the opinion that this material is beneficial in supplementing
its research and analysis; and, therefore, it may benefit the Trust by improving
the quality of the Adviser's investment advice. The advisory fees paid by the
Trust are not reduced because the Adviser receives such services.
Some broker/dealers may indicate that the provision of research
services is dependent upon the generation of certain specified levels of
commissions and underwriting concessions by the Adviser's clients, including the
Master Portfolios.
ITEM 17. CAPITAL STOCK AND OTHER SECURITIES.
DESCRIPTION OF SHARES
The Agreement and Declaration of Trust authorizes the issuance of an
unlimited number of units of the Master Portfolios. Each unit of a Master
Portfolio represents an equal proportionate interest in that Master Portfolio
with each other unit. Units are entitled upon liquidation to a pro rata share in
the net assets of the Master Portfolios. Interestholders have no preemptive
rights. The Agreement and Declaration of Trust provides that the Trustees of the
Trust may create additional series of interests. All consideration received by
the Trust for Beneficial Interest in any additional series and all assets in
which such consideration is invested would belong to that Master Portfolio and
would be subject to the liabilities related thereto. Certificates representing
Beneficial Interests will not be issued.
Each Master Portfolio will vote separately on matters pertaining solely
to such Master Portfolio. Such matters include matters relating to a Master
Portfolio's investment advisory agreement. All Master Portfolios will vote as a
whole on matters affecting all Master Portfolios such as the election of
Trustees and the appointment of the Trust's independent accountant.
Net investment income for the Master Portfolios for dividend purposes
consists of (i) interest accrued and original issue discount earned on a Master
Portfolio's assets, (ii) plus the amortization of market discount and minus the
amortization of market premium on such assets, (iii) less accrued expenses
directly attributable to the Master Portfolio and the general expenses of the
Trust prorated to a Master Portfolio on the basis of its relative net assets,
plus dividend or distribution income on a Master Portfolio's assets.
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Prior to purchasing Beneficial Interests in one of the Master
Portfolios, the impact of dividends or distributions which are expected to be or
have been declared, but not paid, should be carefully considered. Any dividend
or distribution declared shortly after a purchase of such Beneficial Interests
prior to the record date will have the effect of reducing the per unit of
interest net asset value by the per unit amount of the dividend or distribution.
All or a portion of such dividend or distribution, although in effect a return
of capital, may be subject to tax.
Interestholders receiving a distribution in the form of additional
units will be treated as receiving an amount equal to the fair market value of
the units received, determined as of the reinvestment date.
The Master Portfolios use the so-called "equalization accounting
method" to allocate a portion of earnings and profits to redemption proceeds.
This method permits a Master Portfolio to achieve more balanced distributions
for both continuing and departing interestholders. Continuing interestholders
should realize tax savings or deferrals through this method, and departing
interestholders will not have their tax obligations change. Although using this
method will not affect a Master Portfolio's total returns, it may reduce the
amount that otherwise would be distributable to continuing interestholders by
reducing the effect of redemptions on dividend and distribution amounts.
ITEM 18. PURCHASE, REDEMPTION, AND PRICING OF SHARES
Beneficial Interests in the Master Portfolios are issued by the Trust
in private placement transactions which do not involve a "public offering"
within the meaning of Section 4(2) of the Securities Act of 1933, as amended
("1933 Act"). Investments in the Master Portfolios may only be made by
investment companies or other entities which are "accredited investors" within
the meaning of Regulation D under the 1933 Act. The Master Portfolios are
prohibited by the Trust's Declaration of Trust from accepting investments from
individuals, S corporations, partnerships and grantor trusts.
In addition to cash purchases of Beneficial Interests, if accepted by
the Trust, investments in Beneficial Interests of a Master Portfolio may be made
in exchange for securities which are eligible for purchase by the Master
Portfolio and consistent with the Master Portfolio's investment objective and
policies as described in Part A.
In connection with an in-kind securities payment, a Master Portfolio
may require, among other things, that the securities (i) be valued on the day of
purchase in accordance with the pricing methods used by the Master Portfolio;
(ii) are accompanied by satisfactory assurance that the Master Portfolio will
have good and marketable title to such securities received by it; (iii) are not
subject to any restrictions upon resale by the Master Portfolio; (iv) be in
proper form for transfer to the Master Portfolio; and (v) are accompanied by
adequate information concerning the basis and other tax matters relating to the
securities. All dividends, interest, subscription or other rights pertaining to
such securities shall become the property of the Master Portfolio engaged in the
in-kind purchase transaction and must be delivered to such Master Portfolio by
the investor upon receipt from the issuer. Securities acquired through an
in-kind purchase will be acquired for investment and not for immediate resale.
Shares purchased in exchange for securities generally cannot be redeemed until
the transfer has settled.
The Trust is required to redeem for cash all full and fractional units
of Beneficial Interests in the Trust. The redemption price is the net asset
value per unit of each Master Portfolio next determined after receipt by the
Distributor of the redemption order.
The Trust reserves the right to reject a purchase order when the
Distributor determines that it is not in the best interest of the Trust and/or
interestholder(s) to accept such purchase order. The Trust reserves the right to
suspend the right of redemption and/or to postpone the date of payment upon
redemption for any period during which trading on the Exchange is restricted, or
during the existence of an emergency (as determined by the SEC by rule or
regulation) as a result of which disposal or valuation of the portfolio
securities is not reasonably practicable, or for such other periods as the SEC
has by order permitted. The Trust also reserves the right to suspend sales of
Beneficial Interests in a Master Portfolio for any period during which the
Exchange, Bank of America, the Distributor, the Administrator, the
Co-Administrator, and/or the Custodian are not open for business.
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By use of the exchange privilege, the interestholder authorizes the
transfer agent or the interestholder's financial institution to rely on
telephonic instructions from any person representing himself to be the investor
and reasonably believed to be genuine. The transfer agent's or a financial
institution's records of such instructions are binding. Exchanges are taxable
transactions for Federal income tax purposes; therefore, an interestholder will
realize a capital gain or loss depending on whether the interest being exchanged
has a value which is more or less than its adjusted cost basis.
The Trust may limit the number of times the exchange privilege may be
exercised by an interestholder within a specified period of time. Also, the
exchange privilege may be terminated or revised at any time by the Trust upon
such notice as may be required by applicable regulatory agencies (presently
sixty days for termination or material revision), provided that the exchange
privilege may be terminated or materially revised without notice under certain
unusual circumstances.
