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PROSPECTUS APRIL 28, 1995
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KEYSTONE TAX FREE FUND
200 BERKELEY STREET, BOSTON, MASSACHUSETTS 02116-5034
CALL TOLL FREE 1-800-343-2898
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Keystone Tax Free Fund (the "Fund") is a mutual fund that seeks the highest
possible current income, exempt from federal income taxes, while preserving
capital. The Fund invests primarily in municipal bonds. The Fund's net asset
value per share will fluctuate in response to changes in the market value of its
portfolio securities.
Except as noted below, the Fund generally offers its shares by direct
investment only to those shareholders who already beneficially own shares of the
Fund. The Fund also offers its shares through exchanges to shareholders of
certain other funds in the Keystone Investments Family of Funds. Beginning May
1, 1995, the Fund will be reopen to new investors. It is presently intended that
the Fund remain open until July 31, 1995 or until the Fund attains $50,000,000
in aggregate sales, whichever occurs first (the "Special Offering Period").
Your purchase payment is fully invested. There is no sales charge when you buy
the Fund's shares. The Fund may impose a deferred sales charge, which declines
from 4% to 1%, if you redeem your shares within four years of purchase.
The Fund has adopted a Distribution Plan (the "Distribution Plan") pursuant to
Rule 12b-1 under the Investment Company Act of 1940 (the "1940 Act") under which
it bears some of the costs of selling its shares to the public.
This prospectus sets forth concisely the information about the Fund that you
should know before investing. Please read it and retain it for future reference.
Additional information about the Fund is contained in a statement of
additional information dated April 28, 1995, which has been filed with the
Securities and Exchange Commission and is incorporated by reference into this
prospectus. For a free copy, or for other information about the Fund, write to
the address or call the telephone number listed above.
SHARES OF THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, ANY BANK, AND SHARES ARE NOT FEDERALLY INSURED BY THE FEDERAL
DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY.
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TABLE OF CONTENTS
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Page
Fee Table .......................................... 2
Financial Highlights ............................... 3
Fund Description ................................... 5
Fund Objective and Policies ........................ 5
Investment Restrictions ............................ 7
Risk Factors ....................................... 7
Pricing Shares ..................................... 8
Dividends and Taxes ................................ 8
Fund Management and Expenses ....................... 10
How to Buy Shares .................................. 12
Distribution Plan .................................. 13
How to Redeem Shares ............................... 15
Shareholder Services ............................... 17
Performance Data ................................... 18
Fund Shares ........................................ 18
Additional Information ............................. 19
Additional Investment Information................... (i)
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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.
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<PAGE>
FEE TABLE
KEYSTONE TAX FREE FUND
The purpose of the fee table is to assist investors in understanding the
costs and expenses that an investor in the Fund will bear directly or
indirectly. For more complete descriptions of the various costs and expenses,
see the following sections of this prospectus: "Fund Management and Expenses";
"How to Buy Shares"; "Distribution Plan"; and "Shareholder Services."
SHAREHOLDER TRANSACTION EXPENSES
Contingent Deferred Sales Charge\1/ .................... 4.00%
(as a percentage of the lesser of total cost
or net asset value of shares redeemed)
Exchange Fee\2/ ........................................ $10.00
(per exchange)
ANNUAL FUND OPERATING EXPENSES\3/
(as a percentage of average net assets)
Management Fees ........................................ 0.43%
12b-1 Fees\4/ .......................................... 0.61%
Other Expenses ......................................... 0.15%
-----
Total Fund Operating Expenses .......................... 1.19%
=====
1 Year 3 Years 5 Years 10 Years
EXAMPLE\5/ ------ ------- ------- --------
You would pay the following expenses
on a $1,000 investment, assuming (1)
5% annual return and (2) redemption
at the end of each period: ........... $52.00 $58.00 $65.00 $144.00
You would pay the following
expenses on the same investment,
assuming no redemption: ............. $12.00 $38.00 $65.00 $144.00
AMOUNTS SHOWN IN THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST
OR FUTURE EXPENSES; ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
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(1) The deferred sales charge declines from 4% to 1% of amounts redeemed within
four calendar years after purchase. No deferred sales charge is imposed
thereafter.
(2) There is no exchange fee for exchange orders received by the Fund from an
individual shareholder over the Keystone Automated Response Line ("KARL").
(For a description of KARL, see "Shareholder Services.")
(3) To reflect current fees, expense ratios are estimated for the Fund's fiscal
year ending December 31, 1995. The estimated expense ratios reflect certain
actions taken by the Fund's Board of Trustees, in connection with the
reopening of the Fund on May 1, 1995, with respect to the maximum annual
expenditures permitted under the Fund's Distribution Plan. See "Distribution
Plan."
(4) Long-term shareholders may pay more than the economic equivalent of the
maximum front end sales charge permitted by rules adopted by the National
Association of Securities Dealers, Inc. ("NASD"). See "Distribution Plan."
(5) The Securities and Exchange Commission requires use of a 5% annual return
figure for purposes of this example. Actual return for the Fund may be
greater or less than 5%.
<PAGE>
FINANCIAL HIGHLIGHTS
KEYSTONE TAX FREE FUND
(For a share outstanding throughout the year)
The following table contains important financial information relating to the
Fund and has been audited by KPMG Peat Marwick LLP, the Fund's independent
auditors. The table appears in the Fund's Annual Report and should be read in
conjunction with the Fund's financial statements and related notes, which also
appear, together with the independent auditors' report, in the Fund's Annual
Report. The Fund's financial statements, related notes, and independent
auditors' report are included in the statement of additional information.
