PRINCIPAL GROWTH FUND INC /MD/, 497, 2000-06-21

PRINCIPAL GROWTH FUND INC /MD/
497, 2000-06-21

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SUPPLEMENT DATED JUNE 16, 2000
TO THE STATEMENT OF ADDITIONAL INFORMATION
DATED MARCH 1, 2000 (as revised through May 1, 2000) FOR

Principal Balanced Fund, Inc.
Principal Blue Chip Fund, Inc.
Principal Bond Fund, Inc.
Principal Capital Value Fund, Inc.
Principal Cash Management Fund, Inc.
Principal European Equity Fund, Inc.
Principal Government Securities Income Fund, Inc.
Principal Growth Fund, Inc.
Principal High Yield Fund, Inc.
Principal International Emerging Markets Fund, Inc.
Principal International Fund, Inc.
Principal International SmallCap Fund, Inc.
Principal LargeCap Stock Index Fund, Inc.
Principal Limited Term Bond Fund, Inc.
Principal MidCap Fund, Inc.
Principal Pacific Basin Fund, Inc.
Principal Partners Aggressive Growth Fund, Inc.
Principal Partners LargeCap Growth Fund, Inc.
Principal Partners MidCap Growth Fund, Inc.
Principal Real Estate Fund, Inc.
Principal SmallCap Fund, Inc.
Principal Tax-Exempt Bond Fund, Inc.
Principal Utilities Fund, Inc.

Please add the following as Appendix D:

Appendix D

Established in 1879 and a member of the Fortune 500, the Principal Financial
Group is a leading provider of a wide range of financial products and services
for businesses and individuals globally. Offerings include retirement and
investment services, life and health insurance and mortgage banking. The company
provides administrative services to more 401(k) plans than any other provider in
the United States. Worldwide, the Principal Financial Group serves more than 11
million customers from more than 250 locations including offices in Asia,
Australia, Europe, Latin America and the United States.

Clientele

The Principal Financial Group
o 11.2 million customers served (individuals and their dependents)

Financial Data

The Principal Financial Group (highlights of consolidated operations)
o Total GAAP assets under management: $117 billion*
o Total amounts received from customers in 1999: $20.1 billion
o Total amounts credited to customers in 1999: $17.0 billion
o Total life insurance in force in 1999: $163 billion
o Individual: $75.2 billion
o Group: $87.8 billion

Ratings

Principal Life Insurance Company
o A+ (Superior) Financial Quality rating from A.M. Best Company (as of
11/99).
o AA+ (Very High) Claims Paying Ability rating from Duff & Phelps Rating
Co. (as of 6/99).
o Aa2 (Excellent) Financial Strength rating from Moody's Investors
Service (as of 6/99).
o AA (Very Strong) Financial Strength rating from Standard & Poor's (as
of 12/99).

PRINCIPAL MUTUTAL FUNDS by Investment Style
--------------------------------------------

<TABLE>
<CAPTION>
Equity Style

Value Blend Growth
<S> <C> <C> <C> <C>
Large Principal Balanced Fund Principal European Equity Fund Principal Growth Fund
Market Principal Blue Chip Fund Principal Pacific Basin Fund Principal International Fund
Capitalization Principal Capital Value Fund Principal Partners Aggressive Principal Partners LargeCap Growth
Growth Fund Fund

Medium Principal Utilities Fund Principal Real Estate Fund Principal MidCap Fund
Principal Partners MidCap Growth Fund

Small Principal SmallCap Fund Principal International SmallCap Fund
Principal International Emerging
Markets Fund
</TABLE>

<TABLE>
<CAPTION>
Income Style

Value Blend Growth
<S> <C> <C> <C> <C>
Large Principal Cash Management Principal Limited Term Bond Fund
Market Fund Principal Government Securities
Capitalization Income Fund

Medium Principal Bond Fund
Principal Tax-Exempt Bond Fund

Small Principal High Yield Fund
</TABLE>

PRINCIPAL MUTUAL FUNDS by Risk Measurement
-------------------------------------------

Domestic Growth-Oriented Mutual Funds
-------------------------------------
Most Aggressive

Principal SmallCap Fund
Principal MidCap Fund
Principal Growth Fund
Principal LargeCap Stock Index Fund
Principal Capital Value Fund
Principal Blue Chip Fund
Principal Balanced Fund
Principal Real Estate Fund
Principal Utilities Fund

Most Conservative

International Growth-Oriented Mutual Funds
------------------------------------------

Most Aggressive

Principal International Emerging Markets Fund
Principal International SmallCap Fund
Principal Pacific Basin Fund
Principal European Equity Fund
Principal International Fund

Most Conservative

Partners Growth-Oriented Mutual Funds
-------------------------------------

Most Aggressive

Principal Partners MidCap Growth Fund
Principal Partners LargeCap Growth Fund
Principal Partners Aggressive Growth Fund

Most Conservative

Income-Oriented Mutual Funds
----------------------------

Most Aggressive

Principal High Yield Fund
Principal Tax-Exempt Bond Fund
Principal Bond Fund
Principal Government Securities Income Fund
Principal Limited Term Bond Fund
Principal Cash Management Fund

Most Conservative

Risk Measurements are for comparative purposes within the Principal Mutual Funds
family only. They are intended to describe general fund characteristics and not
intended to represent past of future performance of any fund.

For the most recent month's performance information, visit our website at
www.principal.com.

MM 1600-2

Statement of Additional Information

dated March 1, 2000
as revised through
May 1, 2000

This Statement of Additional Information is not a prospectus but is a part of
the prospectuses for the Funds listed above. The most recent prospectuses dated
March 1, 2000 and shareholder report are available without charge. Please call
1-800-247-4123 to request a copy. The prospectus for Class A, Class B and Class
C shares of all funds may also be viewed on our web site at
www.principal.com/funds.
TABLE OF CONTENTS

Investment Policies and Restrictions of the Funds.................. 4
Growth-Oriented Funds.............................................. 7
Income-Oriented Funds ............................................. 13
Money Market Fund.................................................. 17
Funds' Investments................................................. 19
Management of the Funds............................................ 32
Manager and Sub-Advisors........................................... 37
Cost of Manager's Services......................................... 38
Brokerage on Purchases and Sales of Securities..................... 43
How to Purchase Shares............................................. 48
Offering Price of Funds' Shares.................................... 50
Distribution Plan.................................................. 58
Determination of Net Asset Value of Funds' Shares ................. 61
Performance Calculation............................................ 62
Tax Treatment of Funds, Dividends and Distributions .............. 68
General Information and History.................................... 70
Financial Statements .............................................. 71
Appendix A ........................................................ 72
Appendix B......................................................... 73
Appendix C......................................................... 76
Statement of Net Assets for Principal Partners
Aggressive Growth Fund, Inc. .................................. 81
Statements of Net Assets for Principal LargeCap Stock Index
Fund, Inc., Principal Partners LargeCap Growth Fund, Inc. and
Principal Partners MidCap Growth Fund, Inc..................... 85
Statements of Net Assets for Principal European Equity Fund, Inc.
and Principal Pacific Basin Fund, Inc.......................... 89

INVESTMENT POLICIES AND RESTRICTIONS OF THE FUNDS

The following information about the Principal Mutual Funds, a family of
separately incorporated, open-end management investment companies, commonly
called mutual funds, supplements the information provided in the Prospectuses
under the caption "CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS".

There are four categories of Principal Mutual Funds:

Domestic Growth-Oriented Funds which include:
o seven Funds which seek to achieve growth of capital primarily through
investments in equity securities (Capital Value Fund, Growth Fund, MidCap
Fund, Partners Aggressive Growth Fund, Partners LargeCap Growth Fund,
Partners MidCap Growth Fund and SmallCap Fund);
o one Fund which seeks a total investment return including both capital
appreciation and income through investments in equity and debt securities
(Balanced Fund);
o one Fund which seeks growth of capital and growth of income primarily
through investments in common stocks of well-capitalized, established
companies (Blue Chip Fund);
o one Fund which seeks to generate total return by investing primarily in
equity securities of companies principally engaged in the real estate
industry (Real Estate Fund);
o one Fund which seeks to approximate the performance of the Standard &
Poor's 500 Composite Stock Price Index (LargeCap Stock Index Fund); and
o one Fund which seeks current income and long-term growth of income and
capital by investing primarily in equity and fixed-income securities of
companies in the public utilities industry (Utilities Fund).

International Growth-Oriented Funds which include five Funds which seek growth
of capital primarily through investments in equity securities (European Equity
Fund, International Emerging Markets Fund, International Fund, International
SmallCap Fund and Pacific Basin Fund).

Income-Oriented Funds which include five funds which seek primarily a high level
of income through investments in debt securities (Bond Fund, Government
Securities Income Fund, High Yield Fund, Limited Term Bond Fund and Tax-Exempt
Bond Fund).

Money Market Fund which seeks primarily a high level of income through
investments in short-term debt securities (Cash Management Fund).

In seeking to achieve its investment objective, each Fund has adopted as matters
of fundamental policy certain investment restrictions which cannot be changed
without approval by the holders of the lesser of: (i) 67% of the Fund's shares
present or represented at a shareholders' meeting at which the holders of more
than 50% of such shares are present or represented by proxy; or (ii) more than
50% of the outstanding shares of the Fund. Similar shareholder approval is
required to change the investment objective of each of the Funds. The following
discussion provides for each Fund a statement of its investment objective, a
description of its investment restrictions that are matters of fundamental
policy and a description of any investment restrictions it may have adopted that
are not matters of fundamental policy and may be changed without shareholder
approval. For purposes of the investment restrictions, all percentage and rating
limitations apply at the time of acquisition of a security, and any subsequent
change in any applicable percentage resulting from market fluctuations or in a
rating by a rating service will not require elimination of any security from the
portfolio. Unless specifically identified as a matter of fundamental policy,
each investment policy discussed in the Prospectuses or the Statement of
Additional Information is not fundamental and may be changed by the respective
Fund's Board of Directors.

The Table on the next page graphically illustrates each Fund's emphasis on
producing current income or capital growth and the stability of the market value
of the Fund's portfolio. These illustrations represent comparative relationships
only with regard to the investment objectives sought by the Funds. Relative
income, stability and growth may vary among the Funds with certain market
conditions. The illustrations are not intended and should not be construed as
projected relative performances of the Principal Mutual Funds.

INCOME-ORIENTED FUNDS

PRINCIPAL LIMITED TERM BOND FUND . . . for investors seeking a high level of
current income combined with a relative high level of stability of principal by
investing in fixed-income securities with maturities of 5 years or less.

PRINCIPAL GOVERNMENT SECURITIES INCOME FUND . . . for investors seeking a high
level of current income, liquidity, and relative safety from a portfolio
emphasizing GNMA securities.

PRINCIPAL BOND FUND . . . for investors seeking high current income from a
portfolio of higher quality bonds.

PRINCIPAL TAX-EXEMPT BOND FUND . . . for investors seeking a high level of
current income exempt from federal income tax, consistent with preservation of
capital.

PRINCIPAL HIGH YIELD FUND . . . for investors seeking higher current income from
a portfolio of lower or non-rated fixed-income securities.

MONEY MARKET FUND

PRINCIPAL CASH MANAGEMENT FUND . . . for investors seeking income, liquidity and
the stability of money market securities.

GROWTH ORIENTED
INTERNATIONAL FUNDS

PRINCIPAL INTERNATIONAL FUND . . . for investors seeking growth from common
stocks of companies domiciled in any of the major nations of the world.

PRINCIPAL EUROPEAN EQUITY FUND . . . for investors seeking growth of capital by
investing primarily in equity securities (or other securities with equity
characteristics) of issuers located in Europe.

PRINCIPAL PACIFIC BASIN FUND . . . for investors seeking growth of capital by
investing primarily in equity securities (or other securities with equity
characteristics) of issuers located in the Pacific Basin.

PRINCIPAL INTERNATIONAL SMALLCAP FUND . . . for investors seeking long-term
growth from equities from non-United States companies with relatively small
market capitalization.

PRINCIPAL INTERNATIONAL EMERGING MARKETS FUND . . . for investors seeking
long-term growth by investing in stocks of companies in emerging market
countries.

GROWTH-ORIENTED DOMESTIC FUNDS

PRINCIPAL UTILITIES FUND . . . for investors seeking current income and
long-term growth of income and capital from securities issued by public
utilities companies.

PRINCIPAL REAL ESTATE FUND . . . for investors seeking long-term capital growth
and current income from securities of companies primarily engaged in the real
estate industry.

PRINCIPAL BALANCED FUND . . . for investors seeking total return from a flexible
portfolio of common stocks, corporate bonds and money market securities.

PRINCIPAL BLUE CHIP FUND . . . for investors seeking growth of capital and
growth of income from stocks of well capitalized, established companies.

PRINCIPAL CAPITAL VALUE FUND . . . for investors seeking long-term capital
appreciation, with growth of income as a secondary objective.

PRINCIPAL LARGECAP STOCK INDEX FUND . . . for investors seeking long-term growth
of capital by investing in widely held common stocks representing industrial,
financial, utilities and transportation companies.

PRINCIPAL GROWTH FUND . . . for investors seeking long-term growth opportunities
from a common stock portfolio.

PRINCIPAL MIDCAP FUND . . . for investors seeking long-term capital growth from
securities of emerging and other growth-oriented companies.

PRINCIPAL PARTNERS AGGRESSIVE GROWTH FUND . . . for investors seeking long-term
capital appreciation from a portfolio of primarily equity securities.

PRINICIPAL PARTNERS LARGECAP GROWTH FUND . . . for investors seeking long-term
growth of capital by investing primarily in common stocks of larger
capitalization domestic companies.

PRINCIPAL PARTNERS MIDCAP GROWTH FUND . . . for investors seeking long-term
growth of capital by investing primarily in medium capitalization U.S.
companies.

PRINCIPAL SMALLCAP FUND . . . for investors seeking long-term growth of capital
from a portfolio of investment securities issued by companies domiciled in the
United States with comparatively smaller market capitalization.

* These illustrations represent comparative relationships only with regard to
the investment objectives sought by the funds. Relative income, stability and
growth may vary among the funds with certain market conditions. In no way
should the illustrations be construed as projected relative performances of
the Principal funds.

GROWTH-ORIENTED FUNDS

Investment Objectives

Principal Balanced Fund, Inc. ("Balanced Fund") seeks to generate a total
investment return consisting of current income and capital appreciation while
assuming reasonable risks in furtherance of the investment objective.

Principal Blue Chip Fund, Inc. ("Blue Chip Fund") seeks to achieve growth of
capital and growth of income by investing primarily in common stocks of well
capitalized, established companies.

Principal Capital Value Fund, Inc. ("Capital Value Fund") seeks to achieve
primarily long-term capital appreciation and secondarily growth of investment
income through the purchase primarily of common stocks, but the Fund may invest
in other securities.

Principal European Equity Fund, Inc. ("European Equity Fund") seeks to achieve
growth of capital. The Fund seeks to achieve its objective by investing
primarily in equity securities (or other securities with equity characteristics)
of issuers located in Europe.

Principal Growth Fund, Inc. ("Growth Fund") seeks to achieve growth of capital
through the purchase primarily of common stocks, but the Fund may invest in
other securities.

Principal International Emerging Markets Fund, Inc. ("International Emerging
Markets Fund") seeks to achieve long-term growth of capital by investing
primarily in equity securities of issuers in emerging market countries.

Principal International Fund, Inc. ("International Fund") seeks to achieve
long-term growth of capital by investing in a portfolio of equity securities of
companies domiciled in any of the nations of the world.

Principal International SmallCap Fund, Inc. ("International SmallCap Fund")
seeks to achieve long-term growth of capital by investing primarily in equity
securities of non-United States companies with comparatively smaller market
capitalizations.

Principal LargeCap Stock Index Fund, Inc. ("LargeCap Stock Index") seeks to
achieve long-term growth of capital. The Fund attempts to mirror the investment
results of the Standard & Poor's 500 Composite Stock Price Index ("S&P 500").

Principal MidCap Fund, Inc. ("MidCap Fund") seeks to achieve capital
appreciation by investing primarily in securities of emerging and other
growth-oriented companies.

Principal Pacific Basin Fund, Inc. ("Pacific Basin Fund") seeks to achieve
growth of capital. The Fund seeks to achieve its objective by investing
primarily in equity securities (or other securities with equity characteristics)
of issuers located in the Pacific Basin.

Principal Partners Aggressive Growth Fund, Inc. ("Partners Aggressive Growth
Fund") seeks to achieve long-term capital appreciation by investing primarily in
equity securities.

Principal Partners LargeCap Growth Fund, Inc. ("Partners LargeCap Growth Fund")
seeks to achieve long-term growth of capital by investing primarily in common
stocks of larger capitalization domestic companies.

Principal Partners MidCap Growth Fund, Inc. ("Partners MidCap Growth Fund")
seeks to achieve long-term growth of capital by investing primarily in medium
capitalization U.S. companies with strong earnings growth potential.

Principal Real Estate Fund, Inc. ("Real Estate Fund") seeks to generate total
return by investing primarily in equity securities of companies principally
engaged in the real estate industry.

Principal SmallCap Fund, Inc. ("SmallCap Fund") seeks to achieve long-term
growth of capital by investing primarily in equity securities of companies with
comparatively smaller market capitalizations.

Principal Utilities Fund, Inc. ("Utilities Fund") seeks to achieve high current
income and long-term growth of income and capital. The Fund seeks to achieve its
objective by investing primarily in equity and fixed income securities of
companies in the public utilities industry.

Investment Restrictions

European Equity Fund, LargeCap Stock Index Fund, Partners Aggressive Growth
Fund, Pacific Basin Fund, Partners LargeCap Growth Fund and Partners MidCap
Growth Fund

Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The European Equity Fund,
LargeCap Stock Index Fund, Pacific Basin Fund, Partners Aggressive Growth Fund,
Partners LargeCap Growth Fund and Partners MidCap Growth Fund each may not:

(1) Issue any senior securities as defined in the Investment Company Act of
1940, as amended. Purchasing and selling securities and futures contracts
and options thereon and borrowing money in accordance with restrictions
described below do not involve the issuance of a senior security.

(2) Invest in physical commodities or commodity contracts (other than foreign
currencies), but it may purchase and sell financial futures contracts,
options on such contracts, swaps and securities backed by physical
commodities.

(3) Invest in real estate, although it may invest in securities that are
secured by real estate and securities of issuers that invest or deal in
real estate.

(4) Borrow money, except that it may (a) borrow from banks (as defined in the
Investment Company Act of 1940, as amended) or other financial institutions
or through reverse repurchase agreements in amounts up to 33 1/3% of its
total assets (including the amount borrowed); (b) to the extent permitted
by applicable law, borrow up to an additional 5% of its total assets for
temporary purposes; (c) obtain short-term credits as may be necessary for
the clearance of purchases and sales of portfolio securities; and (d)
purchase securities on margin to the extent permitted by applicable law
(the deposit or payment of margin in connection with transactions in
options and financial futures contracts is not considered purchase of
securities on margin).

(5) Make loans, except that the Fund may (a) purchase and hold debt obligations
in accordance with its investment objective and policies; (b) enter into
repurchase agreements; and (c) lend its portfolio securities without
limitation against collateral (consisting of cash or securities issued or
guaranteed by the United States Government or its agencies or
instrumentalities) equal at all times to not less than 100% of the value of
the securities loaned. This limit does not apply to purchases of debt
securities or commercial paper.

(6) Invest more than 5% of its total assets in the securities of any one issuer
(other than obligations issued or guaranteed by the United States
Government or its agencies or instrumentalities) or purchase more than 10%
of the outstanding voting securities of any one issuer, except that this
limitation shall apply only with respect to 75% of the total assets of the
Fund. This restriction does not apply to the Partners LargeCap Growth Fund
as this Fund is not intended to qualify as a diversified management
investment company as defined by the Investment Company Act of 1940.

(7) Act as an underwriter of securities, except to the extent that the Fund may
be deemed to be an underwriter in connection with the sale of securities
held in its portfolio.

(8) Concentrate its investments in any particular industry, except that the
Fund may invest up to 25% of the value of its total assets in a single
industry, provided that, when the Fund has adopted a temporary defensive
posture, there shall be no limitation on the purchase of obligations issued
or guaranteed by the United States Government or its agencies or
instrumentalities. This restriction applies to the LargeCap Stock Index
Fund except to the extent that the Standard & Poor's 500 Stock Index also
is so concentrated.

(9) Sell securities short (except where the Fund holds or has the right to
obtain at no added cost a long position in the securities sold that equals
or exceeds the securities sold short).

Each of these Funds has also adopted the following restrictions that are not
fundamental policies and that may be changed without shareholder approval. It is
contrary to each Fund's present policy to:

(1) Invest more than 15% of its net assets in illiquid securities and in
repurchase agreements maturing in more than seven days except to the extent
permitted by applicable law.

(2) Pledge, mortgage or hypothecate its assets, except to secure permitted
borrowings. The deposit of underlying securities and other assets in escrow
and other collateral arrangements in connection with transactions in put or
call options, futures contracts and options on futures contracts are not
deemed to be pledges or other encumbrances.

(3) Invest in companies for the purpose of exercising control or management.

(4) Invest more than 25% (10% for the LargeCap Stock Index and Partners MidCap
Growth Funds) of its total assets in securities of foreign issuers. This
restriction does not apply to the European Equity Fund or the Pacific Basin
Fund.

(5) Enter into (a) any futures contracts and related options for non-bona fide
hedging purposes within the meaning of Commodity Futures Trading Commission
(CFTC) regulations if the aggregate initial margin and premiums required to
establish such positions will exceed 5% of the fair market value of the
Fund's net assets, after taking into account unrealized profits and
unrealized losses on any such contracts it has entered into; and (b) any
futures contracts if the aggregate amount of such Fund's commitments under
outstanding futures contracts positions would exceed the market value of
its total assets.

(6) Invest more than 5% of its total assets in real estate limited partnership
interests or real estate investment trusts. This restriction does not apply
to the Partners MidCap Growth Fund.

(7) Acquire securities of other investment companies, except as permitted by
the Investment Company Act of 1940, as amended, or any rule, order or
interpretation thereunder, or in connection with a merger, consolidation,
reorganization, acquisition of assets or an offer of exchange. The Fund may
purchase securities of closed-end investment companies in the open market
where no underwriter or dealer's commission or profit, other than a
customary broker's commission, is involved.

Balanced Fund, Blue Chip Fund, International Emerging Markets Fund,
International Fund, International SmallCap Fund, MidCap Fund, Real Estate Fund,
SmallCap Fund and Utilities Fund

Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The Balanced Fund, Blue
Chip Fund, International Fund, International Emerging Markets Fund,
International SmallCap Fund, MidCap Fund, Real Estate Fund, SmallCap Fund and
Utilities Fund each may not:

(1) Issue any senior securities as defined in the Investment Company Act of
1940. Purchasing and selling securities and futures contracts and options
thereon and borrowing money in accordance with restrictions described below
do not involve the issuance of a senior security.

(2) Purchase or retain in its portfolio securities of any issuer if those
officers or directors of the Fund or its Manager owning beneficially more
than one-half of 1% (0.5%) of the securities of the issuer together own
beneficially more than 5% of such securities.

(3) Invest in commodities or commodity contracts, but it may purchase and sell
financial futures contracts and options on such contracts.

(4) Invest in real estate, although it may invest in securities which are
secured by real estate and securities of issuers which invest or deal in
real estate.

(5) Borrow money, except for temporary or emergency purposes, in an amount not
to exceed 5% of the value of the Fund's total assets at the time of the
borrowing.

(6) Make loans, except that the Fund may (i) purchase and hold debt obligations
in accordance with its investment objective and policies, (ii) enter into
repurchase agreements, and (iii) lend its portfolio securities without
limitation against collateral (consisting of cash or securities issued or
guaranteed by the United States Government or its agencies or
instrumentalities) equal at all times to not less than 100% of the value of
the securities loaned.

(7) Invest more than 5% of its total assets in the securities of any one issuer
(other than obligations issued or guaranteed by the United States
Government or its agencies or instrumentalities) or purchase more than 10%
of the outstanding voting securities of any one issuer, except that these
limitations shall apply only with respect to 75% of the Fund's total
assets.

(8) Act as an underwriter of securities, except to the extent the Fund may be
deemed to be an underwriter in connection with the sale of securities held
in its portfolio.

(9) Concentrate its investments in any particular industry or industries,
except that
(a) the Utilities Fund may not invest less than 25% of its total assets in
securities of companies in the public utilities industry,

(b) the Balanced Fund, Blue Chip Fund, International Emerging Markets Fund,
International Fund, International SmallCap Fund, MidCap Fund and
SmallCap Fund each may invest not more than 25% of the value of its
total assets in a single industry, and
(c) the Real Estate Fund may not invest less than 25% of its total assets
in securities of companies in the real estate industry.

(10) Sell securities short (except where the Fund holds or has the right to
obtain at no added cost a long position in the securities sold that equals
or exceeds the securities sold short) or purchase any securities on margin,
except it may obtain such short-term credits as are necessary for the
clearance of transactions. The deposit or payment of margin in connection
with transactions in options and financial futures contracts is not
considered the purchase of securities on margin.

(11) Invest in interests in oil, gas or other mineral exploration or development
programs, although the Fund may invest in securities of issuers which
invest in or sponsor such programs.

Each of these Funds has also adopted the following restrictions which are not
fundamental policies and may be changed without shareholder approval. It is
contrary to each Fund's present policy to:

(1) Invest more than 15% of its total assets in securities not readily
marketable and in repurchase agreements maturing in more than seven days.
The value of any options purchased in the Over-the-Counter market are
included as part of this 15% limitation.

(2) Purchase warrants in excess of 5% of its total assets, of which 2% may be
invested in warrants that are not listed on the New York or American Stock
Exchange. The 2% limitation for the International Fund also includes
warrants not listed on the Toronto Stock Exchange. The 2% limitation for
the International Emerging Markets Fund and International SmallCap Fund
also includes warrants not listed on the Toronto Stock Exchange and the
Chicago Board Options Exchange.

(3) Purchase securities of any issuer having less than three years' continuous
operation (including operations of any predecessors) if such purchase would
cause the value of the Fund's investments in all such issuers to exceed 5%
of the value of its total assets.

(4) Pledge, mortgage or hypothecate its assets, except to secure permitted
borrowings. The deposit of underlying securities and other assets in escrow
and other collateral arrangements in connection with transactions in put
and call options, futures contracts and options on futures contracts are
not deemed to be pledges or other encumbrances.

(5) Invest in companies for the purpose of exercising control or management.

(6) Invest more than 5% of its total assets in the purchase of covered spread
options and the purchase of put and call options on securities, securities
indices and financial futures contracts. Options on financial futures
contracts and options on securities indices will be used solely for hedging
purposes; not for speculation.

(7) Invest more than 5% of its assets in initial margin and premiums on
financial futures contracts and options on such contracts.

(8) Invest in arbitrage transactions.

(9) Invest in real estate limited partnership interests except that this
restriction shall not apply to the Real Estate Fund.

(10) Invest in mineral leases.

The Balanced Fund, Blue Chip Fund, MidCap Fund, SmallCap Fund and Utilities Fund
have also adopted a restriction, which is not a fundamental policy and may be
changed without shareholder approval, that each such Fund may not invest more
than 20% of its total assets in securities of foreign issuers.

The Real Estate Fund has adopted a restriction, which is not a fundamental
policy and may be changed without shareholder approval, that the Fund may not
invest more than 25% of its total assets in securities of foreign issuers.

The Balanced Fund, Blue Chip Fund, International Emerging Markets Fund,
International Fund, International SmallCap Fund, MidCap Fund, SmallCap Fund and
Utilities Fund have also adopted a restriction, which is not a fundamental
policy and may be changed without shareholder approval, that each Fund may not
invest more than 10% of its assets in securities of other investment companies,
invest more than 5% of its total assets in the securities of any one investment
company or acquire more than 3% of the outstanding voting securities of any one
investment company except in connection with a merger, consolidation or plan of
reorganization and the Funds may purchase securities of closed-end companies in
the open market where no underwriter or dealer's commission or profit, other
than a customary broker's commission, is involved.

The Utilities Fund has also adopted a restriction, which is not a fundamental
policy and may be changed without shareholder approval, that the Fund may not
own more than 5% of the outstanding voting securities of more than one public
utility company as defined by the Public Utility Holding Company Act of 1935.

Capital Value Fund and Growth Fund

Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The Capital Value Fund and
Growth Fund each may not:

(1) Concentrate its investments in any one industry. No more than 25% of the
value of its total assets will be invested in any one industry.

(2) Invest more than 5% of its total assets in the securities of any one issuer
(other than obligations issued or guaranteed by the United States
Government or its agencies or instrumentalities) or purchase more than 10%
of the outstanding voting securities of any one issuer, except that these
limitations shall apply only with respect to 75% of the Fund's total
assets.

(3) Underwrite securities of other issuers, except that the Fund may acquire
portfolio securities under circumstances where if sold the Fund might be
deemed an underwriter for purposes of the Securities Act of 1933.

(4) Purchase securities of any company with a record of less than three years'
continuous operation (including that of predecessors) if the purchase would
cause the value of the Fund's aggregate investments in all such companies
to exceed 5% of the Fund's total assets.

(5) Engage in the purchase and sale of illiquid interests in real estate. For
this purpose, readily marketable interests in real estate investment trusts
are not interests in real estate.

(6) Invest in commodities or commodity contracts, but it may purchase and sell
financial futures contracts and options on such contracts.

(7) Purchase or retain in its portfolio securities of any issuer if those
officers and directors of the Fund or its Manager owning beneficially more
than one-half of one percent (0.5%) of the securities of the issuer
together own beneficially more than 5% of such securities.

(8) Purchase securities on margin, except it may obtain such short-term credits
as are necessary for the clearance of transactions. The Fund may not sell
securities short (except where the Fund holds or has the right to obtain at
no added cost a long position in the securities sold that equals or exceeds
the securities sold short). The deposit or payment of margin in connection
with transactions in options and financial futures contracts is not
considered the purchase of securities on margin. The Fund will not issue or
acquire put and call options.

(9) Invest more than 5% of its assets at the time of purchase in rights and
warrants (other than those that have been acquired in units or attached to
other securities).

(10) Invest more than 20% of its total assets in securities of foreign issuers.

In addition:

(11) The Fund may not make loans, except that the Fund may (i) purchase and hold
debt obligations in accordance with its investment objective and policies,
(ii) enter into repurchase agreements, and (iii) lend its portfolio
securities without limitation against collateral (consisting of cash or
securities issued or guaranteed by the United States Government or its
agencies or instrumentalities) equal at all times to not less than 100% of
the value of the securities loaned.

(12) The Fund does not propose to borrow money except for temporary or emergency
purposes from banks in an amount not to exceed the lesser of (i) 5% of the
value of the Fund's assets, less liabilities other than such borrowings, or
(ii) 10% of the Fund's assets taken at cost at the time such borrowing is
made. The Fund may not pledge, mortgage, or hypothecate its assets (at
value) to an extent greater than 15% of the gross assets taken at cost. The
deposit of underlying securities and other assets in escrow and other
collateral arrangements in connection with transactions in put and call
options, futures contracts and options on futures contracts are not deemed
to be pledges or other encumbrances.

Each of these Funds has also adopted the following restrictions which are not
fundamental policies and may be changed without shareholder approval, each Fund
may not:

(1) Invest in companies for the purpose of exercising control or management.

(2) Purchase warrants in excess of 5% of its total assets, of which 2% may be
invested in warrants that are not listed on the New York or American Stock
Exchange.

(3) Invest more than 15% of its total assets in securities not readily
marketable and in repurchase agreements maturing in more than seven days.

(4) Invest in real estate limited partnership interests.

(5) Invest in interests in oil, gas, or other mineral exploration or
development programs, but the Fund may purchase and sell securities of
companies which invest or deal in such interests.

(6) Invest more than 10% of its assets in securities of other investment
companies, invest more than 5% of its total assets in the securities of any
one investment company, or acquire more than 3% of the outstanding voting
securities of any one investment company except in connect with a merger,
consolidation or plan of reorganization.

(7) Invest more than 5% of its total assets in the purchase of covered spread
options and the purchase of put and call options on securities, securities
indices and financial futures contracts. Options on financial futures
contracts and options on securities indices will be used solely for hedging
purposes, not for speculation.

(8) Invest more than 5% of its assets in initial margin and premiums on
financial futures contracts and options on such contracts.

INCOME-ORIENTED FUNDS

Investment Objectives

Principal Bond Fund, Inc. ("Bond Fund") seeks to provide as high a level of
income as is consistent with preservation of capital and prudent investment
risk.

Principal Government Securities Income Fund, Inc. ("Government Securities Income
Fund") seeks a high level of current income, liquidity and safety of principal
by purchasing obligations issued or guaranteed by the United States Government
or its agencies, with emphasis on Government National Mortgage Association
Certificates ("GNMA Certificates"). The guarantee by the United States
Government extends only to principal and interest. There are certain risks
unique to GNMA Certificates.

Principal High Yield Fund, Inc. ("High Yield Fund") seeks high current income
primarily by purchasing high yielding, lower or non-rated fixed income
securities which are believed to not involve undue risk to income or principal.
Capital growth is a secondary objective when consistent with the objective of
high current income.

Principal Limited Term Bond Fund, Inc. ("Limited Term Bond Fund") seeks a high
level of current income consistent with a relatively high level of principal
stability by investing in a portfolio of securities with a dollar weighted
average maturity of five years or less.

Principal Tax-Exempt Bond Fund, Inc. ("Tax-Exempt Bond Fund") seeks as high a
level of current income exempt from federal income tax as is consistent with
preservation of capital. The Fund seeks to achieve its objective primarily
through the purchase of investment grade quality, tax-exempt fixed income
obligations.

Investment Restrictions

Bond Fund, High Yield Fund and Limited Term Bond Fund

Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The Bond Fund, High Yield
Fund and Limited Term Bond Fund each may not:

(2) Purchase or retain in its portfolio securities of any issuer if those
officers or directors of the fund or its Manager owning beneficially more
than one-half of 1% (0.5%) of the securities of the issuer together own
beneficially more than 5% of such securities.

(3) Invest in commodities or commodity contracts, but it may purchase and sell
financial futures contracts and options on such contracts.

