<PAGE>
PAGE 1
Prospectus for the T. Rowe Price Tax-Exempt Money Fund, Inc., T. Rowe Price
Tax-Free Short-Intermediate Fund, Inc., T. Rowe Price Tax-Free Insured
Intermediate Bond Fund, Inc., T. Rowe Price Tax-Free Income Fund, Inc., and T.
Rowe Price Tax-Free High Yield Fund, Inc. Fund dated July 1, 1994, should be
inserted here.
TO OPEN AN ACCOUNT
INVESTOR SERVICES
1-800-638-5660
1-410-547-2308
FOR EXISTING ACCOUNTS
SHAREHOLDER SERVICES
1-800-225-5132
1-410-625-6500
FOR YIELDS & PRICES
TELE*ACCESS (REGISTERED TRADEMARK)
1-800-638-2587
1-410-625-7676
24 HOURS, 7 DAYS
INVESTOR CENTERS
101 EAST LOMBARD ST.
BALTIMORE, MD
T. ROWE PRICE
FINANCIAL CENTER
10090 RED RUN BLVD.
OWINGS MILLS, MD
FARRAGUT SQUARE
900 17TH STREET, N.W.
WASHINGTON, D.C.
ARCO TOWER
31ST FLOOR
515 SOUTH FLOWER ST.
LOS ANGELES, CA
Invest With Confidence
To help you achieve your financial goals, T. Rowe Price offers a wide range of
stock, bond, and money market investments, as well as convenient services and
timely, informative reports.
PROSPECTUS
T. ROWE PRICE
TAX-FREE FUNDS
T. ROWE PRICE
TAX-FREE FUNDS
JULY 1, 1994
_____________________________________________________________________________
A family of municipal bond and money funds for investors seeking income that
is exempt from federal income taxes.
Facts at a Glance
Objectives The highest possible levels of income exempt from federal income
taxes, consistent with each Fund's prescribed investment program. As with all
mutual funds, these Funds may not meet their objectives.
Strategy and Risk/Reward Potential
Tax-Exempt Money Fund, Inc(registered trademark) Invests in high-quality,
short-term municipal securities, and its average maturity will not exceed 90
days. The Fund is managed to maintain a stable share price of $1.00 but there
is no assurance the price will always be stable. Your investment in the Fund
is neither insured nor guaranteed by the U.S. Government. Risk/Reward: Lowest
potential risk and reward.
Tax-Free Short-Intermediate Fund, Inc.(registered trademark) Invests primarily
in investment grade short- and intermediate-term municipal bonds. Risk/Reward:
Moderate income level and share-price fluctuation.
Tax-Free Insured Intermediate Bond Fund, Inc. Invests primarily in
intermediate- term municipal bonds whose interest and principal payments are
insured by private insurance companies. Insurance does not apply to the Fund's
share price, which will fluctuate. Risk/Reward: Somewhat higher income and
potential share-price fluctuation than the Short-Intermediate Fund. (See
discussion on insurance on page 21.)
Tax-Free Income Fund, Inc.(registered trademark) Invests primarily in
longer-term, investment-grade municipal bonds. Risk/Reward: Higher income and
potential share-price fluctuation than the shorter-term Funds.
Tax-Free High Yield Fund, Inc.(registered trademark) Can invest entirely in
lower-quality, long-term municipal bonds often called "high yield" or "junk
bonds." These bonds represent greater default risk than higher rated bonds.
Before investing, you should carefully consider the greater risks of junk
bonds as explained in "Investment Policies and Practices." Risk/Reward:
Highest income, greatest credit risk, and highest potential share-price
volatility.
Investor Profile Investors whose income tax level enables them to benefit from
tax-exempt income. Not appropriate for tax-deferred retirement plans, such as
IRAs.
Fees and Charges 100% no load. No fees or charges to buy or sell shares or to
reinvest dividends; no 12b-1 marketing fees; free telephone exchange.
Investment Manager Founded in 1937, T. Rowe Price Associates, Inc. and its
affiliates currently manage over $54 billion, including over $5 billion in
municipal bond assets, for approximately three million individual and
institutional investor accounts.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION, OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION, OR ANY STATE SECURITIES commission, PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
T. ROWE PRICE
TAX-FREE FUNDS
JULY 1, 1994
PROSPECTUS
Contents
________________________________________________________________________
1 About the Tax-Free Funds
________________________________________________________________________
Transaction and Fund Expenses . . . . . . . . . . . . . . . . . . . 2
________________________________________________________________________
Financial Highlights. . . . . . . . . . . . . . . . . . . . . . . . 4
________________________________________________________________________
Fund and Market Characteristics . . . . . . . . . . . . . . . . . . 6
________________________________________________________________________
2 About Your Account
________________________________________________________________________
Pricing Shares;
Receiving Sale Proceeds . . . . . . . . . . . . . . . . . . . . . .12
________________________________________________________________________
Distributions and Taxes . . . . . . . . . . . . . . . . . . . . . .13
________________________________________________________________________
Transaction Procedures and
Special Requirements. . . . . . . . . . . . . . . . . . . . . . . .15
________________________________________________________________________
3 More About the Funds
________________________________________________________________________
Organization and Management . . . . . . . . . . . . . . . . . . . .17
________________________________________________________________________
Understanding Fund Performance. . . . . . . . . . . . . . . . . . .18
________________________________________________________________________
Investment Policies and Practices . . . . . . . . . . . . . . . . .19
________________________________________________________________________
4 Investing With T. Rowe Price
________________________________________________________________________
Meeting Requirements
for New Accounts. . . . . . . . . . . . . . . . . . . . . . . . . .27
________________________________________________________________________
Opening a New Account . . . . . . . . . . . . . . . . . . . . . . .27
________________________________________________________________________
Purchasing Additional Shares. . . . . . . . . . . . . . . . . . . .28
________________________________________________________________________
Exchanging and Redeeming. . . . . . . . . . . . . . . . . . . . . .28
________________________________________________________________________
Shareholder Services. . . . . . . . . . . . . . . . . . . . . . . .29
________________________________________________________________________
This prospectus contains information you should know before investing. Please
keep it for future reference. A Statement of Additional Information about the
funds, dated July 1, 1994, has been filed with the Securities and Exchange
Commission and is incorporated by reference in this prospectus. To obtain a
free copy, call 1-800-638-5660.
1 About the Tax-Free Funds
1 ABOUT THE TAX-FREE FUNDS
Transaction and Fund Expenses
These tables should help you understand the kinds of expenses you will bear
directly or indirectly as a fund shareholder.
The first part of the table, "Shareholder Transaction Expenses," shows that
you pay no sales charges. All the money you invest in a fund goes to work for
you subject to the fees explained below.
_____________________________________________________________________________
LIKE ALL T. ROWE PRICE FUNDS, THE TAX-FREE FUNDS ARE 100% NO-LOAD.
_____________________________________________________________________________
Shareholder Transaction Expenses
Money Short- Insured Income High
Intermediate Intermediate Yield
_____________________________________________________________________________
Sales charge "load" None None None None None
on purchases
_____________________________________________________________________________
Sales charge "load" None None None None None
on reinvested
dividends
_____________________________________________________________________________
Redemption fees None None None None None
_____________________________________________________________________________
Exchange fees None None None None None
_____________________________________________________________________________
Annual Fund Expenses Percentage of Fiscal 1994 Average Net Assets
Money Short- Insured Income High
Intermediate Intermediate Yield
(After
Reduction)*
_____________________________________________________________________________
Management fee 0.44% 0.44% 0.15% 0.49% 0.64%
_____________________________________________________________________________
Total other
(Shareholder servicing,
custodial, auditing,
etc.) 0.15% 0.16% 0.50% 0.10% 0.15%
_____________________________________________________________________________
Marketing fees (12b-1) None None None None None
_____________________________________________________________________________
Total fund expenses 0.59% 0.60% 0.65% 0.59% 0.79%
_____________________________________________________________________________
* The Insured Intermediate Fund's management fee and its total expense ratio
would have been 0.39% and 0.90%, respectively, had T. Rowe Price not agreed
to reduce management fees in accordance with the expense limitation. From
July 1, 1993 through February 28, 1994, T. Rowe Price agreed to waive its
fees and bear any expenses to the extent such fees or expenses would cause
the fund's ratio of expenses to average net assets to exceed 0.50%.
Effective March 1, 1994, T. Rowe Price agreed to waive its fees and bear
any expenses through February 29, 1996 to the extent such fees and expenses
would cause the fund's ratio of expenses to average net assets to exceed
0.65%. Fees waived or expenses paid or assumed under each agreement are
subject to reimbursement to T. Rowe Price by the fund whenever the fund's
expense ratio is below 0.50% (for the first agreement) and 0.65% (for the
second agreement). However, no reimbursement will be made after February
29, 1996 (for the first agreement) and February 28, 1998 (for the second
agreement), or if it would result in the expense ratio exceeding 0.50% (for
the first agreement) and 0.65% (for the second agreement).
Note: The funds charge a $5.00 fee for wire redemptions under $5,000, subject
to change without notice.
_____________________________________________________________________________
Table 1
The second half of the table, "Annual Fund Expenses," provides an estimate of
how much it will cost to operate each Fund for a year, based on 1994 fiscal
year expenses (and any applicable expense limitations). These are costs you
pay indirectly, because they are deducted from the fund's total assets before
the daily share price is calculated and before dividends and other
dis-tributions are made. In other words, you will not see these expenses on
your account statement.
The main types of expenses, which all mutual funds may charge against fund
assets, are:
o A management fee-the percent of fund assets paid to the fund's
investment manager. Each fund's fee comprises both a group fee,
described later, and an individual fund fee, as follows: Money 0.10%;
Short-Intermediate 0.10%; Insured Intermediate 0.05%; Income 0.15%; and
High Yield 0.30%,
o "Other" administrative expenses-primarily the servicing of shareholder
accounts, such as providing statements, reports, disbursing dividends as
well as custodial services. For the fiscal year ended February 28, 1994,
the funds paid the following fees to T. Rowe Price Services, Inc. for
transfer and dividend disbursing functions and shareholder services and
to T. Rowe Price for fund accounting services.
_____________________________________________________________________________
Transfer Agent and
Fund Shareholder Services Accounting
_____________________________________________________________________________
Money $461,000 $ 93,000
_____________________________________________________________________________
Short-Intermediate $308,000 $ 85,000
_____________________________________________________________________________
Insured Intermediate $123,000 $ 53,000
_____________________________________________________________________________
Income $641,000 $ 100,000
_____________________________________________________________________________
High Yield $574,000 $ 110,000
_____________________________________________________________________________
Table 2A
o Marketing or distribution fees-an annual charge ("12b-1") to existing
shareholders to defray the cost of selling shares to new shareholders.
T. Rowe Price funds do not levy 12b-1 fees.
For further details on fund fees, please see "The Funds' Organization
and Management."
o Hypothetical example: Assume you invest $1,000, the fund returns 5%
annually, expense ratios remain as previously listed, and you close your
account at the end of the time periods shown. Your expenses would be:
_____________________________________________________________________________
THE TABLE AT RIGHT IS JUST AN EXAMPLE AND ACTUAL EXPENSES CAN BE HIGHER OR
LOWER THAN THOSE SHOWN.
_____________________________________________________________________________
Fund 1 year 3 years 5 years 10 years
_____________________________________________________________________________
Money $6 $19 $33 $74
_____________________________________________________________________________
Short-Intermediate $6 $19 $33 $75
_____________________________________________________________________________
Insured Intermediate $7 $21 $36 $81
_____________________________________________________________________________
Income $6 $19 $33 $74
_____________________________________________________________________________
High Yield $8 $25 $44 $98
_____________________________________________________________________________
Table 2B
Financial Highlights
The following table provides information about each fund's financial history.
It is based on a single share outstanding throughout each fiscal year. The
respective table is part of each fund's financial statements which are
included in each fund's annual report and are incorporated by reference into
the Statement of Additional Information. This document is available to
shareholders upon request. The financial statements in the annual report have
been audited by the funds' independent accountants whose respective
unqualified reports cover the periods shown.
<TABLE>
<CAPTION>
Investment Activities Distributions
Net
Net Realized
Asset and
Value Unrealized Total
Year Beginning Net Gain (Loss) from Net Net
Ended of Investment on Investment Investment Realized Total
Feb. 28 Period Income Investments Activites Income Gain Distributions
____________________________________________________________________________________________________________
<S> <C> <C> <C> <C> <C> <C> <C>
Money
1985 $1.000 $.058 - $.058 $(.058) - $(.058)
1986 1.000 .049 - .049 (.049) - (.049)
1987 1.000 .042 - .042 (.042) - (.042)
**1988 1.000 .044 - .044 (.044) - (.044)
1989 1.000 .050 - .050 (.050) - (.050)
1990 1.000 .057 - .057 (.057) - (.057)
1991 1.000 .051 - .051 (.051) - (.051)
**1992 1.000 .036 - .036 (.036) - (.036)
1993 1.000 .023 - .023 (.023) - (.023)
1994 1.000 .020 - .020 (.020) - (.020)
Short-
Intermediate
1985 $4.97 $.32 $ .05 $.37 $(.32) - $(.32)
1986 5.02 .32 .18 .50 (.32) - (.32)
1987 5.20 .29 .13 .42 (.29) - (.29)
**1988 5.33 .27 (.16) .11 (.27) $(.02) (.29)
1989 5.15 .28 (.12) .16 (.28) - (.28)
1990 5.03 .30 .06 .36 (.30) - (.30)
1991 5.09 .29 .06 .35 (.29) - (.29)
**1992 5.15 .28 .07 .35 (.28) - (.28)
1993 5.22 .24 .14 .38 (.24) - (.24)
1994 5.36 .22 (.04) .18 (.22) - (.22)
<CAPTION>
End of Period
Total
Net Asset Return Ratio Ratio of Net
Value (Includes of Expenses Investment
End of Reinvested Net Assets to Average to Average Portfolio
Period Dividends) ($ Thousands) Net Assets Net Assets Turnover Rate
<S> <C> <C> <C> <C> <C>
____________________________________________________________________________________________________________
$1.000 5.93% $948,941 0.61% 5.81% -
1.000 5.02% 872,040 0.61% 4.89% -
1.000 4.30% 1,131,755 0.60% 4.23% -
1.000 4.47% 1,247,256 0.60% 4.41% -
1.000 5.08% 1,157,246 0.60% 4.97% -
1.000 5.87% 1,064,141 0.60% 5.75% -
1.000 5.22% 977,638 0.60% 5.12% -
1.000 3.69% 801,846 0.61% 3.65% -
1.000 2.36% 695,699 0.60% 2.35% -
1.000 2.05% 732,900 0.59% 2.04% -
$5.02 0.64% $68,015 !!0.90% 6.51% 300.7%
5.20 10.30% 155,420 0.90% 6.26% 128.7%
5.33 8.41% 405,092 0.73% 5.60% 119.5%
5.15 2.25% 291,850 0.74% 5.29% 225.2%
5.03 3.14% 249,489 0.74% 5.46% 53.4%
5.09 7.36% 223,180 0.75% 5.93% 190.8%
5.15 7.06% 232,923 0.74% 5.67% 190.1%
5.22 6.94% 328,312 0.67% 5.34% 81.3%
5.36 7.51% 454,162 0.63% 4.61% 38.5%
5.32 3.49% 540,728 0.60% 4.18% 51.1%
____________________________________________________________________________________________________________
Table 3 (continued on next page)
<CAPTION>
Investment Activities Distributions
Net
Net Realized
Asset and
Value Unrealized Total
Year Beginning Net Gain (Loss) from Net Net
Ended of Investment on Investment Investment Realized Total
Feb. 28 Period Income Investments Activites Income Gain Distributions
____________________________________________________________________________________________________________
<S> <C> <C> <C> <C> <C> <C> <C>
Insured
Intermediate
!1993 $10.00 !!!$.13 $ .55 $ .68 $ (.13) - $ (.13)
1994 10.55 !!! .48 .09 .57 (.48) $ (.06) (.54)
Income
1985 $ 8.48 $.65 $ (.07) $ .58 $ (.65) - $ (.65)
1986 8.41 .71 1.32 2.03 (.71) - (.71)
1987 9.73 .68 .54 1.22 (.68) - (.68)
**1988 10.27 .59 (.92) (.33) (.59) $ (.54) (1.13)
1989 8.81 .59 (.24) .35 (.59) - (.59)
1990 8.57 .59 .09 .68 (.59) - (.59)
1991 8.66 .57 .13 .70 (.57) - (.57)
**1992 8.79 .57 .30 .87 (.57) - (.57)
1993 9.09 .56 .75 1.31 (.56) - (.56)
1994 9.84 .54 - .54 (.54) (.18) (.72)
High Yield
*1986 $10.00 $.87 $1.43 $2.30 $ (.87) - $ (.87)
1987 11.43 .87 .78 1.65 (.87) - (.87)
**1988 12.21 .83 (.77) .06 (.83) $(.25) (1.08)
1989 11.19 .83 .06 .89 (.83) - (.83)
1990 11.25 .84 .20 1.04 (.84) (.06) (.90)
1991 11.39 .83 .04 .87 (.83) (.03) (.86)
**1992 11.40 .81 .35 1.16 (.81) (.10) (.91)
1993 11.65 .78 .78 1.56 (.78) (.10) (.88)
1994 12.33 .74 .16 .90 (.74) (.23) (.97)
<CAPTION>
End of Period
Total
Net Asset Return Ratio Ratio of Net
Value (Includes of Expenses Investment
End of Reinvested Net Assets to Average to Average Portfolio
Period Dividends) ($ Thousands) Net Assets Net Assets Turnover Rate
<S> <C> <C> <C> <C> <C>
____________________________________________________________________________________________________________
$ 10.55 6.81% $ 37,960 o!!!0.00% o5.08% o65.3%
10.58 5.49% 99,162 !!!0.33% 4.45% 74.8%
$ 8.41 7.24% $ 936,791 0.63% 7.84% 277.2%
9.73 25.37% 1,325,179 0.63% 8.07% 187.8%
10.27 13.07% 1,558,795 0.61% 6.94% 236.6%
8.81 (3.17%) 1,094,430 0.65% 6.72% 180.6%
8.57 4.11% 1,023,204 0.66% 6.81% 115.9%
8.66 8.15% 1,123,143 0.64% 6.80% 140.5%
8.79 8.40% 1,128,635 0.63% 6.59% 79.7%
9.09 10.17% 1,245,297 0.62% 6.34% 57.9%
9.84 14.88% 1,441,646 0.61% 5.98% 76.7%
9.66 5.50% 1,452,581 0.59% 5.40% 71.2%
$11.43 24.24% $ 168,308 #1.00% 8.47% 156.8%
12.21 15.04% 324,094 0.98% 7.45% 111.4%
11.19 0.83% 280,580 0.96% 7.49% 127.6%
11.25 8.27% 331,329 0.92% 7.45% 61.8%
11.39 9.54% 443,372 0.88% 7.38% 72.4%
11.40 7.93% 505,025 0.85% 7.30% 51.2%
11.65 10.56% 623,877 0.83% 7.01% 51.0%
12.33 13.94% 853,185 0.81% 6.58% 34.7%
12.26 7.49% 941,295 0.79% 5.95% 59.3%
_____________________________________________________________________________
<FN>
! For the period November 30, 1992 (commencement of operations) to February 28, 1993.
!! Excludes investment management fees and fund expenses in excess of a 0.90% voluntary expense
limitation in effect through February 28, 1985.
!!! T. Rowe Price voluntarily agreed to bear all expenses of the Fund through June 30, 1993. Excludes
expenses in excess of a 0.20% voluntary expense limitation in effect July 1, 1993 through July 31,
1993, a 0.30% voluntary expense limitation in effect August 1, 1993 through August 31, 1993, a
0.40% voluntary expense limitation in effect September 1, 1993 through September 30, 1993, and a
0.50% voluntary expense limitation in effect October 1, 1993 through February 28, 1994.
o Annualized.
* For the period March 1, 1985 (commencement of operations) to February 28, 1986.
** Year ended February 29.
# Excludes investment management fees in excess of a 1.0% voluntary expense limitation in effect
through February 28, 1986.
_____________________________________________________________________________
Table 3
</TABLE>
Fund and Market Characteristics: What to Expect
To help you decide whether a tax-free fund is appropriate for you, this
section takes a closer look at the T. Rowe Price Funds' investment programs
and the securities in which they invest.
Who issues municipal securities?
State and local governments and governmental authorities sell notes and bonds
(usually called "municipals") to pay for public projects and services.
Who buys municipal securities?
Individuals are the primary investors, and a principal way they invest is
through mutual funds. Prices of municipals may be affected by major changes in
flows of money into or out of municipal funds. For example, substantial and
sustained redemptions from municipal bond funds could result in lower prices
for these securities.
_____________________________________________________________________________
CHARACTERISTOCS OF MUNICIPAL SECURITIES.
What is "tax-free" about municipal bonds and bond funds?
The regular income dividends you receive from the fund are exempt from federal
income taxes. In addition, your state may not tax that portion of the fund's
income earned on their own obligations (if any). However, capital gains
distributed by the funds are taxable to you. (See "Useful Information on
Distributions and Taxes", page 13, for details.)
Is interest income from municipal issues always exempt from federal taxes?
No. For example, since 1986, income from so-called "private activity"
municipals has been subject to the federal alternative minimum tax (AMT). For
example, some bonds financing airports, stadiums, and student loan programs
fall into this category. Shareholders subject to the AMT must include income
derived from private-activity bonds in their AMT calculation. Relatively few
taxpayers are required to pay the tax. The fund will report annually to
shareholders the portion of income, if any, subject to AMT. (Please see
"Distributions and Taxes-Taxes on Fund Distributions.")
Why are yields on municipals usually below those on otherwise comparable
taxable securities?
Since the income provided by most municipals is exempt from federal taxation,
investors are willing to accept lower yields on a municipal bond than on an
otherwise similar (in quality and maturity) taxable bond.
How can I tell if a tax-free or taxable fund is more suitable for me?
The primary factor is your expected federal income tax rate. The higher your
tax bracket, the more likely tax-frees will be appropriate. If the after-tax
yield on a taxable bond or money market is less than a municipal fund's
tax-exempt yield, then your income will be higher in the municipal fund. To
find what a taxable fund would have to yield to equal the tax-free yield on a
municipal bond, divide the municipal bond's yield by one minus your tax rate.
Is a fund's yield fixed or will it vary?
It will vary. The yield is calculated every day by dividing a fund's net
income per share, expressed at annual rates, by the share price. Since both
income and share price will fluctuate, a fund's yield will also vary.
Is a fund's "yield" the same thing as the "total return"?
Not for bond funds. Your total return is the result of reinvested income and
the change in share price for a given time period. Since money funds are
managed to maintain a stable share price, their yield and total return should
be the same.
What is "credit quality" and how does it affect a fund's yield?
Credit quality refers to a bond issuer's expected ability to make all required
interest and principal payments in a timely manner. Because highly rated bond
issuers represent less risk, they can borrow at lower interest rates than less
creditworthy issuers. Therefore, a fund investing in high-quality securities
should have a lower yield than an otherwise comparable fund investing in lower
credit-quality securities.
What is meant by a bond or bond fund's maturity?
Every bond has a stated maturity date when the issuer must repay the bond's
entire principal value to the investor. Some types of bonds may also have an
"effective maturity" that is shorter than the stated date. Many corporate and
municipal bonds are "callable," meaning the principal can be repaid before
their stated maturity dates on (or after) specified call dates. Bonds are most
likely to be called when interest rates are falling, because the issuer wants
to refinance at a lower rate. In such an environment, a bond's "effective
maturity" is usually its nearest call date.
A bond mutual fund has no maturity in the strict sense of the word, but does
have a weighted average maturity. This number is an average of the stated
maturities of the underlying bonds, with each maturity "weighted" by the
percentage of fund assets it represents. Funds that target effective
maturities would use the effective (rather than stated) maturities of the
underlying bonds when computing the average.
What is meant by a bond or bond fund's "duration"?
Duration is a better measure than maturity of a bond's sensitivity to interest
rate changes because it measures the recovery of the original investment by
taking into account the cash flows generated over the bond's life. Future
interest and principal payments are discounted to reflect their present value
and then are multiplied by the number of years they will be received to
produce a value that is expressed in years, i.e., the duration. Effective
duration takes into account call features and sinking fund payments which may
shorten a bond's life.
You can multiply the duration by the potential change in interest rates to
estimate the effect on principal value. For example, the price of a bond or
bond fund with a duration of five years would rise or fall roughly 5% if rates
fell or rose by one percentage point.
What are the main risks of investing in bond funds?
o Interest rate or market risk-the decline in bond prices that accompanies
a rise in the level of interest rates (this should not apply to money
funds, which are managed to maintain a stable share price); and
o Credit risk-the chance that any of a fund's holdings will have its
credit rating downgraded or will default (fail to make scheduled
interest and principal payments), potentially reducing the fund's income
level and/or share price.
How is a municipal's price affected by changes in interest rates?
When interest rates rise, a municipal's price usually falls, and vice versa.
