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As filed with the Securities and Exchange Commission on October 6, 2000
Investment Company Act File No. 811-10089
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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. 1 [X]
(Check appropriate box or boxes)
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FUND ASSET MANAGEMENT MASTER TRUST
(Exact name of Registrant as Specified in Charter)
725 South Figueroa Street, Suite 4000, Los Angeles, California 90017
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (213) 430-1000
Turner Swan
725 South Figueroa Street, Suite 4000
Los Angeles, California 90017
(Name and Address of Agent for Service)
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 (the "Investment
Company Act"). However, beneficial interests in the Registrant are not being
registered under the Securities Act of 1933, as amended (the "1933 Act"),
because such interests will be issued solely in private placement transactions
that do not involve any "public offering" within the meaning of Section 4(2) of
the 1933 Act. Investments in the Registrant may be made only by a limited number
of institutional investors, including investment companies, common or commingled
trust funds, group trusts and certain other "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 any offer to buy, any
beneficial interests in the Registrant.
This Registration Statement has been prepared as a single document
consisting of Parts A, B and C, none of which is to be used or distributed as a
stand-alone document.
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TABLE OF CONTENTS
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PART A. INFORMATION REQUIRED IN A PROSPECTUS
ITEM 1. FRONT AND BACK COVER PAGES......................................... *
ITEM 2. RISK/RETURN SUMMARY: INVESTMENTS, RISKS, AND PERFORMANCE.......... *
ITEM 3. RISK/RETURN SUMMARY: FEE TABLE.................................... *
ITEM 4. INVESTMENT OBJECTIVES, PRINCIPAL INVESTMENT STRATEGIES, AND
RELATED RISKS.................................................... 1
ITEM 5. MANAGEMENT'S DISCUSSION OF FUND PERFORMANCE........................ *
ITEM 6. MANAGEMENT, ORGANIZATION, AND CAPITAL STRUCTURE.................... 10
ITEM 7. SHAREHOLDER INFORMATION............................................ 11
ITEM 8. DISTRIBUTION ARRANGEMENTS.......................................... 12
ITEM 9. FINANCIAL HIGHLIGHTS INFORMATION................................... *
PART B INFORMATION REQUIRED IN A STATEMENT OF ADDITIONAL INFORMATION
ITEM 10. COVER PAGE AND TABLE OF CONTENTS................................... 1
ITEM 11. FUND HISTORY....................................................... 2
ITEM 12. DESCRIPTION OF THE FUND AND ITS INVESTMENTS AND RISKS.............. 2
ITEM 13. MANAGEMENT OF THE FUND............................................. 17
ITEM 14. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES................ 19
ITEM 15. INVESTMENT ADVISORY AND OTHER SERVICES............................. 20
ITEM 16. BROKERAGE ALLOCATION AND OTHER PRACTICES........................... 22
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* Responses to Items 1, 2, 3, 5, and 9 have been omitted pursuant to paragraph
2(b) of Instruction B of the General Instructions to Form N-1A.
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ITEM 17. CAPITAL STOCK AND OTHER SECURITIES................................. 23
ITEM 18. PURCHASE, REDEMPTION, AND PRICING OF SECURITIES.................... 24
ITEM 19. TAXATION OF THE FUND............................................... 26
ITEM 20. UNDERWRITERS....................................................... 28
ITEM 21. CALCULATION OF PERFORMANCE DATA.................................... 28
ITEM 22. FINANCIAL STATEMENTS............................................... 29
PART C OTHER INFORMATION
ITEM 23. EXHIBITS........................................................... C-1
ITEM 24. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH THE FUND........ C-3
ITEM 25. INDEMNIFICATION.................................................... C-3
ITEM 26. BUSINESS AND OTHER CONNECTIONS OF THE INVESTMENT ADVISER........... C-5
ITEM 27. PRINCIPAL UNDERWRITERS............................................. C-10
ITEM 28. LOCATION OF ACCOUNTS AND RECORDS................................... C-10
ITEM 29. MANAGEMENT SERVICES................................................ C-11
ITEM 30. UNDERTAKINGS....................................................... C-11
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PART A
Responses to Items 1 through 3, 5 and 9 have been omitted pursuant to
paragraph 2(b) of Instruction B of the General Instructions to Form N-1A.
ITEM 4. - INVESTMENT OBJECTIVES, PRINCIPAL INVESTMENT STRATEGIES, AND RELATED
RISKS.
Fund Asset Management Master Trust (the "Trust") is a no-load, open-end,
management investment company which was organized as a Delaware business trust
on July 7, 2000. The Low Duration Master Portfolio is a diversified series of
the Trust. The Total Return Bond Master Portfolio also is a series of the Trust
and also is diversified. Each Portfolio has different investment objectives and
policies. There can, of course, be no assurance that the investment objective(s)
of either Portfolio will be achieved.
INVESTMENT OBJECTIVES AND PRINCIPAL INVESTMENT STRATEGIES.
The LOW DURATION MASTER PORTFOLIO's objective is to maximize long-term
total return, consistent with preservation of capital. The Low Duration Master
Portfolio invests in a diversified portfolio of bonds of different maturities,
including U.S. GOVERNMENT SECURITIES, CORPORATE BONDS, ASSET-BACKED SECURITIES
and MORTGAGE-BACKED SECURITIES. U.S. government securities include direct
obligations issued by the U. S. Treasury and securities issued or guaranteed by
U.S. government agencies and instrumentalities. Corporate bonds are debt
securities issued by corporations, as distinct from bonds issued by a government
or its agencies or instrumentalities. Asset-backed securities are bonds or notes
backed by loan paper or accounts receivable originated by banks, credit card
companies, or other providers of credit. Mortgage-backed securities are
securities that give the holder the right to receive a portion of principal
and/or interest payments made on a pool of residential or commercial mortgage
loans, which in some cases are guaranteed by government agencies.
At least 70% of the Low Duration Master Portfolio's investments will be
in securities rated A or better by a major rating agency such as Moody's
Investors Service or Standard & Poor's Ratings Group. Up to 30% of its
investments in securities rated BBB/Baa and up to 10% of its investments may be
in securities rated below investment grade, that is, rated below BBB/Baa (none
below B). Fund Asset Management, L.P. (the "Investment Adviser") can invest in
unrated securities and will assign them the rating of a rated security of
comparable quality. After the Portfolio buys a security, it may be given a lower
rating or stop being rated. This will not require the Portfolio to sell it, but
the Investment Adviser will consider the change in rating in deciding whether to
keep the security. The Investment Adviser may actively and frequently trade the
Portfolio's portfolio securities.
The Low Duration Master Portfolio's DURATION will be from one to three
years. Duration measures the potential volatility of the price of a bond or a
portfolio of bonds prior to maturity. Duration is the magnitude of the change in
price of a bond relative to a given change in the market interest rate. Duration
incorporates a bond's yield, coupon interest payments, final maturity, call and
put features and prepayment exposure into one measure.
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For any bond with interest payments occurring before principal is
repaid, duration is ordinarily less than maturity. Generally, the lower the
stated or coupon rate of interest of a bond, the longer the duration. The higher
the stated or coupon rate of interest of a bond, the shorter the duration. The
calculation of duration is based on estimates.
Duration is a tool to measure interest rate risk. Assuming a 1% change
in interest rates and the duration shown below, a Portfolio's price would change
as follows:
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Duration Change in Interest Rates
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4.5 yrs. 1% decline > 4.5% gain in Portfolio price
1% rise > 4.5% decline in Portfolio price
2 yrs. 1% decline > 2% gain in Portfolio price
1% rise > 2% decline in Portfolio price
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Other factors such as changes in credit quality, prepayments, the shape
of the yield curve and liquidity affect the price of a Portfolio and may
correlate with changes in interest rates. These factors can increase swings in
the Portfolio's share price during periods of volatile interest rate changes.
The TOTAL RETURN BOND MASTER PORTFOLIO's investment objective is to
maximize long-term return. The Portfolio invests in a diversified portfolio of
bonds of different maturities, including U.S. government securities, corporate
bonds, asset-backed securities and mortgage-backed securities, as described
above. At least 85% of its investments will be investment grade, that is, rated
in the top four categories by a major rating agency. Up to 15% of its
investments may be rated below investment grade (none below B). The Investment
Adviser can invest in unrated securities and will assign them the rating of a
rated security of comparable quality. After the Portfolio buys a security, it
may be given a lower rating or stop being rated. This will not require the
Portfolio to sell it, but the Investment Adviser will consider the change in
rating in deciding whether to keep the security. The Total Return Bond Master
Portfolio's duration will be from two to eight years. Duration is described
above. The Investment Adviser may actively and frequently trade the Portfolio's
portfolio securities.
Both Portfolios.
Each Portfolio seeks to achieve its objective by investing mainly in
investment grade, interest-bearing securities of varying maturities. These
include:
- U.S. government securities
- preferred stocks
- mortgage-backed and other asset-backed securities
- corporate bonds
- bonds that are convertible into stocks
The Investment Adviser sells securities to manage portfolio duration,
yield curve exposure, sector exposure, diversification and credit quality. In
addition to these principal investments, the Portfolios also may invest in:
- bank certificates of deposit, fixed time deposits and bankers'
acceptances
- repurchase agreements, reverse repurchase agreements and dollar
rolls
- obligations of foreign governments or their subdivisions,
agencies and instrumentalities
- obligations of international agencies or supra-national entities
- municipal bonds
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Each Portfolio may invest in foreign bonds as follows:
- up to 25% of total assets in foreign bonds that are denominated
in U.S. dollars
- up to 15% of total assets in foreign bonds that are not
denominated in U.S. dollars
- up to 15% of total assets in emerging market foreign bonds
To meet redemptions and when waiting to invest cash receipts, a
Portfolio may invest in short-term, investment grade bonds, money market mutual
funds and other MONEY MARKET INSTRUMENTS. Also, a Portfolio temporarily can
invest up to 100% of its assets in short-term, investment grade bonds and other
money market instruments.
As a result of the strategies described above, a Portfolio may have an
annual PORTFOLIO TURNOVER RATE above 100%. Portfolio turnover is generally the
percentage found by dividing the lesser of portfolio purchases or sales by the
monthly average value of the portfolio. High portfolio turnover (100% or more)
results in higher mark ups and other transaction costs and can affect a
Portfolio's performance. It also can result in a greater amount of distributions
as ordinary income rather than long-term capital gains.
Each Portfolio may use many different strategies and each has certain
investment restrictions all of which are explained in Part B of this
Registration Statement.
Investment Risks.
This section contains a summary of the general risks of investing in a
Portfolio. As with any mutual fund, there can be no guarantee that a Portfolio
will meet its goals, or that the Portfolio's performance will be positive over
any period of time.
General.
Each Portfolio's principal risks are listed below:
As with any mutual fund, the value of a Portfolio's investments, and
therefore the value of Portfolio shares, may go down. These changes may
occur in response to interest rate changes or other factors that may affect a
particular issuer or obligation. Generally, when interest rates go up, the value
of bonds goes down. The value of a Portfolio's shares also may be affected by
market conditions and economic or political developments. The longer the
duration of a Portfolio, the more the Portfolio's price will go down if interest
rates go up. If the value of the Portfolio's investments goes down, you may lose
money.
Each Portfolio invests in mortgage-backed and asset-backed securities.
In addition to normal bond risks, these securities are subject to PREPAYMENT
RISK and EXTENSION RISK, and may involve more VOLATILITY than other bonds of
similar maturities. The Fund also may invest in "JUNK" BONDS, which have more
credit risk and tend to be less liquid than higher-rated securities. Prepayment
risk is the risk that certain obligations will be paid off by the obligor more
quickly than anticipated and the value of these securities will fall. Extension
risk is the risk that certain obligations will be paid off more slowly by the
obligor than anticipated and the value
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of these securities will fall. Volatility is the amount and frequency of changes
in a security's value. "Junk" bonds are bonds with a credit rating of BB/Ba or
lower by rating agencies.
Market and Selection Risk.
Market risk is the risk that the market will go down in value, including
the possibility that the market will go down sharply and unpredictably.
Selection risk is the risk that the investments that Portfolio management
selects will underperform the market or other funds with similar investment
objectives and investment strategies.
Mortgage-Backed Securities.
Mortgage-backed securities are the right to receive a portion of
principal and/or interest payments made on a pool of residential or commercial
mortgage loans. When interest rates fall, borrowers may refinance or otherwise
repay principal on their mortgages earlier than scheduled. When this happens,
certain types of mortgage-backed securities will be paid off more quickly than
originally anticipated. Prepayment reduces the yield to maturity and average
life of the mortgage-backed securities. In addition, when a Portfolio reinvests
the proceeds of a prepayment, it may receive a lower interest rate than the rate
on the security that was prepaid. This risk is known as "prepayment risk." When
interest rates rise, certain types of mortgage-backed securities will be paid
off more slowly than originally anticipated and the value of these securities
will fall. This risk is known as extension risk.
Because of prepayment risk and extension risk, mortgage-backed
securities react differently to changes in interest rates than other bonds.
Small movements in interest rates (both up and down) may quickly and
significantly reduce the value of certain mortgage-backed securities.
Mortgage-backed securities are issued by Federal government agencies
like the Government National Mortgage Association ("Ginnie Mae") or the Federal
Home Loan Mortgage Association ("Fannie Mae") or the Federal Home Loan Mortgage
Corporation ("Freddie Mac"). Principal and interest payments on mortgage-backed
securities issued by Federal government agencies are guaranteed by either the
Federal government or the government agency. This means that such securities
have very little credit risk. Other mortgage-backed securities are issued by
private corporations rather than Federal agencies. Private mortgage-backed
securities have credit risk as well as prepayment risk and extension risk.
Mortgage-backed securities may be either pass-through securities or
collateralized mortgage obligations ("CMOs"). Pass-through securities represent
a right to receive principal and interest payments collected on a pool of
mortgages, which are passed through to security holders (less servicing costs).
CMOs are created by dividing the principal and interest payments collected on a
pool of mortgages into several revenue streams ("tranches") with different
priority rights to portions of the underlying mortgage payments. Certain CMO
tranches may represent a right to receive interest only ("IOs"), principal only
("POs") or an amount that remains after other floating-rate tranches are paid
(an "inverse floater"). These securities are frequently referred
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to as "mortgage derivatives" and may be extremely sensitive to changes in
interest rates. If a Portfolio invests in CMO tranches (including CMO tranches
issued by government agencies) and interest rates move in a manner not
anticipated by the Investment Adviser, it is possible that the Portfolio could
lose all or substantially all of its investment.
Asset-Backed Securities.
Like traditional bonds, the value of asset-backed securities typically
increases when interest rates fall and decreases when interest rates rise.
Certain asset-backed securities may also be subject to the risk of prepayment.
In a period of declining interest rates, borrowers may pay what they owe on the
underlying assets more quickly than anticipated. Prepayment reduces the yield to
maturity and the average life of the asset-backed securities. In addition, when
a Portfolio reinvests the proceeds of a prepayment, it may receive a lower
interest rate than the rate on the security that was prepaid. In a period of
rising interest rates, prepayments may occur at a slower rate than expected. As
a result, the average maturity of a Portfolio's portfolio will increase. The
value of long-term securities changes more widely in response to changes in
interest rates than shorter-term securities.
Credit Risk.
Credit risk is the risk that the issuer of bonds will be unable to pay
interest or principal when due. The degree of credit risk depends on both the
financial condition of the issuer and the terms of the specific bonds.
Interest Rate Risk.
Interest rate risk is the risk that prices of bonds generally increase
when interest rates decline and decrease when interest rates increase. Prices of
longer-term securities generally change more in response to interest rate
changes than do prices of shorter-term securities.
Call and Redemption Risk.
Investments in bonds carry the risk that a bond's issuer will call the
bond for redemption prior to the bond's maturity. If there is an early call of a
bond, a Portfolio may lose income and may have to invest the proceeds of the
redemption in bonds with lower yields than the called bond.
Junk Bonds.
Junk bonds are bonds that are rated below investment grade by the major
rating agencies or are unrated securities that the Portfolio's Investment
Adviser believes are of comparable quality. Although junk bonds generally pay
higher rates of interest than investment grade bonds, they are high risk
investments that may cause income and principal losses for a Portfolio. Junk
bonds generally are less liquid and experience more price volatility than higher
rated bonds. The issuers of junk bonds may have a larger amount of outstanding
debt relative to their assets than issuers of investment grade bonds. In the
event of an issuer's bankruptcy, claims of other
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creditors may have priority over the claims of junk bond holders, leaving few or
no assets available to repay junk bond holders. Junk bonds may be subject to
greater call and redemption risk than higher rated debt securities.
Each Portfolio also may be subject to the following risks:
When-Issued Securities, Delayed-Delivery Securities and Forward Commitments.
These types of investments involve the risk that the security a
Portfolio buys will lose value prior to its delivery to the Portfolio. There
also is the risk that the security will not be issued or that the other party
will not meet its obligation, in which case the Portfolio loses the investment
opportunity of the assets it has set aside to pay for the security and any gain
in the securities price.
Variable Rate Demand Obligations.
These are floating rate securities that consist of an interest in a
long-term bond and the conditional right to demand payment prior to the bond's
maturity from a bank or other financial institution. If the bank or other
financial institution is unable to pay on demand, a Portfolio may be adversely
affected. In addition, these securities are subject to credit risk.
Indexed and Inverse Floating Rate Securities.
A Portfolio may invest in securities whose potential returns are
directly related to changes in an underlying index or interest rate, known as
indexed securities. The return on indexed securities will rise when the
underlying index or interest rate rises and fall when the index or interest rate
falls. The Portfolios may also invest in securities whose return is inversely
related to changes in an interest rate ("inverse floaters"). In general, inverse
floaters change in value in a manner that is opposite to most bonds -- that is,
interest rates on inverse floaters will decrease when short-term rates increase
and increase when short-term rates decrease. Investments in indexed securities
and inverse floaters may subject a Portfolio to the risk of reduced or
eliminated interest payments. Investments in indexed securities also may subject
a Portfolio to loss of principal. In addition, certain indexed securities and
inverse floaters may increase or decrease in value at a greater rate than the
underlying interest rate, which effectively leverages the Portfolio's
investment. As a result, the market value of such securities will generally be
more volatile than that of fixed rate securities. Both indexed securities and
inverse floaters can be derivative securities and can be considered speculative.
Sovereign Debt.
Each Portfolio may invest in sovereign debt securities. These securities
are issued or guaranteed by foreign government entities. Investments in
sovereign debt subject the Portfolio to the risk that a government entity may
delay or refuse to pay interest or repay principal on its sovereign debt. Some
of these reasons may include cash flow problems, insufficient foreign currency
reserves, political considerations, the relative size of its debt position to
its economy or its failure to put in place economic reforms required by the
International Monetary Fund or other multilateral agencies. If a government
entity defaults, it may ask for more time in which to pay
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or for further loans. There is no legal process for collecting sovereign debts
that a government does not pay.
Corporate Loans.
Corporate loans are subject to the risk of loss of principal and income.
Borrowers do not always provide collateral for corporate loans and the value of
the collateral may not completely cover the borrower's obligations at the time
of a default. If a borrower files for protection from its creditors under the
U.S. bankruptcy laws, these laws may limit a Portfolio's rights to its
collateral. In addition, the value of collateral may erode during a bankruptcy
case. In the event of a bankruptcy, the holder of a corporate loan may not
recover its principal, may experience a long delay in recovering its investment
and may not receive interest during the delay.
Convertible Securities.
Convertibles are generally bonds or preferred stocks that may be
converted into common stock. Convertibles typically pay current income, as
either interest (bond convertibles) or dividends (preferred stocks). A
convertible's value usually reflects both the stream of current income payment
and the value of the underlying common stock. The market value of a convertible
performs like regular bonds; that is, if market interest rates rise, the value
of a convertible usually falls. Since it is convertible into common stock, the
convertible also has the same types of market and issuer risk as the underlying
common stock.
Foreign Market Risk.
Each Portfolio may invest a portion of its assets in foreign securities.
These investments involve special risks not present in U.S. investments that can
increase the chances that the Portfolio will lose money. In particular,
investments in foreign securities involve the following risks, which are
generally greater for investments in emerging markets:
- The economies of some foreign markets often do not compare
favorably with that of the U.S. in areas such as growth of gross
national product, reinvestment of capital, resources, and balance
of payments. Some of these economies may rely heavily on
particular industries or foreign capital. They may be more
vulnerable to adverse diplomatic developments, the imposition of
economic sanctions against a particular country or countries,
changes in international trading patterns, trade barriers and
other protectionist or retaliatory measures.
- Investments in foreign markets may be adversely affected by
governmental actions such as the imposition of capital controls,
nationalization of companies or industries, expropriation of
assets or the imposition of punitive taxes.
- The governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital
markets or in certain industries. Any of these actions could
severely affect security prices. They could also impair a
Portfolio's ability to purchase or sell foreign securities or
transfer its assets or
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income back into the U.S., or otherwise adversely affect the
Portfolio's operations.
- Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign
government securities, difficulties in enforcing favorable legal
judgments in foreign courts and political and social instability.
Legal remedies available to investors in some foreign countries
may be less extensive than those available to investors in the
U.S.
- Prices of foreign securities may go up and down more than prices
of securities traded in the U.S.
- Foreign markets may have different clearance and settlement
procedures. In certain markets, settlements may be unable to keep
pace with the volume of securities transactions. If this occurs,
settlement may be delayed and a Portfolio's assets may be
uninvested and not earning returns. A Portfolio also may miss
investment opportunities or be unable to sell an investment
because of these delays.
- The value of a Portfolio's foreign holdings (and hedging
transactions in foreign currencies) will be affected by changes
in currency exchange rates.
- The costs of foreign securities transactions tend to be higher
than those of U.S. transactions.
- If a Portfolio purchases a bond issued by a foreign government,
the government may be unwilling or unable to make payments when
due. There may be no formal bankruptcy proceedings to collect
amounts owed by a foreign government.
European Economic and Monetary Union (EMU).
A number of European countries have entered into EMU in an effort to
reduce trade barriers between themselves and eliminate fluctuations in their
currencies. EMU established a single European currency (the euro), which was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all initial EMU participants by July 1, 2002. Certain securities
(beginning with government and corporate bonds) were redenominated in the euro.