Additional information about the Fund's performance is contained in its Annual
Report, which will be made available upon request and without charge.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
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1994 1993 1992 1991 1990(d) 1989 1988 1987 1986 1985
---- ---- ---- ---- ------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE:
BEGINNING OF YEAR $ 8.12 $ 8.04 $ 8.07 $ 7.90 $ 8.06 $ 8.18 $ 8.09 $ 8.85 $ 8.31 $ 7.57
Income from investment
operations
Net investment
income ...................... 0.37 0.39 0.46 0.46 0.52 0.57 0.55 0.56 0.68 0.70
Net gains (losses) on
investments ................. (0.96) 0.48 0.12 0.36 (0.01) 0.15 0.30 (0.58) 0.88 0.81
Net commissions paid on fund
share sales (b) ............. -0- -0- -0- -0- -0- -0- -0- -0- (0.08) (0.07)
----- ---- ---- ---- ---- ---- ---- ---- ---- ----
Total from investment
operations .................. (0.59) 0.87 0.58 0.82 0.51 0.72 0.85 (0.02) 1.48 1.44
----- ---- ---- ---- ---- ---- ---- ---- ---- ----
Less distributions from
Investment income -- net(a) .. (0.37) (0.39) (0.46) (0.46) (0.52) (0.60) (0.63) (0.64) (0.68) (0.70)
In excess of investment
income -- net ............... (0.06) (0.06) (0.04) (0.07) (0.03) -0- -0- -0- -0- -0-
Realized capital
gains -- net ................ -0- (0.33) (0.11) (0.12) (0.12) (0.24) (0.13) (0.10) (0.26) -0-
In excess of realized capital
gains -- net ................ -0- (0.01) -0- -0- -0- -0- -0- -0- -0- -0-
----- ---- ---- ---- ---- ---- ---- ---- ---- ----
Total distributions .......... (0.43) (0.79) (0.61) (0.65) (0.67) (0.84) (0.76) (0.74) (0.94) 0.70)
----- ---- ---- ---- ---- ---- ---- ---- ---- ----
NET ASSET VALUE:
END OF YEAR ................. $ 7.10 $ 8.12 $ 8.04 $ 8.07 $ 7.90 $ 8.06 $ 8.18 $ 8.09 $ 8.85 $ 8.31
===== ====== ====== ====== ====== ====== ====== ====== ====== ======
TOTAL RETURN(C) .............. (7.34%) 11.15% 7.55% 10.80% 6.66% 9.11% 10.89% (0.14%) 18.26% 19.96%
RATIOS/SUPPLEMENTAL DATA
Ratios to average net assets:
Operating and management
expenses .................... 1.55% 1.66% 1.38% 1.75% 1.18% 1.23% 1.79% 1.70% 0.83% 0.92%
Investment income - net ...... 4.92% 4.72% 5.71% 5.78% 6.54% 6.94% 6.74% 6.80% 7.79% 8.65%
Portfolio turnover rate ...... 84% 76% 78% 77% 64% 69% 61% 43% 44% 55%
Net assets, end of year
(thousands) ................. $1,197,727 1,548,503 $1,453,199 $1,146,185 $1,060,826 $901,912 $903,132 $894,768 $1,025,084 863,720
</TABLE>
<PAGE>
NOTES TO FINANCIAL HIGHLIGHTS
(a) Effective January 1, 1993 the Fund adopted Statement of Position 93-2:
"Determination, Disclosure, and Financial Statement Presentation of Income,
Capital Gain and Return of Capital Distributions by Investment Companies.
"As a result, distribution amounts exceeding book basis investment
income--net (or tax basis net income on a temporary basis) are presented as
"Distributions in excess of investment income--net." Similarly, capital gain
distributions in excess of book basis gains (or tax basis capital gains on a
temporary basis) are presented as "Distributions in excess of realized
capital gains." For the fiscal years ended December 31, 1992, 1991 and 1990,
distributions in excess of book basis net income were presented as
"distribution from paid-in capital."
(b) Prior to June 30, 1987, net commissions paid on new sales of shares under
the Fund's Rule 12b-1 Distribution Plan had been treated for both financial
statement and tax purposes as capital charges. On June 11, 1987, the
Securities and Exchange Commission adopted a rule that required for
financial statements for the periods ended on or after June 30, 1987, that
net commissions paid under Rule 12b-1 be treated as operating expenses
rather than capital charges. Accordingly, beginning with the year ended
December 31, 1987, the Fund's financial statements reflect 12b-1
Distribution Plan expenses (i.e., shareholder service fees plus commissions
paid net of deferred sales charges received by the Fund) as a component of
net investment income.
(c) Excluding contingent deferred sales charges.
(d) Calculation based on average shares outstanding.
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FUND DESCRIPTION
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The Fund is an open-end, diversified, management investment company, commonly
known as a mutual fund. The Fund has been operating continuously since April 12,
1977 when it was created under Massachusetts law as a Massachusetts business
trust. The Fund is one of twenty funds managed by Keystone Management, Inc.
("Keystone Management"), the Fund's investment manager, and is one of
twenty-nine funds managed or advised by Keystone Investment Management Company
(formerly Keystone Custodian Funds, Inc.) ("Keystone"), the Fund's investment
adviser. Keystone and Keystone Management are, from time to time, also
collectively referred to as "Keystone."
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FUND OBJECTIVE AND POLICIES
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The Fund's investment objective is to provide shareholders with the highest
possible current income, exempt from federal income taxes, while preserving
capital.
The Fund invests substantially all and, under ordinary circumstances, at least
80% of its assets in federally tax-exempt obligations, including municipal bonds
and notes and tax-exempt commercial paper (municipal bonds), which are
obligations issued by or on behalf of states, territories and possessions of the
United States ("U.S."), the District of Columbia and their political
subdivisions, agencies and instrumentalities, the interest from which is, in the
opinion of counsel to the issuers of such bonds, exempt from federal income
taxes, including the alternative minimum tax.
Municipal bonds include debt obligations issued by or on behalf of a political
subdivision of the U.S. or any agency or instrumentality thereof to obtain funds
for various public purposes. In addition, municipal bonds include certain types
of industrial revenue bonds issued by or on behalf of public authorities to
finance privately operated facilities.
General obligation bonds involve the credit of an issuer possessing taxing
power and are payable from the issuer's general unrestricted revenues. Their
payment may be dependent upon an appropriation by the issuer's legislative body
and may be subject to quantitative limitations on the issuer's taxing power.
Limited obligation or revenue bonds are payable only from the revenues of a
particular facility or class of facilities or, in some cases, from the proceeds
of a special excise or other specific revenue source, such as the user of the
facility.
Since the Fund considers preservation of capital as well as the level of tax
exempt income, the Fund may realize less income than a fund willing to expose
shareholders' capital to greater risk.