(4) Invest in real estate, although it may invest in securities which are
secured by real estate and securities of issuers which invest or deal in
real estate.

(5) Borrow money, except for temporary or emergency purposes, in an amount not
to exceed 5% of the value of the Fund's total assets at the time of the
borrowing.

(8) Act as an underwriter of securities, except to the extent the Fund may be
deemed to be an underwriter in connection with the sale of securities held
in its portfolio.

(9) Concentrate its investments in any particular industry or industries,
except that the Fund may invest not more than 25% of the value of its total
assets in a single industry.

(11) Invest in interests in oil, gas or other mineral exploration or development
programs, although the Fund may invest in securities of issuers which
invest in or sponsor such programs.

Each of these Funds has also adopted the following restrictions which are not
fundamental policies and may be changed without shareholder approval. It is
contrary to each Fund's present policy to:

(2) Purchase warrants in excess of 5% of its total assets, of which 2% may be
invested in warrants that are not listed on the New York or American Stock
Exchange.

(4) Purchase securities of other investment companies except in connection with
a merger, consolidation, or plan of reorganization or by purchase in the
open market of securities of closed-end companies where no underwriter or
dealer's commission or profit, other than a customary broker's commission,
is involved, and if immediately thereafter not more than 10% of the value
of the Fund's total assets would be invested in such securities.

(5) Pledge, mortgage or hypothecate its assets, except to secure permitted
borrowings. The deposit of underlying securities and other assets in escrow
and other collateral arrangements in connection with transactions in put
and call options, futures contracts and options on futures contracts are
not deemed to be pledges or other encumbrances.

(6) Invest in companies for the purpose of exercising control or management.

(7) Invest more than 20% of its total assets in securities of foreign issuers.

(8) Invest more than 5% of its total assets in the purchase of covered spread
options and the purchase of put and call options on securities, securities
indices and financial futures contracts. Options on financial futures
contracts and options on securities indices will be used solely for hedging
purposes; not for speculation.

(9) Invest more than 5% of its assets in initial margin and premiums on
financial futures contracts and options on such contracts.

(10) Invest in arbitrage transactions.

(11) Invest in real estate limited partnership interests.

Government Securities Income Fund

Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The Government Securities
Income Fund may not:

(1) Issue any senior securities.

(2) Purchase any securities other than obligations issued or guaranteed by the
United States Government or its agencies or instrumentalities, except that
the Fund may maintain reasonable amounts in cash or commercial paper or
purchase short-term debt securities not issued or guaranteed by the United
States Government or its agencies or instrumentalities for daily cash
management purposes or pending selection of particular long-term
investments. There is no limit on the amount of its assets which may be
invested in the securities of any one issuer of obligations issued by the
United States Government or its agencies or instrumentalities.

(3) Act as an underwriter of securities, except to the extent the Fund may be
deemed to be an underwriter in connection with the sale of GNMA
certificates held in its portfolio.

(4) Engage in the purchase and sale of interests in real estate, including
interests in real estate investment trusts (although it will invest in
securities secured by real estate or interests therein, such as
mortgage-backed securities) or invest in commodities or commodity
contracts, oil and gas interests, or mineral exploration or development
programs.

(5) Purchase or retain in its portfolio securities of any issuer if those
officers and directors of the Fund or its Manager owning beneficially more
than one-half of 1% (0.5%) of the securities of the issuer together own
beneficially more than 5% of such securities.

(6) Sell securities short or purchase any securities on margin, except it may
obtain such short-term credits as are necessary for the clearance of
transactions. The deposit or payment of margin in connection with
transactions in options and financial futures contracts is not considered
the purchase of securities on margin.

(7) Invest in companies for the purpose of exercising control or management.

(8) Make loans, except that the Fund may purchase or hold debt obligations in
accordance with the investment restrictions set forth in paragraph (2) and
may enter into repurchase agreements for such securities, and may lend its
portfolio securities without limitation against collateral consisting of
cash, or securities issued or guaranteed by the United States Government or
its agencies or instrumentalities, which is equal at all times to 100% of
the value of the securities loaned.

(9) Borrow money, except for temporary or emergency purposes, in an amount not
to exceed 5% of the value of the Fund's total assets.

(10) Enter into repurchase agreements maturing in more than seven days if, as a
result, thereof, more than 10% of the Fund's total assets would be invested
in such repurchase agreements and other assets without readily available
market quotations.

(11) Invest more than 5% of its total assets in the purchase of covered spread
options and the purchase of put and call options on securities, securities
indices and financial futures contracts.

(12) Invest more than 5% of its assets in initial margin and premiums on
financial futures contracts and options on such contracts.

The Fund has also adopted the following restrictions which are not fundamental
policies and may be changed without shareholder approval. It is contrary to the
Fund's current policy to:

(2) Pledge, mortgage or hypothecate its assets, except to secure permitted
borrowings. The deposit of underlying securities and other assets in escrow
and other collateral arrangements in connection with transactions in put
and call options, futures contracts and options on futures contracts are
not deemed to be pledges or other encumbrances.

(3) Invest in real estate limited partnership interests.

(4) Invest more than 10% of its assets in securities of other investment
companies, invest more than 5% of its total assets in the securities of any
one investment company, or acquire more than 3% of the outstanding voting
securities of any one investment company except in connection with a
merger, consolidation or plan of reorganization.

Tax-Exempt Bond Fund

Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The Tax-Exempt Bond Fund
may not:

(1) Issue any senior securities as defined in the Act except insofar as the
Fund may be deemed to have issued a senior security by reason of: (a)
purchasing any securities on a when-issued or delayed delivery basis; or
(b) borrowing money in accordance with restrictions described below.

(2) Purchase any securities other than Municipal Obligations and Taxable
Investments as defined in the Prospectus and Statement of Additional
Information.

(3) Act as an underwriter of securities, except to the extent the Fund may be
deemed to be an underwriter in connection with the sale of securities held
in its portfolio.

(5) Purchase or retain in its portfolio securities of any issuer if those
officers and directors of the Fund or its Manager owning more than one-half
of 1% (0.5%) of the securities of the issuer together own beneficially more
than 5% of such securities.

(6) Invest in companies for the purpose of exercising control or management.

(7) Invest more than:
(a) Invest more than 5% of its total assets in the securities of any one
issuer (other than obligations issued or guaranteed by the United
States Government or its agencies or instrumentalities) or purchase
more than 10% of the outstanding voting securities of any one issuer,
except that these limitations shall apply only with respect to 75% of
the Fund's total assets.
(b) 15% of its total assets in securities that are not readily marketable
and in repurchase agreements maturing in more than seven days.

(8) Invest in real estate, although it may invest in securities which are
secured by real estate and securities of issuers which invest or deal in
real estate.

(9) Invest in commodities or commodity futures contracts.

(10) Write, purchase or sell puts, calls or combinations thereof.

(11) Invest in interests in oil, gas or other mineral exploration or development
programs, although it may invest in securities of issuers which invest in
or sponsor such programs.

(12) Make short sales of securities.

(13) Purchase any securities on margin, except it may obtain such short-term
credits as are necessary for the clearance of transactions.

(14) Make loans, except that the Fund may purchase and hold debt obligations in
accordance with its investment objective and policies, enter into
repurchase agreements, and may lend its portfolio securities without
limitation against collateral, consisting of cash or securities issued or
guaranteed by the United States Government or its agencies or
instrumentalities, which is equal at all times to 100% of the value of the
securities loaned.

(15) Borrow money, except for temporary or emergency purposes from banks in an
amount not to exceed 5% of the value of the Fund's total assets at the time
the loan is made.

(16) Pledge, mortgage or hypothecate its assets, except to secure permitted
borrowings.

The Fund has also adopted the following restriction which is not fundamental and
may be changed without shareholder approval. It is contrary to the Fund's
current policy to invest in real estate limited partnership interests.

The identification of the issuer of a Municipal Obligation depends on the terms
and conditions of the security. When the assets and revenues of an agency,
authority, instrumentality or other political subdivision are separate from
those of the government creating the subdivision and the security is backed only
by the assets and revenues of the subdivision, the subdivision is deemed the
sole issuer. Similarly, in the case of an industrial development bond, if that
bond is backed only by the assets and revenues of the non-governmental user,
then such non-governmental user is deemed the sole issuer. If, in either case,
the creating government or some other entity guarantees a security, the
guarantee is considered a separate security and is treated as an issue of such
government or other entity. However, that guarantee is not deemed a security
issued by the guarantor if the value of all securities issued or guaranteed by
the guarantor and owned by the Fund does not exceed 10% of the value of the
Fund's total assets.

The Fund may invest without limit in debt obligations of issuers located in the
same state and in debt obligations which are repayable out of revenue sources
generated from economically related projects or facilities. Sizable investments
in such obligations could increase the risk to the Fund since an economic,
business or political development or change affecting one security could also
affect others. The Fund may also invest without limit in industrial development
bonds, but it will not invest more than 20% of its total assets in any Municipal
Obligation the interest on which is treated as a tax preference item for
purposes of the federal alternative minimum tax.

MONEY MARKET FUND

Investment Objectives

Principal Cash Management Fund, Inc. ("Cash Management Fund") seeks as high a
level of income available from short-term securities as is considered consistent
with preservation of principal and maintenance of liquidity by investing in a
portfolio of money market instruments.

Investment Restrictions

Cash Management Fund

Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The Cash Management Fund
may not:

(1) Concentrate its investments in any one industry. No more than 25% of the
value of its total assets will be invested in securities of issuers having
their principal activities in any one industry, other than securities
issued or guaranteed by the U.S. Government or its agencies or
instrumentalities, or obligations of domestic branches of U.S. banks and
savings institutions. (See "Bank Obligations").

(2) Purchase the securities of any issuer if the purchase will cause more than
5% of the value of its total assets to be invested in the securities of any
one issuer (except securities issued or guaranteed by the U.S. Government,
its agencies or instrumentalities).

(3) Purchase the securities of any issuer if the purchase will cause more than
10% of the outstanding voting securities of the issuer to be held by the
Fund (other than securities issued or guaranteed by the U.S. Government,
its agencies or instrumentalities).

(4) Act as an underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an underwriter
under the federal securities laws.

(5) Purchase securities of any company with a record of less than 3 years
continuous operation (including that of predecessors) if the purchase would
cause the value of the Fund's aggregate investments in all such companies
to exceed 5% of the value of the Fund's total assets.

(6) Engage in the purchase and sale of illiquid interests in real estate,
including interests in real estate investment trusts (although it may
invest in securities secured by real estate or interests therein) or invest
in commodities or commodity contracts, oil and gas interests, or mineral
exploration or development programs.

(7) Purchase securities of other investment companies except in connection with
a merger, consolidation, or plan of reorganization.

(8) Purchase or retain in its portfolio securities of any issuer if those
officers and directors of the Fund or its Manager owning beneficially more
than one-half of 1% (0.5%) of the securities of the issuer together own
beneficially more than 5% of such securities.

(9) Purchase securities on margin, except it may obtain such short-term credits
as are necessary for the clearance of transactions. The Fund will not
effect a short sale of any security. The Fund will not issue or acquire put
and call options, straddles or spreads or any combination thereof.

(10) Invest in companies for the purpose of exercising control or management.

(12) Borrow money except from banks for temporary or emergency purposes,
including the meeting of redemption requests which might otherwise require
the untimely disposition of securities, in an amount not to exceed the
lesser of (i) 5% of the value of the Fund's assets, or (ii) 10% of the
value of the Fund's net assets taken at cost at the time such borrowing is
made. The Fund will not issue senior securities except in connection with
such borrowings. The Fund may not pledge, mortgage, or hypothecate its
assets (at value) to an extent greater than 10% of the net assets.

(13) Invest in time deposits maturing in more than seven days; time deposits
maturing from two business days through seven calendar days may not exceed
10% of the value of the Fund's total assets.

(14) Invest more than 10% of its total assets in securities not readily
marketable and in repurchase agreements maturing in more than seven days.

The Fund has also adopted the following restriction which is not fundamental and
may be changed without shareholder approval. It is contrary to the Fund's
current policy to:

(1) Invest in real estate limited partnership interests.

FUNDS' INVESTMENTS

The following information supplements the discussion of the Funds' investment
objectives and policies in the Prospectuses under the caption "CERTAIN
INVESTMENT STRATEGIES AND RELATED RISKS."

Selections of equity securities for the Funds (except the European Equity Fund,
LargeCap Stock Index, Pacific Basin Fund, Partners Aggressive Growth, Partners
LargeCap Growth and Partners MidCap Growth Funds) are made based on an approach
described broadly as "company-by-company" fundamental analysis. Three basic
steps are involved in this analysis.

o First is the continuing study of basic economic factors in an effort to
conclude what the future general economic climate is likely to be over the
next one to two years.
o Second, given some conviction as to the likely economic climate, the
Manager or Sub-Advisor attempts to identify the prospects for the major
industrial, commercial and financial segments of the economy. By looking at
such factors as demand for products, capacity to produce, operating costs,
pricing structure, marketing techniques, adequacy of raw materials and
components, domestic and foreign competition, and research productivity,
the Manager or Sub-Advisor evaluates the prospects for each industry for
the near and intermediate term.
o Finally, determinations are made regarding earnings prospects for
individual companies within each industry by considering the same types of
factors described above. These earnings prospects are evaluated in relation
to the current price of the securities of each company.

In selecting securities for the Partners Aggressive Growth Fund and the Partners
LargeCap Growth Fund, the Sub-Advisors, Morgan Stanley Asset Management ("Morgan
Stanley") and Duncan-Hurst Capital Management Inc. ("Duncan-Hurst"),
respectively, follow a flexible investment program in looking for companies with
above average capital appreciation potential. The Sub-Advisor focuses on
companies with consistent or rising earnings growth records and compelling
business strategies. The Sub-Advisor continually and rigorously studies company
developments, including business strategy, management focus and financial
results, to identify companies with earnings growth and business momentum. In
addition, the Sub-Advisor closely monitors analysts' expectations to identify
issuers that have the potential for positive earnings surprises versus consensus
expectations. In its selection of securities for the Partners Aggressive Growth
Fund, Morgan Stanley considers valuation to be of secondary importance and
viewed in the context of prospects for sustainable earnings growth and the
potential for positive earnings surprises in relation to consensus expectations.

The Sub-Advisor for the Partners MidCap Growth Fund, Turner Investment Partners,
Inc. ("Turner"), selects securities that it believes to have strong earnings
growth potential. Turner seeks to purchase securities that are well diversified
across economic sectors and to maintain sector concentrations that approximate
the economic sector weightings comprising the Russell Midcap Growth Index (or
such other appropriate index selected by Turner). Any remaining assets may be
invested in securities issued by smaller capitalization companies and larger
capitalization companies, warrants and rights to purchase common stocks, and it
may invest to 10% of its total assets in ADRs. Turner will only purchase
securities that are traded on registered exchanges or the over-the-counter
market in the United States.

The Sub-Advisor for the LargeCap Stock Index Fund, Invista Capital Management,
LLC ("Invista"), allocates Fund assets in approximately the same weightings as
the S&P 500. Invista may omit or remove any S&P 500 stocks from the Fund if it
determines that the stock is not sufficiently liquid. In addition, Invista may
exclude or remove a stock from the Fund if extraordinary events or financial
conditions lead it to believe that such stock should not be a part of the Fund's
assets. Fund assets may be invested in futures and options.

The Sub-Advisor, BT Funds Management (International) Limited ("BT"), of the
Pacific Basin and European Equity Funds, uses a disciplined active investment
process which is the core of how BT's assets under management grew from US$625
million in 1980 to approximately US$25 billion at the turn of the century.

The cornerstone of this process is the belief that investment markets are not
always efficient and that investment outperformance can be achieved with
superior research and analysis. BT's proprietary research process allows fund
managers and analysts to identify quality investment opportunities before they
are widely recognized by the market, investments which will potentially add
value to portfolios, creating wealth for clients.

It is truly a global approach, developed over time to recognize the
international interdependence of markets and utilize, under one roof, the
collective knowledge of the 100-strong investment team. Investment specialists
manage all asset classes, blending bottom-up and top-down approaches to
portfolio construction along with fully integrated risk management. These
professionals are consistently recognized in local and international surveys for
the quality of their investment research and investment product.

Restricted Securities

Each of the Funds has adopted investment restrictions that limit its investments
in restricted securities or other illiquid securities to 15% (10% for the
Government Securities Income Fund and the Money Market Fund) of its net assets.
The Board of Directors of each of the Growth-Oriented and Income-Oriented Funds
has adopted procedures to determine the liquidity of Rule 4(2) short-term paper
and of restricted securities under Rule 144A. Securities determined to be liquid
under these procedures are excluded from the preceding investment restriction.

Generally, restricted securities are not readily marketable because they are
subject to legal or contractual restrictions upon resale. They are sold only in
a public offering with an effective registration statement or in a transaction
which is exempt from the registration requirements of the Securities Act of
1933. When registration is required, a Fund may be obligated to pay all or part
of the registration expenses and a considerable period may elapse between the
time of the decision to sell and the time the Fund may be permitted to sell a
security. If, during such a period, adverse market conditions were to develop,
the Fund might obtain a less favorable price than existed when it decided to
sell. Restricted securities and other securities not readily marketable are
priced at fair value as determined in good faith by or under the direction of
the Board of Directors.

Foreign Securities

Each of the following Funds may invest in foreign securities to the indicated
percentage of its assets:
o European Equity, International, International Emerging Markets,
International SmallCap and Pacific Basin Funds - 100%;
o Partners Aggressive Growth, Partners LargeCap Growth and Real Estate Funds
- 25%;
o Balanced, Blue Chip, Bond, Capital Value, Growth, High Yield, Limited Term
Bond, MidCap, SmallCap and Utilities Funds - 20%;
o LargeCap Stock Index and Partners MidCap Growth Funds - 10%.

Foreign companies may not be subject to the same uniform accounting, auditing
and financial reporting practices as are required of U.S. companies. In
addition, there may be less publicly available information about a foreign
company than about a U.S. company. Securities of many foreign companies are less
liquid and more volatile than securities of comparable U.S. companies.
Commissions on foreign securities exchanges may be generally higher than those
on U.S. exchanges, although each Fund seeks the most favorable net results on
its portfolio transactions.

Foreign markets also have different clearance and settlement procedures than
those in U.S. markets. In certain markets there have been times when settlements
have been unable to keep pace with the volume of securities transactions, making
it difficult to conduct these transactions. Delays in settlement could result in
temporary periods when a portion of Fund assets are not invested and are earning
no return. If a Fund is unable to make intended security purchases due to
settlement problems, the Fund may miss attractive investment opportunities. In
addition, a Fund may incur a loss as a result of a decline in the value of its
portfolio if it is unable to sell a security.

With respect to certain foreign countries, there is the possibility of
expropriation or confiscatory taxation, political or social instability, or
diplomatic developments that could affect a Fund's investments in those
countries. In addition, a Fund may also suffer losses due to nationalization,
expropriation or differing accounting practices and treatments. Investments in
foreign securities are subject to laws of the foreign country that may limit the
amount and types of foreign investments. Changes of governments or of economic
or monetary policies, in the U.S. or abroad, changes in dealings between
nations, currency convertibility or exchange rates could result in investment
losses for a Fund. Finally, even though certain currencies may be convertible
into U.S. dollars, the conversion rates may be artificial relative to the actual
market values and may be unfavorable to fund investors.

Foreign securities are often traded with less frequency and volume, and
therefore may have greater price volatility, than is the case with many U.S.
securities. Brokerage commissions, custodial services, and other costs relating
to investment in foreign countries are generally more expensive than in the U.S.
Though the Funds intend to acquire the securities of foreign issuers where there
are public trading markets, economic or political turmoil in a country in which
a Fund has a significant portion of its assets or deterioration of the
relationship between the U.S. and a foreign country may negatively impact the
liquidity of a Fund's portfolio. The Fund may have difficulty meeting a large
number of redemption requests. Furthermore, there may be difficulties in
obtaining or enforcing judgments against foreign issuers.

Investments in companies of developing countries may be subject to higher risks
than investments in companies in more developed countries. These risks include
o increased social, political and economic instability;
o a smaller market for these securities and low or nonexistent volume of
trading that results in a lack of liquidity and in greater price
volatility;
o lack of publicly available information, including reports of payments of
dividends or interest on outstanding securities;
o foreign government policies that may restrict opportunities, including
restrictions on investment in issuers or industries deemed sensitive to
national interests;
o relatively new capital market structure or market-oriented economy;
o the possibility that recent favorable economic developments may be slowed
or reversed by unanticipated political or social events in these countries;
o restrictions that may make it difficult or impossible for the fund to vote
proxies, exercise shareholder rights, pursue legal remedies, and obtain
judgments in foreign courts; and
o possible losses through the holding of securities in domestic and foreign
custodial banks and depositories.

In addition, many developing countries have experienced substantial, and in some
periods, extremely high rates of inflation for many years. Inflation and rapid
fluctuations in inflation rates have had and may continue to have negative
effects on the economies and securities markets of those countries.

Repatriation of investment income, capital and proceeds of sales by foreign
investors may require governmental registration and/or approval in some
developing countries. A Fund could be adversely affected by delays in or a
refusal to grant any required governmental registration or approval for
repatriation.

Further, the economies of developing countries generally are heavily dependent
upon international trade and, accordingly, have been and may continue to be
adversely affected by trade barriers, exchange controls, managed adjustments in
relative currency values and other protectionist measures imposed or negotiated
by the countries with which they trade.

Depositary Receipts

Depositary Receipts are generally subject to the same sort of risks as direct
investments in a foreign country, such as, currency risk, political and economic
risk, and market risk, because their values depend on the performance of a
foreign security denominated in its home currency.

The International Growth Funds may invest in:
o American Depositary Receipts ("ADRs") which are:
o receipts issued by an American bank or trust company evidencing
ownership of underlying securities issued by a foreign issuer; and
o designed for use in U.S. securities markets.
o European Depositary Receipts ("EDRs") which are
o receipts issued by a European financial institution evidencing an
arrangement similar to that of ADRs; and
o designed for use in European securities markets.
o Global Depositary Receipts ("GDRs") are securities convertible into equity
securities of foreign issuers.

Securities of Smaller Companies

The Funds may invest in securities of companies with small- or mid-sized market
capitalizations. Market capitalization is defined as total current market value
of a company's outstanding common stock. Investments in companies with smaller
market capitalizations may involve greater risks and price volatility (wide,
rapid fluctuations) than investments in larger, more mature companies. Smaller
companies may be less mature than older companies. At this earlier stage of
development, the companies may have limited product lines, reduced market
liquidity for their shares, limited financial resources or less depth in
management than larger or more established companies. Small companies also may
be less significant factors within their industries and may be at a competitive
disadvantage relative to their larger competitors. While smaller companies may
be subject to these additional risks, they may also realize more substantial
growth than larger or more established companies.

Unseasoned Issuers

The Funds may invest in the securities of unseasoned issuers. Unseasoned issuers
are companies with a record of less than three years continuous operation,
including the operation of predecessors and parents. Unseasoned issuers by their
nature have only a limited operating history which can be used for evaluating
the companies' growth prospects. As a result, investment decisions for these
securities may place a greater emphasis on current or planned product lines and
the reputation and experience of the companies management and less emphasis on
fundamental valuation factors than would be the case for more mature growth
companies. In addition, many unseasoned issuers also may be small companies and
involve the risks and price volatility associated with smaller companies.

Spread Transactions, Options on Securities and Securities Indices, and Futures
Contracts and Options on Futures Contracts

The Funds (except Cash Management) may each engage in the practices described
under this heading. The Tax-Exempt Bond Fund may invest in financial futures
contracts as described under this heading. In the following discussion, the
terms "the Fund," "each Fund" or "the Funds" refer to each of these Funds.

Spread Transactions

Each Fund may purchase covered spread options. Such covered spread options
are not presently exchange listed or traded. The purchase of a spread
option gives the Fund the right to put, or sell, a security that it owns at
a fixed dollar spread or fixed yield spread in relationship to another
security that the Fund does not own, but which is used as a benchmark. The
risk to the Fund in purchasing covered spread options is the cost of the
premium paid for the spread option and any transaction costs. In addition,
there is no assurance that closing transactions will be available. The
purchase of spread options can be used to protect each Fund against adverse
changes in prevailing credit quality spreads, i.e., the yield spread
between high quality and lower quality securities. The security covering
the spread option is maintained in a segregated account by each Fund's
custodian. The Funds do not consider a security covered by a spread option
to be "pledged" as that term is used in the Funds' policy limiting the
pledging or mortgaging of assets.

Options on Securities and Securities Indices

Each Fund may write (sell) and purchase call and put options on securities
in which it invests and on securities indices based on securities in which
the Fund invests. The International Fund would only write covered call
options on its portfolio securities; it does not write or purchase put
options. The Funds may write call and put options to generate additional
revenue, and may write and purchase call and put options in seeking to
hedge against a decline in the value of securities owned or an increase in
the price of securities which the Fund plans to purchase.

Writing Covered Call and Put Options. When a Fund writes a call option, it
gives the purchaser of the option the right to buy a specific security at a
specified price at any time before the option expires. When a Fund writes a
put option, it gives the purchaser of the option the right to sell to the
Fund a specific security at a specified price at any time before the option
expires. In both situations, the Fund receives a premium from the purchaser
of the option.

The premium received by a Fund reflects, among other factors, the current
market price of the underlying security, the relationship of the exercise
price to the market price, the time period until the expiration of the
option and interest rates. The premium generates additional income for the
Fund if the option expires unexercised or is closed out at a profit. By
writing a call, a Fund limits its opportunity to profit from any increase
in the market value of the underlying security above the exercise price of
the option, but it retains the risk of loss if the price of the security
should decline. By writing a put, a Fund assumes the risk that it may have
to purchase the underlying security at a price that may be higher than its
market value at time of exercise.

The Funds write only covered options and comply with applicable regulatory
and exchange cover requirements. The Funds usually (and the International
Fund must) own the underlying security covered by any outstanding call
option. With respect to an outstanding put option, each Fund deposits and
maintains with its custodian cash or other liquid assets with a value at
least equal to the exercise price of the option.

Once a Fund has written an option, it may terminate its obligation before
the option is exercised. The Fund executes a closing transaction by
purchasing an option of the same series as the option previously written.
The Fund has a gain or loss depending on whether the premium received when
the option was written exceeds the closing purchase price plus related
transaction costs.

Purchasing Call and Put Options. When a Fund purchases a call option, it
receives, in return for the premium it pays, the right to buy from the
writer of the option the underlying security at a specified price at any
time before the option expires. A Fund purchases call options in
anticipation of an increase in the market value of securities that it
intends ultimately to buy. During the life of the call option, the Fund is
able to buy the underlying security at the exercise price regardless of any
increase in the market price of the underlying security. In order for a
call option to result in a gain, the market price of the underlying
security must exceed the sum of the exercise price, the premium paid and
transaction costs.

When a Fund purchases a put option, it receives, in return for the premium
it pays, the right to sell to the writer of the option the underlying
security at a specified price at any time before the option expires. A Fund
purchases put options in anticipation of a decline in the market value of
the underlying security. During the life of the put option, the Fund is
able to sell the underlying security at the exercise price regardless of
any decline in the market price of the underlying security. In order for a
put option to result in a gain, the market price of the underlying security
must decline, during the option period, below the exercise price enough to
cover the premium and transaction costs.

Once a Fund purchases an option, it may close out its position by selling
an option of the same series as the option previously purchased. The Fund
has a gain or loss depending on whether the closing sale price exceeds the
initial purchase price plus related transaction costs.

None of the Funds will invest more than 5% of its assets in the purchase of
call and put options on individual securities, securities indices and
financial futures contracts.

Options on Securities Indices. Each Fund may purchase and sell put and call
options on any securities index based on securities in which the Fund may
invest. Securities index options are designed to reflect price fluctuations
in a group of securities or segment of the securities market rather than
price fluctuations in a single security. Options on securities indices are
similar to options on securities, except that the exercise of securities
index options requires cash payments and does not involve the actual
purchase or sale of securities. The Funds engage in transactions in put and
call options on securities indices for the same purposes as they engage in
transactions in options on securities. When a Fund writes call options on
securities indices, it holds in its portfolio underlying securities which,
in the judgment of the Manager or Sub-Advisor, correlate closely with the
securities index and which have a value at least equal to the aggregate
amount of the securities index options.

Risks Associated with Options Transactions. An options position may be
closed out only on an exchange which provides a secondary market for an
option of the same series. The Funds generally purchase or write only those
options for which there appears to be an active secondary market. However,
there is no assurance that a liquid secondary market on an exchange exists
for any particular option, or at any particular time. If a Fund is unable
to effect closing sale transactions in options it has purchased, it has to
exercise its options in order to realize any profit and may incur
transaction costs upon the purchase or sale of underlying securities. If a
Fund is unable to effect a closing purchase transaction for a covered
option that it has written, it is not able to sell the underlying
securities, or dispose of the assets held in a segregated account, until
the option expires or is exercised. A Fund's ability to terminate option
positions established in the over-the-counter market may be more limited
than for exchange-traded options and may also involve the risk that
broker-dealers participating in such transactions might fail to meet their
obligations.

Futures Contracts and Options on Futures Contracts

Each Fund may purchase and sell financial futures contracts and options on
those contracts. Financial futures contracts are commodities contracts
based on financial instruments such as U.S. Treasury bonds or bills or on
securities indices such as the S&P 500 Index. Futures contracts, options on
futures contracts and the commodity exchanges on which they are traded are
regulated by the Commodity Futures Trading Commission ("CFTC"). Through the
purchase and sale of futures contracts and related options, a Fund seeks to
hedge against a decline in securities owned by the Fund or an increase in
the price of securities which the Fund plans to purchase. The Partners
Aggressive Growth Fund may also purchase and sell futures contracts and
related options to maintain cash reserves while simulating full investment
in equity securities and to keep substantially all of its assets exposed to
the market.

Futures Contracts. When a Fund sells a futures contract based on a
financial instrument, the Fund is obligated to deliver that kind of
instrument at a specified future time for a specified price. When a Fund
purchases that kind of contract, it is obligated to take delivery of the
instrument at a specified time and to pay the specified price. In most
instances, these contracts are closed out by entering into an offsetting
transaction before the settlement date. The Fund realizes a gain or loss
depending on whether the price of an offsetting purchase plus transaction
costs are less or more than the price of the initial sale or on whether the
price of an offsetting sale is more or less than the price of the initial
purchase plus transaction costs. Although the Funds usually liquidate
futures contracts on financial instruments in this manner, they may make or
take delivery of the underlying securities when it appears economically
advantageous to do so.

A futures contract based on a securities index provides for the purchase or
sale of a group of securities at a specified future time for a specified
price. These contracts do not require actual delivery of securities but
result in a cash settlement. The amount of the settlement is based on the
difference in value of the index between the time the contract was entered
into and the time it is liquidated (at its expiration or earlier if it is
closed out by entering into an offsetting transaction).

When a futures contract is purchased or sold a brokerage commission is
paid. Unlike the purchase or sale of a security or option, no price or
premium is paid or received. Instead, an amount of cash or other liquid
assets (generally about 5% of the contract amount) is deposited by the Fund
with its custodian for the benefit of the futures commission merchant
through which the Fund engages in the transaction. This amount is known as
"initial margin." It does not involve the borrowing of funds by the Fund to
finance the transaction. It instead represents a "good faith" deposit
assuring the performance of both the purchaser and the seller under the
futures contract. It is returned to the Fund upon termination of the
futures contract if all the Fund's contractual obligations have been
satisfied.

Subsequent payments to and from the broker, known as "variation margin,"
are required to be made on a daily basis as the price of the futures
contract fluctuates, a process known as "marking to market." The
fluctuations make the long or short positions in the futures contract more
or less valuable. If the position is closed out by taking an opposite
position prior to the settlement date of the futures contract, a final
determination of variation margin is made. Any additional cash is required
to be paid to or released by the broker and the Fund realizes a loss or
gain.

In using futures contracts, the Fund seeks to establish more certainly than
would otherwise be possible the effective price of or rate of return on
portfolio securities or securities that the Fund proposes to acquire. A
Fund, for example, sells futures contracts in anticipation of a rise in
interest rates which would cause a decline in the value of its debt
investments. When this kind of hedging is successful, the futures contract
increases in value when the Fund's debt securities decline in value and
thereby keep the Fund's net asset value from declining as much as it
otherwise would. A Fund also sells futures contracts on securities indices
in anticipation of or during a stock market decline in an endeavor to
offset a decrease in the market value of its equity investments. When a
Fund is not fully invested and anticipates an increase in the cost of
securities it intends to purchase, it may purchase financial futures
contracts. When increases in the prices of equities are expected, a Fund
purchases futures contracts on securities indices in order to gain rapid
market exposure that may partially or entirely offset increases in the cost
of the equity securities it intends to purchase.

Options on Futures Contracts. The Funds may also purchase and write call
and put options on futures contracts. A call option on a futures contract
gives the purchaser the right, in return for the premium paid, to purchase
a futures contract (assume a long position) at a specified exercise price
at any time before the option expires. A put option gives the purchaser the
right, in return for the premium paid, to sell a futures contract (assume a
short position), for a specified exercise price, at any time before the
option expires.

Upon the exercise of a call, the writer of the option is obligated to sell
the futures contract (to deliver a long position to the option holder) at
the option exercise price, which will presumably be lower than the current
market price of the contract in the futures market. Upon exercise of a put,
the writer of the option is obligated to purchase the futures contract
(deliver a short position to the option holder) at the option exercise
price, which will presumably be higher than the current market price of the
contract in the futures market. However, as with the trading of futures,
most options are closed out prior to their expiration by the purchase or
sale of an offsetting option at a market price that reflects an increase or
a decrease from the premium originally paid. Options on futures can be used
to hedge substantially the same risks addressed by the direct purchase or
sale of the underlying futures contracts. For example, if a Fund
anticipates a rise in interest rates and a decline in the market value of
the debt securities in its portfolio, it might purchase put options or
write call options on futures contracts instead of selling futures
contracts.