_____________________________________________________________________________
GENERALLY SPEAKING, THE LONGER THE SECURITY'S MATURITY, THE GREATER THE PRICE
INCREASE OR DECREASE IN RESPONSE TO A CHANGE IN INTEREST RATES, AS SHOWN IN
THE TABLE AT RIGHT.
_____________________________________________________________________________
How Interest Rates Affect Bond Prices
Bond Maturity Coupon Price Per $1,000 of Bond Face Value if Interest Rates:
Increase Decrease
1% 2% 1% 2%
_____________________________________________________________________________
1 year 3.60% $990 $981 $1,010 $1,020
_____________________________________________________________________________
5 years 4.80 957 916 1,045 1,093
_____________________________________________________________________________
10 years 5.30 927 860 1,081 1,169
_____________________________________________________________________________
20 years 5.90 892 801 1,127 1,276
_____________________________________________________________________________
30 years 6.00 875 774 1,155 1,348
_____________________________________________________________________________
Table 4 Coupons reflect yields on AAA-rated municipals as of May 31, 1994.
This is an illustration and does not represent expected yields or
share-price changes of any T. Rowe Price fund.
How do T. Rowe Price fund managers try to reduce risk?
Consistent with each fund's objective, T. Rowe Price actively manages each
fund to minimize risks and increase total return. Risk management tools
include:
o Diversification of assets to reduce the impact of a single holding on a
fund's net asset value;
o Thorough credit research by our own analysts; and
o Maturity adjustments to reflect the fund manager's interest rate
outlook.
How can I decide which investments are most appropriate for me?
_____________________________________________________________________________
FOR FURTHER DETAILS ABOUT THE FUNDS' INVESTMENT PROGRAMS, RISKS AND
FUNDAMENTAL POLICIES, PLEASE SEE THE SECTION, "INVESTMENT POLICIES AND
PRACTICES."
Review your own financial objectives, time horizon, and risk tolerance. Use
the following table, which summarizes the funds' main characteristics, to help
choose a fund (or funds) for your particular needs. For example, only the
Tax-Exempt Money Fund provides principal stability, which makes it a good
choice for money you may need for contingencies. However, if you are investing
for the highest possible tax-free income and can tolerate price fluctuation,
you should consider a longer-term bond fund. Keep in mind that the share
prices of the Bond Funds will fluctuate. The price you receive when you sell
your shares may be higher or lower than the price you paid originally.
_____________________________________________________________________________
Differences Among Funds
Fund Credit Income Risk of Expected
Quality Share-Price Average
Maturity
Categories Fluctuation
_____________________________________________________________________________
Money Two highest Low Stable No more than
90 days
_____________________________________________________________________________
Short Four highest Low to Moderate Low to Moderate 2 to 5 years
- -Intermediate
_____________________________________________________________________________
Insured Two highest Moderate Moderate 5 to 10 years
Intermediate
_____________________________________________________________________________
Income Predominately Moderate Greater 15+ years
four highest
_____________________________________________________________________________
High Yield Generally High Highest 15+ years
upper-medium
to low quality
_____________________________________________________________________________
Table 5
Is there additional information about the five funds to help me make a
decision?
You should review the following details about each fund's program:
_____________________________________________________________________________
THE FUND OR FUNDS YOU SELECT SHOULD REFLECT YOUR INDIVIDUAL INVESTMENT GOALS,
BUT SHOULD NOT REPRESENT YOUR COMPLETE INVESTMENT PROGRAM. NO FUND SHOULD BE
USED FOR SHORT-TERM TRADING PURPOSES.
Tax-Exempt Money Fund. The fund's objectives are to seek preservation of
capital, liquidity and, consistent with these objectives, the highest current
income exempt from federal income taxes. The fund's yield will fluctuate in
response to changes in the general level of interest rates, but the share
price is managed to remain stable at $1.00. Although the fund has maintained a
constant share price since its inception, and fund managers will make every
effort to continue to meet this objective, the price could drop below $1.00
under certain circumstances, such as a major change in interest rates or
default on one or more fund holdings. Unlike a bank account or certificate of
deposit, your investment is not insured or guaranteed by the U.S. Government.
The fund generally purchases securities with maturities of 13 months or less,
and its dollar weighted average maturity will not exceed 90 days. All
securities purchased by the fund will have ratings in the two highest
categories established by well known rating agencies, or, if unrated,will be
of equivalent quality as determined by T. Rowe Price analysts. The fund may
retain a security that is downgraded after purchase to noninvestment grade,
but only in accordance with Rule 2a-7 under the Investment Company Act of
1940.
Incorporated in Maryland in 1980, the fund has an Investment Advisory
Committee composed of the following members: Patrice L. Berchtenbreiter,
Chairman, Janet G. Albright, Paul W. Boltz, Michael P. Buckley, Patricia S.
Deford, Laura L. McAree, Mary J. Miller, William T. Reynolds, and Edward A.
Wiese. The Chairman has day-to-day responsibility for managing the fund and
works with the Committee in developing and executing the fund's investment
program. Ms. Berchtenbreiter has been Chairman of the fund since 1992. She
joined T. Rowe Price in 1972 and has been managing investments since 1987.
Tax-Free Short-Intermediate Fund. The fund's objective is to seek a high level
of income exempt from federal income taxes consistent with modest price
fluctuation by investing primarily in municipal securities in the four highest
credit categories. The fund will not purchase any bonds which are rated below
investment grade (e.g., BBB) by a national rating agency (or, if unrated, the
T. Rowe Price equivalent). This policy does not prohibit the fund from
retaining a security which is downgraded after purchase. Investment-grade
securities include a range of securities from the highest rated to medium
quality (BBB). Securities in the BBB category may be more susceptible to
adverse economic conditions or changing circumstances and the securities at
the lower end of the BBB category have certain speculative characteristics.
This is the most conservative of the four T. Rowe Price tax-free bond funds.
Under normal market conditions its dollar weighted average maturity will range
between two and five years and, as a result, its price fluctuation should be
modest in response to changes in interest rates. Its interest income should be
above the money fund but lower than the other bond funds.
Incorporated in Maryland in 1983, the fund has an Investment Advisory
Committee composed of the following members: Mary J. Miller, Chairman, Janet
G. Albright, Patrice L. Berchtenbreiter, Paul W. Boltz, Patricia S. Deford,
Charles B. Hill, Laura L. McAree, and William T. Reynolds. The Chairman has
day-to-day responsibility for managing the fund
and works with the Committee in developing and executing the fund's investment
program. Mrs. Miller has been Chairman of the fund since 1990. She joined T.
Rowe Price in 1983 and has been managing investments since 1987.
Tax-Free Insured Intermediate Bond Fund. The fund's objective is to seek a
high level of income exempt from federal income taxes, maximum credit
protection, and moderate price fluctuation by investing primarily in insured
municipal securities. By maintaining a dollar weighted average maturity
between five and ten years, this fund should provide higher income and
volatility than the Short-Intermediate Fund and lower income and volatility
than the other bond funds.
_____________________________________________________________________________
THE BOND FUNDS MAY RETAIN A SECUIRTY WHOSE CREDIT QUALITY IS DOWNGRADED TO A
NONINVESTMENT-GRADE LEVEL AFTER PURCHASE.
For extra credit-quality protection, the fund will invest at least 65% of its
total assets in municipals insured by companies carrying the highest credit
rating from a national rating organization, e.g., AAA by Standard & Poor's or
Aaa by Moody's Investors Service. (The insurer's rating determines the rating
of the insured bond.) Up to 35% of assets may also be invested in other
municipals rated at least AA or Aa by rating agencies or, if unrated, which
are believed to be of comparable quality at the time of purchase.
Incorporated in Maryland in 1992, the fund has an Investment Advisory
Committee composed of the following members: William T. Reynolds, Chairman,
Janet G. Albright, Paul W. Boltz, Patricia S. Deford, Charles B. Hill,
Konstantine B. Mallas, Laura L. McAree, and Mary J. Miller. The Chairman has
day-to-day responsibility for managing the fund and works with the Committee
in developing and executing the fund's investment program. Mr. Reynolds has
been Chairman of the fund since 1992. He has been managing investments since
joining T. Rowe Price in 1981.
Tax-Free Income Fund. The fund's objective is to seek a high level of income
exempt from federal income taxes by investing primarily in long-term,
investment-grade municipal securities. The fund has no maturity restrictions
but normally its dollar weighted average maturity will exceed 15 years. As
such, the fund is suitable for more aggressive investors than the funds with
shorter average maturities. It will be actively managed to seek capital
appreciation and minimize losses due to interest rate movements. From time to
time, the fund may purchase below investment grade securities (including
securities which have received the lowest rating or are not rated by a
national rating organization) however, no such purchase will be made if it
would cause the fund's investments in non-investment grade bonds to exceed 5%
of total assets.
Incorporated in Maryland in 1976, the fund has an Investment Advisory
Committee composed of the following members: William T. Reynolds, Chairman,
Paul W. Boltz, Michael P. Buckley, Patricia S. Deford, Hugh D. McGuirk, Mary
J. Miller, Konstantine B. Mallas, and William F. Snider, Jr. The Chairman has
day-to-day responsibility for managing the fund and works with the Committee
in developing and executing the fund's investment program. Mr. Reynolds has
been Chairman of the fund since 1990. He has been managing investments since
joining T. Rowe Price in 1981.
_____________________________________________________________________________
THE COMBINATION OF LONG MATURITY AND LOWER CREDIT QUALITY MAKES THE HIGH YIELD
FUND POTENTIALLY THE MOST RISKY AS WELL AS POTENTIALLY THE MOST REWARDING OF
THE TAX-FREE FUNDS. (SEE "HIGH YIELD/HIGH RISK INVESTING" ON PAGE 24. )
Tax-Free High Yield Fund. The fund's objective is to seek a high level of
income exempt from federal income tax by investing primarily in long-term,
low- to upper-medium quality municipal securities. This is the most aggressive
of our bond funds and should provide the highest income, because the average
credit quality of its holdings is lower than our other funds. Less
creditworthy borrowers must offer higher interest payments to compensate
investors for taking greater risk. The fund may invest a substantial portion
of assets in noninvestment-grade municipal bonds, which have a higher risk of
default than investment-grade bonds. Similar bonds in the taxable bond market
are called "junk." The fund may also purchase bonds which are in default, but
such bonds are not expected to exceed 10% of the fund's total assets.
Lower-quality municipals are more vulnerable to real or perceived changes in
the business climate than higher-quality bonds, they may also be considerably
less liquid and more volatile in price. As a result, we rely heavily on our
proprietary research when selecting investments and judgement may play a
bigger role in valuing the fund's securities. The fund has no maturity
restrictions, but normally 80% of its total assets will have maturities over
15 years.
Incorporated in Maryland in 1984, the fund has an Investment Advisory
Committee composed of the following members: C. Stephen Wolfe, II, Chairman,
Patricia S. Deford, Charles O. Holland, Konstantine B. Mallas, and William T.
Reynolds. The Committee Chairman has day-to-day responsibility for managing
the fund and works with the Committee in developing and executing the fund's
investment program. Mr. Wolfe has been Chairman of the fund since 1994. He
joined T. Rowe Price in 1985 and has been managing investments since 1991.
Is there additional information about the funds to help me make a decision?
You should review the investment policies and practices section (pages 19-26)
which discusses the following: Types of Portfolio Securities (municipal
securities, private-activity bonds, municipal lease obligations, securities
with "puts" or other demand features, securities with credit enhancements,
synthetic or derivative securities, and private placements); Types of Fund
Management Practices (cash position, when-issued securities and forwards,
interest rate futures, borrowing money and transferring assets, portfolio
turnover, sector concentration, high yield/high risk investing, credit quality
considerations and credit quality and the High Yield Fund).
2 About Your Account
2 ABOUT YOUR ACCOUNT
Pricing Shares and Receiving Sale Proceeds
Here are some procedures you should know when investing in a fund. This
section applies to all T. Rowe Price tax-free bond and money funds.
_____________________________________________________________________________
THE VARIOUS WAYS YOU CAN BUY, SELL, AND EXCHANGE SHARES ARE EXPLAINED AT THE
END OF THIS PROSPECTUS AND ON THE NEW ACCOUNT FORM.
How and when shares are priced
Bond and Money Funds. The share price (also called "net asset value" or NAV
per share) for each fund is calculated at 4 p.m. ET each day the New York
Stock Exchange is open for business. To calculate the NAV, a fund's assets are
priced and totaled, liabilities are subtracted, and the balance, called net
assets, is divided by the number of shares outstanding.
Money fund NAVs, which are managed to remain at $1.00, are calculated at noon
ET each day as well as 4 p.m. Amortized cost or amortized market value is used
to value money fund securities that mature in 60 days or less.
_____________________________________________________________________________
WHEN FILLING OUT THE NEW ACCOUNT FORM, YOU MAY WISH TO GIVE YOURSELF THE
WIDEST RANGE OF OPTIONS FOR RECEIVING PROCEEDS FROM A SALE.
How your purchase, sale, or exchange price is determined
If we receive your request in correct form before 4 p.m. ET, your transaction
will be priced at that day's NAV. If we receive it after 4 p.m., it will be
priced at the next business day's NAV.
We cannot accept orders that request a particular day or price for your
transaction or any other special conditions.
Note: The time at which transactions are priced may be changed in case of an
emergency or if the New York Stock Exchange closes at a time other than 4 p.m.
ET.
_____________________________________________________________________________
IF FOR SOME REASON WE CANNOT ACCEPT YOUR REQUEST TO SELL SHARES, WE WILL
CONTACT YOU.
How you can receive the proceeds from a sale
If your request is received by 4 p.m. ET in correct form, proceeds are usually
sent on the next business day. Proceeds can be sent to you by mail, or to your
bank account by ACH transfer or bank wire. Proceeds sent by bank wire should
be credited to your account the next business day, and proceeds sent by ACH
transfer should be credited the second day after the sale. ACH (Automated
Clearing House) is an automated method of initiating payments from and
receiving payments in your financial institution account. ACH is a payment
system supported by over 20,000 credit unions, banks and savings banks which
electronically exchange the transactions primarily through the Federal Reserve
Banks.
Exception:
o Under certain circumstances and when deemed to be in the fund's best
interests, your proceeds may not be sent for up to five business days
after receiving your sale or exchange request. If you were exchanging
into a bond or money fund, your new investment would not begin to earn
dividends until the sixth business day.
Useful Information on Distributions and Taxes
_____________________________________________________________________________
THE FUNDS DISTRIBUTE ALL NET INVESTMENT INCOME AND REALIZED CAPITAL GAINS TO
SHAREHOLDERS.
Dividends and other distributions
Dividend and capital gain distributions are reinvested in additional fund
shares in your account unless you select another option on your New Account
Form. The advantage of reinvesting distributions arises from compounding; that
is, you receive interest and capital gain distributions on a rising number of
shares.
Dividends not reinvested are paid by check or transmitted to your bank account
via ACH. If the Post Office cannot deliver your check, or if your check
remains uncashed for six months, the fund reserves the right to reinvest your
distribution check in your account at the then current NAV and to reinvest all
subsequent distributions in shares of the fund.
Income dividends.
o Bond funds declare income dividends daily at 4 p.m. ET to shareholders
of record on the previous business day.
o Money funds declare income dividends daily at noon ET to shareholders of
record at that time.
o Bond and money funds pay dividends on the last business day of each
month.
o Bond and money fund shares will earn dividends through the date of
redemption; also shares redeemed on a Friday or prior to a holiday will
continue to earn dividends until the next business day. Generally, if
you redeem all of your shares at any time during the month, you will
also receive all dividends earned through the date of redemption in the
same check. When you redeem only a portion of your shares, all dividends
accrued on those shares will be reinvested, or paid in cash, on the next
dividend payment date
Capital gains.
o A capital gain or loss is the difference between the purchase and sale
price of a security.
o If the fund has net capital gains for the year (after subtracting any
capital losses), they are usually declared and paid in December to
shareholders of record on a specified date that month. If a second
distribution is necessary, it is usually declared and paid during the
first quarter of the following year.
_____________________________________________________________________________
THE FUNDS SEND TIMELY INFORMATION FOR YOUR TAX FILING NEEDS.
Tax information
Although the regular monthly income dividends you receive from the funds are
expected to be exempt from federal income taxes, you need to be aware of the
possible tax consequences when:
o you sell fund shares, including an exchange from one fund to another, or
o the fund makes a short- and/or long-term capital gain distribution to
your account.
Due to 1993 tax legislation, a portion of the capital gains realized on the
sale of market discount bonds with maturities beyond one year may be treated
as ordinary income and cannot be offset by other capital losses. Therefore, to
the extent the fund invests in these securities, the likelihood of a taxable
gain distribution will be increased.
Note: You must report your total tax-exempt income on IRS Form 1040. The IRS
uses this information to help determine the tax status of any social security
payments you may have received during the year.
_____________________________________________________________________________
THE FUNDS FURNISH AVERAGE COST AND CAPITAL GAIN (LOSS) INFOMRATION ON MOST
SHARE REDEMPTIONS.
Taxes on your fund redemptions. When you sell shares in any fund, you may
realize a gain or loss. An exchange from one fund to another is still a sale
for tax purposes. If you realize a loss on the sale or exchange of fund shares
held six months or less, your capital loss is reduced by the tax-exempt
dividends received on those shares.
In January, the funds will send you and the IRS Form 1099-B, indicating the
date and amount of each sale you made in the fund during the prior year. We
will also tell you the average cost of the shares you sold during the year.
Average cost information is not reported to the IRS, and you do not have to
use it. You may calculate the cost basis using other methods acceptable to the
IRS, such as "specific identification."
To help you maintain accurate records, we send you a confirmation immediately
following each transaction (except for systematic purchases and redemptions)
you make and a year-end statement detailing all your transactions in each fund
account during the year.
_____________________________________________________________________________
CAPITAL GAIN DISTRIBUTIONS ARE TAXABLE WHETHER REINVESTED IN ADDITIONAL SHARES
OR RECEIVED IN CASH.
Taxes on fund distributions. In January, the funds will send you and the IRS
Form 1099-DIV indicating the tax status of any capital gain distribution made
to you. All capital gain distributions are taxable to you for the year in
which they are paid. The only exception is that distributions declared during
the last three months of the year and paid in January are taxed as though they
were paid by December 31. Dividends are expected to be tax exempt.
Short-term capital gains are taxable as ordinary income and long-term gains
are taxable at the applicable long-term gain rate. The gain is long or short
term depending on how long the fund held the securities, not how long you held
shares in the fund.
If the funds invest in certain "private activity" bonds, shareholders who are
subject to the alternative minimum tax (AMT) must include income generated by
these bonds in their AMT computation. The portion of your fund's income which
should be included in your AMT calculation, if any, will be reported to you in
January.
Tax effect of buying shares before a capital gain distribution. If you buy
shares shortly before or on the "record date"-the date that establishes you as
the person to receive the upcoming distribution-you will receive, in the form
of a taxable distribution, a portion of the money you just invested.
Therefore, you may wish to find out a fund's record date(s) before investing.
Of course, a fund's share price may reflect undistributed capital gains or
unrealized appreciation, if any.
Transaction Procedures and Special Requirements
_____________________________________________________________________________
FOLLOWING THESE PROCEDURES HELPS ASSURE TIMELY AND ACCURATE TRANSACTIONS.
Purchase Conditions
Nonpayment. If your payment is not received or you pay with a check or ACH
transfer that does not clear, your purchase will be cancelled. You will be
responsible for any losses or expenses incurred by the fund or transfer agent,
and the fund can redeem shares you own in this or another identically
registered T. Rowe Price fund as reimbursement. The fund and its agents have
the right to reject or cancel any purchase, exchange, or redemption due to
nonpayment.
U.S. Dollars. All purchases must be paid for in U.S. dollars; checks must be
drawn on U.S. banks.
Sale (Redemption) Conditions
10-day Hold. If you sell shares that you just purchased and paid for by check
or ACH transfer, the fund will process your redemption but will generally
delay sending you the proceeds for up to 10 calendar days to allow the check
or transfer to clear. If your redemption request was sent by mail or mailgram,
proceeds will be mailed no later than the seventh calendar day following
receipt unless the check or ACH transfer has not cleared. If, during the
clearing period, we receive a check drawn against your bond or money market
account, it will be returned marked "uncollected." (The 10-day hold does not
apply to purchases paid for by: bank wire; cashier's, certified, or
treasurer's checks; or automatic purchases through your paycheck.)
Telephone Transactions. Telephone exchange and redemption are established
automatically when you sign the New Account Form unless you check the box
which states that you do not want these services. The fund uses reasonable
procedures (including shareholder identity verification) to confirm that
instructions given by telephone are genuine. If these procedures are not
followed, it is the opinion of certain regulatory agencies that a fund may be
liable for any losses that may result from acting on the instructions given.
All conversations are recorded, and a confirmation is sent within five
business days after the telephone transaction.
Redemptions over $250,000. Large sales can adversely affect a portfolio
manager's ability to implement a fund's investment strategy by causing the
premature sale of securities that would otherwise be held. If in any 90-day
period, you redeem (sell) more than $250,000, or your sale amounts to more
than 1% of the fund's net assets, the fund has the right to delay sending your
proceeds for up to five business days after receiving your request, or to pay
the difference between the redemption amount and the lesser of the two
previously mentioned figures with securities from the fund.
_____________________________________________________________________________
T. ROWE PRICE MAY BAR EXCESSIVE TRADERS FROM PURCHASING SHARES.
Excessive Trading
Frequent trades involving either substantial fund assets or a substantial
portion of your account or accounts controlled by you, can disrupt management
of the fund and raise its expenses. We define "excessive trading" as exceeding
one purchase and sale involving the same fund within any 120-day period.
For example, you are in fund A. You can move substantial assets from A to fund
B, and, within the next 120 days, sell your shares in fund B to return to fund
A or move to fund C.
If you exceed the number of trades described above, you may be barred
indefinitely from further purchases of T. Rowe Price funds.
Three types of transactions are exempt from excessive trading guidelines: (1)
trades solely between money market funds, (2) redemptions that are not part of
exchanges, and (3) systematic purchases or redemptions (see "Shareholder
Services").
Keeping Your Account Open
Due to the relatively high cost of maintaining small accounts, we ask you to
maintain an account balance of at least $1,000. If your balance is below
$1,000 for three months or longer, the fund has the right to close your
account after giving you 60 days in which to increase your balance.
Signature Guarantees
_____________________________________________________________________________
A SIGNATURE GUARANTEE IS DESIGNED TO PROTECT YOU AND THE FUND FROM FRAUD BY
VERIFYING YOUR SIGNATURE.
You may need to have your signature guaranteed in certain situations, such as:
o Written requests 1) to redeem over $50,000 or 2) to wire redemption
proceeds.
o Remitting redemption proceeds to any person, address, or bank account
not on record.
o Transferring redemption proceeds to a T. Rowe Price fund account with a
different registration from yours.
o Establishing certain services after the account is opened.
You can obtain a signature guarantee from most banks, savings institutions,
broker/dealers and other guarantors acceptable to T. Rowe Price. We cannot
accept guarantees from notaries public or organizations that do not provide
reimbursement in the case of fraud.
3 More About the Funds
3 MORE ABOUT THE FUNDS
The Funds' Organization and Management
How are the funds organized?
The funds are "diversified, open-end investment companies," or mutual funds.
Mutual funds pool money received from shareholders and invest it to try to
achieve specified objectives.
_____________________________________________________________________________
SHAREHOLDERS BENEFIT FROM T. ROWE PRICE'S 57 YEARS OF INVESTMENT MANAGEMENT
EXPERIENCE.
What is meant by "shares"?
As with all mutual funds, investors purchase "shares" when they invest in a
fund. These shares are part of the fund's authorized capital stock, but share
certificates are not issued.
Each share and fractional share entitles the shareholder to:
o receive a proportional interest in a fund's income and capital gain
distributions;
o cast one vote per share on certain fund matters, including the election
of fund directors/ trustees, changes in fundamental policies, or
approval of changes in a fund's management contract.
Does each fund have an annual shareholder meeting?
The funds are not required to hold annual meetings and do not intend to do so
except when certain matters, such as a change in a fund's fundamental
policies, are to be decided. In addition, shareholders representing at least
10% of all eligible votes may call a special meeting if they wish for the
purpose of voting on the removal of any fund director(s). If a meeting is held
and you cannot attend, you can vote by proxy. Before the meeting, the fund
will send you proxy materials that explain the issues to be decided and
include a voting card for you to mail back.
_____________________________________________________________________________
ALL DECISIONS REGARDING THE PURCHASE AND SALE OF FUND INVESTMENTS ARE MADE BY
T. ROWE PRICE ASSOCIATES-SPECIFICALLY BY THE FUNDS' PORTFOLIO MANAGERS.
Who runs the funds?
General oversight. Each fund is governed by a Board of Directors or Trustees
that meets regularly to review the fund's investments, performance, expenses,
and other business affairs. The Board elects the fund's officers.
Marketing. T. Rowe Price Investment Services, Inc., a wholly-owned subsidiary
of T. Rowe Price, distributes (sells) shares of these and all other T. Rowe
Price funds.