The Fund invests in municipal bonds only if, at the date of investment, they
are rated within the four highest grades by Standard & Poor's Corporation
("S&P") (AAA, AA, A and BBB), by Moody's Investors Service, Inc. ("Moody's")
(Aaa, Aa, A and Baa) or by Fitch Investors Service, Inc. -- Municipal Division
("Fitch") (AAA, AA, A and BBB) or, if not rated, are of comparable quality to
obligations so rated as determined by Keystone.
Bonds rated Baa by Moody's are considered to be 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 have
speculative characteristics as well.
Debt rated BBB by S&P is regarded as having an adequate capacity to pay
interest and repay principal. While it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are generally
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in high rated categories.
Bonds rated BBB by Fitch are considered to be investment grade and of
satisfactory credit quality. The obligator'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.
Keystone expects that under normal circumstances at least 65% of the Fund's
total assets invested in municipal bonds will be within the three highest
ratings of such services or, if not rated, will be of comparable quality.
The Tax Reform Act of 1986 made significant changes in the federal tax status
of certain obligations that previously were fully federally tax-exempt. As a
result, three categories of such obligations issued after August 7, 1986 now
exist: (1) "public purpose" bonds, the income from which remains fully exempt
from federal income taxes; (2) qualified "private activity" industrial
development bonds, the income from which, while exempt from federal income taxes
under Section 103 of the Internal Revenue Code ("the Code"), is includable in
the calculation of the federal alternative minimum tax; and (3) "private
activity" (private purpose) bonds, the income from which is not exempt from
federal income taxes. Investments in qualified "private activity" industrial
development bonds will be limited by the Fund's policy of investing no more than
20% of its total assets in securities that pay interest that is not exempt from
federal taxation. The Fund currently will not invest in "private activity"
(private purpose) bonds.
The Fund also may invest in securities that pay interest that is not exempt
from federal income taxes, such as corporate and bank obligations, obligations
issued or guaranteed by the U.S. government or by any of its agencies or
instrumentalities, commercial paper and repurchase agreements. Such securities
must be rated at least BBB by S&P or Baa by Moody's or, if not rated, must be
determined by Keystone to be of comparable quality. However, except for
temporary defensive purposes, the Fund will not invest more than 20% of its
total assets in such securities.
The Fund also may enter into reverse repurchase agreements and firm commitment
agreements for securities and currencies. The Fund may enter into options
transactions and may write covered call and put options, purchase call and put
options, including purchasing call and put options to close out existing
positions, and purchase call options to fix the interest rates of obligations
held by it. The Fund may also employ new investment techniques involving such
options. In addition, the Fund may enter into currency and other financial
futures contracts and related options transactions for hedging purposes and not
for speculation and employ new investment techniques with respect to such
futures contracts and related options. In addition, the Fund may also invest in
obligations denominated in foreign currencies that are exempt from federal
income tax.
In addition to the options and futures contracts mentioned above, only if it
is consistent with its investment objective, the Fund may also invest in certain
other types of "derivative instruments," including structured securities.
In addition, the Fund may, notwithstanding any other investment policy or
restriction, invest all of its assets in the securities of a single open-end
management investment company with substantially the same fundamental investment
objectives, policies and restrictions as the Fund. The Fund does not currently
intend to implement this policy and would do so only if the Trustees were to
determine such action to be in the best interest of the Fund and its
shareholders. In the event of such implementation, the Fund will comply with
such requirements as to written notice to shareholders as are then in effect.
For further information about the types of investments and investment
techniques available to the Fund, including the associated risks, see the
section of this prospectus entitled "Additional Investment Information" and the
statement of additional information.
FUNDAMENTAL NATURE OF INVESTMENT OBJECTIVE
The investment objective of the Fund set forth above is fundamental and may
not be changed without the vote of a majority of the Fund's outstanding shares
(which means the lesser of (1) 67% of the shares represented at a meeting at
which more than 50% of the outstanding shares are represented or (2) more than
50% of the outstanding shares). Of course, there can be no assurance that the
Fund will achieve its investment objective since there is uncertainty in every
investment.
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INVESTMENT RESTRICTIONS
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The Fund has adopted the fundamental restrictions summarized below, which may
not be changed without the approval of a majority of the Fund's outstanding
shares. These restrictions and certain other fundamental and non-fundamental
restrictions are set forth in detail in the statement of additional information.
Generally, the Fund may not do the following: (1) invest more than 5% of its
total assets in the securities of any one issuer; (2) borrow money, except that
the Fund may borrow money from banks for emergency or extraordinary purposes in
aggregate amounts up to one-third (normally less than 5%) of its net assets and
enter into reverse repurchase agreements; (3) pledge more than 15% of its total
assets to secure borrowings; and (4) invest more than 25% of its total assets in
securities of issuers in the same industry;
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RISK FACTORS
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GENERAL
The risk inherent in investing in the Fund is the risk common to investing in
any security, i.e., the net asset value will fluctuate in response to changes in
economic conditions, interest rates and the market's perception of the
underlying portfolio securities of the Fund.
The Fund is not intended to constitute a balanced investment program and is
not designed for investors seeking capital appreciation or maximum tax-exempt
income irrespective of fluctuations in principal or marketability. Shares of the
Fund would not be suitable for tax-exempt institutions and may not be suitable
for certain retirement plans that are unable to benefit from the Fund's
tax-exempt dividends. In addition, the Fund may not be an appropriate investment
for entities that are "substantial users" of facilities financed by industrial
development bonds or related persons thereof.
<PAGE>
MUNICIPAL OBLIGATIONS
The ability of the Fund to achieve its investment objective is dependent upon
the continuing ability of issuers of municipal bonds to meet their obligations
to pay interest and principal when due. Obligations of issuers of municipal
bonds, including municipal bonds issued by them, are subject to the provisions
of bankruptcy, insolvency and other laws affecting the rights and remedies of
creditors, such as the federal Bankruptcy Act and laws, if any, that may be
enacted by Congress or state legislatures extending the time for payment of
principal or interest, or both, or imposing other constraints upon enforcement
of such obligations. There is also the possibility that as a result of
litigation or other conditions, the power or ability of any one or more issuers
to pay, when due, principal and interest on its or their municipal bonds may be
materially affected. In addition, the market for municipal bonds is often thin
and can be temporarily affected by large purchases and sales, including those by
the Fund.