Part A describes the exchange privileges available to interestholders.
DETERMINATION OF NET ASSET VALUE
A security listed or traded on an exchange is valued at its last sales
price on the exchange where the security is principally traded or, lacking any
sales on a particular day, the security is valued at the mean between the
closing bid and asked prices on that day. Each security traded in the
over-the-counter market (but not including securities reported on the NASDAQ
National Market System) is valued at the mean between the last bid and asked
prices based upon quotes furnished by market makers for such securities. Each
security reported on the NASDAQ National Market System is valued at the last
sales price on the valuation date. With respect to Nations Intermediate Bond
Master Portfolio, securities may be valued on the basis of prices provided by an
independent pricing service. Prices provided by the pricing service may be
determined without exclusive reliance on quoted prices, and may reflect
appropriate factors such as yield, type of issue, coupon rate maturity and
seasoning differential. Securities for which prices are not provided by the
pricing service are valued at the mean between the last bid and asked prices
based upon quotes furnished by market makers for such securities.
Securities for which market quotations are not readily available are
valued at fair value as determined in good faith by or under the supervision of
the Trust's officers in a manner specifically authorized by the Board of
Trustees of the Trust. Short-Term obligations having 60 days or less to maturity
are valued at amortized cost, which approximates market value.
Generally, trading in foreign securities, as well as U.S. Government
securities, money market instruments and repurchase agreements, is substantially
completed each day at various times prior to the close of the New York Stock
Exchange. The values of such securities used in computing the net asset value of
the Master Portfolio are determined as of such times. Foreign currency exchange
rates are also generally determined prior to the close of the New York Stock
Exchange. Occasionally, events affecting the value of such securities and such
exchange rates may occur between the times at which they are determined and the
close of the New York Stock Exchange, which will not be reflected in the
computation of net asset value. If during such periods events occur which
materially affect the value of such securities, the securities will be valued at
their fair market value as determined in good faith by the Trustees.
For purposes of determining the net asset value of the Master
Portfolios that invest in foreign securities or engage in Foreign Currency
Transactions, all assets and liabilities of the Master Portfolios initially
expressed in foreign currencies will be converted into U.S. dollars at the mean
between the bid and offer prices of such currencies against U.S. dollars quoted
by a major bank that is a regular participant in the foreign exchange market or
on the basis of a pricing service that takes into account the quotes provided by
a number of such major banks.
The Trust may redeem Beneficial Interests involuntarily to reimburse
the Master Portfolios for any loss sustained by reason of the failure of a an
interestholder to make full payment for interests/units purchased by the
interestholder or to collect any charge relating to a transaction effected for
the benefit of an interestholder which is applicable to such interest as
provided in Part A from time to time. The Trust also may make payment for
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redemptions in readily marketable securities or other property if it is
appropriate to do so in light of the Trust's responsibilities under the 1940
Act.
ITEM 19. TAXATION.
The Trust is organized as a business trust under Delaware law. Under
the Trust's current classification for federal income tax purposes, it is
intended that each Master Portfolio will be treated as a non-publicly traded
partnership for such purposes and, therefore, such Master Portfolio will not be
subject to any federal income tax. However, each investor in a Master Portfolio
will be taxable on its share (as determined in accordance with the governing
instruments of the Trust) of such Master Portfolio's ordinary income and capital
gain in determining its federal income tax liability. The determination of such
share will be made in accordance with the Internal Revenue Code of 1986, as
amended (the "Code"), and regulations promulgated thereunder.
Each Master Portfolio's assets, income and distributions will be
managed in such a way that an investor in the Master Portfolio may satisfy the
requirements of Subchapter M of the Code, by investing substantially all of its
investable assets in the Master Portfolio. Investors are advised to consult
their own tax advisors as to the tax consequences of an investment in a Master
Portfolio.
ITEM 20. UNDERWRITERS.
Stephens Inc. (the "Distributor") serves as the principal underwriter
and distributor of the Beneficial Interests in the Master Portfolios.
Pursuant to a distribution agreement (the "Distribution Agreement"),
the Distributor, as agent, sells Beneficial Interests in the Master Portfolios
on a continuous basis and transmits purchase and redemption orders that it
receives to the Trust or the Transfer Agent. Additionally, the Distributor has
agreed to use appropriate efforts to solicit orders for the sale of Beneficial
Interests and to undertake such advertising and promotion as it believes
appropriate in connection with such solicitation. Pursuant to the Distribution
Agreement, the Distributor, at its own expense, finances those activities which
are primarily intended to result in the sale of shares of the Master Portfolios,
including, but not limited to, advertising, compensation of underwriters,
dealers and sales personnel, the printing of Part A to other than existing
interestholders, and the printing and mailing of sales literature. The
Distributor, however, may be reimbursed for all or a portion of such expenses to
the extent permitted by a distribution plan adopted by the Trust pursuant to
Rule 12b-1 under the 1940 Act.
The Distribution Agreement will continue year to year as long as such
continuance is approved at least annually by (i) the Board of Trustees or a vote
of the majority (as defined in the 1940 Act) of the outstanding voting
Beneficial Interests of the Master Portfolio and (ii) a majority of the Trustees
who are not parties to the Distribution Agreement or "interested persons" of any
such party by a vote cast in person at a meeting called for such purpose. The
Distribution Agreement is not assignable and is terminable with respect to a
Master Portfolio, without penalty, on 60 days' notice by the Board of Trustees,
the vote of a majority (as defined in the 1940 Act) of the outstanding voting
Beneficial Interest in the Master Portfolio, or by the Distributor.
ITEM 21. CALCULATION OF PERFORMANCE DATA.
Not applicable.
ITEM 22. FINANCIAL STATEMENTS.
The Board of Trustees has selected PricewaterhouseCoopers LLP, with
offices at 160 Federal Street, Boston MA 02110, to serve as the independent
accountants to the Trust. PricewaterhouseCoopers LLP, 1177 Avenue of the
Americas, New York, NY 10036, were the independent accountants for each of the
Blue Chip Fund (predecessor to Nations Blue Chip Master Portfolio) and the
Investment Grade Bond Fund (predecessor to Nations Intermediate Bond Master
Portfolio) for the fiscal year ended February 28, 1999. Certain financial
information which appears in the financial statements has been audited by the
accountants.