Shareholder Services. T. Rowe Price Services, Inc., another wholly-owned
subsidiary, acts as the funds' transfer and dividend disbursing agent and
provides shareholder and administrative services. The address for T. Rowe
Price Investment Services, Inc. and T. Rowe Price Services is 100 East Pratt
St., Baltimore, MD 21202.
How are fund expenses determined?
The management agreement spells out the expenses to be paid by each fund. In
addition to the management fee, each fund pays for the following: shareholder
service expenses; custodial, accounting, legal, and audit fees; costs of
preparing and printing prospectuses and reports sent to shareholders;
registration fees and expenses; proxy and annual meeting expenses (if any);
and director/trustee fees and expenses.
The Management Fee. This fee has two parts-an "individual fund fee" (discussed
on page 3) which reflects the fund's particular investment management costs,
and a "group fee." The group fee, which is designed to reflect the benefits
of the shared resources of the T. Rowe Price investment management complex, is
calculated monthly based on the net combined assets of all T. Rowe Price funds
(except Equity Index and both Spectrum Funds and any institutional or private
label mutual funds). The group fee schedule (shown below) is graduated,
declining as the asset total rises, so shareholders benefit from the overall
growth in mutual fund assets.
0.480% First $1 billion 0.370% Next $1 billion 0.330% Next $10 billion
0.450% Next $1 billion 0.360% Next $2 billion 0.320% Next $10 billion
0.420% Next $1 billion 0.350% Next $2 billion 0.310% Thereafter
0.390% Next $1 billion 0.340% Next $5 billion
Each fund's portion of the Group Fee is determined by the ratio of its daily
net assets to the daily net assets of all the Price funds as described above.
Based on combined Price funds' assets of approximately $36 billion at February
28, 1994, the Group Fee was 0.34%.
Understanding Performance Information
This section should help you understand the terms used to describe the funds'
performance. You will come across them in shareholder reports you receive
from us four times a year, in our newsletter, "Insights" reports, in T. Rowe
Price advertisements, and in the media.
_____________________________________________________________________________
TOTAL RETURN IS THE MOST WIDELY USED PERFORMANCE MEASURE. DETAILED
PERFORMANCE INFORMATION IS INCLUDED IN THE FUNDS' ANNUAL REPORTS AND QUARTERLY
SHAREHOLDER REPORTS.
Total Return
This tells you how much an investment in a fund has changed in value over a
given time period. It reflects any net increase or decrease in the share price
and assumes that all dividends and capital gains (if any) paid during the
period were reinvested in additional shares. Including reinvested
distributions means that total return numbers include the effect of
compounding, i.e., you receive income and capital gain distributions on a
rising number of shares.
Advertisements for a fund may include cumulative or compound average annual
total return figures, which may be compared with various indices, other
performance measures, or other mutual funds.
Cumulative Total Return
This is the actual rate of return on an investment for a specified period. A
cumulative return does not indicate how much the value of the investment may
have fluctuated between the beginning and the end of the period specified.
Average Annual Total Return
This is always hypothetical. Working backward from the actual cumulative
return, it tells you what constant year-by-year return would have produced the
actual, cumulative return. By smoothing out all the variations in annual
performance, it gives you an idea of the investment's annual contribution to
your portfolio provided you held it for the entire period in question.
_____________________________________________________________________________
YOU WILL SEE FREQUENT REFERENCES TO THE FUNDS' YIELDS AND TAX EQUIVALENT
YIELDS IN OUR REPORTS, ADVERTISEMENTS, IN MEDIA STORES, AND SO ON
Yield
The current or "dividend yield" on the fund or any investment tells you the
relationship between the investment's current level of annual income and its
price on a particular day. The dividend yield reflects the actual income paid
to shareholders for a given period, annualized, and divided by the average
price during the given period. For example, a fund providing $5 of annual
income per share and a price of $50 has a current yield of 10%. Yields can be
calculated for any time period. The Money Fund may advertise a "current
yield", reflecting the latest 7-day income annualized, or an "effective yield"
which assumes the income has been reinvested in the fund.
For the Bond Funds, the advertised or "SEC yield" is found by determining the
net income per share (as defined by the SEC) earned by the fund during a
30-day base period and dividing this amount by the per-share price on the last
day of the base period. The "SEC yield" may differ from the dividend yield.
Investment Policies and Practices
This section takes a detailed look at some of the types of securities the
funds may hold in their portfolios and the various kinds of investment
practices that may be used in day-to-day portfolio management. Each fund's
investment program is subject to further restrictions and risks described in
the "Statement of Additional Information."
_____________________________________________________________________________
FUND MANAGERS HAVE CONSIDERABLE LEEWAY IN CHOOSING INVESTMENT STRATEGIES AND
SELECTING SECURITIES THEY BELIEVE WILL HELP THE FUNDS ACHIEVE THEIR
OBJECTIVES.
Shareholder approval is required to substantively change a fund's objective
and certain investment restrictions noted in the following section as
"fundamental policies." The managers also follow certain "operating policies"
which can be changed without shareholder approval. How-ever, significant
changes are discussed with shareholders in fund reports. Each fund adheres to
applicable investment restrictions and policies at the time it makes an
investment. A later change in circumstances will not require the sale of an
investment if it was proper at the time it was made.
Types of Portfolio Securities
In seeking to meet their investment objectives, the funds may invest in any
type of interest-bearing security whose yield, credit quality, and maturity
characteristics are consistent with the funds' investment programs. These and
some of the other investment techniques the funds may use are described in the
following pages.
_____________________________________________________________________________
IN PURCHASING MUNICIPALS, THE FUNDS RELY ON THE OPINION OF THE ISSUER'S BOND
COUNSEL REGARDING THE TAX-EXEMPT STATUS OF THE INVESTMENT.
Municipal Securities. Each fund's assets are invested primarily in various
income-producing tax-free municipal debt securities. The issuers have a
contractual obligation to pay interest at a stated rate on specific dates and
to repay principal (the bond's face value) on a specified date or dates. An
issuer may have the right to redeem or "call" a bond before maturity, and the
investor may have to reinvest the proceeds at lower rates.
There are two broad categories of municipal bonds. General obligation bonds
are backed by the issuer's "full faith and credit," that is, its full taxing
and revenue raising power. Revenue bonds usually rely exclusively on a
specific revenue source, such as charges for water and sewer service, to
generate money for debt service.
Fundamental policy: A fund will not purchase a security if, as a result with
respect to 75% of its total assets, more than 5% of its total assets would be
invested in securities of that issuer.
Private Activity Bonds. While income from most municipals is exempt from
federal income taxes, the income from certain types of so-called private
activity bonds (a type of revenue bond) may be subject to the alternative
minimum tax (AMT). However, only persons subject to AMT pay this tax. Private
activity bonds may be issued for purposes such as housing or airports or to
benefit a private company. (Being subject to the AMT does not mean the
investor necessarily pays this tax. For further information, please see
"Distributions and Taxes.")
Fundamental policy: Under normal market conditions, the funds will not
purchase any security if, as a result, less than 80% of the funds' income
would be exempt from federal income taxes. The income included under the 80%
test does not include income from securities subject to the alternative
minimum tax.
Operating policy: During periods of abnormal market conditions, for temporary
defensive purposes, the funds may invest without limit in high-quality,
short-term securities whose income is subject to federal income tax.
In addition to general obligation and revenue bonds, the funds' investments
may include, but are not limited to, the following types of securities:
Municipal Lease Obligations. A lease is not a full faith and credit obligation
of the issuer and is usually backed only by the borrowing government's
unsecured pledge to make annual appropriation for lease payments. There have
been challenges to the legality of lease financing in numerous states and,
from time to time, certain municipalities have considered not appropriating
money to make lease payments. In deciding whether to purchase a lease
obligation, the funds would assess the financial condition of the borrower,
the merits of the project, the level of public support for the project, and
the legislative history of lease financing in the state. These securities may
be less readily marketable than other municipals. The funds may also purchase
unrated lease-obligations. Based on information supplied by T. Rowe Price, the
funds' Board of Directors will periodically review the credit quality of
non-rated leases and assess the likelihood of their being cancelled.
Operating policy: Each fund may invest no more than 20% of its assets in lease
obligations.
Securities with "Puts" or other Demand Features. Some longer-term municipals
give the investor the right to "put" or sell the security at par (face value)
within a specified number of days following the investor's request-usually one
to seven days. This demand feature enhances a security's liquidity by
dramatically shortening its effective maturity and enables it to trade at a
price equal to or very close to par. If the demand feature were terminated
prior to being exercised, the funds would hold the longer-term security.
Securities with Credit Enhancements.
o Letters of Credit. Letters of credit are issued by a third party,
usually a bank, to enhance liquidity and/or ensure repayment of
principal and any accrued interest if the underlying municipal security
should default.
o Municipal Bond Insurance. This insurance, which is usually purchased by
the bond issuer from a private, nongovernmental insurance company,
provides an unconditional and irrevocable guarantee that the insured
bond's principal and interest will be paid when due. Insurance does not
guarantee the price of a bond or the share price of any fund. The credit
rating of an insured bond reflects the credit rating of the insurer,
based on its claims paying ability. T. Rowe Price periodically reviews
the credit quality of the insurer.
The obligation of a municipal bond insurance company to pay a claim extends
over the life of each insured bond. Although defaults on insured municipal
bonds have been low to date and municipal insurers have met these claims,
there is no assurance this will continue. A higher than expected default rate
could strain the insurer's loss reserves and adversely affect its ability to
pay claims to bondholders, such as the funds. The number of municipal bond
insurers is relatively small, and not all of them have the highest rating.
While all the funds may buy insured bonds from time to time, such bonds will
compose at least 65% of the total assets of the Insured Intermediate Fund. The
Insured Intermediate Fund's purchase of insured bonds will be limited to those
which, at the time of purchase, have the highest credit rating from a national
rating agency. There is no guarantee that this rating will be maintained.
o Standby Repurchase Agreements. A Standby Bond Purchase Agreement (SBPA)
is a liquidity facility provided to pay the purchase price of bonds that
cannot be remarketed. The obligation of the liquidity provider (usually
a bank) is only to advance funds to purchase tendered bonds which cannot
be remarketed and does not cover principal or interest under any other
circumstances. The liquidity provider's obligations under the SBPA are
usually subject to numerous conditions, including the continued
creditworthiness of the underlying borrower.
Synthetic or Derivative Securities. These securities are created from existing
municipal bonds:
o Residual Interest Bonds (Bond Funds). The income stream provided by an
underlying bond is divided to create two securities, one short-term and
one long-term. The interest rate on the short-term component is reset by
an index or auction process normally every seven to 35 days. After
income is paid on the short-term securities at current rates, the
residual income goes to the long-term securities. Therefore, rising
short-term interest rates result in lower income for the longer-term
portion, and vice versa. The longer-term bonds can be very volatile and
may be less liquid than other municipals of comparable maturity.
Operating policy: Each fund will not invest more than 10% of its total assets
in residual interest bonds.
o Participation Interests. This term covers various types of securities
created by converting fixed-rate bonds into short-term, variable-rate
certificates. These securities have been developed in the secondary
market to meet the demand for short-term, tax-exempt securities. The
funds will invest only in securities deemed tax-exempt by a nationally
recognized bond counsel, but there is no guarantee the interest will be
exempt because the IRS has not issued a definitive ruling on the matter.
o Embedded Interest Rate Swaps and Caps (Bond Funds). In a fixed-rate,
long-term municipal bond with an interest rate swap attached to it, the
bondholder usually receives the bond's fixed-coupon payment as well as a
variable rate payment that represents the difference between a fixed
rate for the term of the swap (which is typically shorter than the bond
it is attached to) and a variable rate short-term municipal index. The
bondholder receives excess income when short-term rates remain below the
fixed interest rate swap rate. If short-term rates rise above the
fixed-income swap rate, the bondholder's income is reduced. At the end
of the interest rate swap term, the bond reverts to a single
fixed-coupon payment. Embedded interest rate swaps enhance yields, but
also increase interest rate risk.
An embedded interest rate cap allows the bondholder to receive payments
whenever short-term rates rise above a level established at the time of
purchase. They normally are used to hedge against rising short-term interest
rates.
Both instruments may be volatile and of limited liquidity and their use may
adversely affect a fund's total return.
Operating policy: Each Bond Fund will not invest more than 10% of its total
assets in embedded interest rate swaps and caps.
Private Placements. The funds may seek to enhance their yield through the
purchase of private placements. These securities are sold through private
negotiations, usually to institutions or mutual funds, and may have resale
restrictions. Their yields are usually higher than comparable public
securities to compensate the investor for their limited marketability.
Operating policy: Each Bond Fund may not invest more than 15% (10% for the
Money Fund) of its net assets in illiquid securities, including unmarketable
private placements.
_____________________________________________________________________________
CASH RESERVES PROVIDE FLEXIBILITY AND SERVE AS A SHORT-TERM DEFENSE DURING
PERIODS OF UNUSUAL MARKET VOLATILITY.
Types of Fund Management Practices
Cash Position (Bond Funds). Each fund will hold a portion of its assets in
short-term, tax-exempt money market securities maturing in one year or less.
The reserve position: provides flexibility in meeting redemptions, expenses,
and the timing of new investments; can help in structuring a fund's weighted
average maturity; and serves as a short-term defense during periods of unusual
market volatility. Each fund's cash reserve position will be comprised of
short-term, investment-grade securities including tax-exempt commercial paper,
municipal notes and short-term maturity bonds. Some of these securities may
have adjustable, variable or floating rates.
When-Issued Securities (All Funds) and Forwards (Bond Funds). New issues of
municipals are often sold on a "when-issued" basis, that is, delivery and
payment take place 15-45 days after the buyer has agreed to the purchase. Some
bonds, called "forwards," have longer than standard settlement dates, in some
cases exceeding one to three years. When buying these securities, each fund
identifies cash or high-grade marketable securities held by its custodian
equal in value to its commitment for these securities. The funds do not earn
interest on when- issued and forward securities until settlement, and the
value of the securities may fluctuate between purchase and settlement.
Municipal "forwards" typically carry a substantial yield premium to compensate
the buyer for their greater interest rate, credit, and liquidity risks.
Interest Rate Futures (Bond Funds). Futures are often used to manage risk,
because they enable the investor to buy or sell an asset in the future at an
agreed upon price. Specifically, the funds may use futures (and options on
futures) to hedge against a potentially unfavorable change in interest rates
and to adjust their exposure to the municipal bond market. The use of futures
for hedging and non-hedging purposes may not always be successful. Their
prices can be highly volatile, using them could lower the fund's total return
and the potential loss from their use could exceed a fund's initial investment
in such contracts.
Operating policy: Initial margin deposits on futures and premiums on options
used for non-hedging purposes will not equal more than 5% of a fund's net
asset value.
Borrowing Money and Transferring Assets. Each fund can borrow money from banks
as a temporary measure for emergency purposes, to facilitate redemption
requests, or for other proper purposes consistent with each fund's investment
objective and program. Such borrowings may be collateralized with fund assets,
subject to restrictions.
Fundamental policy: Borrowings may not exceed 331_3% of a fund's total assets.
Operating policy: Each fund may not transfer as collateral any portfolio
securities except as necessary in connection with permissible borrowings or
investments and then such transfers may not exceed 331_3% of a fund's total
assets. Each fund may not purchase additional securities when borrowings
exceed 5% of total assets.
Portfolio Turnover (Bond Funds). Each fund generally purchases securities with
the intention of holding them for investment, however, when market conditions
or other circumstances warrant, securities may be purchased and sold without
regard to the length of time held. Due to the nature of each fund's investment
program, a fund's portfolio turnover rate may exceed 100%. Although the funds
do not expect to generate any taxable income, a high turnover rate may
increase transaction costs and may affect taxes paid by shareholders to the
extent short-term gains are distributed. The funds' portfolio turnover rates
for the previous three fiscal years are shown in Table 6.
_____________________________________________________________________________
Portfolio Turnover Rates
1992 1993 1994
_____________________________________________________________________________
Short-Intermediate 81.3% 38.5% 51.1%
_____________________________________________________________________________
Insured Intermediate * 65.3% 74.8%
_____________________________________________________________________________
Income 57.9% 76.7% 71.2%
_____________________________________________________________________________
High Yield 51.0% 34.7% 59.3%
_____________________________________________________________________________
*Prior to fund's inception.
_____________________________________________________________________________
Table 6
Sector Concentration. It is possible that each fund could have a considerable
amount of assets (25% or more) in securities that would tend to respond
similarly to particular economic or political developments. An example would
be, securities of issuers related to a single industry, such as health care or
nuclear energy.
Operating policy: Each fund will not invest more than 25% of total assets in
any single state or in industrial development bonds of projects in the same
industry (such as solid waste, nuclear utility or airlines). Bonds which are
refunded with escrowed U.S. Government securities are not subject to the 25%
limitation.
High Yield/High Risk Investing (High Yield Fund). The total return and yield
of lower quality (high yield/high risk) bonds, commonly referred to as "junk
bonds," can be expected to fluctuate more than the total return and yield of
higher quality, shorter-term bonds. Junk bonds are regarded as predominantly
speculative with respect to the issuer's continuing ability to meet principal
and interest payments. Successful investment in low and lower-medium quality
bonds involves greater investment risk and is highly dependent on T. Rowe
Price's credit analysis. A real or perceived economic downturn or higher
interest rates could cause a decline in high yield bond prices, because such
events could lessen the ability of issuers to make principal and interest
payments. These bonds are thinly traded and can be more difficult to sell and
value accurately than high-quality bonds. Because objective pricing data may
be less available, judgment may place a greater role in the valuation process.
Credit Quality Considerations. The credit quality of most bond issues is
evaluated by rating agencies such as Moody's and Standard & Poor's. Credit
quality refers to the issuer's ability to meet all required interest and
principal payments. The highest ratings are assigned to issuers perceived to
be the best credit risks. T. Rowe Price research analysts also evaluate all
portfolio holdings of each fund, including those rated by outside agencies.
The lower the rating on a bond, the higher the yield, other things being
equal.
Table 7 shows the rating scale used by the major rating agencies. T. Rowe
Price considers publicly available ratings, but emphasizes its own credit
analysis when selecting investments.
_____________________________________________________________________________
Ratings of Municipal Debt Securities
Moody's Standard Fitch Investors Definition
Investors & Poor's Service, Inc.
Service, Inc. Corporation
_____________________________________________________________________________
Long-Term Aaa AAA AAA Highest quality
_____________________________________________________________________________
Aa AA AA High quality
_____________________________________________________________________________
A A A Upper medium grade
_____________________________________________________________________________
Baa BBB BBB Medium grade
_____________________________________________________________________________
Ba BB BB Speculative
_____________________________________________________________________________
B B B Highly speculative
_____________________________________________________________________________
Caa CCC, CC CCC, CC Vulnerable to default
_____________________________________________________________________________
Ca C C Default is imminent
_____________________________________________________________________________
C D DDD, DD, D Probably in default
_____________________________________________________________________________
Table 7 (continued on next page)
_____________________________________________________________________________
Ratings of Municipal Debt Securities (continued)
Moody's S&P Fitch
_____________________________________________________________________________
Short-Term MIG1/VMIG1 Best SP1+ Very F-1+ Exceptionally
quality strong strong quality
quality
SP1 Strong grade F-1 Very strong
quality
_________________________________________________________________
MIG2/VMIG2 High SP2 Satisfactory F-2 Good credit
quality grade quality
_________________________________________________________________
MIG3/VMIG3 Favorable F-3 Fair credit
quality quality
_________________________________________________________________
MIG4/VMIG4 Adequate
quality
_________________________________________________________________
SG Speculative SP3 Speculative F-S Weak credit
grade grade quality
_________________________________________________________________
Commercial P-1 Superior quality A-1+ Extremely F-1+ Exceptionally
Paper strong Strong
quality quality
A-1 Strong F-1 Very strong
quality quality
_________________________________________________________________
P-2 Strong quality A-2 Satisfactory F-2 Good credit
quality quality
_________________________________________________________________
P-3 Acceptable quality A-3 Adequate F-3 Fair credit
quality quality
_________________________________________________________________
B Speculative F-S Weak credit
quality quality
_________________________________________________________________
C Doubtful
quality
_________________________________________________________________
Table 7
_____________________________________________________________________________
Explanation of Quality Ratings
Bond
Rating Explanation
_____________________________________________________________________________
Moody's Investors Aaa Highest quality, smallest degree of investment
Service, Inc. risk.
___________________________________________________________
Aa High quality; together with Aaa bonds, they
compose the high-grade bond group.
___________________________________________________________
A Upper-medium grade obligations; many favorable
investment attributes.
___________________________________________________________
Baa Medium-grade obligations; neither highly
protected nor poorly secured. Interest and
principal appear adequate for the present but
certain protective elements may be lacking or may
be unreliable over any great length of time.
___________________________________________________________
Ba More uncertain, with speculative elements.
Protection of interest and principal payments not
well safeguarded during good and bad times.
___________________________________________________________
B Lack characteristics of desirable investment;
potentially low assurance of timely interest and
principal payments or maintenance of other
contract terms over time.
___________________________________________________________
Caa Poor standing, may be in default; elements of
danger with respect to principal or interest
payments.
___________________________________________________________
Ca Speculative in a high degree; could be in default
or have other marked shortcomings.
___________________________________________________________
C Lowest-rated; extremely poor prospects of ever
attaining investment standing.
_____________________________________________________________________________
Standard & Poor's AAA Highest rating; extremely strong capacity to pay
Corporation principal and interest.
___________________________________________________________
AA High quality; very strong capacity to pay
principal and interest.
___________________________________________________________
A Strong capacity to pay principal and interest;
somewhat more susceptible to the adverse effects
of changing circumstances and economic
conditions.
___________________________________________________________
BBB Adequate capacity to pay principal and interest;
normally exhibit adequate protection parameters,
but adverse economic conditions or changing
circumstances more likely to lead to a weakened
capacity to pay principal and interest than for
higher-rated bonds.
___________________________________________________________
BB, B, Predominantly speculative with respect to the
issuer's capacity to meet required interest and
___________________________________________________________
CCC, CC principal payments. BB - lowest degree of
speculation; CC - the highest degree of
speculation. Quality and protective
characteristics outweighed by large uncertainties
or major risk exposure to adverse conditions.
___________________________________________________________
D In default.
_____________________________________________________________________________
Table 8
(continued on next page)
_____________________________________________________________________________
Explanation of Quality Ratings (continued)
Fitch Investors AAA Highest quality; obligor has exceptionally strong
Service, Inc. ability to pay interest and repay principal,
which is unlikely to be affected by reasonably
foreseeable events.
___________________________________________________________
AA Very high quality; obligor's ability to pay
interest and repay principal is very strong.
Because bonds rated in the AAA and AA categories
are not significantly vulnerable to foreseeable
future developments, short-term debt of these
issuers is generally rated F-1+.
___________________________________________________________
A High quality; obligor's ability to pay interest
and repay principal is considered to be strong,
but may be more vulnerable to adverse changes in
economic conditions and circumstances than
higher-rated bonds.
___________________________________________________________
BBB Satisfactory credit quality; obligor's ability to
pay interest and repay principal is considered
adequate. Unfavorable changes in economic
conditions and circumstances are more likely to
adversely affect these bonds and impair timely
payment. The likelihood that the ratings of these
bonds will fall below investment grade is higher
than for higher-rated bonds.
___________________________________________________________
BB, CCC, Not investment-grade; predominantly speculative
CC, C with respect to the issuer's capacity to repay
interest and repay principal in accordance with
the terms of the obligation for bond issues not
in default. BB is least speculative. C is the
most speculative.
_____________________________________________________________________________
Table 8
_____________________________________________________________________________
PORTFOLIO MANAGERS DIVERSIFY FUND ASSETS TO LOWER RISK.
Credit Quality and the High Yield Fund.
In seeking its primary objective of high income, the Tax-Free High Yield Fund
invests a portion of its assets in bonds rated below-investment-grade (BB or
lower). Such bonds are regarded as speculative with respect to the issuer's
ability to meet interest and principal payments.
For the fiscal year ended February 28, 1994, the Tax-Free High Yield Fund's
assets were invested in the credit categories shown at right. Percentages are
computed on a dollar-weighted basis and are an average of 12 monthly
calculations.
_____________________________________________________________________________
Tax-Free High Yield Fund: Asset Composition
TRPA's
Assessment of
Standard & Poor's Percentage of Not Rated
Rating* Total Assets Securities
_____________________________________________________________________________
AAA 7.6 0.1
_____________________________________________________________________________
AA 10.7 0.0
_____________________________________________________________________________
A 17.5 1.6
_____________________________________________________________________________
BBB 25.1 10.1
_____________________________________________________________________________
BB 3.8 15.4
_____________________________________________________________________________
B 0.3 2.2
_____________________________________________________________________________
CCC-D 0.0 0.4 (CCC and CC)
_____________________________________________________________________________
Not Rated 29.8 -
_____________________________________________________________________________
Reserves 5.2 -
_____________________________________________________________________________
100.0% 29.8%
_____________________________________________________________________________
*Equivalent ratings by Moody's used in the absence of a S&P rating.