These securities trade and make dividend and other payments only in euros. Like
other investment companies and business organizations, including the companies
in which the Portfolios invest, a Portfolio could be adversely affected if the
transition to the euro, or EMU as a whole, does not take effect as planned or if
a participating country withdraws from EMU.
Derivatives.
Each Portfolio also may use "derivatives." Derivatives are financial
instruments, like futures, forwards, options and swaps, the values of which are
derived from other securities, commodities (such as gold or oil) or indexes
(such as the S&P 500).
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Derivatives may allow a Portfolio to increase or decrease its level of
risk exposure more quickly and efficiently than transactions in other types of
instruments. If a Portfolio invests in derivatives, the investments may not be
effective as a hedge against price movements and can limit potential for growth
in the value of an interest in the Portfolio. Derivatives are volatile and
involve significant risks, including:
- Leverage Risk -- Leverage risk is the risk associated with
certain types of investments or trading strategies that
relatively small market movements may result in large changes in
the value of an investment. Certain investments or trading
strategies that involve leverage can result in losses that
greatly exceed the amount originally invested.
- Credit Risk -- Credit risk is the risk that the counterparty on a
derivative transaction will be unable to honor its financial
obligation to the Portfolio.
- Currency Risk -- Currency risk is the risk that changes in the
exchange rate between two currencies will adversely affect the
value (in U.S. dollar terms) of an investment.
- Liquidity Risk -- Liquidity risk is the risk that certain
securities may be difficult or impossible to sell at the time
that the seller would like or at the price that the seller
believes the security is currently worth.
PART B
If you would like further information about a Portfolio, including how
it invests, please see Part B.
ITEM 6. - MANAGEMENT, ORGANIZATION, AND CAPITAL STRUCTURE.
INVESTMENT ADVISER.
Fund Asset Management, L.P., manages each Portfolio's investments under
the overall supervision of the Board of Trustees of the Trust. The Investment
Adviser has the responsibility for making all investment decisions for each
Portfolio.
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The Investment Adviser and its affiliates manage portfolios with over
$555 billion in assets (as of June 30, 2000) for individuals and institutions
seeking investments worldwide. This amount includes assets managed for Merrill
Lynch affiliates. The advisory agreements between the Trust on behalf of the
Portfolios and the Investment Adviser give the Investment Adviser the
responsibility for making all investment decisions.
The Investment Adviser is paid at the annual rate of 0.21% of the Low
Duration Master Portfolio's average daily net assets and 0.30% of the Total
Return Bond Master Portfolio's average daily net assets.
Michael Sanchez is a co-Portfolio Manager of each Portfolio. He joined
the Investment Adviser in 1996. He was the co-Portfolio Manager of the Mercury
Low Duration Fund and the Mercury Total Return Bond Fund, each a series of the
Mercury HW Funds, and the respective predecessors of the Low Duration Master
Portfolio and the Total Return Bond Master Portfolio, respectively, from 1996
until October 2000. Before joining the Investment Adviser, Mr. Sanchez was with
Provident Investment Counsel as senior vice president and portfolio manager from
1991 to 1995 and with ARCO Investment Management Company as Director of Fixed
Income Investments from 1988 to 1991.
John Queen is a co-Portfolio Manager of each Portfolio. He was the
co-Portfolio Manager of the Mercury Low Duration Fund and the Mercury Total
Return Bond Fund since 1997. Prior to joining the Investment Adviser in 1997,
Mr. Queen was associated with The Capital Group as a member of an analyst team
responsible for $8 billion in fixed-income assets.
CAPITAL STOCK.
Investors in the Trust have no preemptive or conversion rights and
beneficial interests in a Portfolio are fully paid and non-assessable. The Trust
has no current intention to hold annual meetings of investors, except to the
extent required by the Investment Company Act, but will hold special meetings of
investors, when in the judgment of the Trustees, it is necessary or desirable to
submit matters for an investor vote. Upon liquidation of the Trust or a
Portfolio, investors would be entitled to share, in proportion to their
investment in the Trust or the Portfolio (as the case may be), in the assets of
the Trust or the Portfolio available for distribution to investors.
The Trust is organized as a Delaware business trust and currently
consists of two Portfolios. Each investor is entitled to a vote in proportion to
its investment in the Trust or the Portfolio (as the case may be). Investors in
a Portfolio will participate equally in accordance with their pro rata interests
in the earnings, dividends and assets of the particular Portfolio. The Trust
reserves the right to create and issue interests in additional Portfolios.
Investments in the Trust may not be transferred, but an investor may
withdraw all or any portion of its investment in a Portfolio at net asset value
on any day on which the New York Stock Exchange is open.
ITEM 7. - SHAREHOLDER INFORMATION.
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PRICING.
Each Portfolio calculates its net asset value (generally by using market
quotations) each day the New York Stock Exchange (the "Exchange") is open as of
the close of regular trading on the Exchange based on prices at the time of
closing. Regular trading on the Exchange generally closes at 4:00 p.m. Eastern
time. The net asset value used in determining the price of an interest in a
Portfolio is the one calculated after the purchase or redemption order is
placed. The net asset value is determined by deducting the amount of the
Portfolio's total liabilities from the value of its total assets. Net asset
value is generally calculated by valuing each security at its closing price for
the day. Non-U.S. securities sometimes trade on days that the Exchange is
closed. As a result, a Portfolio's net asset value may change on days when an
investor will not be able to purchase or redeem the Portfolio's interests.
Securities and assets for which market quotations are not readily available are
generally valued at fair value as determined in good faith by or under the
direction of the Board of Trustees.
Each investor in the Trust may add to or reduce its investment in a
Portfolio on each day the Exchange is open for trading. The value of each
investor's beneficial interest in a Portfolio will be determined by multiplying
the net asset value of the Portfolio by the percentage, effective for that day,
that represents that investor's share of the aggregate beneficial interests in
the Portfolio. Any additions or withdrawals, which are to be effected on that
day, will then be effected. The investor's percentage of the aggregate
beneficial interests in the Portfolio will then be re-computed as the percentage
equal to the fraction (i) the numerator of which is the value of such investor's
investment in the Portfolio as of the time of determination on such day plus or
minus, as the case may be, the amount of any additions to or withdrawals from
the investor's investment in the Portfolio effected on such day, and (ii) the
denominator of which is the aggregate net asset value of the Portfolio as of
such time on such day plus or minus, as the case may be, the amount of the net
additions to or withdrawals from the aggregate investments in the Portfolio by
all investors in the Portfolio. The percentage so determined will then be
applied to determine the value of the investor's interest in the Portfolio as of
the close of regular trading of the Exchange on the next day the Portfolio
calculates its net asset value.
PURCHASE OF SECURITIES.
Beneficial interests in the Trust are issued solely in private placement
transactions that do not involve any "public offering" within the meaning of
Section 4(2) of the 1933 Act. Investments in each Portfolio of the Trust may
only be made by a limited number of institutional investors including investment
companies, common or commingled trust funds, group trusts, and certain other
"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 "security" within the meaning of the 1933
Act.
There is no minimum initial or subsequent investment in a Portfolio.
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Each Portfolio reserves the right to cease accepting investments at any
time or to reject any investment order.
REDEMPTION.
An investor in the Trust may withdraw all or a portion of its investment
in a Portfolio on any day the Exchange is open for trading at the net asset
value next determined after a withdrawal request in proper form is furnished by
the investor to the Portfolio. The proceeds of the withdrawal will be paid by
the Portfolio normally on the business day on which the withdrawal is effected,
but in any event within seven days. Investments in a Portfolio of the Trust may
not be transferred.
TAX CONSEQUENCES.
Under the anticipated method of operation of the Portfolios, a Portfolio
will be treated as a separate partnership for tax purposes and, thus, will not
be subject to any income tax. Based upon the status of each Portfolio as a
partnership, each investor in the Portfolio will be taxable on its share (as
determined in accordance with the governing instruments of the Trust) of such
Portfolio's ordinary income and capital gains in determining its 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 Treasury Regulations
promulgated thereunder.
It is intended that a Portfolio's assets, income and distributions will
be managed in such a way that an investor in the Portfolio that is a regulated
investment company will be able to satisfy the requirements of Subchapter M of
the Code assuming that the investor has invested all of its assets in the
Portfolio.
ITEM 8. - DISTRIBUTION ARRANGEMENTS.
Investments in each Portfolio will be made without a sales charge. All
investments are made at net asset value next determined after an order is
received by the Portfolio. The net asset value of each Portfolio is determined
on each day the Exchange is open for trading.
The Trust's placement agent is FAM Distributors, Inc.
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PART B
Except as otherwise indicated herein, all capitalized terms shall have
the meaning assigned to them in Part A hereof.
ITEM 10. - COVER PAGE AND TABLE OF CONTENTS.
Low Duration Master Portfolio and Total Return Bond Master Portfolio
each is a series of Fund Asset Management Master Trust (the "Trust"). This
Statement of Additional Information is not a prospectus and should be read in
conjunction with the Prospectus of the Portfolios, dated October 6, 2000 (the
"Prospectus"), which has been filed with the Securities and Exchange Commission
(the "Commission") and can be obtained, without charge, by calling the Trust at
1-800-MER-FUND or by writing to Fund Asset Management Master Trust, 725 South
Figueroa Street, Suite 4000, Los Angeles, California 90017. The Prospectus is
incorporated by reference into this Statement of Additional Information, and
this Statement of Additional Information has been incorporated by reference into
the Prospectus.
The date of this Statement of Additional Information is October 6, 2000.
ITEM 11. - FUND HISTORY.
The Trust is a Delaware business trust organized on July 7, 2000. The
Trust consists of two series.
ITEM 12. - DESCRIPTION OF THE FUND AND ITS INVESTMENTS AND RISKS.
INVESTMENT OBJECTIVES, STRATEGIES AND RISKS.
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INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Low Duration Master Portfolio is to
maximize long-term total return, consistent with preservation of capital. The
investment objective of the Total Return Bond Master Portfolio is to maximize
long-term total return.
The investment objective is a fundamental policy and may not be changed
without the approval of a majority of the Portfolio's outstanding voting
securities as defined in the Investment Company Act of 1940, as amended (the
"1940 Act").
Fund Asset Management, L.P. (the "Investment Adviser"), the Portfolio's
investment adviser, is responsible for the management of the Portfolios.
INVESTMENT RESTRICTIONS
Each Portfolio has adopted the following restrictions (in addition to its
investment objective) as fundamental policies, which may not be changed without
the favorable vote of the holders of a "majority" of the Portfolio's outstanding
voting securities, as defined in the 1940 Act. Under the 1940 Act, the vote of
the holders of a "majority" of the Portfolio's outstanding voting securities
means the vote of the holders of the lesser of (1) 67% of the shares of the
Portfolio represented at a meeting at which the holders of more than 50% of its
outstanding shares are represented or (2) more than 50% of the outstanding
shares.
Except as noted, a Portfolio may not:
1. Purchase any security, other than obligations of the U.S. government,
its agencies, or instrumentalities ("U.S. government securities"), if
as a result: (i) with respect to 75% of its total assets, more than 5%
of the Portfolio's total assets (determined at the time of investment)
would then be invested in securities of a single issuer; or (ii) more
than 25% of the Portfolio's total assets (determined at the time of
investment) would be invested in one or more issuers having their
principal business activities in a single industry.
2. Purchase securities on margin (but the Portfolio may obtain such
short-term credits as may be necessary for the clearance of
transactions), provided that the deposit or payment by the Portfolio of
initial or maintenance margin in connection with futures or options is
not considered the purchase of a security on margin.
3. Make short sales of securities or maintain a short position, unless at
all times when a short position is open it 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
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amount to, the securities sold short (short sale against-the-box), and
unless not more than 25% of the Portfolio's net assets (taken at
current value) is held as collateral for such sales at any one time.
4. Issue senior securities, borrow money or pledge its assets except that
the Portfolio may borrow from a bank for temporary or emergency
purposes in amounts not exceeding 10% (taken at the lower of cost or
current value) of its total assets (not including the amount borrowed)
and pledge its assets to secure such borrowings. (The Portfolio may
borrow from banks or enter into reverse repurchase agreements and
pledge assets in connection therewith, but only if immediately after
each borrowing there is asset coverage of 300%.)
5. Purchase any security (other than U.S. government securities) if as a
result, with respect to 75% of the Portfolio's total assets, the
Portfolio would then hold more than 10% of the outstanding voting
securities of an issuer.
6. Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an
underwriter under certain federal securities laws.
7. Make investments for the purpose of exercising control or management.
8. Participate on a joint or joint and several basis in any trading
account in securities.
Each Portfolio has adopted the following non-fundamental investment
restriction. A Portfolio may not make loans, except (i) through repurchase
agreements or (ii) having an aggregate market value in excess of one-third of
the total assets of the Portfolio. The acquisition of debt obligations in which
the Portfolio may invest is not considered the making of a loan.
Any percentage limitation on a Portfolio's investments is determined when the
investment is made, unless otherwise noted.
Each Portfolio may buy and sell commodities and commodity contracts and
real estate and interests in real estate to the extent set forth in the
Prospectus and Statement of Additional Information.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with the Investment Adviser, each Portfolio is
prohibited from engaging in certain transactions involving Merrill Lynch or its
affiliates except for brokerage transactions permitted under the 1940 Act
involving only usual and customary commissions or transactions pursuant to an
exemptive order under the 1940 Act. Without such an exemptive order a Portfolio
would be prohibited from engaging in portfolio transactions with Merrill Lynch
or any of its affiliates acting as principal.
REPURCHASE AGREEMENTS
A repurchase agreement is an agreement where the seller agrees to
repurchase a security from a Portfolio at a mutually agreed-upon time and price.
The period of maturity is usually quite short, possibly overnight or a few days,
although it may extend over a number of months. The resale price is more than
the purchase price, reflecting an agreed-upon rate of return effective for the
period of time the Portfolio's money is invested in the repurchase agreement.
The Portfolio's repurchase agreements will at all times be fully collateralized
in an amount at least equal to the resale price. The instruments held as
collateral are valued daily, and if the value of instruments declines, the
Portfolio will require additional collateral. In the event of a default,
insolvency or bankruptcy by a seller, the Portfolio will promptly seek to
liquidate the collateral. In such circumstances, the Portfolio could experience
a delay or be prevented from disposing of the collateral. To the extent that the
proceeds from any sale of such collateral upon a default in the obligation to
repurchase are less than the repurchase price, the Portfolio will suffer a loss.
BONDS
The term "bond" or "bonds" as used in the Prospectus and this Statement of
Additional Information is intended to include all manner of fixed-income
securities, debt securities, asset-backed and mortgage-backed securities and
other debt obligations unless specifically defined or the context requires
otherwise.
U.S. GOVERNMENT SECURITIES
U.S. government agencies or instrumentalities which issue or guarantee
securities include the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Banks, Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Federal Land Banks,
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Tennessee Valley Authority, Inter-American Development Bank, Asian Development
Bank, Student Loan Marketing Association and the International Bank for
Reconstruction and Development.
Except for U.S. Treasury securities, obligations of U.S. government
agencies and instrumentalities may or may not be supported by the full faith and
credit of the United States. Some are backed by the right of the issuer to
borrow from the Treasury; others by discretionary authority of the U.S.
government to purchase the agencies' obligations; while still others, such as
the Student Loan Marketing Association, are supported only by the credit of the
instrumentality. In the case of securities not backed by the full faith and
credit of the United States, the investor must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate repayment,
and may not be able to assert a claim against the United States itself in the
event the agency or instrumentality does not meet its commitment. A Portfolio
will invest in securities of such instrumentality only when the Investment
Adviser is satisfied that the credit risk with respect to any instrumentality is
acceptable.
Each Portfolio may invest in component parts of U.S. Treasury notes or
bonds, namely, either the corpus (principal) of such Treasury obligations or one
of the interest payments scheduled to be paid on such obligations. These
obligations may take the form of (1) Treasury obligations from which the
interest coupons have been stripped; (2) the interest coupons that are stripped;
(3) book-entries at a Federal Reserve member bank representing ownership of
Treasury obligation components; or (4) receipts evidencing the component parts
(corpus or coupons) of Treasury obligations that have not actually been
stripped. Such receipts evidence ownership of component parts of Treasury
obligations (corpus or coupons) purchased by a third party (typically an
investment banking firm) and held on behalf of the third party in physical or
book-entry form by a major commercial bank or trust company pursuant to a
custody agreement with the third party. These custodial receipts are known by
various names, including "Treasury Receipts," "Treasury Investment Growth
Receipts" ("TIGRs") and "Certificates of Accrual on Treasury Securities"
("CATS"), and are not issued by the U.S. Treasury; therefore they are not U.S.
government securities, although the underlying bonds represented by these
receipts are debt obligations of the U.S. Treasury.
MUNICIPAL OBLIGATIONS
Each Portfolio may invest in municipal obligations. The two principal
classifications of municipal bonds, notes and commercial paper are "general
obligation" and "revenue" bonds, notes or commercial paper. General obligation
bonds, notes or commercial paper are secured by the issuer's pledge of its
faith, credit and taxing power for the payment of principal and interest.
Issuers of general obligation bonds, notes or commercial paper include states,
counties, cities, towns and other governmental units. Revenue bonds, notes and
commercial paper are payable from the revenues derived from a particular
facility or class of facilities or, in some cases, from specific revenue
sources. Revenue bonds, notes or commercial paper are issued for a wide variety
of purposes, including the financing of electric, gas, water and sewer systems
and other public utilities; industrial development and pollution control
facilities; single and multifamily housing units; public buildings and
facilities; air and marine ports; transportation facilities such as toll roads,
bridges and tunnels; and health and educational facilities such as hospitals and
dormitories. They rely primarily on user fees to pay debt service, although the
principal revenue source is often supplemented by additional security features
which are intended to enhance the creditworthiness of the issuer's obligations.
In some cases, particularly revenue bonds issued to finance housing and public
buildings, a direct or implied "moral obligation" of a governmental unit may be
pledged to the payment of debt service. In other cases, a special tax or other
charge may augment user fees.
Included within the revenue bonds category are participations in municipal
lease obligations or installment purchase contracts of municipalities
(collectively, "lease obligations"). State and local governments issue lease
obligations to acquire equipment leases and facilities. Lease obligations may
have risks not normally associated with general obligation or other revenue
bonds. Leases and installment purchase or conditional sale contracts (which may
provide for title to the leased asset to pass eventually to the issuer) have
developed as a means for governmental issuers to acquire property and equipment
without the necessity of complying with the constitutional and statutory
requirements generally applicable for the issuance of debt. Certain lease
obligations contain "non-appropriation" clauses that provide that the
governmental issuer has no obligation to make future payments under the lease or
contract unless money is appropriated for such purpose
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by the appropriate legislative body on an annual or other periodic basis.
Consequently, continued lease payments on those lease obligations containing
"non-appropriation" clauses are dependent on future legislative actions. If such
legislative actions do not occur, the holders of the lease obligations may
experience difficulty in exercising their rights, including disposition of the
property.
Private activity obligations are issued to finance, among other things,
privately operated housing facilities, pollution control facilities, convention
or trade show facilities, mass transit, airport, port or parking facilities and
certain facilities for water supply, gas, electricity, sewage or solid waste
disposal. Private activity obligations are also issued to privately held or
publicly owned corporations in the financing of commercial or industrial
facilities. The principal and interest on these obligations may be payable from
the general revenues of the users of such facilities. Shareholders, depending on
their individual tax status, may be subject to the Federal alternative minimum
tax on the portion of a distribution attributable to these obligations. Interest
on private activity obligations will be considered exempt from Federal income
taxes; however, shareholders should consult their own tax advisers to determine
whether they may be subject to the Federal alternative minimum tax.
Resource recovery obligations are a type of municipal revenue obligation
issued to build facilities such as solid waste incinerators or waste-to-energy
plants. Usually, a private corporation will be involved and the revenue cash
flow will be supported by fees or units paid by municipalities for the use of
the facilities. The viability of a resource recovery project, environmental
protections regulations and project operator tax incentives may affect the value
and credit quality of these obligations.
Tax, revenue or bond anticipation notes are issued by municipalities in
expectation of future tax or other revenues which are payable from these
specific taxes or revenues. Bond anticipation notes usually provide interim
financing in advance of an issue of bonds or notes, the proceeds of which are
used to repay the anticipation notes. Tax-exempt commercial paper is issued by
municipalities to help finance short-term capital or operating needs in
anticipation of future tax or other revenue.
A variable rate obligation is one whose terms provide for the adjustment of
its interest rate on set dates and which, upon such adjustment, can reasonably
be expected to have a market value that approximates its par value. A floating
rate obligation has terms which provide for the adjustment of its interest rate
whenever a specified interest rate changes and which, at any time, can
reasonably be expected to have a market value that approximates its par value.
Variable or floating rate obligations may be secured by bank letters of credit.
Variable rate auction and residual interest obligations are created when an
issuer or dealer separates the principal portion of a long-term, fixed-rate
municipal bond into two long-term, variable-rate instruments. The interest rate
on one portion reflects short-term interest rates, while the interest rate on
the other portion is typically higher than the rate available on the original
fixed-rate bond.
Yields on municipal securities are dependent on a variety of factors,
including the general conditions of the municipal bond and municipal note
markets, the size of a particular offering, the maturity of the obligation and
the rating of the issue. The achievement of a Portfolio's investment objective
is dependent in part on the continuing ability of the issuers of municipal
securities in which the Portfolio invests to meet their obligations for the
payment of principal and interest when due. Obligations of issuers of municipal
securities are subject to the provisions of bankruptcy, insolvency and other
laws affecting the rights and remedies of creditors, such as the Bankruptcy
Reform Act of 1978, as amended. Therefore, the possibility exists that, as a
result of litigation or other conditions, the ability of any issuer to pay, when
due, the principal of and interest on its municipal securities may be materially
affected.
CORPORATE DEBT SECURITIES
A Portfolio's investments in U.S. dollar or foreign currency-denominated
corporate debt securities of domestic or foreign issuers are limited to
corporate debt securities (corporate bonds, debentures, notes and other similar
corporate debt instruments) which meet the minimum ratings criteria set forth
for the Portfolio, or, if unrated, are in the Investment Adviser's opinion
comparable in quality to corporate debt securities in which
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the Portfolio may invest. The rate of return or return of principal on some debt
obligations may be linked or indexed to the level of exchange rates between the
U.S. dollar and a foreign currency or currencies.