56
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The Annual Reports for the Blue Chip Fund (predecessor to Nations Blue
Chip Master Portfolio) and the Investment Grade Bond Fund (predecessor to
Nations Intermediate Bond Master Portfolio) for the fiscal year ended February
28, 1999 are incorporated herein by reference. No other Master Portfolio has yet
completed a fiscal year as of the date of this SAI. Accordingly, Annual Reports
for these other Master Portfolios are not yet available. Annual Reports, when
available, will be sent free of charge with Part B to any interestholder who
requests a copy of Part B.
57
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SCHEDULE A
----------
DESCRIPTION OF RATINGS
The following summarizes the highest six ratings used by Standard &
Poor's Corporation ("S&P") for corporate and municipal bonds. The first four
ratings denote investment-grade securities.
AAA - This is the highest rating assigned by S&P to a debt obligation
and indicates an extremely strong capacity to pay interest and repay principal.
AA - Debt rated AA is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in a 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 those in higher-rated categories.
BB, B - Bonds rated BB and B are regarded, on balance as predominantly
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligation. Debt rated BB has less near-term
vulnerability to default than other speculative issues. However, it faces major
ongoing uncertainties or exposure to adverse business, financial, or economic
conditions which could lead to inadequate capacity to meet timely interest and
principal payments. Debt rated B has a greater vulnerability to default but
currently has the capacity to meet interest payments and principal repayments.
Adverse business, financial, or economic conditions will likely impair capacity
or willingness to pay interest and repay principal.
To provide more detailed indications of credit quality, the AA, A and
BBB, BB and B ratings may be modified by the addition of a plus or minus sign to
show relative standing within these major rating categories.
The following summarizes the highest six ratings used by Moody's
Investors Service, Inc. ("Moody's") for corporate and municipal bonds. The first
four denote investment grade securities.
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
which 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 upper medium grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa - Bonds that are rated Baa are considered 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.
A-1
<PAGE>
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 thereby not as well
safeguarded during both good times and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B - Bond that are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Moody's applies numerical modifiers (1, 2 and 3) with respect to
corporate bonds rated Aa through B. The modifier 1 indicates that the bond being
rated 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 bond ranks
in the lower end of its generic rating category. With regard to municipal bonds,
those bonds in the Aa, A and Baa groups which Moody's believes possess the
strongest investment attributes are designated by the symbols Aal, A1 or Baal,
respectively.
The following summarizes the highest four ratings used by Duff & Phelps
Credit Rating Co. ("D&P") for bonds, each of which denotes that the securities
are investment grade.
AAA - Bonds that are rated AAA are of the highest credit quality. The
risk factors are considered to be negligible, being only slightly more than for
risk-free U.S. Treasury debt.
AA - Bonds that are rated AA are of high credit quality. Protection
factors are strong. Risk is modest but may vary slightly from time to time
because of economic conditions.
A - Bonds that are rated A have protection factors which are average
but adequate. However risk factors are more variable and greater in periods of
economic stress.
BBB - Bonds that are rated BBB have below average protection factors
but still are considered sufficient for prudent investment. Considerable
variability in risk exists during economic cycles.
To provide more detailed indications of credit quality, the AA, A and
BBB ratings may modified by the addition of a plus or minus sign to show
relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch
Investors Service, Inc. ("Fitch") for bonds, each of which denotes that the
securities are investment grade:
AAA - Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
AA - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated AAA. Because bonds rated in
the AAA and AA categories are not significantly vulnerable to foreseeable future
developments, short-term debt of these issuers is generally rated F-1+.
A - Bonds considered to be investment grade and of high credit quality.
The obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these bonds,
and therefore impair timely payment. The likelihood that the ratings of these
bonds will fall below investment grade is higher than for bonds with higher
ratings.
A-2
<PAGE>
To provide more detailed indications of credit quality, the AA, A and
BBB ratings may be modified by the addition of a plus or minus sign to show
relative standing within these major rating categories.
The following summarizes the two highest ratings used by Moody's for
short-term municipal notes and variable-rate demand obligations:
MIG-1/VMIG-1 -- Obligations bearing these designations are of the best
quality, enjoying strong protection from established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
MIG-2/VMIG-2 -- Obligations bearing these designations are of high
quality, with ample margins of protection although not so large as in the
preceding group.
The following summarizes the two highest ratings used by S&P for
short-term municipal notes:
SP-1 - Indicates very strong or strong capacity to pay principal and
interest. Those issues determined to possess overwhelming safety characteristics
are given a "plus" (+) designation.
SP-2 - Indicates satisfactory capacity to pay principal and interest.
The three highest rating categories of D&P for short-term debt, each of
which denotes that the securities are investment grade, are D-1, D-2, and D-3.
D&P employs three designations, D-1+, D-1 and D-1-, within the highest rating
category. D-1+ indicates highest certainty of timely payment. Short-term
liquidity, including internal operating factors and/or access to alternative
sources of Master Portfolios, is judged to be "outstanding, and safety is just
below risk-free U.S. Treasury short-term obligations." D-1 indicates very high
certainty of timely payment. Liquidity factors are excellent and supported by
good Fundamental protection factors. Risk factors are considered to be minor.
D-1 indicates high certainty of timely payment. Liquidity factors are strong and
supported by good Fundamental protection factors. Risk factors are very small.
D-2 indicates good certainty of timely payment. Liquidity factors and company
Fundamentals are sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small. D-3 indicates satisfactory liquidity and other protection factors which
qualify the issue as investment grade. Risk factors are larger and subject to
more variation. Nevertheless, timely payment is expected.
The following summarizes the two highest rating categories used by
Fitch for short-term obligations each of which denotes that the securities are
investment grade:
F-1+ securities possess exceptionally strong credit quality. Issues
assigned this rating are regarded as having the strongest degree of assurance
for timely payment.
F-1 securities possess very strong credit quality. Issues assigned this
rating reflect an assurance of timely payment only slightly less in degree than
issues rated F-1+.
F-2 securities possess good credit quality. Issues carrying this rating
have a satisfactory degree of assurance for timely payment, but the margin of
safety is not as great as for issues assigned the F-1+ and F-1 ratings.