_____________________________________________________________________________
Table 9
Note: Although each fund offers only its own shares, it is possible that a
fund might become liable for a misstatement in this prospectus about another
fund. The Board of each fund has considered this factor in approving the use
of a single combined prospectus.
4 Investing with T. Rowe Price
4 Investing with T. Rowe Price
Meeting Requirements for New Accounts
_____________________________________________________________________________
ALWAYS VERIFY YOUR TRANSACTIONS BY CAREFULLY REVIEWING THE CONFIRMATION WE
SEND YOU. PLEASE REPORT ANY DISCREPANCIES TO SHAREHOLDER SERVICES.
Tax Identification Number
We must have your correct social security or corporate tax identification
number and a signed New Account Form or W-9 Form. Otherwise, federal law
requires the fund to withhold a percentage (currently 31%) of your dividends,
capital gain distributions, and redemptions, and may subject you to an IRS
fine. You will also be prohibited from opening another account by exchange. If
this information is not received within 60 days after your account is
established, your account may be redeemed, priced at the NAV on the date of
redemption.
Unless you request otherwise, one shareholder report will be mailed to
multiple account owners with the same tax identification number and same zip
code and to shareholders who have requested that their account be combined
with someone else's for financial reporting.
Opening a New Account: $2,500 minimum initial investment; $1,000 for gifts or
transfers to minors (UGMA/UTMA) accounts
Account Registration
If you own other T. Rowe Price funds, be sure to register any new account just
like your existing accounts so you can exchange among them easily. (The name
and account type would have to be identical.)
_____________________________________________________________________________
REGULAR MAIL
T. ROWE PRICE
ACCOUNT SERVICES
P.O. BOX 17300
BALTIMORE, MD
21298-9353
By Mail
Please make your check payable to T. Rowe Price Funds (otherwise it may be
returned) and send it together with the New Account Form to the address at
left.
By Wire
o Call Investor Services for an account number and use the wire address
below.
o Complete a New Account Form and mail it to one of the appropriate
addresses listed at left.
o Give the following wire address to your bank: Morgan Guaranty Trust Co.
of New York, ABA# 021000238, T. Rowe Price [fund name], AC-00153938.
Provide fund name, account name(s), and account number.
_____________________________________________________________________________
MAILGRAM, EXPRES,
REGISTERED, OR
CERTIFIED MAIL
T. ROWE PRICE
ACCOUNT SERVICES
10090 RED RUN BLVD.
OWINGS MILLS, MD
21117
By Exchange
Call Shareholder Services. The new account will have the same registration as
the account from which you are exchanging. Services for the new account may be
carried over by telephone request if preauthorized on the existing account.
(See explanation of "Excessive Trading" under "Transaction Procedures.")
_____________________________________________________________________________
DROP-OFF LOCATIONS
101 EAST LOMBARD ST.
BALTIMORE, MD
T. ROWE PRICE
FINANCIAL CENTER
10090 RED RUN BLVD.
OWINGS MILLS, MD
In Person
Drop off your New Account Form at any of the locations listed at left and
obtain a receipt.
Note: The fund and its agents have the right to waive or lower investment
minimums; to accept initial purchases by telephone or mailgram; to cancel or
reject any purchase or ex-change if the written confirmation has not been
received by the shareholder; to otherwise modify the conditions of purchase or
any services at any time; or to act on instructions believed to be genuine.
FARRAGUT SQUARE
900 17TH STREET, N.W.
WASHINGTON, D.C.
Purchasing Additional Shares: $100 minimum purchase; $50 minimum for Automatic
Asset Builder; $5,000 minimum for telephone purchases
ARCO TOWER
31ST FLOOR
515 SOUTH FLOWER ST.
LOS ANGELES, CA
By ACH Transfer
Use Tele*Access(registered trademark), PC*Access(registered trademark), or
call Investor Services if you have established electronic transfers using the
ACH network.
_____________________________________________________________________________
REGULAR MAIL
T. ROWE PRICE FUNDS
ACCOUNT SERVICES
P. O. BOX 89000
BALTIMORE, MD
21289-1500
By Wire
Call Shareholder Services or use the wire address in "Opening a New Account."
By Mail
o Provide your account number and the fund name on your check.
o Mail the check to the address shown at left either with a reinvestment
slip or a note indicating the fund and account number in which you wish
to purchase shares.
By Automatic Asset Builder
Fill out the Automatic Asset Builder section on the New Account or Shareholder
Services Form ($50 minimum).
By Phone
Call Shareholder Services to lock in that day's closing price; payment is due
within five days ($5,000 minimum).
Exchanging and Redeeming Shares
By Phone
Call Shareholder Services. If you find our phones busy during unusually
volatile markets, please consider placing your order by Tele*Access or
PC*Access (if you have previously authorized telephone services), or by
express mail or mailgram. For exchange policies, please see "Transaction
Procedures and Special Requirements-Excessive Trading."
Redemption proceeds can be mailed to your account address, sent by ACH
transfer, or wired to your bank. For charges, see "Electronic Transfers-By
Wire" on the next page.
_____________________________________________________________________________
REGULAR MAIL
T. ROWE PRICE
ACCOUNT SERVICES
P.O. BOX 89000
BALTIMORE, MD
21289-0220
By Mail
Provide account name(s) and numbers, fund name(s), and exchange or redemption
amount. For exchanges, mail to the appropriate address at left, indicate the
fund you are exchanging from and the fund(s) you are exchanging into. T. Rowe
Price requires the signatures of all owners exactly as registered, and
possibly a signature guarantee (see "Transaction Procedures and Special
Requirements-Signature Guarantees").
_____________________________________________________________________________
MAILGRAM, EXPRESS,
REGISTERED, OR
CERTIFIED MAIL
(SEE PAGE 27.)
Shareholder Services
Many services are available to you as a T. Rowe Price shareholder; some you
receive automatically and others you must authorize on the New Account Form.
By signing up for services on the New Account Form rather than later, you
avoid having to complete a separate form and obtain a signature guarantee.
This section reviews some of the principal services currently offered. Our
Services Guide contains detailed descriptions of these and other services. If
you are a new T. Rowe Price investor, you will receive a Services Guide with
our Welcome Kit.
_____________________________________________________________________________
INVESTOR SERVICES
1-800-638-5660
1-410-547-2308
Exchange Service
You can move money from one account to an existing identically registered
account, or open a new identically registered account. Remember, exchanges are
purchases and sales for tax purposes. (Exchanges into a state tax-free fund
are limited to investors living in states where the funds are registered.)
Some of the T. Rowe Price funds may impose a redemption fee of .50% to 2%,
payable to such funds, on shares held for less than one year, or in some
funds, six months.
Note: Shares purchased by telephone may not be exchanged to another fund until
payment is received.
Automated Services
Tele*Access. 24-hour service via toll-free number provides information such as
yields, prices, dividends, account balances, and your latest transaction, as
well as the ability to request prospectuses and account forms and initiate
purchase, redemption and exchange orders in your accounts (see "Electronic
Transfers" below).
PC*Access. 24-hour service via dial-up modem provides the same information as
Tele*Access, but on a personal computer. Please call Investor Services for an
information guide.
Telephone and Walk-In Services
Buy, sell, or exchange shares by calling one of our service representatives or
by visiting one of our four investor center locations.
Electronic Transfers
By ACH. With no charges to pay, you can initiate a purchase or redemption for
as little as $100 or as much as $100,000 between your bank account and fund
account using the ACH network. Enter instructions via Tele*Access, PC*Access
or call Shareholder Services.
By Wire. Electronic transfers can also be conducted via bank wire. There is
currently a $5 fee for wire redemptions under $5,000, and your bank may charge
for wire transfers regardless of size.
Checkwriting
You may write an unlimited number of free checks on bond and money funds, with
a minimum of $500 per check. Keep in mind, however that a check results in a
redemption; a check written on a bond fund will create a taxable event which
you and we must report to the IRS.
Automatic Investing ($50 minimum)
You can invest automatically in several different ways, including:
o Automatic Asset Builder. You instruct us to move $50 or more once a
month or less often from your bank account, or you can instruct your
employer to send all or a portion of your paycheck, to the fund or funds
you designate.
o Automatic Exchange. Enables you to set up systematic investments from
one fund account into another, such as from a money fund into a stock
fund.
Discount Brokerage
You can trade stocks, bonds, options, precious metals and other securities at
a substantial savings over regular commission rates. Call Investor Services
for information.
Note: If you buy or sell T. Rowe Price funds through anyone other than T. Rowe
Price, such as broker-dealers or banks, you may be charged transaction or
service fees by those institutions. No such fees are charged by T. Rowe Price
Investment Services or the fund for transactions conducted directly with the
fund.
_____________________________________________________________________________
DESCRIPTION OF SIGNIFICANT DIFFERENCES BETWEEN EDGAR FILING AND PRINTED COPY
Information appearing in all capital letters before a paragraph in the Edgar
filing will appear, in the printed copy, as call-outs in the left margin.
<PAGE>
PAGE 2
Prospectus
To Open an Account Tax-Free Funds
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<PAGE>
PAGE 3
STATEMENT OF ADDITIONAL INFORMATION
T. Rowe Price Tax-Exempt Money Fund, Inc.
T. Rowe Price Tax-Free Short-Intermediate Fund, Inc.
T. Rowe Price Tax-Free Insured Intermediate Bond Fund, Inc.
T. Rowe Price Tax-Free Income Fund, Inc.
T. Rowe Price Tax-Free High Yield Fund, Inc.
(the "Funds")
This Statement of Additional Information is not a prospectus but
should be read in conjunction with the Funds' prospectus dated July 1, 1994,
which may be obtained from T. Rowe Price Investment Services, Inc., 100 East
Pratt Street, Baltimore, Maryland 21202.
The date of this Statement of Additional Information is July 1,
1994. <PAGE>
PAGE 4
TABLE OF CONTENTS
Page Page
Capital Stock. . . . . . . . .52 Investment Restrictions. . . . . .23
(page 14 in Prospectus) . . . . . . . . Legal Counsel54
Custodian. . . . . . . . . . .37 Management of Funds. . . . . . . .32
Determination of Maturity of Municipal Securities. . . . . 7
Securities . . . . . . . . .14 Net Asset Value Per Share. . . . .44
Distributor for Funds. . . . .37 Options. . . . . . . . . . . . . .23
Dividends. . . . . . . . . . .45 Participation Interests. . . . . .11
Federal and State Registration
Portfolio Transactions . . . .38
of Shares. . . . . . . . . .54 Portfolio Turnover . . . . . . . .14
Forwards . . . . . . . . . . .12 Pricing of Securities. . . . . . .43
Futures Contracts. . . . . . .15 Principal Holders of Securities. .34
General Information and History51 Ratings of Commercial Paper. . . .31
Independent Accountants. . . .55 Ratings of Municipal Debt Securities 29
Investment Management Services34 Ratings of Municipal Notes and Variable
(page 14 in Prospectus) . . . . . Rate Securities31
Investment in Taxable Money Market Residual Interest Bonds . . .31
Securities. . . . . . . . .13 Risk Factors . . . . . . . . . . . 4
Investment Objectives. . . . . 3 Tax-Exempt vs. Taxable Yields. . .47
(pages 1 and 16 in Prospectus) Tax Status (page 11 in Prospectus)45
Investment Objectives and Policies 2 Variable and Floating Rate
Investment Performance . . . .47 Securities. . . . . . . . . . .10
Investment Programs. . . . . . 7 When-Issued Securities . . . . . .12
(pages 6-9 and 16-23 in Prospectus) . . . . . . Yield Information46
INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the discussion of each
Fund's investment objectives and policies discussed on pages 1 and 16, and 6
through 9 and 16 through 23 of the prospectus. The Funds will not make a
material change in their investment objectives without obtaining shareholder
approval. Unless otherwise specified, the investment programs and
restrictions of the Funds are not fundamental policies. Each Fund's operating
policies are subject to change by its Board of Directors without shareholder
approval. However, shareholders will be notified of a material change in an
operating policy. Each Fund's fundamental policies may not be changed without
the approval of at least a majority of the outstanding shares of the Fund or,
if it is less, 67% of the shares represented at a meeting of shareholders at
which the holders of 50% or more of the shares are represented.
<PAGE>
PAGE 5
RISK FACTORS
All Funds
The Funds are designed for investors who, because of their tax
bracket, can benefit from investment in municipal bonds whose income is exempt
from federal taxes. The Funds are not appropriate for qualified retirement
plans where income is already tax deferred.
Municipal Securities
There can be no assurance that the Funds will achieve their
investment objectives. Yields on municipal securities are dependent on a
variety of factors, including the general conditions of the money market and
the municipal bond market, the size of a particular offering, the maturity of
the obligation, and the rating of the issue. Municipal securities with longer
maturities tend to produce higher yields and are generally subject to
potentially greater capital appreciation and depreciation than obligations
with shorter maturities and lower yields. The market prices of municipal
securities usually vary, depending upon available yields. An increase in
interest rates will generally reduce the value of portfolio investments, and
a decline in interest rates will generally increase the value of portfolio
investments. The ability of all the Funds to achieve their investment
objectives is also dependent on the continuing ability of the issuers of
municipal securities in which the Funds invest to meet their obligations for
the payment of interest and principal when due. The ratings of Moody's, S&P,
and Fitch represent their opinions as to the quality of municipal securities
which they undertake to rate. Ratings are not absolute standards of quality;
consequently, municipal securities with the same maturity, coupon, and rating
may have different yields. There are variations in municipal securities, both
within a particular classification and between classifications, depending on
numerous factors. It should also be pointed out that, unlike other types of
investments, municipal securities have traditionally not been subject to
regulation by, or registration with, the SEC, although there have been
proposals which would provide for regulation in the future.
The federal bankruptcy statutes relating to the debts of political
subdivisions and authorities of states of the United States provide that, in
certain circumstances, such subdivisions or authorities may be authorized to
initiate bankruptcy proceedings without prior notice to or consent of
creditors, which proceedings could result in material and adverse changes in
the rights of holders of their obligations.
Proposals have been introduced in Congress to restrict or
eliminate the federal income tax exemption for interest on municipal
securities, and similar proposals may be introduced in the future. Some of
the past proposals would have applied to interest on municipal securities
issued before the date of enactment, which would have adversely affected their
value to a material degree. If such a proposal were enacted, the availability
of municipal securities for investment by the Funds and the value of a Fund's
portfolio would be affected and, in such an event, a Fund would reevaluate its
investment objectives and policies.
Although the banks and securities dealers with which the Fund will
transact business will be banks and securities dealers that T. Rowe Price
believes to be financially sound, there can be no assurance that they will be
able to honor their obligations to the Fund with respect to such securities.
After purchase by a Fund, a security may cease to be rated or its
rating may be reduced below the minimum required for purchase by the Fund.
For the Money Fund, the procedures set forth in Rule 2a-7, under the
PAGE 6
Investment Company Act of 1940, may require the prompt sale of any such
security. For the other Funds, neither event would require a sale of such
security by the Fund. However, T. Rowe Price Associates, Inc. ("T. Rowe
Price") will consider such event in its determination of whether the Fund
should continue to hold the security. To the extent that the ratings given by
Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's Corporation
("S&P"), or Fitch Investors Service, Inc. ("Fitch") may change as a result of
changes in such organizations or their rating systems, the Fund will attempt
to use comparable ratings as standards for investments in accordance with the
investment policies contained in the prospectus. When purchasing unrated
securities, T. Rowe Price, under the supervision of the Fund's Board of
Directors, determines whether the unrated security is of a qualify comparable
to that which the Fund is allowed to purchase.
Municipal Bond Insurance. All of the Funds may purchase insured
bonds from time to time. Municipal bond insurance provides an unconditional
and irrevocable guarantee that the insured bond's principal and interest will
be paid when due. The guarantee is purchased from a private, non-governmental
insurance company.
There are two types of insured securities that may be purchased by
the Funds, bonds carrying either (1) new issue insurance or (2) secondary
insurance. New issue insurance is purchased by the issuer of a bond in order
to improve the bond's credit rating. By meeting the insurer's standards and
paying an insurance premium based on the bond's principal value, the issuer is
able to obtain a higher credit rating for the bond. Once purchased, municipal
bond insurance cannot be cancelled, and the protection it affords continues as
long as the bonds are outstanding and the insurer remains solvent.
The Funds may also purchase bonds which carry secondary insurance
purchased by an investor after a bond's original issuance. Such policies
insure a security for the remainder of its term. Generally, the Funds expect
that portfolio bonds carrying secondary insurance will have been insured by a
prior investor. However, the Funds may, on occasion, purchase secondary
insurance on their own behalf.
Each of the municipal bond insurance companies has established
reserves to cover estimated losses. Both the method of establishing these
reserves and the amount of the reserves vary from company to company. The
obligation of a municipal bond insurance company may have to pay a claim
extends over the life of each insured bond. Municipal bond insurance
companies are obligated to pay a bond's interest and principal when due if the
issuing entity defaults on the insured bond. Although defaults on insured
municipal bonds have been low to date and municipal insurers have met these
claims, there is no assurance this low rate will continue in the future. A
higher than expected default rate could deplete loss reserves and adversely
affect the ability of a municipal bond insurer to pay claims to holders of
insured bonds, such as the Fund.
<PAGE>
PAGE 7
Money Fund
The Fund will limit its purchases of portfolio instruments to
those U.S. dollar-denominated securities which the Fund's Board of Directors
determines present minimal credit risk, and which are Eligible Securities as
defined in Rule 2a-7 under the Investment Company Act of 1940 (1940 Act).
Eligible Securities are generally securities which have been rated (or whose
issuer has been rated or whose issuer has comparable securities rated) in one
of the two highest short-term rating categories by nationally recognized
statistical rating organizations or, in the case of any instrument that is not
so rated, is of comparable high quality as determined by T. Rowe Price
pursuant to written guidelines established in accordance with Rule 2a-7 under
the Investment Company Act of 1940 under the supervision of the Fund's Board
of Directors. In addition, the Funds may treat variable and floating rate
instruments with demand features as short-term securities pursuant to Rule 2a-
7 under the 1940 Act.
There can be no assurance that the Money Fund will achieve its
investment objectives or be able to maintain its net asset value per share at
$1.00. The price stability and liquidity of the Money Fund may not be equal
to that of a taxable money market fund which exclusively invests in short-term
taxable money market securities. The taxable money market is a broader and
more liquid market with a greater number of investors, issuers, and market
makers than the short-term municipal securities market. The weighted average
maturity of the Fund varies: the shorter the average maturity of a portfolio,
the less its price will be impacted by interest rate fluctuations.
Bond Funds
Because of their investment policies, the Bond Funds may not be
suitable or appropriate for all investors. The Funds are designed for
investors who wish to invest in non-money market funds for income, and who
would benefit, because of their tax bracket, from receiving income that is
exempt from federal income taxes. The Funds' investment programs permit the
purchase of investment grade securities that do not meet the high quality
standards of the Money Fund. Since investors generally perceive that there
are greater risks associated with investment in lower quality securities, the
yields from such securities normally exceed those obtainable from higher
quality securities. In addition, the principal value of long term lower-rated
securities generally will fluctuate more widely than higher quality
securities. Lower quality investments entail a higher risk of default--that
is, the nonpayment of interest and principal by the issuer than higher quality
investments. The value of the portfolio securities of the Bond Funds will
fluctuate based upon market conditions. Although these Funds seek to reduce
credit risk by investing in a diversified portfolio, such diversification does
not eliminate all risk. The Funds are also not intended to provide a vehicle
for short-term trading purposes.
<PAGE>
PAGE 8
Special Risks of High Yield Investing.
Junk bonds are regarded as predominantly speculative with respect
to the issuer's continuing ability to meet principal and interest payments.
Because investment in low and lower-medium quality bonds involves greater
investment risk, to the extent the Funds invest in such bonds, achievement of
their investment objectives will be more dependent on T. Rowe Price's credit
analysis than would be the case if the Funds were investing in higher quality
bonds. High yield bonds may be more susceptible to real or perceived adverse
economic conditions than investment grade bonds. A projection of an economic
downturn, or higher interest rates, for example, could cause a decline in high
yield bond prices because the advent of such events could lessen the ability
of highly leverage issuers to make principal and interest payments on their
debt securities. In addition, the secondary trading market for high yield
bonds may be less liquid than the market for higher grade bonds, which can
adversely affect the ability of a Fund to dispose of its portfolio securities.
Bonds for which there is only a "thin" market can be more difficult to value
inasmuch as objective pricing data may be less available and judgment may play
a greater role in the valuation process.
Reference is also made to the sections entitled "Types of
Securities" and "Portfolio Management Practices" for discussions of the risks
associated with the investments and practices described therein.
INVESTMENT PROGRAMS
(Throughout the discussion on Investments, the term "the Fund" is intended to
refer to each of the Funds eligible to invest in the security or engage in the
practice being described)
Type of Securities
Municipal Securities
Subject to the investment objectives and programs described in the
prospectus and the additional investment restrictions described in this
Statement of Additional Information, each Fund's portfolio may consist of any
combination of the various types of municipal securities described below or
other types of municipal securities that may be developed. The amount of each
Fund's assets invested in any particular type of municipal security can be
expected to vary.
The term "municipal securities" means 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, as well as certain other persons and entities, the interest
from which is exempt from federal income tax. In determining the tax-exempt
status of a municipal security, the Fund relies on the opinion of the issuer's
bond counsel at the time of the issuance of the security. However, it is
possible this opinion could be overturned, and as a result, the interest
received by the Fund from such a security might not be exempt from federal
income tax.
Municipal securities are classified by maturity as notes, bonds,
or adjustable rate securities.
<PAGE>
PAGE 9
Municipal Notes. Municipal notes generally are used to provide
for short-term operating or capital needs and generally have maturities of one
year or less. Municipal notes include:
Tax Anticipation Notes. Tax anticipation notes are issued to
finance working capital needs of municipalities. Generally, they
are issued in anticipation of various seasonal tax revenue, such
as income, property, use and business taxes, and are payable from
these specific future taxes.
Revenue Anticipation Notes. Revenue anticipation notes are issued
in expectation of receipt of other types of revenue, such as
federal or state revenues available under the revenue sharing or
grant programs.
Bond Anticipation Notes. Bond anticipation notes are issued to
provide interim financing until long-term financing can be
arranged. In most cases, the long-term bonds then provide the
money for the repayment of the notes.
Tax-Exempt Commercial Paper. Tax-exempt commercial paper is a
short-term obligation with a stated maturity of 270 days or less.
It is issued by state and local governments or their agencies to
finance seasonal working capital needs or as short-term financing
in anticipation of longer term financing.
Municipal Bonds. Municipal bonds, which meet longer term capital
needs and generally have maturities of more than one year when issued, have
two principal classifications: general obligation bonds and revenue bonds.
Two additional categories of potential purchases are lease revenue bonds and
pre-refunded/escrowed to maturity bonds. Another type of municipal bond is
referred to as an Industrial Development Bond.
General Obligation Bonds. Issuers of general obligation bonds
include states, counties, cities, towns, and special districts.
The proceeds of these obligations are used to fund a wide range of
public projects, including construction or improvement of schools,
public buildings, highways and roads, and general projects not
supported by user fees or specifically identified revenues. The
basic security behind general obligation bonds is the issuer's
pledge of its full faith and credit and taxing power for the
payment of principal and interest. The taxes that can be levied
for the payment of debt service may be limited or unlimited as to
the rate or amount of special assessments. In many cases voter
approval is required before an issuer may sell this type of bond.
Revenue Bonds. The principal security for a revenue bond is
generally the net revenues derived from a particular facility, or
enterprise, or in some cases, the proceeds of a special charge or
other pledged revenue source. Revenue bonds are issued to finance
a wide variety of capital projects including: electric, gas, water
and sewer systems; highways, bridges, and tunnels; port and
airport facilities; colleges and universities; and hospitals.
Revenue bonds are sometimes used to finance various privately
operated facilities provided they meet certain tests established
for tax-exempt status.
PAGE 10
Although the principal security behind these bonds may vary,
many provide additional security in the form of a mortgage or debt
service reserve fund. Some authorities provide further security
in the form of the state's ability (without obligation) to make up
deficiencies in the debt service reserve fund. Revenue bonds
usually do not require prior voter approval before they may be
issued.
Lease Revenue Bonds. Municipal borrowers may also finance capital
improvements or purchases with tax-exempt leases. The security
for a lease is generally the borrower's pledge to make annual
appropriations for lease payments. The lease payment is treated
as an operating expense subject to appropriation risk and not a
full faith and credit obligation of the issuer. Lease revenue
bonds are generally considered less secure than a general
obligation or revenue bond and often do not include a debt service
reserve fund. To the extent the Fund's Board determines such
securities are illiquid, they will be subject to the Fund's 15%
limit on illiquid securities (10% limit for the Money Fund).
There have also been certain legal challenges to the use of lease
revenue bonds in various states.
The liquidity of such securities will be determined based on a
variety of factors which may include, among others: (1) the
frequency of trades and quotes for the obligation; (2) the number
of dealers willing to purchase or sell the security and the number
of other potential buyers; (3) the willingness of dealers to
undertake to make a market in the security; (4) the nature of the
marketplace trades, including, the time needed to dispose of the
security, the method of soliciting offers, and the mechanics of
transfer; and (5) the rating assigned to the obligation by an
established rating agency or T. Rowe Price.