From time to time, proposals have been introduced before Congress for the
purpose of restricting or eliminating the federal income tax exemption for
interest on municipal bonds, and similar proposals may be introduced in the
future. If such a proposal were enacted, the availability of municipal bonds for
investment by the Fund and the value of the Fund's portfolio could be materially
affected, in which event, the Fund would re-evaluate its investment objective
and policies and consider changes in the structure of the Fund or dissolution.
OTHER CONSIDERATIONS
Investment in some securities may involve special considerations. For example,
the Fund may invest in master demand notes, a type of commercial paper that is
redeemable on demand, but for which there is no secondary market. Furthermore,
the Fund may enter into repurchase agreements with domestic banks and
broker-dealers. The payment of interest accrued by the Fund under its repurchase
agreements is dependent on the ability of the seller to perform its obligations
to the Fund. If the seller of a repurchase agreement refused to repurchase the
securities underlying the agreement, the Fund would suffer a loss if the
proceeds from the sale of the underlying securities were less than the agreed
upon repurchase price, and the loss would be increased by any cost of selling
the securities. If the defaulting seller filed for bankruptcy or became
insolvent, the sale of the securities might be delayed by pending court action.
In such a case, it is not clear that the Fund would have the right, against
other claimants, to keep the securities.
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PRICING SHARES
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The net asset value of a Fund share is computed each day on which the New York
Stock Exchange (the "Exchange") is open as of the close of trading on the
Exchange (currently 4:00 p.m. eastern time for the purpose of pricing Fund
shares) except on days when changes in the value of the Fund's securities do not
affect the current net asset value of its shares. The Exchange currently is
closed on weekends, New Year's Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day. The net asset
value per share is arrived at by determining the value of all of the Fund's
assets, subtracting all liabilities and dividing the result by the number of
shares outstanding.
The Fund values municipal bonds on the basis of valuations provided by a
pricing service, approved by the Fund's Board of Trustees, which uses
information with respect to transactions in bonds, quotations from bond dealers,
market transactions in comparable securities and various relationships between
securities in determining value. The Fund values short-term instruments with
maturities of sixty days or less at amortized cost (original purchase cost as
adjusted for amortization of premium or accretion of discount), which, when
combined with accrued interest, approximates market. Short-term instruments
maturing in more than sixty days for which market quotations are readily
available are valued at current market value. Short-term instruments maturing in
more than sixty days when purchased that are held on the sixtieth day prior to
maturity are valued at amortized cost (market value on the sixtieth day adjusted
for amortization of premium or accretion of discount), which, when combined with
accrued interest, approximates market and which in any case reflects fair value
as determined by the Fund's Board of Trustees. All other investments are valued
at market value or, where market quotations are not readily available, at fair
value as determined in good faith using methods prescribed by the Fund's Board
of Trustees.
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DIVIDENDS AND TAXES
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The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Code. The Fund qualifies if, among other things, it
distributes to its shareholders at least 90% of its net investment income for
its fiscal year. The Fund also intends to make timely distributions, if
necessary, sufficient in amount to avoid the nondeductible 4% excise tax imposed
on a regulated investment company to the extent that it fails to distribute,
with respect to each calendar year, at least 98% of its ordinary income for such
calendar year and 98% of its net capital gains for the one-year period ending on
October 31 of such calendar year. Any taxable distribution would be (1) declared
in October, November, or December to shareholders of record in such a month, (2)
paid by the following January 31, and (3) includable in the taxable income of
shareholders for the year in which such distributions were declared. If the Fund
qualifies and if it distributes substantially all of its net investment income
and net capital gains, if any, to shareholders, it will be relieved of any
federal income tax liability.
As of April 1, 1995, in compliance with a recent ruling issued by the Internal
Revenue Service ("IRS"), the Fund treats its 12b-1 fees for tax purposes as
operating expenses, rather than capital charges.
The Fund intends to declare dividends from net investment income daily and
distribute to its shareholders such dividends monthly and to declare and
distribute all net realized long-term capital gains annually. All dividends and
distributions will be payable in shares or, at the option of the shareholder, in
cash. All shareholders may receive dividends in shares without being subject to
a deferred sales charge when such shares are redeemed. Shareholders who have not
opted prior to the record date for any distribution to receive cash will have
the number of such shares determined on the basis of the Fund's net asset value
per share computed at the end of the day on the record date after adjustment for
the distribution. Net asset value is used in computing the number of shares in
both capital gains and income distribution reinvestments. There is a possibility
that shareholders may lose the tax-exempt status on accrued income on municipal
bonds if shares of the Fund are redeemed before a dividend has been declared.
Account statements and/or checks as appropriate will be mailed to shareholders
within seven days after the Fund pays the distribution. Unless the Fund receives
instructions to the contrary from a shareholder before the record date, it will
assume that the shareholder wishes to receive that distribution and future
capital gains and income distributions in shares. Instructions continue in
effect until changed in writing.
Under normal circumstances, the Fund expects that substantially all of its
dividends will be "exempt interest dividends," which will be treated by its
shareholders as excludable from federal gross income. In order to pay exempt
interest dividends, at the close of each quarter at least 50% of the value of
the Fund's assets must consist of federally tax-exempt obligations. An exempt
interest dividend is any dividend or part thereof (other than a capital gain
dividend) paid by the Fund with respect to its net federally excludable
municipal bond interest and designated as an exempt interest dividend in a
written notice mailed to shareholders not later than sixty days after the close
of its taxable year. The percentage of the total dividends paid by the Fund with
respect to any taxable year that qualifies as exempt interest dividends will be
the same for all shareholders receiving dividends with respect to such year. If
a shareholder receives an exempt interest dividend with respect to any share and
such share is held for six months or less, any loss on the sale or exchange of
such share will be disallowed to the extent of the exempt interest dividend
amount.
Any shareholder who may be a "substantial user" of a facility financed with an
issue of tax-exempt obligations or a "related person" to such a user should
consult his tax adviser concerning his qualification to receive exempt interest
dividends should the Fund hold obligations financing such facility.