If a Fund purchases an option on a futures contract, it may obtain benefits
similar to those that would result if it held the futures position itself.
But in contrast to a futures transaction, the purchase of an option
involves the payment of a premium in addition to transaction costs. In the
event of an adverse market movement, however, the Fund is not subject to a
risk of loss on the option transaction beyond the price of the premium it
paid plus its transaction costs.

When a Fund writes an option on a futures contract, the premium paid by the
purchaser is deposited with the Fund's custodian. The Fund must maintain
with its custodian all or a portion of the initial margin requirement on
the underlying futures contract. It assumes a risk of adverse movement in
the price of the underlying futures contract comparable to that involved in
holding a futures position. Subsequent payments to and from the broker,
similar to variation margin payments, are made as the premium and the
initial margin requirement are marked to market daily. The premium may
partially offset an unfavorable change in the value of portfolio
securities, if the option is not exercised, or it may reduce the amount of
any loss incurred by the Fund if the option is exercised.

Risks Associated with Futures Transactions. There are a number of risks
associated with transactions in futures contracts and related options. A
Fund's successful use of futures contracts is subject to the Manager's or
Sub-Advisor's ability to predict correctly the factors affecting the market
values of the Fund's portfolio securities. For example, if a Fund is hedged
against the possibility of an increase in interest rates which would
adversely affect debt securities held by the Fund and the prices of those
debt securities instead increases, the Fund loses part or all of the
benefit of the increased value of its securities it hedged because it has
offsetting losses in its futures positions. Other risks include imperfect
correlation between price movements in the financial instrument or
securities index underlying the futures contract, on the one hand, and the
price movements of either the futures contract itself or the securities
held by the Fund, on the other hand. If the prices do not move in the same
direction or to the same extent, the transaction may result in trading
losses.

Prior to exercise or expiration, a position in futures may be terminated
only by entering into a closing purchase or sale transaction. This requires
a secondary market on the relevant contract market. The Fund enters into a
futures contract or related option only if there appears to be a liquid
secondary market. There can be no assurance, however, that such a liquid
secondary market exists for any particular futures contract or related
option at any specific time. Thus, it may not be possible to close out a
futures position once it has been established. Under such circumstances,
the Fund continues to be required to make daily cash payments of variation
margin in the event of adverse price movements. In such situations, if the
Fund 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. In addition, the Fund may be required to perform
under the terms of the futures contracts it holds. The inability to close
out futures positions also could have an adverse impact on the Fund's
ability effectively to hedge its portfolio.

Most United States futures exchanges limit the amount of fluctuation
permitted in futures contract prices during a single trading day. This
daily limit establishes the maximum amount that the price of a futures
contract may vary either up or down from the previous day's settlement
price at the end of a trading session. Once the daily limit has been
reached in a particular type of contract, no more trades may be made on
that day at a price beyond that limit. The daily limit governs only price
movements during a particular trading day and therefore does not limit
potential losses because the limit may prevent the liquidation of
unfavorable positions. Futures contract prices have occasionally moved to
the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.

Limitations on the Use of Futures and Options on Futures Contracts. Each
Fund intends to come within an exclusion from the definition of "commodity
pool operator" provided by CFTC regulations by complying with certain
limitations on the use of futures and related options prescribed by those
regulations.

None of the Funds will purchase or sell futures contracts or options
thereon for non-bona fide hedging purposes if immediately thereafter the
aggregate initial margin and premiums exceed 5% of the fair market value of
the Fund's assets, after taking into account unrealized profits and
unrealized losses on any such contracts it has entered into (except that in
the case of an option that is in-the-money at the time of purchase, the
in-the-money amount generally may be excluded in computing the 5%).

The Funds may enter into futures contracts and related options transactions
only for bona fide hedging purposes as permitted by the CFTC and for other
appropriate risk management purposes, if any, which the CFTC deems
appropriate for mutual funds excluded from the regulations governing
commodity pool operators, and to a limited extent to enhance returns. The
Funds (other than European Equity, Pacific Basin and Partners Aggressive
Growth) are not permitted to engage in speculative futures trading. Each
Fund determines that the price fluctuations in the futures contracts and
options on futures used for hedging or risk management purposes are
substantially related to price fluctuations in securities held by the Fund
or which it expects to purchase. In pursuing traditional hedging
activities, each Fund may sell futures contracts or acquire puts to protect
against a decline in the price of securities that the Fund owns. Each Fund
may purchase futures contracts or calls on futures contracts to protect the
Fund against an increase in the price of securities the Fund intends to
purchase before it is in a position to do so.

When a Fund purchases a futures contract, or purchases a call option on a
futures contract, it places any asset, including equity securities and
non-investment grade debt in a segregated account, so long as the asset is
liquid and marked to the market daily. The amount so segregated plus the
amount of initial margin held for the account of its broker equals the
market value of the futures contract.

The Funds do not maintain open short positions in futures contracts, call
options written on futures contracts, and call options written on
securities indices if, in the aggregate, the value of the open positions
(marked to market) exceeds the current market value of that portion of its
securities portfolio being hedged by those futures and options plus or
minus the unrealized gain or loss on those open positions, adjusted for the
historical volatility relationship between that portion of the portfolio
and the contracts (i.e., the Beta volatility factor). To the extent a Fund
writes call options on specific securities in that portion of its
portfolio, the value of those securities is deducted from the current
market value of that portion of the securities portfolio. If this
limitation is exceeded at any time, the Fund takes prompt action to close
out the appropriate number of open short positions to bring its open
futures and options positions within this limitation.

Forward Foreign Currency Exchange Contracts

The International Growth Oriented, Partners Aggressive Growth, Partners LargeCap
Growth and Partners MidCap Growth Funds may enter into forward foreign currency
exchange contracts under various circumstances. The Funds (other than European
Equity and Pacific Basin) will enter into forward foreign currency exchange
contracts only for the purpose of "hedging," that is limiting the risks
associated with changes in the relative rates of exchange between the U.S.
dollar and foreign currencies in which securities owned by a Fund are
denominated or exposed. They do not enter into such forward contracts for
speculative purposes. The European Equity and Pacific Basin Funds each may
engage in speculative forward foreign currency exchange contracts to a limited
percentage of its assets.

The typical use of a forward contract is to "lock in" the price of a security
in U.S. dollars or some other foreign currency which a Fund is holding in its
portfolio. By entering into a forward contract for the purchase or sale, for a
fixed amount of dollars or other currency, of the amount of foreign currency
involved in the underlying security transactions, a Fund may be able to protect
itself against a possible loss resulting from an adverse change in the
relationship between the U.S. dollar or other currency which is being used for
the security purchase and the foreign currency in which the security is
denominated during the period between the date on which the security is
purchased or sold and the date on which payment is made or received.

The Sub-Advisor also may from time to time utilize forward contracts for other
purposes. For example, they may be used to hedge a foreign security held in the
portfolio or a security which pays out principal tied to an exchange rate
between the U.S. dollar and a foreign currency, against a decline in value of
the applicable foreign currency. They also may be used to lock in the current
exchange rate of the currency in which those securities anticipated to be
purchased are denominated. At times, a Fund may enter into "cross-currency"
hedging transactions involving currencies other than those in which securities
are held or proposed to be purchased are denominated.

A Fund sets up a separate account with the Custodian to place foreign securities
denominated in the currency for which the Fund has entered into forward
contracts under the second circumstance, as set forth above, for the term of the
forward contract. It should be noted that the use of forward foreign currency
exchange contracts does not eliminate fluctuations in the underlying prices of
the securities. It simply establishes a rate of exchange between the currencies
that can be achieved at some future point in time. Additionally, although such
contracts tend to minimize the risk of loss due to a decline in the value of the
hedged currency, they also tend to limit any potential gain which might result
if the value of the currency increases.

Currency hedging involves some of the same risks and considerations as other
transactions with similar instruments. Currency transactions can result in
losses to a Fund if the currency being hedged fluctuates in value to a degree or
in a direction that is not anticipated. Further, the risk exists that the
perceived linkage between various currencies may not be present or may not be
present during the particular time that a Fund is engaging in proxy hedging.
Currency transactions are also subject to risks different from those of other
portfolio transactions. Because currency control is of great importance to the
issuing governments and influences economic planning and policy, purchases and
sales of currency and related instruments can be adversely affected by
government exchange controls, limitations or restrictions on repatriation of
currency, and manipulations or exchange restrictions imposed by governments.
These forms of governmental actions can result in losses to a Fund if it is
unable to deliver or receive currency or monies in settlement of obligations.
They could also cause hedges the Fund has entered into to be rendered useless,
resulting in full currency exposure as well as incurring transaction costs.
Currency exchange rates may also fluctuate based on factors extrinsic to a
country's economy. Buyers and sellers of currency futures contracts are subject
to the same risks that apply to the use of futures contracts generally. Further,
settlement of a currency futures contract for the purchase of most currencies
must occur at a bank based in the issuing nation. The ability to establish and
close out positions on trading options on currency futures contracts is subject
to the maintenance of a liquid market that may not always be available.

Although the European Equity and Pacific Basin Funds each value its assets daily
in terms of U.S. dollars, they do not intend to convert holdings of foreign
currencies into U.S. dollars on a daily basis. Each Fund will, however, do so
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 spread between the prices at
which they are buying and selling various currencies. Thus, a dealer may offer
to sell a foreign currency to a Fund at one rate, while offering a lesser rate
of exchange should the Fund desire to resell that currency to the dealer.

Repurchase Agreements

All Funds may invest in repurchase agreements. None of the Growth-Oriented or
Income-Oriented Funds may enter into repurchase agreements that do not mature
within seven days if any such investment, together with other illiquid
securities held by the Fund, amount to more than 15% of its net assets. The
Money Market Fund does not enter into repurchase agreements that do not mature
within seven days of such investment together with other illiquid securities
held by the Fund, amount to more than 10% of its assets. Repurchase agreements
typically involve the acquisition by the Fund of debt securities from a selling
financial institution such as a bank, savings and loan association or
broker-dealer. A repurchase agreement provides that the Fund sells back to the
seller and that the seller repurchases the underlying securities at a specified
price and at a fixed time in the future. Repurchase agreements may be viewed as
loans by a Fund collateralized by the underlying securities. This arrangement
results in a fixed rate of return that is not subject to market fluctuation
during the Fund's holding period. Although repurchase agreements involve certain
risks not associated with direct investments in debt securities, each of the
Funds follows procedures established by its Board of Directors which are
designed to minimize such risks. These procedures include entering into
repurchase agreements only with large, well-capitalized and well-established
financial institutions which the Fund's Manager or Sub-Advisor believes present
minimum credit risks. In addition, the value of the collateral underlying the
repurchase agreement is always at least equal to the repurchase price, including
accrued interest. In the event of a default or bankruptcy by a selling financial
institution, the affected Fund bears a risk of loss. In seeking to liquidate the
collateral, a Fund may be delayed in or prevented from exercising its rights and
may incur certain costs. Further to the extent that proceeds from any sale upon
a default of the obligation to repurchase are less than the repurchase price,
the Fund could suffer a loss.

Lending of Portfolio Securities

All Funds may lend their portfolio securities. None of the Funds will lend its
portfolio securities if as a result the aggregate of such loans made by the Fund
would exceed the limits established by the Investment Company Act. Portfolio
securities may be lent to unaffiliated broker-dealers and other unaffiliated
qualified financial institutions provided that such loans are callable at any
time on not more than five business days' notice and that cash or other liquid
assets equal to at least 100% of the market value of the securities loaned,
determined daily, is deposited by the borrower with the Fund and is maintained
each business day. While such securities are on loan, the borrower pays the Fund
any income accruing thereon. The Fund may invest any cash collateral, thereby
earning additional income, and may receive an agreed-upon fee from the borrower.
Borrowed securities must be returned when the loan terminates. Any gain or loss
in the market value of the borrowed securities which occurs during the term of
the loan belongs to the Fund and its shareholders. A Fund pays reasonable
administrative, custodial and other fees in connection with such loans and may
pay a negotiated portion of the interest earned on the cash or government
securities pledged as collateral to the borrower or placing broker. A Fund does
not normally retain voting rights attendant to securities it has lent, but it
may call a loan of securities in anticipation of an important vote.

When-Issued and Delayed Delivery Securities

Each of the Funds may from time to time purchase securities on a when-issued
basis and may purchase or sell securities on a delayed delivery basis. The price
of such a transaction is fixed at the time of the commitment, but delivery and
payment take place on a later settlement date, which may be a month or more
after the date of the commitment. No interest accrues to the purchaser during
this period. The securities are subject to market fluctuation which involve the
risk for the purchaser that yields available in the market at the time of
delivery are higher than those obtained in the transaction. Each Fund only
purchases securities on a when-issued or delayed delivery basis with the
intention of acquiring the securities. However, a Fund may sell the securities
before the settlement date, if such action is deemed advisable. At the time a
Fund commits to purchase securities on a when-issued or delayed delivery basis,
it records the transaction and reflects the value of the securities in
determining its net asset value. Each Fund also establishes a segregated account
with its custodian bank in which it maintains cash or other liquid assets equal
in value to the Fund's commitments for when-issued or delayed delivery
securities. The availability of liquid assets for this purpose and the effect of
asset segregation on a Fund's ability to meet its current obligations, to honor
requests for redemption and to have its investment portfolio managed properly
limit the extent to which the Fund may engage in forward commitment agreements.
Except as may be imposed by these factors, there is no limit on the percent of a
Fund's total assets that may be committed to transactions in such agreements.

Industry Concentrations

Each of the Funds, except the Real Estate and Utilities Funds, may not
concentrate (invest more than 25% of its assets)its investments in any
particular industry. The LargeCap Stock Index Fund may concentrate its
investments in a particular industry only to the extent that the S&P 500 Index
is so concentrated. For purposes of applying the Partners LargeCap Growth's
industry concentration restriction, the Fund uses the industry groups used in
the Data Monitoring System of William O'Neill & Co., Incorporated. The European
Equity and Pacific Basin Funds use the industry groups of Morgan Stanley Capital
International - Global Industry Classification Standard. The other Funds use
industry classifications based on the "Directory of Companies Filing Annual
Reports with the Securities and Exchange Commission."

Money Market Instruments

The Cash Management Fund invests all of its available assets in money market
instruments maturing in 397 days or less.

The types of money market instruments which the Funds may purchase are described
below.

(1) U.S. Government Securities -- Securities issued or guaranteed by the U.S.
Government, including treasury bills, notes and bonds.

(2) U.S. Government Agency Securities -- Obligations issued or guaranteed by
agencies or instrumentalities of the U.S. Government.
o U.S. agency obligations include, but are not limited to, the Bank for
Co-operatives, Federal Home Loan Banks, Federal Intermediate Credit
Banks, and the Federal National Mortgage Association.
o U.S. instrumentality obligations include, but are not limited to, the
Export-Import Bank and Farmers Home
Administration.

Some obligations issued or guaranteed by U.S. Government agencies and
instrumentalities are supported by the full faith and credit of the U.S.
Treasury. Others, such as those issued by the Federal National Mortgage
Association, are supported by discretionary authority of the U.S.
Government to purchase certain obligations of the agency or
instrumentality. Still others, such as those issued by the Student Loan
Marketing Association, are supported only by the credit of the agency or
instrumentality.

(3) Bank Obligations -- Certificates of deposit, time deposits and bankers'
acceptances of U.S. commercial banks having total assets of at least one
billion dollars and overseas branches of U.S. commercial banks and foreign
banks, which in the Manager's opinion, are of comparable quality. However,
each such bank with its branches has total assets of at least five billion
dollars, and certificates, including time deposits of domestic savings and
loan associations having at least one billion dollars in assets which are
insured by the Federal Savings and Loan Insurance Corporation. The Fund may
acquire obligations of U.S. banks which are not members of the Federal
Reserve System or of the Federal Deposit Insurance Corporation.

Any obligations of foreign banks must be denominated in U.S. dollars.
Obligations of foreign banks and obligations of overseas branches of U.S.
banks are subject to somewhat different regulations and risks than those of
U.S. domestic banks. For example, an issuing bank may be able to maintain
that the liability for an investment is solely that of the overseas branch
which could expose the Fund to a greater risk of loss. In addition,
obligations of foreign banks or of overseas branches of U.S. banks may be
affected by governmental action in the country of domicile of the branch or
parent bank. Examples of adverse foreign governmental actions include the
imposition of currency controls, the imposition of withholding taxes on
interest income payable on such obligations, interest limitations, seizure
or nationalization of assets, or the declaration of a moratorium. Deposits
in foreign banks or foreign branches of U.S. banks are not covered by the
Federal Deposit Insurance Corporation. The Fund only buys short-term
instruments where the risks of adverse governmental action are believed by
the Manager to be minimal. The Fund considers these factors along with
other appropriate factors in making an investment decision to acquire such
obligations. It only acquires those which, in the opinion of management,
are of an investment quality comparable to other debt securities bought by
the Fund. The Fund invests in certificates of deposit of selected banks
having less than one billion dollars of assets providing the certificates
do not exceed the level of insurance (currently $100,000) provided by the
applicable government agency.

A certificate of deposit is issued against funds deposited in a bank or
savings and loan association for a definite period of time, at a specified
rate of return. Normally they are negotiable. However, the Fund
occasionally invests in certificates of deposit which are not negotiable.
Such certificates may provide for interest penalties in the event of
withdrawal prior to their maturity. A bankers' acceptance is a short-term
credit instrument issued by corporations to finance the import, export,
transfer or storage of goods. They are termed "accepted" when a bank
guarantees their payment at maturity and reflect the obligation of both the
bank and drawer to pay the face amount of the instrument at maturity.

(4) Commercial Paper -- Short-term promissory notes issued by U.S. or foreign
corporations.

(5) Short-term Corporate Debt -- Corporate notes, bonds and debentures which at
the time of purchase have 397 days or less remaining to maturity.

(6) Repurchase Agreements -- Instruments under which securities are purchased
from a bank or securities dealer with an agreement by the seller to
repurchase the securities at the same price plus interest at a specified
rate. (See "FUND INVESTMENTS - Repurchase Agreements.")

(7) Taxable Municipal Obligations -- Short-term obligations issued or
guaranteed by state and municipal issuers which generate taxable income.

The ratings of nationally recognized statistical rating organization (NRSRO),
such as Moody's Investor Services, Inc. ("Moody's") and Standard and Poor's
("S&P"), which are described in Appendix B, represent their opinions as to the
quality of the money market instruments which they undertake to rate. It should
be emphasized, however, that ratings are general and are not absolute standards
of quality. These ratings, including ratings of NRSROs other than Moody's and
S&P, are the initial criteria for selection of portfolio investments, but the
Manager further evaluates these securities.

Municipal Obligations

The Tax-Exempt Bond Fund can invest in "Municipal Obligations." Municipal
Obligations are obligations issued by or on behalf of states, territories, and
possessions of the United States and the District of Columbia and their
political subdivisions, agencies and instrumentalities, including municipal
utilities, or multi-state agencies or authorities. The interest on Municipal
Obligations is exempt from federal income tax in the opinion of bond counsel to
the issuer. Three major classifications of Municipal Obligations are: Municipal
Bonds, which generally have a maturity at the time of issue of one year or more,
Municipal Notes, which generally have a maturity at the time of issue of six
months to three years, and Municipal Commercial Paper, which generally has a
maturity at the time of issue of 30 to 270 days.

The term "Municipal Obligations" includes debt obligations issued to obtain
funds for various public purposes, including the construction of a wide range of
public facilities such as airports, bridges, highways, housing, hospitals, mass
transportation, schools, streets, water and sewer works, and electric utilities.
Other public purposes for which Municipal Obligations are issued include
refunding outstanding obligations, obtaining funds for general operating
expenses and lending such funds to other public institutions and facilities.

Industrial development bonds are issued by or on behalf of public authorities to
obtain funds to provide for the construction, equipment, repair or improvement
of privately operated housing facilities, sports facilities, convention or trade
show facilities, airport, mass transit, industrial, port or parking facilities,
air or water pollution control facilities and certain local facilities for water
supply, gas, electricity or sewage or solid waste disposal. They are considered
to be Municipal Obligations if the interest paid thereon qualifies as exempt
from federal income tax in the opinion of bond counsel to the issuer, even
though the interest may be subject to the federal alternative minimum tax.

Municipal Bonds. Municipal Bonds may be either "general obligation" or "revenue"
issues. General obligation bonds are secured by the issuer's pledge of its
faith, credit and taxing power for the payment of principal and interest.
Revenue bonds are payable from the revenues derived from a particular facility
or class of facilities or, in some cases, from the proceeds of a special excise
tax or other specific revenue source (e.g., the user of the facilities being
financed), but not from the general taxing power. Industrial development bonds
and pollution control bonds in most cases are revenue bonds and generally do not
carry the pledge of the credit of the issuing municipality. The payment of the
principal and interest on industrial revenue bonds depends solely on the ability
of the user of the facilities financed by the bonds to meet its financial
obligations and the pledge, if any, of real and personal property so financed as
security for such payment. The Fund may also invest in "moral obligation" bonds
which are normally issued by special purpose public authorities. If an issuer of
moral obligation bonds is unable to meet its obligations, the repayment of the
bonds becomes a moral commitment but not a legal obligation of the state or
municipality in question.

Municipal Notes. Municipal Notes usually are general obligations of the issuer
and are sold in anticipation of a bond sale, collection of taxes or receipt of
other revenues. Payment of these notes is primarily dependent upon the issuer's
receipt of the anticipated revenues. Other notes include "Construction Loan
Notes" issued to provide construction financing for specific projects, and "Bank
Notes" issued by local governmental bodies and agencies to commercial banks as
evidence of borrowings. Some notes ("Project Notes") are issued by local
agencies under a program administered by the United States Department of Housing
and Urban Development. Project Notes are secured by the full faith and credit of
the United States.

Bond Anticipation Notes (BANs) are usually general obligations of state and
local governmental issuers which are sold to obtain interim financing for
projects that will eventually be funded through the sale of long-term debt
obligations or bonds. The ability of an issuer to meet its obligations on its
BANs is primarily dependent on the issuer's access to the long-term municipal
bond market and the likelihood that the proceeds of such bond sales will be used
to pay the principal and interest on the BANs.

Tax Anticipation Notes (TANs) are issued by state and local governments to
finance the current operations of such governments. Repayment is generally to be
derived from specific future tax revenues. TANs are usually general obligations
of the issuer. A weakness in an issuer's capacity to raise taxes due to, among
other things, a decline in its tax base or a rise in delinquencies, could
adversely affect the issuer's ability to meet its obligations on outstanding
TANs.

Revenue Anticipation Notes (RANs) are issued by governments or governmental
bodies with the expectation that future revenues from a designated source will
be used to repay the notes. In general they also constitute general obligations
of the issuer. A decline in the receipt of projected revenues, such as
anticipated revenues from another level of government, could adversely affect an
issuer's ability to meet its obligations on outstanding RANs. In addition, the
possibility that the revenues would, when received, be used to meet other
obligations could affect the ability of the issuer to pay the principal and
interest on RANs.

Construction Loan Notes are issued to provide construction financing for
specific projects. Frequently, these notes are redeemed with funds obtained from
the Federal Housing Administration.

Bank Notes are notes issued by local governmental bodies and agencies such as
those described above to commercial banks as evidence of borrowings. The
purposes for which the notes are issued are varied but they are frequently
issued to meet short-term working-capital or capital-project needs. These notes
may have risks similar to the risks associated with TANs and RANs.

Municipal Commercial Paper. Municipal Commercial Paper refers to short-term
obligations of municipalities which may be issued at a discount and may be
referred to as Short-Term Discount Notes. Municipal Commercial Paper is likely
to be used to meet seasonal working capital needs of a municipality or interim
construction financing. Generally they are repaid from general revenues of the
municipality or refinanced with long-term debt. In most cases Municipal
Commercial Paper is backed by letters of credit, lending agreements, note
repurchase agreements or other credit facility agreements offered by banks or
other institutions.

Variable and Floating Rate Obligations. Certain Municipal Obligations,
obligations issued or guaranteed by the U.S. Government or its agencies or
instrumentalities and debt instruments issued by domestic banks or corporations
may carry variable or floating rates of interest. Such instruments bear interest
at rates which are not fixed, but which vary with changes in specified market
rates or indices, such as a bank prime rate or tax-exempt money market index.
Variable rate notes are adjusted to current interest rate levels at certain
specified times, such as every 30 days. A floating rate note adjusts
automatically whenever there is a change in its base interest rate adjustor,
e.g., a change in the prime lending rate or specified interest rate indices.
Typically such instruments carry demand features permitting the Fund to redeem
at par.

A Fund's right to obtain payment at par on a demand instrument upon demand could
be affected by events occurring between the date the Fund elects to redeem the
instrument and the date redemption proceeds are due which affects the ability of
the issuer to pay the instrument at par value. The Manager monitors on an
ongoing basis the pricing, quality and liquidity of such instruments and
similarly monitors the ability of an issuer of a demand instrument, including
those supported by bank letters of credit or guarantees, to pay principal and
interest on demand. Although the ultimate maturity of such variable rate
obligations may exceed one year, the Funds treat the maturity of each variable
rate demand obligation as the longer of (i) the notice period required before
the Fund is entitled to payment of the principal amount through demand, or (ii)
the period remaining until the next interest rate adjustment. Floating rate
instruments with demand features are deemed to have a maturity equal to the
period remaining until the principal amount can be recovered through demand.

The Funds may purchase participation interests in variable rate Municipal
Obligations (such as industrial development bonds). A participation interest
gives the purchaser an undivided interest in the Municipal Obligation in the
proportion that its participation interest bears to the total principal amount
of the Municipal Obligation. A Fund has the right to demand payment on seven
days' notice, for all or any part of the Fund's participation interest in the
Municipal Obligation, plus accrued interest. Each participation interest is
backed by an irrevocable letter of credit or guarantee of a bank. Each
participation interest is backed by an irrevocable letter of credit or guarantee
of a bank. Banks will retain a service and letter of credit fee and a fee for
issuing repurchase commitments in an amount equal to the excess of the interest
paid on the Municipal Obligations over the negotiated yield at which the
instruments were purchased by the Funds. No Fund committed during the last
fiscal year or intends to commit during the present fiscal year more than 5% of
its net assets to participation interests.

Other Municipal Obligations. Other kinds of Municipal Obligations are
occasionally available in the marketplace, and a Fund may invest in such other
kinds of obligations to the extent consistent with its investment objective and
limitations. Such obligations may be issued for different purposes and with
different security than those mentioned above.

Risks of Municipal Obligations. The yields on Municipal Obligations are
dependent on a variety of factors, including general economic and monetary
conditions, money market factors, conditions in the Municipal Obligations
market, size of a particular offering, maturity of the obligation, and rating of
the issue. Each Fund's ability to achieve its investment objective also depends
on the continuing ability of the issuers of the Municipal Obligations in which
it invests to meet their obligation for the payment of interest and principal
when due.

Municipal Obligations are subject to the provisions of bankruptcy, insolvency
and other laws affecting the rights and remedies of creditors, such as the
Federal Bankruptcy Act. They are also subject to federal or state laws, if any,
which extend the time for payment of principal or interest, or both, or impose
other constraints upon enforcement of such obligations or upon municipalities to
levy taxes. The power or ability of issuers to pay, when due, principal of and
interest on Municipal Obligations may also be materially affected by the results
of litigation or other conditions.

From time to time, proposals have been introduced before Congress for the
purpose of restricting or eliminating the federal income tax exemption for
interest on Municipal Obligations. It may be expected that similar proposals
will be introduced in the future. If such a proposal was enacted, the ability of
the Funds to pay "exempt interest" dividends may be adversely affected. Each
Fund would reevaluate its investment objective and policies and consider changes
in its structure.

Taxable Investments of the Tax-Exempt Bond Fund

The Tax-Exempt Bond Fund may invest up to 20% of its assets in taxable
short-term investments consisting of: Obligations issued or guaranteed by the
United States Government or its agencies or instrumentalities; domestic bank
certificates of deposit and bankers' acceptances; short-term corporate debt
securities such as commercial paper; and repurchase agreements ("Taxable
Investments"). These investments must have a stated maturity of one year or less
at the time of purchase and must meet the following standards: banks must have
assets of at least $1 billion; commercial paper must be rated at least "A" by
S&P or "Prime" by Moody's or, if not rated, must be issued by companies having
an outstanding debt issue rated at least "A" by S&P or Moody's; corporate bonds
and debentures must be rated at least "A" by S&P or Moody's. Interest earned
from Taxable Investments is taxable to investors. When, in the opinion of the
Fund's Manager, it is advisable to maintain a temporary "defensive" posture, the
Fund may invest more than 20% of its total assets in Taxable Investments. At
other times, Taxable Investments, Municipal Obligations that do not meet the
quality standards required for the 80% portion of the portfolio and Municipal
Obligations the interest on which is treated as a tax preference item for
purposes of the federal alternative minimum tax will not exceed 20% of the
Fund's total assets.

Portfolio Turnover

Portfolio turnover normally differs for each Fund, varies from year to year (as
well as within a year) and is affected by portfolio securities sales necessary
to meet cash requirements for redemptions of Fund shares. This need to redeem
may in some cases limit the ability of a Fund to effect certain portfolio
transactions. The portfolio turnover rate for a Fund is calculated by dividing
the lesser of purchases or sales of its portfolio securities during the fiscal
year by the monthly average of the value of its portfolio securities (excluding
from the computation all securities, including options, with maturities at the
time of acquisition of one year or less). A high rate of portfolio turnover
generally involves correspondingly greater brokerage commission expenses which
are paid by the Fund.

No portfolio turnover rate can be calculated for the Cash Management Fund
because of the short maturities of the securities in which it invests. No
turnover rates are calculated for the European Equity, LargeCap Stock Index,
Pacific Basin, Partners Aggressive Growth, Partners LargeCap Growth and Partners
MidCap Growth Funds as they have been in existence for less than six months.

The portfolio turnover rates for each of the other Funds for its most recent and
immediately preceding fiscal periods were as follows (annualized when reporting
period is less than one year):

Balanced Fund 24.2% and 57.0%
Blue Chip Fund 16.4% and 0.5%
Bond Fund 48.9% and15.2%
Capital Value Fund 44.5% and 23.2%
Government Securities Income Fund 19.4% and 17.1%
Growth Fund 32.4% and 21.9%
High Yield Fund 86.1% and 65.9%
International Emerging Markets Fund 95.8% and 45.2%
International Fund 58.7% and 38.7%
International SmallCap Fund 191.5% and 99.8%
Limited Term Bond Fund 20.9% and 23.8%
MidCap Fund 59.9% and 25.1%
Real Estate Fund 55.1% and 60.4%
SmallCap Fund 100.7% and 20.5%
Tax-Exempt Bond Fund 15.6% and 6.6%
Utilities Fund 23.5% and 11.9%

MANAGEMENT OF THE FUNDS

Board of Directors

Under Maryland law, a Board of Directors oversees each of the Funds. The
Directors have financial or other relevant experience and meet several times
during the year to review contracts, Fund activities and the quality of services
provided to the Funds. Other than serving as Directors, most of the Board
members have no affiliation with the Funds or service providers.

The current Directors and Officers are shown below. Each person (except
Aschenbrenner, Gilbert and Kimball who do not serve as directors of Principal
Special Markets Fund, Inc.) also has the same position with Principal Special
Markets Fund, Inc. and Principal Variable Contracts Fund, Inc. which are also
sponsored by Principal Life Insurance Company. Unless an address is shown, the
mailing address for the Directors and Officers is Principal Financial Group, Des
Moines, Iowa 50392.

* John E. Aschenbrenner, 50, Director. Executive Vice President, Principal
Life Insurance Company since 2000; Senior Vice President, 1996-2000; Vice
President - Individual Markets 1990-1996. Director, Principal Management
Corporation and Princor Financial Services Corporation.

@ James D. Davis, 66, Director. 4940 Center Court, Bettendorf, Iowa.
Attorney. Vice President, Deere and Company, Retired.

*& Ralph C. Eucher, 47, Director and President. Vice President, Principal Life
Insurance Company since 1999. Director and President, Princor Financial
Services Corporation and Principal Management Corporation since 1999. Prior
thereto, Second Vice President, Principal Life Insurance Company.

@ Pamela A. Ferguson, 56, Director. 4112 River Oaks Drive, Des Moines, Iowa.
Professor of Mathematics, Grinnell College since 1998. Prior thereto,
President, Grinnell College.

Richard W. Gilbert, 59, Director. 5040 Arbor Lane, #302, Northfield,
Illinois. President, Gilbert Communications, Inc. since 1993. Prior
thereto, President and Publisher, Pioneer Press.

*& J. Barry Griswell, 51, Director and Chairman of the Board. President and
CEO, Principal Life Insurance Company since 2000; President, 1998-2000;
Executive Vice President, 1996-1998; Senior Vice President, 1991-1996.
Director and Chairman of the Board, Principal Management Corporation and
Princor Financial Services Corporation.

@ William C. Kimball, 52, Director. 4700 Westown Parkway, Suite 300, West Des
Moines, Iowa. Chairman and CEO, Medicap Pharmacies, Inc. since 1998. Prior
thereto, President and CEO.

& Barbara A. Lukavsky, 59, Director. 13731 Bay Hill Court, Clive, Iowa.
President and CEO, Barbican Enterprises, Inc. since 1997. President and
CEO, Lu San ELITE USA, L.C. 1985-1998.

* Craig L. Bassett, 48, Treasurer. Second Vice President and Treasurer,
Principal Life Insurance Company since 1998. Director - Treasury 1996-1998.
Prior thereto, Associate Treasurer.

* Michael J. Beer, 39, Financial Officer. Executive Vice President, Princor
Financial Services Corporation and Principal Management Corporation since
1999. Senior Vice President and Chief Operating Officer, 1997-1999. Vice
President and Chief Operating Officer, 1995-1997. Prior thereto, Financial
Officer.

* Arthur S. Filean, 61, Vice President and Secretary. Senior Vice President,
Princor Financial Services Corporation and Principal Management
Corporation, since 2000. Vice President, Princor Financial Services
Corporation, 1990-2000. Vice President, Principal Management Corporation,
1996-2000.

* Ernest H. Gillum, 44, Vice President and Assistant Secretary. Vice
President - Product Development, Princor Financial Services Corporation and
Principal Management Corporation, since 2000. Vice President - Compliance
and Product Development, Princor Financial Services Corporation and
Principal Management Corporation, 1998-2000. Prior thereto, Assistant Vice
President, Registered Products, 1995-1998. Prior thereto, Product
Development and Compliance Officer.