Pre-refunded/Escrowed to Maturity Bonds. Certain municipal bonds
have been refunded with a later bond issue from the same issuer.
The proceeds from the later issue are used to defease the original
issue. In many cases the original issue cannot be redeemed or
repaid until the first call date or original maturity date. In
these cases, the refunding bond proceeds typically are used to buy
U.S. Treasury securities that are held in an escrow account until
the original call date or maturity date. The original bonds then
become "pre-refunded" or "escrowed to maturity" and are considered
as high quality investments. While still tax-exempt, the security
is the proceeds of the escrow account. To the extent permitted by
the Securities and Exchange Commission and the Internal Revenue
Service, a Fund's investment in such securities refunded with U.S.
Treasury securities will, for purposes of diversification rules
applicable to the Fund, be considered as an investment in the U.S.
Treasury securities.
Private Activity Bonds. Under current tax law all municipal debt
is divided broadly into two groups: governmental purpose bonds
and private activity bonds. Governmental purpose bonds are issued
to finance traditional public purpose projects such as public
buildings and roads. Private activity bonds may be issued by a
state or local government or public authority but principally
benefit private users and are considered taxable unless a specific
exemption is provided.
PAGE 11
The tax code currently provides exemptions for certain private
activity bonds such as not-for-profit hospital bonds, small-issue
industrial development revenue bonds and mortgage subsidy bonds,
which may still be issued as tax-exempt bonds. Some, but not all,
private activity bonds are subject to alternative minimum tax.
Industrial Development Bonds. Industrial development bonds are
considered Municipal Bonds if the interest paid is exempt from
federal income tax. They are issued by or on behalf of public
authorities to raise money to finance various privately operated
facilities for business and manufacturing, housing, sports, and
pollution control. These bonds are also used to finance public
facilities such as airports, mass transit systems, ports, and
parking. The payment of the principal and interest on such bonds
is dependent solely on the ability of the facility's user to meet
its financial obligations and the pledge, if any, of real and
personal property so financed as security for such payment.
Adjustable Rate Securities. Municipal securities may be issued
with adjustable interest rates that are reset periodically by pre-determined
formulas or indexes in order to minimize movements in the principal value of
the investment. Such securities may have long-term maturities, but may be
treated as a short-term investment under certain conditions. Generally, as
interest rates decrease or increase, the potential for capital appreciation or
depreciation on these securities is less than for fixed-rate obligations.
These securities may take the following forms:
Variable Rate Securities. Variable rate instruments are those
whose terms provide for the adjustment of their interest rates
on set dates and which, upon such adjustment, can reasonably
be expected to have a market value that approximates its par
value. Subject to the provisions of Rule 2a-7 under the
Investment Company Act of 1940, (1) a variable rate
instrument, the principal amount of which is scheduled to be
paid in 397 days or less, is deemed to have a maturity equal
to the period remaining until the next readjustment of the
interest; (2) a variable rate instrument which is subject to a
demand feature which entitles the purchaser to receive the
principal amount of the underlying security or securities
either (i) upon notice of usually 30 days, or (ii), at
specified intervals not exceeding 397 days and upon no more
than 30 days notice is deemed to have a maturity equal to the
longer of the period remaining until the next readjustment of
the interest rate or the period remaining until the principal
amount can be recovered through demand; and (3) an instrument
that is issued or guaranteed by the U.S. government or any
agency thereof which has a variable rate of interest
readjusted no less frequently than every 762 days may be
deemed to have a maturity equal to the period remaining until
the next readjustment of the interest rate. Should the
provisions of Rule 2a-7 change, the Fund will determine the
maturity of these securities in accordance with the amended
provisions of such rule.
PAGE 12
Floating Rate Securities. Floating rate instruments are those
whose terms provide for the adjustment of their interest rates
whenever a specified interest rate changes and which, at any
time, can reasonably be expected to have a market value that
approximates its par value. Subject to the provisions of Rule
2a-7 under the Investment Company Act of 1940, (1) the
maturity of a floating rate instrument is deemed to be the
period remaining until the date (noted on the face of the
instrument) on which the principal amount must be paid, or in
the case of an instrument called for redemption, the date on
which the redemption payment must be made; and (2) 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. Should the provisions
of Rule 2a-7 change, the Fund will determine the maturity of
these securities in accordance with the amended provisions of
such rule.
Put Option Bonds. Long-term obligations with maturities
longer than one year may provide purchasers an optional or
mandatory tender of the security at par value at predetermined
intervals, often ranging from one month to several years
(e.g., a 30-year bond with a five-year tender period). These
instruments are deemed to have a maturity equal to the period
remaining to the put date.
Residual Interest Bonds (Bond Funds). The Funds may purchase
municipal bond issues that are structured as two-part,
residual interest bond and variable rate security offerings.
The issuer is obligated only to pay a fixed amount of tax-free
income that is to be divided among the holders of the two
securities. The interest rate for the holders of the variable
rate securities will be determined by an index or auction
process held approximately every 7 to 35 days while the bond
holders will receive all interest paid by the issuer minus the
amount given to the variable rate security holders and a
nominal auction fee. Therefore, the coupon of the residual
interest bonds, and thus the income received, will move
inversely with respect to short-term, 7 to 35 day tax-exempt
interest rates. There is no assurance that the auction will
be successful and that the variable rate security will provide
short-term liquidity. The issuer is not obligated to provide
such liquidity. In general, these securities offer a
significant yield advantage over standard municipal
securities, due to the uncertainty of the shape of the yield
curve (i.e., short term versus long term rates) and consequent
income flows.
Unlike many adjustable rate securities, residual interest
bonds are not necessarily expected to trade at par and in fact
present significant market risks. In certain market
environments, residual interest bonds may carry substantial
premiums or be at deep discounts. This is a relatively new
product in the municipal market with limited liquidity to
date.
PAGE 13
Participation Interests. The Funds may purchase from third
parties participation interests in all or part of specific
holdings of municipal securities. The purchase may take
different forms: in the case of short-term securities, the
participation may be backed by a liquidity facility that
allows the interest to be sold back to the third party (such
as a trust, broker or bank) for a predetermined price of par
at stated intervals. The seller may receive a fee from the
Funds in connection with the arrangement.
In the case of longer term bonds, the Intermediate and Income
Funds may purchase interests in a pool of municipal bonds or a
single municipal bond or lease without the right to sell the
interest back to the third party.
The Funds will not purchase participation interests unless a
satisfactory opinion of counsel or ruling of the Internal
Revenue Service has been issued that the interest earned from
the municipal securities on which the Funds holds
participation interests is exempt from federal income tax to
the Funds. However, there is no guarantee the IRS would treat
such interest income as tax-exempt.
Embedded Interest Rate Swaps and Caps (Bond Funds). In a
fixed-rate, long-term municipal bond with an interest rate
swap attached to it, the bondholder usually receives the
bond's fixed-coupon payment as well as a variable rate payment
that represents the difference between a fixed rate for the
term of the swap (which is typically shorter than the bond it
is attached to) and a variable rate short-term municipal
index. The bondholder receives excess income when short-term
rates remain below the fixed interest rate swap rate. If
short-term rates rise above the fixed-income swap rate, the
bondholder's income is reduced. At the end of the interest
rate swap term, the bond reverts to a single fixed-coupon
payment. Embedded interest rate swaps enhance yields, but
also increase interest rate risk.
An embedded interest rate cap allows the bondholder to receive
payments whenever short-term rates rise above a level
established at the time of purchase. They normally are used
to hedge against rising short-term interest rates.
Both instruments may be volatile and of limited liquidity and
their use may adversely affect a fund's total return.
The Funds may invest in other types of derivative instruments
as they become available.
There are, of course, other types of municipal securities that
are, or may become, available, and the Funds reserve the right to invest in
them.
For the purpose of the Funds' investment restrictions, the
identification of the "issuer" of municipal securities which are not general
obligation bonds is made by the Funds' investment manager, T. Rowe Price, on
the basis of the characteristics of the obligation as described above, the
most significant of which is the source of funds for the payment of principal
and interest on such securities.
PAGE 14
When-Issued Securities
New issues of municipal securities are often offered on a when-
issued basis; that is, delivery and payment for the securities normally takes
place 15 to 45 days or more after the date of the commitment to purchase. The
payment obligation and the interest rate that will be received on the
securities are each fixed at the time the buyer enters into the commitment. A
Fund will only make a commitment to purchase such securities with the
intention of actually acquiring the securities. However, a Fund may sell
these securities before the settlement date if it is deemed advisable as a
matter of investment strategy. Each Fund will maintain cash and/or high-grade
marketable debt securities with its custodian bank equal in value to
commitments for when-issued securities. Such securities either will mature
or, if necessary, be sold on or before the settlement date. Securities
purchased on a when-issued basis and the securities held in a Fund's portfolio
are subject to changes in market value based upon the public perception of the
creditworthiness of the issuer and changes in the level of interest rates
(which will generally result in similar changes in value; i.e., both
experiencing appreciation when interest rates decline and depreciation when
interest rates rise). Therefore, to the extent a Fund remains fully invested
or almost fully invested at the same time that it has purchased securities on
a when-issued basis, there will be greater fluctuations in its net asset value
than if it solely set aside cash to pay for when-issued securities. In the
case of the Money Fund, this could increase the possibility that the market
value of the Fund's assets could vary from $1.00 per share. In addition,
there will be a greater potential for the realization of capital gains, which
are not exempt from federal income tax. When the time comes to pay for when-
issued securities, a Fund will meet its obligations from then-available cash
flow, sale of securities or, although it would not normally expect to do so,
from sale of the when-issued securities themselves (which may have a value
greater or less than the payment obligation). The policies described in this
paragraph are not fundamental and may be changed by a Fund upon notice to its
shareholders.
Forwards
(Bond Funds)
The Funds may purchase bonds on a when-issued basis with longer
than standard settlement dates, in some cases exceeding one to two years. In
such cases, the Funds must execute a receipt evidencing the obligation to
purchase the bond on the specified issue date, and must segregate cash
internally to meet that forward commitment. Municipal "forwards" typically
carry a substantial yield premium to compensate the buyer for the risks
associated with a long when-issued period, including: shifts in market
interest rates that could materially impact the principal value of the bond,
deterioration in the credit quality of the issuer, loss of alternative
investment options during the when-issued period, changes in tax law or issuer
actions that would affect the exempt interest status of the bonds and prevent
delivery, failure of the issuer to complete various steps required to issue
the bonds, and limited liquidity for the buyer to sell the escrow receipts
during the when-issued period.
<PAGE>
PAGE 15
Investment in Taxable Money Market Securities
Although the Funds expect to be solely invested in municipal
securities, for temporary defensive purposes they may elect to invest in the
taxable money market securities listed below (without limitation) when such
action is deemed to be in the best interests of shareholders. The interest
earned on these money market securities is not exempt from federal income tax
and may be taxable to shareholders as ordinary income.
U.S. Government Obligations - direct obligations of the
government and its agencies and instrumentalities;
U.S. Government Agency Securities - obligations issued or
guaranteed by U.S. government sponsored enterprises, federal agencies, and
international institutions. Some of these securities are supported by the
full faith and credit of the U.S. Treasury; others are supported by the right
of the issuer; and the remainder are supported only by the credit of the
instrumentality;
Bank Obligations - certificates of deposit, bankers'
acceptances, and other short-term obligations of U.S. and Canadian banks and
their foreign branches;
Commercial Paper - paper rated A-2 or better by S&P, Prime-2
or better by Moody's, or F-2 or better by Fitch, or, if not rated, is issued
by a corporation having an outstanding debt issue rated A or better by
Moody's, S&P or Fitch and, with respect to the Money Fund, is of equivalent
investment quality as determined by the Board of Directors; and
Short-Term Corporate Debt Securities - short-term corporate
debt securities rated at least AA by S&P, Moody's or Fitch.
Determination of Maturity of Money Market Securities
The Money Fund may only purchase securities which at the time of
investment have remaining maturities of 397 calendar days or less, or with
respect to U.S. government securities, have remaining maturities of 762
calendar days or less. The other Funds may also purchase money-market
securities. In determining the maturity of money market securities, the Funds
will follow the povisions of Rule 2a-7 under the Investment Company Act of
1940.
Futures Contracts
Bond Funds (Throughout the discussion on Futures Contracts, the Funds are
referred to as "the Fund")
Transactions in Futures
The Fund may enter into interest rate futures contracts ("futures"
or "futures contracts"). Interest rate futures contracts may be used as a
hedge against changes in prevailing levels of interest rates in order to
establish more definitely the effective return on securities held or intended
to be acquired by the Fund. The Fund could sell interest rate futures as an
offset against the effect of expected increases in interest rates and purchase
such futures as an offset against the effect of expected declines in interest
rates. Futures can also be used as an efficient means of regulating a Fund's
exposure to the market.
PAGE 16
The Fund will enter into futures contracts which are traded on
national futures exchanges and are standardized as to maturity date and
underlying financial instrument. A public market exists in futures contracts
covering various taxable fixed income securities as well as municipal bonds.
Futures exchanges and trading in the United States are regulated under the
Commodity Exchange Act by the Commodity Futures Trading Commission ("CFTC").
Although techniques other than the sale and purchase of futures contracts
could be used for the above-referenced purposes, futures contracts offer an
effective and relatively low cost means of implementing the Fund's objectives
in these areas.
Regulatory Limitations
The Fund will engage in futures contracts and options thereon only
for bona fide hedging, yield enhancement, and risk management purposes, in
each case in accordance with rules and regulations of the CFTC and applicable
state law.
The Fund may not purchase or sell futures contracts or related
options if, with respect to positions which do not quality as bona fide
hedging under applicable CFTC rules, the sum of the amounts of initial margin
deposits and premiums paid on those positions would exceed 5% of the net asset
value of the Fund after taking into account unrealized profits and unrealized
losses on any such contracts it has entered into; provided, however, that in
the case of an option that is in-the-money at the time of purchase, the in-
the-money amount may be excluded in calculating the 5% limitation. For
purposes of this policy, options on futures contracts traded on a commodities
exchange will be considered "related options." This policy may be modified by
the Board of Directors without a shareholder vote and does not limit the
percentage of the Fund's assets at risk to 5%.
In accordance with the rules of the State of California, the Fund
will apply the above 5% test without excluding the value of initial margin and
premiums paid for bona fide hedging purposes.
The Fund's use of futures will not result in leverage. Therefore,
to the extent necessary, in instances involving the purchase of futures
contracts or the writing of calls or put options thereon by the Fund, an
amount of cash, U.S. government securities or other liquid, high-grade debt
obligations, equal to the market value of the futures contracts and options
thereon (less any related margin deposits), will be identified in an account
with the Fund's custodian to cover the position, or alternative cover (such as
owning an offsetting position) will be employed. Assets used as cover or held
in an identified account cannot be sold while the position in the
corresponding option or future is open, unless they are replaced with similar
assets. As a result, the commitment of a large portion of a Fund's assets to
cover or identified accounts could impede portfolio management or the Fund's
ability to meet redemption requests or other current obligations.
If the CFTC or other regulatory authorities adopt different
(including less stringent) or additional restrictions, the Fund would comply
with such new restrictions.
Trading in Futures Contracts
A futures contract provides for the future sale by one party and
purchase by another party of a specified amount of a specific financial
instrument (e.g., units of a debt security) for a specified price, date, time
and place designated at the time the contract is made. Brokerage fees are
incurred when a futures contract is bought or sold and margin deposits must be
PAGE 17
maintained. Entering into a contract to buy is commonly referred to as buying
or purchasing a contract or holding a long position. Entering into a contract
to sell is commonly referred to as selling a contract or holding a short
position.
It is possible that the Fund's hedging activities will occur
primarily through the use of municipal bond index futures contracts since the
uniqueness of that index contract should better correlate with the Fund's
portfolio and thereby be more effective. However, there may be times when it
is deemed in the best interest of shareholders to engage in the use of
Treasury bond futures, and the Fund reserves to right to use Treasury bond
futures at any time. Use of these futures could occur, as an example, when
both the Treasury bond contract and municipal bond index futures contract are
correlating well with municipal bond prices, but the Treasury bond contract is
trading at a more advantageous price making the hedge less expensive with the
Treasury bond contract than would be obtained with the municipal bond index
futures contract. The Fund's activity in futures contracts generally will be
limited to municipal bond index futures contracts and Treasury bond and note
contracts.
Unlike when the Fund purchases or sells a security, no price would
be paid or received by the Fund upon the purchase or sale of a futures
contract. Upon entering into a futures contract, and to maintain the Fund's
open positions in futures contracts, the Fund would be required to deposit
with its custodian in a segregated account in the name of the futures broker
an amount of cash, U.S. government securities, suitable money market
instruments, or liquid, high-grade debt securities, known as "initial margin."
The margin required for a particular futures contract is set by the exchange
on which the contract is traded, and may be significantly modified from time
to time by the exchange during the term of the contract. Futures contracts
are customarily purchased and sold on margins that may range upward from less
than 5% of the value of the contract being traded.
If the price of an open futures contract changes (by increase in
the case of a sale or by decrease in the case of a purchase) so that the loss
on the futures contract reaches a point at which the margin on deposit does
not satisfy margin requirements, the broker will require an increase in the
margin. However, if the value of a position increases because of favorable
price changes in the futures contract so that the margin deposit exceeds the
required margin, the broker will pay the excess to the Fund.
These subsequent payments, called "variation margin," to and from
the futures broker, are made on a daily basis as the price of the underlying
assets fluctuate making the long and short positions in the futures contract
more or less valuable, a process known as "marking to the market." The Fund
expects to earn interest income on its margin deposits.
Although certain futures contracts, by their terms, require actual
future delivery of and payment for the underlying instruments, in practice
most futures contracts are usually closed out before the delivery date.
Closing out an open futures contract purchase or sale is effected by entering
into an offsetting futures contract sale or purchase, respectively, for the
same aggregate amount of the identical securities and the same delivery date.
If the offsetting purchase price is less than the original sale price, the
Fund realizes a gain; if it is more, the Fund realizes a loss. Conversely, if
the offsetting sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The transaction
PAGE 18
costs must also be included in these calculations. There can be no assurance,
however, that the Fund will be able to enter into an offsetting transaction
with respect to a particular futures contract at a particular time. If the
Fund is not able to enter into an offsetting transaction, the Fund will
continue to be required to maintain the margin deposits on the futures
contract.
As an example of an offsetting transaction in which the underlying
instrument is not delivered, the contractual obligations arising from the sale
of one contract of September municipal bond index futures on an exchange may
be fulfilled at any time before delivery of the contract is required (i.e., on
a specified date in September, the "delivery month") by the purchase of one
contract of September municipal bond index futures on the same exchange. In
such instance, the difference between the price at which the futures contract
was sold and the price paid for the offsetting purchase, after allowance for
transaction costs, represents the profit or loss to the Fund.
Special Risks of Transactions in Futures Contracts
Volatility and Leverage. The prices of futures contracts are
volatile and are influenced, among other things, by actual and anticipated
changes in the market and interest rates, which in turn are affected by fiscal
and monetary policies and national and international political and economic
events.
Most United States futures exchanges limit the amount of
fluctuation permitted in futures contract prices during a single trading day.
The 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 futures contract, no trades may be made on that day at a
price beyond that limit. The daily limit governs only price movement 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.
Because of the low margin deposits required, futures trading
involves an extremely high degree of leverage. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss, as well as gain, to the investor. For example, if at the
time of purchase, 10% of the value of the futures contract is deposited as
margin, a subsequent 10% decrease in the value of the futures contract would
result in a total loss of the margin deposit, before any deduction for the
transaction costs, if the account were then closed out. A 15% decrease would
result in a loss equal to 150% of the original margin deposit, if the contract
were closed out. Thus, a purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract. However, the
Fund would presumably have sustained comparable losses if, instead of the
futures contract, it had invested in the underlying financial instrument and
sold it after the decline. Furthermore, in the case of a futures contract
purchase, in order to be certain that the Fund has sufficient assets to
satisfy its obligations under a futures contract, the Fund earmarks to the
futures contract money market instruments equal in value to the current value
of the underlying instrument less the margin deposit.
PAGE 19
Liquidity. The Fund may elect to close some or all of its futures
positions at any time prior to their expiration. The Fund would do so to
reduce exposure represented by long futures positions or short futures
positions. The Fund may close its positions by taking opposite positions
which would operate to terminate the Fund's position in the futures contracts.
Final determinations of variation margin would then be made, additional cash
would be required to be paid by or released to the Fund, and the Fund would
realize a loss or a gain.
Futures contracts may be closed out only on the exchange or board
of trade where the contracts were initially traded. Although the Fund intends
to purchase or sell futures contracts only on exchanges or boards of trade
where there appears to be an active market, there is no assurance that a
liquid market on an exchange or board of trade will exist for any particular
contract at any particular time. In such event, it might not be possible to
close a futures contract, and in the event of adverse price movements, the
Fund would continue to be required to make daily cash payments of variation
margin. However, in the event futures contracts have been used to hedge the
underlying instruments, the Fund would continue to hold the underlying
instruments subject to the hedge until the futures contracts could be
terminated. In such circumstances, an increase in the price of underlying
instruments, if any, might partially or completely offset losses on the
futures contract. However, as described below, there is no guarantee that the
price of the underlying instruments will, in fact, correlate with the price
movements in the futures contract and thus provide an offset to losses on a
futures contract.
Hedging Risk. A decision of whether, when, and how to hedge
involves skill and judgment, and even a well-conceived hedge may be
unsuccessful to some degree because of unexpected market behavior, market or
interest rate trends. There are several risks in connection with the use by
the Fund of futures contracts as a hedging device. One risk arises because of
the imperfect correlation between movements in the prices of the futures
contracts and movements in the prices of the underlying instruments which are
the subject of the hedge. T. Rowe Price will, however, attempt to reduce this
risk by entering into futures contracts whose movements, in its judgment, will
have a significant correlation with movements in the prices of the Fund's
underlying instruments sought to be hedged.
Successful use of futures contracts by the Fund for hedging
purposes is also subject to T. Rowe Price's ability to correctly predict
movements in the direction of the market. It is possible that, when the Fund
has sold futures to hedge its portfolio against a decline in the market, the
index, indices, or instruments underlying futures are written might advance
and the value of the underlying instruments held in the Fund's portfolio might
decline. If this were to occur, the Fund would lose money on the futures and
also would experience a decline in value in its underlying instruments.
However, while this might occur to a certain degree, T. Rowe Price believes
that over time the value of the Fund's portfolio will tend to move in the same
direction as the market indices used to hedge the portfolio. It is also
possible that if the Fund were to hedge against the possibility of a decline
in the market (adversely affecting the underlying instruments held in its
portfolio) and prices instead increased, the Fund would lose part or all of
the benefit of increased value of those underlying instruments that it has
hedged, because it would have offsetting losses in its futures positions. In
addition, in such situations, if the Fund had insufficient cash, it might have
to sell underlying instruments to meet daily variation margin requirements.
Such sales of underlying instruments might be, but would not necessarily be,
at increased prices (which would reflect the rising market). The Fund might
PAGE 20
have to sell underlying instruments at a time when it would be disadvantageous
to do so.
In addition to the possibility that there might be an imperfect
correlation, or no correlation at all, between price movements in the futures
contracts and the portion of the portfolio being hedged, the price movements
of futures contracts might not correlate perfectly with price movements in the
underlying instruments due to certain market distortions. First, all
participants in the futures market are subject to margin deposit and
maintenance requirements. Rather than meeting additional margin deposit
requirements, investors might close futures contracts through offsetting
transactions, which could distort the normal relationship between the
underlying instruments and futures markets. Second, the margin requirements
in the futures market are less onerous than margin requirements in the
securities markets, and as a result the futures market might attract more
speculators than the securities markets do. Increased participation by
speculators in the futures market might also cause temporary price
distortions. Due to the possibility of price distortion in the futures market
and also because of the imperfect correlation between price movements in the
underlying instruments and movements in the prices of futures contracts, even
a correct forecast of general market trends by T. Rowe Price might not result
in a successful hedging transaction over a very short time period.
Options on Futures Contracts
The Fund might trade in municipal bond index option futures or
similar options on futures developed in the future. In addition, the Fund may
also trade in options on futures contracts on U.S. government securities and
any U.S. government securities futures index contract which might be
developed. In the opinion of T. Rowe Price, there is a high degree of
correlation in the interest rate, and price movements of U.S. government
securities and municipal securities. However, the U.S. government securities
market and municipal securities markets are independent and may not move in
tandem at any point in time.
The Fund will purchase put options on futures contracts to hedge
its portfolio of municipal securities against the risk of rising interest
rates, and the consequent decline in the prices of the municipal securities it
owns. The Funds will also write call options on futures contracts as a hedge
against a modest decline in prices of the municipal securities held in the
Fund's portfolio. If the futures price at expiration of a written call option
is below the exercise price, the Fund will retain the full amount of the
option premium, thereby partially hedging against any decline that may have
occurred in the Fund's holdings of debt securities. If the futures price when
the option is exercised is above the exercise price, however, the Fund will
incur a loss, which may be wholly or partially offset by the increase of the
value of the securities in the Fund's portfolio which were being hedged.