Interest on certain "private activity bonds" issued after August 7, 1986,
although otherwise tax-exempt, is treated as a tax preference item for
alternative minimum tax purposes. Under regulations to be promulgated, the
Fund's exempt interest dividends will be treated the same way to the extent
attributable to interest paid on such private activity bonds. Corporate
shareholders should also be aware that the receipt of exempt interest dividends
could subject them to alternative minimum tax under the provisions of Section
56(g) of the Code.
Some or all of the Fund's exempt interest dividends may be subject to state
income taxes. The Fund will report to shareholders on a state by state basis the
sources of its exempt interest dividends.
Since none of the Fund's income will consist of corporate dividends, no
distributions will qualify for the 70% corporate dividends received deduction.
The Fund intends to distribute its net capital gains as capital gain
dividends; such dividends are treated by shareholders as long-term capital
gains. Such distributions will be designated as capital gain dividends by a
written notice mailed to each shareholder no later than sixty days after the
close of the Fund's taxable year. If a shareholder receives a capital gain
dividend and holds his shares for six months or less, then any allowable loss on
disposition of such shares will be treated as a long-term capital loss to the
extent of such capital gain dividend.
Interest on indebtedness incurred or continued by shareholders to purchase or
carry shares of the Fund will not be deductible for federal income tax purposes
to the extent of the portion of the interest expense relating to exempt interest
dividends; that portion is determined by multiplying the total amount of
interest paid or accrued on the indebtedness by a fraction, the numerator of
which is the exempt interest dividends received by a shareholder in his taxable
year and the denominator of which is the sum of the exempt interest dividends
and the taxable distributions out of the Fund's investment income and short-term
capital gains received by the shareholder.
As mentioned above, at the end of each quarter at least 50% of the value of
the Fund's assets must be invested in tax-exempt obligations in order for
distributions to qualify as exempt interest dividends. Under particularly
unusual circumstances, such as when the Fund is in a prolonged defensive
investment position, it is possible that no portion of the Fund's distributions
of income to its shareholders for a fiscal year would be exempt from federal
income tax; however, the Fund does not presently anticipate that such unusual
circumstances will occur.
For the fiscal year ended December 31, 1994, approximately 100% of the Fund's
income distributions were designated as exempt from federal income taxes. The
Fund advises its shareholders annually as to the federal tax status of all
distributions made during the year.
The foregoing is only a summary of some of the important tax considerations
generally affecting the Fund and its shareholders. No attempt is made to present
a detailed explanation of the federal income tax treatment of the Fund or its
shareholders, and this discussion is not intended as a substitute for careful
tax planning. Accordingly, potential investors in the Fund are urged to consult
their tax advisers with specific reference to their own tax situations.
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FUND MANAGEMENT AND EXPENSES
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FUND MANAGEMENT
Subject to the general supervision of the Fund's Board of Trustees, Keystone
Management, located at 200 Berkeley Street, Boston, Massachusetts 02116-5034,
serves as investment manager to the Fund and is responsible for the overall
management of the Fund's business and affairs. Keystone Management, organized in
1989, is a wholly-owned subsidiary of Keystone, and its directors and principal
executive officers have been affiliated with Keystone, a seasoned investment
adviser, for a number of years. Keystone Management also serves as investment
manager to each of the other funds in the Keystone Fund Family and to certain
other funds in the Keystone Investments Family of Funds.
The Fund pays Keystone Management at the end of each calendar month a fee for
its services consisting of (1) an amount calculated as set forth below:
<PAGE>
Annual Aggregate Net Asset Value
Management of the Shares
Fee Income of the Fund
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2.0% of
Gross Dividend and
Interest Income
Plus
0.50% of the first $100,000,000, plus
0.45% of the next $100,000,000, plus
0.40% of the next $100,000,000, plus
0.35% of the next $100,000,000, plus
0.30% of the next $100,000,000, plus
0.25% of amounts over $500,000,000;
and (2) an amount equal to the amount of reimbursable expenses of Keystone
Management accrued during such calendar month.
Pursuant to its Investment Management Agreement with the Fund (the "Management
Agreement"), Keystone Management has delegated its investment management
functions, except for certain administrative and management services, to
Keystone and has entered into an Investment Advisory Agreement with Keystone
(the "Investment Advisory Agreement"), under which Keystone provides investment
advisory and management services to the Fund. Services performed by Keystone
Management generally include (1) performing research and planning with respect
to (a) the Fund's qualification as a regulated investment company under
Subchapter M of the Code, (b) tax treatment of the Fund's portfolio investments,
(c) tax treatment of special corporate actions (such as reorganizations), (d)
state tax matters affecting the Fund, and (e) the Fund's distributions of income
and capital gains; (2) preparing the Fund's federal and state tax returns; (3)
providing services to the Fund's shareholders in connection with federal and
state taxation and distributions of income and capital gains; and (4) storing
documents relating to the Fund's activities.
Keystone, located at 200 Berkeley Street, Boston, Massachusetts 02116-5034,
has provided investment advisory and management services to investment companies
and private accounts since it was organized in 1932. Keystone is a wholly-owned
subsidiary of Keystone Investments, Inc. (formerly Keystone Group, Inc.)
("Keystone Investments"), 200 Berkeley Street, Boston, Massachusetts 02116-5034.
Keystone Investments is a corporation predominantly owned by former and
current members of management of Keystone and its affiliates. The shares of
Keystone Investments common stock beneficially owned by management are held in a
number of voting trusts, the trustees of which are George S. Bissell, Albert H.
Elfner, III, Edward F. Godfrey and Ralph J. Spuehler, Jr. Keystone Investments
provides accounting, bookkeeping, legal, personnel and general corporate
services to Keystone Management, Keystone, their affiliates and the Keystone
Investments Family of Funds.
Pursuant to the Investment Advisory Agreement, Keystone receives for its
services an annual fee representing 85% of the management fee received by
Keystone Management under the Management Agreement.