CONVERTIBLE SECURITIES
Each Portfolio may invest in convertible securities of domestic or foreign
issuers, which meet the ratings criteria set forth in the prospectus. A
convertible security is a fixed-income security (a bond or preferred stock)
which may be converted at a stated price within a specified period of time into
a certain quantity of common stock or other equity securities of the same or a
different issuer. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to similar
non-convertible securities. While providing a fixed-income stream (generally
higher in yield than the income derivable from common stock but lower than that
afforded by a similar non-convertible security), a convertible security also
affords an investor the opportunity, through its conversion feature, to
participate in the capital appreciation attendant upon a market price advance in
the convertible security's underlying common stock.
In general, the market value of a convertible security is at least the
higher of its "investment value" (that is, its value as a fixed-income security)
or its "conversion value" (that is, its value upon conversion into its
underlying stock). As a fixed-income security, a convertible security tends to
increase in market value when interest rates decline and tends to decrease in
value when interest rates rise. However, the price of a convertible security is
also influenced by the market value of the security's underlying common stock.
The price of a convertible security tends to increase as the market value of the
underlying stock rises, whereas it tends to decrease as the market value of the
underlying stock declines. While no securities investment is without some risk,
investments in convertible securities generally entail less risk than
investments in the common stock of the same issuer.
MORTGAGE-RELATED SECURITIES
Each Portfolio may invest in residential or commercial mortgage-related
securities, including mortgage pass-through securities, collateralized mortgage
obligations ("CMOs"), adjustable rate mortgage securities, CMO residuals,
stripped mortgage-related securities, floating and inverse floating rate
securities and tiered index bonds.
Mortgage Pass-Through Securities. Mortgage pass-through securities
represent interests in pools of mortgages in which payments of both principal
and interest on the securities are generally made monthly, in effect "passing
through" monthly payments made by borrowers on the residential or commercial
mortgage loans which underlie the securities (net of any fees paid to the issuer
or guarantor of the securities). Mortgage pass-through 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. Early repayment of principal on mortgage pass-through securities (arising
from prepayments of principal due to the sale of underlying property,
refinancing, or foreclosure, net of fees and costs which may be incurred) may
expose the Fund to a lower rate of return upon reinvestment of principal. Also,
if a security subject to repayment has been purchased at a premium, in the event
of prepayment, the value of the premium would be lost.
There are currently three types of mortgage pass-through securities: (1)
those issued by the U.S. government or one of its agencies or instrumentalities,
such as the Government National Mortgage Association ("Ginnie Mae"), the Federal
National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage
Corporation ("Freddie Mac"); (2) those issued by private issuers that represent
an interest in or are collateralized by pass-through securities issued or
guaranteed by the U.S. government or one of its agencies or instrumentalities;
and (3) those issued by private issuers that represent an interest in or are
collateralized by whole mortgage loans or pass-through securities without a
government guarantee but usually having some form of private credit enhancement.
Ginnie Mae is a wholly-owned U.S. government corporation within the
Department of Housing and Urban Development. Ginnie Mae 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 the institutions
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approved by Ginnie Mae (such as savings and loan institutions, commercial banks
and mortgage banks), and backed by pools of FHA-insured or VA-guaranteed
mortgages.
Obligations of Fannie Mae and Freddie Mac are not backed by the full faith
and credit of the U.S. government. In the case of obligations not
backed by the full faith and credit of the U.S. government, a Portfolio
must look principally to the agency issuing or guaranteeing the obligation for
ultimate repayment. Fannie Mae and Freddie Mac may borrow from the U.S. Treasury
to meet their obligations, but the U.S. Treasury is under no obligation to lend
to Fannie Mae or Freddie Mac.
Private mortgage pass-through securities are structured similarly to Ginnie
Mae, Fannie Mae, and Freddie Mac mortgage pass-through securities and are issued
by originators of and investors in mortgage loans, including depository
institutions, mortgage banks, investment banks and special purpose subsidiaries
of the foregoing.
Pools created by private mortgage pass-through issuers generally offer a
higher rate of interest than government and government-related pools because
there are no direct or indirect government or agency guarantees of payments in
the private pools. However, timely payment of interest and principal of these
pools may be supported by various forms of insurance or guarantees, including
individual loan, title, pool and hazard insurance and letters of credit. The
insurance and guarantees are issued by governmental entities, private insurers
and the mortgage poolers. The insurance and guarantees and the creditworthiness
of the issuers thereof will be considered in determining whether a
mortgage-related security meets a Portfolio's investment quality standards.
There can be no assurance that the private insurers or guarantors can meet their
obligations under the insurance policies or guarantee arrangements. Private
mortgage pass-through securities may be bought without insurance or guarantees
if, through an examination of the loan experience and practices of the
originator/servicers and poolers, the Investment Adviser determines that the
securities meet the Portfolio's quality standards.
Collateralized Mortgage Obligations. CMOs are debt obligations
collateralized by residential or commercial mortgage loans or residential or
commercial mortgage pass-through securities. Interest and prepaid principal are
generally paid monthly. CMOs may be collateralized by whole mortgage loans or
private mortgage pass-through securities but are more typically collateralized
by portfolios of mortgage pass-through securities guaranteed by Ginnie Mae,
Freddie Mac, or Fannie Mae. The issuer of a series of CMOs may elect to be
treated as a Real Estate Mortgage Investment Conduit ("REMIC"). All future
references to CMOs also include REMICs.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral which is ordinarily unrelated to the stated
maturity date. CMOs often provide for a modified form of call protection through
a de facto breakdown of the underlying pool of mortgages according to how
quickly the loans are repaid. Monthly payment of principal received from the
pool of underlying mortgages, including prepayments, is first returned to
investors holding the shortest maturity class. Investors holding the longer
maturity classes usually receive principal only after the first class has been
retired. An investor may be partially protected against a sooner than desired
return of principal because of the sequential payments.
Certain issuers of CMOs are not considered investment companies pursuant to
a rule adopted by the Securities and Exchange Commission (the "Commission"), and
the Fund may invest in the securities of such issuers without the limitations
imposed by the 1940 Act on investments by a Portfolio in other investment
companies. In addition, in reliance on an earlier Commission interpretation, a
Portfolio's investments in certain other qualifying CMOs, which cannot or do not
rely on the rule, are also not subject to the limitation of the 1940 Act on
acquiring interests in other investment companies. In order to be able to rely
on the Commission's interpretation, these CMOs must be unmanaged, fixed asset
issuers, that: (1) invest primarily in mortgage-backed securities; (2) do not
issue redeemable securities; (3) operate under general exemptive orders
exempting them from all provisions of the 1940 Act; and (4) are not registered
or regulated under the 1940 Act as investment companies. To the extent that a
Portfolio selects CMOs that cannot rely on the rule or do not meet the above
requirements, the Portfolio may not invest more than 10% of its assets in all
such entities and may not acquire more than 3% of the voting securities of any
single such entity.
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Each Portfolio may also invest in, among other things, parallel pay CMOs,
Planned Amortization Class CMOs ("PAC bonds"), sequential pay CMOs, and floating
rate CMOs. Parallel pay CMOs are structured to provide payments of principal on
each payment date to more than one class. PAC bonds generally require payments
of a specified amount of principal on each payment date. Sequential pay CMOs
generally pay principal to only one class while paying interest to several
classes. Floating rate CMOs are securities whose coupon rate fluctuates
according to some formula related to an existing market index or rate. Typical
indexes would include the eleventh district cost-of-funds index ("COFI"), the
London Interbank Offered Rate ("LIBOR"), one-year Treasury yields, and ten-year
Treasury yields.
Adjustable Rate Mortgage Securities. Adjustable rate mortgage securities
("ARMs") are pass-through securities collateralized by mortgages with adjustable
rather than fixed rates. ARMs eligible for inclusion in a mortgage pool
generally provide for a fixed initial mortgage interest rate for either the
first three, six, twelve, thirteen, thirty-six, or sixty scheduled monthly
payments. Thereafter, the interest rates are subject to periodic adjustment
based on changes to a designated benchmark index.
The ARMs contain maximum and minimum rates beyond which the mortgage
interest rate may not vary over the lifetime of the security. In addition,
certain ARMs provide for additional limitations on the maximum amount by which
the mortgage interest rate may adjust for any single adjustment period. In the
event that market rates of interest rise more rapidly to levels above that of
the ARM's maximum rate, the ARM's coupon may represent a below market rate of
interest. In these circumstances, the market value of the ARM security will
likely have fallen.
Certain ARMs contain limitations on changes in the required monthly
payment. In the event that a monthly payment is not sufficient to pay the
interest accruing on an ARM, any such excess interest is added to the principal
balance of the mortgage loan, which is repaid through future monthly payments.
If the monthly payment for such an instrument exceeds the sum of the interest
accrued at the applicable mortgage interest rate and the principal payment
required at such point to amortize the outstanding principal balance over the
remaining term of the loan, the excess is then utilized to reduce the
outstanding principal balance of the ARM.
CMO Residuals. CMO residuals are derivative mortgage securities issued by
agencies or instrumentalities of the U.S. government or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks, and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
part, the yield to maturity on the CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
interest-only ("IO") class of stripped mortgage-related securities. See
"Stripped Mortgage-Related Securities" below. In addition, if a series of a CMO
includes a class that bears interest at an adjustable rate, the yield to
maturity on the related CMO residual will also be extremely sensitive to changes
in the level of the index upon which interest rate adjustments are based. As
described below with respect to stripped mortgage-related securities, in certain
circumstances a Portfolio may fail to recoup fully its initial investment in a
CMO residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has recently developed and CMO residuals currently may not have
the liquidity of other more established securities trading in other markets.
Transactions in CMO residuals are generally completed only after careful review
of the characteristics of the securities in question. In addition, CMO residuals
may or, pursuant to an exemption therefrom, may not have been registered under
the Securities Act of 1933, as amended ("Securities Act"). CMO residuals,
whether or
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not registered under such Act, may be subject to certain restrictions on
transferability, and may be deemed "illiquid" and subject to the Portfolio
limitations on investment in illiquid securities.
Stripped Mortgage-Related Securities. Stripped mortgage-related securities
("SMBS") are derivative multi-class mortgage securities. SMBS may be issued by
agencies or instrumentalities of the U.S. government, or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks, and special purpose entities
of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In the most
extreme case, one class will receive all of the interest (the IO class), while
the other class will receive all of the principal (the PO class). The yield to
maturity on an IO class is extremely sensitive to the rate of principal payments
(including prepayments) on the related underlying mortgage assets, and a rapid
rate of principal payments may have a material adverse effect on a Portfolio's
yield to maturity from these securities. If the underlying mortgage assets
experience greater than anticipated prepayments of principal, the Portfolio may
fail to fully recoup its initial investment in these securities even if the
security is in one of the highest rating categories.
Although SMBS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these securities
were only recently introduced. As a result, established trading markets have not
yet been fully developed and accordingly, these securities may be deemed
"illiquid" and subject to the Portfolio's limitations on investment in illiquid
securities.
Inverse Floaters. An inverse floater is a debt instrument with a floating
or variable interest rate that moves in the opposite direction to the interest
rate on another security or index level. Changes in the interest rate on the
other security or index inversely affect the residual interest rate paid on the
inverse floater, with the result that the inverse floater's price will be
considerably more volatile than that of a fixed rate bond. Inverse floaters may
experience gains when interest rates fall and may suffer losses in periods of
rising interest rates. The market for inverse floaters is relatively new.
Tiered Index Bonds. Tiered index bonds are relatively new forms of
mortgage-related securities. The interest rate on a tiered index bond is tied to
a specified index or market rate. So long as this index or market rate is below
a predetermined "strike" rate, the interest rate on the tiered index bond
remains fixed. If, however, the specified index or market rate rises above the
"strike" rate, the interest rate of the tiered index bond will decrease. Thus,
under these circumstances, the interest rate on a tiered index bond, like an
inverse floater, will move in the opposite direction of prevailing interest
rates, with the result that the price of the tiered index bond may be
considerably more volatile than that of a fixed-rate bond.
ASSET-BACKED SECURITIES
Each Portfolio may invest in various types of asset-backed securities.
Through the use of trusts and special purpose corporations, various types of
assets, primarily automobile and credit card receivables and home equity loans,
are being securitized in pass-through structures similar to the mortgage
pass-through or in a pay-through structure similar to the CMO structure.
Investments in these and other types of asset-backed securities must be
consistent with the investment objective and policies of the Portfolio.
RISK FACTORS RELATING TO INVESTING IN MORTGAGE-RELATED AND ASSET-BACKED
SECURITIES
The yield characteristics of mortgage-related and asset-backed securities
differ from traditional debt securities. Among the major differences are that
interest and principal payments are made more frequently, usually monthly, and
that principal may be prepaid at any time because the underlying mortgage loans
or other assets generally may be prepaid at any time. As a result, if a
Portfolio purchases such a security at a premium, a prepayment rate that is
faster than expected will reduce yield to maturity, while a prepayment rate that
is slower than expected will have the opposite effect of increasing yield to
maturity. Alternatively, if the Portfolio purchases these securities at a
discount, faster than expected prepayments will increase, while slower
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than expected prepayments will reduce, yield to maturity. A Portfolio may invest
a portion of its assets in derivative mortgage-related securities which are
highly sensitive to changes in prepayment and interest rates. The Investment
Adviser will seek to manage these risks (and potential benefits) by diversifying
its investments in such securities and through hedging techniques.
During periods of declining interest rates, prepayment of mortgages
underlying mortgage-related securities can be expected to accelerate.
Accordingly, a Portfolio's ability to maintain positions in high-yielding
mortgage-related securities will be affected by reductions in the principal
amount of such securities resulting from such prepayments, and its ability to
reinvest the returns of principal at comparable yields is subject to generally
prevailing interest rates at that time. Conversely, slower than expected
prepayments may effectively change a security that was considered short or
intermediate-term at the time of purchase into a long-term security. Long-term
securities tend to fluctuate more in response to interest rate changes, leading
to increased net asset value volatility. Prepayments may also result in the
realization of capital losses with respect to higher yielding securities that
had been bought at a premium or the loss of opportunity to realize capital gains
in the future from possible future appreciation.
Asset-backed securities involve certain risks that are not posed by
mortgage-related securities, resulting mainly from the fact that asset-backed
securities do not usually contain the complete benefit of a security interest in
the related collateral. For example, credit card receivables generally are
unsecured and the debtors are entitled to the protection of a number of state
and federal consumer credit laws, some of which may reduce the ability to obtain
full payment. In the case of automobile receivables, due to various legal and
economic factors, proceeds from repossessed collateral may not always be
sufficient to support payments on these securities.
DURATION
In selecting securities for the Portfolios, the Investment Adviser makes
use of the concept of duration for fixed-income securities. Duration is a
measure of the expected life of a fixed-income security. Duration incorporates a
bond's yield, coupon interest payments, final maturity and call features into
one measure. Most debt obligations provide interest ("coupon") payments in
addition to a final ("par") payment at maturity. Some obligations also have call
provisions. Depending on the relative magnitude of these payments, the market
values of debt obligations may respond differently to changes in the level and
structure of interest rates.
Duration is a measure of the expected life of a fixed-income security on a
present value basis. Duration takes the length of the time intervals between the
present time and the time that the interest and principal payments are scheduled
or, in the case of a callable bond, expected to be received, and weights them by
the present values of the cash to be received at each future point in time. For
any fixed-income security with interest payments occurring prior to the payment
of principal, duration is always less than maturity. In general, all other
things being the same, the lower the stated or coupon rate of interest of a
fixed-income security, the longer the duration of the security; conversely, the
higher the stated or coupon rate of interest of a fixed-income security, the
shorter the duration of the security.
Futures, options and options on futures have durations which, in general,
are closely related to the duration of the securities which underlie them.
Holding long futures or call option positions (backed by a segregated account of
cash and cash equivalents) will lengthen the Portfolio's duration by
approximately the same amount that holding an equivalent amount of the
underlying securities would.
Short futures or put options positions have durations roughly equal to the
negative duration of the securities that underlie those positions, and have the
effect of reducing portfolio duration by approximately the same amount that
selling an equivalent amount of the underlying securities would.
There are some situations where even the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or more
years; however, their interest rate exposure corresponds to the frequency of the
coupon reset. Another example where the interest rate exposure is not properly
captured by duration is the case of mortgage pass-through securities. The stated
final maturity of such securities is generally 30 years, but
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current prepayment rates are more critical in determining the securities'
interest rate exposure. In these and other similar situations, the Investment
Adviser will use more sophisticated analytical techniques that incorporate the
economic life of a security into the determination of its interest rate
exposure.
DERIVATIVE INSTRUMENTS
To the extent consistent with its investment objective and policies and the
investment restrictions listed in this Statement of Additional Information, a
Portfolio may purchase and write call and put options on securities, securities
indexes and foreign currencies and enter into forward contracts and futures
contracts and use options on futures contracts. Each Portfolio also may enter
into swap agreements with respect to foreign currencies, interest rates and
securities indexes. The Portfolio may use these techniques to hedge against
changes in interest rates, foreign currency exchange rates, or securities prices
or as part of its overall investment strategies. The Portfolio may also purchase
and sell options relating to foreign currencies for the purpose of increasing
exposure to a foreign currency or to shift exposure to foreign currency
fluctuations from one country to another. The Portfolio will mark as segregated
cash, U.S. government securities, equity securities or other liquid,
unencumbered assets, marked-to-market daily (or, as permitted by applicable
regulation, enter into certain offsetting positions), to cover its obligations
under forward contracts, futures contracts, swap agreements and options to avoid
leveraging of the Portfolio.
Options on Securities and on Securities Indexes. Each Portfolio may
purchase put options on securities to protect holdings in an underlying or
related security against a substantial decline in market value. The Portfolio
may purchase call options on securities to protect against substantial increases
in prices of securities the Portfolio intends to purchase pending its ability to
invest in such securities in an orderly manner. The Portfolio may sell put or
call options it has previously purchased, which could result in a net gain or
loss depending on whether the amount realized on the sale is more or less than
the premium and other transaction costs paid on the put or call option which is
sold. The Portfolio may write a call or put option only if the option is
"covered" by the Portfolio holding a position in the underlying securities or by
other means which would permit immediate satisfaction of the Portfolio's
obligation as writer of the option. Prior to exercise or expiration, an option
may be closed out by an offsetting purchase or sale of an option of the same
series.
The purchase and writing of options involve certain risks. During the
option period, the covered call writer has, in return for the premium on the
option, given up the opportunity to profit from a price increase in the
underlying securities above the exercise price, but, as long as its obligation
as a writer continues, has retained the risk of loss should the price of the
underlying securities decline. The writer of an option has no control over the
time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying securities at the exercise price. If a
put or call option purchased by a Portfolio is not sold when it has remaining
value, and if the market price of the underlying security, in the case of a put,
remains equal to or greater than the exercise price or, in the case of a call,
remains less than or equal to the exercise price, the Portfolio will lose its
entire investment in the option. Also, where a put or call option on a
particular security is purchased to hedge against price movements in a related
security, the price of the put or call option may move more or less than the
price of the related security. There can be no assurance that a liquid market
will exist when the Portfolio seeks to close out an option position.
Furthermore, if trading restrictions or suspensions are imposed on the options
markets, the Portfolio may be unable to close out a position.
There are several risks associated with transactions in options on
securities and on indexes. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when and how to use options involves
the exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There can be no assurance that a liquid market will exist when a Portfolio
seeks to close out an option position. If the Portfolio were unable to close out
an option that it had purchased on a security, it would have to exercise the
option in order to realize any profit or the option may expire worthless. If the
Portfolio were unable to close out a covered call option that it had written on
a security, it would not be able to sell the underlying
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security unless the option expired without exercise. As the writer of a covered
call option, the Portfolio forgoes, during the option's life, the opportunity to
profit from increases in the market value of the security covering the call
option above the sum of the premium and the exercise price of the call.
If trading were suspended in an option purchased by the Portfolio, the
Portfolio would not be able to close out the option. If restrictions on exercise
were imposed, the Portfolio might be unable to exercise an option it had
purchased. Except to the extent that a call option on an index written by the
Portfolio is covered by an option on the same index purchased by the Portfolio,
movements in the index may result in a loss to the Portfolio; however, such
losses may be mitigated by changes in the value of the Portfolio's securities
during the period the option was outstanding.
Futures Contracts and Options on Futures Contracts. Each Portfolio may use
interest rate, foreign currency or index futures contracts, as specified for the
Portfolio in its prospectus. An interest rate, foreign currency or index futures
contract provides for the future sale by one party and purchase by another party
of a specified quantity of a financial instrument, foreign currency or the cash
value of an index at a specified price and time. A futures contract on an index
is an agreement pursuant to which two parties agree to take or make delivery of
an amount of cash equal to the difference between the value of the index at the
close of the last trading day of the contract and the price at which the index
contract was originally written. Although the value of an index might be a
function of the value of certain specified securities, no physical delivery of
these securities is made.
The Portfolio may purchase and write call and put options on futures.
Options on futures possess many of the same characteristics as options on
securities and indexes (discussed above). An option on a futures contract gives
the holder the right, in return for the premium paid, to assume a long position
(call) or short position (put) in a futures contract at a specified exercise
price at any time during the period of the option. Upon exercise of a call
option, the holder acquires a long position in the futures contract and the
writer is assigned the opposite short position. In the case of a put option, the
opposite is true.
Each Portfolio will use futures contracts and options on futures contracts
in accordance with the rules of the Commodity Futures Trading Commission
("CFTC"). For example, the Portfolio might use futures contracts to hedge
against anticipated changes in interest rates that might adversely affect either
the value of the Portfolio's securities or the price of the securities which the
Portfolio intends to purchase. The Portfolio's hedging activities may include
sales of futures contracts as an offset against the effect of expected increases
in interest rates, and purchases of futures contracts as an offset against the
effect of expected declines in interest rates. Although other techniques could
be used to reduce the Portfolio's exposure to interest rate fluctuations, the
Portfolio may be able to hedge its exposure more effectively and perhaps at a
lower cost by using futures contracts and options on futures contracts.