Writing a put option on a futures contract serves as a partial
hedge against an increase in the value of securities the Fund intends to
acquire. If the futures price at expiration of the option is above the
exercise price, the Fund will retain the full amount of the option premium
which provides a partial hedge against any increase that may have occurred in
the price of the debt securities the Fund intends to acquire. If the futures
price when the option is exercised is below the exercise price, however, the
Fund will incur a loss, which may be wholly or partially offset by the
decrease in the price of the securities the Fund intends to acquire.
Options on futures are similar to options on underlying
instruments except that options on futures give the purchaser the right, in
PAGE 21
return for the premium paid, to assume a position in a futures contract (a
long position if the option is a call and a short position if the option is a
put), rather than to purchase or sell the futures contract, at a specified
exercise price at any time during the period of the option. Upon exercise of
the option, the delivery of the futures position by the writer of the option
to the holder of the option will be accompanied by delivery of the accumulated
balance in the writer's futures margin account which represents the amount by
which the market price of the futures contract, at exercise, exceeds (in the
case of a call) or is less than (in the case of a put) the exercise price of
the option on the futures contract. Purchasers of options who fail to
exercise their options prior to the exercise date suffer a loss of the premium
paid.
From time to time a single order to purchase or sell futures
contracts (or options thereon) may be made on behalf of the Fund and other T.
Rowe Price Funds. Such aggregated orders would be allocated among the Fund
and the other T. Rowe Price Funds in a fair and non-discriminatory manner.
Special Risks of Transactions in Options on Futures Contracts
The risks described under "Special Risks of Transactions on
Futures Contracts" are substantially the same as the risks of using options on
futures. In addition, where the Fund seeks to close out an option position by
writing or buying an offsetting option covering the same index, underlying
instrument or contract and having the same exercise price and expiration date,
its ability to establish and close out positions on such options will be
subject to the maintenance of a liquid secondary market. Reasons for the
absence of a liquid secondary market on an exchange include the following: (i)
there may be insufficient trading interest in certain options; (ii)
restrictions may be imposed by an exchange on opening transactions or closing
transactions or both; (iii) trading halts, suspensions or other restrictions
may be imposed with respect to particular classes or series of options, or
underlying instruments; (iv) unusual or unforeseen circumstances may interrupt
normal operations on an exchange; (v) the facilities of an exchange or a
clearing corporation may not at all times be adequate to handle current
trading volume; or (vi) one or more exchanges could, for economic or other
reasons, decide or be compelled at some future date to discontinue the trading
of options (or a particular class or series of options), in which event the
secondary market on that exchange (or in the class or series of options) would
cease to exist, although outstanding options on the exchange that had been
issued by a clearing corporation as a result of trades on that exchange would
continue to be exercisable in accordance with their terms. There is no
assurance that higher than anticipated trading activity or other unforeseen
events might not, at times, render certain of the facilities of any of the
clearing corporations inadequate, and thereby result in the institution by an
exchange of special procedures which may interfere with the timely execution
of customers' orders. In the event no such market exists for a particular
contract in which the Fund maintains a position, in the case of a written
option, the Fund would have to wait to sell the underlying securities or
futures positions until the option expires or is exercised. The Fund would be
required to maintain margin deposits on payments until the contract is closed.
Options on futures are treated for accounting purposes in the same way as the
analogous option on securities are treated.
In addition, the correlation between movements in the price of
options on futures contracts and movements in the price of the securities
hedged can only be approximate. This risk is significantly increased when an
option on a U.S. government securities future or an option on a municipal
securities index future is used to hedge a municipal bond portfolio. Another
risk is that the movements in the price of options on futures contracts may
PAGE 22
not move inversely with changes in interest rates. If the Fund has written a
call option on a futures contract and the value of the call increases by more
than the increase in the value of the securities held as cover, the Fund may
realize a loss on the call which is not completely offset by the appreciation
in the price of the securities held as cover and the premium received for
writing the call.
The successful use of options on futures contracts requires
special expertise and techniques different from those involved in portfolio
securities transactions. A decision of whether, when and how to hedge
involves skill and judgment, and even a well-conceived hedge may be
unsuccessful to some degree because of unexpected market behavior or interest
rate trends. During periods when municipal securities market prices are
appreciating, the Fund may experience poorer overall performance than if it
had not entered into any options on futures contracts.
General Considerations
Transactions by the Fund in options on futures will be subject to
limitations established by each of the exchanges, boards of trade or other
trading facilities governing the maximum number of options in each class which
may be written or purchased by a single investor or group of investors acting
in concert, regardless of whether the options are written on the same or
different exchanges, boards of trade or other trading facilities or are held
or written in one or more accounts or through one or more brokers. Thus, the
number of contracts which the Fund may write or purchase may be affected by
contracts written or purchased by other investment advisory clients of T. Rowe
Price. An exchange, board of trade or other trading facility may order the
liquidations of positions found to be in excess of these limits, and it may
impose certain other sanctions.
Additional Futures and Options Contracts
Although the Fund has no current intention of engaging in futures
or options transactions other than those described above, it reserves the
right to do so. Such futures and options trading might involve risks which
differ from those involved in the futures and options described above.
Federal Tax Treatment of Futures Contracts
Although the Fund invests almost exclusively in securities which
generate income which is exempt from federal income taxes, the instruments
described above are not exempt from such taxes. Therefore, use of the
investment techniques described above could result in taxable income to
shareholders of the Fund.
Generally, the Fund is required, for federal income tax purposes,
to recognize as income for each taxable year its net unrealized gains and
losses on futures contracts as of the end of the year as well as those
actually realized during the year. Gain or loss recognized with respect to a
futures contract will generally be 60% long-term capital gain or loss and 40%
short-term capital gain or loss, without regard to the holding period of the
contract.
Futures contracts which are intended to hedge against a change in
the value of securities may be classified as "mixed straddles," in which case
the recognition of losses may be deferred to a later year. In addition, sales
of such futures contracts on securities may affect the holding period of the
PAGE 23
hedged security and, consequently, the nature of the gain or loss on such
security on disposition.
In order for the Fund to continue to qualify for federal income
tax treatment as a regulated investment company, at least 90% of its gross
income for a taxable year must be derived from qualifying income; i.e.,
dividends, interest, income derived from loans of securities, and gains from
the sale of securities. Gains realized on the sale or other disposition of
securities, including futures contracts on securities held for less than three
months, must be limited to less than 30% of the Fund's annual gross income.
In order to avoid realizing excessive gains on securities held less than three
months, the Fund may be required to defer the closing out of futures contracts
beyond the time when it would otherwise be advantageous to do so. It is
anticipated that unrealized gains on futures contracts, which have been open
for less than three months as of the end of the Fund's fiscal year and which
are recognized for tax purposes, will not be considered gains on securities
held less than three months for purposes of the 30% test.
The Fund will distribute to shareholders annually any net gains
which have been recognized for federal income tax purposes from futures
transactions (including unrealized gains at the end of the Fund's fiscal
year). Such distributions will be combined with distributions of ordinary
income or capital gains realized on the Fund's other investments.
Shareholders will be advised of the nature of the payments. The Fund's
ability to enter into transactions in options on futures contracts may be
limited by the Internal Revenue Code's requirements for qualification as a
regulated investment company.
Options on Securities
Bond Funds
The Funds have no current intention of investing in options on
securities, although they reserve the right to do so. Appropriate disclosure
would be added to the Funds' prospectus and Statement of Additional
Information when and if the Funds decide to invest in options.
INVESTMENT RESTRICTIONS
All Funds
Fundamental policies may not be changed without the approval of
the lesser of (1) 67% of a Fund's shares present at a meeting of shareholders
if the holders of more than 50% of the outstanding shares are present in
person or by proxy or (2) more than 50% of a Fund's outstanding shares. Other
restrictions in the form of operating policies are subject to change by a
Fund's Board of Directors without shareholder approval. Any investment
restriction which involves a maximum percentage of securities or assets shall
not be considered to be violated unless an excess over the percentage occurs
immediately after, and is caused by, an acquisition of securities or assets
of, or borrowings by, a Fund.
Fundamental Policies
As a matter of fundamental policy, the Fund may not:
PAGE 24
(1) Borrowing. Borrow money except that the Fund may (i) borrow for
non-leveraging, temporary or emergency purposes and (ii) engage
in reverse repurchase agreements and make other investments or
engage in other transactions, which may involve a borrowing, in
a manner consistent with the Fund's investment objective and
program, provided that the combination of (i) and (ii) shall
not exceed 33 1/3% of the value of the Fund's total assets
(including the amount borrowed) less liabilities (other than
borrowings) or such other percentage permitted by law. Any
borrowings which come to exceed this amount will be reduced in
accordance with applicable law. The Fund may borrow from
banks, other Price Funds or other persons to the extent
permitted by applicable law.
(2) Commodities. Purchase or sell physical commodities; except
that the Fund (other than the Money Fund) may enter into
futures contracts and options thereon;
(3) Industry Concentration. Purchase the securities of any issuer
if, as a result, more than 25% of the value of the Fund's total
assets would be invested in the securities of issuers having
their principal business activities in the same industry;
(4) Loans. Make loans, although the Fund may (i) lend portfolio
securities and participate in an interfund lending program with
other Price Funds provided that no such loan may be made if, as
a result, the aggregate of such loans would exceed 33 1/3% of
the value of the Fund's total assets; (ii) purchase money
market securities and enter into repurchase agreements; and
(iii) acquire publicly-distributed or privately-placed debt
securities and purchase debt;
(5) Percent Limit on Assets Invested in Any One Issuer. Purchase a
security if, as a result, with respect to 75% of the value of
its total assets, more than 5% of the value of the Fund's total
assets would be invested in the securities of a single issuer,
except securities issued or guaranteed by the U.S. Government
or any of its agencies or instrumentalities;
(6) Percent Limit on Share Ownership of Any One Issuer. Purchase a
security if, as a result, with respect to 75% of the value of
the Fund's total assets, more than 10% of the outstanding
voting securities of any issuer would be held by the Fund
(other than obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities);
(7) Real Estate. Purchase or sell real estate unless acquired as a
result of ownership of securities or other instruments (but
this shall not prevent the Fund from investing in securities or
other instruments backed by real estate or securities of
companies engaged in the real estate business);
(8) Senior Securities. Issue senior securities except in
compliance with the Investment Company Act of 1940;
PAGE 25
(9) Taxable Securities. During periods of normal market conditions,
purchase any security if, as a result, less than 80% of the
Fund's income would be exempt from federal income tax. The
income included under the 80% test doesn't include income from
securities subject to the alternative minimum tax (AMT); or
(10) Underwriting. Underwrite securities issued by other persons,
except to the extent that the Fund may be deemed to be an
underwriter within the meaning of the Securities Act of 1933 in
connection with the purchase and sale of its portfolio
securities in the ordinary course of pursuing its investment
program.
NOTES
The following Notes should be read in connection with the above-
described fundamental policies. The Notes are not fundamental
policies.
With respect to investment restrictions (1) and (4) the Fund will
not borrow from or lend to any other T. Rowe Price Fund unless they
apply for and receive an exemptive order from the SEC or the SEC
issues rules permitting such transactions. The Fund has no current
intention of engaging in any such activity and there is no assurance
the SEC would grant any order requested by the Fund or promulgate
any rules allowing the transactions.
With respect to investment restriction (1), the Money Fund has no
current intention of engaging in any borrowing transactions.
With respect to investment restriction (2), the Fund does not
consider hybrid instruments to be commodities.
For purposes of investment restriction (3), U.S., state or local
governments, or related agencies or instrumentalities, are not
considered an industry. Industrial development bonds issued by
nongovernmental users are not considered municipal securities for
purposes of this exception.
Operating Policies
As a matter of operating policy, the Fund may not:
(1) Borrowing. The Fund will not purchase additional securities
when money borrowed exceeds 5% of its total assets.
(2) Control of Portfolio Companies. Invest in companies for the
purpose of exercising management or control;
(3) Equity Securities. Purchase any equity security or security
convertible into an equity security provided that the Fund
(other than the Money Fund) may invest up to 10% of its total
assets in equity securities which pay tax-exempt dividends and
which are otherwise consistent with the Fund's investment
objective and, further provided, that the Money Fund may invest
up to 10% of its total assets in equity securities of other
tax-free open-end money market funds;
PAGE 26
(4) Futures Contracts. Purchase a futures contract or an option
thereon if, with respect to positions in futures or options on
futures which do not represent bona fide hedging, the aggregate
initial margin and premiums on such positions would exceed 5%
of the Fund's net asset value.
(5) Illiquid Securities. Purchase illiquid securities if, as a
result, more than 15% (10% for the Money Fund) of its net
assets would be invested in such securities;
(6) Investment Companies. Purchase securities of open-end or
closed-end investment companies except in compliance with the
Investment Company Act of 1940 and applicable state law
provided that, the Money Fund may only purchase the securities
of other tax-free open-end money market investment
companies;
(7) Margin. Purchase securities on margin, except (i) for use of
short-term credit necessary for clearance of purchases of
portfolio securities and (ii) it may make margin deposits in
connection with futures contracts or other permissible
investments;
(8) Mortgaging. Mortgage, pledge, hypothecate or, in any manner,
transfer any security owned by the Fund as security for
indebtedness except as may be necessary in connection with
permissible borrowings or investments and then such mortgaging,
pledging or hypothecating may not exceed 33 1/3% of the Fund's
total assets at the time of borrowing or investment;
(9) Oil and Gas Programs. Purchase participations or other direct
interests or enter into leases with respect to, oil, gas, or
other mineral exploration or development programs;
(10) Options, Etc. Invest in puts, calls, straddles, spreads, or
any combination thereof, except to the extent permitted by the
prospectus and Statement of Additional Information;
(11) Ownership of Portfolio Securities by Officers and Directors.
Purchase or retain the securities of any issuer if, to the
knowledge of the Fund's management, those officers and
directors of the Fund, and of its investment manager, who each
own beneficially more than .5% of the outstanding securities of
such issuer, together own beneficially more than 5% of such
securities.
(12) Short Sales. Effect short sales of securities;
(13) Unseasoned Issuers. Purchase a security (other than
obligations issued or guaranteed by the U.S., any foreign,
state or local government, their agencies or instrumentalities)
if, as a result, more than 5% of the value of the Fund's total
assets would be invested in the securities issuers which at the
time of purchase had been in operation for less than three
years (for this purpose, the period of operation of any issuer
shall include the period of operation of any predecessor or
unconditional guarantor of such issuer). This restriction does
not apply to securities of pooled investment vehicles or
mortgage or asset-backed securities; or
PAGE 27
(14) Warrants. Invest in warrants if, as a result thereof, more
than 2% of the value of the total assets of the Fund would be
invested in warrants which are not listed on the New York Stock
Exchange, the American Stock Exchange, or a recognized foreign
exchange, or more than 5% of the value of the total assets of
the Fund would be invested in warrants whether or not so
listed. For purposes of these percentage limitations, the
warrants will be valued at the lower of cost or market and
warrants acquired by the Fund in units or attached to
securities may be deemed to be without value.
For purposes of investment restriction (6), the Fund has no current
intention of purchasing the securities of other investment companies.
Duplicate fees could result from any such purchases.
For purposes of investment restriction (13), the Fund will not consider
industrial development bonds issued by nongovernmental users as
municipal securities.
RATINGS OF MUNICIPAL DEBT SECURITIES
Moody's Investors Service, Inc.
Aaa - Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk.
Aa - Bonds 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.
A - Bonds rated A possess many favorable investment attributes and are to be
considered as upper medium grade obligations.
Baa - Bonds 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 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
characterize bonds in this class.
B - Bonds rated B generally lack the characteristics of a 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 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 rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked short-comings.
Standard & Poor's Corporation
AAA - This is the highest rating assigned by Standard & Poor's to a debt
obligation and indicates an extremely strong capacity to pay principal and
interest.
AA - Debt rated AA has a very strong capacity to pay principal and interest
and differs from highest rated issues only in a small degree.
PAGE 28
A - Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions.
BBB - Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds
in this category than for bonds in the A category.
BB, B, CCC, CC - Bonds rated BB, B, CCC, and CC are regarded on balance, as
predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal. BB indicates the lowest degree of speculation
and CC the highest degree of speculation. While such bonds will likely have
some quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
Fitch Investors Service, Inc.
AAA - Bonds rated AAA are considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
AA - Bonds rated AA are considered to be investment grade and of very high
credit quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong
as bonds rated AAA. Because bonds rated in the AAA and AA categories are not
significantly vulnerable to foreseeable future developments, short-term debt
of these issuers is generally rate F-1+.
A - Bonds rated A are considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
BBB - Bonds rated BBB are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in economic
conditions and circumstances, however, are more likely to have adverse impact
on these bonds, and therefore impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than for
bonds with higher ratings.
BB, B, CCC, CC, and C are regarded on balance as predominantly speculative
with respect to the issuer's capacity to repay interest and repay principal in
accordance with the terms of the obligation for bond issues not in default.
BB indicates the lowest degree of speculation and C the highest degree of
speculation. The rating takes into consideration special features of the
issue, its relationship to other obligations of the issuer, and the current
and prospective financial condition and operating performance of the issuer.
RATINGS OF MUNICIPAL NOTES AND VARIABLE RATE SECURITIES
MOODY'S INVESTORS SERVICE, INC. VMIG1/MIG-1: the best quality.
VMIG2/MIG-2: high quality, with margins of protection ample though not so
large as in the preceding group. VMIG3/MIG-3: favorable quality, with all
security elements accounted for, but lacking the undeniable strength of the
preceding grades. Market access for refinancing, in particular, is likely to
be less well established. VMIG4/MIG4: adequate quality but there is specific
risk.
STANDARD & POOR'S CORPORATION. SP-1: very strong or strong capacity to
pay principal and interest. Those issues determined to possess overwhelming
safety characteristics will be given a plus (+) designation. SP-2:
satisfactory capacity to pay interest and principal. SP-3: speculative
capacity to pay principal and interest.
FITCH INVESTORS SERVICE. F-1+: exceptionally strong credit quality,
strongest degree of assurance for timely payment. F-1: Very strong credit
quality. F-2: Good credit quality, having a satisfactory degree of assurance
for timely payment. F-3: Fair credit quality, assurance for timely payment
is adequate but adverse changes could cause the securities to be rated below
investment grade. F-5: Weak credit quality, having characteristics
suggesting a minimal degree of assurance for timely payment.
RATINGS OF COMMERCIAL PAPER
MOODY'S INVESTORS SERVICES, INC. P-1: superior capacity for repayment.
P-2: strong capacity for repayment. P-3: acceptable capacity for repayment
of short-term promissory obligations.
STANDARD & POOR'S CORPORATION. A-1: highest category, degree of safety
regarding timely payment is strong. Those issues determined to possess
extremely strong safety characteristics are denoted with a plus sign (+)
designation. A-2: satisfactory capacity to pay principal and interest. A-3:
adequate capacity for timely payment, but are vulnerable to adverse effects of
changes in circumstances than higher rated issues. B and C: speculative
capacity to pay principal and interest.
FITCH INVESTORS SERVICE. F-1+: exceptionally strong credit quality,
strongest degree of assurance for timely payment. F-1: Very strong credit
quality. F-2: Good credit quality, having a satisfactory degree of assurance
for timely payment. F-3: Fair credit quality, assurance for timely payment
is adequate but adverse changes could cause the securities to be rated below
investment grade. F-5: Weak credit quality, having characteristics
suggesting a minimal degree of assurance for timely payment.
MANAGEMENT OF FUNDS
The officers and directors of each of the Funds are listed below.
Unless otherwise noted, the address of each is 100 East Pratt Street,
Baltimore, Maryland 21202. Except as indicated, each has been an employee of
T. Rowe Price for more than five years. In the list below, the Funds'
directors who are considered "interested persons" of T. Rowe Price as defined
under Section 2(a)(19) of the Investment Company Act of 1940 are noted with an
asterisk (*). These directors are referred to as inside directors by virtue
of their officership, directorship, and/or employment with T. Rowe Price.
ROBERT P. BLACK, Director--Retired; formerly President, Federal Reserve Bank
of
Richmond; Address: 10 Dahlgren Road, Richmond, Virginia 23233
CALVIN W. BURNETT, PH.D., Director--President, Coppin State College;
Director, Maryland
Chamber of Commerce and Provident Bank of Maryland; President,
Baltimore Area Council Boy Scouts of America; Vice President, Board of
Directors, The Walters Art Gallery; Address: 2500 West North Avenue,
Baltimore, Maryland 21216
@*GEORGE J. COLLINS, Chairman of the Board--President, Managing Director, and
Chief
Executive Officer, T. Rowe Price; Director, Rowe Price-Fleming
International, Inc., T. Rowe Price Trust Company and T. Rowe Price
Retirement Plan Services, Inc., Chartered Investment Counselor
PAGE 30
ANTHONY W. DEERING, Director--Director, President and Chief Operating Officer,
The
Rouse Company, real estate developers, Columbia, Maryland; Advisory
Director, Kleinwort, Benson (North America) Corporation, a registered
broker-dealer; Address: 10275 Little Patuxent Parkway, Columbia,
Maryland 21044
F. PIERCE LINAWEAVER, Director--President, F. Pierce Linaweaver & Associates,
Inc.; formerly
(1987-1991) Executive Vice President, EA Engineering, Science, and
Technology, Inc., and (1987-1990) President, EA Engineering, Inc.,
Baltimore, Maryland; Address: The Legg Mason Tower, 111 South Calvert
Street, Suite 2700, Baltimore, Maryland 21202
+*MARY J. MILLER, President and Director--Managing Director, T. Rowe Price
++*WILLIAM T. REYNOLDS, President and Director--Managing Director, T. Rowe
Price
@@*JAMES S. RIEPE, Vice President and Director--Managing Director, T. Rowe
Price; Chairman
of the Board, T. Rowe Price Services, Inc., T. Rowe Price Retirement
Plan Services, Inc.; President and Director, T. Rowe Price Investment
Services, Inc.; President and Trust Officer, T. Rowe Price Trust
Company; Director, Rowe Price-Fleming International, Inc. and Rhone-
Poulenc Rorer, Inc.
JOHN G. SCHREIBER, Director--President, Schreiber Investments, a real estate
investment
company; Director and formerly (1/80-12/90) Executive Vice President,
JMB Realty Corporation, a national real estate investment manager and
developer; Address: 1115 East Illinois Road, Lake Forest, Illinois
60045
ANNE MARIE WHITTEMORE, Director--Partner, law firm of McGuire, Woods, Batte
& Boothe;
formerly, Chairman and Director, Federal Reserve Bank of Richmond;
Director, Owens & Minor, Inc., USF&G Corporation, Old Dominion
University and James River Corporation; Member, Richmond Bar
Association and American Bar Association; Address: One James Center,
901 East Cary Street, Richmond, Virginia 23219-4030
JANET G. ALBRIGHT, Vice President--Vice President, T. Rowe Price
+++PATRICE L. BERCHTENBREITER, Executive Vice President--Vice President, T.
Row Price
#C. STEPHEN WOLFE, II, Executive Vice President-- Vice President, T. Rowe
Price
##PAUL W. BOLTZ, Vice President--Vice President and Financial Economist, T.
Rowe Price
MICHAEL P. BUCKLEY, Vice President--Vice President, T. Rowe Price
PATRICIA S. DEFORD, Vice President--Vice President, T. Rowe Price
!CHARLES B. HILL, Vice President--Assistant Vice President, T. Rowe Price;
formerly (9/86-
11/91) managed municipal bonds at Riggs National Bank, Washington, D.C.
CHARLES O. HOLLAND, Vice President--Vice President, T. Rowe Price
HENRY H. HOPKINS, Vice President--Managing Director, T. Rowe Price; Vice
President and
Director, T. Rowe Price Investment Services, Inc., T. Rowe Price
Services, Inc., and T. Rowe Price Trust Company; Vice President, Rowe
Price-Fleming International, Inc. and T. Rowe Price Retirement Plan
Services, Inc.; Director, ICI Mutual Insurance Company
!!KONSTANTINE B. MALLAS, Vice President--Assistant Vice President, T. Rowe
Price
ALAN P. RICHMAN, Vice President--Vice President, T. Rowe Price; formerly
(10/89-6/91)
Manager, Public Finance, Credit Local de France, New York, New York and
Public Finance, Tokai Bank, New York, New York
PAGE 31
LENORA V. HORNUNG, Secretary--Vice President, T. Rowe Price
CARMEN F. DEYESU, Treasurer--Vice President, T. Rowe Price, T. Rowe Price
Services, Inc.,
and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller--Vice President, T. Rowe Price, T. Rowe Price
Services, Inc.,
and T. Rowe Price Trust Company
ROGER L. FIERY, III Assistant Vice President--Vice President, Rowe Price-
Fleming International,
Inc.