* Jane E. Karli, 43, Assistant Treasurer. Assistant Treasurer, Principal Life
Insurance Company since 1998; Senior Accounting and Custody Administrator
1994-1998; Prior thereto, Senior Investment Cost Accountant.

* Layne A. Rasmussen, 41, Controller. Controller - Mutual Funds, Princor
Financial Services Corporation since 1995.

* Michael D. Roughton, 48, Counsel. Vice President and Senior Securities
Counsel, Principal Life Insurance Company, since 1999. Counsel 1994-1999.
Counsel, Invista Capital Management, LLC, Princor Financial Services
Corporation and Principal Management Corporation.

* Jean B. Schustek, 48, Assistant Vice President and Assistant Secretary.
Assistant Vice President - Registered Products, Princor Financial Services
Corporation since 2000. Prior thereto, Compliance Officer - Registered
Products.

* Traci L. Weldon, 34, Assistant Counsel. Counsel, Principal Life Insurance
Company since 1999. Assistant Counsel 1998-1999. Assistant State Attorney
General, Iowa Attorney General's Office, 1994-1998. Prior thereto,
Investment Banker, Kirkpatrick Pettis.

* Considered to be "Interested Persons" as defined in the Investment Company
Act of 1940, as amended, because of current or former affiliation with the
Manager or Principal Life.

@ Member of Audit and Nominating Committee

& Member of Executive Committee (which is selected by the Board and which may
exercise all the powers of the Board, with certain exceptions, when the
Board is not in session. The Committee must report its actions to the
Board.)
COMPENSATION TABLE*
fiscal year ended October 31, 1999

Compensation from Compensation from
Director Each Principal Mutual Fund Fund Complex

James D. Davis $1,350 $53,250
Pamela A. Ferguson 1,200 47,700
Richard W. Gilbert 1,350 50,850
Barbara A. Lukavsky 1,200 47,700

* None of the Funds provide retirement benefits for any of the directors.

As of April 7, 2000, Principal Life Insurance Company, a life insurance company
organized in 1879 under the laws of Iowa, its subsidiaries and affiliates owned
of record a percentage of the outstanding voting shares of each Fund:

% of Outstanding
Fund Shares Owned

Balanced Fund 0.17%
Blue Chip Fund 0.33
Bond Fund 0.70
Capital Value Fund 25.85
Cash Management Fund 7.26
Government Securities Income Fund 0.04
Growth Fund 0.37
High Yield Fund 8.19
International Emerging Markets Fund 31.08
International Fund 24.78
International SmallCap Fund 26.07
LargeCap Stock Index Fund 88.12
Limited Term Bond Fund 18.30
MidCap Fund 0.36
Partners Aggressive Growth Fund 8.36
Partners LargeCap Growth Fund 86.73
Partners MidCap Growth Fund 78.97
Real Estate Fund 60.87
SmallCap Fund 8.09
Tax-Exempt Bond Fund 0.05
Utilities Fund 0.30

As of April 26, 2000, Principal Life Insurance Company owned 100% of the
outstanding voting shares of the Principal European Equity and Principal Pacific
Basin Funds which represented start-up capital.

As of April 11, 2000, the Officers and Directors of each Fund as a group owned
less than 1% of the outstanding shares of any Class of any of the Funds.

As of April 7, 2000, the following shareholders of the Funds owned 5% or more of
the outstanding shares of any Class of the Funds:

<TABLE>
<CAPTION>
Percentage
Name Address of Ownership
<S> <C> <C>
Principal Balanced Fund, Inc.
Class C
Louis Barbieri 23 Highland Cross 16.3%
Rutherford, NJ 07070-2110

Wanda J. Mayer 301 6th Avenue 12.2
Hiawatha, IA 52233-1704
Principal Blue Chip Fund, Inc.
Class C
Edward Chester 920 SW 6th Street, Apt. 112 17.5
Gainesville, FL 32601-6692

Principal Life Insurance Company Custodian 8912 Brierfield Road 6.6
IRA of Richard A. Jackson Granbury, TX 76049-4215

Principal Bond Fund, Inc.
Class C
Principal Life Insurance Company Custodian 8912 Brierfield Road 24.5
IRA of Richard A. Jackson Granbury, TX 76049-4215

Donaldson Lufkin Jenrette P.O. Box 2052 9.1
Securities Corporation, Inc. Jersey City, NJ 07303-9998

Ellen M. Bryan TOD 2608 W. Castle Court 6.4
Peoria, IL 60614-3727

Principal Capital Accumulation Fund, Inc.
Class C
Principal Life Insurance Company Custodian P.O. Box 1523 8.8
IRA of Theodore J. Gomes Kahului, HI 96733-1523

Principal Life Insurance Company Custodian 291 Dairy Road 7.7
IRA of David Masanda Kahului, HI 96732-2914

Principal Life Insurance Company Custodian 9107 W. Monks Lane 6.8
IRA of Donald D. Davis Mapleton, IL 61547-9783

Woodland Heights Presbyterian Church 722 W. Atlantic Street 5.0
Attn: Gregory W. Esselman Springfield, MO 65803-1516

Principal Cash Management Fund, Inc.
Class A
Delaware Charter Guarantee & Trust Co. P.O. Box 8704 7.5
Attn: Thomas R. Kline, CFO Wilmington, DE 19899-8704

Class C
Principal Life Insurance Company Custodian 9107 W. Monks Lane 21.3
IRA of Donald D. Davis Mapleton, IL 61547-9783

Janice Mae Firth & Brian Andrew Firth 3212 Stony Pointe Drive 8.9
Greensboro, NC 27406-5420

Principal Life Insurance Company Custodian 3434 Thyme Drive 6.1
IRA of Thomas L. Parr Rockford, IL 61114-5385

Principal Government Securities Income Fund, Inc.
Class C
Principal Life Insurance Company Custodian 8912 Brierfield Road 19.0%
IRA of Richard A. Jackson Granbury, TX 76049-4215

Dominica M. Bradley 26751 Via Zaragosa 6.8
Mission Viejo, CA 92691-5024

George F. Kenney & Merlyn J. Kenney 3690 S. Willow Water Lane 6.5
Springfield, MO 65809-4238

Principal Growth Fund, Inc.
Class C
Tarbell Financial Corp. 1403 N. Tustin Avenue, Suite 380 14.0
Non-Qualified Plan Reserve Santa Ana, CA 92705-8620

Edward Chester 920 SW 6th Street, Apt. 112 11.2
Gainesville, FL 32601-6692

Principal Life Insurance Company Custodian 8912 Brierfield Road 7.5
IRA of Richard A. Jackson Granbury, TX 76049-4215

Principal High Yield Fund, Inc.
Class C
Principal Life Insurance Company Custodian 8912 Brierfield Road 27.0
IRA of Richard A. Jackson Granbury, TX 76049-4215

Ellen M. Bryan TOD 2608 W. Castle Court 21.1
Peoria, IL 61614-3727

Marguerite M. Dunn & Patricia A. Kunz 125 N. Main Street 7.3
Carroll, IA 51401-2852

Class R
Principal Life Insurance Company Custodian 1313 Little Blue Heron Court 6.5
IRA of William Flatley Naples, FL 34108-3311

Principal International Emerging Markets Fund, Inc.
Class C
Betty Jo Fagerholt Revocable Living Trust 7575 139th Avenue NE 17.7
Hoople, ND 58243-9523
Principal International Fund, Inc.
Class C
Edward Chester 920 SW 6th Street., Apt. 112 13.8
Gainesville, FL 32601-6692

Principal Life Insurance Company Custodian 8912 Brierfield Road 9.1
IRA of Richard A. Jackson Granbury, TX 76049-4215

Principal Life Insurnace Company Custodian 9107 W. Monks Lane 7.3
IRA of Donald D. Davis Mapleton, IL 61547-9783

Principal International SmallCap Fund, Inc.
Class C
Edward Chester 920 SW 6th Street, Apt. 112 13.8
Gainesville, FL 32601-6692

Principal Life Insurance Company Custodian 8912 Brierfield Rd. 12.8
IRA of Richard A. Jackson Granbury, TX 76049-4215

Betty Jo Fagerholt Revocable Living Trust 7575 139th Avenue NE 7.3
Hoople, ND 58243-9523

Principal Life Insurance Company Trust 47 Roxiticus Road 5.9
Roth IRA of Robin E. Behm Mendham, NJ 07945-2501

Principal LargeCap Stock Index Fund, Inc.
Class A
Donaldson Lufkin Jenrette P.O. Box 2052 8.1%
Securities Corporation, Inc. Jersey City, NJ 07303-2052

Rhythums Net Connections, Inc. 6933 S. Revere Pkwy 6.5
Englewood, CO 80112-3981

Principal Limited Term Bond Fund, Inc.
Class C
Principal Life Insurance Company Custodian 2101 Sumac Drive 13.7
IRA of William P. Klein Champaign, IL 61821-6323

Principal Life Insurance Company Custodian 2101 Sumac Drive 9.6
Conduit IRA of Mary F. McClain Champaign, IL 61821-6323

Donaldson Lufkin Jenrette P.O. Box 2052 7.1
Securities Corporation Inc. Jersey City, NJ 07303-9998

Principal Life Insurance Company Custodian 3748 Maple Hill Road 6.0
Conduit IRA of Frederic Angelo Hibbing, MN 55746-8339

Principal MidCap Fund, Inc.
Class C
Betty Jo Fagerholt Revocable Living Trust 7575 139th Avenue NE 9.7
Hoople, ND 58243-9523

Woodland Heights Presbyterian Church 722 W. Atlantic Street 8.1
Attn: Gregory W. Esselman Springfield, MO 65803-1516

Donaldson Lufkin Jenrette P.O. Box 2052 5.4
Securities Corporation, Inc. Jersey City, NJ 07303-9998

Principal Partners Aggressive Growth Fund, Inc.
Class C
Betty Jo Fagerholt Revocable Living Trust 7575 139th Avenue NE 6.8
Hoople, ND 58243-9523
Principal Partners LargeCap Growth Fund, Inc.
Class C
Donaldson Lufkin Jenrette P.O. Box 2052 5.3
Securities Corporation, Inc. Jersey City, NJ 07303-9998

Principal Real Estate Fund, Inc.
Class C
Principal Life Insurance Company Custodian 3344 Kalamazoo Avenue SE 9.0
Inherited IRA of Nicola L. Kern Grand Rapid, MI 49508-2558
Beneficiary of Richard Kern

Principal SmallCap Fund, Inc.
Class C
Edward Chester 920 SW 6th Street, Apt. 112 15.7
Gainesville, FL 32601-6692

Betty Jo Fagerholt Revocable Living Trust 7575 139th Avenue NE 6.1
Hoople, ND 58243-9523
Principal Tax-Exempt Bond Fund, Inc.
Class B
Allan S. Noddle The Grand Oudezijds Voorburgawal 197 9.5
Amsterdam Netherlands 1012 EX
Netherlands
Class C
Shirley M. Parish 4234 Cedar Bend Drive 11.3
Missouri City, TX 77459-4586

JME, Inc. 3020 E. Oakland Avenue 54.1
Bloomington, IL 61704-6214

Principal Utilities Fund, Inc.
Class C
James W. Smith RR 1 Box 183 15.2%
Eastman, WI 54626-9798

Donaldson Lufkin Jenrette P.O. Box 2052 5.6
Securities Corporation, Inc. Jersey City, NJ 07303-9998

Delaware Charter Guarantee and Trust Co. 11452 Clarkson Road 5.2
Biomedical Research Laboratories Inc. PSP Los Angeles, CA 90064-3831
FBO Hun-Chi Lin
</TABLE>

MANAGER AND SUB-ADVISORS

The Manager of each of the Funds is Principal Management Corporation, a
wholly-owned subsidiary of Princor Financial Services Corporation ("Princor")
which is a wholly-owned subsidiary of Principal Financial Services, Inc.
Principal Financial Services, Inc. is a holding company which is a wholly-owned
subsidiary of Principal Financial Group, Inc. The Principal Financial Group,
Inc. is a holding company which is a wholly-owned subsidiary of Principal Mutual
Holding Company. The address of the Manager is the Principal Financial Group,
Des Moines, Iowa 50392-0200. The Manager was organized on January 10, 1969 and
since that time has managed various mutual funds sponsored by Principal Life
Insurance Company.

The Manager has executed agreements with various Sub-Advisors. Under those
Sub-Advisory agreements, the Sub-Advisor agrees to assume the obligations of the
Manager to provide investment advisory services for a specific Fund. For these
services, each Sub-Advisor is paid a fee by the Manager.

Funds: Balanced, Blue Chip, Capital Value, Government Securities Income,
Growth, International, International Emerging Growth,
International SmallCap, LargeCap Stock Index, Limited Term Bond,
MidCap, SmallCap and Utilities Funds.
Sub-Advisor: Invista, an indirectly wholly-owned subsidiary of Principal Life
Insurance Company and an affiliate of the Manager, was founded in
1985 and manages investments for institutional investors,
including Principal Life Insurance Company. Assets under
management at December 31, 1999 were approximately $35.3 billion.
Invista's address is 1800 Hub Tower, 699 Walnut, Des Moines, Iowa
50309.

Fund: European Equity and Pacific Basin Funds.
Sub-Advisor: BT Funds Management (International) Limited ("BT") is an
indirectly wholly owned subsidiary of BT Funds Management Limited
("BTFM") and a member of the Principal Financial Group. A global
active investment manager dedicated to delivering superior
investment returns, BT, together with BTFM, has approximately $24
billion under management for more than 410,000 institutional and
individual clients, as at January 2000. Offering institutional
investment product since the early 1970s, BT's team of over 100
investment specialists manages all asset classes from its
headquarters in Sydney, Australia. It has specialized expertise
in European and Asian regional equity portfolios as well as
global equities, global and Australian fixed interest, currency
management, asset allocation and Australian real estate. Its
address is The Chifley Tower, 2 Chifley Square, Sydney 2000
Australia.

Fund: Partners Aggressive Growth Fund
Sub-Advisor: Morgan Stanley with principal offices at 1221 Avenue of the
Americas, New York, NY 10020, provides a broad range of portfolio
management services to customers in the U.S. and abroad. As of
December 31, 1999, Morgan Stanley, together with its affiliated
institutional asset management companies, managed investments of
approximately $184.9 billion as named fiduciary or fiduciary
advisor. On December 1, 1998, Morgan Stanley Asset Management
Inc. changed it name to Morgan Stanley Dean Witter Investment
Management Inc. but continues to do business in certain instances
using the name Morgan Stanley Asset Management.

Fund: Partners LargeCap Growth Fund
Sub-Advisor: Duncan-Hurst was founded in 1990. Its address is 4365 Executive
Drive, Suite 1520, San Diego CA 92121. As of December 31, 1999,
Duncan-Hurst managed assets of approximately $5.9 billion for
institutional and individual investors.

Fund: Partners MidCap Growth Fund
Sub-Advisor: Turner was founded in 1990. Its address is 1235 Westlake Drive,
Suite 350, Berwyn PA 19312. As of December 31, 1999, Turner had
discretionary management authority with respect to approximately
$5.7 billion in assets.

The Boards of Directors of the Manager, Princor (as principal underwriter of the
Funds), each of the Sub-Advisors and each of the Funds have adopted a Code of
Ethics designed to prevent persons with access to information regarding the
portfolio trading activity of the Funds from using that information for their
personal benefit. In certain circumstances personal securities trading is
permitted in accordance with procedures established by the Code of Ethics. The
Boards of Directors of the Manager, Princor, each of the Sub-Advisors and each
of the Funds periodically review their respective Code of Ethics. The Codes of
Ethics are on file with, and available from, the Securities and Exchange
Commission.

Each of the persons affiliated with a Fund who is also an affiliated person of
the Manager or Invista is named below, together with the capacities in which
such person is affiliated:

<TABLE>
<CAPTION>
Name Office Held With Each Fund Office Held With The Manager/Invista

<S> <C> <C>
John E. Aschenbrenner Director Director (Manager)
Michael J. Beer Financial Officer Executive Vice President and Chief
Operating Officer(Manager)
Ralph C. Eucher Director and President Director and President (Manager)
Arthur S. Filean Vice President and Secretary Senior Vice President (Manager)
Ernest H. Gillum Vice President and Assistant Secretary Vice President - Product Development (Manager)
J. Barry Griswell Director and Chairman of the Board Director and Chairman of the Board (Manager)
Layne A. Rasmussen Controller Controller - Mutual Funds (Manager)
Michael D. Roughton Counsel Counsel (Manager; Invista)
Jean B. Schustek Assistant Vice President and Assistant Vice President - Registered Products (Manager)
Assistant Secretary
</TABLE>

COST OF MANAGER'S SERVICES

For providing the investment advisory services, and specified other services,
the Manager, under the terms of the Management Agreement for each Fund, is
entitled to receive a fee computed and accrued daily and payable monthly, at the
following annual rates:

<TABLE>
<CAPTION>
Net Asset Value of Fund

First Next Next Next
Fund $250,000,000 $250,000,000 $250,000,000 $250,000,000 Thereafter

<S> <C> <C> <C> <C> <C>
Blue Chip, Capital Value and Growth Funds .60% .55% .50% .45% .40%
Partners Aggressive Growth Fund .75 .70 .65 .60 .55
International Fund .85 .80 .75 .70 .65
</TABLE>

<TABLE>
<CAPTION>
Net Asset Value of Fund

First Next Next Next Over
Fund $100,000,000 $100,000,000 $100,000,000 $100,000,000 $400,000,000

<S> <C> <C> <C> <C> <C>
Balanced, High Yield, and Utilities Funds .60% .55% .50% .45% .40%
International Emerging Markets Fund 1.25 1.20 1.15 1.10 1.05
International SmallCap Fund 1.20 1.15 1.10 1.05 1.00
MidCap Fund .65 .60 .55 .50 .45
Real Estate Fund .90 .85 .80 .75 .70
SmallCap Fund .85 .80 .75 .70 .65
All Other Funds .50 .45 .40 .35 .30
</TABLE>

Fund Overall Fee

LargeCap Stock Index Fund .35%
Partners LargeCap Growth Fund .90%
Partners MidCap Growth Fund .90%

<TABLE>
<CAPTION>
Net Asset Value of Fund

First Next Next Next
Fund $250,000,000 $250,000,000 $250,000,000 $250,000,000 Thereafter

<S> <C> <C> <C> <C> <C>
European Equity Fund 0.90% 0.85% 0.80% 0.75% 0.70%
Pacific Basin Fund 1.10 1.05 1.00 0.95 0.90
</TABLE>

There is no assurance that any of the Funds' net assets will reach sufficient
amounts to be able to take advantage of the rate decreases. The net assets of
each Fund on October 31, 1999 and the rate of the fee for each Fund for
investment management services as provided in the Management Agreement for the
fiscal year then ended were as follows:
Management Fee
Net Assets as of For Fiscal Year Ended
Fund October 31, 1999 October 31, 1999

Balanced Fund $160,113,402 0.58%
Blue Chip Fund 291,707,955 0.46
Bond Fund 187,792,641 0.48
Capital Value Fund 670,726,648 0.37
Cash Management Fund 374,707,858 0.44
Government Securities Income Fund 279,432,929 0.45
Growth Fund 636,878,130 0.38
High Yield Fund 40,312,045 0.60
International Emerging Markets Fund 22,166,474 0.68
International Fund 408,882,643 1.25
International SmallCap Fund 40,867,074 1.20
Limited Term Bond Fund 33,418,483 0.50*
MidCap Fund 407,721,977 0.56
Real Estate Fund 13,009,308 0.90
SmallCap Fund 66,121,454 0.85
Tax-Exempt Bond Fund 198,589,990 0.46
Utilities Fund 126,445,559 0.59

* Before waiver.

The Manager pays for office space, facilities and simple business equipment and
the costs of keeping the books of the Fund. The Manager also compensates all
personnel who are officers and directors, if such officers and directors are
also affiliated with the Manager.

Each Fund pays all its other corporate expenses incurred in the operation of the
Fund and the continuous public offering of its shares, but not selling expenses.
Among other expenses, the Fund pays its taxes (if any), brokerage commissions on
portfolio transactions, interest, the cost of stock issue and transfer and
dividend disbursement, administration of shareholder accounts, custodial fees,
expenses of registering and qualifying shares for sale after the initial
registration, auditing and legal expenses, fees and expenses of unaffiliated
directors, and costs of shareholder meetings. The Manager pays most of these
expenses in the first instance, and is reimbursed for them by the Fund as
provided in the Management Agreement. The Manager also is responsible for the
performance of certain of the functions described above, such as transfer and
dividend disbursement and administration of shareholder accounts, the cost of
which the Manager is reimbursed by the Fund.

Under a Sub-Advisory Agreement between BT and the Manager, BT performs all the
investment advisory responsibilities of the Manager under the Management
Agreement for the European Equity Fund. The Manager pays BT a fee that is
accrued daily and payable monthly. The fee is based on the net asset value of
the Fund as follows: first $250 million of net assets - the fee is 0.50%; next
$250 million - 0.475%; next $250 million - 0.450%; next $250 million - 0.425%;
and net assets over $1 billion - 0.40%.

Under a Sub-Advisory Agreement between BT and the Manager, BT performs all the
investment advisory responsibilities of the Manager under the Management
Agreement for the Pacific Basin Fund. The Manager pays BT a fee that is accrued
daily and payable monthly. The fee is based on the net asset value of the Fund
as follows: first $250 million of net assets - the fee is 0.60%; next $250
million - 0.575%; next $250 million - 0.550%; next $250 million - 0.525%; and
net assets over $1 billion - 0.50%.

Under a Sub-Advisory Agreement between Duncan-Hurst and the Manager,
Duncan-Hurst Stanley performs all the investment advisory responsibilities of
the Manager under the Management Agreement for the Partners LargeCap Growth
Fund. The Manager pays Duncan-Hurst a fee that is accrued daily and payable
monthly. The fee of 0.50% is based on the net asset value of the Fund.

Under a Sub-Advisory Agreement between Morgan Stanley and the Manager, Morgan
Stanley performs all the investment advisory responsibilities of the Manager
under the Management Agreement for the Partners Aggressive Growth Fund. The
Manager pays Morgan Stanley a fee that is accrued daily and payable monthly. The
fee is based on the net asset value of the Fund as follows: first $200 million
of net assets - the fee is 0.30%; next $100 million - 0.25%; and net assets over
$300 million - 0.20%.

Under a Sub-Advisory Agreement between Turner and the Manager, Turner performs
all the investment advisory responsibilities of the Manager under the Management
Agreement for the Partners MidCap Growth Fund. The Manager pays Turner a fee
that is accrued daily and payable monthly. The fee of 0.50% is based on the net
asset value of the Fund.

Fees paid for investment management services during the periods indicated were
as follows:

<TABLE>
<CAPTION>
Management Fees For Fiscal Years Ended October 31,

Fund 1999 1998 1997

<S> <C> <C> <C>
Balanced Fund $ 914,378 $ 750,616 $ 556,009
Blue Chip Fund 1,142,839 764,784 417,958
Bond Fund 909,902 782,241(1) 636,217(1)
Capital Value Fund 2,570,792 2,349,118 2,031,143
Cash Management Fund 1,526,404 2,127,595(1) 2,864,916(1)
Government Securities Income Fund 1,283,959 1,239,644 1,227,604
Growth Fund 2,283,089 1,863,070 1,443,120
High Yield Fund 259,764 287,858 230,667
International Emerging Markets Fund 216,500 157,324 28,487(2)
International Fund 2,673,903 2,492,037 1,882,664
International SmallCap Fund 358,891 242,403 30,283(2)
Limited Term Bond Fund 160,694(1) 133,825(1) 97,039(1)
MidCap Fund 2,461,880 2,548,924 2,004,305
Real Estate Fund 114,693 87,653(3) N/A
SmallCap Fund 412,361 147,083(3) N/A
Tax-Exempt Bond Fund 972,660 974,740 941,387
Utilities Fund 685,175 531,644(1) 436,296(1)
<FN>
(1)Before waiver.
(2)Period from August 14, 1997 (Date Operations Commenced) through October 31, 1997.
(3)Period from December 11, 1997 (Date Operations Commenced) through October 31, 1998.
</FN>
</TABLE>

The Manager waived $66,728, $100,270 and $59,630 of its fee for the Limited Term
Bond Fund for the years ended October 31, 1999, 1998 and 1997, respectively. The
Manager waived $172,366 and $60,665 of its fee for the Bond Fund for the years
ended October 31, 1998 and 1997, respectively. The Manager also waived $1,343
and $7,933 of its fee for the Cash Management Fund for the years ended October
31, 1998 and 1997, respectively. The Manager also waived $82,515 and $79,048 of
its fee for the Utilities Fund for the years ended October 31, 1998 and 1997,
respectively.

Costs reimbursed to the Manager during the periods indicated for providing other
services pursuant to the Management Agreement were as follows:
<TABLE>
<CAPTION>
Reimbursement by Fund
of Certain Costs For
Fiscal Years Ended October 31,

Fund 1999 1998 1997

<S> <C> <C> <C>
Balanced Fund $ 664,179 $ 521,852 $ 364,442
Blue Chip Fund 1,336,983 832,394 402,003
Bond Fund 534,104 482,817 278,385
Capital Value Fund 1,415,788 1,247,865 837,825
Cash Management Fund 788,303 854,575 1,833,423
Government Securities Income Fund 544,396 499,207 407,146
Growth Fund 1,613,707 1,421,948 1,121,832
High Yield Fund 170,349 217,020 98,481
International Emerging Markets Fund 148,065 119,948 4,116(1)
International Fund 1,111,335 1,168,106 906,359
International SmallCap Fund 168,397 153,320 4,283(1)
Limited Term Bond Fund 123,038 90,187 44,634
MidCap Fund 1,733,436 1,840,474 1,308,608
Real Estate Fund 93,688 76,546(2) N/A
SmallCap Fund 348,721 199,807 (2) N/A
Tax-Exempt Bond Fund 165,845 199,780 135,553
Utilities Fund 390,699 304,813 230,151

<FN>
(1)Period from August 14, 1997 (Date Operations Commenced) through October 31, 1997.
(2)Period from December 11, 1997 (Date Operations Commenced) through October 31, 1998.
</FN>
</TABLE>

NOTE: The Manager has agreed to waive a portion of its fee for the Blue Chip
Fund from November 1, 1999. The Manager intends to continue the waiver
and, if necessary, pay expenses normally payable by the Blue Chip Fund
through the period ending October 31, 2000. The waiver will maintain a
total level of operating expenses (expressed as a percent of average net
assets attributable to a Class on an annualized basis) not to exceed
1.20% for Class A Shares, 1.95% for Class B Shares, 1.95% for Class C
Shares and 1.70% for Class R Shares. The effect of the waiver is to
reduce the Fund's annual operating expenses.

The Manager has agreed to waive a portion of its fee for the European
Equity Fund from May 1, 2000. The Manager intends to continue the waiver
and, if necessary, pay expenses normally payable by the Partners MidCap
Growth Fund through the period ending October 31, 2000. The waiver will
maintain a total level of operating expenses (expressed as a percent of
average net assets attributable to a Class on an annualized basis) not
to exceed 2.50% for Class A Shares, 3.25% for Class B Shares, 3.25% for
Class C Shares and 3.00% for Class R Shares. The effect of the waiver is
to reduce the Fund's annual operating expenses.

The Manager has agreed to waive a portion of its fee for the
International Emerging Markets Fund from November 1, 1999. The Manager
intends to continue the waiver and, if necessary, pay expenses normally
payable by the International Emerging Markets Fund through the period
ending October 31, 2000. The waiver will maintain a total level of
operating expenses (expressed as a percent of average net assets
attributable to a Class on an annualized basis) not to exceed 2.50% for
Class A Shares, 3.25% for Class B Shares, 3.25% for Class C Shares and
3.00% for Class R Shares. The effect of the waiver is to reduce the
Fund's annual operating expenses.

The Manager has agreed to waive a portion of its fee for the LargeCap
Stock Index Fund from March 1, 2000. The Manager intends to continue the
waiver and, if necessary, pay expenses normally payable by the LargeCap
Stock Index Fund through the period ending October 31, 2000. The waiver
will maintain a total level of operating expenses (expressed as a
percent of average net assets attributable to a Class on an annualized
basis) not to exceed 0.80% for Class A Shares, 1.15% for Class B Shares,
1.15% for Class C Shares and 1.30% for Class R Shares. The effect of the
waiver is to reduce the Fund's annual operating expenses.

The Manager voluntarily waived a portion of its fee for the Limited Term
Bond Fund from the date operations commenced and intends to continue
such waiver and, if necessary, pay expenses normally payable by the
Limited Term Bond Fund through the period ending October 31, 2000 in an
amount that will maintain a total level of operating expenses, which as
a percent of average net assets attributable to a class on an annualized
basis will not exceed 1.00% for the Class A shares, 1.35% for the Class
B shares, 1.35% for the Class C shares and 1.60% for the Class R shares.
The effect of the waiver was and will be to reduce the Fund's annual
operating expenses and increase the Fund's yield and effective yield.

The Manager has agreed to waive a portion of its fee for the Pacific
Basin Fund from May 1, 2000. The Manager intends to continue the waiver
and, if necessary, pay expenses normally payable by the Partners MidCap
Growth Fund through the period ending October 31, 2000. The waiver will
maintain a total level of operating expenses (expressed as a percent of
average net assets attributable to a Class on an annualized basis) not
to exceed 2.50% for Class A Shares, 3.25% for Class B Shares, 3.25% for
Class C Shares and 3.00% for Class R Shares. The effect of the waiver is
to reduce the Fund's annual operating expenses.

The Manager has agreed to waive a portion of its fee for the Partners
Aggressive Growth Fund from November 1, 1999. The Manager intends to
continue the waiver and, if necessary, pay expenses normally payable by
the Partners Aggressive Growth Fund through the period ending October
31, 2000. The waiver will maintain a total level of operating expenses
(expressed as a percent of average net assets attributable to a Class on
an annualized basis) not to exceed 1.60% for Class A Shares, 2.35% for
Class B Shares, 2.35% for Class C Shares and 2.10% for Class R Shares.
The effect of the waiver is to reduce the Fund's annual operating
expenses.

The Manager has agreed to waive a portion of its fee for the Partners
LargeCap Growth Fund from March 1, 2000. The Manager intends to continue
the waiver and, if necessary, pay expenses normally payable by the
Partners LargeCap Growth Fund through the period ending October 31,
2000. The waiver will maintain a total level of operating expenses
(expressed as a percent of average net assets attributable to a Class on
an annualized basis) not to exceed 1.80% for Class A Shares, 2.55% for
Class B Shares, 2.55% for Class C Shares and 2.30% for Class R Shares.
The effect of the waiver is to reduce the Fund's annual operating
expenses.

The Manager has agreed to waive a portion of its fee for the Partners
MidCap Growth Fund from March 1, 2000. The Manager intends to continue
the waiver and, if necessary, pay expenses normally payable by the
Partners MidCap Growth Fund through the period ending October 31, 2000.
The waiver will maintain a total level of operating expenses (expressed
as a percent of average net assets attributable to a Class on an
annualized basis) not to exceed 1.80% for Class A Shares, 2.55% for
Class B Shares, 2.55% for Class C Shares and 2.30% for Class R Shares.
The effect of the waiver is to reduce the Fund's annual operating
expenses.

The Manager has agreed to waive a portion of its fee for the Real Estate
Fund from November 1, 1999. The Manager intends to continue the waiver
and, if necessary, pay expenses normally payable by the Real Estate Fund
through the period ending October 31, 2000. The waiver will maintain a
total level of operating expenses (expressed as a percent of average net
assets attributable to a Class on an annualized basis) not to exceed
1.90% for Class A Shares, 2.65% for Class B Shares, 2.65% for Class C
Shares and 2.40% for Class R Shares. The effect of the waiver is to
reduce the Fund's annual operating expenses.

The Manager has agreed to waive a portion of its fee for the SmallCap
Fund from November 1, 1999. The Manager intends to continue the waiver
and, if necessary, pay expenses normally payable by the SmallCap Fund
through the period ending October 31, 2000. The waiver will maintain a
total level of operating expenses (expressed as a percent of average net
assets attributable to a Class on an annualized basis) not to exceed
1.80% for Class A Shares, 2.55% for Class B Shares, 2.55% for Class C
Shares and 2.30% for Class R Shares. The effect of the waiver is to
reduce the Fund's annual operating expenses

Each Fund has entered into certain agreements that provide for continuation in
effect from year to year only so long as such continuation is specifically
approved at least annually either by the Board of Directors of the Fund or by
vote of a majority of the outstanding voting securities of the applicable Fund,
provided that in either event such continuation shall be approved by vote of a
majority of the Directors who are not "interested persons" (as defined in the
Investment Company Act of 1940) of the Manager, Principal Life Insurance Company
or its subsidiaries or the Fund, cast in person at a meeting called for the
purpose of voting on such approval. The Agreements may be terminated at any time
on 60 days written notice to the Manager or applicable Sub-Advisor either by
vote of the Board of Directors of the applicable Fund or by a vote of a majority
of the outstanding securities of the Fund and by the Manager, the respective
sub-advisor, if any, or Principal Life Insurance Company, as the case may be, on
60 days written notice to the Fund. The Agreements will automatically terminate
in the event of their assignment.

The Management Agreement for each Fund (except Growth, LargeCap Stock Index,
MidCap, Partners Aggressive Growth, Partners LargeCap Growth and Partners MidCap
Growth) was last approved by shareholders of the applicable Fund on November 2,
1999. Shareholders approved the Management Agreement for the other Funds as
follows: European Equity - April 28, 2000; Growth - November 9, 1999; LargeCap
Stock Index - February 25, 2000; MidCap - December 10, 1999; Pacific Basin -
April 28, 2000; Partners Aggressive Growth - November 1, 1999; Partners LargeCap
Growth - February 25, 2000; and Partners MidCap Growth - February 25, 2000.