A Portfolio will only enter into futures contracts and options on futures
contracts which are standardized and traded on a U.S. or foreign exchange, board
of trade, or similar entity, or quoted on an automated quotation system.
When a purchase or sale of a futures contract is made by a Portfolio, the
Portfolio is required to deposit with its custodian or futures commission
merchant a specified amount of cash or U.S. government securities ("initial
margin"). The margin required for a futures contract is set by the exchange on
which the contract is traded and may be modified during the term of the
contract. The initial margin is in the nature of a performance bond or good
faith deposit on the futures contract which is returned to the Portfolio upon
termination of the contract, assuming all contractual obligations have been
satisfied. The Portfolio expects to earn interest income on its initial margin
deposits. A futures contract held by the Portfolio is valued daily at the
official settlement price of the exchange on which it is traded. Each day the
Portfolio pays or receives cash, called "variation margin", equal to the daily
change in value of the futures contract. This process is known as "marking to
market". Variation margin does not represent a borrowing or loan by the
Portfolio but is instead a settlement between the Portfolio and the broker of
the amount one would owe the other if the futures contract expired. In computing
daily net asset value, the Portfolio will mark to market its open futures
positions.
A Portfolio is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures
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contract (and the related initial margin requirements), the current market value
of the option, and other futures positions held by the Portfolio.
Although some futures contracts call for making or taking delivery of the
underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts (same
exchange, underlying security or index and delivery month). If an offsetting
purchase price is less than the original sale price, the Portfolio realizes a
capital gain, or if it is more, the Portfolio realizes a capital loss.
Conversely, if an offsetting sale price is more than the original purchase
price, the Portfolio realizes a capital gain, or if it is less, the Portfolio
realizes a capital loss. The transaction costs must also be included in these
calculations.
Limitations on Use of Futures and Options Thereon. When purchasing a
futures contract, the Portfolio will maintain with its custodian (and
mark-to-market on a daily basis) cash, U.S. government securities, equity
securities or other liquid, unencumbered assets that, when added to the amounts
deposited as margin with a futures commission merchant or the custodian, are
equal to the market value of the futures contract. Alternatively, the Portfolio
may "cover" its position by purchasing a put option on the same futures contract
with a strike price as high or higher than the price of the contract held by the
Portfolio.
When selling a futures contract, the Portfolio will maintain with its
custodian (and mark-to-market on a daily basis) liquid assets that, when added
to the amount deposited as margin with a futures commission merchant or the
custodian, are equal to the market value of the instruments underlying the
contract. Alternatively, the Portfolio may "cover" its position by owning the
instruments underlying the contract (or, in the case of an index futures
contract, a portfolio with a volatility substantially similar to that of the
index on which the futures contract is based), or by holding a call option
permitting the Portfolio to purchase the same futures contract at a price no
higher than the price of the contract written by the Portfolio (or at a higher
price if the difference is maintained in liquid assets with the Trust's
custodian).
When selling a call option on a futures contract, a Portfolio will maintain
with its custodian (and mark-to-market on a daily basis) cash, U.S. government
securities, equity securities or other liquid, unencumbered assets that, when
added to the amounts deposited as margin with a futures commission merchant or
the custodian, equal the total market value of the futures contract underlying
the call option. Alternatively, the Portfolio may cover its position by entering
into a long position in the same futures contract at a price no higher than the
strike price of the call option, by owning the instruments underlying the
futures contract, or by holding a separate call option permitting the Portfolio
to purchase the same futures contract at a price not higher than the strike
price of the call option sold by the Portfolio.
When selling a put option on a futures contract, the Portfolio will
maintain with its custodian (and mark-to-market on a daily basis) cash, U.S.
government securities, equity securities or other liquid, unencumbered assets
that equal the purchase price of the futures contract, less any margin on
deposit. Alternatively, the Portfolio may cover the position either by entering
into a short position in the same futures contract, or by owning a separate put
option permitting it to sell the same futures contract so long as the strike
price of the purchased put option is the same or higher than the strike price of
the put option sold by the Portfolio.
In order to comply with current applicable regulations of the CFTC pursuant
to which the Trust avoids being deemed a "commodity pool operator," each
Portfolio is limited in its futures trading activities to positions which
constitute "bona fide hedging" positions within the meaning and intent of
applicable CFTC rules, or to non-hedging positions for which the aggregate
initial margin and premiums will not exceed 5% of the liquidation value of the
Portfolio's assets.
Risk Factors in Futures Transactions and Options. Investment in futures
contracts involves the risk of imperfect correlation between movements in the
price of the futures contract and the price of the security being hedged. The
hedge will not be fully effective when there is imperfect correlation between
the movements in the prices of two financial instruments. For example, if the
price of the futures contract moves more than the price of the hedged security,
the Portfolio will experience either a loss or gain on the futures contract
which is not completely offset by movements in the price of the hedged
securities. To compensate for imperfect correlations, the Portfolio may purchase
or sell futures contracts in a greater dollar amount than the hedged securities
if the volatility of the hedged securities is historically greater than the
volatility of the futures
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contracts. Conversely, the Portfolio may purchase or sell fewer futures
contracts if the volatility of the price of the hedged securities is
historically less than that of the futures contracts.
The particular securities comprising the index underlying the index
financial futures contract may vary from the securities held by the Portfolio.
As a result, the Portfolio's ability to hedge effectively all or a portion of
the value of its securities through the use of such financial futures contracts
will depend in part on the degree to which price movements in the index
underlying the financial futures contract correlate with the price movements of
the securities held by the Portfolio. The correlation may be affected by
disparities in the Portfolio's investments as compared to those comprising the
index and general economic or political factors. In addition, the correlation
between movements in the value of the index may be subject to change over time
as additions to and deletions from the index alter its structure. The
correlation between futures contracts on U.S. government securities and the
securities held by the Portfolio may be adversely affected by similar factors
and the risk of imperfect correlation between movements in the prices of such
futures contracts and the prices of securities held by the Portfolio may be
greater. The trading of futures contracts also is subject to certain market
risks, such as inadequate trading activity, which could at times make it
difficult or impossible to liquidate existing positions.
Each Portfolio expects to liquidate a majority of the futures contracts it
enters into through offsetting transactions on the applicable contract market.
There can be no assurance, however, that a liquid secondary market will exist
for any particular futures contract at any specific time. Thus, it may not be
possible to close out a futures position. In the event of adverse price
movements, the Portfolio would continue to be required to make daily cash
payments of variation margin. In such situations, if the Portfolio has
insufficient cash, it may be required to sell portfolio securities to meet daily
variation margin requirements at a time when it may be disadvantageous to do so.
The inability to close out futures positions also could have an adverse impact
on the Portfolio's ability to hedge effectively its investments. 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. Prices have in the past moved beyond the daily limit on a
number of consecutive trading days. The Portfolio will enter into a futures
position only if, in the judgment of the Investment Adviser, there appears to be
an actively traded secondary market for such futures contracts.
The successful use of transactions in futures and related options also
depends on the ability of the Investment Adviser to forecast correctly the
direction and extent of interest rate movements within a given time frame. To
the extent interest rates remain stable during the period in which a futures
contract or option is held by the Portfolio or such rates move in a direction
opposite to that anticipated, the Portfolio may realize a loss on a hedging
transaction which is not fully or partially offset by an increase in the value
of portfolio securities. As a result, the Portfolio's total return for such
period may be less than if it had not engaged in the hedging transaction.
Because of low initial margin deposits made upon the opening of a futures
position, futures transactions involve substantial leverage. As a result,
relatively small movements in the price of the futures contracts can result in
substantial unrealized gains or losses. There is also the risk of loss by a
Portfolio of margin deposits in the event of the bankruptcy of a broker with
whom the Portfolio has an open position in a financial futures contract.
The amount of risk the Portfolio assumes when it purchases an option on a
futures contract is the premium paid for the option plus related transaction
costs. In addition to the correlation risks discussed above, the purchase of an
option on a futures contract 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.
FOREIGN SECURITIES
Each Portfolio may invest in American Depositary Receipts ("ADRs"),
European Depositary Receipts ("EDRs") or other securities convertible into
securities of issuers based in foreign countries. These securities may not
necessarily be denominated in the same currency as the securities into which
they may be converted.
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ADRs are receipts, usually issued by a U.S. bank or trust company, evidencing
ownership of the underlying securities; EDRs are European receipts evidencing a
similar arrangement. Generally, ADRs are issued in registered form, denominated
in U.S. dollars, and are designed for use in the U.S. securities markets; EDRs
are issued in bearer form, denominated in other currencies, and are designed for
use in European securities markets.
Each Portfolio may also invest in fixed-income securities of issuers
located in emerging foreign markets. Emerging markets generally include every
country in the world other than the United States, Canada, Japan, Australia,
Malaysia, New Zealand, Hong Kong, South Korea, Singapore and most Western
European countries. In determining what countries constitute emerging markets,
the Investment Adviser will consider, among other things, data, analysis and
classification of countries published or disseminated by the International Bank
for Reconstruction and Development (commonly known as the World Bank) and the
International Finance Corporation. Currently, investing in many emerging markets
may not be desirable or feasible, because of the lack of adequate custody
arrangements for the Portfolio's assets, overly burdensome repatriation and
similar restrictions, the lack of organized and liquid securities markets,
unacceptable political risks or other reasons. As opportunities to invest in
securities in emerging markets develop, the Portfolio expects to expand and
further broaden the group of emerging markets in which it invests.
From time to time, emerging markets have offered the opportunity for higher
returns in exchange for a higher level of risk. Accordingly, the Investment
Adviser believes that the Portfolio's ability to invest in emerging markets
throughout the world can assist in the overall diversification of the
Portfolio's portfolio.
Each Portfolio may invest in the following types of emerging market
fixed-income securities: (1) fixed-income securities issued or guaranteed by
governments, their agencies, instrumentalities or political subdivisions, or by
government owned, controlled or sponsored entities, including central banks
(collectively, "Sovereign Debt"), including Brady Bonds (described below); (2)
interests in issuers organized and operated for the purpose of restructuring the
investment characteristics of Sovereign Debt; (3) fixed-income securities issued
by banks and other business entities; and (4) fixed-income securities
denominated in or indexed to the currencies of emerging markets. Fixed-income
securities held by the Portfolio may take the form of bonds, notes, bills,
debentures, bank debt obligations, short-term paper, loan participations,
assignments and interests issued by entities organized and operated for the
purpose of restructuring the investment characteristics of any of the foregoing.
There is no requirement with respect to the maturity of fixed-income securities
in which the Portfolio may invest.
The Portfolio may invest in Brady Bonds and other Sovereign Debt of
countries that have restructured or are in the process of restructuring
Sovereign Debt pursuant to the Brady Plan. "Brady Bonds" are debt securities
issued under the framework of the Brady Plan, an initiative announced by former
U.S. Treasury Secretary Nicholas F. Brady in 1989 as a mechanism for debtor
nations to restructure their outstanding external commercial bank indebtedness.
In restructuring its external debt under the Brady Plan framework, a debtor
nation negotiates with its existing bank lenders as well as multilateral
institutions such as the World Bank and the International Monetary Fund ("IMF").
The Brady Plan framework, as it has developed, contemplates the exchange of
commercial bank debt for newly issued Brady Bonds. Brady Bonds may also be
issued in respect of new money being advanced by existing lenders in connection
with the debt restructuring. The World Bank and/or the IMF support the
restructuring by providing funds pursuant to loan agreements or other
arrangements which enable the debtor nation to collateralize the new Brady Bonds
or to repurchase outstanding bank debt at a discount.
Emerging market fixed-income securities generally are considered to be of a
credit quality below investment grade, even though they often are not rated by
any nationally recognized statistical rating organizations. Investment in
emerging market fixed-income securities will be allocated among various
countries based upon the Investment Adviser's analysis of credit risk and its
consideration of a number of factors, including: (1) prospects for relative
economic growth among the different countries in which the Portfolio may invest;
(2) expected levels of inflation; (3) government policies influencing business
conditions; (4) the outlook for currency relationships; and (5) the range of the
individual investment opportunities available to international investors. The
Investment Adviser's emerging market sovereign credit analysis includes an
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<PAGE> 31
evaluation of the issuing country's total debt levels, currency reserve levels,
net exports/imports, overall economic growth, level of inflation, currency
fluctuation, political and social climate and payment history. Particular
fixed-income securities will be selected based upon a credit risk analysis of
potential issuers, the characteristics of the security, the interest rate
sensitivity of the various debt issues available with respect to a particular
issuer, an analysis of the anticipated volatility and liquidity of the
particular debt instruments, and the tax implications to the Portfolio. The
emerging market fixed-income securities in which a Portfolio may invest are not
subject to any minimum credit quality standards.
FOREIGN CURRENCY OPTIONS AND RELATED RISKS
Each Portfolio may take positions in options on foreign currencies to hedge
against the risk that foreign exchange rate fluctuations will affect the value
of foreign securities the Portfolio holds in its portfolio or intends to
purchase. For example, if the Portfolio were to enter into a contract to
purchase securities denominated in a foreign currency, it could effectively fix
the maximum U.S. dollar cost of the securities by purchasing call options on
that foreign currency. Similarly, if the Portfolio held securities denominated
in a foreign currency and anticipated a decline in the value of that currency
against the U.S. dollar, it could hedge against such a decline by purchasing a
put option on the currency involved. The markets in foreign currency options are
relatively new, and the Portfolio's ability to establish and close out positions
in such options is subject to the maintenance of a liquid secondary market.
There can be no assurance that a liquid secondary market will exist for a
particular option at any specific time. In addition, options on foreign
currencies are affected by all of those factors that influence foreign exchange
rates and investments generally.
The quantities of currencies underlying option contracts represent odd lots
in a market dominated by transactions between banks, and as a result extra
transaction costs may be incurred upon exercise of an option.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations be firm or revised on a
timely basis. Quotation information is generally representative of very large
transactions in the interbank market and may not reflect smaller transactions
where rates may be less favorable. Option markets may be closed while
round-the-clock interbank currency markets are open, and this can create price
and rate discrepancies.
Risks of Options Trading. Each Portfolio may effectively terminate its
rights or obligations under options by entering into closing transactions.
Closing transactions permit the Portfolio to realize profits or limit losses on
its options positions prior to the exercise or expiration of the option. The
value of a foreign currency option depends on the value of the underlying
currency relative to the U.S. dollar. Other factors affecting the value of an
option are the time remaining until expiration, the relationship of the exercise
price to market price, the historical price volatility of the underlying
currency and general market conditions. As a result, changes in the value of an
option position may have no relationship to the investment merit of a foreign
security. Whether a profit or loss is realized on a closing transaction depends
on the price movement of the underlying currency and the market value of the
option.
Options normally have expiration dates of up to nine months. The exercise
price may be below, equal to or above the current market value of the underlying
currency. Options that expire unexercised have no value, and the Portfolio will
realize a loss of any premium paid and any transaction costs. Closing
transactions may be effected only by negotiating directly with the other party
to the option contract, unless a secondary market for the options develops.
Although each Portfolio intends to enter into foreign currency options only with
dealers which agree to enter into, and which are expected to be capable of
entering into, closing transactions with the Portfolio, there can be no
assurance that the Portfolio will be able to liquidate an option at a favorable
price at any time prior to expiration. In the event of insolvency of the
counter-party, the Portfolio may be unable to liquidate a foreign currency
option. Accordingly, it may not be possible to effect closing transactions with
respect to certain options, with the result that the Portfolio would have to
exercise those options that it had purchased in order to realize any profit.
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FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
A Portfolio may use forward contracts to protect against uncertainty in the
level of future exchange rates. The Portfolio will not speculate with forward
contracts or foreign currency exchange rates.
A Portfolio may enter into forward contracts with respect to specific
transactions. For example, when the Portfolio enters into a contract for the
purchase or sale of a security denominated in a foreign currency, or when the
Portfolio anticipates the receipt in a foreign currency of dividend or interest
payments on a security that it holds, the Portfolio may desire to "lock in" the
U.S. dollar price of the security or the U.S. dollar equivalent of the payment,
by entering into a forward contract for the purchase or sale, for a fixed amount
of U.S. dollars or foreign currency, of the amount of foreign currency involved
in the underlying transaction. The Portfolio will thereby be able to protect
itself against a possible loss resulting from an adverse change in the
relationship between the currency exchange rates during the period between the
date on which the security is purchased or sold, or on which the payment is
declared, and the date on which such payments are made or received.
A Portfolio also may use forward contracts in connection with portfolio
positions to lock in the U.S. dollar value of those positions, to increase the
Portfolio's exposure to foreign currencies that the Investment Adviser believes
may rise in value relative to the U.S. dollar or to shift the Portfolio's
exposure to foreign currency fluctuations from one country to another. For
example, when the Investment Adviser believes that the currency of a particular
foreign country may suffer a substantial decline relative to the U.S. dollar or
another currency, it may enter into a forward contract to sell the amount of the
former foreign currency approximating the value of some or all of the
Portfolio's portfolio securities denominated in such foreign currency. This
investment practice generally is referred to as "cross-hedging" when another
foreign currency is used.
The precise matching of the forward contract amounts and the value of the
securities involved will not generally be possible because the future value of
such 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 the date it matures. Accordingly, it may be necessary for
the Portfolio to purchase additional foreign currency on the spot (that is,
cash) market (and bear the expense of such purchase) if the market value of the
security is less than the amount of foreign currency the Portfolio is obligated
to deliver and if a decision is made to sell the security and make delivery of
the foreign currency. Conversely, it may be necessary to sell on the spot market
some of the foreign currency received upon the sale of the portfolio security if
its market value exceeds the amount of foreign currency the Portfolio is
obligated to deliver. The projection of short-term currency market movements is
extremely difficult, and the successful execution of a short-term hedging
strategy is highly uncertain. Forward contracts involve the risk that
anticipated currency movements will not be accurately predicted, causing the
Portfolio to sustain losses on these contracts and transaction costs. The
Portfolio may enter into forward contracts or maintain a net exposure to such
contracts only if (1) the consummation of the contracts would not obligate the
Portfolio to deliver an amount of foreign currency in excess of the value of the
Portfolio's portfolio securities or other assets denominated in that currency,
or (2) the Portfolio marks as segregated cash, U.S. government securities,
equity securities or other liquid, unencumbered assets, marked-to-market daily,
in an amount not less than the value of the Portfolio's total assets committed
to the consummation of the contracts. Under normal circumstances, consideration
of the prospect for currency parities will be incorporated into the longer term
investment decisions made with regard to overall diversification strategies.
However, the Investment Adviser believes it is important to have the flexibility
to enter into such forward contracts when it determines that the best interests
of the Portfolio will be served.
At or before the maturity date of a forward contract that requires a
Portfolio to sell a currency, the Portfolio may either sell a portfolio security
and use the sale proceeds to make delivery of the currency or retain the
security and offset its contractual obligation to deliver the currency by
purchasing a second contract pursuant to which the Portfolio will obtain, on the
same maturity date, the same amount of the currency that it is obligated to
deliver. Similarly, the Portfolio may close out a forward contract requiring it
to purchase a specified currency by entering into a second contract entitling it
to sell the same amount of the same currency on the maturity date of the first
contract. The Portfolio would realize a gain or loss as a result of entering
into such an offsetting forward contract under either circumstance to the extent
the exchange rate between the currencies involved moved between the execution
dates of the first and second contracts.
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<PAGE> 33
The cost to the Portfolio of engaging in forward contracts varies with
factors such as the currencies involved, the length of the contract period and
the market conditions then prevailing. Because forward contracts are usually
entered into on a principal basis, no fees or commissions are involved. The use
of forward contracts does not eliminate fluctuations in the prices of the
underlying securities the Portfolio owns or intends to acquire, but it does fix
a rate of exchange in advance. In addition, although forward contracts limit the
risk of loss due to a decline in the value of the hedged currencies, at the same
time they limit any potential gain that might result should the value of the
currencies increase.
Although the Portfolio values its assets daily in terms of U.S. dollars, it
does not intend to convert holdings of foreign currencies into U.S. dollars on a
daily basis. The Portfolio may convert foreign currency from time to time, and
investors should be aware of the costs of currency conversion. Although foreign
exchange dealers do not charge a fee for conversion, they do realize a profit
based on the difference between the prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to the
Portfolio at one rate, while offering a lesser rate of exchange should the
Portfolio desire to resell that currency to the dealer.
FOREIGN INVESTMENT RISKS
Foreign Market Risk. Each Portfolio may invest a portion of its assets in
foreign securities. Foreign security investment involves special risks not
present in U.S. investments that can increase the chances that the Portfolio
will lose money. Prices of foreign securities may fluctuate more than prices of
securities traded in the United States.
Foreign Economy Risk. The economies of certain foreign markets often do not
compare favorably with that of the United States with respect to such issues as
growth of gross national product, reinvestment of capital, resources, and
balance of payments position. Certain such economies may rely heavily on
particular industries or foreign capital and are more vulnerable to diplomatic
developments, the imposition of economic sanctions against a particular country
or countries, changes in international trading patterns, trade barriers, and
other protectionist or retaliatory measures. Investments in foreign markets may
also be adversely affected by governmental actions such as the imposition of
capital controls, nationalization of companies or industries, expropriation of
assets, or the imposition of punitive taxes. In addition, the governments of
certain countries may prohibit or impose substantial restrictions on foreign
investing in their capital markets or in certain industries. Any of these
actions could severely affect security prices, impair a Portfolio's ability to
purchase or sell foreign securities or transfer the Portfolio's assets or income
back into the United States, or otherwise adversely affect the Portfolio's
operations. Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government securities,
difficulties in enforcing favorable legal judgments in foreign courts, and
political and social instability. Legal remedies available to investors in
certain foreign countries may be less extensive than those available to
investors in the United States or other foreign countries.
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<PAGE> 34
Currency Risk and Exchange Risk. Securities in which a Portfolio invests
may be denominated or quoted in currencies other than the U.S. dollar. Changes
in foreign currency exchange rates will affect the value of the securities of
the Portfolio. Generally, when the U.S. dollar rises in value against a foreign
currency, your investment in a security denominated in that currency loses value
because the currency is worth fewer U.S. dollars. Similarly when the U.S. dollar
decreases in value against a foreign currency, your investment in a security
denominated in that currency gains value because the currency is worth more U.S.
dollars. This risk is generally known as "currency risk" which is the
possibility that a stronger U.S. dollar will reduce returns for U.S. investors
investing overseas and a weak U.S. dollar will increase returns for U.S.
investors investing overseas.