Commercial paper rated A-1 by S&P indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted A-1+. Capacity for timely payment on
commercial paper rated A-2 is satisfactory, but the relative degree of safety is
not as high as for issues designated A-1.
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Issuers rated Prime-1 (or related supporting institutions) are
considered to have a superior capacity for repayment of senior short-term
promissory obligations. Issuers rated Prime-2 (or related supporting
institutions) are considered to have a strong capacity for repayment of senior
short-term promissory obligations. This will normally be evidenced by many of
the characteristics of issuers rated Prime-1, but to a lesser degree. Earnings
trends and coverage ratios, while sound, will
A-3
<PAGE>
be more subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternate
liquidity is maintained.
For commercial paper, D&P uses the short-term debt ratings described
above.
For commercial paper, Fitch uses the short-term debt ratings described
above.
Thomson BankWatch, Inc. ("BankWatch") ratings are based upon a
qualitative and quantitative analysis of all segments of the organization
including, where applicable, holding company and operating subsidiaries.
BankWatch ratings do not constitute a recommendation to buy or sell securities
of any of these companies. Further, BankWatch does not suggest specific
investment criteria for individual clients.
BankWatch long-term ratings apply to specific issues of long-term debt
and preferred stock. The long-term ratings specifically assess the likelihood of
untimely payment of principal or interest over the term to maturity of the rated
instrument. The following are the four investment grade ratings used by
BankWatch for long-term debt:
AAA - The highest category; indicates ability to repay principal and
interest on a timely basis is extremely high.
AA - The second highest category; indicates a very strong ability to
repay principal and interest on a timely basis with limited incremental risk
versus issues rated in the highest category.
A - The third highest category; indicates the ability to repay
principal and interest is strong. Issues rated "A" could be more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
BBB - The lowest investment grade category; indicates an acceptable
capacity to repay principal and interest. Issues rated "BBB" are, however, more
vulnerable to adverse developments (both internal and external) than obligations
with higher ratings.
Long-term debt ratings may include a plus (+) or minus (-) sign to
indicate where within a category the issue is placed.
The BankWatch short-term ratings apply to commercial paper, other
senior short-term obligations and deposit obligations of the entities to which
the rating has been assigned. The BankWatch short-term ratings specifically
assess the likelihood of an untimely payment of principal or interest.
TBW-1 The highest category; indicates a very high likelihood that
principal and interest will be paid on a timely basis.
TBW-2 The second highest category; while the degree of safety regarding
timely repayment of principal and interest is strong, the relative degree of
safety is not as high as for issues rated "TBW-1".
TBW-3 The lowest investment grade category; indicates that while more
susceptible to adverse developments (both internal and external) than
obligations with higher ratings, capacity to service principal and interest in a
timely fashion is considered adequate.
TBW-4 The lowest rating category; this rating is regarded as
non-investment grade and therefore speculative.
The following summarizes the four highest long-term debt ratings used
by IBCA Limited and its affiliate, IBCA Inc. (collectively "IBCA"):
A-4
<PAGE>
AAA - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk significantly.
AA - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic or financial conditions may
increase investment risk albeit not very significantly.
A - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business, economic or financial conditions may lead
to increased investment risk.
BBB - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial conditions
are more likely to lead to increased investment risk than for obligations in
other categories.
A plus or minus sign may be appended to a rating below AAA to denote
relative status within major rating categories.
The following summarizes the two highest short-term debt ratings used by
IBCA:
A1+ When issues possess a particularly strong credit feature, a rating of A1+ is
assigned.
A1 - Obligations supported by the highest capacity for timely repayment.
A2 - Obligations supported by a good capacity for timely repayment.
A-5
<PAGE>
SCHEDULE B
ADDITIONAL INFORMATION CONCERNING
OPTIONS & FUTURES
As stated in Part A, each Market Master Portfolio, may enter into
futures contracts and options for hedging purposes. Such transactions are
described in this Schedule. During the current fiscal year, each of these Master
Portfolios intends to limit its transactions in futures contracts and options so
that not more than 5% of the Master Portfolio's net assets are at risk.
Furthermore, in no event would any Master Portfolio purchase or sell futures
contracts, or related options thereon, for hedging purposes if, immediately
thereafter, the aggregate initial margin that is required to be posted by the
Master Portfolio under the rules of the exchange on which the futures contract
(or futures option) is traded, plus any premiums paid by the Master Portfolio on
its open futures options positions, exceeds 5% of the Master Portfolio's total
assets, after taking into account any unrealized profits and unrealized losses
on the Master Portfolio's open contracts and excluding the amount that a futures
option is "in-the-money" at the time of purchase. (An option to buy a futures
contract is "in-the-money" if the value of the contract that is subject to the
option exceeds the exercise price; an option to sell a futures contract is
"in-the-money" if the exercise Price exceeds the value of the contract that is
subject of the option.)
I. Interest Rate Futures Contracts.
-------------------------------
Use of Interest Rate Futures Contracts. Bond prices are established in
both the cash market and the futures market. In the cash market, bonds are
purchased and sold with payment for the full purchase price of the bond being
made in cash, generally within five business days after the trade. In the
futures market, only a contract is made to purchase or sell a bond in the future
for a set price on a certain date. Historically, the prices for bonds
established in the futures market have tended to move generally in the aggregate
in concert with the cash market prices and have maintained fairly predictable
relationships. Accordingly, a Master Portfolio may use interest rate futures as
a defense, or hedge, against anticipated interest rate changes and not for
speculation. As described below, this would include the use of futures contract
sales to protect against expected increases in interest rates and futures
contract purchases to offset the impact of interest rate declines.
A Master Portfolio presently could accomplish a similar result to that
which it hopes to achieve through the use of futures contracts by selling bonds
with long maturities and investing in bonds with short maturities when interest
rates are expected to increase, or conversely, selling short-term bonds and
investing in long-term bonds when interest rates are expected to decline.
However, because of the liquidity that is often available in the futures market
the protection is more likely to be achieved, perhaps at a lower cost and
without changing the rate of interest being earned by the Master Portfolio,
through using futures contracts.