The agreements for each Fund were last approved by the Board of Directors for
that Fund as follows:

<TABLE>
<CAPTION>
Investment Service Management Sub-Advisory
Fund Agreement Agreement Agreement

<S> <C> <C> <C>
Balanced 9/13/99 9/13/99 9/13/99
Blue Chip 9/13/99 9/13/99 9/13/99
Bond 9/13/99 9/13/99 9/13/99
Capital Value 9/13/99 9/13/99 9/13/99
Cash Management 9/13/99 9/13/99 9/13/99
European Equity 3/13/00 3/13/00 3/13/00
Government Securities Income 9/13/99 9/13/99 9/13/99
Growth 9/13/99 9/13/99 9/13/99
High Yield 9/13/99 9/13/99 9/13/99
International 9/13/99 9/13/99 9/13/99
International Emerging Markets 9/13/99 9/13/99 9/13/99
International SmallCap 9/13/99 9/13/99 9/13/99
LargeCap Stock Index 12/13/99 12/13/99 12/13/99
Limited Term Bond 9/13/99 9/13/99 9/13/99
MidCap 9/13/99 9/13/99 9/13/99
Pacific Basin 3/13/00 3/13/00 3/13/00
Partners Aggressive Growth N/A 9/13/99 9/13/99
Partners LargeCap Growth N/A 12/13/99 12/13/99
Partners MidCap Growth N/A 12/13/99 12/13/99
Real Estate 9/13/99 9/13/99 9/13/99
SmallCap 9/13/99 9/13/99 9/13/99
Tax-Exempt Bond 9/13/99 9/13/99 9/13/99
Utilities 9/13/99 9/13/99 9/13/99
</TABLE>

BROKERAGE ON PURCHASES AND SALES OF SECURITIES

In distributing brokerage business arising out of the placement of orders for
the purchase and sale of securities for any Fund, the objective of the Fund's
Manager or Sub-Advisor is to obtain the best overall terms. In pursuing this
objective, the Manager or Sub-Advisor considers all matters it deems relevant,
including the breadth of the market in the security, the price of the security,
the financial condition and executing capability of the broker or dealer and the
reasonableness of the commission, if any (for the specific transaction and on a
continuing basis). This may mean in some instances that the Manager or
Sub-Advisor will pay a broker commissions that are in excess of the amount of
commissions another broker might have charged for executing the same transaction
when the Manager or Sub-Advisor believes that such commissions are reasonable in
light of (a) the size and difficulty of the transaction (b) the quality of the
execution provided and (c) the level of commissions paid relative to commissions
paid by other institutional investors. (Such factors are viewed both in terms of
that particular transaction and in terms of all transactions that broker
executes for accounts over which the Manager or Sub-Advisor exercises investment
discretion. The Manager or Sub-Advisor may purchase securities in the
over-the-counter market, utilizing the services of principal market makers
unless better terms can be obtained by purchases through brokers or dealers, and
may purchase securities listed on the New York Stock Exchange from non-Exchange
members in transactions off the Exchange.)

The Manager or Sub-Advisor may give consideration in the allocation of business
to services performed by a broker (e.g., the furnishing of statistical data and
research generally consisting of, but not limited to, information of the
following types: analyses and reports concerning issuers, industries, economic
factors and trends, portfolio strategy and performance of client accounts). If
any such allocation is made, the primary criteria used will be to obtain the
best overall terms for such transactions. The Manager or Sub-Advisor may also
pay additional commission amounts for research services. Such statistical data
and research information received from brokers or dealers as described above may
be useful in varying degrees and the Manager or Sub-Advisor may use it in
servicing some or all of the accounts it manages. Some statistical data and
research information obtained may not be useful to the Manager or Sub-Advisor in
managing the client account, brokerage for which resulted in the Manager's or
Sub-Advisor's receipt of the statistical data and research information. However,
in the Manager's or Sub-Advisor's opinion, the value thereof is not determinable
and it is not expected that the Manager's or Sub-Advisor's expenses will be
significantly reduced since the receipt of such statistical data and research
information is only supplementary to the Manager's or Sub-Advisor's own research
efforts. The Manager or Sub-Advisor allocated portfolio transactions for the
Funds indicated in the following table to certain brokers during the fiscal year
ended October 31, 1999 due to research services provided by such brokers. The
table also indicates the commissions paid to such brokers as a result of these
portfolio transactions.

Fund Commissions Paid

Balanced $12,785
Capital Value 41,550
Growth 88,339
International Emerging Markets 215
International 65,764
International SmallCap 241
MidCap 66,150
SmallCap 3,055

Subject to the rules promulgated by the SEC, as well as other regulatory
requirements, a Sub-Advisor may also allocate orders on behalf of a Fund to
broker-dealers affiliated with the Sub-Advisor. The Sub-Advisor shall determine
the amounts and proportions of orders allocated to the Sub-Advisor or affiliate.
The Boards of Directors of the Fund will receive quarterly reports on thses
transactions.

Purchases and sales of debt securities and money market instruments usually are
principal transactions; portfolio securities are normally purchased directly
from the issuer or from an underwriter or marketmaker for the securities. Such
transactions are usually conducted on a net basis with the Fund paying no
brokerage commissions. Purchases from underwriters include a commission or
concession paid by the issuer to the underwriter, and the purchases from dealers
serving as marketmakers include the spread between the bid and asked prices.

The following table shows the brokerage commissions paid during the periods
indicated. In each year, 100% of the commissions paid by each Fund went to
broker-dealers which provided research, statistical or other factual
information.

<TABLE>
<CAPTION>
Total Brokerage Commissions Paid

Fund 1999 1998 1997

<S> <C> <C> <C>
Balanced Fund $ 50,867 $ 70,261 $ 47,096
Blue Chip Fund 149,945 41,024 113,923
Capital Value Fund 695,270 331,316 339,994
Growth Fund 438,476 276,004 43,018
International Emerging Markets Fund 125,801 51,821 45,140*
International Fund 1,201,021 758,808 708,333
International SmallCap Fund 306,636 101,485 46,970*
MidCap Fund 517,173 242,311 98,217
Real Estate Fund 36,634 40,791** N/A
SmallCap Fund 154,031 46,957** N/A
Utilities Fund 95,017 39,470 58,450

<FN>
* Period from August 14, 1997 (date operations commenced) through October
31, 1997.
** Period from December 11, 1997 (date operations commenced) through
October 31, 1998.
</FN>
</TABLE>

Brokerage commissions paid to affiliates during the fiscal year ending October
31 were as follows:

<TABLE>
<CAPTION>
Commissions Paid to Goldman Sachs Co.
Total Dollar As Percent of Percent of Dollar Amount
Fund Amount Total Commissions of Commissionable Transactions
<S> <C> <C> <C>
Balanced Fund
1999 $ 1,725 3.39% 1.94%
1998 2,950 4.20% 1.87%
Blue Chip Fund
1999 7,735 5.16% 5.25%
Capital Value Fund
1999 87,440 12.58% 10.41%
Growth Fund
1999 10,650 2.43% 3.63%
1998 5,000 1.81% 1.87%
International Emerging Markets Fund
1999 6,756 5.37% 5.97%
1998 662 1.28% 1.54%
International Fund
1999 90,123 7.50% 5.97%
1998 41,600 5.48% 5.79%
International SmallCap Fund
1999 26,377 8.60% 9.72%
1998 2,326 2.29% 2.96%
MidCap Fund
1999 21,673 4.19% 3.49%
Real Estate Fund
1999 135 0.37% 0.47%
SmallCap Fund
1999 2,370 1.54% 2.95%
1998 210 0.45% 0.61%
Utilities Fund
1999 3,160 3.33% 3.83%
1998 1,500 3.80% 3.71%
</TABLE>

<TABLE>
<CAPTION>
Commissions Paid to J.P. Morgan Securities
Total Dollar As Percent of Percent of Dollar Amount
Fund Amount Total Commissions of Commissionable Transactions
<S> <C> <C> <C>
Balanced Fund
1999 $ 6,841 13.45% 15.18%
1998 500 0.71% 1.03%
Blue Chip Fund
1999 8,485 5.66% 5.82%
1998 1,950 4.75% 5.35%
Capital Value Fund
1999 9,470 1.36% 1.83%
1998 18,935 5.72% 6.27%
Growth Fund
1999 23,170 5.28% 5.47%
1998 1,250 0.45% 0.39%
International Emerging Markets Fund
1999 4,492 3.57% 4.82%
1998 2,570 4.96% 6.77%
International Fund
1999 13,911 1.16% 1.22%
1998 17,961 2.37% 1.80%
MidCap Fund
1999 10,715 2.07% 1.87%
Real Estate Fund
1999 8,845 24.14% 23.03%
1998 3,205 7.86% 7.67%
SmallCap Fund
1999 3,065 1.99% 2.68%
Utilities Fund
1999 3,935 4.14% 4.98%
</TABLE>

<TABLE>
<CAPTION>
Commissions Paid to Morgan Stanley& Co. Incorporated
Total Dollar As Percent of Percent of Dollar Amount
Fund Amount Total Commissions of Commissionable Transactions
<S> <C> <C> <C>
Balanced Fund
1999 $ 2,300 4.52% 4.33%
1998 2,630 3.74% 2.27%
1997 45 - 0.1%
Blue Chip Fund
1999 13,950 9.30% 11.72%
1998 365 0.89% 0.99%
1997 4,602 4.0% 2.4%
Capital Value Fund
1999 12,575 1.81% 2.48%
1998 13,740 4.15% 3.78%
1997 9,900 2.9% 2.4%
Growth Fund
1999 12,338 2.81% 3.90%
1998 12,500 4.53% 4.92%
1997 3,250 7.6% 8.5%
International Emerging Markets Fund
1999 2,570 2.04% 2.76%
1998 1,499 2.89% 3.64%
1997 1,586 3.5% 9.3%
International Fund
1999 128,900 10.73% 11.76%
1998 78,938 10.40% 10.03%
1997 20,595 2.9% 2.7%
International SmallCap Fund
1999 18,755 6.12% 8.26%
1998 4,284 4.22% 7.42%
1997 1,502 3.2% 4.2%
MidCap Fund
1999 21,551 4.17% 5.00%
1998 7,716 3.18% 4.19%
1997 3,750 3.8% 2.8%
Real Estate Fund
1999 1,600 4.37% 4.10%
1998 11,540 28.29% 28.36%
SmallCap Fund
1999 795 0.52% 0.81%
1998 840 1.79% 1.65%
Utilities Fund
1999 340 0.36% 0.49%
1998 1,735 4.40% 5.95%
</TABLE>

Goldman Sachs Asset Management, a separate operating division of Goldman Sachs &
Co., acts as sub-advisor for an account of the Principal Variable Contracts
Fund, Inc. In addition, J.P. Morgan Investment Management Inc., an affiliate of
J.P. Morgan Securities, acts as a sub-advisor of an account of the Principal
Variable Contracts Fund, Inc.

Morgan Stanley and Co. is affiliated with Morgan Stanley Asset Management, which
acts as sub-advisor to two accounts of the Principal Variable Contracts Fund and
one fund included in the Fund Complex. On December 1, 1998 Morgan Stanley Asset
Management Inc. changed its name to Morgan Stanley Dean Witter Investment
Management Inc. but continues to do business in certain instances using the name
Morgan Stanley Asset Management.

The Manager acts as investment advisor for each of the funds sponsored by
Principal Life Insurance Company. The Manager or Sub-Advisor, if any, places
orders to trade portfolio securities for each of these Funds.

For the Bond, Cash Management, High Yield and Tax-Exempt Bond Funds as well as
those for which Invista serves as Sub-Advisor, the following describes the
allocation process used. If, in carrying out the investment objectives of the
Funds, occasions arise when purchases or sales of the same equity securities are
to be made for two or more of the Funds at the same time (or, in the case of
accounts managed by a Sub-Advisor, for two or more Funds and any other accounts
managed by the Sub-Advisor), the Manager or Sub-Advisor may submit the orders to
purchase or, whenever possible, to sell, to a broker/dealer for execution on an
aggregate or "bunched" basis (including orders for accounts in which Registrant,
its affiliates and/or its personnel have beneficial interests). The Manager (or,
in the case of accounts managed by a Sub-Advisor, the Sub-Advisor) may create
several aggregate or "bunched" orders relating to a single security at different
times during the same day. On such occasions, the Manager (or, in the case of
accounts managed by a Sub-Advisor, the Sub-Advisor) shall compose, before
entering an aggregated order, a written Allocation Statement as to how the order
will be allocated among the various accounts. Securities purchased or proceeds
of sales received on each trading day with respect to each such aggregate or
"bunched" order shall be allocated to the various Funds (or, in the case of a
Sub-Advisor, the various Funds and other client accounts) whose individual
orders for purchase or sale make up the aggregate or "bunched" order by filling
each Fund's (or, in the case of a Sub-Advisor, each Fund's or other client
account's) order in accordance with the Allocation Statement. If the order is
partially filled, it shall be allocated pro rata based on the Allocation
Statement. Securities purchased for funds (or, in the case of a Sub-Advisor,
Funds and other client accounts) participating in an aggregate or "bunched"
order will be placed into those Funds and, where applicable, other client
accounts at a price equal to the average of the prices achieved in the course of
filling that aggregate or "bunched" order.

If purchases or sales of the same debt securities are to be made for two or more
of the Funds at the same time, the securities will be purchased or sold
proportionately in accordance with the amount of such security sought to be
purchased or sold at that time for each Fund.

Invista expects aggregation or "bunching" of orders, on average, to reduce
slightly the cost of execution. Invista will not aggregate a client's order if,
in a particular instance, it believes that aggregation will increase the
client's cost of execution. In some cases, aggregation or "bunching" of orders
may increase the price a client pays or receives for a security or reduce the
amount of securities purchased or sold for a client account.

Invista may enter aggregated orders for shares issued in an initial public
offering (IPO). In determining whether to enter an order for an IPO for any
client account, Invista considers the account's investment restrictions, risk
profile, asset composition and cash level. Accordingly, it is unlikely that
every client account will participate in every available IPO. Partially filled
orders for IPOs will be allocated to participating accounts in accordance with
the procedures set out above. Often, however, the amount of shares designated by
an underwriter for Invista's clients are insufficient to provide a meaningful
allocation to each participating account. In such cases, Invista will employ an
allocation system it feels treats all participating accounts fairly and
equitably over time.

The following describes the allocation process utilized by the Sub-Advisor for
the European Equity and Pacific Basin Funds:

Client monies are assigned to BT portfolio managers and are generally grouped
into product types. All portfolios within each product type will have similar
investment objectives, although individual portfolios may have investment
objectives and restrictions that differ to some extent from the overall
objectives for that product type.

The portfolio manager will decide, prior to trading, which products and
therefore which portfolios will take part in the subsequent allocation. All
portfolios within a product managed by a particular portfolio manager will
participate in the allocation except in the following circumstances:
o where client cash flow mean that a client's portfolio has to be traded
separately;
o where there are specific client restrictions which preclude an allocation;
o where a non-standard benchmark or target results in a security being deemed
unsuitable for that portfolio;
o where, in the case of sales, a particular portfolio does not hold the
security; and
o where the trade is partially filled, either for normal trading or for an
Initial Public Offering.
In these cases, if there is no indication on the order form as to priority of
allocation then BT will allocate on a pro-rata basis. Priority of allocation on
the order forms may be set due to sensitivity to transaction costs, tax status,
tolerance for small holding, tolerance for large holdings or specific exposures
(proximity to limits) and turnover considerations.

The following describes the allocation process utilized by the Sub-Advisor for
the Partners Aggressive Growth Fund:

Transactions for each portfolio account advised by Morgan Stanley generally are
completed independently. Morgan Stanley, however, may purchase or sell the same
securities or instruments for a number of portfolio accounts, including
portfolios of its affiliates, simultaneously. These accounts will include pooled
vehicles, including partnerships and investment companies for which Morgan
Stanley and related persons of Morgan Stanley act as investment manager and
administrator, and in which Morgan Stanley, its officers, employees and its
related persons have a financial interest, and accounts of pension plans
covering employees of Morgan Stanley and its affiliates ("Proprietary
Accounts"). When possible, orders for the same security are combined or
"batched" to facilitate test execution and to reduce brokerage commissions or
other costs. Morgan Stanley effects batched transactions in a manner designed to
ensure that no participating portfolio, including any Proprietary Account, is
favored over any other portfolio. Specifically, each portfolio (including the
Partners Aggressive Growth Fund) that participates in a batched transaction will
participate at the average share price for all of Morgan Stanley `s transactions
in that security on that business day, with respect to that batched order.
Securities purchased or sold in a batched transaction are allocated pro-rata,
when possible, to the participating portfolio accounts in proportion to the size
of the order placed for each account. Morgan Stanley may, however, increase or
decrease the amount of securities allocated to each account if necessary to
avoid holding odd-lot or small numbers of shares for particular portfolios.
Additionally, if Morgan Stanley is unable to fully execute a batched transaction
and Morgan Stanley determines that it would be impractical to allocate a small
number of securities among the accounts participating in the transaction on a
pro-rata basis, Morgan Stanley may allocate such securities in a manner
determined in good faith to be a fair allocation.

The following describes the allocation process utilized by the Sub-Advisor for
the Partners LargeCap Growth Fund:

Where Duncan-Hurst buys or sells the same security for two or more clients, it
may place concurrent orders with a single broker, to be executed together as a
single "block" in order to facilitate orderly and efficient execution. Whenever
Duncan-Hurst does so, each account on whose behalf an order was placed will
receive the average price and will bear a proportionate share of all transaction
costs, based on the size of that account's order. Clients receiving such
concurrent treatment may include investment limited partnerships of which
Duncan-Hurst is a general partner and accounts as to which Duncan-Hurst may
receive performance-based fees. In some cases, they may also include affiliates
of Duncan-Hurst.

The following describes the allocation process utilized by the Sub-Advisor for
the Partners MidCap Growth Fund:

Turner has developed an allocation system for limited opportunities: block
orders that cannot be filled in one day and IPOs. Allocation of all partially
filled trades will be done pro-rata, unless the small size would cause excessive
ticket charges. In that case, allocation will begin with the next account on the
rotational account listing. Any directed brokerage arrangement will result in
the inability of Turner to, in all cases, include trades for that particular
client in block orders if the block transaction is executed through a broker
other than the one that has been directed. The benefits of that kind of
transaction, a sharing of reduced cost and possible more attractive prices, will
not extend to the directed client. Allocations exceptions may be made if
documented and approved timely by the firm's compliance officer. Turner's
proprietary accounts may trade in the same block with client accounts, if it is
determined to be advantageous to the client to do so.

HOW TO PURCHASE SHARES

Each Fund, except the Tax-Exempt Bond Fund, offers investors four classes of
shares which bear sales charges in different forms and amounts: Class A, Class
B, Class C and Class R shares. The Tax-Exempt Bond Fund offers only Class A,
Class B and Class C shares.

Purchases are generally made by completing an Account Application or a Principal
Mutual Fund IRA Application and mailing it to Princor. Shares are issued at the
offering price next computed after the application is received at Princor's main
office and Princor receives the amount to be invested. Share certificates will
be only issued to shareholders upon request. Certificates are not available for
the Cash Management Fund.

Redemptions by shareholders investing by check will be effected only after
payment has been collected on the check, which may take up to 8 business days or
more. Investors considering redeeming or exchanging shares shortly after
purchase should pay for those shares with a certified check, bank cashier's
check or money order to avoid any delay in redemption, exchange or transfer.

Class A Shares. An investor who purchases less than $1 million of Class A shares
(except Class A shares of the Cash Management Fund) pays a sales charge at the
time of purchase. As a result, such shares are not subject to any charges when
they are redeemed. An investor who purchases $1 million or more of Class A
shares does not pay a sales charge at the time of purchase. However, a
redemption of such shares occurring within 18 months from the date of purchase
will be subject to a contingent deferred sales charge ("CDSC") at the rate of
.75% (.25% for the LargeCap Stock Index and Limited Term Bond Funds) the lesser
of the value of the shares redeemed (exclusive of reinvested dividend and
capital gain distributions) or the total cost of such shares. Shares subject to
the CDSC which are exchanged into another Principal Mutual Fund will continue to
be subject to the CDSC until the original 18 month period expires. However no
CDSC is payable with respect to redemption of Class A shares used to fund a
Principal Mutual Fund 401(a) or Principal Mutual Fund 401(k) retirement plan,
except redemptions resulting from the termination of the plan or transfer of
plan assets. In addition, the CDSC will be waived in connection with 1)
redemption of shares from retirement plans to satisfy minimum distribution rules
under the Code or 2) shares redeemed through a systematic withdrawal plan that
permits up to 10% of the value of a shareholder's Class A shares of a particular
Fund on the last business day of December of each year to be withdrawn
automatically in equal monthly installments throughout the year. Certain
purchases of Class A shares qualify for reduced sales charges. Class A shares
for each Fund, except the Cash Management Fund, currently bear a 12b-1 fee at
the annual rate of up to 0.25% (0.15% for the LargeCap Stock Index and Limited
Term Bond Funds) of the Fund's average net assets attributable to Class A
shares. See "Distribution Plan."

Class B Shares. Class B shares are purchased without an initial sales charge,
but are subject to a declining CDSC of up to 4% (1.25% for the LargeCap Stock
Index and Limited Term Bond Funds) if redeemed within six years. Class B shares
purchased under certain sponsored Principal Mutual Fund plans established after
February 1, 1998, are subject to a CDSC of up to 3% if redeemed within five
years of purchase. (See "Plans Other than Administered Employee Benefit Plans"
("AEBP") for discussion of sponsored Principal Mutual Fund plans.) See "Offering
Price of Funds' Shares." Class B shares bear a higher 12b-1 fee than Class A
shares, currently at the annual rate of up to 1.00% (.50% for the LargeCap Stock
Index and Limited Term Bond Funds) of the Fund's average net assets attributable
to Class B shares. See "Distribution Plan." Class B shares provide an investor
the benefit of putting all of the investor's dollars to work from the time the
investment is made, but (until conversion to Class A shares) have a higher
expense ratio and pay lower dividends than Class A shares due to the higher
12b-1 fee. Class B shares automatically convert into Class A shares, based on
relative net asset value (without a sales charge), seven years after the
purchase date. Class B shares acquired by exchange from Class B shares of
another Principal Mutual Fund convert into Class A shares based on the time of
the initial purchase. At the same time, a pro rata portion of all shares
purchased through reinvestment of dividends and distributions convert into Class
A shares, with that portion determined by the ratio that the shareholder's Class
B shares converting into Class A shares bears to the shareholder's total Class B
shares that were not acquired through dividends and distributions. The
conversion of Class B shares to Class A shares is subject to the continuing
availability of a ruling from the Internal Revenue Service or an opinion of
counsel that such conversions will not constitute taxable events for Federal tax
purposes. There can be no assurance that such ruling or opinion will be
available, and the conversion of Class B shares to Class A shares will not occur
if such ruling or opinion is not available. In such event, Class B shares would
continue to be subject to higher expenses than Class A shares for an indefinite
period.

Class C Shares. Class C shares are sold without the imposition of an initial
sales charge; however, Class C shares redeemed within one year of purchase are
subject to a CDSC of 1% (.5% for LargeCap Stock Index and Limited Term Bond
Funds). The charge is assessed on the amount equal to the lesser of the current
market value or the original purchase cost of the shares being redeemed. No CDSC
is imposed on increases in account value above the initial purchase price,
including shares derived from the reinvestment of dividends or capital gains
distributions. Class C shares do not convert to any other class of Fund shares.

Class C shares bear a higher 12b-1 fee than other Class shares. Currently Class
C share 12b-1 fees are set at the annual rate of up to 1.00% (.50% for the
LargeCap Stock Index and Limited Term Bond Funds) of the Fund's average net
assets. See "Distribution Plan." Class C shares provide an investor the benefit
of putting all of the investor's dollars to work from the time the investment is
made, but have a higher expense ratio and pay lower dividends than other Class
shares due to the higher 12b-1 fee. Class C shares do not convert into other
Class shares. Class C shares are subject to higher expenses than other Class
shares for an indefinite period.

Which arrangement between Class A, Class B and Class C Shares is better for an
investor? The decision as to which class of shares provides a more suitable
investment for an investor depends on a number of factors, including the amount
and intended length of the investment. Investors making investments that qualify
for reduced sales charges might consider Class A shares. Investors who prefer
not to pay an initial sales charge and who plan to hold their investment for
more than seven years might consider Class B shares. Orders from individuals for
Class B shares for $250,000 or more will be treated as orders for Class A shares
unless the shareholder provides written acknowledgment that the order should be
treated as an order for Class B shares. Sales personnel may receive different
compensation depending on which class of shares are purchased. If you prefer not
to pay an initial sales charge and you plan to hold your investment for greater
than one but less than seven years, you may prefer Class C shares.

Class R Shares. Class R shares are purchased without an initial sales charge or
a contingent deferred sales charge ("CDSC"). Class R shares bear a higher 12b-1
fee than Class A shares, currently at the annual rate of up to .75% (.65% for
the LargeCap Stock Index Fund) of the Fund's average net assets attributable to
Class R shares. See "Distribution and Shareholder Servicing Plans and Fees."
Class R shares provide an investor the benefit of putting all of the investor's
dollars to work from the time the investment is made, but (until conversion to
Class A shares) have a higher expense ratio and pay lower dividends than Class A
shares due to the higher 12b-1 fee. Class R shares automatically convert to
Class A shares, based on relative net asset value (without a sales charge), 49
months after the purchase date. Class R shares acquired by exchange from Class R
shares of another Principal Mutual Fund convert into Class A shares based on the
time of the initial purchase. (See "How to Exchange Shares Among Principal
Mutual Funds" in the Prospectus.) At the same time, a pro rata portion of all
shares purchased through reinvestment of dividends and distributions convert
into Class A shares, with that portion determined by the ratio that the
shareholder's Class R shares converting into Class A shares bears to the
shareholder's total Class R shares that were not acquired through dividends and
distributions. The conversion of Class R shares to Class A shares is subject to
the continuing availability of a ruling from the Internal Revenue Service or an
opinion of counsel that such conversions will not constitute taxable events for
Federal tax purposes. There can be no assurance that such ruling or opinion will
be available, and the conversion of Class R shares to Class A shares will not
occur if such ruling or opinion is not available. In such event, Class R shares
would continue to be subject to higher expenses that Class A shares for an
indefinite period.

Purchasing Class R Shares. Class R shares are offered only to individuals (and
his/her spouse, child, parent, grandchild and trusts primarily for their
benefit) who: receive lump sum distributions from retirement plans serviced by
Principal Life Insurance Company; or are participants in retirement and employer
welfare benefit plans serviced by Principal Life Insurance Company; or own
individual life or disability insurance policies issued by Principal Life
Insurance Company; or have mortgages which are serviced by Principal Life
Insurance Company; or are customers of Principal Bank; or have existing
Principal Mutual Fund Class R Share accounts. Generally, the initial amount to
be invested in a Principal Mutual Fund IRA is directly transferred to Princor
from the Administered Employee Benefit Plans ("AEBP"). However, in some cases
the investor purchases shares by check. If investing by check, shares are issued
at the offering price next computed after the completed application and check
are received at Princor's main office. Orders from individuals for Class R
shares that equal or exceed $500,000 are treated as orders for Class A shares,
unless accompanied by a written acknowledgment that the order should be treated
as an order for Class R shares. Class R shares are currently available through
certain registered representatives of Princor Financial Services Corporation who
are also employees of Principal Life Insurance Company.

OFFERING PRICE OF FUNDS' SHARES

The Funds offer their respective shares continuously through Princor, which is
the principal underwriter for the Funds and sells shares as agent on behalf of
the Funds. Princor may select other dealers through which shares of the Funds
may be sold. Certain dealers may not sell all classes of shares.

Class A shares
Class A shares of the Cash Management Fund is sold to the public at net asset
value; no sales charge applies to purchases of the Cash Management Fund. Class A
shares of the Growth-Oriented and Income-Oriented Funds, except the LargeCap
Stock Index and Limited Term Bond Funds, are sold to the public at the net asset
value plus a sales charge which ranges from a high 4.75% to a low of 0% of the
offering price (equivalent to a range of 4.99% to 0% of the net amount invested)
according to the schedule below. Class A shares of the LargeCap Stock Index and
Limited Term Bond Funds are sold to the public at the net asset value plus a
sales charge which ranges from a high of 1.50% to a low of 0% of the offering
price according to the schedule below. Selected dealers are allowed a concession
as shown. At Princor's discretion, the entire sales charge may at times be
reallowed to dealers. In some situations, depending on the services provided by
the dealer, the concession may be less. Any dealer allowance on purchases not
involving a sales charge is determined by Princor. Upon notice to all
broker-dealers with whom it has a selling agreement, Princor may allow to
broker-dealers electing to participate up to the full applicable sales charge,
as shown in the table below, during periods and for transactions specified in
such notice, and such reallowances may be based in whole or in part upon
attainment of minimum sales levels. Certain commercial banks may make shares of
the Funds available to their customers on an agency basis. Pursuant to the
agreements between Princor and such banks all or a portion of the sales charge
paid by a bank customer in connection with a purchase of Fund shares may be
retained by or remitted to the bank.

<TABLE>
<CAPTION>
Sales Charge for
All Funds Except Sales Charge for
LargeCap Stock Index and LargeCap Stock Index and
Limited Term Bond Funds Limited Term Bond Funds

Sales Charge as % of: Sales Charge as % of:
Offering Amount Offering Amount
Amount of Purchase Price Invested Price Invested

<S> <C> <C> <C> <C>
Less than $50,000 4.75% 4.99% 1.50% 1.52%
$50,000 but less than $100,000 4.25 4.44 1.25 1.27
$100,000 but less than $250,000 3.75 3.90 1.00 1.01
$250,000 but less than $500,000 2.50 2.56 0.75 0.76
$500,000 but less than $1,000,000 1.50 1.52 0.50 0.50
$1,000,000 or more No Sales Charge 0.00 No Sales Charge 0.00
</TABLE>

<TABLE>
<CAPTION>
Payroll Deduction Plan
Dealer Allowance as Dealer Allowance as
% of Offering Price % of Offering Price
All Funds LargeCap All Funds LargeCap
Except LargeCap Stock Index Except LargeCap Stock Index
Stock Index and Limited Stock Index and Limited
and Limited Term and Limited Term
Amount of Purchase Term Bond Funds Bond Funds Term Bond Funds Bond Funds

Rights of Accumulation. The applicable sales charge is determined by adding the
current net asset value of any Class A shares, Class B shares and Class C shares
already owned by the investor to the amount of the new purchase. The
corresponding percentage factor in the schedule is then applied to the entire
amount of the new purchase. For example, if an investor currently owns Class A,
Class B or Class C shares with a value of $5,000 and makes an additional
investment of $45,000 in Class A shares of a Growth-Oriented Fund (the total of
which equals $50,000), the charge applicable to the $45,000 investment would be
4.25% of the offering price. If the investor purchases shares of more than one
Principal Mutual Fund at the same time, those purchases are aggregated and added
to the net asset value of the shares of Principal Mutual Funds already owned by
the investor to determine the sales charge for the new purchase. Class A shares
of the Cash Management Fund are not counted in determining either the amount of
a new purchase or the current net asset value of shares already owned, unless
the shares of the Cash Management Fund were acquired in exchange for shares of
other Principal Mutual Funds. If the investor purchases shares from a
broker/dealer other than Princor, the dealer should be advised of any shares
already owned.

Investments made by an individual, or by an individual's spouse and dependent
children purchasing shares for their own account or by a trust primarily for the
benefit of such persons, or by a trustee or other fiduciary purchasing for a
single trust estate or single fiduciary account (including a pension,
profit-sharing, or other employee-benefit trust created pursuant to a plan
qualified under Section 401 of the Internal Revenue Code) will be treated as
investments made by a single investor in calculating the sales charge. In
addition, investments made through an employer by or on behalf of an employee
(including independent contractors) by means of payroll deductions or otherwise,
are also considered investments by a single investor in calculating the sales
charge. Other groups (as allowed by rules of the Securities and Exchange
Commission) may be considered for a reduced sales charge. An investor whose new
account qualifies for a reduced charge on the basis of other accounts owned by
the individual, spouse or children, should be certain to identify those accounts
at the time of the new application.

Statement of Intention (SOI). Another method is available by which a purchaser
may qualify for a reduced sales charge on the purchase of Class A shares of the
Funds. A purchaser may execute an SOI indicating the total amount (excluding
reinvested dividends and capital gains distributions) intended to be invested
(including all investments for the account of the spouse and dependent children
or trusts for the benefit of such persons) in Class A shares (except Class A
shares of the Cash Management Fund), Class B shares and Class C shares of the
Funds within a thirteen-month period (two-year period if the intended investment
is made by a trustee of a Section 401(a) plan or is equal to or greater than $1
million). The SOI may be submitted by a shareholder other than a trustee of a
Principal Mutual Fund 401(a) plan, within 90 days after the date of the first
purchase to be included within the SOI period. A trustee of a Principal Mutual
Fund 401(a) plan must submit the SOI at the time the first plan purchase is
made; the SOI may not be submitted after the initial plan purchase and the 90
day backdating is not available. The SOI period begins on the date of the first
purchase included for purposes of satisfying the statement. When an existing
shareholder submits an SOI, the net asset value of all Class A shares (except
Class A shares of the Cash Management Fund), Class B shares and Class C shares
in that shareholder's account or accounts combined for rights of accumulation
purposes, is added to the amount that has been indicated will be invested during
the applicable period, and the sales charge applicable to all purchases of Class
A shares made under the SOI is the sales charge which applies to a single
purchase of this total amount.

An SOI may be entered into for any amount provided such amount, when added to
the net asset value of any shares already held, equals or is in excess of the
amount needed to qualify for a reduced sales charge. In the event a shareholder
invests an amount in excess of the indicated amount, such excess is allowed any
further reduced sales charge for which it qualifies.