EMU. For a number of years, certain European countries have been seeking
economic unification that would, among other things, reduce barriers between
countries, increase competition among companies, reduce government subsidies in
certain industries, and reduce or eliminate currency fluctuations among these
European countries. The Treaty of European Union (the "Maastricht Treaty") seeks
to set out a framework for the European Economic and Monetary Union ("EMU")
among the countries that comprise the European Union ("EU"). Among other things,
EMU established a single common European currency (the "euro") that was
introduced on January 1, 1999 and is expected to replace the existing national
currencies of all EMU participants by July 1, 2002. Upon implementation of EMU,
certain securities issued in participating EU countries (beginning with
government and corporate bonds) were redenominated in euros, and are now listed,
traded, declaring dividends and making other payments only in euros.
No assurance can be given that the changes planned for the EU can be
successfully implemented, or that these changes will result in the economic and
monetary unity and stability intended. There is a possibility that EMU will not
be completed, or will be completed but then partially or completely unwound.
Because any participating country may opt out of EMU within the first three
years, it is also possible that a significant participant could choose to
abandon EMU, which could diminish its credibility and influence. Any of these
occurrences could have adverse effects on the markets of both participating and
non-participating countries, including sharp appreciation or depreciation of
participants' national currencies and a significant increase in exchange rate
volatility, a resurgence in economic protectionism, an undermining of confidence
in the European markets, an undermining of European economic stability, the
collapse or slowdown of the drive toward European economic unity, and/or
reversion of the attempts to lower government debt and inflation rates that were
introduced in anticipation of EMU. Also, withdrawal from EMU at any time by an
initial participant could cause disruption of the financial markets as
securities redenominated in euros are transferred back into that country's
national currency, particularly if the withdrawing country is a major economic
power. Such developments could have an adverse impact on a Portfolio's
investments in Europe generally or in specific countries participating in EMU.
Governmental Supervision and Regulation/Accounting Standards. Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the U.S. government does. Some countries may not have laws
to protect investors the way that the United States securities laws do.
Accounting standards in other countries are not necessarily the same as in the
United States. If the accounting standards in another country do not require as
much disclosure or detail as U.S. accounting standards, it may be harder for the
Portfolio's portfolio managers to completely and accurately determine a
company's financial condition.
Certain Risks of Holding Fund Assets Outside the United States. Each
Portfolio generally holds the foreign securities in which it invests outside the
United States in foreign banks and securities depositories. These foreign banks
and securities depositories may be recently organized or new to the foreign
custody business. They may also have operations subject to limited or no
regulatory oversight. Also, the laws of certain countries may put limits on the
Portfolio's ability to recover its assets if a foreign bank or depository or
issuer of a security or any of their agents goes bankrupt. In addition, it can
be expected that it will be more expensive for the Portfolio to buy, sell and
hold securities in certain foreign markets than it is in the U.S. market due to
higher brokerage, transaction, custody and/or other costs. The increased expense
of investing in foreign markets reduces the amount the Portfolio can earn on its
investments.
Settlement and clearance procedures in certain foreign markets differ
significantly from those in the United States. Foreign settlement and clearance
procedures and trade regulations also may involve certain risks (such as delays
in payment for or delivery of securities) not typically involved with the
settlement of U.S. investments. Communications between the United States and
emerging market countries may be unreliable, increasing the risk of delayed
settlements or losses of security certificates. Settlements in certain foreign
countries at times have not kept pace with the number of securities
transactions. These problems may make it difficult for a Portfolio to carry out
transactions. If the Portfolio cannot settle or is delayed in settling a
purchase of securities, it may miss attractive investment opportunities and
certain of its assets may be uninvested with no return earned thereon for some
period. If the Portfolio cannot settle or is delayed in settling a sale of
securities, it may lose money if the value of the security then declines or, if
it has contracted to sell the security to another party, the Portfolio could be
liable to that party for any losses incurred.
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<PAGE> 35
Dividends or interest on, or proceeds from the sale of, foreign securities
may be subject to foreign withholding taxes, and special U.S. tax considerations
may apply.
SWAP AGREEMENTS
A Portfolio may enter into interest rate, index and currency exchange rate
swap agreements for purposes of attempting to obtain a particular desired return
at a lower cost to the Portfolio than if the Portfolio had invested directly in
an instrument that yielded the desired return. Swap agreements are two party
contracts entered into primarily by institutional investors for periods ranging
from a few weeks to more than one year. In a standard "swap" transaction, two
parties agree to exchange the returns (or differentials in rates of return)
earned or realized on particular predetermined investments or instruments. The
gross returns to be exchanged or "swapped" between the parties are calculated
with respect to a "notional amount," i.e., the dollar amount invested at a
particular interest rate, in a particular foreign currency, or in a "basket" of
securities representing a particular index. The "notional amount" of the swap
agreement is only a fictive basis on which to calculate the obligations which
the parties to a swap agreement have agreed to exchange. The Portfolio's
obligations (or rights) under a swap agreement will generally be equal only to
the net amount to be paid or received under the agreement based on the relative
values of the positions held by each party to the agreement (the "net amount").
The Portfolio's obligations under a swap agreement will be accrued daily (offset
against any amounts owing to the Portfolio) and any accrued but unpaid net
amounts owed to a swap counter-party will be covered by marking as segregated
cash, U.S. government securities, equity securities or other liquid,
unencumbered assets, marked-to-market daily, to avoid any potential leveraging
of the Portfolio's portfolio. The Portfolio will not enter into a swap agreement
with any single party if the net amount owed or to be received under existing
contracts with that party would exceed 5% of the Portfolio's assets.
Whether a Portfolio's use of swap agreements will be successful in
furthering its investment objective of total return will depend on the
Investment Adviser's ability to correctly predict whether certain types of
investments are likely to produce greater returns than other investments.
Because they are two party contracts and because they may have terms of greater
than seven days, swap agreements may be considered to be illiquid. Moreover, the
Portfolio bears the risk of loss of the amount expected to be received under a
swap agreement in the event of the default or bankruptcy of a swap agreement
counter-party. Restrictions imposed by the Internal Revenue Code of 1986, as
amended (the "Code"), may limit the Portfolio's ability to use swap agreements.
The swaps market is a relatively new market and is largely unregulated. It is
possible that developments in the swaps market, including potential government
regulation, could adversely affect the Portfolio's ability to terminate existing
swap agreements or to realize amounts to be received under such agreements.
RISK FACTORS RELATING TO INVESTING IN HIGH YIELD SECURITIES
A description of security ratings is attached as an Appendix. Lower-rated
or unrated (that is, high yield) securities are more likely to react to
developments affecting market risk (such as interest rate sensitivity, market
perception of the creditworthiness of the issuer and general market liquidity)
and credit risk (such as the issuer's inability to meet its obligations) than
are more highly rated securities, which react primarily to movements in the
general level of interest rates. The Investment Adviser considers both credit
risk and market risk in making investment decisions for the Portfolios.
The amount of high yield securities outstanding proliferated in the 1980's
in conjunction with the increase in merger and acquisition and leveraged buyout
activity. Under adverse economic conditions, there is a risk that highly
leveraged issuers may be unable to service their debt obligations upon maturity.
In addition, the secondary market for high yield securities, which is
concentrated in relatively few market makers, may not be as liquid as the
secondary market for more highly rated securities. Under adverse market or
economic conditions, the secondary market for high yield securities could
contract further, independent of any specific adverse changes in the condition
of a particular issuer. As a result, the Investment Adviser could find it more
difficult to sell these securities or may be able to sell the securities only at
prices lower than if such securities were widely traded. Prices realized upon
the sale of such lower-rated or unrated securities, under these circumstances,
may be less than the prices used in calculating a Portfolio's net asset value
prior to the sale.
Lower-rated or unrated debt obligations also present risks based on payment
expectations. If an issuer calls the obligation for redemption, the Portfolio
may have to replace the security with a lower yielding security, resulting in a
decreased return for investors. If the Portfolio experiences unexpected net
redemptions, it may be forced to sell its higher-rated securities, resulting in
a decline in the overall credit quality of the Portfolio's portfolio and
increasing the exposure of the Portfolio to the risks of high yield securities.
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<PAGE> 36
ILLIQUID SECURITIES
A Portfolio may not hold more than 15% of its net assets in illiquid
securities. Illiquid securities generally include repurchase agreements which
have a maturity of longer than seven days, and securities that are illiquid by
virtue of the absence of a readily available market (either within or outside of
the United States) or because they have legal or contractual restrictions on
resale. Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act, securities which are otherwise not readily
marketable and repurchase agreements that have a maturity of longer than seven
days. Securities which have not been registered under the Securities Act are
referred to as private placements or restricted securities and are purchased
directly from the issuer or in the secondary market. Limitations on resale may
have an adverse effect on the marketability of portfolio securities and a mutual
fund might be unable to dispose of restricted or other illiquid securities
promptly or at reasonable prices and might thereby experience difficulty
satisfying redemption within seven days. The absence of a trading market can
make it difficult to ascertain a market value for illiquid investments. Also
market quotations are less readily available. The judgment of the Investment
Adviser may at times play a greater role in valuing these securities than in the
case of unrestricted securities. A mutual fund might also have to register such
restricted securities in order to dispose of them resulting in additional
expense and delay. Adverse market conditions could impede such a public offering
of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A established a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The Investment Adviser anticipates that the
market for certain restricted securities such as institutional commercial paper
and foreign securities will expand further as a result of this regulation and
the development of automated systems for the trading, clearance and settlement
of unregistered securities of domestic and foreign issuers.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The Investment Adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Trustees. In reaching liquidity decisions, the Investment Adviser will consider,
among others, the following factors: (1) the frequency of trades and quotes for
the security; (2) the number of dealers wishing to purchase or sell the security
and the number of other potential purchasers; (3) dealer undertakings to make a
market in the security; and (4) the nature of the security and the nature of the
marketplace trades (for example, the time needed to dispose of the security, the
method of soliciting offers and the mechanics of the transfer). In addition, in
order for commercial paper that is issued in reliance on Section 4(2) of the
Securities Act to be considered liquid, (1) it must be rated in one of the two
highest rating categories by at least two nationally recognized statistical
rating organizations ("NRSROs"), or if only one NRSRO rates the securities, by
that NRSRO, or, if unrated, be of comparable quality in the view of the
Investment Adviser; and (2) it must not be "traded flat" (that is, without
accrued interest) or in default as to principal or interest. Investing in Rule
144A securities could have the effect of increasing the level of Portfolio
illiquidity to the extent that qualified institutional buyers become, for a
time, uninterested in purchasing these securities. In addition, Rule 144A
securities are generally not deemed illiquid if they are freely tradable in
their primary market offshore. Repurchase agreements subject to demand are
deemed to have a maturity equal to the notice period.
REVERSE REPURCHASE AGREEMENTS
A Portfolio may enter into reverse repurchase agreements, whereby the
Portfolio sells securities concurrently with entering into an agreement to
repurchase those securities at a later date at a fixed price. During the reverse
repurchase agreement period, the Portfolio continues to receive principal and
interest payments on those
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<PAGE> 37
securities. Reverse repurchase agreements are speculative techniques involving
leverage and are considered borrowings by the Portfolio for purposes of the
limit applicable to borrowings.
DOLLAR ROLLS
A Portfolio may use dollar rolls as part of its investment strategy. In a
dollar roll, the Portfolio sells securities for delivery in the current month
and simultaneously contracts to repurchase substantially similar securities
(same type and coupon) on a specified future date from the same party. During
the roll period, the Portfolio forgoes principal and interest paid on the
securities. The Portfolio is compensated by the difference between the current
sales price and the forward price for the future purchase (often referred to as
the "drop") as well as by the interest earned on the cash proceeds of the
initial sale. A "covered roll" is a specific type of dollar roll for which there
is an offsetting cash position or cash equivalent security position that matures
on or before the forward settlement date of the dollar roll transaction.
A Portfolio will mark as segregated cash, U.S. government securities,
equity securities or other liquid, unencumbered assets, marked-to-market daily,
equal in value to their obligations with respect to dollar rolls. Dollar rolls
involve the risk that the market value of the securities retained by the
Portfolio may decline below the price of the securities the Portfolio has sold
but is obligated to repurchase under the agreement. If the buyer of the
securities under a dollar roll files for bankruptcy or becomes insolvent, the
Portfolio's use of the proceeds of the agreement may be restricted pending a
determination by the other party, or its trustee or receiver, whether to enforce
the Portfolio's obligation to repurchase the securities. Dollar rolls are
speculative techniques involving leverage and are considered borrowings by the
Portfolio for purposes of the limit applicable to borrowings.
BORROWING
A Portfolio may borrow for temporary or emergency purposes. This borrowing
may be unsecured. The 1940 Act requires each Portfolio to maintain continuous
asset coverage (that is, total assets including borrowings, less liabilities
exclusive of borrowings) of 300% of the amount borrowed. Borrowing subjects the
Portfolio to interest costs which may or may not be recovered by appreciation of
the securities purchased, and can exaggerate the effect on net asset value of
any increase or decrease in the market value of the Portfolio's portfolio. This
is the speculative factor known as leverage.
LOANS OF PORTFOLIO SECURITIES
For the purpose of achieving income, a Portfolio may lend its portfolio
securities, provided: (1) the loan is secured continuously by collateral
consisting of short-term, high quality debt securities, including U.S.
government securities, negotiable certificates of deposit, bankers' acceptances
or letters of credit, maintained on a daily marked-to-market basis in an amount
at least equal to the current market value of the securities loaned; (2) the
Portfolio may at any time call the loan and obtain the return of the securities
loaned; (3) the Portfolio will receive any interest or dividends paid on the
loaned securities; and (4) the aggregate market value of securities loaned will
not at any time exceed one-third of the total assets of the Portfolio.
WHEN-ISSUED SECURITIES
A Portfolio may purchase securities on a when-issued or delayed-delivery
basis, generally in connection with an underwriting or other offering.
When-issued and delayed-delivery transactions occur when securities are bought
with payment for and delivery of the securities scheduled to take place at a
future time, beyond normal settlement dates, generally from 15 to 45 days after
the transaction. The price that the Portfolio is obligated to pay on the
settlement date may be different from the market value on that date. While
securities may be sold prior to the settlement date, the Portfolio intends to
purchase such securities with the purpose of actually acquiring them, unless a
sale would be desirable for investment reasons. At the time the Portfolio makes
a commitment to purchase a security on a when-issued basis, it will record the
transaction and reflect the value of the security each day in determining the
Portfolio's net asset value. The Portfolio will also mark as segregated with its
custodian cash, U.S. government securities, equity securities or other liquid,
unencumbered assets, marked-to-market daily, equal in value to its obligations
for when-issued securities.
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<PAGE> 38
REAL ESTATE INVESTMENT TRUSTS
A Portfolio may invest in securities of real estate investment trusts or
REITs. Unlike corporations, REITs do not have to pay income taxes if they meet
certain requirements under the Code. REITs offer investors greater liquidity and
diversification than direct ownership of properties, as well as greater income
potential than an investment in common stocks. Like any investment in real
estate, though, a REIT's performance depends on several factors, such as its
ability to find tenants for its properties, to renew leases and to finance
property purchases and renovations.
SHARES OF OTHER INVESTMENT COMPANIES
A Portfolio can invest in securities of other investment companies except
to the extent prohibited by law. Like all equity investments, these investments
may go up or down in value. They also may not perform in correlation with the
Portfolio's principal strategies. A Portfolio will pay additional fees through
its investments in other investment companies.
SHORT SALES AGAINST-THE-BOX
A Portfolio can borrow and sell "short" securities when it also owns an
equal amount of those securities (or their equivalent). No more than 25% of the
Portfolio's total assets can be held as collateral for short sales at any one
time.
CORPORATE LOANS
A Portfolio can invest in corporate loans. Commercial banks and other
financial institutions make corporate loans to companies that need capital to
grow or restructure. Borrowers generally pay interest on corporate loans at
rates that change in response to changes in market interest rates such as the
London Interbank Offered Rate ("LIBOR") or the prime rates of U.S. banks. As a
result, the value of corporate loan investments is generally less responsive to
shifts in market interest rates. Because the trading market for corporate loans
is less developed than the secondary market for bonds and notes, the Fund may
experience difficulties from time to time in selling its corporate loans.
Borrowers frequently provide collateral to secure repayment of these
obligations. Leading financial institutions often act as agent for a broader
group of lenders, generally referred to as a "syndicate". The syndicate's agent
arranges the corporate loans, holds collateral and accepts payments of principal
and interest. If the agent developed financial problems, the Portfolio may not
recover its investment, or there might be a delay in the Portfolio's recovery.
By investing in a corporate loan, the Portfolio becomes a member of the
syndicate.
TEMPORARY DEFENSIVE POSITION
When adverse market or economic conditions indicate to the Investment
Adviser that a temporary defensive strategy is appropriate, a Portfolio may
invest all or part of its assets in short-term investment grade debt obligations
of the U.S. government, its agencies and instrumentalities, money market mutual
funds, bank certificates of deposit, bankers' acceptances, high quality
commercial paper, demand notes and repurchase agreements.
ITEM 13. - MANAGEMENT OF THE FUND.
TRUSTEES AND OFFICERS.
The Trustees of the Trust consist of seven individuals, five of whom are
not "interested persons" of the Trust as defined in the 1940 Act. The Trustees
are responsible for the overall supervision of the operations of the Trust and
perform the various duties imposed on the trustees of investment companies by
the 1940 Act. Information about the Trustees and executive officers of the
Trust, their ages and their principal occupations for at least the last five
years are set forth below.
(* denotes "interested" Trustee as defined in the 1940 Act, due to the
relationship with the Investment Adviser) and officers of the Trust are:
MICHAEL BAXTER* (37) -- Trustee -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. Managing Director of the Investment Adviser (since
1996); Co-Head of the Investment Adviser (1999-2000); Partner of the
Investment Adviser (1994 - 1996); Portfolio Manager of the Investment Adviser
(since 1990).
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<PAGE> 39
ROBERT L. BURCH III (66) -- Trustee -- One Rockefeller Plaza, New York, NY
10020. Managing Partner, A.W. Jones Co. (investments) (since 1984); Chairman,
Jonathan Mfg. Corp. (slide manufacturing) (since 1977).
JOHN A. G. GAVIN (69) -- Trustee -- 2100 Century Park West, Los Angeles, CA
90067. Partner and Managing Director, Hicks, Muse, Tate & Furst (Latin America)
(private equity investment firm) (since 1994); Chairman, Gamma Holdings
(investment holding company) (since 1968); Principal, Gavin, Dailey & Partners
(consulting) (since 1993); U.S. Ambassador to Mexico (1981 - 1986); Director,
Apex Mortgage Capital, Inc., Atlantic Richfield Co., International Wire Corp.
and Krause's Furniture, Inc.
JOE GRILLS (65) -- Trustee -- P.O. Box 98, Rapidan, VA 22733. Member of the
Committee of Investment of Employee Benefit Assets of the Financial Executives
Institute ("CIEBA") (affiliation changed in June 2000 to the Association of
Financial Professionals) (since 1986); Member of CIEBA's Executive Committee
(since 1988) and its Chairman (1991 - 1992); Assistant Treasurer of
International Business Machines Incorporated ("IBM") and Chief Investment
Officer of IBM Retirement Funds (1986 - 1993); Member of the Investment Advisory
Committees of the State of New York Common Retirement Fund and the Howard Hughes
Medical Institute (since 1997); Director, Duke Management Company (since 1992)
and Vice Chairman (since 1998); Director, Kimco Realty Corporation (since 1997);
Director, LaSalle Street Fund (since 1995); Member of the Investment Advisory
Committee of the Virginia Retirement System (since 1998); Member of the
Investment Committee of the Woodberry Forest School (since 2000); Member of the
Investment Committee of the National Trust for Historic Preservation (since
2000); Director, Montpelier Foundation (since 1998); Trustee or Director of 24
registered investment companies (consisting of 56 portfolios) for which the
Investment Adviser or an advisory affiliate is the adviser.
NIGEL HURST-BROWN* (49) -- Trustee -- 725 South Figueroa Street, Suite
4000, Los Angeles, CA 90017-5400. Managing Director of the Investment Adviser
(since 1998); Co-Head of the Investment Adviser (1999 - 2000); Director of
Mercury Asset Management Group Plc. (since 1990).
MADELEINE A. KLEINER (49) -- Trustee -- 1900 Avenue of the Stars, Suite
1700, Los Angeles, CA 90067. Former Senior Executive Vice President, Chief
Administrative Officer and General Counsel, H.F. Ahmanson & Company and Home
Savings of America, FSB (banking company) (1995 - 1998); Partner, Gibson, Dunn &
Crutcher (law firm) (1983 - 1995).
RICHARD R. WEST (62) -- Trustee -- Box 604, Genoa, NV 89411. Professor of
Finance (since 1984), Dean (1984 - 1993), and currently Dean Emeritus, New York
University Leonard N. Stern School of Business Administration; Director, Vornado
Realty Trust, Inc. and Vornado Operating (real estate holding company);
Director, Bowne & Co., Inc. (financial printers); Director, Alexander's, Inc.
(real estate company); Trustee or Director of 67 registered investment companies
(consisting of 72 portfolios) for which the Investment Adviser or an advisory
affiliate is the adviser.
NANCY D. CELICK (49) -- President -- 725 South Figueroa Street, Suite 4000,
Los Angeles, CA 90017-5400. First Vice President of the Investment Adviser
(since 2000); Chief Administrative Officer of the Investment Adviser (1998 -
2000); Chief Financial Officer of the Investment Adviser (1993 - 1998); Chief
Financial Officer of Kennedy-Wilson, Inc. (auction marketing services) (1992 -
1993); Chief Financial Officer of First National Corporation (bank holding
company) (1984 - 1992).