Description of Interest Rates Futures Contracts. An interest rate
futures contract sale would create an obligation by a Master Portfolio, as
seller, to deliver the specific type of financial instrument called for in the
contract at a specific future time for a specified price. A futures contract
purchase would create an obligation by the Master Portfolio, as purchaser, to
take delivery of the specific type of financial instrument at a specific future
time at a specific price. The specific securities delivered or taken,
respectively, at settlement date, would not be determined until at or near that
date. The determination would be in accordance with the rules of the exchange on
which the futures contract sale or purchase was made.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of securities, in most cases the contracts are closed out
before the settlement date without the making or taking of delivery of
securities. Closing out a futures contract sale is effected by the Master
Portfolio's entering into a futures contract purchase for the same aggregate
amount of the specific type of financial instrument and the same delivery date.
If the price in the sale exceeds the price in the offsetting purchase, the
Master Portfolio is paid the difference and thus realizes a gain. If the
offsetting purchase price exceeds the sale price, the Master Portfolio pays the
difference and realizes a loss. Similarly, the closing out of a futures contract
purchase is effected by the Master Portfolio's entering into a futures contract
sale. If the offsetting sale price exceeds the purchase price, the Master
Portfolio realizes a gain, and if the purchase price exceeds the offsetting sale
price, the Master Portfolio realizes a loss.
B-1
<PAGE>
Interest rate futures contracts are traded in an auction environment on
the floors of several exchanges - principally, the Chicago Board of Trade, the
Chicago Mercantile Exchange and the New York Futures Exchange. A Master
Portfolio would deal only in standardized contracts on recognized changes. Each
exchange guarantees performance under contract provisions through a clearing
corporation, a nonprofit organization managed by the exchange membership.
A public market now exists in futures contracts covering various
financial instruments including long-term United States Treasury Bonds and
Notes; Government National Mortgage Association ("GNMA") modified pass-through
mortgage-backed securities; three-month United States Treasury Bills; and
ninety-day commercial paper. The Master Portfolios may trade in any futures
contract for which there exists a public market, including, without limitation,
the foregoing instruments.
Examples of Futures Contract Sale. A Master Portfolio would engage in
an interest rate futures contract sale to maintain the income advantage from
continued holding of a long-term bond while endeavoring to avoid part or all of
the loss in market value that would otherwise accompany a decline in long-term
securities prices. Assume that the market value of a certain security in a
Master Portfolio tends to move in concert with the futures market prices of
long-term United States Treasury bonds ("Treasury Bonds"). The Adviser wishes to
fix the current market value of this portfolio security until some point in the
future. Assume the portfolio security has a market value of 100, and the Adviser
believes that, because of an anticipated rise in interest rates, the value will
decline to 95. The Master Portfolio might enter into futures contract sales of
Treasury bonds for an equivalent of 98. If the market value of the portfolio
securities does indeed decline from 100 to 95, the equivalent futures market
price for the Treasury bonds might also decline from 98 to 93.
In that case, the five-point loss in the market value of the portfolio
security would be offset by the five-point gain realized by closing out the
futures contract sale. Of course, the futures market price of Treasury bonds
might well decline to more than 93 or to less than 93 because of the imperfect
correlation between cash and futures prices mentioned below.
The Adviser could be wrong in its forecast of interest rates and the
equivalent futures market price could rise above 98. In this case, the market
value of the portfolio securities, including the portfolio security being
protected, would increase. The benefit of this increase would be reduced by the
loss realized on closing out the futures contract sale.
If interest rate levels did not change, the Master Portfolio in the
above example might incur a loss of 2 points (which might be reduced by an
offsetting transaction prior to the settlement date). In each transaction,
transaction expenses would also be incurred.
Examples of Future Contract Purchase. A Master Portfolio would engage
in an interest rate futures contract purchase when it is not fully invested in
long-term bonds but wishes to defer for a time the purchase of long-term bonds
in light of the availability of advantageous interim investments, e.g.,
shorter-term securities whose yields are greater than those available on
long-term bonds. The Master Portfolio's basic motivation would be to maintain
for a time the income advantage from investing in the short-term securities; the
Master Portfolio would be endeavoring at the same time to eliminate the effect
of all or part of an expected increase in market price of the long-term bonds
that the Master Portfolio may purchase.
For example, assume that the market price of a long-term bond that the
Master Portfolio may purchase, currently yielding 10%, tends to move in concert
with futures market prices of Treasury bonds. The Adviser wishes to fix the
current market price (and thus 10% yield) of the long-term bond until the time
(four months away in this example) when it may purchase the bond. Assume the
long-term bond has a market price of 100, and the Adviser believes that, because
of an anticipated fall in interest rates, the price will have risen to 105 (and
the yield will have dropped to about 9-1/2%) in four months. The Master
Portfolio might enter into futures contracts purchases of Treasury bonds for an
equivalent price of 98. At the same time, the Master Portfolio would assign a
pool of investments in short-term securities that are either maturing in four
months or earmarked for sale in four months, for purchase of the long-term bond
at an assumed market price of 100. Assume these short-term securities are
yielding
B-2
<PAGE>
15%. If the market price of the long-term bond does indeed rise from 100 to 105,
the equivalent futures market price for Treasury bonds might also rise from 98
to 103. In that case, the 5-point increase in the price that the Master
Portfolio pays for the long-term bond would be offset by the 5-point gain
realized by closing out the futures contract Purchase.
The Adviser could be wrong in its forecast of interest rates; long-term
interest rates might rise to above 10%; and the equivalent futures market price
could fall below 98. If short-term rates at the same time fall to 10% or below,
it is possible that the Master Portfolio would continue with its purchase
program for long-term bonds. The market price of available long-term bonds would
have decreased. The benefit of this price decrease, and thus yield increase,
will be reduced by the loss realized on closing out the futures contract
purchase.
If, however, short-term rates remained above available long-term rates,
it is possible that the Master Portfolio would discontinue its purchase program
for long-term bonds. The yield on short-term securities in the portfolio,
including those originally in the pool assigned to the particular long-term
bond, would remain higher than yields on long-term bonds. The benefit of this
continued incremental income will be reduced by the loss realized on closing out
the futures contract purchase.
In each transaction, expenses also would be incurred.