!!!LAURA McAREE, Assistant Vice President--Assistant Vice President, T. Rowe
Price; formerly
(4/90-11/90) trader, Boeing Company, Seattle, Washington and (8/87-
3/90) financial analyst, Harvard Management Company, Boston,
Massachusetts
*HUGH D. MCGUIRK, Assistant Vice President--Assistant Vice President, T.
Rowe Price;
formerly (1987-1989) account marketing representative, IBM, (summer of
1990) summer associate in capital markets, Goldman Sachs & Company, and
(1991-1993) municipal underwriter, Alex. Brown & Sons, Inc., Baltimore,
Maryland
EDWARD T. SCHNEIDER, Assistant Vice President--Vice President, T. Rowe Price
Services, Inc.
**THEODORE E. ROBSON, Assistant Vice President--Employee, T. Rowe Price
***WILLIAM F. SNIDER, JR., Assistant Vice President--Assistant Vice President,
T. Rowe
Price
INGRID I. VORDEMBERGE, Assistant Vice President--Employee, T. Rowe Price
@ Mr. Collins is Chairman of the Board of the Money, Short-Intermediate,
and Income Funds and a Director of the High Yield and Insured
Intermediate Bond Funds.
@@ Mr. Riepe is a Vice President and Director of the Money, Short-
Intermediate, Income, and High Yield Funds and a Director of Insured
Intermediate Bond Fund.
+ Ms. Miller is President and Director of the Short-Intermediate Fund
only and a Vice President of the Money, Insured Intermediate Bond,
Income, and High Yield Funds.
++ Mr. Reynolds is Chairman of the Board of the High Yield Fund, President
and Director of the Income and Insured Intermediate Bond, a Vice
President and Director of the Money Fund, and a Vice President of the
Short-Intermediate Fund.
+++ Ms. Berchtenbreiter is President of the Money Fund only and a Vice
President of the Short-Intermediate, Insured Intermediate Bond, Income,
and High Yield Funds.
# Mr. Wolfe is President of the High Yield Fund only and a Vice President
of the Money, Short-Intermediate, Insured Intermediate Bond, and Income
Funds.
## Mr. Boltz is a Vice President of the Money Fund only.
! Mr. Hill is a Vice President of the Short-Intermediate, Insured
Intermediate Bond, Income, and High Yield Funds.
!! Mr. Mallas is a Vice President of the Short-Intermediate, Insured
Intermediate Bond, Income, and High Yield Funds.
!!! Ms. McAree is an Assistant Vice President of the Money, Insured
Intermediate Bond and Short-Intermediate Funds only.
* Mr. McGuirk is an Assistant Vice President of the High Yield, Income,
Insured Intermediate Bond, and Short-Intermediate Funds only.
** Mr. Robson is an Assistant Vice President of the Money Fund only.
*** Mr. Snider is an Assistant Vice President of the High Yield, Income,
and Insured Intermediate Bond Funds only.
PAGE 32
The Executive Committee of the Money, Income, and High Yield Funds,
comprised of Messrs. Collins, Reynolds, and Riepe, the Executive Committee of
the Short-Intermediate Fund, comprised of Mrs. Miller and Messrs. Collins and
Riepe, and the Executive Committee of the Insured Intermediate Bond Fund,
comprised of Messrs. Collins and Riepe, have been authorized by their
respective Board of Directors to exercise all powers of the Board to manage
the Fund in the intervals between meetings of the Board, except the powers
prohibited by statute from being delegated.
PRINCIPAL HOLDERS OF SECURITIES
As of the date of the prospectus, the officers and directors of the
Funds, as a group, owned less than 1% of the outstanding shares of each Fund.
INVESTMENT MANAGEMENT SERVICES
Services Provided by T. Rowe Price
Under each Fund's Management Agreement, T. Rowe Price provides each
Fund with discretionary investment services. Specifically, T. Rowe Price is
responsible for supervising and directing the investments of each Fund in
accordance with its investment objectives, programs, and restrictions as
provided in the prospectus and this Statement of Additional Information. T.
Rowe Price is also responsible for effecting all security transactions on
behalf of each Fund, including the allocation of principal business and
portfolio brokerage and the negotiation of commissions. In addition to these
services, T. Rowe Price provides each Fund with certain corporate
administrative services, including: maintaining the Fund's corporate
existence, corporate records, and registering and qualifying the Fund's shares
under federal and state laws; monitoring the financial, accounting, and
administrative functions of each Fund; maintaining liaison with the agents
employed by each Fund such as the Fund's custodian and transfer agent;
assisting each Fund in the coordination of such agents' activities; and
permitting T. Rowe Price's employees to serve as officers, directors, and
committee members of each Fund without cost to the Fund.
Each Fund's Management Agreement also provides that T. Rowe Price,
its directors, officers, employees, and certain other persons performing
specific functions for the Fund will only be liable to the Fund for losses
resulting from willful misfeasance, bad faith, gross negligence, or reckless
disregard of duty.
Management Fee
Each Fund pays T. Rowe Price a fee ("Fee") which consists of two
components: a Group Management Fee ("Group Fee") and an Individual Fund Fee
("Fund Fee"). The Fee is paid monthly to the T. Rowe Price on the first
business day of the next succeeding calendar month and is calculated as
described below.
The monthly Group Fee ("Monthly Group Fee") is the sum of the daily
Group Fee accruals ("Daily Group Fee Accruals") for each month. The Daily
Group Fee Accrual for any particular day is computed by multiplying the Price
Funds' group fee accrual as determined below ("Daily Price Funds' Group Fee
Accrual") by the ratio of the Fund's net assets for that day to the sum of the
aggregate net assets of the Price Funds for that day. The Daily Price Funds'
Group Fee Accrual for any particular day is calculated by multiplying the
fraction of one (1) over the number of calendar days in the year by the
PAGE 33
annualized Daily Price Funds' Group Fee Accrual for that day as determined in
accordance with the following schedule:
Price Funds'
Annual Group Base Fee
Rate for Each Level of Assets
_____________________________
0.480% First $1 billion
0.450% Next $1 billion
0.420% Next $1 billion
0.390% Next $1 billion
0.370% Next $1 billion
0.360% Next $2 billion
0.350% Next $2 billion
0.340% Next $5 billion
0.330% Next $10 billion
0.320% Next $10 billion
0.310% Thereafter
For the purpose of calculating the Group Fee, the Price Funds
include all the mutual funds distributed by T. Rowe Price Investment Services,
Inc. (excluding T. Rowe Price Spectrum Fund, Inc. and any institutional or any
private label mutual funds). For the purpose of calculating the Daily Price
Funds' Group Fee Accrual for any particular day, the net assets of each Price
Fund are determined in accordance with the Fund's prospectus as of the close
of business on the previous business day on which the Fund was open for
business.
The monthly Fund Fee ("Monthly Fund Fee") is the sum of the daily
Fund Fee accruals ("Daily Fund Fee Accruals") for each month. The Daily Fund
Fee Accrual for any particular day is computed by multiplying the fraction of
one (1) over the number of calendar days in the year by the individual Fund
Fee Rate and multiplying this product by the net assets of the Fund for that
day, as determined in accordance with the Fund's prospectus as of the close of
business on the previous business day on which the Fund was open for business.
The individual fund fees for each Fund are listed in the chart below:
Individual Fund Fees
Money Fund 0.10%
Short-Intermediate Fund 0.10%
Insured Intermediate Bond Fund 0.05%
Income Fund 0.15%
High Yield 0.30%
Listed below are the total amounts paid to T. Rowe Price by the
Money, Short-Intermediate, Income and High Yield Funds under the investment
management contract which was in effect, for each of the last three fiscal
years.
Insured
Short-IntermediateIntermediate High Yield
Year Money Fund Fund Bond Fund Income Fund Fund
____ _______ _______________ ____________ _________ ________
1994 $ 3,132,000 $ 2,256,000 $ 9,000 $ 7,362,000 $ 5,954,000
1993 $ 3,404,000 $ 1,753,000 * $ 6,609,000 $ 4,681,000
1992 $ 3,964,000 $ 1,308,000 * $ 6,105,000 $ 3,809,000
PAGE 34
* Due to the effect of the Insured Intermediate Bond Fund's expense
limitation, for the fiscal periods ended February 28, 1993 and
February 29, 1994, the Fund did not pay T. Rowe Price an investment
management fee.
Limitation on Fund Expenses
The Management Agreement between each Fund and T. Rowe Price
provides that each Fund will bear all expenses of its operations not
specifically assumed by T. Rowe Price. However, in compliance with certain
state regulations, T. Rowe Price will reimburse a Fund for any expenses
(excluding interest, taxes, brokerage, other expenditures which are
capitalized in accordance with generally accepted accounting principles, and
extraordinary expenses) which in any year exceed the limits prescribed by any
state in which a Fund's shares are qualified for sale. Presently, the most
restrictive expense ratio limitation imposed by any state is 2.5% of the first
$30 million of the Fund's average daily net assets, 2% of the next $70 million
of such assets, and 1.5% of net assets in excess of $100 million.
Money, Short-Intermediate, Income, and High Yield Funds
For the purpose of determining whether a Fund is entitled to
reimbursement, the expenses of a Fund are calculated on a monthly basis. If a
Fund is entitled to reimbursement, that month's advisory fee will be reduced
or postponed, with any adjustment made after the end of the year.
Insured Intermediate Bond Fund
Reimbursement by the Fund to T. Rowe Price of any expenses paid or
assumed under a state expense limitation may not be made more than two years
after the end of the fiscal year in which the expenses were paid or assumed.
The Management Agreement provides that T. Rowe Price may
voluntarily agree to limit the expenses of the Fund. In the interest of
limiting the expenses of the Fund during its initial period of operations, T.
Rowe Price agreed to bear all expenses of the Fund through June 30, 1993.
Thereafter, T. Rowe Price has agreed to bear any expenses through February 28,
1994, which would cause the Fund's ratio of expenses to average daily net
assets to exceed 0.50%. Effective March 1, 1994, T. Rowe Price agreed to
waive its fees and bear any expenses through February 29, 1996, to the extent
such fees and expenses would cause the Fund's ratio of expenses to average net
assets to exceed 0.65%. Fees waived or expenses paid or assumed under the
second and third agreements are subject to reimbursement to T. Rowe Price by
the Fund whenever its expense ratio is below 0.50% or 0.65%, respectively;
however, no reimbursement will be made after February 29, 1996 (for the second
agreement) or February 28, 1998 (for the third agreement), or if it would
result in the expense ratio exceeding 0.50% or 0.65%, respectively.
DISTRIBUTOR FOR FUNDS
T. Rowe Price Investment Services, Inc. ("Investment Services"), a
Maryland corporation formed in 1980 as a wholly-owned subsidiary of T. Rowe
Price, serves as the distributor of the Funds. Investment Services is
registered as a broker-dealer under the Securities Exchange Act of 1934 and is
a member of the National Association of Securities Dealers, Inc. The offering
of each Fund's shares is continuous.
PAGE 35
Investment Services is located at the same address as the Funds
and T. Rowe Price -- 100 East Pratt Street, Baltimore, Maryland 21202.
Investment Services serves as distributor to the Funds pursuant to
individual Underwriting Agreements ("Underwriting Agreements"), which provide
that each Fund will pay all fees and expenses in connection with: registering
and qualifying its shares under the various state "blue sky" laws; preparing,
setting in type, printing, and mailing its prospectuses and reports to
shareholders; and issuing its shares, including expenses of confirming
purchase orders.
The Underwriting Agreements provide that Investment Services will
pay all fees and expenses in connection with: printing and distributing
prospectuses and reports for use in offering and selling shares for each Fund;
preparing, setting in type, printing, and mailing all sales literature and
advertising; Investment Services' federal and state registrations as a
broker-dealer; and offering and selling shares for each Fund, except for those
fees and expenses specifically assumed by the Funds. Investment Services'
expenses are paid by T. Rowe Price.
Investment Services acts as the agent of the Funds in connection
with the sale of their shares in all states in which the shares are qualified
and in which Investment Services is qualified as a broker-dealer. Under the
Underwriting Agreement, Investment Services accepts orders for Fund shares at
net asset value. No sales charges are paid by investors or the Funds.
CUSTODIAN
State Street Bank and Trust Company is the custodian for each
Fund's securities and cash, but it does not participate in the Funds'
investment decisions. The Funds have authorized the Bank to deposit certain
portfolio securities in central depository systems as allowed by federal law.
In addition, the Funds are authorized to maintain certain of their securities,
in particular variable rate demand notes in uncertificated form in the
proprietary deposit systems of various dealers in municipal securities. The
Bank's main office is 225 Franklin Street, Boston, Massachusetts 02107.
PORTFOLIO TRANSACTIONS
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio
securities on behalf of the Fund are made by T. Rowe Price. T. Rowe Price is
also responsible for implementing these decisions, including the negotiation
of commissions and the allocation of portfolio brokerage and principal
business. The Fund's purchases and sales of portfolio securities are normally
done on a principal basis and do not involve the payment of a commission
although they may involve the designation of selling concessions. That part
of the discussion below relating solely to brokerage commissions would not
normally apply to the Funds. However, it is included because T. Rowe Price
does manage a significant number of common stock portfolios which do engage in
agency transactions and pay commissions and because some research and services
resulting from the payment of such commissions may benefit the Funds.
How Brokers and Dealers are Selected
PAGE 36
Fixed Income Securities
Fixed income securities are generally purchased from the issuer or
a primary market-maker acting as principal for the securities on a net basis,
with no brokerage commission being paid by the client although the price
usually includes an undisclosed compensation. Transactions placed through
dealers serving as primary market-makers reflect the spread between the bid
and asked prices. Securities may also be purchased from underwriters at
prices which include underwriting fees.
T. Rowe Price may effect principal transactions on behalf of the
Fund with a broker or dealer who furnishes brokerage and/or research services,
designate any such broker or dealer to receive selling concessions, discounts
or other allowances, or otherwise deal with any such broker or dealer in
connection with the acquisition of securities in underwritings. T. Rowe Price
may receive brokerage and research services in connection with such
designations in fixed price underwritings.
How Evaluations are Made of the Overall Reasonableness of Brokerage
Commissions Paid
On a continuing basis, T. Rowe Price seeks to determine what
levels of commission rates are reasonable in the marketplace for transactions
executed on behalf of the Fund. In evaluating the reasonableness of
commission rates, T. Rowe Price considers: (a) historical commission rates,
both before and since rates have been fully negotiable; (b) rates which other
institutional investors are paying, based on available public information; (c)
rates quoted by brokers and dealers; (d) the size of a particular transaction,
in terms of the number of shares, dollar amount, and number of clients
involved; (e) the complexity of a particular transaction in terms of both
execution and settlement; (f) the level and type of business done with a
particular firm over a period of time; and (g) the extent to which the broker
or dealer has capital at risk in the transaction.
Description of Research Services Received from Brokers and Dealers
T. Rowe Price receives a wide range of research services from
brokers and dealers. These services include information on the economy,
industries, groups of securities, individual companies, statistical
information, accounting and tax law interpretations, political developments,
legal developments affecting portfolio securities, technical market action,
pricing and appraisal services, credit analysis, risk measurement analysis,
performance analysis and analysis of corporate responsibility issues. These
services provide both domestic and international perspective. Research
services are received primarily in the form of written reports, computer
generated services, telephone contacts and personal meetings with security
analysts. In addition, such services may be provided in the form of meetings
arranged with corporate and industry spokespersons, economists, academicians
and government representatives. In some cases, research services are
generated by third parties but are provided to T. Rowe Price by or through
broker-dealers.
Research services received from brokers and dealers are
supplemental to T. Rowe Price's own research effort and, when utilized, are
subject to internal analysis before being incorporated by T. Rowe Price into
its investment process. As a practical matter, it would not be possible for
T. Rowe Price to generate all of the information presently provided by brokers
and dealers. T. Rowe Price pays cash for certain research services received
from external sources. T. Rowe Price also allocates brokerage for research
PAGE 37
services which are available for cash. While receipt of research services
from brokerage firms has not reduced T. Rowe Price's normal research
activities, the expenses of T. Rowe Price could be materially increased if it
attempted to generate such additional information through its own staff. To
the extent that research services of value are provided by brokers or dealers,
T. Rowe Price may be relieved of expenses which it might otherwise bear.
T. Rowe Price has a policy of not allocating brokerage business in
return for products or services other than brokerage or research services. In
accordance with the provisions of Section 28(e) of the Securities Exchange Act
of 1934, T. Rowe Price may from time to time receive services and products
which serve both research and non-research functions. In such event, T. Rowe
Price makes a good faith determination of the anticipated research and non-
research use of the product or service and allocates brokerage only with
respect to the research component.
Commissions to Brokers who Furnish Research Services
Certain brokers and dealers who provide quality brokerage and
execution services also furnish research services to T. Rowe Price. With
regard to the payment of brokerage commissions, T. Rowe Price has adopted a
brokerage allocation policy embodying the concepts of Section 28(e) of the
Securities Exchange Act of 1934, which permits an investment adviser to cause
an account to pay commission rates in excess of those another broker or dealer
would have charged for effecting the same transaction, if the adviser
determines in good faith that the commission paid is reasonable in relation to
the value of the brokerage and research services provided. The determination
may be viewed in terms of either the particular transaction involved or the
overall responsibilities of the adviser with respect to the accounts over
which it exercises investment discretion. Accordingly, while T. Rowe Price
cannot readily determine the extent to which commission rates or net prices
charged by broker-dealers reflect the value of their research services, T.
Rowe Price would expect to assess the reasonableness of commissions in light
of the total brokerage and research services provided by each particular
broker. T. Rowe Price may receive research, as defined in Section 28(e), in
connection with selling concessions and designations in fixed price offerings
in which the Funds participate.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a specific amount
of business to any broker or dealer over any specific time period.
Historically, the majority of brokerage placement has been determined by the
needs of a specific transaction such as market-making, availability of a buyer
or seller of a particular security, or specialized execution skills. However,
T. Rowe Price does have an internal brokerage allocation procedure for that
portion of its discretionary client brokerage business where special needs do
not exist, or where the business may be allocated among several brokers or
dealers which are able to meet the needs of the transaction.
Each year, T. Rowe Price assesses the contribution of the
brokerage and research services provided by brokers or dealers, and attempts
to allocate a portion of its brokerage business in response to these
assessments. Research analysts, counselors, various investment committees,
and the Trading Department each seek to evaluate the brokerage and research
services they receive from brokers or dealers and make judgments as to the
level of business which would recognize such services. In addition, brokers
or dealers sometimes suggest a level of business they would like to receive in
return for the various brokerage and research services they provide. Actual
PAGE 38
brokerage received by any firm may be less than the suggested allocations but
can, and often does, exceed the suggestions, because the total business is
allocated on the basis of all the considerations described above. In no case
is a broker or dealer excluded from receiving business from T. Rowe Price
because it has not been identified as providing research services.
Miscellaneous
T. Rowe Price's brokerage allocation policy is consistently
applied to all its fully discretionary accounts, which represent a substantial
majority of all assets under management. Research services furnished by
brokers or dealers through which T. Rowe Price effects securities transactions
may be used in servicing all accounts (including non-Fund accounts) managed by
T. Rowe Price. Conversely, research services received from brokers or dealers
which execute transactions for the Fund are not necessarily used by T. Rowe
Price exclusively in connection with the management of the Fund.
From time to time, orders for clients may be placed through a
computerized transaction network.
The Fund does not allocate business to any broker-dealer on the
basis of its sales of the Fund's shares. However, this does not mean that
broker-dealers who purchase Fund shares for their clients will not receive
business from the Fund.
Some of T. Rowe Price's other clients have investment objectives
and programs similar to those of the Fund. T. Rowe Price may occasionally
make recommendations to other clients which result in their purchasing or
selling securities simultaneously with the Fund. As a result, the demand for
securities being purchased or the supply of securities being sold may
increase, and this could have an adverse effect on the price of those
securities. It is T. Rowe Price's policy not to favor one client over another
in making recommendations or in placing orders. T. Rowe Price frequently
follows the practice of grouping orders of various clients for execution which
generally results in lower commission rates being attained. In certain cases,
where the aggregate order is executed in a series of transactions at various
prices on a given day, each participating client's proportionate share of such
order reflects the average price paid or received with respect to the total
order. T. Rowe Price has established a general investment policy that it will
ordinarily not make additional purchases of a common stock of a company for
its clients (including the T. Rowe Price Funds) if, as a result of such
purchases, 10% or more of the outstanding common stock of such company would
be held by its clients in the aggregate.
To the extent possible, T. Rowe Price intends to recapture
solicitation fees paid in connection with tender offers through T. Rowe Price
Investment Services, Inc., the Fund's distributor. At the present time, T.
Rowe Price does not recapture commissions or underwriting discounts or selling
group concessions in connection with taxable securities acquired in
underwritten offerings. T. Rowe Price does, however, attempt to negotiate
elimination of all or a portion of the selling-group concession or
underwriting discount when purchasing tax-exempt municipal securities on
behalf of its clients in underwritten offerings.
Other
The Funds engaged in portfolio transactions involving broker-
dealers in the following amounts for the fiscal years ended February 28, 1994,
February 28, 1993, and February 29, 1992:
PAGE 39
1994 1993 1992
Tax-Exempt Money Fund $3,848,865,486 $4,251,498,766
Tax-Free Short-Intermediate
Fund $1,368,139,000 1,111,763,067 1,080,195,909
Tax-Free Insured Intermediate
Bond Fund 883,604,000 75,345,466+ *
Tax-Free Income Fund 3,328,250,640 2,593,636,961
Tax-Free High Yield Fund 1,408,187,092 1,322,907,667
The following amounts consisted of principal transactions as to
which the Funds have no knowledge of the profits or losses realized by the
respective broker-dealers for the fiscal years ended February 28, 1994,
February 28, 1993, and February 29, 1992:
1994 1993 1992
Tax-Exempt Money Fund $3,832,043,696 $4,231,418,766
Tax-Free Short-Intermediate Fund 1,250,892,000 1,111,763,067 1,080,195,909
Tax-Free Insured Intermediate
Bond Fund 843,890,000 70,657,019+ *
Tax-Free Income Fund 3,328,250,640 2,593,636,961
Tax-Free High Yield Fund 1,408,187,092 1,322,907,667
The following amounts involved trades with brokers acting as
agents or underwriters for the fiscal years ended February 28, 1994, February
28, 1993, and February 29, 1992:
1994 1993 1992
Tax-Exempt Money Fund $16,821,790 $20,081,000
Tax-Free Short-Intermediate Fund 117,247,000 72,966,445 23,436,017
Tax-Free Insured Intermediate
Bond Fund 39,714,000 4,688,447+ *
Tax-Free Income Fund 430,457,963 136,376,415
Tax-Free High Yield Fund 172,407,132 51,825,895
The following amounts involved trades with brokers acting as agents
or underwriters, in which such brokers received total commissions, including
discounts received in connection with underwritings for the fiscal years ended
February 28, 1994, February 28, 1993, and February 29, 1992:
1994 1993 1992
Tax-Exempt Money Fund $22,695 $15,000
Tax-Free Short-Intermediate
Fund 582,000 367,470 123,414
Tax-Free Insured Intermediate
Bond Fund 256,000 25,094+ *
Tax-Free Income Fund 3,068,760 970,894
Tax-Free High Yield Fund 1,281,863 398,343
Of all such portfolio transactions, none were placed with firms
which provided research, statistical, or other services to T. Rowe Price in
connection with the management of the Funds, or in some cases, to the Funds.
PAGE 40
The portfolio turnover rates of the Funds for the fiscal years
ended February 28, 1994, February 28, 1993, and February 29, 1992, have been
as follows:
1994 1993 1992
Tax-Free Short-Intermediate Fund 51.1% 38.5% 81.3%
Tax-Free Insured Intermediate
Bond Fund 74.8% 65.3%+ *
Tax-Free Income Fund 71.2% 76.7% 57.9%
Tax-Free High Yield Fund 59.3% 34.7% 51.0%
+Fiscal period ended February 28, 1993.
*Prior to commencement of operations.
PRICING OF SECURITIES
Fixed income securities are generally traded in the over-the-counter
market. Investments in securities with remaining maturities of one year or
more are stated at fair value using a bid-side valuation as furnished by
dealers who make markets in such securities or by an independent pricing
service, which considers yield or price of bonds of comparable quality,
coupon, maturity, and type, as well as prices quoted by dealers who make
markets in such securities.
Except with respect to certain securities held by the Money Fund,
securities with remaining maturities less than one year are stated at fair
value which is determined by using a matrix system that establishes a value
for each security based on bid-side money market yields. Securities
originally purchased by the Money Fund with remaining maturities of 60 days or
less are valued at amortized cost. In addition, securities purchased by the
Money Fund with maturities in excess of 60 days, but which currently have
maturities of 60 days or less, are valued at their amortized cost for the 60
days prior to maturity--such amortization being based on the fair value of the
securities on the 61st day prior to maturity.
There are a number of pricing services available, and the Directors
of the Funds, on the basis of ongoing evaluation of these services, may use or
may discontinue the use of any pricing service in whole or in part.
Securities or other assets for which the above valuation procedures
are deemed not to reflect fair value will be appraised at prices deemed best
to reflect their fair value. Such determinations will be made in good faith
by or under the supervision of officers of each Fund as authorized by the
Board of Directors.