DONALD C. BURKE (40) -- Vice President and Treasurer -- P.O. Box 9011,
Princeton, NJ 08543-9011. Senior Vice President and Treasurer of the Investment
Adviser (since 1999); Senior Vice President and Treasurer of Princeton Services,
Inc. (since 1999); Vice President of FAM Distributors, Inc. (since 1999); First
Vice President of the Investment Adviser (1990 - 1997).
ANNA MARIE S. LOPEZ (32) -- Assistant Treasurer and Assistant
Secretary -- 725 South Figueroa Street, Suite 4000, Los Angeles, CA 90017-5400.
Compliance Officer of the Investment Adviser (since 1997); Manager, Price
Waterhouse (1991 - 1997).
TURNER SWAN (38) -- Secretary -- 725 South Figueroa Street, Suite 4000, Los
Angeles, CA 90017-5400. Attorney with the Investment Adviser (since 1997);
Attorney, Sheppard, Mullin, Richter & Hampton LLP (1995 - 1997); Attorney, Trout
Trading Management Company Ltd. (1993 - 1995).
B-24
<PAGE> 40
As of the date of this Part B, the officers and Trustees of the Trust as a
group (11 persons) owned an aggregate of less than 1% of the outstanding shares
of common stock of ML & Co. and owned an aggregate of less than 1% of the
outstanding shares of each Portfolio.
COMPENSATION OF DIRECTORS/TRUSTEES.
The following table sets forth the aggregate compensation Mercury Low
Duration Fund and Mercury Total Return Bond Fund, which invest all of their
assets in the respective Portfolios effective October 6, 2000, and the
Trust expect to pay to the non-interested Trustees for their first full fiscal
year and the aggregate compensation paid by all investment companies advised by
FAM or its affiliates ("Mercury and Affiliates-Advised Funds") to the
non-interested Trustees for the calendar year ended December 31, 1999.
<TABLE>
<CAPTION>
TOTAL 1999
COMPENSATION
FROM TRUST
AND FUND
AGGREGATE COMPLEX
COMPENSATION PAID
NAME OF TRUSTEE FROM TRUST TO TRUSTEES*
--------------- ------------ ------------
<S> <C> <C>
Michael Baxter..................................... $ -0- $ -0-
Robert L. Burch III................................ $1,500 $ 34,000
John A. G. Gavin................................... $1,500 $ 25,000
Joe Grills......................................... $1,500 $232,333
Nigel Hurst-Brown.................................. $ -0- $ -0-
Madeleine A. Kleiner............................... $1,500 $ 18,000
Richard R. West.................................... $1,500 $422,225
</TABLE>
---------------
* Each Trustee also serves as a Trustee of Mercury HW Variable Trust,
Mercury HW Funds and Merrill Lynch Investment Managers Funds, Inc. Messrs.
Grills and West also serve on the boards of other investment companies
advised by the Investment Adviser or its advisory affiliates.
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<PAGE> 41
ITEM 14. - CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES.
Mercury Low Duration Fund of Mercury HW Funds controls the Low Duration
Master Portfolio and Mercury Total Return Bond Fund of Mercury HW Funds
controls the Total Return Bond Master Portfolio.
All holders of interests ("Holders") are entitled to vote in proportion to
the amount of their interest in a Portfolio or in the Trust, as the case may
be. There is no cumulative voting. Accordingly, the Holder or Holders of more
than 50% of the aggregate beneficial interests of the Trust would be able to
elect all the Trustees. With respect to the election of Trustees and
ratification of accountants the Holders of separate Portfolios vote together;
they generally vote separately by Portfolio on other matters.
ITEM 15. - INVESTMENT ADVISORY AND OTHER SERVICES.
The Trust on behalf of each Portfolio has entered into an investment
advisory agreement with the Investment Adviser (the "Investment Advisory
Agreement"). As discussed in Part A, the Investment Adviser receives for its
services to the Low Duration Master Portfolio monthly compensation at the annual
B-26
<PAGE> 42
rate of 0.21% of the average daily net assets of the Portfolio and the Total
Return Bond Master Portfolio pays the Investment Adviser monthly compensation
at the annual rate of 0.30% of the average daily net assets of the Portfolio.
Each Investment Advisory Agreement obligates the Investment Adviser to
provide investment advisory services and to pay, or cause an affiliate to pay,
for maintaining its staff and personnel and to provide office space, facilities
and necessary personnel for the Trust. The Investment Adviser is also obligated
to pay, or cause an affiliate to pay, the fees of all officers and Trustees who
are affiliated persons of the Investment Adviser or any sub-adviser or of an
affiliate of the Investment Adviser or any sub-adviser. The Trust pays, or
causes to be paid, all other expenses incurred in the operation of the Portfolio
and the Trust (except to the extent paid by FAM Distributors, Inc., as Placement
Agent), including, among other things, taxes, expenses for legal and auditing
services, costs of printing proxies, shareholder reports, copies of the
Registration Statement, charges of the custodian, any sub-custodian and the
transfer agent, expenses of portfolio transactions, expenses of redemption of
shares, Commission fees, expenses of registering the shares under Federal, state
or non-U.S. laws, fees and actual out-of-pocket expenses of non-interested
Trustees, accounting and pricing costs (including the daily calculation of net
asset value), insurance, interest, brokerage costs, litigation and other
extraordinary or non-recurring expenses, and other expenses properly payable by
the Trust or the Portfolio. Accounting services are provided to the Trust by the
Investment Adviser or an affiliate of the Investment Adviser, and the Trust
reimburses the Investment Adviser or an affiliate of the Investment Adviser for
its costs in connection with such services.
Securities held by a Portfolio, or other portfolios of the Trust, may also
be held by, or be appropriate investments for, other funds or investment
advisory clients for which the Investment Adviser or its affiliates act as an
adviser. Because of different objectives or other factors, a particular
security may be bought for one or more clients when one or more clients are
selling the same security. If purchases or sales of securities by the
Investment Adviser for the Trust's portfolios or other funds for which it acts
as investment adviser or for its advisory clients arise for consideration at or
about the same time, transactions in such securities will be made, insofar as
feasible, for the respective funds and clients in a manner deemed equitable to
all. To the extent that transactions on behalf of more than one client of the
Investment Adviser or its affiliates during the same period may increase the
demand for securities being purchased or the supply of securities being sold,
there may be an adverse effect on price.
B-27
<PAGE> 43
The Investment Adviser is a limited partnership, the partners of which are
Merrill Lynch & Co., Inc. ("ML & Co."), a financial services holding company and
the parent of Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill
Lynch") and Princeton Services, Inc. ML & Co. and Princeton Services, Inc. are
"controlling persons" of the Investment Adviser as defined under the 1940 Act
because of their ownership of its voting securities and their power to exercise
a controlling influence over its management or policies.
Duration and Termination. Unless earlier terminated as described below,
each Advisory Agreement will continue in effect for two years from its effective
date. Thereafter, it will remain in effect from year to year if approved
annually (a) by the Board of Trustees of the Trust or by a majority of the
outstanding shares of the applicable Portfolio and (b) by a majority of the
Trustees of the Trust who are not parties to the Advisory Agreement or
interested persons (as defined in the 1940 Act) of any such party. The Advisory
Agreement is not assignable and will automatically terminate in the event of its
assignment. In addition, such contract may be terminated by the vote of a
majority of the outstanding voting securities of the applicable Portfolio or by
the Investment Adviser without penalty on 60 days' written notice to the other
party.
B-28
<PAGE> 44
CODE OF ETHICS.
The Board of Trustees of the Trust, the Board of Trustees of the Hotchkis
and Wiley Funds, the Board of Directors of Merrill Lynch Investment Managers
Fund, Inc., the Investment Adviser, and FAM have each approved a Code of Ethics
under Rule 17j-1 of the Investment Company Act (together the "Codes"). The Codes
significantly restrict the personal investing activities of all employees of the
Investment Adviser and FAM Distributors, Inc. and, as described below, impose
additional, more onerous, restrictions on portfolio investment personnel. The
Code of Ethics requires that all employees of the Investment Adviser and FAM
Distributors, Inc. pre-clear any personal securities investments (with limited
exceptions, such as mutual funds, high-quality short-term securities and direct
obligations of the U.S. government). The pre-clearance requirement and
associated procedures are designed to identify any substantive prohibition or
limitation applicable to the proposed investment. The substantive restrictions
applicable to all employees of the Investment Adviser and FAM Distributors, Inc.
include a ban on acquiring any securities in a "hot" initial public offering. In
addition, investment personnel are prohibited from profiting on short-term
trading in securities. No employee may purchase or sell any security that at the
time is being purchased or sold (as the case may be), or to the knowledge of the
employee is being considered for purchase or sale, by any fund advised by the
Investment Adviser. Furthermore, the Code of Ethics provides for trading
"blackout periods" which prohibit trading by investment personnel of the
Portfolio within seven calendar days before or after trading by the Portfolio in
the same or an equivalent security.
INDEPENDENT AUDITORS.
PricewaterhouseCoopers LLP, 100 E. Wisconsin Avenue, Milwaukee, Wisconsin
53202, has been selected as the independent auditors of the Trust. The
independent auditors are responsible for auditing the annual financial
statements of the Trust.
LEGAL COUNSEL.
Gardner, Carton, & Douglas, 321 North Clark Street, Chicago, Illinois
60610, is counsel for the Trust.
B-29
<PAGE> 45
CUSTODIAN.
Brown Brothers Harriman & Co. (the "Custodian"), 40 Water Street, Boston,
Massachusetts 02109, acts as the custodian of each Portfolio's assets. Under its
contract with the Trust, the Custodian is authorized to establish separate
accounts in foreign currencies and to cause foreign securities owned by a
Portfolio to be held in its offices outside the United States and with certain
foreign banks and securities depositors. The Custodian is responsible for safe
guarding and controlling each Portfolio's cash and securities, handling the
receipt and delivery of securities and collecting interest and dividends on the
Portfolio's investments.
ITEM 16. - BROKERAGE ALLOCATION AND OTHER PRACTICES.
Subject to policies established by the Board of Trustees, the Investment
Adviser is primarily responsible for the execution of each Portfolio's portfolio
transactions and the allocation of brokerage. The Trust has no obligation to
deal with any broker or group of brokers in the execution of transactions in
portfolio securities and does not use any particular broker or dealer. In
executing transactions with brokers and dealers, the Investment Adviser seeks to
obtain the best net results for the Portfolio, taking into account such factors
as price (including the applicable brokerage commission or dealer spread), size
of order, difficulty of execution and operational facilities of the firm and the
firm's risk in positioning a block of securities. While the Investment Adviser
generally seeks reasonable competitive commission rates, a Portfolio does not
necessarily pay the lowest spread or commission available. In addition,
consistent with the Conduct Rules of the NASD and policies established by the
Board of Trustees, the Investment Adviser may consider sales of shares of a
Portfolio as a factor in the selection of brokers or dealers to execute
portfolio transactions for the Trust; however, whether or not a particular
broker or dealer sells shares of a Portfolio neither qualifies not disqualifies
such broker or dealer to execute transactions for the Trust.
Subject to obtaining the best net results, brokers who provide
supplemental investment research services to the Investment Adviser may receive
orders for transactions by the Trust. Such supplemental research services
ordinarily consist of assessments and analyses of the business or prospects of a
company, industry or economic sector. Information so received will be in
addition to and not in lieu of the services required to be performed by the
Investment Adviser under its Investment Advisory Agreement and the expenses of
the Investment Adviser will not necessarily be reduced as a result of the
receipt of such supplemental information. If in the judgment of the Investment
Adviser the Trust will benefit from supplemental research services, the
Investment Adviser is authorized to pay brokerage commissions to a broker
furnishing such services that are in excess of commissions that another broker
may have charged for effecting the same transaction. Certain supplemental
research services may primarily benefit one or more other investment companies
or other accounts for which the Investment Adviser exercises investment
discretion. Conversely, the Trust may be the primary beneficiary of the
supplemental research services received as a result of portfolio transactions
effected for such other accounts or investment companies.
B-30
<PAGE> 46
The Trust may invest in certain securities traded in the OTC market and
intends to deal directly with the dealers who make a market in securities
involved, except in those circumstances in which better prices and execution are
available elsewhere. Under the 1940 Act, persons affiliated with the Trust and
persons who are affiliated with such affiliated persons are prohibited from
dealing with the Trust as principal in the purchase and sale of securities
unless a permissive order allowing such transactions is obtained from the
Commission. Since transactions in the OTC market usually involve transactions
with dealers acting as principal for their own accounts, the Trust will not deal
with affiliated persons, including Merrill Lynch and its affiliates, in
connection with such transactions. However, an affiliated person of the Trust
may serve as its broker in OTC transactions conducted on an agency basis
provided that, among other things, the fee or commission received by such
affiliated broker is reasonable and fair compared to the fee or commission
received by non-affiliated brokers in connection with comparable transactions.
In addition, the Trust may not purchase securities during the existence of any
underwriting syndicate for such securities of which Merrill Lynch is a member or
in a private placement in which Merrill Lynch serves as placement agent except
pursuant to procedures approved by the Board of Trustees of the Trust that
either comply with rules adopted by the Commission or with interpretations of
the Commission staff. See "Investment Objectives and Policies -- Investment
Restrictions."
Section 11(a) of the Exchange Act generally prohibits members of the U.S.
national securities exchanges from executing exchange transactions for their
affiliates and institutional accounts that they manage unless the member (i) has
obtained prior express authorization from the account to effect such
transactions, (ii) at least annually furnishes the account with the aggregate
compensation received by the member in effecting such transactions, and (iii)
complies with any rules the Commission has prescribed with respect to the
requirements of clauses (i) and (ii). To the extent Section 11(a) would apply to
Merrill Lynch acting as a broker for the Trust in any of its portfolio
transactions executed on any such securities exchange of which it is a member,
appropriate consents have been obtained from the Trust and annual statements as
to aggregate compensation will be provided to the Trust.
The Board of Trustees of the Trust has considered the possibility of
seeking to recapture for the benefit of the Portfolio brokerage commissions and
other expenses of portfolio transactions by conducting portfolio transactions
through affiliated entities. For example, brokerage commissions received by
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<PAGE> 47
affiliated brokers could be offset against the advisory fee paid by a
Portfolio to the Investment Adviser. After considering all factors deemed
relevant, the Board of Trustees made a determination not to seek such recapture.
The Trustees will reconsider this matter from time to time.
Because of different objectives or other factors, a particular security
may be bought for one or more clients of the Investment Adviser or an affiliate
when one or more clients of the Investment Adviser or an affiliate are selling
the same security. If purchases or sales of securities arise for consideration
at or about the same time that would involve the Trust or other clients or funds
for which the Investment Adviser or an affiliate acts as manager, transactions
in such securities will be made, insofar as feasible, for the respective funds
and clients in a manner deemed equitable to all. To the extent that transactions
on behalf of more than one client of the Investment Adviser or an affiliate
during the same period may increase the demand for securities being purchased or
the supply or securities being sold, there may be an adverse effect on price.
ITEM 17. - CAPITAL STOCK AND OTHER SECURITIES.
Under the Declaration of Trust that establishes the Trust, a Delaware
business trust, the Trustees are authorized to issue beneficial interests in
each Portfolio of the Trust. Investors are entitled to participate, in
proportion to their investment, in distributions of taxable income, loss, gain
and deduction with respect to the Portfolio in which they have invested. Upon
liquidation or dissolution of the Portfolio, investors are entitled to share in
proportion to their investment in the Portfolio's net assets available for
distribution to its investors. Interests in the Portfolio have no preference,
preemptive, conversion or similar rights and are fully paid and nonassessable,
except as set forth below. Investments in the Portfolio generally may not be
transferred.
Each investor is entitled to a vote in proportion to the amount of its
interest in the Portfolio or in the Trust, as the case may be. Investors in the
Trust, or in the Portfolio, do not have cumulative voting rights, and investors
holding more than 50% of the aggregate beneficial interests in the Trust may
elect all of the Trustees of the Trust if they choose to do so and in such event
the other investors in the Trust would not be able to elect any Trustee. The
Trust is not required and has no current intention to hold annual meetings of
investors but the Trust will hold special meetings of investors when in the
judgment of the Trustees it is necessary or desirable to submit matters for an
investor vote.
A Portfolio shall be dissolved by unanimous consent of the Trustees by
written notice of dissolution to the Holders of the interests of the Portfolio.
The Trust shall be dissolved upon the dissolution of the last remaining
Portfolio.
The Declaration of Trust provides that obligations of the Trust and a
Portfolio are not binding upon the Trustees individually but only upon the
property of the Portfolio and that the Trustees will not be liable for any
action or failure to act (including without limitation, the failure to compel in
any way any former or acting Trustee to redress any breach of trust), but
nothing in the Declaration of Trust protects a Trustee against any liability to
which he would otherwise be subject by reason of willful misfeasance, bad faith,
gross negligence, or reckless disregard of the duties involved in the conduct of
his office. The Declaration of Trust provides that the Trust may maintain
appropriate insurance (for example, fidelity bond and errors and omissions
insurance) for the protection of the Portfolio, its Holders, Trustees, officers,
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<PAGE> 48
employees and agents covering possible tort and other liabilities.
The Trust currently consists of two Portfolios. The Trust reserves the
right to create and issue interests in a number of additional Portfolios. As
indicated above, Holders of each Portfolio participate equally in the earnings
and assets of the particular Portfolio. Holders of each Portfolio are entitled
to vote separately to approve advisory agreements or changes in investment
policy, but Holders of all Portfolios vote together in the election or selection
of Trustees and accountants for the Trust. Upon liquidation or dissolution of a
Portfolio, the Holders of such Portfolio are entitled to share in proportion to
their investment in the net assets of such Portfolio available for distribution
to Holders.
ITEM 18. - PURCHASE, REDEMPTION, AND PRICING OF SECURITIES.
Beneficial interests in the Trust are not offered to the public and are issued
solely in private placement transactions that do not involve any "public
offering" within the meaning of Section 4(2) of the 1933 Act. Investments in the
Trust may be made only by a limited number of institutional investors, including
investment companies, common or commingled trust funds, group trusts and certain
other entities that are "accredited investors" within the meaning of Regulation
D under the 1933 Act. The number of Holders of each Portfolio shall be limited
to fewer than 100. This Registration Statement does not constitute an offer to
sell, or the solicitation of an offer to buy, any "security" within the meaning
of the 1933 Act.
The net asset value of the shares of each Portfolio is determined once
daily Monday through Friday after the close of regular trading on the New York
Stock Exchange ("NYSE") on each day the NYSE is open for trading based on prices
at the time of closing. The NYSE generally closes at 4:00 p.m., Eastern time.
Any assets or liabilities initially expressed in terms of non-U.S. dollar
currencies are translated into U.S. dollars at the prevailing market rates as
quoted by one or more banks or dealers on the day of valuation. The NYSE is not
open for trading on New Year's Day, Martin Luther King, Jr. Day, Presidents'
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day
and Christmas Day.
The net asset value is computed by deducting the amount of the Portfolio's
total liabilities from the value of its total assets. Expenses, including the
advisory fees payable to the Investment Adviser, are accrued daily.
Portfolio securities that are traded on stock exchanges are valued at the
last sale price on the exchange on which such securities are traded as of the
close of business on the day the securities are being valued, or lacking any
sales, at the closing bid price. In cases where securities are traded on more
than one exchange, the securities are valued on the exchange designated by or
under the authority of the Board of Trustees as the primary market. Long
positions in securities traded in the OTC market are valued at the most recent
bid price obtained from one or more dealers or pricing services approved by the
Board of Trustees of the Trust. Short positions in securities traded in the OTC
market are valued at the last available ask price. Portfolio securities that are
traded both in the OTC market and on a stock exchange are valued according to
the broadest and most representative market. When the Portfolio writes an
option, the amount of the premium received is recorded on the books of the
Portfolio as an asset and an equivalent liability. The amount of the liability
is subsequently valued to reflect the
B-33
<PAGE> 49
current market value of the option written, based upon the last sale price in
the case of exchange-traded options or, in the case of options traded in the OTC
market, the last ask price. Options purchased by the Portfolio are valued at
their last sale price in the case of exchange-traded options or, in the case of
options traded in the OTC market, the last bid price. The value of swaps,
including interest rate swaps, caps and floors, will be determined by obtaining
dealer quotations. Other investments, including financial futures contracts and
related options, are stated at market value. Obligations with remaining
maturities of 60 days or less are valued at amortized cost unless the Investment
Adviser believes that this method no longer produces fair valuations. Repurchase
agreements will be valued at cost plus accrued interest. Securities and assets
for which market quotations are not readily available are valued at fair value
as determined in good faith by or under the direction of the Board of Trustees
of the Trust. Such valuations and procedures will be reviewed periodically by
the Board of Trustees of the Trust.
Bonds held by the Portfolio are traded primarily in the OTC markets. In
determining net asset value, the Portfolio uses the valuations of portfolio
securities furnished by a pricing service approved by the Board of Trustees. The
pricing service typically values portfolio securities at the bid price or the
yield equivalent when quotations are readily available. The bonds for which
quotations are not readily available are valued at fair market value on a
consistent basis as determined by the pricing service using a matrix system to
determine valuations. The procedures of the pricing service and its valuations
are reviewed by the officers of the Portfolio under the general supervision of
the Board of Trustees. The Board of Trustees has determined in good faith that
the use of a pricing service is a fair method of determining the valuation of
portfolio securities.
Generally, trading in non-U.S. securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the NYSE. The values of such
securities used in computing the net asset value of a Portfolio's shares are
determined as of such times. Foreign currency exchange rates are also generally
determined prior to the close of business on the NYSE. Occasionally, events
affecting the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of business on the
NYSE that may not be reflected in the computation of the Portfolio's net asset
value.
Each investor in the Trust may add to or reduce its investment in a
Portfolio on each day the NYSE is open for trading. The value of each investor's
interest in the Portfolio will be determined as of the close of business on the
NYSE by multiplying the net asset value of the Portfolio by the percentage,
effective for that day, that represents that investor's share of the aggregate
interests in the Portfolio. The close of business on the NYSE is generally 4:00
p.m., Eastern time. Any additions or withdrawals to be effected on that day will
then be effected. The investor's percentage of the aggregate beneficial
interests in the Portfolio will then be recomputed as the percentage equal to
the fraction (i) the numerator of which is the value of such investor's
investment in the Portfolio as of the time or determination on such day plus or
minus, as the case may be, the amount of any additions to or withdrawals from
the investor's investments in the Portfolio effected on such day, and (ii) the
denominator of which is the aggregate net asset value of the Portfolio as of
such time on such day plus or minus, as the case may be, the amount of the net
additions to or withdrawals from the aggregate investments in the Portfolio by
all investors in the Portfolio. The percentage so determined will then be
B-34
<PAGE> 50
applied to determine the value of the investor's interest in the Portfolio after
the close of business of the NYSE on the next determination of net asset value
of the Portfolio. For further information concerning the Portfolio's net asset
value, and the valuation of the Portfolio's assets, see Part A.