II. Index Futures Contracts.
-----------------------
A stock or bond index assigns relative values to the stocks or bonds
included in the index, and the index fluctuates with changes in the market
values of the stocks or bonds included. Some stock index futures contracts are
based on broad market indices, such as the Standard & Poor's 500 or the New York
Stock Exchange Composite Index. In contract, certain exchanges offer futures
contracts on narrower market indices, such as the Standard & Poor's 100, the
Bond Buyer Municipal Bond Index, an index composed of 40 term revenue and
general obligation bonds, or indices based on an industry or market segment,
such as oil and gas stocks. Futures contracts are traded on organized exchanges
regulated by the Commodity Futures Trading Commission. Transactions on such
exchanges are cleared through a clearing corporation, which guarantees the
performance of the parties to each contract.
A Master Portfolio will sell index futures contracts in order to offset
a decrease in market value of its portfolio securities that might otherwise
result from a market decline. The Master Portfolio may do so either to hedge the
value of its portfolio as a whole, or to protect against declines, occurring
prior to sales of securities, in the value of the securities to be sold.
Conversely, a Master Portfolio will purchase index futures contracts in
anticipation of purchases of securities. In a substantial majority of these
transactions, the Master Portfolio will purchase such securities upon
termination of the long futures position, but a long futures position may be
terminated without a corresponding purchase of securities.
In addition, a Master Portfolio may utilize index futures contracts in
anticipation of changes in the composition of its portfolio holdings. For
example, in the event that a Master Portfolio expects to narrow the range of
industry groups represented in its holdings it may, prior to making purchases of
the actual securities, establish a long futures position based on a more
restricted index, such as an index comprised of securities of a particular
industry group. A Master Portfolio also may sell futures contracts in connection
with this strategy, in order to protect against the possibility that the value
of the securities to be sold as part of the restructuring of the portfolio will
decline prior to the time of sale.
The following are examples of transactions in stock index futures (net
of commissions and premiums, if any).
ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objective: Protect Against Increasing Price
Portfolio Futures
-Day Hedge is Placed
Anticipate Buying $62,500 Buying 1 Index Futures at 125
B-3
<PAGE>
Equity Portfolio Value of Futures = $62,500/
Contract
-Day Hedge is Lifted-
Buy Equity Portfolio with Sell 1 Index Futures at 130
Actual Cost = $65,000 Value of Futures = $65,000/
Increase in Purchase Contract
Price = $2,500 Gain on Futures = $2,500
HEDGING A STOCK PORTFOLIO: Sell the Future Hedge
Objective: Protect Against Declining (Value of the Portfolio)
Factors
Value of Stock Portfolio = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Portfolio Beta Relative to the Index - 1 0
Portfolio Futures
-Day Hedge is Placed
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Equity Portfolio Value of Futures = $1,000,000
-Day Hedge is Lifted-
Equity Portfolio-Own Buy 16 Index Futures at 120
Stock with Value = $960,000 Value of Futures = $960,000
Loss in Portfolio Gain on Futures = $40,000
Value = $40 000
IF, HOWEVER, THE MARKET MOVED IN THE OPPOSITE DIRECTION, THAT IS, MARKET
VALUE DECREASED AND THE MASTER PORTFOLIO HAD ENTERED INTO AN ANTICIPATORY
PURCHASE HEDGE, OR MARKET VALUE INCREASED AND THE MASTER PORTFOLIO HAD HEDGED
ITS STOCK PORTFOLIO, THE RESULTS OF THE MASTER PORTFOLIO'S TRANSACTIONS IN STOCK
INDEX FUTURES WOULD BE AS SET FORTH BELOW.
ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objective: Protect Against Increasing Price
Portfolio Futures
-Day Hedge is Placed
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Equity Portfolio Value of Futures = $62,500/
Contract
-Day Hedge is Lifted-
Buy Equity Portfolio with Sell 1 Index Futures at 120
Actual Cost = $60,000 Value of Futures = $60,000/Contract
Decrease in Purchase Loss on Futures = $2,500
Price = $2,500 Contract
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Portfolio
Factors
Value of Stock Portfolio = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Portfolio Beta Relative to the Index - 1 0
Portfolio Futures
-Day Hedge is Placed
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Equity Portfolio Value of Futures = $1,000,000
-Day Hedge is Lifted-
Equity Portfolio-Own Buy 16 Index Futures at 130
Stock with Value = $1,040,000 Value of Futures = $1,040,000
Gain in Portfolio = $40,000 Loss of Futures = $40,000
Value = $40 000
B-4
<PAGE>
III. Margin Payments
---------------
Unlike when a Master Portfolio purchases or sells a security, no price
is paid or received by the Master Portfolio upon the purchase or sale of a
futures contract. Initially, the Master Portfolio will be required to deposit
with the broker or in a segregated account with the Master Portfolio's Custodian
an amount of cash or cash equivalents, the value, of which may vary but is
generally equal to 10% or less of the value of the contract. This amount is
known as initial margin. The nature of initial margin in futures transactions is
different from that of margin in security transactions in that futures contract
margin does not involve the borrowing of Master Portfolios by the customer to
finance the transactions. Rather, the initial margin is in the nature of a
performance bond or good faith deposit on the contract which is returned to the
Master Portfolio upon termination of the futures contract assuming all
contractual obligations have been satisfied. Subsequent payments, called
variation margin, to and from the broker, will be made on a daily basis as the
price of the underlying security or index fluctuates making the long and short
positions in the futures contract more or less valuable, a process known as
marking to the market. For example, when a Master Portfolio has purchased a
futures contract and the price of the contract has risen in response to a rise
in the underlying instruments, that position will have increased in value and
the Master Portfolio will be entitled to receive from the broker a variation
margin payment equal to that increase in value. Conversely, where a Master
Portfolio has purchased a futures contract and the price of the futures contract
has declined in response to a decrease in the underlying instruments, the
position would be less valuable, the Master Portfolio would be required to make
a variation margin payment to the broker. At any time prior to expiration of the
futures contract, the Adviser may elect to close the position by taking an
opposite position, subject to the availability of a secondary market, which will
operate to terminate the Master Portfolio's position in the futures contract. A
final determination of variation margin is then made, additional cash is
required to be paid by or released to the Master Portfolio, and the Master
Portfolio realizes a loss or gain.
IV. Risks of Transactions in Futures Contracts
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There are several risks in connection with the use of futures by a
Master Portfolio as a hedging device. One risk arises because of the imperfect
correlation between movements in the price of the future and movements in the
price of the securities which are the subject of the hedge. The price of the
future may move more than or less than the price of the securities being hedged.