The SOI provides for a price adjustment if the amount actually invested is less
than the amount specified therein. Sufficient Class A shares belonging to the
shareholder, other than a shareholder that is 401(a) qualified plan trustee, are
held in escrow in the shareholder's account by Princor to make up any difference
in sales charges based on the amount actually purchased. If the intended
investment is completed within the thirteen-month period (or two-year period),
such shares are released to the shareholder. If the total intended investment is
not completed within that period shares are, to the extent necessary, redeemed
and the proceeds used to pay the additional sales charge due. A shareholder that
is 401(a) qualified plan trustee is billed by Princor Financial Services
Corporation for any additional sales charge due at the end of the two-year
period. In any event, the sales charge applicable to these purchases is no more
than the applicable sales charge had the shareholder made all of such purchases
at one time. The SOI does not constitute an obligation on the shareholder to
purchase, nor the Funds to sell, the amount indicated.

Purchases at Net Asset Value.
A Fund's Class A shares may be purchased without a sales charge:
o by its Directors, Principal Life and its subsidiaries and affiliates, and
their employees, officers, directors (active or retired), brokers or
agents. This also includes their immediate family members and trusts for
the benefit of these individuals;
o by the Principal Employees' Credit Union;
o by non-ERISA clients of Invista and Principal Capital Management LLC;
o by any employee or Registered Representative (and their employees) of an
authorized broker-dealer;
o through a "wrap account" offered by Princor or through broker-dealers,
investment advisors and other financial institutions that have entered into
an agreement with Princor which includes a requirement that such shares be
sold for the benefit of clients participating in a "wrap account" or
similar program under which clients pay a fee to the broker-dealer,
investment advisor or financial institution;
o by unit investment trusts sponsored by Principal Life and/or its
subsidiaries or affiliates;
o by certain employee welfare benefit plan customers of Principal Life with
Plan Deposit Accounts;
o by participants who receive distributions from certain annuity contracts
offered by Principal Life (except for shares of Tax-Exempt Bond Fund);
o to the extent the investment represents the proceeds of a total surrender
of certain Principal Life issued unregistered group annuity contracts if
Principal Life waives any applicable CDSC or other contract surrender
charge;
o by using cash payments received from Principal Bank under its awards
program;
o to the extent the investment represents redemption proceeds from certain
unregistered group annuity contracts issued by Principal Life to fund an
employer's 401(a) plan where such proceeds are used to fund the employer's
401(a) plan;
o to the extent the purchase proceeds represent a distribution from a
terminating 401(a) plan if the employer or plan trustee has entered into a
written agreement with Princor permitting the group solicitation of active
employees/participants. Such purchases are subject to the CDSC which
applies to purchases of $1 million or more as described above; and
o to fund nonqualified plans administered by Principal Life pursuant to a
written service agreement.

Class A shares may also be purchased without a sales charge if your Registered
Representative has recently become affiliated with a broker-dealer authorized to
sell shares of the Principal Mutual Funds. The following conditions must be met:
o your purchase of Class A shares must take place within the first 180 days
of your Registered Representative's affiliation with the authorized
broker-dealer;
o your investment must represent the sales proceeds from other mutual fund
shares (you must have paid a front-end sales charge or a CDSC) and the sale
must occur within the 180 day period; and
o you must indicate on your Principal Mutual Fund application that you are
eligible for waiver of the front-end sales charge.
o you must send us either:
o the check for the sales proceeds (endorsed to Principal Mutual Funds) or
o a copy of the confirmation statement from the other mutual fund showing
the sale transaction. If you place your order to buy Principal Mutual
Fund shares on the telephone, you must send us a copy of the
confirmation within 21 days of placing the order. If we do not receive
the confirmation within 21 days, we will sell enough of your Class A
shares to pay the sales charge that otherwise would have been charged.

Each of the Funds, except Principal Tax-Exempt Bond Fund, have obtained an
exemptive order from the Securities and Exchange Commission ("SEC") to permit
each Fund to offer its shares at net asset value to participants of certain
annuity contracts issued by Principal Life Insurance Company. In addition, each
of these Funds are available at net asset value to the extent the investment
represents the proceeds from a total surrender of certain unregistered annuity
contracts issued by Principal Life Insurance Company and for which Principal
Life Insurance Company waives any applicable contingent deferred sales charges
or other contract surrender charges.

During the period beginning December 1, 2000 and ending January 31, 2001,
investors may purchase Class A shares of the Funds at net asset value to the
extent that this investment represents the proceeds of a redemption, within the
preceding 60 days, of shares (the purchase price of which shares included a
front-end sales charge on the redemption of which was subject to a contingent
deferred sales charge) of another investment company. This provision does not
apply to purchase of Class A shares used to fund a defined contribution plan.
When making a purchase at net asset value pursuant to this provision, the
investor must indicate on the account application that the purchase qualifies
for a net asset value purchase and must forward to Princor either (i) the
redemption check representing the proceeds of the shares redeemed, endorsed to
the order of Princor Financial Services Corporation, or (ii) a copy of the
confirmation from the other investment company showing the redemption
transactions. In the case of a wire purchase pursuant to this provision, a copy
of the confirmation from the other investment company showing the redemption
must be forwarded to and received by Princor within 21 days following the date
of purchase. If the confirmation is not provided within the 21-day period, a
sufficient number of shares will be redeemed from the shareholder's account to
pay the otherwise applicable sales charge.

Purchases at a Reduced Sales Charge. A reduced sales charge is also available
for purchases of Class A shares of the Funds, except the LargeCap Stock Index
and Limited Term Bond Funds, to the extent that the investment represents the
death benefit proceeds of one or more life insurance policies or annuity
contracts (other than an annuity contract issued to fund an employer-sponsored
retirement plan that is not an SEP, salary deferral 403(b) plan or HR-10 plan)
of which the shareholder is a beneficiary if one or more of such policies or
contracts is issued by Principal Life Insurance Company, or any directly or
indirectly owned subsidiary of Principal Life Insurance Company, and such
investment is made in any Principal Mutual Fund within one year after the date
of death of the insured. (Shareholders should seek advice from their tax
advisors regarding the tax consequences of distributions from annuity
contracts.) Such shares may be purchased at net asset value plus a sales charge
which ranges from a high of 2.50% to a low of 0% of the offering price
(equivalent to a range of 2.56% to 0% of the net amount invested) according to
the schedule below:

<TABLE>
<CAPTION>
Sales Charge as a % of:

Net Dealer Allowance as %
Offering Amount of Offering
Amount of Purchase Price Invested Price

<S> <C> <C> <C> <C>
Less than $500,000 2.50% 2.56% 2.10%
$500,000 but less than $1,000,000 1.50 1.52 1.25
$1,000,000 or more No Sales Charge 0.00 0.75
</TABLE>

Sales Charges for Employer-Sponsored Plans

Administered Employee Benefit Plans. Class A shares of the Growth-Oriented Funds
(except LargeCap Stock Index Fund) and Income-Oriented Funds (except Limited
Term Bond Fund and, in certain circumstances, Tax-Exempt Bond Fund which is not
available for certain retirement plans) are sold at net asset value to stock
bonus, pension or profit sharing plans that meet the requirements for
qualification under Section 401 of the Internal Revenue Code of 1986, as
amended, certain Section 403(b) Plans, Section 457 Plans and other Non-qualified
Plans administered by Principal Life Insurance Company pursuant to a written
service agreement ("Administered Employee Benefit Plans"). The service agreement
between Principal Life Insurance Company and the employer relating to the
administration of the plan includes a charge payable by the employer for any
commissions which Princor is authorized to pay in connection with such sales.
Principal Life Insurance Company in turn pays the amount of these charges to
Princor. The commission payable by Princor in connection with any such sale may
be determined in accordance with one of the following schedules:

<TABLE>
<CAPTION>
Schedule 1
Amount Payable by Employer as a Percent
Amount of Plan Contributions* in Each Year of Plan Contributions

<S> <C> <C>
The first $5,000 4.50%
The next $5,000 3.00
The next $5,000 1.70
The next $35,000 1.40
The next $50,000 0.90
The next $400,000 0.60
Excess over $500,000 0.25

Schedule 2
The first $50,000 3.00%
The next $50,000 2.00
The next $400,000 1.00
The next $2,500,000 0.50
Excess over $3,000,000 0.25

<FN>
* Plan contributions directed to an annuity contract issued by Principal
Life Insurance Company to fund the plan are combined with contributions
directed to the Funds to determine the applicable commission charge.
</FN>
</TABLE>

Generally, the commission level described in Schedule 2 apply for salary
deferral Plans and the commission level described in Schedule 1 apply to other
plans. No commission will be payable by the employer if shares of the Funds used
to fund an Administered Employee Benefit Plan are purchased through a registered
representative of Princor Financial Services Corporation who is also a Group
Insurance Representative employee of Principal Life Insurance Company.

Plans Other Than Administered Employee Benefit Plans. Shares of the Funds are
offered to fund certain sponsored Princor plans. These plans can be divided into
three categories: Retirement plans meeting the requirements of Section 401 of
the Internal Revenue Code (e.g. 401(k) Plans, Profit Sharing Plans and Money
Purchase Pension Plans); Group Solicited Plan Terminations; and other
employer-sponsored retirement plans (SIMPLE IRA Plans, Simplified Employee
Pension Plans, Salary Reduction Simplified Employee Pension Plans, Non-Qualified
Deferred Compensation Plans, Payroll Deduction Plans ("PDP") and certain
Association Plan.

Princor 401 Plans
When establishing a Princor Section 401 Plan, the employer chooses whether
to fund the plan with either Class A shares, Class B shares or Class C
shares. If Class A shares are used to fund the plan, all plan investments
are treated as made by a single investor to determine whether a reduced
sales charge is available. The regular sales charge table for Class A
shares applies to purchases $250,000 or more. If Class B shares are used to
fund the plan, contributions into the plan after the plan assets amount to
$250,000 or more, are used to purchase Class A shares unless the plan
trustee directs otherwise. Plan assets are not combined with investments
made outside of the plan to determine the sales charge applicable to such
investments. Investments made by plan participants outside of the plan are
not included with plan assets to determine the sales charge applicable to
the plan.

Group Solicited Plan Terminations
Occasionally, an employer terminates a Section 401 Plan. If the employer or
plan trustee enters into a written agreement with Princor permitting the
group solicitation of the employees/plan participants, the proceeds of
distributions from such plans are eligible to purchase shares of the funds
at net asset value. A redemption of such shares within 18 months after
purchase are subject to a contingent deferred sales charge ("CDSC") at the
rate of .75% (.25% for the LargeCap Stock Index and Limited Term Bond
Funds) of the lesser of the value of the shares redeemed (exclusive of
reinvested dividends and capital gain distributions) or the total cost of
such shares. The CDSC is waived in connection with (1) redemption of shares
to satisfy IRS minimum distribution rules or (2) shares redeemed through a
systematic withdrawal plan that permits up to 10% of the value of the
shareholder's Class A shares of a Fund on the last business day of December
each year to be withdrawn automatically in equal monthly installments
throughout the year.

Other Employer Sponsored Princor Plans
When establishing an employer-sponsored Princor plan, the employer chooses
whether to fund the plan with either Class A shares, Class B shares or
Class C shares. If Class A shares are used to fund the plan, all plan
investments are treated as made by a single investor to determine whether a
reduced sales charge is available. The regular sales charge table for Class
A shares applies to purchases of $250,000 or more. If Class B shares are
used to fund the plan and a plan participant has $250,000 or more invested
in Class B shares, Class A shares are purchased with plan contributions
attributable to the plan participant, unless the plan participant elects
otherwise. Plan assets are not combined with investments made outside of
the plan to determine the sales charge applicable to such investments.
Investments made by plan participants outside of the plan are not included
with plan assets to determine the sales charge applicable to the plan.

Shares of the funds are also available to participants of Princor 403(b) plans
at the same sales charge levels available to other employer-sponsored Princor
plans described above. However, contributions by plan participants are not
combined to determine sales charges.

The Funds reserve the right to discontinue offering shares at net asset value
and/or at a reduced sales charge at any time for new accounts and upon 60-days
notice to shareholders of existing accounts. Other types of sponsored plans may
be added in the future.

Class B shares
Class B shares are sold without an initial sales charge, although a CDSC is
imposed if you redeem shares within six years of purchase. Class B shares
purchased under certain sponsored Princor plans established after February 1,
1998, are subject to a CDSC of up to 3% if redeemed within five years of
purchase. (See "Plans Other than Administered Employee Benefit Plans" above for
discussion of sponsored Princor plans.) The following types of shares may be
redeemed without charge at any time: (i) shares acquired by reinvestment of
distributions and (ii) shares otherwise exempt from the CDSC, as described
below. Subject to the foregoing exclusions, the amount of the charge is
determined as a percentage of the lesser of the current market value or the cost
of the shares being redeemed. Therefore, when a share is redeemed, any increase
in its value above the initial purchase price is not subject to any CDSC. The
amount of the CDSC will depend on the number of years since you invested and the
dollar amount being redeemed, according to the following table:

Contingent Deferred Sales Charge as a
Percentage of Dollar Amount Subject to Charge

<TABLE>
<CAPTION>
For Certain Sponsored Plans
Commenced After 2/1/98

All Funds All Funds
Except LargeCap LargeCap Stock Except LargeCap LargeCap Stock
Stock Index and Index and Stock Index and Index and
Years Since Purchase Limited Term Limited Term Limited Term Limited Term
Payments Made Bond Funds Bond Funds Bond Funds Bond Funds

<S> <C> <C> <C> <C>
2 years or less 4.00% 1.25% 3.00% .75%
more than 2 years, up to 4 years 3.00 0.75 2.00 .50
more than 4 years, up to 5 years 2.00 0.50 1.00 .25
more than 5 years, up to 6 years 1.00 0.25 None None
more than 6 years None None None None
</TABLE>

In determining whether a CDSC is payable on any redemption, the Fund first
redeems shares not subject to any charge, and then shares held longest during
the six (five) year period. For information on how sales charges are calculated
if shares are exchanged, see "How To Exchange Shares Among Principal Mutual
Funds" in the Prospectus.

The CDSC is waived on redemptions of Class B shares in connection with the
following types of transactions:
a. Shares redeemed due to a shareholder's death;
b. Shares redeemed due to the shareholder's disability, as defined in the
Internal Revenue Code of 1986 (the "Code"), as amended;
c. Shares redeemed from retirement plans to satisfy minimum distribution rules
or to satisfy substantially equal periodic payment calculation rules under
the Code;
d. Shares redeemed to pay surrender charges;
e. Shares redeemed to pay retirement plan fees;
f. Shares redeemed involuntarily from small balance accounts (values of less
than $300);
g. Shares redeemed through a systematic withdrawal plan that permits up to 10%
of the value of a shareholder's Class B shares of a particular Fund on the
last business day of December of each year to be withdrawn automatically in
equal monthly installments throughout the year;
h. Shares redeemed from a retirement plan to assure the plan complies with
Sections 401(k), 401(m), 408(k) and 415 of the Code; or
i. Shares redeemed from retirement plans qualified under Section 401(a) of the
Code due to the plan participant's death, disability, retirement or
separation from service after attaining age 55.

<TABLE>
<CAPTION>
Selected dealers may be paid a concession as shown: % of Offering Price

<S> <C> <C>
All purchases other than through Payroll Deduction Plans (PDP)
All Funds except Cash Management, LargeCap Stock Index and Limited Term Bond 4.00%
LargeCap Stock Index and Limited Term Bond 1.25%
PDP
All Funds except Cash Management, LargeCap Stock Index and Limited Term Bond 3.00%
LargeCap Stock Index and Limited Term Bond 0.75%
</TABLE>

Class C Shares
Class C shares are sold without a sales charge; however, Class C shares redeemed
within one year of purchase are subject to a CDSC of 1% (.5% for LargeCap Stock
Index and Limited Term Bond Funds). The charge is assessed on the amount equal
to the lesser of the current market value or the original purchase cost of the
shares being redeemed. The amount of the CDSC, if any, is calculated as a
percentage of the amount being redeemed according to the following table.

<TABLE>
<CAPTION>
Contingent Deferred Sales Charge as a
Percentage of Dollar Amount Subject to Charge

For Certain Sponsored Plans
Commenced After 2/1/98

For the purpose of determining the holding period of Class C shares, all
payments during a month are aggregated and considered to have be made on the
first day of that month. In processing redemptions of Class C shares, the Fund
first redeems shares not subject to any CDSC, and then shares held for the
shortest period of time during the one-year period. As a result, you pay the
lowest possible CDSC.

The CDSC on Class C shares may be waived or reduced as follows
o for automatic redemptions (Periodic Withdrawal Plans) (limited to 10% of
the value of the account);
o if the redemption results from the death or a total and permanent
disability (as defined in Section 72 of the Internal Revenue Code)
occurring after the purchase of the shares being redeemed of a shareholder
or participant in an employer-sponsored retirement plan;
o if the distribution is part of a series of substantially equal payments
made over the life expectancy of the participant or the joint life
expectancy of the participant and his or her beneficiary; or
o if the distribution is to a participant in an employer-sponsored retirement
plan and is
o a return of excess employee deferrals or contributions,
o a qualifying hardship distribution as defined by the Code,
o from a termination of employment,
o in the form of a loan to a participant in a plan which permits loans,
or
o from qualified defined contribution plan and represents a
participant's directed transfer (provided that this privilege has been
pre-authorized through a prior agreement with PFD regarding
participant directed transfers).

The CDSC may be waived or reduced for either non-retirement or retirement plan
accounts if the redemption is made pursuant to the Fund's right to liquidate or
involuntarily redeem shares in a shareholder's account. The CDSC is not
applicable if the selling broker-dealer elects, with Princor's approval, to
waive receipt of the commission normally paid at the time of the sale.

Class C shares of the Cash Management Fund may be purchased only by exchange
from other Class C share accounts. Class C shares do not convert into any other
Class shares. Class C shares provide you the benefit of putting all your dollars
to work from the time of investment, but have higher ongoing fees and lower
dividends than Class A shares.

<TABLE>
<CAPTION>
Selected dealers may be paid a concession as shown: % of Offering Price

<S> <C> <C>
All purchases other than through Payroll Deduction Plans (PDP)
All Funds except Cash Management, LargeCap Stock Index and Limited Term Bond 1.00%
LargeCap Stock Index and Limited Term Bond 0.50%
PDP
All Funds except Cash Management, LargeCap Stock Index and Limited Term Bond 1.00%
LargeCap Stock Index and Limited Term Bond 0.50%
</TABLE>

As principal underwriter, Princor received underwriting fees from the sale of
shares for the periods indicated as follows:
<TABLE>
<CAPTION>
Underwriting Fees for
Fiscal Years Ended October 31,

Fund 1999 1998 1997

<S> <C> <C> <C>
Balanced Fund $ 689,518 $ 716,315 $ 518,345
Blue Chip Fund 1,419,225 1,230, 098 816,203
Bond Fund 800,916 887,870 582,903
Capital Value Fund 1,647,688 1,769,043 1,383,995
Cash Management Fund 76,773 19,171 14,123
Government Securities Income Fund 940,825 846,821 737,229
Growth Fund 2,515,833 2,079,726 1,548,696
High Yield Fund 200,747 335,156 321,051
International Emerging Markets Fund 111,950 114,325 33,588(1)
International Fund 1,032,623 1,369,016 1,524,740
International SmallCap Fund 156,120 197,039 38,421(1)
Limited Term Bond Fund 89,515 77,191 50,773
MidCap Fund 1,677,041 2,447,638 2,152,664
Real Estate Fund 50,841 53,280(2) N/A
SmallCap Fund 453,831 398,391(2) N/A
Tax-Exempt Bond Fund 576,841 667,756 558,697
Utilities Fund 513,501 339,353 169,904
<FN>
(1) Period from August 14, 1997 (Date Operations Commenced) through
October 31, 1997.
(2) Period from December 11, 1997 (Date Operations Commenced) through
October 31, 1998.
</FN>
</TABLE>

DISTRIBUTION PLAN

Rule 12b-1 of the Investment Company Act of 1940 (the "Act"), as amended,
permits a mutual fund to finance distribution activities and bear expenses
associated with the distribution of its shares provided that any payments made
by the Fund are made pursuant to a written plan adopted in accordance with the
Rule. A majority of the Board of Directors of each Fund, including a majority of
the Directors who have no direct or indirect financial interest in the operation
of the Plan or any agreements related to the Plan and who are not "interested
persons" as defined in the Act, adopted the Distribution Plans as described
below. No such Plan was adopted for Class A shares of the Cash Management Fund.
Shareholders of each class of shares of each Fund approved the adoption of the
Plan for their respective class of shares.

Class A Distribution Plan. Each of the Funds, except the Cash Management Fund,
has adopted a distribution plan for the Class A shares. The Class A Plan
provides that the Fund makes payments from its assets to Princor pursuant to
this Plan to compensate Princor and other selling Dealers for providing
shareholder services to existing Fund shareholders and rendering assistance in
the distribution and promotion of the Fund Class A shares to the public. The
Fund pays Princor a fee after the end of each month at an annual rate no greater
than 0.25% (.15% for the LargeCap Stock Index and Limited Term Bond Funds) of
the daily net asset value of the Fund. Princor retains such amounts as are
appropriate to compensate for actual expenses incurred in distributing and
promoting the sale of the Fund shares to the public but may remit on a
continuous basis up to .25% (.15% for the LargeCap Stock Index and Limited Term
Bond Funds) to Registered Representatives and other selected Dealers (including
for this purpose, certain financial institutions) as a trail fee in recognition
of their services and assistance.

Class B Distribution Plan. Each Class B Plan provides for payments by the Fund
to Princor at the annual rate of up to 1.00% (.50% for the LargeCap Stock Index
and Limited Term Bond Funds) of the Fund's average net asset attributable to
Class B shares. Princor also receives the proceeds of any CDSC imposed on
redemptions of such shares.

Although Class B shares are sold without an initial sales charge, Princor pays a
sales commission equal to 4.00% (3.00% for certain sponsored plans or 1.25% for
the LargeCap Stock Index and Limited Term Bond Funds) of the amount invested to
dealers who sell such shares. These commissions are not paid on exchanges from
other Principal Mutual Funds. In addition, Princor may remit on a continuous
basis up to .25% (.15% for the LargeCap Stock Index and Limited Term Bond Funds)
to the Registered Representatives and other selected Dealers (including for this
purpose, certain financial institutions) as a trail fee in recognition of their
services and assistance.

Class C Distribution Plan. Each Class C Plan provides for payments by the Fund
to Princor at the annual rate of up to 1.00% (.50% for the LargeCap Stock Index
and Limited Term Bond Funds) of the Fund's average net asset attributable to
Class C shares. Princor also receives the proceeds of any CDSC imposed on
redemptions of such shares.

Class C shares are sold without an initial sales charge. Princor may remit on a
continuous basis up to 1.00% (.50% for the LargeCap Stock Index and Limited Term
Bond Funds) to the Registered Representatives and other selected Dealers
(including for this purpose, certain financial institutions) as a trail fee in
recognition of their services and assistance.

Class R Distribution Plan. Each of the Funds, except the Tax-Exempt Bond Fund,
has adopted a distribution plan for the Class R shares. Each Class R Plan
(except the LargeCap Stock Index Fund) provides for payments by the Fund to
Princor at the annual rate of up to .75% of the Fund's average net assets
attributable to Class R shares. The Class R Plan for the LargeCap Stock Index
Fund provides for payments from the Fund to Princor at the annual rate of up to
.65% of the Fund's average net assets attributable to Class R shares

Although Class R shares are sold without an initial sales charge, Princor incurs
certain distribution expenses. In addition, Princor may remit on a continuous
basis up to .25% to Registered Representatives and other selected Dealers
(including, for this purpose, certain financial institutions) as a trail fee in
recognition of their ongoing services and assistance.

General Information Regarding Distribution Plans. A representative of Princor
provides to each Fund's Board of Directors, and the Board reviews, at least
quarterly, a written report of the amounts expended pursuant to the Plans and
the purposes for which such expenditures were made.

If expenses under a Class A, Class B or Class R Plan exceed the compensation
limit for Princor described in the Plan in any one fiscal year, the Fund does
not carry over such expenses to the next fiscal year. The Funds have no legal
obligation to pay any amount pursuant to these Plans that exceeds the
compensation limit. The Funds do not pay, directly or indirectly, interest,
carrying charges, or other financing costs in connection with these Plans. If
the aggregate payments received by Princor under these Plans in any fiscal year
exceed the expenditures made by Princor in that year pursuant to the Plan,
Princor promptly reimburses the Fund for the amount of the excess.

The Funds pay Princor the compensation described in the Class C Plan. The amount
of the payment and the distribution expenses are reviewed annually by the Board
of Directors of each Fund.

The amount received from each Fund and retained by Princor during the year ended
October 31, 1999 and the manner in which such amounts were spent pursuant to the
Class A Distribution Plan for the last fiscal period of each of the Funds were
as follows:
<TABLE>
<CAPTION>
Expenditures

Prospectus and Registered
Shareholder Salaries Representative
Amount Report Sales & Sales Service Total
Fund Retained Printing Brochures Overhead Materials Fees Expenditures

<S> <C> <C> <C> <C> <C> <C> <C>
Balanced $ 281,544 $ 11,194 $12,931 $ 124,364 $14,319 $118,736 $ 281,544
Blue Chip 398,224 15,688 16,313 186,708 20,675 158,840 398,224
Bond 377,708 13,024 13,263 138,124 16,779 196,518 377,708
Capital Value 1,009,068 26,762 25,938 248,032 34,818 673,518 1,009,068
Government Securities Income 588,420 14,355 15,455 160,619 18,754 379,237 588,420
Growth 1,142,540 36,918 33,145 307,895 47,162 717,419 1,142,540
High Yield 81,018 3,988 4,787 49,543 5,266 17,433 81,018
International Emerging Markets 25,107 1,392 2,236 17,745 2,465 1,269 25,107
International 672,611 21,377 26,347 210,368 32,949 381,569 672,611
International SmallCap 42,474 2,490 3,692 28,608 4,190 3,494 42,474
Limited Term Bond 40,320 2,304 2,911 25,896 2,971 6,238 40,320
MidCap 845,826 27,815 26,807 249,771 37,042 504,390 845,826
Real Estate 15,770 912 1,276 12,034 1,158 389 15,770
SmallCap 75,376 4,656 5,144 48,854 6,132 10,590 75,376
Tax-Exempt Bond 496,651 12,614 14,795 151,653 16,572 301,017 496,651
Utilities 235,289 9,153 11,126 102,293 11,858 100,859 235,289
</TABLE>

The amount received from each Fund and retained by Princor during the period
ended October 31, 1999 and the manner in which such amounts were spent pursuant
to the Class B Distribution Plan for the last fiscal period of each of the Funds
were as follows:

<TABLE>
<CAPTION>
Expenditures

Prospectus and Registered
Shareholder Salaries Representative
Amount Report Sales & Sales Service Total
Fund Retained Printing Brochures Overhead Materials Fees Commissions Expenditures

<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balanced $198,343 $5,586 $ 3,744 $64,090 $ 7,209 $28,814 $ 88,901 $198,343
Blue Chip 418,361 10,834 7,262 91,904 14,143 64,340 229,878 418,361
Bond 229,930 6,180 4,157 68,540 8,077 35,695 107,282 229,930
Capital Value 439,339 10,779 7,245 101,434 14,024 84,401 221,456 439,339
Cash Management 15,843 879 573 8,668 1,103 4,620 0 15,843
Government Securities Income 258,662 5,564 3,720 64,241 7,235 39,721 138,182 258,662
Growth 751,729 17,277 11,289 141,284 21,888 142,742 417,249 751,729
High Yield 75,683 3,148 2,217 41,591 4,261 9,282 15,185 75,683
International Emerging Markets 33,938 1,681 1,144 21,563 2,197 1,360 5,993 33,938
International 342,736 10,269 6,885 95,233 13,145 81,155 136,049 342,736
International SmallCap 69,817 3,427 2,358 40,517 4,534 5,900 13,081 69,817
Limited Term Bond 11,986 505 334 9,324 648 479 697 11,986
MidCap 480,422 12,406 8,747 114,879 16,753 123,863 203,775 480,422
Real Estate 25,863 1,345 923 19,225 1,789 369 2,212 25,863
SmallCap 85,272 3,167 2,129 33,866 4,116 5,674 36,320 85,272
Tax-Exempt Bond 78,975 2,140 1,412 26,272 2,774 18,452 27,925 78,975
Utilities 129,593 4,113 2,750 47,240 5,329 16,749 53,410 129,593
</TABLE>

The amount received from each Fund and retained by Princor during the period
ended October 31, 1999 and the manner in which such amounts were spent pursuant
to the Class C Distribution Plan for the last fiscal period of each of the Funds
were as follows:

<TABLE>
<CAPTION>
Expenditures

Prospectus and Registered
Shareholder Salaries Representative
Amount Report Sales & Sales Service Total
Fund Retained Printing Brochures Overhead Materials Fees Commissions Expenditures

<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balanced $553 $205 $ 82 $19 $ 93 $0 $154 $553
Blue Chip 626 267 107 14 121 0 116 626
Bond 589 188 75 19 85 0 223 589
Capital Value 454 184 74 11 83 0 103 454
Cash Management 371 65 26 4 30 0 245 371
Government Securities Income 680 224 90 27 101 0 238 680
Growth 871 373 149 16 169 0 164 871
High Yield 450 76 30 34 34 0 276 450
International Emerging Markets 333 77 31 19 35 0 172 333
International 459 141 56 11 64 0 187 459
International SmallCap 408 142 57 29 64 0 117 408
Limited Term Bond 679 174 69 59 78 0 298 679
MidCap 515 196 78 12 88 0 141 515
Real Estate 325 48 19 25 22 0 210 325
SmallCap 468 186 75 16 84 0 107 468
Tax-Exempt Bond 390 85 34 64 39 0 168 390
Utilities 575 202 81 20 91 0 181 575
</TABLE>

The amount received from each Fund and retained by Princor during the period
ended October 31, 1999 and the manner in which such amounts were spent pursuant
to the Class R Distribution Plan for the last fiscal period of each of the Funds
were as follows:

<TABLE>
<CAPTION>
Expenditures

Prospectus and Registered
Shareholder Representative Underwriter's
Amount Report Sales Sales Service Salaries and Total
Fund Retained Printing Brochures Materials Fees Overhead Expenditures

<S> <C> <C> <C> <C> <C> <C> <C>
Balanced $165,857 $5,852 $4,044 $ 8,019 $ 57,285 $ 90,657 $165,857
Blue Chip 320,689 8,641 5,912 11,685 107,005 187,446 320,689
Bond 99,448 3,709 2,550 5,021 37,080 51,087 99,448
Capital Value 270,170 7,949 5,508 10,814 108,796 137,103 270,170
Cash Management 61,325 1,596 1,071 2,104 30,279 26,276 61,325
Government Securities Income 71,106 2,747 1,842 3,692 25,910 36,915 71,106
Growth 301,974 7,315 4,958 9,891 96,761 183,048 301,974
High Yield 17,181 1,566 1,056 2,111 6,831 5,618 17,181
International Emerging Markets 8,084 767 484 943 857 5,033 8,084
International 142,372 5,161 3,588 7,077 51,402 75,143 142,372
International SmallCap 10,270 730 477 949 1,241 6,873 10,270
Limited Term Bond 20,129 1,684 1,193 2,386 5,961 8,905 20,129
MidCap 175,791 6,275 4,354 8,534 64,347 92,281 175,791
Real Estate 15,022 2,344 1,493 2,910 1,315 6,959 15,022
SmallCap 50,365 2,393 1,549 3,032 6,951 36,439 50,365
Utilities 46,756 1,941 1,287 2,578 10,898 30,051 46,756
</TABLE>

A Plan may be terminated at any time by vote of a majority of the Directors who
are not interested persons (as defined in the Act), or by vote of a majority of
the outstanding voting securities of the class of shares of a Fund to which the
Plan relates. Any change in a Plan that would materially increase the
distribution expenses of a class of shares of a Fund provided for in the Plan
requires approval of the shareholders of the class of shares to which such
increase would relate.

While a Distribution Plan is in effect for a Fund, the selection and nomination
of Directors who are not interested persons of that Fund is at the discretion of
the Directors who are not interested persons.

Each Plan continues in effect from year to year as long as its continuance is
specifically approved at least annually by a majority vote of the directors of
the Fund including a majority of the non-interested directors. The Plans for
Class A, B, C and R shares were last approved by the Boards of Directors of all
Funds (except European Equity, Pacific Basin and Tax-Exempt Bond), including a
majority of the non-interested directors, on December 13, 1999. The Board of
Directors of the Tax-Exempt Bond Fund, including a majority of the
non-interested directors, approved Plans for Class A, B and C shares on December
13, 1999. The Plans for Class A, B, C and R shares were approved by the Boards
of Directors of the European Equity and Pacific Basin Funds, including a
majority of the non-interested directors, on March 13, 2000.

DETERMINATION OF NET ASSET VALUE OF FUNDS' SHARES

Growth-Oriented and Income-Oriented Funds

The share price of each class of the Growth-Oriented and Income-Oriented Funds
is calculated each day that the New York Stock Exchange is open. The Funds treat
as customary national business holidays the days when the New York Stock
Exchange is closed (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 share price for each class of shares for each Fund is determined by dividing
the value of securities in the Fund's investment portfolio plus all other assets
attributable to that class, less all liabilities attributable to that class, by
the number of Fund shares of that class outstanding. Securities for which market
quotations are readily available, including options and futures traded on an
exchange, are valued at market value, which is for exchanged-listed securities,
the closing price; for United Kingdom-listed securities, the marketmaker
provided price; and for non-listed equity securities, the bid price. Non-listed
corporate debt securities, government securities and municipal securities are
usually valued using an evaluated bid price provided by a pricing service. If
closing prices are unavailable for exchange-listed securities, generally the bid
price, or in the case of debt securities an evaluated bid price, is used to
value such securities. When reliable market quotations are not considered to be
readily available, which may be the case, for example, with respect to certain
debt securities, preferred stocks, foreign securities and over-the-counter
options, the investments are valued by using market quotations considered
reliable, prices provided by market makers, which may include dealers with which
the Fund has executed transactions, or estimates of market values obtained from
yield data and other factors relating to instruments or securities with similar
characteristics in accordance with procedures established in good faith by the
Board of Directors. Securities with remaining maturities of 60 days or less are
valued at amortized cost. Other assets are valued at fair value as determined in
good faith through procedures established by the Board of Directors of the Fund.