For the fiscal year ended December 31, 1994, the Fund paid or accrued to
Keystone Management investment management fees of $5,941,545, which represented
0.43% of the Fund's average net assets. Of such amount paid to Keystone
Management, $5,050,313 was paid to Keystone for its services to the Fund. In
addition, the Fund reimbursed Keystone Management $2,029,000, which represented
0.14% of the Fund's average net assets, in connection with reimbursable expenses
paid by Keystone Management on behalf of the Fund under the Management
Agreement. For the fiscal year ended December 31, 1994, the total fee paid to
Keystone Management by the Fund for investment management and administrative
services fees was $7,970,545, which represented 0.57% of the Fund's average net
assets.
Keystone, Keystone Management and the Fund have each adopted a Code of Ethics
incorporating policies on personal securities trading as recommended by the
Investment Company Institute.
FUND EXPENSES
In addition to the investment advisory and management fees discussed above,
the principal expenses that the Fund is expected to pay include, but are not
limited to, expenses of its transfer agent, its custodian and its independent
auditors, expenses under its Distribution Plan, fees of its independent Trustees
("Independent Trustees"); expenses of shareholders' and Trustees' meetings, fees
payable to government agencies, including registration and qualification fees of
the Fund and its shares under federal and state securities laws, expenses of
preparing, printing and mailing Fund prospectuses, notices, reports and proxy
material and certain extraordinary expenses. In addition to such expenses, the
Fund pays its brokerage commissions, interest charges and taxes. For the fiscal
year ended December 31, 1994, the Fund paid 1.55% of its average net assets in
expenses.
During the fiscal year ended December 31, 1994, the Fund paid or accrued to
Keystone Investments $23,917 for certain accounting services and to Keystone
Investor Resource Center, Inc. ("KIRC"), the Fund's transfer and dividend
disbursing agent, $1,418,000 for certain transfer agent services. KIRC is a
wholly-owned subsidiary of Keystone. The amount for transfer agent services is
included in the amount of reimbursable expenses paid on behalf of the Fund by
Keystone Management.
PORTFOLIO MANAGER
Betsy A. Blacher has been the Fund's Portfolio Manager since 1991. She is a
Keystone Senior Vice President and Group Head and has more than 16 years of
investment experience.
SECURITIES TRANSACTIONS
Keystone selects broker-dealers to execute transactions subject to the receipt
of best execution. When selecting broker-dealers to execute portfolio
transactions for the Fund, Keystone may follow a policy of considering as a
factor the number of shares of the Fund sold by such broker-dealers. In
addition, broker-dealers may, from time to time, be affiliated with the Fund,
Keystone Management, Keystone, the Fund's principal underwriter or their
affiliates.
PORTFOLIO TURNOVER
The Fund's portfolio turnover rates for the fiscal years ended December 31,
1994 and 1993 were 84% and 76%, respectively.
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HOW TO BUY SHARES
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Except as noted below the Fund generally offers its shares by direct
investment only to those shareholders who already beneficially own shares of the
Fund. The Fund also offers its shares through exchanges to shareholders of
certain other funds in Keystone Investments Family of Funds. As previously
mentioned, the Fund will be open however, to new investors during the Special
Offering Period.
Shares of the Fund may be purchased from any broker-dealer that has a selling
agreement with Keystone Investment Distributors Company (formerly named Keystone
Distributors, Inc.) the Fund's principal underwriter ("Principal Underwriter").
The Principal Underwriter, a wholly-owned subsidiary of Keystone, is located at
200 Berkeley Street, Boston, Massachusetts 02116-5034.
Shares become entitled to income distributions declared on the first business
day following receipt by the Fund's transfer agent of payment for the shares. It
is the investor's responsibility to see that his dealer promptly forwards
payment to the Principal Underwriter for shares being purchased through the
dealer.
Orders for shares received by broker-dealers prior to that day's close of
trading on the Exchange and transmitted to the Fund prior to its close of
business that day will receive the offering price equal to the net asset value
per share computed at the close of trading on the Exchange on the same day.
Orders received by broker-dealers after that day's close of trading on the
Exchange and transmitted to the Fund prior to the close of business on the next
business day will receive the next business day's offering price. The initial
purchase must be at least $10,000. During the Special Offering Period, the
minimum initial investment will be $1,000. Purchase payments are fully invested
at net asset value. There are no sales charges on purchases of Fund shares at
the time of purchase.
CONTINGENT DEFERRED SALES CHARGE
With certain exceptions, when shares are redeemed within four calendar years
after their purchase, a contingent deferred sales charge may be imposed at rates
ranging from a maximum of 4% of amounts redeemed during the calendar year of
purchase to 1% of amounts redeemed during the third calendar year after the year
of purchase. No contingent deferred sales charge is imposed on amounts redeemed
thereafter or on shares purchased through reinvestment of dividends and
distributions. If imposed, the contingent deferred sales charge is deducted from
the redemption proceeds otherwise payable to the shareholder. Since July 8,
1992, the contingent deferred sales charge attributable to shares purchased
prior to January 1, 1992 has been retained by the Fund, and the contingent
deferred sales charge attributable to shares purchased after January 1, 1992 is,
to the extent permitted by NASD rules, paid to the Principal Underwriter.
Accordingly, for the fiscal year ended December 31, 1994, the Fund retained
$97,865 and the Principal Underwriter received $745,076, in deferred sales
charges.
The contingent deferred sales charge is a declining percentage of the lesser
of (1) the net asset value of the shares redeemed or (2) the total cost of such
shares. No contingent deferred sales charge is imposed when a shareholder
redeems amounts derived from (1) increases in the value of his account above the
total cost of such shares due to increases in the net asset value per share of
the Fund; (2) certain shares with respect to which the Fund did not pay a
commission on issuance, including shares acquired through reinvestment of
dividend income and capital gains distributions; or (3) shares held in all or
part of more than four consecutive calendar years.
In determining whether a contingent deferred sales charge is payable and, if
so, the percentage charge applicable, it is assumed that shares held the longest
are the first to be redeemed. There is no deferred sales charge imposed on
permitted exchanges of shares between Keystone funds that have adopted
distribution plans pursuant to Rule 12b-1 under the 1940 Act. Moreover, when
shares of one such fund have been exchanged for shares of another such fund, for
purposes of any future contingent deferred sales charge, the calendar year of
the purchase of the shares of the fund exchanged into is assumed to be the year
shares tendered for exchange were originally purchased.