If the price of the future moves less than the price of the securities which are
the subject of the hedge, the hedge will not be fully effective but, if the
price of securities being hedged has moved in an unfavorable direction, the
Master Portfolio would be in a better position than if it had not hedged at Al.
If the price of the securities being hedged has moved in a favorable direction,
this advance will be partially offset by the loss on the future. If the price of
the future moves more than the price of the hedged securities, the Master
Portfolio involved will experience either a loss or gain on the future which
will not be completely offset by movements in the price of the securities which
are the subject of the hedge.
To compensate for the imperfect correlation of movements in the price
of securities being hedged and movements in the price of futures contracts, a
Master Portfolio may buy or sell futures contracts in a greater dollar amount
than the dollar amount of securities being hedged if the volatility over a
particular time period of the prices of such securities has been greater than
the volatility over such time period of the future, or if otherwise deemed to be
appropriate by the Adviser. Conversely, a Master Portfolio may buy or sell fewer
futures contracts if the volatility over a particular time period of the prices
of the securities being hedged is less than the volatility over such time period
of the futures contract being used, or if otherwise deemed to be appropriate by
the Adviser. It also is possible that, where a Master Portfolio has sold futures
to hedge its portfolio against a decline in the market, the market may advance,
and the value of securities held by the Master Portfolio may decline. If this
occurred, the Master Portfolio would lose money on the future and also
experience a decline in value in its portfolio securities.
Where futures are purchased to hedge against a possible increase in the
price of securities before a Master Portfolio is able to invest its cash (or
cash equivalents) in securities (or options) in an orderly fashion, it is
possible that the market may decline instead; if the Master Portfolio then
concludes not to invest in securities or options at that time because of concern
as to possible further market decline or for other reasons, the Master Portfolio
will realize a loss on the futures contract that is not offset by a reduction in
the price of securities purchased.
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In instances involving the purchase of futures contracts by a Master
Portfolio, an amount of cash and cash equivalents, equal to the market value of
the futures contracts, will be deposited in a segregated account with the Master
Portfolio's Custodian and/or in a margin account with a broker to collateralize
the position and thereby insure that the use of such futures is unleveraged.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the futures and the
securities being hedged, the price of futures may not correlate perfectly with
movement in the cash market due to certain market distortions. Rather than
meeting additional margin deposit requirements, investors may close futures
contracts through off-setting transactions which could distort the normal
relationship between the cash and futures markets. Second, with respect to
financial futures contracts, the liquidity of the futures market depends on
participants entering into off-setting transactions rather than making or taking
delivery. To the extent participants decide to make or take delivery, liquidity
in the futures market could be reduced thus producing distortions. Third, from
the point of view of speculators, the deposit requirements in the futures market
are less onerous than margin requirements in the securities market. Therefore,
increased participation by speculators in the futures market may also cause
temporary price distortions. Due to the possibility of Price distortion in the
futures market, and because of the imperfect correlation between the movements
in the cash market and movements in the price of futures, a correct forecast of
general market trends or interest rate movements by the Adviser still may not
result in a successful hedging transaction over a short time frame.
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although the Master
Portfolios intend to purchase or sell futures only on exchanges or boards of
trade where there appear to be active secondary markets, there is no assurance
that a liquid secondary market on any exchange or board of trade will exist for
any particular contract or at any particular time. In such event, it may not be
possible to close a futures investment position, and in the event of adverse
price movements, a Master Portfolio would continue to be required to make daily
cash payments of variation margin. However, in the event futures contracts have
been used to hedge portfolio securities, such securities will not be sold until
the futures contract can be terminated. In such circumstances, an increase in
the price of the securities, if any, may partially or completely offset losses
on the futures contract. However, as described above, there is no guarantee that
the price of the securities will in fact correlate with the price movements in
the futures contract and thus provide an offset on a futures contract.
Further, it should be noted that the liquidity of a secondary market in
a futures contract may be adversely affected by "daily price fluctuation limits"
established by commodity exchanges which limit the amount of fluctuation in a
futures contract price during a single trading day. Once the daily limit has
been reached in the contract, no trades may be entered into at a price beyond
the limit, thus preventing the liquidation of open futures positions.
Successful use of futures by a Master Portfolio also is subject to the
Adviser's ability to predict correctly movements in the direction of the market.
For example, if a Master Portfolio has hedged against the possibility of a
decline in the market adversely affecting securities held in its portfolio and
securities prices increase instead, the Master Portfolio will lose part or all
of the benefit to the increased value of its securities which it has hedged
because it will have offsetting losses in its futures positions. In addition, in
such situations, if the Master Portfolio has insufficient cash, it may have to
sell securities to meet daily variation margin requirements. Such sales of
securities may be, but will not necessarily be, at increased prices which
reflect the rising market. A Master Portfolio may have to sell securities at a
time when it may be disadvantageous to do so.
V. Options on Futures Contracts.
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The Master Portfolios may purchase options on the futures contracts
described above. A futures option gives the holder, in return for the premium
paid, the right to buy (call) from or sell (put) to the writer of the option a
futures contract at a specified price at any time during the period of the
option. Upon exercise, the writer of the option is obligated to pay the
difference between the cash value of the futures contract and the exercise
price. Like the buyer or seller of a futures contract, the holder, or writer, of
an option has the right to terminate its position prior to the scheduled
expiration of the option by selling, or purchasing, an option of the same
series, at which time the person entering into the closing transaction will
realize a gain or loss.
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Investments in futures options involve some of the same considerations
that are involved in connection with investments in futures contracts (for
example, the existence of a liquid secondary market). In addition, the purchase
of an option also entails the risk that changes in the value of the underlying
futures contract will not be fully reflected in the value of the option
purchased. Depending on the pricing of the option compared to either the futures
contract upon which it is based, or upon the price of the securities being
hedged, an option may or may not be less risky than ownership of the futures
contract or such securities. In general, the market prices of options can be
expected to be more volatile than the market prices on the underlying futures
contract. Compared to the purchase or sale of futures contracts, however, the
purchase of call or put options on futures contracts may frequently involve less
potential risk to a Master Portfolio because the maximum amount at risk is the
premium paid for the options (plus transaction costs). Although permitted by
their Fundamental investment policies, the Master Portfolios do not currently
intend to write future options, and will not do so in the future absent any
necessary regulatory approvals.
ACCOUNTING TREATMENT.