Generally, trading in foreign securities is substantially completed each day at
various times prior to the close of the New York Stock Exchange. The values of
foreign securities used to compute the share prices are usually determined when
the foreign market closes. Occasionally, events which affect the values of such
securities and foreign currency exchange rates occur between the times at which
the values are generally determined and the close of the New York Stock Exchange
and would therefore not be reflected in the computation of the Fund's net asset
value. If events materially affecting the value of securities occur during such
period, the securities are valued at their fair value as determined in good
faith by the Manager under procedures established and regularly reviewed by the
Board of Directors. To the extent a Fund invests in foreign securities listed on
foreign exchanges which trade on days on which the Fund does not determine its
net asset value, for example Saturdays and other customary national U.S.
holidays, the Fund's net asset value could be significantly affected on days
when shareholders have no access to the Fund.

Certain securities issued by companies in emerging market countries may have
more than one quoted valuation at any given point in time, sometimes referred to
as a "local" price and a "premium" price. The premium price is often a
negotiated price which may not consistently represent a price at which a
specific transaction can be effected. It is the policy of the International
Emerging Markets Fund, International Fund and International SmallCap Fund to
value such securities at prices at which it is expected those shares may be
sold, and the Manager or any Sub-Advisor is authorized to make such
determinations subject to such oversight by the Fund's Board of Directors as may
from time to time be necessary.

Money Market Fund

The share price of each class of shares of the Cash Management Fund is
determined at the same time and on the same days as the Growth-Oriented and
Income-Oriented Funds as described above. The share price for each class of
shares of the Fund is computed by dividing the total value of the Fund's
securities and other assets, less liabilities, by the number of Fund shares
outstanding.

All securities held by the Cash Management Fund are valued on an amortized cost
basis. Under this method of valuation, a security is initially valued at cost;
thereafter, the Fund assumes a constant proportionate amortization in value
until maturity of any discount or premium, regardless of the impact of
fluctuating interest rates on the market value of the security. While this
method provides certainty in valuation, it may result in periods during which
value, as determined by amortized cost, is higher or lower than the price that
would be received upon sale of the security.

Use of the amortized cost valuation method by the Cash Management Fund requires
the Fund to maintain a dollar weighted average maturity of 90 days or less and
to purchase only obligations that have remaining maturities of 397 days or less
or have a variable or floating rate of interest. In addition, the Fund invests
only in obligations determined by its Board of Directors to be of high quality
with minimal credit risks.

The Board of Directors for the Cash Management Fund has established procedures
designed to stabilize, to the extent reasonably possible, the Fund's price per
share as computed for the purpose of sales and redemptions at $1.00. Such
procedures include a directive to the Manager to test price the portfolio or
specific securities on a weekly basis using a mark-to-market method of valuation
to determine possible deviations in the net asset value from $1.00 per share. If
such deviation exceeds 1/2 of 1%, the Board promptly considers what action, if
any, will be initiated. In the event the Board determines that a deviation
exists which may result in material dilution or other unfair results to
shareholders, the Board takes such corrective action as it regards as
appropriate, including: sale of portfolio instruments prior to maturity; the
withholding of dividends; redemptions of shares in kind; the establishment of a
net asset value per share based upon available market quotations; or splitting,
combining or otherwise recapitalizing outstanding shares. The Fund may also
reduce the number of shares outstanding by redeeming proportionately from
shareholders, without the payment of any monetary compensation, such number of
full and fractional shares as is necessary to maintain the net asset value at
$1.00 per share.

PERFORMANCE CALCULATION

The Principal Mutual Funds advertise their performance in terms of total return
or yield for each class of shares. The figures used for total return and yield
are based on the past performance of a Fund. They show the performance of a
hypothetical investment and are not intended to indicate future performance.
Total return and yield vary from time to time depending upon:
o market conditions
o the composition of a Fund's portfolio
o operating expenses

These factors and differences in the methods used in calculating performance
figures should be considered when comparing a Fund's performance to the
performance of other investments.

A Fund may include in its advertisements performance rankings and other
performance-related information published by independent statistical services or
publishers, such as
o Baron's, Changing Times
o Forbes
o Fortune
o Investment Advisor
o Lipper Analytical Services
o Money Magazine
o Stanger's Investment Advisor
o The Wall Street Journal
o USA Today
o U.S. News
o Weisenberger Investment Companies Services
o W. R. Kipplinger's Personal Finance

A Fund may also include in its advertisements comparisons of the performance of
the Fund to that of various market indices, such as:
o Bond Buyer Municipal Index
o Dow Jones Industrials Index
o Dow Jones Utility Index with Income
o Lehman Brothers BAA Corporate Index
o Lehman Brothers GNMA Index
o Lehman Brothers High Yield Index
o Lehman Brothers Municipal Bond Index
o Lehman Brothers Revenue Bond Index
o Brothers Mutual Fund Short Government/Corporate Index
o Lehman Brothers Intermediate Government/Corporate Index
o Lehman Brothers Government/Corporate Bond Index
o Merrill Lynch Corporate Government Bond Index
o Morgan Stanley Capital International EAFE (Europe, Australia and Far East)
Index
o Morgan Stanley Capital International EMF (Emerging Markets) Index
o Morgan Stanley Capital International European 15 Index
o Morgan Stanley Capital International Pacific Free Index
o Morgan Stanley REIT Index
o Russell 1000 Growth Index
o Russell 2000 Index
o Russell 2000 Growth Index
o Russell 2000 Value Index
o Russell MidCap Value Index
o Salomon Brothers Investment Grade Bond Index
o S&P 400 MidCap Index
o S&P 500 Index
o S&P 600 Index
o S&P Barra Value Index
o Valueline
o World Index

Total Return

The Growth-Oriented and Income-Oriented Funds include its average annual total
return for the one-, five- and ten-year periods as of the last day of the most
recent calendar quarter when advertising total return figures. If the Fund or
class has been in existence for a shorter time period, it uses the time from the
beginning of the Fund (or class) to the end of the most recent calendar quarter.

Average annual total return is calculated by comparing an initial $1,000
investment to the redeemable value of the Fund at the end of 1, 5 or 10 years
(or from the Fund's inception date).

Initial Investment - $1,000 less maximum front-end sales charge (in the
case of Class A shares)
Ending redeemable value - assumes the reinvestment of all dividends and
capital gains at net asset value less the applicable contingent deferred
sales charge (in the case of Class B or Class C shares).

A Fund may also include in its advertising average annual total return for some
other period or cumulative total return for a specified period. These returns
may include reduced sales charges, reflect no sales charge or CDSC in order to
illustrate the change in a Fund's net asset value over time. Cumulative total
return is calculated:

(Ending redeemable value less the initial investment)
-----------------------------------------------------
Initial investment

The following table shows as of October 31, 1999 average annual returns (net of
sales charge) for Class A shares for each of the Funds for the periods
indicated. The returns do not include a sales charge which would make the
returns less than those shown. Class A shares are generally sold subject to a
sales charge.
<TABLE>
<CAPTION>
Fund 1-Year 5-Year 10-Year

<S> <C> <C> <C> <C>
Balanced Fund (0.07)% 11.06% 9.80%
Blue Chip Fund 11.50 18.81 14.01(1)
Bond Fund (9.53) 6.83 7.22
Capital Value Fund (1.84) 16.22 12.42
Government Securities Income Fund (3.30) 7.16 7.13
Growth Fund 11.94 17.89 16.38
High Yield Fund (2.02) 5.90 6.36
International Emerging Markets Fund 24.74 (5.53)(3) N/A
International Fund 10.72 10.21 11.04
International SmallCap Fund 47.25 19.94(3) N/A
Limited Term Bond Fund 0.31 4.67(4) N/A
MidCap Fund 0.60 11.98 13.15
Real Estate Fund (8.87) (13.27)(5) N/A
SmallCap Fund 28.20 4.16(5) N/A
Tax-Exempt Bond Fund (7.09) 5.82 6.07
Utilities Fund 9.35 17.29 12.02(2)

<FN>
(1) Period beginning March 1, 1991 and ending October 31, 1999.
(2) Period beginning December 16, 1992 and ending October 31, 1999.
(3) Period beginning August 29, 1997 and ending October 31, 1999.
(4) Period beginning February 29, 1996 and ending October 31, 1999.
(5) Period beginning January 1, 1998 and ending October 31, 1999.
</FN>
</TABLE>

The following table shows as of October 31, 1999 average annual returns for
Class B shares for each of the Funds for the period indicated:
<TABLE>
<CAPTION>
Fund 1-Year 5-Year

<S> <C> <C> <C>
Balanced Fund 0.06% 12.31(1)
Blue Chip Fund 12.09 20.30(1)
Bond Fund (6.36) 6.72(1)
Capital Value Fund (1.57) 18.12(1)
Government Securities Income Fund (3.17) 7.17(1)
Growth Fund 12.75 20.29(1)
High Yield Fund (1.76) 6.05(1)
International Emerging Markets Fund 25.91 (5.67)(2)
International Fund 11.27 12.45(1)
International SmallCap Fund 49.42 20.65(2)
Limited Term Bond Fund 0.08 4.49(3)
MidCap Fund 1.09 14.26(1)
Real Estate Fund (8.79) (13.20)(4)
SmallCap Fund 29.29 4.16(4)
Tax-Exempt Bond Fund (6.73) 6.48(1)
Utilities Fund 9.85 17.88(1)

<FN>
(1) Period beginning December 9, 1994 and ending October 31, 1999.
(2) Period beginning August 29, 1997 and ending October 31, 1999.
(3) Period beginning February 29, 1996 and ending October 31, 1999.
(4) Period beginning January 1, 1998 and ending October 31, 1999.
</FN>
</TABLE>

The following table shows as of October 31, 1999 average annual returns for
Class C shares for each of the Funds for the period indicated:
<TABLE>
<CAPTION>
Fund 1-Year(1)

<S> <C> <C>
Balanced Fund (5.67)%
Blue Chip Fund (2.29)
Bond Fund (1.40)
Capital Value Fund (8.42)
Government Securities Income Fund 0.11
Growth Fund (4.75)
High Yield Fund (1.99)
International Emerging Markets Fund (5.47)
International Fund 2.95
International SmallCap Fund 16.81
Limited Term Bond Fund 0.34
MidCap Fund (9.36)
Real Estate Fund (11.21)
SmallCap Fund 0.53
Tax-Exempt Bond Fund (3.59)
Utilities Fund (1.47)

<FN>
(1) Period beginning June 30, 1999 and ending October 31, 1999.
</FN>
</TABLE>

The following table shows as of October 31, 1999 average annual returns for
Class R shares for each of the Funds for the period indicated:
<TABLE>
<CAPTION>
Fund 1-Year 5-Year

<S> <C> <C> <C>
Balanced Fund 4.21% 10.14%(1)
Blue Chip Fund 16.31 17.46(1)
Bond Fund (2.45) (4.76)(1)
Capital Value Fund 2.35 14.57(1)
Government Securities Income Fund 0.78 5.25(1)
Growth Fund 16.78 16.29(1)
High Yield Fund 2.01 3.88(1)
International Emerging Markets Fund 30.93 (3.46)(2)
International Fund 15.27 12.18(1)
International SmallCap Fund 54.61 22.77(2)
Limited Term Bond Fund 1.13 4.48(1)
MidCap Fund 4.89 7.49(1)
Real Estate Fund (4.70) (11.07)(3)
SmallCap Fund 33.85 6.77(3)
Utilities Fund 13.97 15.54(1)

<FN>
(1) Period beginning February 29, 1996 and ending October 31, 1999.
(2) Period beginning August 29, 1997 and ending October 31, 1999.
(3) Period beginning January 1, 1998 and ending October 31, 1999.
</FN>
</TABLE>

Yield

Income-Oriented Funds
Each Income-Oriented Fund computes a yield by
1. calculating net investment income per share for a 30 day (or one month)
period
2. annualizing net investment income per share, assuming semi-annual
compounding
3. dividing the annualized net investment income by the maximum public
offering price for Class A shares or the net asset value for Class B, Class
C and Class R shares for the last day of the same period.

The following table shows as of October 31, 1999 the yield for each class of
shares for each of the Income-Oriented Funds:

Yield as of October 31, 1999

Fund Class A Class B Class C Class R

Bond Fund 7.40% 6.63% 6.56% 6.79%
Government Securities Income Fund 6.34 5.48 5.50 5.76
High Yield Fund 9.69 8.74 8.87 8.56
Limited Term Bond Fund 6.23 5.83 5.83 5.58
Tax-Exempt Bond Fund 4.94 4.54 3.96 N/A

The Tax-Exempt Bond Fund may advertise a tax-equivalent yield. Your
tax-equivalent yield would be calculated by:

[(Tax-exemptportion of the yield) divided by (1 minus your tax rate)] plus
[any portion of the yield which is not tax-exempt]

As of October 31, 1999 the Fund's tax-equivalent yields for Class A , Class B
and Class C shares were as follows:

Tax-Equivalent Yield Assumed

Class A Class B Class C Tax Rate

6.53% 6.31% 5.50% 28.0%
7.34 7.09 6.19 36.0
7.78 7.52 6.56 39.6

Money Market Fund

The Cash Management Fund advertises its yield and its effective yield.

Yield is computed by:
o determining the net change (excluding shareholder purchases and
redemptions) in the value of a hypothetical pre-existing account having a
balance of one share at the beginning of the period
o dividing the difference by the value of the account at the beginning of the
base period to obtain the base period return
o multiplying the base period return by (365/7) with the resulting yield
figure carried to at least the nearest hundredth of one percent.

The following table shows as of October 31, 1999 the yield for each class of
shares for the Cash Management Fund:

Yield as of October 31, 1999

Fund Class A Class B Class C Class R

Cash Management Fund 5.17% 4.75% 4.65% 3.63%

There may be a difference in the net investment income per share used to
calculate yield and the net investment income per share used for dividend
purposes. This is because the calculation for yield purposes does not include
net short-term realized gains or losses on the Fund's investment, which are
included in the calculation for dividend purposes.

Effective yield is computed by:
o determining the net change (excluding shareholder purchases and
redemptions) in the value of a hypothetical pre-existing account having a
balance of one share at the beginning of the period
o dividing the difference by the value of the account at the beginning of the
base period to obtain the base period return compounding the base period
return by adding 1, raising the sum to a power equal to 365 divided by 7,
and subtracting 1 from the result.
The resulting effective yield figure is carried to at least the nearest
hundredth of one percent.

The following table shows as of October 31, 1999 the effective yield for each
class of shares for the Cash Management Fund:

Effective Yield as of October 31, 1999

Fund Class A Class B Class C Class R

Cash Management Fund 5.30% 4.85% 3.69% 4.75%

The yield quoted at any time for the Cash Management Fund represents the amount
that has earned during a specific, recent seven-day period and is a function of:
o the quality of investments in the Fund's portfolio
o types of investments in the Fund's portfolio
o length of maturity of investments in the Fund's portfolio
o Fund's operating expenses.

The length of maturity for the portfolio is calculated using the average dollar
weighted maturity of all investments. This means that the portfolio has an
average maturity of a stated number of days for its investments. The calculation
is weighted by the relative value of each investment.

The yield for the Cash Management Fund will fluctuate daily as the income earned
on the investments of the Fund fluctuates. There is no assurance the yield
quoted on any given occasion will remain in effect for any period of time. It
should also be emphasized that the Funds are open-end investment companies.
There is no guarantee that the net asset value or any stated rate of return will
remain constant. A shareholder's investment in the Fund is not insured.
Investors comparing results of the Cash Management Fund with investment results
and yields from other sources such as banks or savings and loan associations
should understand these distinctions. Historical and comparative yield
information may be presented by the Funds.

A Fund may include in its advertisements the compounding effect of reinvested
dividends over an extended period of time as shown in the following
illustrations.

The Power of Compounding

Fund shareholders who reinvest their distributions get the advantage of
compounding. Here's what happens to a $10,000 investment with monthly income
reinvested at 6 percent, 8 percent and 10 percent over 20 years.

These figures assume no change in the value of principal. This chart is for
illustration purposes only and is not an indication of the results a shareholder
may receive as a shareholder of a specific Fund. The return and capital value of
an investment in a Fund vary so that the value, when redeemed, may be worth more
or less than the original cost.

(chart)
Year 6% 8% 10%
0 $10,000 $10,000 $10,000
20 $32,071 $46,610 $67,275

A Fund may also include in its advertisements an illustration of the impact of
income taxes and inflation on earnings from bank certificates of deposit
("CD's"). The interest rate on the hypothetical CD will be based upon average CD
rates for a stated period as reported in the Federal Reserve Bulletin. The
illustrated annual rate of inflation will be the core inflation rate as measured
by the Consumer Price Index for the 12-month period ended as of the most recent
month prior to the advertisement's publication. The illustrated income tax rate
may include any federal income tax rate that may apply to individuals at the
time the advertisement is published. Any such advertisement will indicate that,
unlike bank CD's, an investment in the Fund is not insured nor is there any
guarantee that the Fund's net asset value or any stated rate of return will
remain constant.

An example of a typical calculation included in such advertisements is as
follows: the after-tax and inflation-adjusted earnings on a bank CD, assuming a
$10,000 investment in a six-month bank CD with an annual interest rate of 6.04%
(monthly average six-month CD rate for the month of October, 1999, as reported
in the Federal Reserve Bulletin) and an inflation rate of 2.6% (rate of
inflation for the 12-month period ended October 31, 1999 as measured by the
Consumer Price Index) and an income tax bracket of 28% would be $(87).

($10,000 x 6.04%) / 2 = $302 Interest for six-month period
- 85 Federal income taxes (28%)
-130 Inflation's impact on invested principal
$(10,000 x 2.6%) / 2
($87) After-tax, inflation-adjusted earnings

A Fund may also include in its advertisements an illustration of tax-deferred
accumulation versus currently taxable accumulation in conjunction with the
Fund's use as a funding vehicle for 403(b) plans, IRAs or other retirement
plans. The illustration set forth below assumes a monthly investment of $200, an
annual return of 8% compounded monthly, and a 28% tax bracket.

The information is for illustrative purposes only and is not meant to represent
the performance of any of the Principal Mutual Funds. An investment in the
Principal Mutual Funds is not guaranteed; values and returns generally vary with
changes in market conditions.

Tax-deferred vs. taxable savings plan

_______________________________________ - $300,059

---------------------------------------

_______________________________________ --- $192,844

---------------------------------------

---------------------------------------
Years: 5 10 15 20 25 30

- With a tax-deferred savings plan
--- Without a tax-deferred savings plan

TAX TREATMENT OF FUNDS, DIVIDENDS AND DISTRIBUTIONS

It is the policy of each Fund to distribute substantially all net investment
income and net realized gains. Through such distributions, and by satisfying
certain other requirements, each Fund intends to qualify for the tax treatment
accorded to regulated investment companies under the applicable provisions of
the Internal Revenue Code. This means that in each year in which a Fund
qualifies, it is exempt from federal income tax upon the amount distributed to
investors. The Tax Reform Act of 1986 imposed an excise tax on mutual funds
which fail to distribute net investment income and capital gains by the end of
the calendar year in accordance with the provisions of the Act. Each Fund
intends to comply with the Act's requirements and to avoid this excise tax.

Dividends from net investment income will be eligible for a 70% dividends
received deduction generally available to corporations to the extent of the
amount of qualifying dividends received by the Funds from domestic corporations
for the taxable year. Distributions from the Cash Management Fund and
Income-Oriented Funds are generally not eligible for the corporate dividend
received deduction.

All taxable dividends and capital gains are taxable in the year in which
distributed, whether received in cash or reinvested in additional shares.
Dividends declared with a record date in December and paid in January are deemed
to be distributed to shareholders in December. Each Fund informs its
shareholders of the amount and nature of their taxable income dividends and
capital gain distributions. Dividends from a Fund's net income and distributions
of capital gains, if any, may also be subject to state and local taxation.

The Fund is required in certain cases to withhold and remit to the U.S. Treasury
31% of ordinary income dividends and capital gain dividends, and the proceeds of
redemption of shares, paid to any shareholder (1) who has provided either an
incorrect tax identification number or no number at all, (2) who is subject to
backup withholding by the Internal Revenue Service for failure to report the
receipt of interest or dividend income properly, or (3) who has failed to
certify to the Fund that it is not subject to backup withholding or that it is a
corporation or other "exempt recipient."

A shareholder recognizes gain or loss on the sale or redemption of shares of the
Fund in an amount equal to the difference between the proceeds of the sales or
redemption and the shareholder's adjusted tax basis in the shares. All or a
portion of any loss so recognized may be disallowed if the shareholder purchases
other shares of the Fund within 30 days before or after the sale or redemption.
In general, any gain or loss arising from (or treated as arising from) the sale
or redemption of shares of the Fund is considered capital gain or loss
(long-term capital gain or loss if the shares were held for longer than one
year). However, any capital loss arising from the sales or redemption of shares
held for six months or less is disallowed to the extent of the amount of
exempt-interest dividends received on such shares and (to the extent not
disallowed) is treated as a long-term capital loss to the extent of the amount
of capital gain dividends received on such shares. Capital losses in any year
are deductible only to the extent of capital gains plus, in the case of a
noncorporate taxpayer, $3,000 of ordinary income.

If a shareholder (i) incurs a sales load in acquiring shares of the Fund, (ii)
disposes of such shares less than 91 days after they are acquired and (iii)
subsequently acquires shares of the Fund or another fund at a reduced sales load
pursuant to a right to reinvest at such reduced sales load acquired in
connection with the acquisition of the shares disposed of, then the sales load
on the shares disposed of (to the extent of the reduction in the sales load on
the shares subsequently acquired) shall not be taken into account in determining
gain or loss on the shares disposed of but shall be treated as incurred on the
acquisition of the shares subsequently acquired.

Shareholders should consult their own tax advisors as to the federal, state and
local tax consequences of ownership of shares of the Funds in their particular
circumstances.

Special Tax Considerations

Tax-Exempt Bond Fund

The Tax-Exempt Bond Fund also intends to qualify to pay "exempt-interest
dividends" to its shareholders. An exempt-interest dividend is that part of
dividend distributions made by the Fund which consist of interest received
by that Fund on tax-exempt Municipal Obligations. Shareholders incur no
federal income taxes on exempt-interest dividends. However, these
exempt-interest dividends may be taxable under state or local law. Fund
shareholders that are corporations must include exempt-interest dividends
in determining whether they are subject to the corporate alternative
minimum tax. Exempt-interest dividends that derive from certain private
activity bonds must be included by individuals as a preference item in
determining whether they are subject to the alternative minimum tax. The
Fund may also pay ordinary income dividends and distribute capital gains
from time to time. Ordinary income dividends and distributions of capital
gains, if any, are taxable for federal purposes.

If a shareholder receives an exempt-interest dividend with respect to
shares of the Funds held for six months or less, then any loss on the sale
or exchange of such shares, to the extent of the amount of such dividend,
is disallowed. If a shareholder receives a capital gain dividend with
respect to shares held for six months or less, then any loss on the sale or
exchange of such shares is treated as a long term capital loss to the
extent the loss exceeds any exempt-interest dividend received with respect
to such shares, and is disallowed to the extent of such exempt-interest
dividend.

Interest on indebtedness incurred or continued by a shareholder to purchase
or carry shares of this Fund is not deductible. Furthermore, entities or
persons who are "substantial users" (or related persons) under Section
147(a) of the Code of facilities financed by private activity bonds should
consult their tax advisors before purchasing shares of the Fund.

From time to time, proposals have been introduced before Congress for the
purpose of restricting or eliminating the federal income tax exemption for
interest on Municipal Obligations. If legislation is enacted that
eliminates or significantly reduces the availability of Municipal
Obligations, it could adversely affect the ability of the Fund to continue
to pursue its investment objectives and policies. In such event, the Fund
would reevaluate its investment objectives and policies.

International Growth-Oriented Funds

In each fiscal year when, at the close of such year, more than 50% of the
value of the total assets of these Funds are invested in securities of
foreign corporations, the Fund may elect pursuant to Section 853 of the
Code to permit shareholders to take a credit (or a deduction) for foreign
income taxes paid by the Fund. In that case, shareholders should include in
their report of gross income in their federal income tax returns both cash
dividends received from the Fund and the amount which the Fund advises is
their pro rata portion of foreign income taxes paid with respect to, or
withheld from, dividends and interest paid to the Fund from its foreign
investments. Shareholders are then entitled to subtract from their federal
income taxes the amount of such taxes withheld, or treat such foreign taxes
as a deduction from gross income, if that should be more advantageous. As
in the case of individuals receiving income directly from foreign sources,
the above-described tax credit or tax deduction is subject to certain
limitations. Shareholders or prospective shareholders should consult their
tax advisors on how these provisions apply to them.

Futures Contracts and Options

As previously discussed, some of the Principal Mutual Funds invest in
futures contracts or options thereon, index options or options traded on
qualified exchanges. For federal income tax purposes, capital gains and
losses on futures contracts or options thereon, index options or options
traded on qualified exchanges are generally treated as 60% long-term and
40% short-term. In addition, the Funds must recognize any unrealized gains
and losses on such positions held at the end of the fiscal year. A Fund may
elect out of such tax treatment, however, for a futures or options position
that is part of an "identified mixed straddle" such as a put option
purchased with respect to a portfolio security. Gains and losses on futures
and options included in an identified mixed straddle are considered 100%
short-term and unrealized gain or loss on such positions are not realized
at year end. The straddle provisions of the Code may require the deferral
of realized losses to the extent that a Fund has unrealized gains in
certain offsetting positions at the end of the fiscal year. The Code may
also require recharacterization of all or a part of losses on certain
offsetting positions from short-term to long-term, as well as adjustment of
the holding periods of straddle positions.

GENERAL INFORMATION AND HISTORY

The Funds were incorporated in Maryland on the following dates:

Balanced Fund November 26, 1986
Blue Chip Fund December 10, 1990
Bond Fund December 2, 1986
Capital Value Fund May 26, 1989
Cash Management Fund June 10, 1982
European Equity Fund January 18, 2000
Government Securities Income Fund September 5, 1984
Growth Fund May 26, 1989
High Yield Fund November 26, 1986
International Emerging Markets Fund May 27, 1997
International Fund May 12, 1981
International SmallCap Fund May 27, 1997
LargeCap Stock Index Fund November 24, 1999
Limited Term Bond Fund August 9, 1995
MidCap Fund February 20, 1987
Pacific Basin Fund January 18, 2000
Partners Aggressive Growth Fund August 10, 1999
Partners LargeCap Growth Fund November 24, 1999
Partners MidCap Growth Fund November 24, 1999
Real Estate Fund May 27, 1997
SmallCap Fund August 13, 1997
Tax-Exempt Bond Fund June 7, 1985
Utilities Fund September 3, 1992

Effective January 1, 1998, the following changes were made to the names of
certain of the Funds:

<TABLE>
<CAPTION>
Old Fund Name New Fund Name

<S> <C> <C>
Princor Balanced Fund, Inc. Principal Balanced Fund, Inc.
Princor Blue Chip Fund, Inc. Principal Blue Chip Fund, Inc.
Princor Bond Fund, Inc. Principal Bond Fund, Inc.
Princor Capital Accumulation Fund, Inc. Principal Capital Value Fund, Inc.
Princor Cash Management Fund, Inc. Principal Cash Management Fund, Inc.
Princor Emerging Growth Fund, Inc. Principal MidCap Fund, Inc.
Princor Government Securities Income Fund, Inc. Principal Government Securities Income Fund, Inc.
Princor Growth Fund, Inc. Principal Growth Fund, Inc.
Princor High Yield Fund, Inc. Principal High Yield Fund, Inc.
Princor Limited Term Bond Fund, Inc. Principal Limited Term Bond Fund, Inc.
Princor Tax-Exempt Bond Fund, Inc. Principal Tax-Exempt Bond Fund, Inc.
Princor Utilities Fund, Inc. Principal Utilities Fund, Inc.
Princor World Fund, Inc. Principal International Fund, Inc.
</TABLE>

FINANCIAL STATEMENTS

The financial statements for each of the Principal Mutual Funds (except the
European Equity, LargeCap Stock Index, Pacific Basin, Partners Aggressive
Growth, Partners LargeCap Growth and Partners MidCap Growth Funds) for the year
ended October 31, 1999 are a part of this Statement of Additional Information.
The financial statements appear in the Annual Reports to Shareholders. Reports
on those statements from Ernst & Young LLP, independent auditors, are included
in the Annual Report and are also a part of this Statement of Additional
Information. The Annual Reports are furnished, without charge, to investors who
request copies of the Statement of Additional Information.

The statements of net assets of the Principal Partners Aggressive Growth Fund as
of October 28, 1999, the LargeCap Stock Index, Partners LargeCap Growth and
Partners MidCap Growth Funds as of February 24, 2000, the European Equity and
Pacific Basin Funds as of April 26, 2000 and the report of Ernst & Young LLP
thereon are provided herein following the Appendixes.

APPENDIX A

The following table shows the symbol assigned by the Nasdaq Mutual Fund
Quotation Service to eligible classes of Funds as of March 1, 2000:

Symbol Fund

PRMGX Principal Balanced Fund, Inc. Class A
PBABX Principal Balanced Fund, Inc. Class B

PBLCX Principal Blue Chip Fund, Inc. Class A
PBLBX Principal Blue Chip Fund, Inc. Class B

PRBDX Principal Bond Fund, Inc. Class A
PROBX Principal Bond Fund, Inc. Class B

PCACX Principal Capital Value Fund, Inc. Class A
PCCBX Principal Capital Value Fund, Inc. Class B

PCSXX Principal Cash Management Fund, Inc. Class A

PRGVX Principal Government Securities Income Fund, Inc. Class A
PGVBX Principal Government Securities Income Fund, Inc. Class B

PRGWX Principal Growth Fund, Inc. Class A
PRGBX Principal Growth Fund, Inc. Class B

PHYLX Principal High Yield Fund, Inc. Class A
PRIYX Principal High Yield Fund, Inc. Class B

PRIAX Principal International Emerging Markets Fund, lnc. Class A
PIEBX Principal International Emerging Markets Fund, lnc. Class B

PRWLX Principal International Fund, Inc. Class A
PRBWX Principal International Fund, Inc. Class B

PRSAX Principal International SmallCap Fund, Inc. Class A
PISFX Principal International SmallCap Fund, Inc. Class B

PLTBX Principal Limited Term Bond Fund, Inc. Class A

PEMGX Principal MidCap Fund, Inc. Class A
PRMBX Principal MidCap Fund, Inc. Class B

PGGAX Principal Partners Aggressive Growth Fund, Inc. Class A
PBAGX Principal Partners Aggressive Growth Fund, Inc. Class B

PRRAX Principal Real Estate Fund, Inc. Class A

PLLAX Principal SmallCap Fund, Inc. Class A
PLLBX Principal SmallCap Fund, Inc. Class B

PTBDX Principal Tax-Exempt Bond Fund, Inc. Class A

PUTLX Principal Utilities Fund, Inc. Class A
PRUBX Principal Utilities Fund, Inc. Class B

APPENDIX B

Description of Bond Ratings:

Moody's Investors Service, Inc. Bond Ratings

Aaa: Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred
to as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong
position of such issues.

Aa: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities
or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long-term risks
appear somewhat larger than in Aaa securities.

A: Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate, but
elements may be present which suggest a susceptibility to impairment
sometime in the future.

Baa: Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics
as well.

Ba: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate and thereby not
well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.

B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time
may be small.

Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.

Ca: Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.

C: Bonds which are rated C are the lowest rated class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.

CONDITIONAL RATING: Bonds for which the security depends upon the completion of
some act or the fulfillment of some condition are rated conditionally. These
bonds secured by (a) earnings of projects under construction, (b) earnings of
projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.

RATING REFINEMENTS: Moody's may apply numerical modifiers, 1, 2 and 3 in each
generic rating classification from Aa through B in its bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and a modifier 3
indicates that the issue ranks in the lower end of its generic rating category.

SHORT-TERM NOTES: The four ratings of Moody's for short-term notes are MIG 1,
MIG 2, MIG 3 and MIG 4; MIG 1 denotes "best quality, enjoying strong protection
from established cash flows"; MIG 2 denotes "high quality" with "ample margins
of protection"; MIG 3 notes are of "favorable quality...but lacking the
undeniable strength of the preceding grades"; MIG 4 notes are of "adequate
quality, carrying specific risk for having protection...and not distinctly or
predominantly speculative."

Description of Moody's Commercial Paper Ratings

Moody's Commercial Paper ratings are opinions of the ability to repay punctually
promissory obligations not having an original maturity in excess of nine months.
Moody's employs the following three designations, all judged to be investment
grade, to indicate the relative repayment capacity of rated issuers:

Issuers rated Prime-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations.

Issuers rated Prime-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations.

Issuers rated Prime-3 (or related supporting institutions) have an acceptable
capacity for repayment of short-term promissory obligations.

Issuers rated Not Prime do not fall within any of the Prime rating categories.

Description of Standard & Poor's Corporation's Debt Ratings:

A Standard & Poor's debt rating is a current assessment of the creditworthiness
of an obligor with respect to a specific obligation. This assessment may take
into consideration obligors such as guarantors, insurers, or lessees.

The debt rating is not a recommendation to purchase, sell or hold a security,
inasmuch as it does not comment as to market price or suitability for a
particular investor.

The ratings are based on current information furnished by the issuer or obtained
by Standard & Poor's from other sources Standard & Poor's considers reliable.
Standard & Poor's does not perform an audit in connection with any rating and
may, on occasion, rely on unaudited financial information. The ratings may be
changed, suspended or withdrawn as a result of changes in, or unavailability of,
such information, or for other circumstances.

The ratings are based, in varying degrees, on the following considerations:

I. Likelihood of default -- capacity and willingness of the obligor as to the
timely payment of interest and repayment of principal in accordance with
the terms of the obligation;

II. Nature of and provisions of the obligation;

III. Protection afforded by, and relative position of, the obligation in the
event of bankruptcy, reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditor's rights.

AAA: Debt rated "AAA" has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.

AA: Debt rated "AA" has a very strong capacity to pay interest and repay
principal and differs from the highest-rated issues only in small degree.

A: Debt rated "A" has a strong capacity to pay interest and repay principal
although they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher-rated
categories.

BBB: Debt rated "BBB" is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than for debt in higher-rated categories.