Maintenance of Money Fund's Net Asset Value Per Share at $1.00
It is the policy of the Fund to attempt to maintain a net asset
value of $1.00 per share by rounding to the nearest one cent. This method of
valuation is commonly referred to as "penny rounding" and is permitted by Rule
2a-7 under the Investment Company Act of 1940. Under Rule 2a-7:
(a) The Board of Directors of the Fund must undertake to assure,
to the extent reasonably practical taking into account current
market conditions affecting the Fund's investment objectives, that
the Fund's net asset value will not deviate from $1.00 per share;
PAGE 41
(b) The Fund must (i) maintain a dollar-weighted average
portfolio maturity appropriate to its objective of maintaining a
stable price per share, (ii) not purchase any instrument with a
remaining maturity greater than 397 days (or in the case of U.S.
government securities greater than 762 days), and (iii) maintain a
dollar-weighted average portfolio maturity of 90 days or less;
(c) The Fund must limit its purchase of portfolio instruments,
including repurchase agreements, to those U.S. dollar-denominated
instruments which the Fund's Board of Directors determines present
minimal credit risks, and which are eligible securities as defined
by Rule 2a-7 (eligible Securities are generally securities which
have been rated or whose issuer has been rated or whose issuer has
comparable securities rated in one of the two highest rating
categories by nationally recognized statistical rating
organizations or, in the case of any instrument that is not so
rated, is of comparable quality as determined by procedures
adopted by the Fund's Board of Directors); and
(d) The Board of Directors must determine that (i) it is in the
best interest of the Fund and its shareholders to maintain a
stable net asset value per share or stable price per share under
the penny rounding method; and (ii) the Fund will continue to use
the penny rounding method only so long as the Board of Directors
believes that it fairly reflects the market based net asset value
per share.
Although the Fund believes that it will be able to maintain its
net asset value at $1.00 per share under most conditions, there can be no
absolute assurance that it will be able to do so on a continuous basis. If
the Fund's net asset value per share declined, or was expected to decline,
below $1.00 (rounded to the nearest one cent), the Board of Directors of the
Fund might temporarily reduce or suspend dividend payments in an effort to
maintain the net asset value at $1.00 per share. As a result of such
reduction or suspension of dividends, an investor would receive less income
during a given period than if such a reduction or suspension had not taken
place. Such action could result in an investor receiving no dividend for the
period during which he holds his shares and in his receiving, upon redemption,
a price per share lower than that which he paid. On the other hand, if the
Fund's net asset value per share were to increase, or were anticipated to
increase above $1.00 (rounded to the nearest one cent), the Board of Directors
of the Fund might supplement dividends in an effort to maintain the net asset
value at $1.00 per share.
NET ASSET VALUE PER SHARE
The purchase and redemption price of the Funds' shares is equal to
the Funds' net asset value per share or share price. Each Fund determines its
net asset value per share by subtracting the Funds' liabilities (including
accrued expenses and dividends payable) from its total assets (the market
value of the securities the Fund holds plus cash and other assets, including
income accrued but not yet received) and dividing the result by the total
number of shares outstanding. The net asset value per share of each Fund is
calculated as of the close of trading on the New York Stock Exchange ("NYSE")
every day the NYSE is open for trading. The net asset value of the Money Fund
is also calculated as of 12:00 noon (Eastern time) every day the NYSE is open
for trading. The NYSE is closed on the following days: New Year's Day,
PAGE 42
Washington's Birthday, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day, and Christmas Day.
Determination of net asset value (and the offering, sale
redemption and repurchase of shares) for a Fund may be suspended at times (a)
during which the NYSE is closed, other than customary weekend and holiday
closings, (b) during which trading on the NYSE is restricted, (c) during which
an emergency exists as a result of which disposal by a Fund of securities
owned by it is not reasonably practicable or it is not reasonably practicable
for the Fund fairly to determine the value of its net assets, or (d) during
which a governmental body having jurisdiction over the Fund may by order
permit such a suspension for the protection of the Fund's shareholders;
provided that applicable rules and regulations of the Securities and Exchange
Commission (or any succeeding governmental authority) shall given as to
whether the conditions prescribed in (b), (c), or (d) exist.
DIVIDENDS
Unless you elect otherwise, the Fund's annual capital gain
distributions, if any, will be reinvested on the reinvestment date using the
NAV per share of that date. The reinvestment date normally precedes the
payment date by about 10 days although the exact timing is subject to change.
TAX STATUS
Each Fund intends to qualify as a "regulated investment company"
under Subchapter M of the Internal Revenue Code of 1986, as amended ("Code").
Dividends and distributions paid by any of the Funds are not
eligible for the dividends-received deduction for corporate shareholders. For
tax purposes, it does not make any difference whether dividends and capital
gain distributions are paid in cash or in additional shares. Each Fund must
declare dividends equal to at least 90% of net tax-exempt income (as of its
year-end) to permit pass-through of tax-exempt income to shareholders, and 98%
of capital gains (as of October 31) in order to avoid a federal excise tax and
100% of capital gains (as of its tax year-end) to avoid federal income tax.
At the time of your purchase, a Fund's net asset value may reflect
undistributed capital gains or net unrealized appreciation of securities held
by the Fund. A subsequent distribution to you of such amounts, although
constituting a return of your investment, would be taxable as a capital gain
distribution. For federal income tax purposes, a Fund is permitted to carry
forward its net realized capital losses, if any, for eight years and realize
net capital gains up to the amount of such losses without being required to
pay taxes on, or distribute such gains. On May 31, 1994, the books of each
Fund indicated that the Fund's aggregate net assets included:
Realized Capital Unrealized
Gains/(Losses) Appreciation
________________ ____________
Tax-Exempt Money Fund $ $
Tax-Free Short-Intermediate Fund
Tax-Free Insured Intermediate Bond Fund
Tax-Free Income Fund
Tax-Free High Yield Fund
PAGE 43
If, in any taxable year, the Funds should not qualify as regulated
investment companies under the Code: (i) each Fund would be taxed at normal
corporate rates on the entire amount of its taxable income, if any, without
deduction for dividends or other distributions to shareholders; and (ii) each
Fund's distributions to the extent made out of the Fund's current or
accumulated earnings and profits would be taxable to shareholders as ordinary
dividends (regardless of whether they would otherwise have been considered
capital gain or tax-exempt dividends).
The Funds anticipate acquiring bonds after initial issuance at a
price less than the principal amount of such bonds ("market discount bonds").
Gain on the disposition of such bonds is treated as taxable ordinary income to
the extent of accrued market discount. Such gains cannot be offset by losses
on the sale of other securities but must be distributed to shareholders
annually and taxed as ordinary income.
Each year, the Funds will mail you information on the tax status of
dividends and distributions. The Funds anticipate that substantially all of
the dividends to be paid by each Fund will be exempt from federal income
taxes. If any portion of a Fund's dividends is not exempt from federal income
taxes, you will receive a Form 1099 stating the taxable portion. The Funds
will also advise you of the percentage of your dividends, if any, which should
be included in the computation of alternative minimum tax. Social security
recipients who receive interest from tax-exempt securities may have to pay
taxes on a portion of their social security benefit.
Because the interest on municipal securities is tax exempt, any
interest on money you borrow that is directly or indirectly used to purchase
Fund shares is not deductible. (See Section 265(2) of the Internal Revenue
Code.) Further, entities or persons who are "substantial users" (or persons
related to "substantial users") of facilities financed by industrial
development bonds should consult their tax advisers before purchasing shares
of a Fund. The income from such bonds may not be tax exempt for such
substantial users.
YIELD INFORMATION
Money Fund
The Fund's current and historical yield for a period is calculated by
dividing the net change in value of an account (including all dividends
accrued and dividends reinvested in additional shares) by the account value at
the beginning of the period to obtain the base period return. This base
period return is divided by the number of days in the period then multiplied
by 365 to arrive at the annualized yield for that period. The Fund's
annualized compound yield for such period is compounded by dividing the base
period return by the number of days in the period, and compounding that figure
over 365 days.
Bond Funds
From time to time, a Fund may advertise a yield figure calculated in
the following manner:
An income factor is calculated for each security in the portfolio
based upon the security's market value at the beginning of the period and
yield as determined in conformity with regulations of the Securities and
Exchange Commission. The income factors are then totalled for all securities
in the portfolio. Next, expenses of the Fund for the period net of expected
PAGE 44
reimbursements are deducted from the income to arrive at net income, which is
then converted to a per-share amount by dividing net income by the average
number of shares outstanding during the period. The net income per share is
divided by the net asset value on the last day of the period to produce a
monthly yield which is then annualized. A taxable equivalent yield is
calculated by dividing this yield by one minus the effective federal income
tax rate. Quoted yield factors are for comparison purposes only, and are not
intended to indicate future performance or forecast the dividend per share of
the Fund.
The yield of each Fund calculated under the above-described method
for the month ended May 31, 1994 was:
Tax-Free Short-Intermediate 4.10%
Tax-Free Insured Intermediate Bond 4.63%
Tax-Free Income 5.22%
Tax-Free High Yield 5.90%
The tax equivalent yields for these funds for the same period
were 5.94% (Short-Intermediate), 6.71% (Insured Intermediate), -7.57%
(Income), and 8.55% (High Yield). This assumes a federal tax bracket of
31.0%. Assuming a federal tax bracket of 28.0%, the tax-equivalent yields for
the period would be 5.69% (Short-Intermediate), 6.43% (Insured Intermediate),
7.25% (Income), and 8.19% (High Yield).
From time to time, a Fund may also illustrate the effect of tax
equivalent yields using information such as that set forth below:
APPENDIX A
INVESTMENT PERFORMANCE
Total Return Performance
Each Fund's calculation of total return performance includes the
reinvestment of all capital gain distributions and income dividends for the
period or periods indicated, without regard to tax consequences to a
shareholder in the Fund. Total return is calculated as the percentage change
between the beginning value of a static account in the Fund and the ending
value of that account measured by the then current net asset value, including
all shares acquired through reinvestment of income and capital gains
dividends. The results shown are historical and should not be considered
indicative of the future performance of the Fund. Each average annual
compound rate of return is derived from the cumulative performance of the Fund
over the time period specified. The annual compound rate of return for the
Fund over any other period of time will vary from the average.
PAGE 45
Cumulative Performance Percentage Change
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception
2/28/94 2/28/94 2/28/94 2/28/94
Short-Intermediate Fund 3.49 36.75 85.70 86.88%
12/23/83
Insured Intermediated Bond Fund 5.49 12.67
11/30/92
Income Fund 5.50 56.54 139.86 249.81
10/26/76
High Yield Fund 7.49 60.10 149.82
3/01/85
Average Annual Compound Rates of Return
1 Yr. 5 Yrs. 10 Yrs. Since
Ended Ended Ended Inception
2/28/94 2/28/94 2/28/94 2/28/94
Short-Intermediate Fund 3.49 6.46 6.39 6.33%
12/23/83
Insured Intermediated Bond Fund5.49 10.05
11/30/92
Income Fund 5.50 9.38 9.14 7.49
10/26/76
High Yield Fund 7.49 9.87 10.71 3/01/85
All Funds
From time to time, in reports and promotional literature, the
Funds' performance will be compared to (1) indices of broad groups of managed
and unmanaged securities considered to be representative of or similar to Fund
portfolio holdings (2) other mutual funds, or (3) other measures of
performance set forth in publications such as:
Bond Buyer 20 - an estimation of the yield which would be offered
on 20-year general obligation bonds with a composite rating of
approximately "A." Published weekly by The Bond Buyer, a trade
paper of the municipal securities industry;
Shearson Lehman/American Express Municipal Bond Index - a
composite measure of the total return performance of the municipal
bond market. Based upon approximately 1500 bonds;
Lipper General Purpose Municipal Bond Avg. - an average of
municipal mutual funds which invest 60% or more of their assets in
the top four tax-exempt credit ratings;
Lipper Analytical Services, Inc. - a widely used independent
research firm which ranks mutual funds by overall performance,
investment objectives, and assets;
Lipper Intermediate Municipal Avg. - an average of municipal
mutual funds which restrict their holdings to bonds with
maturities between 5 and 10 years;
PAGE 46
Lipper Insured Municipal Avg. - an average of municipal mutual
funds which utilize insured municipal securities for 65% of their
portfolios.
Lipper High-Yield Municipal Bond Avg. - an average of municipal
mutual funds which may utilize lower rated bonds for 50% of their
portfolio;
Lipper Insured Municipal Avg. - an average of municipal mutual
funds which utilize insured municipal securities for 65% of their
portfolios.
Lipper Short Municipal Debt Avg. - an average of municipal mutual
funds that invest in municipal debt issues with dollar-weighted
average maturities of less than five years.
Donoghue's Tax-Exempt Money Fund Avg. - an average of municipal
money market funds as reported in Donoghue's Money Fund Report,
which tracks the performance of all money market mutual funds;
Prime General Obligations - bonds with maturities from 1-30 years
which are secured by the full faith and credit of issuers with
taxing power;
Morningstar, Inc. - a widely used independent research firm which
rates mutual funds by overall performance, investment objectives,
and assets.
Indices prepared by the research departments of such financial
organizations as Merrill Lynch, Pierce, Fenner & Smith, Inc., will be used, as
well as information provided by the Federal Reserve Board.
Information reported in the Bank Rate Monitor, an independent
publication which tracks the performance of certain bank products, such as
money market deposit accounts and certificates of deposit, will also be used.
Bank certificates of deposit differ from mutual funds in several ways: the
interest rate established by the sponsoring bank is fixed for the term of a
CD; there are penalties for early withdrawal from CDs; and the principal on a
CD is insured.
Performance rankings and ratings reported periodically in national
financial publications such as MONEY, FORBES, BUSINESS WEEK, BARRON'S, etc.
may also be used.
Other Features and Benefits
Each Fund is a member of the T. Rowe Price Family of Funds and may
help investors achieve various long-term investment goals, such as saving for
a down payment on a home or paying college costs. To explain how a Fund could
be used to assist investors in planning for these goals and to illustrate
basic principles of investing, various worksheets and guides prepared by T.
Rowe Price and/or T. Rowe Price Investment Services, Inc. may be made
available. These currently include: the Asset Mix Worksheet which is designed
to show shareholders how to reduce their investment risk by developing a
diversified investment plan and the College Planning Guide which discusses
various aspects of financial planning to meet college expenses and assists
parents in projecting the costs of a college education for their children.
From time to time, other worksheets and guides may be made available as well.
Of course, an investment in a Fund cannot guarantee that such goals will be
met.
From time to time, Insights, a T. Rowe Price publication of
reports on specific investment topics and strategies, may be included in the
Fund's fulfillment kit. Such reports may include information concerning:
calculating taxable gains and losses on mutual fund transactions, coping with
stock market volatility, benefiting from dollar cost averaging, understanding
international markets, investing in high-yield "junk" bonds, growth stock
investing, conservative stock investing, value investing, investing in small
companies, tax-free investing, fixed income investing, investing in mortgage-
backed securities, as well as other topics and strategies.
Other Publications
From time to time, in newsletters and other publications issued by
T. Rowe Price Investment Services, Inc., reference may be made to economic,
financial and political developments in the U.S. and abroad and their effect
on securities prices. Such discussions may take the form of commentary on
these developments by T. Rowe Price mutual fund portfolio managers and their
views and analysis on how such developments could affect investments in mutual
funds.
CAPITAL STOCK
Shareholders are entitled to one vote for each full share held
(and fractional votes for fractional shares held) and will vote in the
election of or removal of directors (to the extent hereinafter provided) and
on other matters submitted to the vote of shareholders. There will normally
be no meetings of shareholders for the purpose of electing directors unless
and until such time as less than a majority of the directors holding office
have been elected by shareholders, at which time the directors then in office
will call a shareholders' meeting for the election of directors. Except as
set forth above, the directors shall continue to hold office and may appoint
successor directors. Voting rights are not cumulative, so that the holders of
more than 50% of the shares voting in the election of directors can, if they
choose to do so, elect all the directors of the Fund, in which event the
holders of the remaining shares will be unable to elect any person as
director. The Board of Directors of each Fund may increase or decrease the
aggregate number of shares of stock or the number of shares of stock of any
class or series authorized to be issued without shareholder approval.
As set forth in the By-Laws of each Fund, a special meeting of
shareholders of a Fund shall be called by the Secretary of the Fund on the
written request of shareholders entitled to cast at least 10% of all the votes
of the Fund entitled to be cast at such meeting. Shareholders requesting such
a meeting must pay to the Fund the reasonably estimated costs of preparing and
mailing the notice of the meeting. Each Fund, however, will otherwise assist
the shareholders seeking to hold the special meeting in communicating to the
other shareholders of the Fund to the extent required by Section 16(c) of the
Investment Company Act of 1940.
Short-Intermediate, Insured Intermediate Bond, Income and High Yield Funds
Each Fund's Charter authorizes the Board of Directors to classify
and reclassify any and all shares which are then unissued, including unissued
shares of capital stock into any number of classes or series, each class or
series consisting of such number of shares and having such designations, such
powers, preferences, rights, qualifications, limitations, and restrictions, as
shall be determined by the Board subject to the Investment Company Act and
PAGE 48
other applicable law. The shares of any such additional classes or series
might therefore differ from the shares of the present class and series of
capital stock and from each other as to preferences, conversions or other
rights, voting powers, restrictions, limitations as to dividends,
qualifications or terms or conditions of redemption, subject to applicable
law, and might thus be superior or inferior to the capital stock or to other
classes or series in various characteristics. The Board of Directors may
increase or decrease the aggregate number of shares of stock or the number of
shares of stock of any class or series that the Fund has authorized to issue
without shareholder approval.
Except to the extent that the Boards of Directors of these Funds
might provide by resolution that holders of shares of a particular class are
entitled to vote as a class on specified matters presented for a vote of the
holders of all shares entitled to vote on such matters, there would be no
right of class vote unless and to the extent that such a right might be
construed to exist under Maryland law. The Funds' Charters contain no
provision entitling the holders of the present class of capital stock to a
vote as a class on any matter. Accordingly, the preferences, rights, and
other characteristics attaching to any class of shares, including the present
class of capital stock, might be altered or eliminated, or the class might be
combined with another class or classes, by action approved by the vote of the
holders of a majority of all the shares of all classes entitled to be voted on
the proposal, without any additional right of vote as a class by the holders
of the capital stock or of another affected class or classes.
Redemptions in Kind
In the unlikely event a shareholder were to receive an in kind
redemption of portfolio securities of the Funds, brokerage fees could be
incurred by the shareholder in a subsequent sale of such securities.
Issuance of Fund Shares for Securities
Transactions involving issuance of Fund shares for securities or
assets other than cash will be limited to (1) bona fide reorganizations; (2)
statutory mergers; or (3) other acquisitions of portfolio securities that: (a)
meet the investment objectives and policies of the Funds; (b) are acquired for
investment and not for resale except in accordance with applicable law; (c)
have a value that is readily ascertainable via listing on or trading in a
recognized United States or international exchange or market; and (d) are not
illiquid.
GENERAL INFORMATION AND HISTORY
Money Fund
The Money Fund, which commenced operation under the name Rowe
Price Prime Reserve Fund II, Inc., was organized as a money market mutual fund
with an investment objective and program substantially identical to that of
the T. Rowe Price Prime Reserve Fund, Inc. ("Prime Reserve Fund"), another T.
Rowe Price Fund. The Fund was initially established to make available shares
of a money market fund to those investors who were not eligible to invest in
the Prime Reserve Fund because of the restrictions placed by the Board of the
Prime Reserve Fund on the sale of its shares as a result of the Credit Control
Program adopted by the Federal Reserve Board on March 14, 1980. When that
program was discontinued on July 28, 1980, the Board of Directors concluded
that the continued operation of the Fund as a general purpose money market
PAGE 49
fund was unnecessary. On August 11, 1980, the sale of the Fund's shares was
suspended and the shares of all shareholders of the Fund (except T. Rowe
Price) were exchanged for shares in the Prime Reserve Fund. Subsequently, T.
Rowe Price, the sole shareholder of the Fund, recommended to the Board of
Directors of the Fund that the Fund's name be changed to T. Rowe Price Tax-
Exempt Money Fund, Inc. and that its investment objective and investment
program be amended for the purpose of changing the Fund from a money market
fund to a tax-exempt money market fund. Such changes were approved by the
Fund's sole shareholder, T. Rowe Price, on January 8, 1981. The Fund
commenced operation as a tax-exempt money market fund on March 30, 1981.
FEDERAL AND STATE REGISTRATION OF SHARES
The Funds' shares are registered for sale under the Securities Act
of 1933 and the Fund or their shares are registered under the laws of all
states which require registration, as well as the District of Columbia and
Puerto Rico.
LEGAL COUNSEL
Shereff, Friedman, Hoffman & Goodman, whose address is 919 Third
Avenue, New York, New York 10022, is legal counsel to each of the Funds.
<PAGE>
PAGE 50
INDEPENDENT ACCOUNTANTS
Money, Insured Intermediate Bond, and High Yield Funds. Coopers &
Lybrand, 217 East Redwood Street, Baltimore, Maryland 21202, are independent
accountants to the Funds. The financial statements of the Funds for the
fiscal year ended February 28, 1994 and the report of independent accountants
are included in each Fund's Annual Report on pages 2 - 12, pages 1-11, and
pages 2 - 18, respectively. A copy of each Annual Report accompanies this
Statement of Additional Information. The following financial statements and
the report of independent accountants appearing in each Annual Report for the
fiscal year ended February 28, 1994, are incorporated into this Statement of
Additional Information by reference:
Money Fund High Yield Fund
Annual Annual
Report Page Report Page
___________ _______________
Report of Independent Accountants 12 18
Statement of Net Assets, February 28, 1994 2-8 2-13
Statement of Operations, year ended
February 28, 1994 9 14
Statement of Changes in Net Assets,
years ended February 28, 1994 and
February 28, 1993 10 15
Notes to Financial Statements,
February 28, 1994 10-11 16-17
Financial Highlights 11 17
Insured Intermediate
Bond Fund
Annual Report Page
___________
Report of Independent Accountants 11
Portfolio Investments, February 28, 1994 1-5
Statement of Assets and Liabilities
February 28, 1994 6
Statement of Operations, year ended, February 28, 1994 7
Statement of Changes in Net Assets, year ended
February 28, 1994 and November 30, 1992
(Commencement of Operations) to February 28, 1993 8
Notes to Financial Statements, February 28, 1994 9-10
Financial Highlights, February 28, 1994
<PAGE>
PAGE 51
Short-Intermediate and Income Funds. Price Waterhouse, 7 St. Paul
Street, Suite 1700, Baltimore, Maryland 21202, are independent accountants to
each Fund. The financial statements of the Funds for the fiscal year ended
February 28, 1994, and the report of independent accountants are included in
each Fund's Annual Report for the year ended February 28, 1994, on pages 2-15
and 2-16, respectively. A copy of each Annual Report accompanies this
Statement of Additional Information. The following financial statements and
the report of independent accountants appearing in each Annual Report for the
fiscal year ended February 28, 1994 are incorporated into this Statement of
Additional Information by reference:
Short-Intermediate
Fund
Annual
Report Page
___________
Report of Independent Accountants 15
Portfolio of Investments, February 28, 1994 2-9
Statement of Assets and Liabilities,
February 28, 1994 10
Statement of Operations, year ended
February 28, 1994 11
Statement of Changes in Net Assets,
years ended February 28, 1994 and
February 28, 1993 12
Notes to Financial Statements,
February 28, 1994 12-13
Financial Highlights 14
Income Fund
Annual
Report Page
_______________
Report of Independent Accountants 16
Statement of Net Assets, February 28, 1994 2-12
Statement of Operations, year ended
February 28, 1994 12
Statement of Changes in Net Assets,
years ended February 28, 1994 and
February 28, 1993 13
Notes to Financial Statements,
February 28, 1994 14-15
Financial Highlights 15
<PAGE>
PAGE 52
APPENDIX A
TAX-EXEMPT VS. TAXABLE YIELDS
___________________________________________________________________________
Taxable Income (1994)*
Joint Return Single Return
Federal
Tax Rates+
___________________________________________________________________________
$38,001- $91,850 $22,751- $55,100 28.0%
91,851- 140,000 55,101- 115,000 31.0
140,001- 250,000 115,001- 250,000 36.0
250,001 and above 250,001 and above 39.6
_______________________________________________________________________
A Tax-Exempt Yield Of:
3% 4% 5% 6% 7% 8% 9% 10% 11%
Is Equivalent to a Taxable Yield of:
_______________________________________________________________________
4.2 5.6 6.9 8.3 9.7 11.1 12.5 13.9 15.3
4.3 5.8 7.2 8.7 10.1 11.6 13.0 14.5 15.9
4.7 6.3 7.8 9.4 10.9 12.5 14.1 15.6 17.2
5.0 6.6 8.3 9.9 11.6 13.2 14.9 16.6 18.2
* Net amount subject to federal income tax after deductions and exemptions.
+ Federal rates may vary depending on family size and amount and nature of
itemized deductions.
<PAGE>