WAIVER OF DEFERRED SALES CHARGE
Shares also may be sold, to the extent permitted by applicable law, at net
asset value without the payment of commissions or the imposition of a deferred
sales charge upon redemption of Fund shares to (1) certain officers, Directors,
Trustees and employees of the Fund, Keystone Management, Keystone and certain of
their affiliates; (2) registered representatives of firms with dealer agreements
with the Principal Underwriter; and (3) a bank or trust company acting as
trustee for a single account.
In addition, no contingent deferred sales charge is imposed on a redemption of
shares of the Fund in the event of (1) death or disability of the shareholder;
(2) a lump sum distribution from a 401(k) plan or other benefit plan qualified
under the Employee Retirement Income Security Act of 1974 ("ERISA"); (3)
Automatic Withdrawals from ERISA plans if the shareholder is at least 59-1/2
years old; (4) involuntary redemptions of accounts having an aggregate net asset
value of less than $1,000; (5) automatic withdrawals under an automatic
withdrawal plan of up to 1 1/2% per month of the shareholder's initial account
balance; (6) withdrawals consisting of loan proceeds to a retirement plan
participant; (7) financial hardship withdrawals made by a retirement plan
participant; or (8) withdrawals consisting of returns of excess contributions or
excess deferral amounts made to a retirement plan participant.
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DISTRIBUTION PLAN
- ------------------------------------------------------------------------------
The Fund bears some of the costs of selling its shares under a Distribution
Plan adopted on June 1, 1983 pursuant to Rule 12b-1 under the 1940 Act. The
Fund's Distribution Plan provides that the Fund may expend up to 0.3125%
quarterly (approximately 1.25% annually) of average daily net asset value of its
shares to pay distribution costs for sales of its shares and to pay shareholder
service fees. The NASD currently limits such annual expenditures to 1%, of which
0.75% may be used to pay such distribution costs and 0.25% may be used to pay
shareholder service fees. The aggregate amount that the Fund may pay for such
distribution costs is limited to 6.25% of gross share sales since the inception
of the Fund's Distribution Plan plus interest at the prime rate plus 1% on
unpaid amounts thereof (less any contingent deferred sales charges paid by
shareholders to the Principal Underwriter).
Payments under the Distribution Plan are currently made to the Principal
Underwriter (which may reallow all or part to others such as dealers) (1) as
commissions for Fund shares sold and (2) as shareholder service fees in respect
to shares maintained by the recipients outstanding on the Fund's books for
specified periods. Amounts paid or accrued to the Principal Underwriter under
(1) and (2) in the aggregate may not exceed the annual limitations referred to
above. The Principal Underwriter generally reallows to brokers or others a
commission equal to 3% of the price paid for each Fund share sold as well as a
shareholder service fee at a rate of 0.25% per annum of the net asset value of
shares maintained by such recipients outstanding on the books of the Fund for
specified periods.
During the Special Offering Period, the Principal Underwriter will reallow an
increased commission equal to 4% of the price paid for each Fund share sold to
those broker/dealers or others who allow their individual selling
representatives to participate in the additional 1% commission. Broker/dealers
or others not allowing their individual selling representatives to so
participate will receive the normal 3% commission.
In connection with the reopening of the Fund during the Special Offering
Period, the maximum annual expenditures permitted under the Fund's Distribution
Plan have been temporarily fixed at 0.65% of the Fund's average daily net assets
until such time as the Principal Underwriter shall have been fully paid all
amounts due it that may have arisen from sales during the Special Offering
Period. The Fund's Board of Trustees, in its sole discretion, may increase or
otherwise modify or eliminate this temporary maximum percentage rate.
If the Fund is unable to pay the Principal Underwriter a commission on a new
sale because the annual maximum has been reached, the Principal Underwriter
intends, but is not obligated, to continue to accept new orders for the purchase
of Fund shares and to pay or accrue commissions and service fees to dealers in
excess of the amount it currently receives from the Fund. While the Fund is
under no contractual obligation to pay the Principal Underwriter such amounts
that exceed the Distribution Plan limitation, the Principal Underwriter intends
to seek full payment of such charges from the Fund (together with interest at
the rate of prime plus one percent) at such time in the future as, and to the
extent that, payment thereof by the Fund would be within permitted limits. The
Principal Underwriter currently intends to seek payment of interest only on such
charges paid or accrued by the Principal Underwriter subsequent to July 7, 1992.
If the Fund's Independent Trustees authorize such payments, the effect would be
to extend the period of time during which the Fund incurs the maximum amount of
costs allowed by the Distribution Plan. If the Distribution Plan is terminated,
the Principal Underwriter will ask the Independent Trustees to take whatever
action they deem appropriate under the circumstances with respect to payment of
such amounts.
During the fiscal year ended December 31, 1994, the Fund recovered $97,865 in
deferred sales charges. During the year, the Fund paid the Principal Underwriter
$13,324,192 (0.98% of the Fund's average daily net asset value during the year)
under the Distribution Plan. The amount paid by the Fund under its Distribution
Plan, net of deferred sales charges, was $13,227,327 (0.97% of the Fund's
average daily net asset value during the year). During the year, the Principal
Underwriter received $9,126,418, after payments of commissions on new sales and
service fees to dealers and others of $4,197,774.
The amounts and purposes of expenditures under the Distribution Plan must be
reported to the Independent Trustees quarterly. The Independent Trustees may
require or approve changes in the operation of the Distribution Plan and may
require that total expenditures by the Fund under the Distribution Plan be kept
within limits lower than the maximum amount permitted by the Distribution Plan
as stated above. If such costs are not limited by the Independent Trustees, such
costs could, for some period of time, be higher than such costs permitted by
most other plans presently adopted by other investment companies.
The Distribution Plan may be terminated at any time by vote of the Fund's
Independent Trustees or by vote of a majority of the outstanding voting shares
of the Fund. Any change in the Distribution Plan that would materially increase
the distribution expenses of the Fund provided for in the Distribution Plan
requires shareholder approval. Otherwise, the Distribution Plan may be amended
by votes of the majority of both (1) the Fund's Trustees and (2) the Independent
Trustees, cast in person at a meeting called for the purpose of voting on such
amendment.