REDEMPTIONS.
An investor in the Trust may withdraw all or a portion of its investment
in a Portfolio on any day the NYSE is open for trading at the net asset value
next determined after a withdrawal request in proper form is furnished by the
investor to the Portfolio. The proceeds of the withdrawal will be paid by the
Portfolio normally on the business day on which the withdrawal is effected, but
in any event within seven days. Investments in a Portfolio of the Trust may
not be transferred.
The Trust, on behalf of each Portfolio, will enter into a joint committed
line of credit with other investment companies advised by the Investment Adviser
and its affiliates and a syndicate of banks that is intended to provide the
Portfolio with a temporary source of cash to be used to meet redemption requests
from Portfolio shareholders in extraordinary or emergency circumstances.
ITEM 19. - TAXATION OF THE FUND
The Trust is organized as a Delaware business trust. Each Portfolio is
treated as a separate partnership under the Internal Revenue Code of 1986, as
amended (the "Code") and, thus, is not subject to Federal income tax at the
Portfolio level. Based upon the status of each Portfolio as a partnership, each
investor in the Portfolio will be required to include its allocable share (as
determined in accordance with the governing instruments of the Portfolio, the
Code and the regulations thereunder) of the Portfolio's ordinary income and
capital gain in determining its income tax liability.
Although, as described above, each Portfolio will not be subject to
federal income tax, it will file appropriate income tax returns. Each
prospective Investor Fund which is a regulated investment company ("RIC") will
be required to agree, in its subscription agreement, that, for purposes of
determining its required distribution under Code Section 4982(a), it will
account for its share of items of income, gain, loss and deduction of the
Portfolio as they are taken into account by the Portfolio.
A Portfolio may invest in futures contracts or options. Certain options,
futures contracts and options on futures contracts are "section 1256 contracts."
Any gains or losses on section 1256 contracts are generally considered 60%
long-term and 40% short-term capital gains or losses ("60/40"). Also, section
1256 contracts held by the Portfolio at the end of each taxable year are treated
for federal income tax purposes as being sold on such date for their fair market
value. The resultant paper gains or losses are also treated as 60/40 gains or
losses. When the section 1256 contract is subsequently disposed of, the actual
gain or loss will be adjusted by the amount of any preceding year-end gain or
loss.
Foreign currency gains or losses on non-U.S. dollar denominated bonds and
other similar debt instruments and on any non-U.S. dollar denominated futures
contracts, options and forward contracts that are not section 1256 contracts
generally will be treated as ordinary income or loss.
B-35
<PAGE> 51
Certain hedging transactions undertaken by a Portfolio may result in
"straddles" for federal income tax purposes. The straddle rules may affect the
character of gains (or losses) realized by the Portfolio. In addition, losses
realized by the Portfolio on positions that are part of a straddle may be
deferred, rather than being taken into account in calculating taxable income for
the taxable year in which such losses are realized. Because only a few
regulations implementing the straddle rules have been promulgated, the tax
consequences of hedging transactions to the Portfolio are not entirely clear.
The Portfolio may make one or more of the elections available under the Code
which are applicable to straddles. If the Portfolio makes any of the elections,
the amount, character and timing of the recognition of gains or losses from the
affected straddle positions will be determined under rules that vary according
to the elections made. The rules applicable under certain of the elections
operate to accelerate the recognition of gains or losses from the affected
straddle positions. Additionally, the conversion transaction or constructive
sale rules may apply to certain transactions (including straddles) to change the
character of capital gains to ordinary income or require the recognition of
income prior to the economic recognition of such income.
A Portfolio may be subject to a tax on dividend or interest income
received from securities of a non-U.S. issuer withheld by a foreign country at
the source. The United States has entered into tax treaties with many foreign
countries which entitle the Portfolio to a reduced rate of tax or exemption from
tax on such income. It is impossible to determine the effective rate of foreign
tax in advance since the amount of the Portfolio's assets to be invested within
various countries is not known.
A Portfolio may make investments that produce income that is not matched
by a corresponding cash receipt by the Portfolio, such as investments in
obligations having original issue discount or market discount (if the Portfolio
elects to accrue the market discount on a current basis with respect to such
instruments). Because such income may not be matched by a corresponding cash
receipt, the Portfolio may be required to borrow money or dispose of other
securities to be able to make distributions to investors.
A Portfolio's taxable income will in most cases be determined on the basis
of reports made to the Portfolio by the issuers of the securities in which the
Portfolio invests. The tax treatment of certain securities in which the
Portfolio may invest is not free from doubt, and it is possible that an Internal
Revenue Service examination of the issuers of such securities or of the
Portfolio could result in adjustments to the income of the Portfolio.
Under the Trust, each Portfolio is to be managed in compliance with the
provisions of the Code applicable to RICs as though such requirements were
applied at the Portfolio level. Thus, consistent with its investment objectives,
the Portfolio will meet the income and diversification of assets tests of the
Code applicable to RICs. Each Portfolio has requested a ruling from the Internal
Revenue Service that Holders of interests in the Portfolio that are RICs will be
treated as owners of their proportionate shares of the Portfolio's assets and
income for purposes of the Code's requirements applicable thereto.
ITEM 20. - UNDERWRITERS.
The exclusive placement agent for each Portfolio of the Trust is FAM
Distributors, Inc., (the "Placement Agent"), an affiliate of the Investment
Adviser and of Merrill Lynch, with offices at 800 Scudders Mill Road,
Plainsboro, New Jersey 08536. The Placement Agent receives no compensation for
serving in this capacity.
B-36
<PAGE> 52
Investment companies, common and commingled trust funds and similar
organizations and entities may continuously invest in a Portfolio.
ITEM 21. - CALCULATION OF PERFORMANCE DATA.
Beneficial interests in the Trust are not offered to the public and are
issued solely in private placement transactions that do not involve any "public
offering" within the meaning of Section 4(2) of the 1933 Act. Accordingly, the
Trust will not advertise a Portfolio's performance. However, certain of the
Trust's Holders may from time to time advertise their performance, which will be
based upon the Trust's performance.
Total return figures are based on historical performance and are not
intended to indicate future performance. Average annual total return is
determined in accordance with a formula specified by the Securities and Exchange
Commission.
Average annual total return quotations for the specified periods are
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return is computed assuming all dividends and distributions
are reinvested and taking into account all applicable recurring and nonrecurring
expenses.
Annual, average annual and annualized total return and aggregate total
return performance data, both as a percentage and as a dollar amount, are based
on a hypothetical $1,000 investment and computed as described above, except that
as required by the periods of the quotations, actual annual, annualized or
aggregate data, rather than average annual data, may be quoted. Actual annual or
annualized total return data generally will be lower than average annual total
return data since the average rates of return reflect compounding of return;
aggregate total return data generally will be higher than average annual total
return data since the aggregate rates of return reflect compounding over a
longer period of time.
Yield quotations will be computed based on a 30-day period by dividing (a)
the net income based on the yield of each security earned during the period by
(b) the average number of shares outstanding during the period that were
entitled to receive dividends multiplied by the maximum offering price per share
on the last day of the period.
B-37
<PAGE> 53
LOW DURATION MASTER PORTFOLIO
OF
FUND ASSET MANAGEMENT MASTER TRUST
STATEMENT OF ASSETS AND LIABILITIES
SEPTEMBER 22, 2000
<TABLE>
<S> <C>
ASSETS:
Cash........................................................ $50,100
Prepaid offering costs (Note 3)............................. 6,000
-------
Total assets...................................... 56,100
Less liabilities and accrued expenses....................... 6,000
-------
Net Assets applicable to investors' interest in the
Portfolio (Note 1)........................................ $50,100
=======
</TABLE>
---------------
Notes to Financial Statement.
(1) Fund Asset Management Master Trust (the "Master Trust") was organized as a
Delaware business trust on July 7, 2000, and is registered under the
Investment Company Act of 1940 as an open-end diversified management
investment company. Low Duration Master Portfolio (the "Portfolio") is a
portfolio of the Master Trust. Mercury Low Duration Fund and Merrill Lynch
Low Duration Fund will invest all of their assets in the Portfolio. To date,
the Portfolio has not had any transactions other than those relating to
organizational matters, a $50,000 capital contribution to the Portfolio by
Mercury Low Duration Fund and a $100 partnership contribution to the
Portfolio by FAM Distributors, Inc. (the "Distributor").
(2) The Master Trust, on behalf of the Portfolio, has entered into an investment
advisory agreement with Fund Asset Management, L.P. (the "Investment
Adviser"). Under the terms of the investment advisory agreement, the
Investment Adviser is paid at the annual rate of 0.21% of the Portfolio's
average daily net assets. Certain officers and/or Trustees of the Master
Trust are officers and/or directors of the Investment Adviser.
(3) Prepaid offering costs consist of legal and printing fees related to
preparing the registration statement, and will be amortized over a 12 month
period beginning with the commencement of operations of the Portfolio. The
Investment Adviser, on behalf of the Portfolio, will incur organization
costs estimated at $20,000.
(4) The Portfolio intends to qualify as a partnership for federal income tax
purposes and thus believes it will not be subject to any federal income tax
on its income and net realized capital gains (if any). However, each
investor in the Portfolio will be taxed on its allocable share of the
Portfolio's income and capital gains for purposes of determining its federal
income tax liability.
B-38
<PAGE> 54
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Trustees of Fund Asset Management
Master Trust and Shareholders of the Low Duration
Master Portfolio
In our opinion, the accompanying statement of assets and liabilities
presents fairly, in all material respects, the financial position of the Low
Duration Master Portfolio (the 'Portfolio', one of the two portfolios of Fund
Asset Management Master Trust) at September 22, 2000, in conformity with
accounting principles generally accepted in the United States of America. This
financial statement is the responsibility of the Portfolio's management; our
responsibility is to express an opinion on this financial statement based on our
audit. We conducted our audit of this financial statement in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statement is free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statement, assessing the accounting principles used
and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
October 2, 2000
B-39
<PAGE> 55
TOTAL RETURN BOND MASTER PORTFOLIO
OF
FUND ASSET MANAGEMENT MASTER TRUST
STATEMENT OF ASSETS AND LIABILITIES
SEPTEMBER 22, 2000
<TABLE>
<S> <C>
ASSETS:
Cash........................................................ $50,100
Prepaid offering costs (Note 3)............................. 6,000
-------
Total assets...................................... 56,100
Less liabilities and accrued expenses....................... 6,000
-------
Net Assets applicable to investors' interest in the
Portfolio (Note 1)........................................ $50,100
=======
</TABLE>
---------------
Notes to Financial Statement.
(1) Fund Asset Management Master Trust (the "Master Trust") was organized as a
Delaware business trust on July 7, 2000, and is registered under the
Investment Company Act of 1940 as an open-end diversified management
investment company. Total Return Bond Master Portfolio (the "Portfolio") is
a portfolio of the Master Trust. Mercury Total Return Bond Fund and Merrill
Lynch Total Return Bond Fund will invest all of their assets in the
Portfolio. To date, the Portfolio has not had any transactions other than
those relating to organizational matters, a $50,000 capital contribution to
the Portfolio by Mercury Total Return Bond Fund and a $100 partnership
contribution to the Portfolio by FAM Distributors, Inc. (the "Distributor").
(2) The Master Trust, on behalf of the Portfolio, has entered into an investment
advisory agreement with Fund Asset Management, L.P. (the "Investment
Adviser"). Under the terms of the investment advisory agreement, the
Investment Adviser is paid at the annual rate of 0.30% of the Portfolio's
average daily net assets. Certain officers and/or Trustees of the Master
Trust are officers and/or directors of the Investment Adviser.
(3) Prepaid offering costs consist of legal and printing fees related to
preparing the registration statement, and will be amortized over a 12 month
period beginning with the commencement of operations of the Portfolio. The
Investment Adviser, on behalf of the Portfolio, will incur organization
costs estimated at $20,000.
(4) The Portfolio intends to qualify as a partnership for federal income tax
purposes and thus believes it will not be subject to any federal income tax
on its income and net realized capital gains (if any). However, each
investor in the Portfolio will be taxed on its allocable share of the
Portfolio's income and capital gains for purposes of determining its federal
income tax liability.
B-40
<PAGE> 56
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Trustees of Fund Asset Management
Master Trust and Shareholders of the Total Return
Bond Master Portfolio
In our opinion, the accompanying statement of assets and liabilities
presents fairly, in all material respects, the financial position of the Total
Return Bond Master Portfolio (the "Portfolio", one of the two portfolios of Fund
Asset Management Master Trust) at September 22, 2000, in conformity with
accounting principles generally accepted in the United States of America. This
financial statement is the responsibility of the Portfolio's management; our
responsibility is to express an opinion on this financial statement based on our
audit. We conducted our audit of this financial statement in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statement is free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statement, assessing the accounting principles used
and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
October 2, 2000
B-41
<PAGE> 57
APPENDIX -- DESCRIPTION OF RATINGS
MOODY'S INVESTORS SERVICE
BOND RATINGS:
"Aaa" -- Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
"Aa" -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in Aaa securities.
"A" -- Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
"Baa" -- Bonds which are rated Baa are considered as medium-grade obligations
(that is, they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but certain
protective elements may be lacking or may be characteristically unreliable over
any great length of time. Such bonds lack outstanding investment characteristics
and in fact have speculative characteristics as well.
"Ba" -- Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate, and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
"B" -- Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Moody's applies numerical modifiers "1," "2" and "3" in each generic rating
classification from Aa through B. The modifier "1" indicates that the obligation
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 company
ranks in the lower end of that generic rating category.
SHORT-TERM DEBT RATINGS:
Moody's short-term debt ratings are opinions of the ability of issuers to honor
senior financial obligations and contracts. These obligations have an original
maturity not exceeding one year, unless explicitly noted.
"PRIME-1" -- Issuers rated "Prime-1" (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of these characteristics:
- Leading market positions in well-established industries.
- High rates of return on funds employed.
- Conservative capitalization structure with moderate reliance on debt and
ample asset protection.
- Broad margins in earnings coverage of fixed financial charges and high
internal cash generation.
- Well-established access to a range of financial markets and assured
sources of alternate liquidity.
"PRIME-2" -- Issuers rated "Prime-2" (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above,
A-1
<PAGE> 58
but to a lesser degree. Earnings trends and coverage ratios, while sound, may
be more subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternate
liquidity is maintained.
MUNICIPAL BOND RATINGS:
Moody's ratings for state and municipal short-term obligations are designated
Moody's Investment Grade or "MIG" with variable rate demand obligations being
designated as "VMIG." A VMIG rating may also be assigned to commercial paper
programs which are characterized as having variable short-term maturities, but
having neither a variable rate nor demand feature. Factors used in determining
ratings include liquidity of the borrower and short-term cyclical elements.
STANDARD & POOR'S RATINGS GROUP
BOND RATINGS:
"AAA" -- An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong.
"AA" -- An obligation rated AA differs from the highest rated obligations only
in small degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
"A" -- An obligation rated A is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than obligations in
higher-rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
"BBB" -- An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its commitment on the
obligation.
Obligations rated BB and B are regarded as having significant speculative
characteristics. While such obligations will likely have some quality and
protective characteristics, these may be outweighed by large uncertainties or
major exposures to adverse conditions.
COMMERCIAL PAPER RATINGS:
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt considered short-term in the relevant market.
"A-1" -- This designation indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus sign (+) designation.
"A-2" -- Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
MUNICIPAL BOND RATINGS:
S&P uses SP-1, SP-2 and SP-3 to rate short-term municipal obligations. A rating
of SP-1 denotes a strong capacity to pay principal and interest. An issue
determined to possess a very strong capacity to pay debt service is given a (+)
designation.
FITCH IBCA, INC. AND DUFF & PHELPS CREDIT RATING CO.
BOND RATINGS:
"AAA" -- Highest credit quality. "AAA" ratings denote the lowest expectation of
credit risk. They are assigned only in case of exceptionally strong capacity for
timely payment of financial commitments. This capacity is highly unlikely to be
adversely affected by foreseeable events.
A-2
<PAGE> 59
"AA" -- Very high credit quality. "AA" ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
"A" -- High credit quality. "A" ratings denote a low expectation of credit risk.
The capacity for timely payment of financial commitments is considered strong.
This capacity may, nevertheless, be more vulnerable to changes in circumstances
or in economic conditions than is the case for higher ratings.
"BBB" -- Good credit quality. "BBB" ratings indicate that there is currently a
low expectation of credit risk. The capacity for timely payment of financial
commitments is considered adequate, but adverse changes in circumstances and in
economic conditions are more likely to impair this capacity. This is the lowest
investment-grade category.
"BB" -- Speculative. "BB" ratings indicate that there is a possibility of credit
risk developing, particularly as the result of adverse economic change over
time; however, business or financial alternatives may be available to allow
financial commitments to be met. Securities rated in this category are not
investment grade.
"B" -- Highly speculative. "B" ratings indicate that significant credit risk is
present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is contingent upon
a sustained, favorable business and economic environment.
PLUS (+) MINUS (-) -- Plus and minus signs may be appended to a rating to
denote relative status within major rating categories. Such suffixes are not
added to the "AAA" long-term rating category or to short-term ratings other than
"F1."
SHORT-TERM DEBT RATINGS:
"F1" -- Highest credit quality. Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
"F2" -- Good credit quality. A satisfactory capacity for timely payment of
financial commitments, but the margin of safety is not as great as in the case
of the higher ratings.
"F3" -- Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.
"B" -- Speculative. Minimal capacity for timely payment of financial commitments
plus vulnerability to near-term adverse changes in financial and economic
conditions.
A-3
<PAGE> 60
PART C. OTHER INFORMATION
Item 23. Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
(a)(1) -- Certificate of Trust of the Registrant.(1)
(2) -- Amended and Restated Declaration of Trust of the Registrant.(1)
(b) -- By-Laws of the Registrant.*
(c) -- Portions of Declaration of Trust and By-Laws of the Registrant
defining the rights of holders of shares of beneficial interest
of the Registrant.(1)
(d)(1) -- Investment Advisory Agreement between the Trust on behalf of
Low Duration Master Portfolio and Fund Asset Management, L.P.*
(2) -- Investment Advisory Agreement between the Trust on behalf of
Total Return Bond Master Portfolio and Fund Asset Management,
L.P.*
(e) -- Not Applicable.
(f) -- Not Applicable.
(g) -- Custody Agreement between the Trust and Brown Brothers
Harriman & Co.*
(h)(1) -- Placement Agency Agreements between the Registrant and FAM
Distributors, Inc.*
(2) -- Credit Agreement. Incorporated by reference to Exhibit
(h)(10) to Post-Effective Agreement No. 2 to the Registration
Statement on Form N-1A of Hotchkis and Wiley Variable Trust
(File No. 333-24349) filed on April 7, 2000.
(i) -- Not Applicable.
(j)(1) -- Consent of PricewaterhouseCoopers LLP.*
(2) -- Consent of Gardner, Carton & Douglas.*
(k) -- Not Applicable.
(l)(1) -- Certificate of FAM Distributors, Inc.*
(2) -- Certificate of Hotchkis and Wiley Funds for the Total Return
Bond Fund and the Low Duration Fund.*
(m) -- Not Applicable.
(n) -- Not Applicable.
(p) -- Code of Ethics. Incorporated by reference to Exhibit (p) to
the Registration Statement on Form N-1A of Merrill Lynch
Investment Managers Funds, Inc. (File No. 333-43552) filed on
August 11, 2000.
</TABLE>
---------------
* Filed herewith.
(1) Incorporated by reference to the Registration Statement on Form N-1A (File
No. 811-10089) filed on August 30, 2000.
Item 24. Persons Controlled by or under Common Control with the Fund.
The Low Duration Fund and Total Return Bond Fund of Hotchkis and
Wiley Funds each have contributed $50,000 to the Low Duration Master Portfolio
and the Total Return Bond Master Portfolio of the Registrant, and FAM
Distributors, Inc. has contributed $100 to each Master Portfolio. The Low
Duration Fund and Total Return Bond Fund thus control the respective Master
Portfolio of the Registrant.
Item 25. Indemnification.
As permitted by Section 17(h) and (i) of the Investment Company
Act of 1940, as amended (the "1940 Act"), and pursuant to Sections 8.2, 8.3 and
8.4 of Article VIII of the Registrant's Declaration of Trust (Exhibit (a)(1) to
this Registrant Statement), Trustees, officers, employees and agents of the
Trust will be indemnified to the maximum extent permitted by Delaware law and
the 1940 Act.
<PAGE> 61
Article VIII, Section 8.2 provides, inter alia, that no Trustee,
officer, employee or agent of the Registrant shall be liable to the Registrant,
its holders, or to any other Trustee, officer, employee or agent thereof for any
action or failure to act (including, without limitation, the failure to compel
in any way any former or acting Trustee to redress any breach of trust) except
for his own bad faith, willful misfeasance, gross negligence or reckless
disregard of his duties.