Accounting for futures contracts and options will be in accordance with
generally accepted accounting principles.
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SCHEDULE C
ADDITIONAL INFORMATION CONCERNING
MORTGAGE-BACKED SECURITIES
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities represent an ownership interest in a pool of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. The mortgagor's monthly
payments to his/her lending institution are "passed-through" to an investor.
Most issuers or poolers provide guarantees of payments, regardless of whether or
not the mortgagor actually makes the payment. The guarantees made by issuers or
poolers are supported by various forms of credit collateral, guarantees or
insurance, including individual loan, title, pool and hazard insurance purchased
by the issuer. There can be no assurance that the private issuers or poolers can
meet their obligations under the policies. Mortgage-backed securities issued by
private issuers or poolers, whether or not such securities are subject to
guarantees, may entail greater risk than securities directly or indirectly
guaranteed by the U.S. Government.
Interests in pools of mortgage-backed securities differ from other
forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Instead, these securities provide a monthly payment which consists of
both interest and principal payments. In effect, these payments are a
"pass-through" of the monthly payments made by the individual borrowers on their
residential mortgage loans, net of any fees paid. Additional payments are caused
by repayments resulting from the sale of the underlying residential property,
refinancing or foreclosure net of fees or costs which may be incurred. Some
mortgage-backed securities are described as "modified pass-through." These
securities entitle the holders to receive all interest and principal payments
owed on the mortgages in the pool, net of certain fees, regardless of whether or
not the mortgagors actually make the payments.
Residential mortgage loans are pooled by the Federal Home Loan Mortgage
Corporation ("FHLMC"). FHLMC is a corporate instrumentality of the U.S.
Government and was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. Its stock is owned by
the twelve Federal Home Loan Banks. FHLMC issues Participation Certificates
("PC's"), which represent interests in mortgages from FHLMC's national
portfolio. FHLMC guarantees the timely payment of interest and ultimate
collection of principal.
The Federal National Mortgage Association ("FNMA") is a Government
sponsored corporation owned entirely by private stockholders. It is subject to
general regulation by the Secretary of Housing and Urban Development. FNMA
purchases residential mortgages from a list of approved sellers/servicers which
include state and federally-chartered savings and loan associations, mutual
savings banks, commercial banks and credit unions and mortgage bankers.
Pass-through securities issued by FNMA are guaranteed as to timely payment of
principal and interest by FNMA.
The principal Government guarantor of mortgage-backed securities is the
Government National Mortgage Association ("GNMA"). GNMA is a wholly-owned U.S.
Government corporation within the Department of Housing and Urban Development.
GNMA is authorized to guarantee, with the full faith and credit of the U.S.
Government, the timely payment of principal and interest on securities issued by
approved institutions and backed by pools of FHA-insured or VA-guaranteed
mortgages.
Commercial banks, savings and loan institutions, private mortgage
insurance companies, mortgage bankers and other secondary market issuers also
create pass-through pools of conventional residential mortgage loans. Pools
created by such non-governmental issuers generally offer a higher rate of
interest than Government and Government-related pools because there are no
direct or indirect Government guarantees of payments in the former pools.
However, timely payment of interest and principal of these pools is supported by
various forms of insurance or guarantees, including individual loan, title, pool
and hazard insurance purchased by the issuer. The insurance and
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guarantees are issued by Governmental entities, private insurers, and the
mortgage poolers. There can be no assurance that the private insurers or
mortgage poolers can meet their obligations under the policies.
The Master Portfolio expects that Governmental or private entities may
create mortgage loan pools offering pass-through investments in addition to
those described above. The mortgages underlying these securities may be
alternative mortgage instruments, that is, mortgage instruments whose principal
or interest payment may vary or whose terms to maturity may be shorter than
previously customary. As new types of mortgage-backed securities are developed
and offered to investors, certain Master Portfolios will, consistent with their
investment objective and policies, consider making investments in such new types
of securities.
UNDERLYING MORTGAGES
Pools consist of whole mortgage loans or participations in loans. The
majority of these loans are made to purchasers of 1-4 family homes. The terms
and characteristics of the mortgage instruments are generally uniform within a
pool but may vary among pools. For example, in addition to fixed-rate,
fixed-term mortgages, a Master Portfolio may purchase pools of variable-rate
mortgages ("VRM"), growing equity mortgages ("GEM"), graduated payment mortgages
("GPM") and other types where the principal and interest payment procedures
vary. VRMs are mortgages which reset the mortgage's interest rate periodically
with changes in open market interest rates. To the extent that the Master
Portfolio is actually invested in VRMs, the Master Portfolio's interest income
will vary with changes in the applicable interest rate on pools of VRMs. GPM and
GEM pools maintain constant interest rates, with varying levels of principal
repayment over the life of the mortgage. These different interest and principal
payment procedures should not impact the Master Portfolio's net asset value
since the prices at which these securities are valued will reflect the payment
procedures.
All poolers apply standards for qualification to local lending
institutions which originate mortgages for the pools. Poolers also establish
credit standards and underwriting criteria for individual mortgages included in
the pools. In addition, some mortgages included in pools are insured through
private mortgage insurance companies.
AVERAGE LIFE
The average life of pass-through pools varies with the maturities of
the underlying mortgage instruments. In addition, a pool's term may be shortened
by unscheduled or early payments of principal and interest on the underlying
mortgages. The occurrence of mortgage prepayments is affected by factors
including the level of interest rates, general economic conditions, the location
and age of the mortgage, and other social and demographic conditions.
As prepayment rates of individual pools vary widely, it is not possible
to accurately predict the average life of a particular pool. For pools of
fixed-rated 30-year mortgages, common industry practice is to assume that
prepayments will result in a 12-year average life. Pools of mortgages with other
maturities or different characteristics will have varying assumptions for
average life.
RETURNS ON MORTGAGE-BACKED SECURITIES
Yields on mortgage-backed pass-through securities are typically quoted
based on the maturity of the underlying instruments and the associated average
life assumption. Actual prepayment experience may cause the yield to differ from
the assumed average life yield.
Reinvestment of prepayments may occur at higher or lower interest rates
than the original investment, thus affecting the yields of the Master Portfolio.
The compounding effect from reinvestments of monthly payments received by the
Master Portfolio will increase its yield to shareholders, compared to bonds that
pay interest semi-annually.
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