BB, B, CCC, CC: Debt rated "BB", "B", "CCC" and "CC" is regarded, on balance,
as predominantly speculative with respect to capacity to pay interest and
repay principal in accordance with the terms of the obligation. "BB"
indicates the lowest degree of speculation and "CC" the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.

C: The rating "C" is reserved for income bonds on which no interest is being
paid.

D: Debt rated "D" is in default, and payment of interest and/or repayment of
principal is in arrears.

Plus (+) or Minus (-): The ratings from "AA" to "B" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.

Provisional Ratings: The letter "p" indicates that the rating is provisional. A
provisional rating assumes the successful completion of the project being
financed by the bonds being rated and indicates that payment of debt service
requirements is largely or entirely dependent upon the successful and timely
completion of the project. This rating, however, while addressing credit quality
subsequent to completion of the project, makes no comment on the likelihood of,
or the risk of default upon failure of, such completion. The investor should
exercise his own judgment with respect to such likelihood and risk.

NR: Indicates that no rating has been requested, that there is insufficient
information on which to base a rating or that Standard & Poor's does not
rate a particular type of obligation as a matter of policy.

Standard & Poor's, Commercial Paper Ratings

A Standard & Poor's Commercial Paper Rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Ratings are graded into four categories, ranging from "A" for the
highest quality obligations to "D" for the lowest. Ratings are applicable to
both taxable and tax-exempt commercial paper. The four categories are as
follows:

A: Issues assigned the highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are delineated with
the numbers 1, 2 and 3 to indicate the relative degree of safety.

A-1: This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Issues that possess
overwhelming safety characteristics will be given a "+" designation.

A-2: Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as high as for issues
designated "A-1".

A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects
of changes in circumstances than obligations carrying the highest
designations.

B: Issues rated "B" are regarded as having only an adequate capacity for
timely payment. However, such capacity may be damaged by changing
conditions or short-term adversities.

C: This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.

D: This rating indicates that the issue is either in default or is expected to
be in default upon maturity.

The Commercial Paper Rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer and obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in or unavailability of, such information.

Standard & Poor's rates notes with a maturity of less than three years as
follows:

SP-1:A very strong, or strong, capacity to pay principal and interest. Issues
that possess overwhelming safety characteristics will be given a "+"
designation.

SP-2:A satisfactory capacity to pay principal and interest.

SP-3:A speculative capacity to pay principal and interest.

APPENDIX C

The following information summarizes the portfolio of each Fund (as of March 31,
2000) except the European Equity and Pacific Basin Funds (as their inception
date is May 1, 2000, information is not available for those Funds) and the Cash
Management Fund. The information provided for the Growth-Oriented Funds shows
the largest industry holdings* and the largest equity holdings*. In addition,
country concentrations* are shown for the International Growth-Oriented Funds.
The information for the Growth-Oriented Funds includes the portfolio
composition* and the maturity profile.
* as a percent of Fund assets

Principal Balanced Fund, Inc.

Top Industry
Computer & Office Equipment 8.9%
Mortgage Pass Thru Securities 5.3%
Commercial Banks 5.3%
Drugs 5.3%
Computer & Data Processing 5.1%
Other 70.1%

Top Holdings
CISCO Systems 3.1%
Intel Corp. 2.4%
General Electric Co. 2.2%
Citigroup Inc. 2.1%
NationsBank Corp. 1.6%
DLJ Comm. Mort. Corp. 1.4%
Microsoft Corp. 1.4%
Nortel Networks Corp. 1.4%
MCI Worldcom Inc. 1.3%
GMAC Commercial Mort. 1.3%
---
Percent of Total Holdings 18.2%

Principal Blue Chip Fund, Inc.

Top Industry
Computer & Office Equipment 17.8%
Drugs 8.6%
Telephone Communication 8.2%
Computer & Data Processing 6.6%
Petroleum Refining 5.7%
Other 53.1%

Top Holdings
Cisco Systems 4.3%
General Electric Co. 4.1%
Hewlett-Packard Co. 3.9%
Motorola, Inc. 3.7%
Dell Computer Corp. 3.7%
Williams Cos Inc. 3.6%
Oracle Systems Corp. 3.5%
Intel Corp. 3.4%
American International 3.4%
Citigroup Inc. 3.3%
---
Percent of Total Holdings 36.9%

Principal Bond Fund, Inc.

Portfolio Composition
Corporate Bonds: 96.0%
Asset-backed Securities: 3.3%
Commercial Paper: 0.7%

Maturity Profile
Average Bond Quality: Baa1
Average Bond Maturity: 10 years
Average Duration: 5.7 years

Principal Capital Value Fund, Inc.

Top Industry
Commercial Banks 12.3%
Petroleum Refining 10.1%
Telephone Communication 8.2%
Drugs 7.3%
Electric Services 5.6%
Other 56.5%

Top Holdings
Chevron Corp. 3.7%
Exxon Mobil Corp. 3.6%
Texaco 3.5%
Atlantic Richfield Co. 3.3%
AT&T Corp. 3.0%
Merck & Co. 3.0%
Enron Corp. 3.0%
Weyerhauser Co. 2.9%
Kimberly Clark Corp. 2.8%
Chase Manhattan 2.8%
---
Percent of Total Holdings 31.6%

Principal Government Securities Income Fund, Inc.

Portfolio Composition
U.S. Government Bonds: 98.2%
Commercial Paper: 1.8%

Maturity Profile
Average Bond Quality: AAA+
Average Bond Maturity: 8.1 years
Average Duration: 4.4 years

Principal Growth Fund, Inc.

Top Industry
Computer & Office Equipment 15.2%
Electronic Components & Access. 10.2%
Computer & Data Processing 8.8%
Communications Equipment 7.9%
Telephone Communication 7.3%
Other 50.6%

Top Holdings
CISCO Systems 9.4%
Intel Corp. 6.0%
Citigroup INc. 4.8%
Nortel Networks Corp. 4.7%
Pfizer, Inc. 4.4%
General Electric Co. 4.4%
Sun Microsystems, Inc. 4.0%
Guidant Corp. 3.8%
Home Depot Inc 3.7%
Microsoft Corp. 3.4%
---
Percent of Total Holdings 48.6%

Principal High Yield Fund, Inc.

Portfolio Composition
Corporate Bonds: 99.3%
Commercial Paper: 0.5%
Preferred Stock: 0.2%

Maturity Profile
Average Bond Quality: Ba3
Average Bond Maturity: 7.4 years
Average Duration: 4.8 years

Principal International Emerging Markets Fund, Inc.

Investments
Top Industry by Country
Telephone Communication 20.6% Korea 13.6%
Commercial Banks 10.9% Taiwan 13.4%
Electronic Components & Access. 10.3% Mexico 11.8%
Computer & Office Equipment 6.1% Brazil 11.1%
Computer & Data Processing 5.0% India 8.6%
Other 47.1% Other 41.5%

Top Holdings
Samsung Electronics 3.1%
Tele Mex (ADR's) 2.5%
Compal Electronics, Inc. 2.5%
Taiwan Semiconductor 2.2%
Asustek Computer, Inc. 2.0%
United Microelectronics 2.0%
The India Fund Inc. 1.9%
Acer Peripherals, Inc. 1.6%
Matav RT ADR 1.5%
China Telecom 1.5%
---
Percent of Total Holdings 20.8%

Principal International Fund, Inc.

Investments
Top Industry by Country
Telephone Communication 14.1% United Kingdom 18.8%
Commercial Banks 7.9% Japan 16.0%
Electronic Components & Access. 7.7% France 15.5%
Computer & Office Equipment 5.9% Netherlands 14.3%
Computer & Data Processing 4.5% Sweden 8.9%
Other 59.9% Other 26.5%

Top Holdings
Philips Electronics 3.4%
Ericsson LM B Shares 3.3%
Vodafone Group 3.0%
Koninklijke KPN NV 2.9%
Nokia Corp. A ADR 2.4%
NEC Corp. 2.3%
Cap Gemini SA 2.3%
Alcatel Alsthom 2.3%
News Corp. Ltd. ADS 2.3%
Getronics NV 2.3%
---
Percent of Total Holdings 26.5%

Principal International SmallCap Fund, Inc.

Investments
Top Industry by Country
Computer & Data Processing 15.8% Japan 10.3%
Federal & Federally Sponsored 6.4% Canada 9.7%
Telephone Communication 6.1% Germany 8.4%
Electronic Components & Access. 5.7% Netherlands 7.2%
Advertising 3.8% Australia 7.0%
Other 62.2% Other 57.4%

Top Holdings
Creo Products, Inc. 2.0%
Davnet Ltd. 1.8%
Mosaic Group, Inc. 1.7%
C-Mac Industries, Inc. 1.7%
Urban Corp. 1.6%
Mikron Holding Ag 1.6%
Prodisc Internatio, Inc. 1.6%
H.I.S. Co. Ltd. 1.6%
Esat Telecom Group ADR 1.4%
Swisslog Holding AG 1.4%
---
Percent of Total Holdings 16.4%

Principal LargeCap Stock Index Fund, Inc.

Top Holdings
Microsoft Corp. 0.6%
CISCO Systems 0.6%
General Electric Co. 0.6%
Intel Corp. 0.5%
Exxon Mobil Corp. 0.3%
Wal-Mart Stores, Inc. 0.3%
Oracle Systems Corp. 0.3%
IBM Corp. 0.3%
Citigroup Inc. 0.2%
Lucent Technologies 0.2%
---
Percent of Total Holdings 3.9%

Principal Limted Term Bond Fund, Inc.

Portfolio Composition
Corporate Bonds: 51.6%
U.S. Government Bonds: 26.2%
Asset-backed Securities: 21.1%
Commercial Paper: 1.1%

Maturity Profile
Average Bond Quality: AA3
Average Bond Maturity: 4 years
Average Duration: 2.8 years

Principal MidCap Fund, Inc.

Top Industry
Computer & Data Processing 24.0%
Electronic Components & Access. 13.2%
Telephone Communication 10.9%
Drugs 5.4%
Commercial Banks 5.2%
Other 41.3%

Top Holdings
Veritas Software 7.3%
Comverse Technology, Inc. 3.1%
Intermedia Communications 2.8%
Altera Corp. 2.5%
Jabil Circuit Inc. 2.5%
Brocade Communications 2.5%
American Power Conversion 2.2%
Family Dollar Stores 2.2%
State Street Corp. 2.1%
Maxim Integrated Products 2.1%
---
Percent of Total Holdings 29.3%

Principal Partners Aggressive Growth Fund, Inc.

Top Industry
Drugs 12.0%
Electronic Components & Access. 8.9%
Computer & Data Processing 8.5%
Computer & Office Equipment 6.3%
General Industrial Machines 6.2%
Other 58.1%

Top Holdings
Tyco International Ltd. 11.7%
CISCO Systems 10.9%
General Electric 8.3%
Microsoft Corp. 8.1%
Intel Corp. 8.0%
United Technologies 7.3%
Home Depot Inc. 5.8%
Warner-Lambert Co. 5.5%
Time Warner, Inc. 5.1%
Clear Channel Comm. 4.6%
---
Percent of Total Holdings 75.3%

Principal Partners LargeCap Growth Fund, Inc.

Top Holdings
Juniper Networks, Inc. 0.10%
CISCO Systems 0.10%
Echostar Comm. Corp. 0.09%
JDS Uniphase Corp. 0.09%
Veritas Software 0.09%
AT&T Corp. Liberty Media 0.09%
Broadcom Corp. Class A 0.08%
Nokia Corp. A ADR 0.07%
Intel Corp. 0.06%
Nextel Communications Inc. 0.06%
----
Percent of Total Holdings 0.83%

Principal Partners MidCap Growth Fund, Inc.

Top Holdings
JDS Uniphase Corp. 0.03%
Veritas Software 0.03%
Exodus Communications Inc. 0.02%
SDL Inc. 0.01%
PMC Sierra, Inc. 0.01%
Broadcom Corp, Class A 0.01%
Nextel Communications 0.01%
Medimmune Inc. 0.01%
KLA-Tencor Corp. 0.01%
PE Corp.-PE Biosystems 0.01%
----
Percent of Total Holdings 0.15%

Principal Real Estate Fund, Inc.

Top Industry
Apartment 4.7%
Hotels & Motels 3.8%
Real Estate Operators 3.3%
Personal Credit Institutions 1.8%
Other 86.4%

Top Holdings
Spieker Properties, Inc. 5.7%
Equity Residential Prop 5.0%
Cornerstone Properties 5.0%
Prologis Trust 4.8%
AMB Property Corp. 3.9%
Simon Property Group 3.9%
Apartment Investment 3.3%
Mirage Resorts, Inc. 3.1%
Equity Office Properties 3.0%
Duke-Weeks Realty Corp. 3.0%
---
Percent of Total Holdings 40.70%

Principal SmallCap Fund, Inc.

Top Industry
Computer & Data Processing 11.1%
Personal Credit Institutions 6.3%
Electronic Components & Access. 5.2%
Communications Equipment 4.4%
Drugs 4.0%
Other 69.0%

Top Holdings
Hot Topic Inc. 2.3%
Digene Corp. 2.1%
Matritech Inc. 1.9%
Hadco Corp. 1.8%
ICG Communications Inc. 1.5%
Bindview Dev. Corp. 1.5%
American Eagle Outfitters 1.5%
Intervoice-Brite, Inc. 1.5%
Internet Pictures Corp. 1.5%
Quintus Corp. 1.5%
---
Percent of Total Holdings 17.1%

Principal Tax-Exempt Bond Fund, Inc.

Portfolio Composition
Long-term Municipal Bonds: 100.5%
Borrowed funds: -0.5%

Maturity Profile
Average Bond Quality: A
Average Bond Maturity: 16 years
Average Duration: 7.4 years

Principal Utilities Fund, Inc.

Top Industry
Electric Services 46.3%
Telephone Communication 23.6%
Combination Utility Services 10.5%
Gas Production & Distribution 6.0%
Radio & Television Broadcasting 3.9%
Other 9.7%

Top Holdings
Enron Corp. 3.7%
FPL Group, Inc. 3.5%
Duke Energy Corp. 3.4%
Niagara Mohawk Holdings 3.2%
AES Corp. 3.2%
Peco Energy Co. 3.0%
Calpine Corp. 2.9%
DQE Inc. 2.9%
Dynegy, Inc. 2.8%
Pinnacle West Capital Cor 2.6%
---
Percent of Total Holdings 31.2%

Principal Partners Aggressive
Growth Fund, Inc.

Statement of Net Assets

October 28, 1999

Assets - cash in bank $4,000,000
==============

Net Assets Applicable to Outstanding Shares $4,000,000
==============

Net Assets Consist of:
Capital stock $ 4,000
Additional paid-in capital 3,996,000
--------------
Total net assets $4,000,000
==============

Capital Stock (par value $.01 a share):
Shares authorized 100,000,000

Net Asset Value Per Share:
Class A:
Net assets $1,000,000
Shares issued and outstanding 100,000
Net asset value per share (b) $10.00
Maximum offering price per share (a) $10.50
Class B:
Net assets $1,000,000
Shares issued and outstanding 100,000
Net asset value per share (b) $10.00
Class C:
Net assets $1,000,000
Shares issued and outstanding 100,000
Net asset value per share (b) $10.00
Class R:
Net assets $1,000,000
Shares issued and outstanding 100,000
Net asset value per share $10.00

(a) Maximum offering price is equal to net asset value plus a front-end sales
charge of 4.75% of the offering price or 4.99% of the net asset value.

(b) Redemption price per share is equal to net asset value less any applicable
contingent deferred sales charge.

See accompanying notes.

<PAGE>

Principal Partners Aggressive
Growth Fund, Inc.

Notes to Statement of Net Assets

October 28, 1999

1. Organization

Principal Partners Aggressive Growth Fund, Inc. ("the Fund") is registered under
the Investment Company Act of 1940, as amended, as open-end diversified
management investment company. On October 28, 1999, the initial purchase of
100,000 shares each of Class A, Class B, Class C and Class R Capital Stock was
made by Principal Life Insurance Company, which is the indirect parent of
Princor Financial Services Corporation and Principal Management Corporation.

All organizational expenses have been paid by Principal Management Corporation.
Certain officers and directors of the Fund are also officers of Principal Life
Insurance Company, Princor Financial Services Corporation and Principal
Management Corporation.

2. Operations

The Fund has agreed to pay investment advisory and management fees to Principal
Management Corporation (the "Manager") computed at an annual percentage rate of
the Fund's average daily net assets. The annual rate to be used in this
calculation for the Funds is as follows:

Net Asset Value of Fund
(in millions)
------------------------------------------------------------
First $250 Next $250 Next $250 Next $250 Over $1,000
----------- ---------- ----------- ----------- -----------

.75% .70% .65% .60% .55%

The Manager has subcontracted the investment advisory services of the Fund to
Morgan Stanley Dean Witter Investment Management, Inc. for a monthly fee
approximating the actual cost of providing the services by Morgan Stanley Dean
Witter Investment Management, Inc.

The Funds have also agreed to pay distribution and shareholder servicing fees to
Princor Financial Services Corporation (the "Underwriter") as follows: Class A,
.25% of the daily net assets of the Fund's Class A shares; Class B, 1.00% of the
daily net assets of the Fund's Class B shares; Class C, 1.00% of the daily net
assets of the Fund's Class C shares; and Class R, .75% of the daily net assets
of the Fund's Class R shares.

The Funds reimburse the Manager for transfer and administrative services,
including the cost of accounting, data processing, supplies and other services
rendered.

<PAGE>

Principal Partners Aggressive
Growth Fund, Inc.

Notes to Statement of Net Assets (continued)

2. Operations (continued)

The Manager may, at its option, waive all or part of its compensation for such
period of time as it deems necessary or appropriate.

The Funds intend to qualify as "regulated investment companies" under the
Internal Revenue Code and intend to distribute each year substantially all of
their net investment income and realized capital gains to their shareholders.

3. Capital Stock

The Fund has authorized 100,000,000 shares and has allocated 25,000,000 shares
each for issuance of Class A, Class B, Class C, and Class R shares.

Class A shares generally are sold with an initial sales charge based on
declining rates and certain purchases may be subject to a contingent deferred
sales charge ("CDSC"). Class B shares are sold without an initial sales charge,
but are subject to a declining CDSC on certain redemptions redeemed within six
years of purchase. Class C shares are sold without an initial sales charge, but
are subject to a CDSC for redemptions within one year of purchase. Class R
shares are sold without an initial sales charge and are not subject to a CDSC.
Class B shares, Class C shares and Class R shares bear a higher ongoing
distribution fee than Class A shares. Class B shares automatically convert into
Class A shares, based on relative net asset value (without a sales charge) after
seven years. Class R shares automatically convert into Class A shares, based on
relative net asset value (without a sales charge) on the first business day of
the 49th month. All classes of shares for each fund represent interests in the
same portfolio of investments, and will vote together as a single class except
where otherwise required by law or as determined by each of the Funds'
respective Board of Directors. In addition, the Board of Directors of each fund
will declare separate dividends on each class of shares.

4. Line of Credit

The Fund participates with other funds and portfolios managed by Principal
Management Corporation in an unsecured joint line of credit with a bank, which
allows the funds to borrow up to $75,000,000, collectively. Borrowings are made
solely to facilitate the handling of unusual and/or unanticipated short-term
cash requirements. Interest is charged to each fund, based on its borrowings, at
a rate equal to the Fed Funds Rate plus .50%. Additionally, a commitment fee is
charged at the annual rate of .09% on the average unused portion of the line of
credit. The commitment fee is allocated among the participating funds and
portfolios in proportion to their average net assets during each quarter. At
October 28, 1999, the Fund had no outstanding borrowings under the line of
credit.

<PAGE>

Report of Independent Auditors

The Board of Directors and Shareholder
Principal Partners Aggressive Growth Fund, Inc.

We have audited the accompanying statement of net assets of Principal Partners
Aggressive Growth Fund, Inc. as of October 28, 1999. This statement of net
assets is the responsibility of the Fund's management. Our responsibility is to
express an opinion on this statement of net assets based on our audit.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the statement of net assets is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the statement of net assets. Our procedures
included confirmation of cash held as of October 28, 1999, by correspondence
with the custodian. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall statement of net assets presentation. We believe that our audit of the
statement of net assets provides a reasonable basis for our opinion.

In our opinion, the statement of net assets referred to above presents fairly,
in all material respects, the financial position of Principal Partners
Aggressive Growth Fund, Inc. at October 28, 1999, in conformity with generally
accepted accounting principles.

/S/ ERNST & YOUNG LLP

Des Moines, Iowa
October 28, 1999

<PAGE>

Principal LargeCap Stock Index Fund, Inc.
Principal Partners LargeCap Growth Fund, Inc.
Principal Partners MidCap Growth Fund, Inc.
<TABLE>
Statements of Net Assets

February 24, 2000
<CAPTION>
Principal Principal
Principal Partners Partners
LargeCap LargeCap MidCap
Stock Index Growth Fund, Growth Fund,
Fund, Inc. Inc. Inc.
------------- ------------- ------------

<S> <C> <C> <C>
Assets - cash in bank $4,000,000 $4,000,000 $4,000,000
============= ========== ==========

Net Assets Applicable to Outstanding Shares $4,000,000 $4,000,000 $4,000,000
============= ========== ==========

Net Assets Consist of:
Capital stock $ 4,000 $ 4,000 $ 4,000
Additional paid-in capital 3,996,000 3,996,000 3,996,000
------------- ------------- ------------
Total net assets $4,000,000 $4,000,000 $4,000,000
============= ========== ==========

Capital Stock (par value $.01 a share):
Shares authorized 100,000,000 100,000,000 100,000,000

Net Asset Value Per Share:
Class A:
Net assets $1,000,000 $1,000,000 $1,000,000
Shares issued and outstanding 100,000 100,000 100,000
Net asset value per share $10.00 $10.00 $10.00
Maximum offering price per share (a) $10.15 $10.50 $10.50
Class B:
Net assets $1,000,000 $1,000,000 $1,000,000
Shares issued and outstanding 100,000 100,000 100,000
Net asset value per share (b) $10.00 $10.00 $10.00
Class C:
Net assets $1,000,000 $1,000,000 $1,000,000
Shares issued and outstanding 100,000 100,000 100,000
Net asset value per share (b) $10.00 $10.00 $10.00
Class R:
Net assets $1,000,000 $1,000,000 $1,000,000
Shares issued and outstanding 100,000 100,000 100,000
Net asset value per share $10.00 $10.00 $10.00
<FN>

(a) Maximum offering price is equal to net asset value plus a front-end sales
charge. For the Principal LargeCap Stock Index Fund, Inc., this charge is
1.5% of the offering price or 1.52% of the net asset value. For the
Principal Partners LargeCap Growth Fund, Inc. and the Principal Partners
MidCap Growth Fund, Inc., this charge is 4.75% of the offering price or
4.99% of the net asset value.

(b) Redemption price per share is equal to net asset value less any applicable
contingent deferred sales charge.
</FN>

See accompanying notes.
</TABLE>

<PAGE>

Principal LargeCap Stock Index Fund, Inc.
Principal Partners LargeCap Growth Fund, Inc.
Principal Partners MidCap Growth Fund, Inc.

Notes to Statements of Net Assets

February 24, 2000

1. Organization

Principal LargeCap Stock Index Fund, Inc., Principal Partners LargeCap Growth
Fund, Inc. and Principal Partners MidCap Growth Fund, Inc. (the "Funds") are
registered under the Investment Company Act of 1940, as amended (the "Act").
Principal LargeCap Stock Index Fund, Inc. and Principal Partners MidCap Fund,
Inc. are registered under the Act as open-end diversified management investment
companies. Principal Partners LargeCap Growth Fund, Inc. is registered under the
Act as an open-end non-diversified management investment company. On February
24, 2000, the initial purchase of 100,000 shares each of Class A, Class B, Class
C and Class R Capital Stock of each of the Funds was made by Principal Life
Insurance Company, which is an affiliate of Princor Financial Services
Corporation and Principal Management Corporation.

All organizational expenses have been paid by Principal Management Corporation.
Certain officers and directors of the Funds are also officers of Principal Life
Insurance Company, Princor Financial Services Corporation and Principal
Management Corporation.

2. Operations

The Funds have agreed to pay investment advisory and management fees to
Principal Management Corporation (the "Manager") computed at an annual
percentage rate of the Fund's average daily net assets. The annual rate used in
this calculation for the Funds is as follows:

Overall Fee
---------------

Principal LargeCap Stock Index Fund, Inc. .35%
Principal Partners LargeCap Growth Fund, Inc. .90%
Principal Partners MidCap Growth Fund, Inc. .90%

The Manager has subcontracted the investment advisory services of the Principal
LargeCap Stock Index Fund, Inc. to Invista Capital Management (an affiliate),
the Principal Partners LargeCap Growth Fund, Inc. to Duncan-Hurst Capital
Management Inc. and the Principal Partners MidCap Growth Fund, Inc. to Turner
Investment Partners, Inc. for a monthly fee approximating the actual cost of
providing the services.

<PAGE>

Principal LargeCap Stock Index Fund, Inc.
Principal Partners LargeCap Growth Fund, Inc.
Principal Partners MidCap Growth Fund, Inc.

Notes to Statements of Net Assets (continued)

2. Operations (continued)

The Funds bear distribution and shareholder servicing fees with respect to each
class computed at an annual rate of the average daily net assets attributable to
each class of each fund. The annual rate will not exceed the following limits:
<TABLE>
<CAPTION>
Class A Class B Class C Class R
-------- -------- ------- -------

<S> <C> <C> <C> <C>
Principal LargeCap Stock Index Fund, Inc. .15% .50% .50% .65%
Principal Partners LargeCap Growth Fund, Inc.
.25 1.00 1.00 .75
Principal Partners MidCap Growth Fund, Inc.
.25 1.00 1.00 .75
</TABLE>

The Funds reimburse the Manager for transfer and administrative services,
including the cost of accounting, data processing, supplies and other services
rendered.

The Manager may, at its option, waive all or part of its compensation for such
period of time as it deems necessary or appropriate.

3. Capital Stock

Each of the Funds has authorized 100,000,000 shares and has allocated 25,000,000
shares each for issuance of Class A, Class B, Class C, and Class R shares.

Class A shares generally are sold with an initial sales charge based on
declining rates and certain purchases may be subject to a contingent deferred
sales charge ("CDSC"). Class B shares are sold without an initial sales charge,
but are subject to a declining CDSC on certain redemptions redeemed within six
years of purchase. Class C shares are sold without an initial sales charge, but
are subject to a CDSC for redemptions within one year of purchase. Class R
shares are sold without an initial sales charge and are not subject to a CDSC.
Class B shares, Class C shares and Class R shares bear a higher ongoing
distribution fee than Class A shares. Class B shares automatically convert into
Class A shares, based on relative net asset value (without a sales charge) after
seven years. Class R shares automatically convert into Class A shares, based on
relative net asset value (without a sales charge) 49 months after purchase. All
classes of shares for each fund represent interests in the same portfolio of
investments, and will vote together as a single class except where otherwise
required by law or as determined by each of the Funds' respective Board of
Directors. In addition, the Board of Directors of each fund will declare
separate dividends on each class of shares.

<PAGE>

Report of Independent Auditors

The Board of Directors and Shareholder
Principal LargeCap Stock Index Fund, Inc.
Principal Partners LargeCap Growth Fund, Inc.
Principal Partners MidCap Growth Fund, Inc.

We have audited the accompanying statements of net assets of Principal LargeCap
Stock Index Fund, Inc., Principal Partners LargeCap Growth Fund, Inc. and
Principal Partners MidCap Growth Fund, Inc. as of February 24, 2000. These
statements of net assets are the responsibility of the Funds' management. Our
responsibility is to express an opinion on these statements of net assets based
on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the statements of net assets are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the statement of net assets.
Our procedures included confirmation of cash held as of February 24, 2000, by
correspondence with the custodian. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall statement of net assets presentation. We believe that
our audits of the statements of net assets provide a reasonable basis for our
opinion.

In our opinion, the statements of net assets referred to above presents fairly,
in all material respects, the financial position of Principal LargeCap Stock
Index Fund, Inc., Principal Partners LargeCap Growth Fund, Inc. and Principal
Partners MidCap Growth Fund, Inc. at February 24, 2000, in conformity with
accounting principles generally accepted in the United States.

/S/ ERNST & YOUNG LLP

Des Moines, Iowa
February 24, 2000

Principal European Equity Fund, Inc.
Principal Pacific Basin Fund, Inc.

Statements of Net Assets

April 26, 2000

<TABLE>
<CAPTION>
Principal Principal
European Equity Pacific
Fund, Inc. Basin
Fund, Inc.
---------------------------------------

<S> <C> <C>
Assets - cash in bank $5,000,000 $5,000,000
=======================================

Net Assets Applicable to Outstanding Shares $5,000,000 $5,000,000
=======================================

Net Assets Consist of:
Capital stock $ 5,000 $ 5,000
Additional paid-in capital 4,995,000 4,995,000
=======================================
Total net assets $5,000,000 $5,000,000
=======================================

Capital Stock (par value $.01 a share):
Shares authorized 100,000,000 100,000,000

Net Asset Value Per Share:
Class A:
Net assets $1,250,000 $1,250,000
Shares issued and outstanding 125,000 125,000
Net asset value per share $10.00 $10.00
Maximum offering price per share (a) $10.50 $10.50
Class B:
Net assets $1,250,000 $1,250,000
Shares issued and outstanding 125,000 125,000
Net asset value per share (b) $10.00 $10.00
Class C:
Net assets $1,250,000 $1,250,000
Shares issued and outstanding 125,000 125,000
Net asset value per share (b) $10.00 $10.00
Class R:
Net assets $1,250,000 $1,250,000
Shares issued and outstanding 125,000 125,000
Net asset value per share $10.00 $10.00

<FN>
(a) Maximum offering price is equal to net asset value plus a front-end sales
charge. For the Principal European Equity Fund, Inc. and the Principal
Pacific Basin Fund, Inc., this charge is 4.75% of the offering price or
4.99% of the net asset value.

(b) Redemption price per share is equal to net asset value less any applicable
contingent deferred sales charge.
</FN>
</TABLE>

See accompanying notes.

Principal European Equity Fund, Inc.
Principal Pacific Basin Fund, Inc.

Notes to Statements of Net Assets

April 26, 2000

1. Organization

Principal European Equity Fund, Inc. and Principal Pacific Basin Fund, Inc. (the
"Funds") are registered under the Investment Company Act of 1940, as amended, as
open-end diversified management investment companies. On April 26, 2000, the
initial purchase of 125,000 shares each of Class A, Class B, Class C and Class R
Capital Stock of each of the Funds was made by Principal Life Insurance Company,
which is an affiliate of Princor Financial Services Corporation and Principal
Management Corporation.

2. Operations

<TABLE>
<CAPTION>
Net Asset Value of Fund
(in millions)
---------------------------------------------------------
First Next $250 Next $250 Next $250 Over
$250 $1,000
---------- ---------- ----------- ----------- -----------

<S> <C> <C> <C> <C> <C>
Principal European Equity Fund, Inc. 0.90% 0.85% 0.80% 0.75% 0.70%
Principal Pacific Basin Fund, Inc. 1.10% 1.05% 1.00% 0.95% 0.90%
</TABLE>

The Manager has subcontracted the investment advisory services of the Funds to
BT Funds Management (International) Limited, an affiliate, for a monthly fee
approximating the actual cost of providing the services.

Principal European Equity Fund, Inc.
Principal Pacific Basin Fund, Inc.

Notes to Statements of Net Assets (continued)

2. Operations (continued)

<TABLE>
<CAPTION>
Class A Class B Class C Class R
------------ ----------- ------------ ------------

<S> <C> <C> <C> <C>
Principal European Equity Fund, Inc. .25% 1.00% 1.00% .75%
Principal Pacific Basin Fund, Inc. .25 1.00 1.00 .75
</TABLE>

The Funds reimburse the Manager for transfer and administrative services,
including the cost of accounting, data processing, supplies and other services
rendered.

The Manager may, at its option, waive all or part of its compensation for such
period of time as it deems necessary or appropriate.

3. Capital Stock

Each of the Funds has authorized 100,000,000 shares and has allocated 25,000,000
shares each for issuance of Class A, Class B, Class C, and Class R shares.

Class A shares generally are sold with an initial sales charge based on
declining rates and certain purchases may be subject to a contingent deferred
sales charge ("CDSC"). Class B shares are sold without an initial sales charge,
but are subject to a declining CDSC on certain redemptions redeemed within six
years of purchase. Class C shares are sold without an initial sales charge, but
are subject to a CDSC for redemptions within one year of purchase. Class R
shares are sold without an initial sales charge and are not subject to a CDSC.
Class B shares, Class C shares and Class R shares bear a higher ongoing
distribution fee than Class A shares. Class B shares automatically convert into
Class A shares, based on relative net asset value (without a sales charge) after
seven years. Class R shares automatically convert into Class A shares, based on
relative net asset value (without a sales charge) 49 months after purchase. All
classes of shares for each fund represent interests in the same portfolio of
investments, and will vote together as a single class except where otherwise
required by law or as determined by each of the Funds' respective Board of
Directors. In addition, the Board of Directors of each fund will declare
separate dividends on each class of shares.

Report of Independent Auditors

The Board of Directors and Shareholder
Principal European Equity Fund, Inc.
Principal Pacific Basin Fund, Inc.

We have audited the accompanying statements of net assets of Principal European
Equity Fund, Inc. and Principal Pacific Basin Fund, Inc. as of April 26, 2000.
These statements of net assets are the responsibility of the Funds' management.
Our responsibility is to express an opinion on these statements of net assets
based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the statements of net assets are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the statements of net assets.
Our procedures included confirmation of cash held as of April 26, 2000, by
correspondence with the custodian. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall statement of net assets presentation. We believe that
our audits of the statements of net assets provide a reasonable basis for our
opinion.

In our opinion, the statements of net assets referred to above presents fairly,
in all material respects, the financial position of Principal European Equity
Fund, Inc. and Principal Pacific Basin Fund, Inc. at April 26, 2000, in
conformity with accounting principles generally accepted in the United States.

/s/ Ernst & Young LLP

Des Moines, Iowa
April 26, 2000