Article VIII, Section 8.3 of the Registrant's Declaration of
Trust provides:
Section 8.3. Indemnification. The Trust shall indemnify each of
its Trustees, officers, employees, and agents (including persons who serve at
its request as directors, officers or trustees of another organization in which
it has any interest, as a shareholder, creditor or otherwise) against all
liabilities and expenses (including amounts paid in satisfaction of judgments,
in compromise, as fines and penalties, and as counsel fees) reasonably incurred
by him in connection with the investigation, defense or disposition of any
action, suit or other proceeding, whether civil or criminal, in which he may be
involved or with which he may be threatened, while in office or thereafter, by
reason of his being or having been such a Trustee, officer, employee or agent,
except with respect to any matter as to which he shall have been adjudicated to
have acted in bad faith, willful misfeasance, gross negligence or reckless
disregard of his duties, such liabilities and expenses being liabilities
belonging to the Series out of which such claim for indemnification arises;
provided, however, that as to any matter disposed of by a compromise payment by
such Person, pursuant to a consent decree or otherwise, no indemnification
either for said payment or for any other expenses shall be provided unless there
has been a determination that such Person did not engage in willful misfeasance,
bad faith, gross negligence or reckless disregard of the duties involved in the
conduct of his office by the court or other body approving the settlement or
other disposition or, in the absence of a judicial determination, by a
reasonable determination, based upon a review of readily available facts (as
opposed to a full trial-type injury), that he did not engage in such conduct,
which determination shall be made by a majority of a quorum of Trustees who are
neither Interested Persons of the Trust nor parties to the action, suit or
proceeding, or by written opinion from independent legal counsel approved by the
Trustees. The rights accruing to any Person under these provisions shall not
exclude any other right to which he may be lawfully entitled; provided that no
Person may satisfy any right of indemnity or reimbursement granted herein or to
which he may be otherwise entitled except out of the Trust Property. The
Trustees may make advance payments in connection with indemnification under this
Section 8.3; provided that any advance payment of expenses by the Trust to any
Trustee, officer, employee or agent shall be made only upon the undertaking by
such Trustee, officer, employee or agent to repay the advance unless it is
ultimately determined that he is entitled to indemnification as above provided,
and only if one of the following conditions is met:
(a) the Trustee, officer, employee or agent to be indemnified
provides a security for his undertaking; or
(b) the Trust shall be insured against losses arising by reason
of any lawful advances; or
<PAGE> 62
(c) there is a determination, based on a review of readily
available facts, that there is reason to believe that the Trustee,
officer, employee or agent to be indemnified ultimately will be entitled
to indemnification, which determination shall be made by:
(i) a majority of a quorum of Trustees who are neither
Interested Persons of the Trust nor parties to the Proceedings; or
(ii) an independent legal counsel in a written opinion.
Article VIII, Section 8.4 of the Registrant's Declaration of
Trust further provides:
Section 8.4. No Protection Against Certain 1940 Act Liabilities.
Nothing contained in Sections 8.1, 8.2 or 8.3 hereof shall protect any Trustee
or officer of the Trust from any liability to the Trust or its holders to which
he would otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his
office. Nothing contained in Sections 8.1, 8.2 or 8.3 hereof or in any agreement
of the character described in Section 4.1 or 4.2 hereof shall protect any
Investment Adviser to the Trust or any Series against any liability to the Trust
or any Series to which he would otherwise be subject by reason of willful
misfeasance, bad faith, or gross negligence in the performance of his or its
duties to the Trust or Series, or by reason of his or its reckless disregard to
his or its obligations and duties under the agreement pursuant to which he
serves as Investment Adviser to the Trust or any Series.
As permitted by Article VIII, Section 8.7, the Trustees may
maintain insurance for the protection of the Trust Property, its holders,
Trustees, officers, employees and agents in the amount the Trustees deem
adequate.
The Registrant hereby undertakes that it will apply the
indemnification provisions of its Declaration of Trust and Bylaws in a manner
consistent with Release No. 11330 of the Securities and Exchange Commission
under the 1940 Act so long as the interpretation of Section 17(h) and 17(i) of
such Act remain in effect and are consistently applied.
Item 26. Business and other Connections of the Investment Adviser.
Fund Asset Management, L.P. ("FAM" or the "Investment Adviser"),
acts as the investment adviser for the following open-end registered investment
companies: CBA Money Fund, CMA Government Securities Fund, CMA Money Fund, CMA
Multi-State Municipal Series Trust, CMA Tax-Exempt Fund, CMA Treasury Fund, The
Corporate Fund Accumulation Program, Inc., Financial Institutions Series Trust,
Merrill Lynch Basic Value Fund, Inc., Merrill Lynch California Municipal Series
Trust, Merrill Lynch Corporate Bond Fund, Inc., Merrill Lynch Corporate High
Yield Fund, Inc., Merrill Lynch Emerging Tigers Fund, Inc., Merrill Lynch
Federal Securities Trust, Merrill Lynch Funds for Institutions Series, Merrill
Lynch Multi-State Limited Maturity Municipal Series Trust, Merrill Lynch
Multi-State Municipal Series Trust, Merrill Lynch Municipal Bond Fund, Inc.,
Merrill Lynch Phoenix Fund, Inc., Merrill Lynch Special Value Fund, Inc.,
Merrill Lynch World Income Fund, Inc. and The Municipal
<PAGE> 63
Fund Accumulation Program, Inc.; and the following closed-end registered
investment companies: Apex Municipal Fund, Inc., Corporate High Yield Fund,
Inc., Corporate High Yield Fund II, Inc., Corporate High Yield Fund III, Inc.,
Debt Strategies Fund, Inc., Debt Strategies Fund II, Inc., Income Opportunities
Fund 1999, Inc., Income Opportunities Fund 2000, Inc., Merrill Lynch Municipal
Strategy Fund, Inc., MuniAssets Fund, Inc., MuniEnhanced Fund, Inc.,
MuniHoldings Fund, Inc., MuniHoldings Fund II, Inc., MuniHoldings Insured Fund ,
MuniHoldings Insured Fund II, MuniHoldings Insured Fund III, MuniHoldings
California Insured Fund, Inc., MuniHoldings California Insured Fund II, Inc.,
MuniHoldings California Insured Fund III, Inc., MuniHoldings California Insured
Fund IV, Inc., MuniHoldings Florida Insured Fund, MuniHoldings Florida Insured
Fund II, MuniHoldings Florida Insured Fund III, MuniHoldings Florida Insured
Fund IV, MuniHoldings New Jersey Insured Fund II, Inc., MuniHoldings New Jersey
Fund III, Inc., MuniHoldings New Jersey Insured Fund, Inc., MuniHoldings New
York Fund, Inc., MuniHoldings New York Insured Fund, Inc., MuniHoldings New York
Insured Fund II, Inc., MuniHoldings New York Insured Fund III, Inc.,
MuniHoldings Michigan Insured Fund, Inc., MuniHoldings Pennsylvania Insured
Fund, MuniInsured Fund, Inc., MuniVest Fund, Inc., MuniVest Fund II, Inc.,
MuniVest Florida Fund, MuniVest Michigan Insured Fund, Inc., MuniVest New Jersey
Fund, Inc., MuniVest Pennsylvania Insured Fund, Inc., MuniYield Arizona Fund,
Inc., MuniYield California Fund, Inc., MuniYield California Insured Fund, Inc.,
MuniYield California Insured Fund II, Inc., MuniYield Florida Fund, MuniYield
Florida Insured Fund, MuniYield Fund, Inc., MuniYield Insured Fund, Inc.,
MuniYield Michigan Fund, Inc., MuniYield Michigan Insured Fund, Inc., MuniYield
New Jersey Fund, Inc., MuniYield New Jersey Insured Fund, Inc., MuniYield New
York Insured Fund, Inc., MuniYield New York Insured Fund II, Inc., MuniYield
Pennsylvania Fund, MuniYield Quality Fund, Inc., MuniYield Quality Fund II,
Inc., Senior High Income Portfolio, Inc., and Worldwide DollarVest Fund, Inc.
Merrill Lynch Investment Managers, L.P. ("MLIM"), acts as the
investment adviser for the following open-end registered investment companies:
Merrill Lynch Adjustable Rate Securities Fund, Inc., Merrill Lynch Americas
Income Fund, Inc., Merrill Lynch Asset Builder Program, Inc., Merrill Lynch
Asset Growth Fund, Inc., Merrill Lynch Asset Income Fund, Inc., Merrill Lynch
Capital Fund, Inc., Merrill Lynch Developing Capital Markets Fund, Inc., Merrill
Lynch Convertible Fund, Inc., Merrill Lynch Dragon Fund, Inc., Merrill Lynch
EuroFund, Merrill Lynch Fundamental Growth Fund, Inc., Merrill Lynch Global
Allocation Fund, Inc., Merrill Lynch Global Bond Fund for Investment and
Retirement, Merrill Lynch Global Convertible Fund, Inc., Merrill Lynch Global
Growth Fund, Inc., Merrill Lynch Global Holdings, Inc., Merrill Lynch Global
Resources Trust, Merrill Lynch Global SmallCap Fund, Inc., Merrill Lynch Global
Utility Fund, Inc., Merrill Lynch Global Value Fund, Inc., Merrill Lynch Growth
Fund, Merrill Lynch Global Technology Fund, Inc., Merrill Lynch Healthcare Fund,
Inc., Merrill Lynch Intermediate Government Bond Fund, Merrill Lynch
International Equity Fund, Merrill Lynch Latin America Fund, Inc., Merrill Lynch
Middle East/Africa Fund, Inc., Merrill Lynch Municipal Series Trust, Merrill
Lynch Pacific Fund, Inc., Merrill Lynch Ready Assets Trust, Merrill Lynch Real
Estate Fund, Inc., Merrill Lynch Retirement Series Trust, Merrill Lynch Series
Fund, Inc., Merrill Lynch Short-Term Global Income Fund, Inc., Merrill Lynch
Strategic Dividend Fund, Merrill Lynch Technology Fund, Inc., Merrill Lynch U.S.
Treasury Money Fund, Merrill Lynch U.S.A. Government Reserves, Merrill Lynch
Utility
<PAGE> 64
Income Fund, Inc., Merrill Lynch Variable Series Funds, Inc., Hotchkis and Wiley
Funds and Hotchkis and Wiley Variable Trust; and for the following closed-end
registered investment companies: Merrill Lynch High Income Municipal Bond Fund,
Inc. and Merrill Lynch Senior Floating Rate Fund, Inc. MLIM also acts as
sub-adviser to Merrill Lynch World Strategy Portfolio and Merrill Lynch Basic
Value Equity Portfolio, two investment portfolios of EQ Advisors Trust.
The address of each of these investment companies is P.O. Box
9011, Princeton, New Jersey 08543-9011, except that the address of Hotchkis and
Wiley Funds and Hotchkis and Wiley Variable Trust is 725 South Figueroa Street,
Suite 4000, Los Angeles, California 90017-5400 and of Merrill Lynch Funds for
Institutions Series and Merrill Lynch Intermediate Government Bond Fund is One
Financial Center, 23rd Floor, Boston, Massachusetts 02111-2646. The address of
MLIM, FAM and Princeton Services, Inc. ("Princeton Services"), and Princeton
Administrators, L.P. is also P.O. Box 9011, Princeton, New Jersey 08543-9011.
The address of FAM Distributors, Inc. ("FAMDI") is P.O. Box 9081, Princeton, New
Jersey 08543-9081. The address of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") and Merrill Lynch & Co., Inc. ("ML & Co.") is
North Tower, World Financial Center, 250 Vesey Street, New York, New York
10281-1201. The address of the Fund's transfer agent, Financial Data Services,
Inc. ("FDS"), is 4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Set forth below is a list of each executive officer and partner
of the Investment Adviser indicating each business, profession, vocation or
employment of a substantial nature in which each such person or entity has been
engaged since September 30, 1995, for his or her own account or in the capacity
of director, officer, partner or trustee. In addition, Mr. Glenn is President
and Mr. Burke is Vice President and Treasurer of substantially all of the
investment companies described in the first two paragraphs of this Item 28 and
Messrs. Giordano and Monagle are directors or officers of one or more of such
companies.
<TABLE>
<CAPTION>
POSITION WITH THE OTHER SUBSTANTIAL BUSINESS, PROFESSION,
NAME INVESTMENT ADVISER VOCATION OR EMPLOYMENT
---- ------------------ -------------------------------------------------
<S> <C> <C>
ML & Co ................ Limited Partner Financial Services Holding Company; Limited
Partner of FAM
Princeton Services...... General Partner General Partner of MLIM
Jeffrey M. Peek ........ President President of MLIM; President and director of
Princeton Services; Executive Vice President
of ML & Co.; Managing Director and Co-Head
of the Investment Banking division of
Merrill Lynch until 1999; Senior Vice
President and Director of the Global
Securities and Economics Division of Merrill
Lynch from 1995 to 1997.
Terry K. Glenn ......... Executive Vice Executive Vice President of MLIM; Executive
President Vice President and Director of Princeton
Services; President and
Director of PFD; Director of
Financial Data Services,
Inc.; President of Princeton
Administrators, L.P.
Donald C. Burke ........ Senior Vice Senior Vice President and Treasurer of MLIM;
President and Senior Vice President and Treasurer of
Treasurer Princeton Services; Vice President and
Treasurer of PFD; First Vice
President of MLIM from 1997
to 1999; Vice President of
MLIM from 1990 to 1997;
Director of Taxation of MLIM
Michael G. Clark ...... Senior Vice Senior Vice President of MLIM; Senior Vice
President President of Princeton Services
</TABLE>
<PAGE> 65
<TABLE>
<S> <C> <C>
Mark DeSario ...... Senior Vice Senior Vice President of FAM; Senior Vice
President President of Princeton Services
Linda L. Federieci ..... Senior Vice Senior Vice President of MLIM; Senior Vice
President President of Princeton Services
Vincent R. Giordano .... Senior Vice Senior Vice President of MLIM; Senior Vice
President President of Princeton Services
Elizabeth A. Griffin ... Senior Vice Senior Vice President of MLIM; Senior Vice
President President of Princeton Services
Michael J. Hennewinkel . Senior Vice Senior Vice President, General Counsel and
President Secretary of MLIM; Secretary and Senior Vice
President of Princeton Services
Philip L. Kirstein ..... Senior Vice Senior Vice President of MLIM; Senior Vice
President President, General Counsel, Director and
Secretary of Princeton Services
Ronald M. Kloss ........ Senior Vice Senior Vice President of MLIM; Senior Vice
President President of Princeton Services
Debra W. Landsman-Yaros Senior Vice Senior Vice President of MLIM; Senior Vice
President President of Princeton Services; Vice
President of FAMDI
Stephen M. Miller ...... Senior Vice Executive Vice President of Princeton
President Administrators, L.P.; Senior Vice President
of Princeton Services
Joseph T. Monagle, Jr. . Senior Vice Senior Vice President of MLIM; Senior Vice
President President of Princeton Services
Brian A. Murdock ....... Senior Vice Senior Vice President of MLIM; Senior Vice
President President of Princeton Services
Gregory D. Upah ........ Senior Vice Senior Vice President of MLIM; Senior Vice
President President of Princeton Services
</TABLE>
Item 27. Principal Underwriters.
(a) The Registrant's principal underwriter, FAM Distributors,
Inc. ("FAMDI"), also acts as principal underwriter for the following open-end
registered investment companies:
The Asset Program, Inc., Financial Institutions Series Trust,
Hotchkis and Wiley Variable Trust, Master Focus Twenty Trust, Master Global
Financial Services Trust, Master Internet Strategies Trust, Master Large Cap
Series Trust, Master Premier Growth Trust, Mercury Global Holdings, Inc. Merrill
Lynch Adjustable Rate Securities Fund, Inc., Merrill Lynch Americas Income Fund,
Inc., Merrill Lynch Asset Builder Program, Inc., Merrill Lynch Asset Growth
Fund, Inc., Merrill Lynch Basic Value Fund, Inc., Merrill Lynch California
Municipal Series Trust, Merrill Lynch Balanced Capital Fund, Inc., Merrill Lynch
Convertible Fund, Inc., Merrill Lynch Corporate Bond Fund, Inc., Merrill Lynch
Corporate High Yield Fund, Inc., Merrill Lynch Developing Capital Markets Fund,
Inc., Merrill Lynch Disciplined Equity Fund, Inc., Merrill Lynch Dragon Fund,
Inc., Merrill Lynch EuroFund, Merrill Lynch Fundamental Growth Fund, Inc.,
Merrill Lynch Funds for Institutions Series, Merrill Lynch Global Allocation
Fund, Inc., Merrill Lynch Global Bond Fund for Investment and Retirement,
Merrill Lynch Global Growth Fund, Inc., Merrill Lynch Global Resources Trust,
Merrill Lynch Global SmallCap Fund, Inc., Merrill Lynch Global Technology Fund,
Inc., Merrill Lynch Global Utility Fund, Inc., Merrill Lynch Global Value Fund,
Inc., Merrill Lynch Growth Fund, Merrill Lynch Healthcare Fund, Inc., Merrill
Lynch Index Funds, Inc., Merrill Lynch Intermediate Government Bond Fund,
Merrill Lynch International Equity Fund, Merrill Lynch Latin America Fund, Inc.,
Merrill Lynch Multi-State Limited Maturity Municipal Series Trust, Merrill Lynch
Multi-State
<PAGE> 66
Municipal Series Trust, Merrill Lynch Municipal Bond Fund, Inc., Merrill Lynch
Municipal Series Trust, Merrill Lynch Pacific Fund, Inc., Merrill Lynch Phoenix
Fund, Inc., Merrill Lynch Ready Assets Trust, Merrill Lynch Real Estate Fund,
Inc., Merrill Lynch Retirement Series Trust, Merrill Lynch Series Fund, Inc.,
Merrill Lynch Short-Term Global Income Fund, Inc., Merrill Lynch SmallCap Value
Fund, Inc., Merrill Lynch Strategic Dividend Fund, Merrill Lynch U.S. Government
Mortgage Fund, Merrill Lynch U.S. Treasury Money Fund, Merrill Lynch U.S.A.
Government Reserves, Merrill Lynch Utility Income Fund, Inc., Merrill Lynch
Variable Series Funds, Inc., and Merrill Lynch World Income Fund, Inc., FAMDI
also acts as the principal underwriter for the following closed-end registered
investment companies: Merrill Lynch High Income Municipal Bond Program, Inc.,
Merrill Lynch Municipal Strategy Fund, Inc., Merrill Lynch Senior Floating Rate
Fund, Inc., and Merrill Lynch Senior Floating Rate Fund II, Inc. A separate
division of FAMDI acts as the principal underwriter of a number of other
investment companies.
(b) Set forth below is information concerning each director and
officer of FAM Distributors, Inc. The principal business address of each such
person is P.O. Box 9081, Princeton, New Jersey 08543-9081, except that the
address of Messrs. Crook, Brady, Breen, Fatseas, and Wasel is One Financial
Center, 23rd Floor, Boston, Massachusetts 02111-2665.
<TABLE>
<CAPTION>
Positions and Offices Positions and Offices
Name with the Distributor with Registrant
---- ---------------------- ---------------------
<S> <C> <C>
Terry K. Glenn President and Director None
Thomas J. Verage Director None
Robert W. Crook Senior Vice President None
Michael J. Brady Vice President None
William M. Breen Vice President None
Michael G. Clark Vice President None
James T. Fatseas Vice President None
Debra W. Landsman-Yaros Vice President None
Michelle T. Lau Vice President None
Donald C. Burke Vice President and Vice President and
Treasurer Treasurer
Salvatore Venezia Vice President None
William Wasel Vice President None
Robert Harris Secretary None
</TABLE>
(c) Not Applicable.
Item 28. Location of Accounts and Records.
All accounts, books and other documents required to be
maintained by the Registrant pursuant to Section 31(a) of the Investment Company
Act of 1940, as amended, and the rules thereunder are in the possession of
Registrant or Registrant's investment adviser, 725 S. Figueroa Street, Suite
4000, Los Angeles, California 90017, or 800 Scudders Mill Road, Plainsboro, New
Jersey 08536, or Registrant's custodian, Brown Brothers Harriman & Co., 40 Water
Street, Boston, Massachusetts 02109.
<PAGE> 67
Item 29. Management Services.
Other than as set forth under the caption "Investment Adviser"
in the Prospectus constituting Part A of the Registration Statement and under
the caption "Management of the Fund--Investment Advisory Arrangements" in the
Statement of Additional Information constituting Part B of the Registration
Statement, the Registrant is not a party to any management-related service
contract.
Item 30. Undertakings.
Not Applicable.
<PAGE> 68
SIGNATURES
Pursuant to the requirements of the Investment Company Act, the
Fund has duly caused this Registration Statement to be signed on its behalf by
the undersigned, duly authorized, in the City of Los Angeles, and State of
California, on the 5th day of October, 2000.
FUND ASSET MANAGEMENT MASTER TRUST
By:/s/ Nancy D. Celick
---------------------------------
Nancy D. Celick
President
<PAGE> 69
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
(a)(1) -- Certificate of Trust of the Registrant.(1)
(2) -- Amended and Restated Declaration of Trust of the Registrant.(1)
(b) -- By-Laws of the Registrant.*
(c) -- Portions of Declaration of Trust and By-Laws of the Registrant
defining the rights of holders of shares of beneficial interest of
the Registrant.(1)
(d)(1) -- Investment Advisory Agreement between the Trust on behalf of Low
Duration Master Portfolio and Fund Asset Management, L.P.*
(2) -- Investment Advisory Agreement between the Trust on behalf of Total
Return Bond Master Portfolio and Fund Asset Management, L.P.*
(e) -- Not Applicable.
(f) -- Not Applicable.
(g) -- Custody Agreement between the Trust and Brown Brothers Harriman &
Co.*
(h)(1) -- Placement Agency Agreements between the Registrant and FAM
Distributors, Inc.*
(2) -- Credit Agreement. Incorporated by reference to Exhibit
(h)(10) to Post-Effective Agreement No. 2 to the Registration
Statement on Form N-1A of Hotchkis and Wiley Variable Trust
(File No. 333-24349) filed on April 7, 2000.
(i) -- Not Applicable.
(j)(1) -- Consent of PricewaterhouseCoopers LLP.*
(2) -- Consent of Gardner, Carton & Douglas.*
(k) -- Not Applicable.
(l)(1) -- Certificate of FAM Distributors, Inc.*
(2) -- Certificate of the Hotchkis and Wiley Funds for the Total Return
Bond Fund and the Low Duration Fund.*
(m) -- Not Applicable.
(n) -- Not Applicable.
(p) -- Code of Ethics. Incorporated by reference to Exhibit (p) to the
Registration Statement on Form N-1A of Merrill Lynch Investment
Managers Funds, Inc. (File No. 333-43552) filed on August 11,
2000.
</TABLE>
---------------
* Filed herewith.
(1) Incorporated by reference to the Registration Statement on Form N-1A (File
No. 811-10089) filed on August 30, 2000.