While the Distribution Plan is in effect, the Fund is required to commit the
selection and nomination of candidates for Independent Trustees to the
discretion of the Independent Trustees.
Whether any expenditure under the Distribution Plan is subject to a state
expense limit depends upon the nature of the expenditure and the terms of the
state law, regulation or order imposing the limit. A portion of the Fund's
Distribution Plan expenses may be includable in the Fund's total operating
expenses for purposes of determining compliance with state expense limits.
ARRANGEMENTS WITH BROKER-DEALERS AND OTHERS
Upon written notice to dealers, the Principal Underwriter, at its own expense
may periodically sponsor programs that offer additional compensation in
connection with sales of Fund shares. Participation in such programs may be
available to all dealers or to selected dealers who have sold or are expected to
sell significant amounts of shares. Additional compensation may also include
financial assistance to dealers in connection with preapproved seminars,
conferences and advertising. No such programs or additional compensation will be
offered to the extent they are prohibited by the laws of any state or any
self-regulatory agency, such as the NASD.
The Principal Underwriter may, at its own expense, pay concessions in addition
to those described above to dealers which satisfy certain criteria established
from time to time by the Principal Underwriter. These conditions relate to
increasing sales of shares of the Keystone funds over prior periods and certain
other factors. Such payments may, depending on the dealer's satisfaction of the
required conditions, be up to 0.25% of the value of shares sold by such dealer.
The Principal Underwriter may also pay a transaction fee (up to the level of
payment allowed to dealers for the sale of shares, as described above) to banks
and other financial service firms that facilitate transactions in shares of the
Fund for their clients.
The Glass-Steagall Act currently limits the ability of a depository
institution (such as a commercial bank or a savings and loan association) to
become an underwriter or distributor of securities. In the event the
Glass-Steagall Act is deemed to prohibit depository institutions from accepting
payments under the arrangement described above, or should Congress relax current
restrictions on depository institutions, the Board of Trustees will consider
what action, if any, is appropriate.
In addition, state securities laws on this issue may differ from the
interpretations of federal law expressed herein and banks and financial
institutions may be required to register as dealers pursuant to state law.
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HOW TO REDEEM SHARES
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Fund shares may be redeemed for cash at the redemption value upon written
order by the shareholder(s) to the Fund, c/o Keystone Investor Resource Center,
Inc., Box 2121, Boston, Massachusetts 02106-2121, and presentation to the Fund
of a properly endorsed share certificate if certificates have been issued. The
signature(s) of the shareholder(s) on the written order and certificates must be
guaranteed. The redemption value is the net asset value adjusted for fractions
of a cent and may be more or less than the shareholder's cost depending upon
changes in the value of the Fund's portfolio securities between purchase and
redemption. A deferred sales charge may be imposed by the Fund at the time of
redemption of certain shares as explained in "How to Buy Shares." If imposed,
the deferred sales charge is deducted from the redemption proceeds otherwise
payable to the shareholder.
At various times, the Fund may be requested to redeem shares for which it has
not yet received good payment. In such a case the Fund will mail the redemption
proceeds upon clearance of the purchase check, which may take up to 15 days or
more. Any delay may be avoided by purchasing shares with a certified check drawn
on a U.S. bank or by bank wire of funds. Although the mailing of a redemption
check or the wiring of redemption proceeds may be delayed, the redemption value
will be determined and the redemption processed in the ordinary course of
business upon receipt of proper documentation. In such a case, after redemption
and prior to the release of the proceeds, no appreciation or depreciation will
occur in the value of the redeemed shares, and no interest will be paid on the
redemption proceeds. If the mailing of a redemption has been delayed, the check
will be mailed or the proceeds wired promptly after good payment has been
collected.
The Fund computes the redemption value at the close of the Exchange at the end
of the day on which it has received all proper documentation from the
shareholder. Payment of the amount due on redemption, less any applicable
deferred sales charge, will be made within seven days thereafter, except as
noted above.
Shareholders also may redeem their shares through their broker-dealers. The
Principal Underwriter, acting as agent for the Fund, stands ready to repurchase
Fund shares upon orders from dealers as follows: redemption requests received by
broker-dealers prior to that day's close of trading on the Exchange and
transmitted to the Fund prior to its close of business that day will receive the
net asset value per share computed at the close of trading on the Exchange on
the same day. Redemption requests received by broker-dealers after that day's
close of trading on the Exchange and transmitted to the Fund prior to the close
of business on the next business day will receive the next business day's net
asset value price. The Principal Underwriter will pay the redemption proceeds,
less any applicable deferred sales charge, to the dealer placing the order
within seven days thereafter, assuming it has received proper documentation. The
Principal Underwriter charges no fees for this service, but the shareholder's
broker-dealer may do so.
For the protection of shareholders, SIGNATURES ON CERTIFICATES, STOCK POWERS
AND ALL WRITTEN ORDERS OR AUTHORIZATIONS MUST BE GUARANTEED BY A U.S. STOCK
EXCHANGE MEMBER, A BANK OR OTHER PERSONS ELIGIBLE TO GUARANTEE SIGNATURES UNDER
THE SECURITIES EXCHANGE ACT OF 1934 AND KIRC'S POLICIES. The Fund and KIRC may
waive this requirement, but may also require additional documents in certain
cases. Currently, the requirement for a signature guarantee has been waived on
redemptions of $50,000 or less where the account address of record has been the
same for a minimum period of 30 days. The Fund and KIRC reserve the right to
withdraw this waiver at any time.
If the Fund receives a redemption or repurchase order, but the shareholder has
not clearly indicated the amount of money or number of shares involved, the Fund
cannot execute the order. In such cases, the Fund will request the missing
information from the shareholder and process the order the day it receives such
information.
TELEPHONE
Under ordinary circumstances, you may redeem up to $50,000 from your account
by telephone by calling toll free 1-800-343-2898. To engage in telephone
transactions generally, you must complete the appropriate sections of the Fund's
application.
In order to insure that instructions received by KIRC are genuine when you
initiate a telephone transaction, you will be asked to verify certain criteria
specific to your account. At the conclusion of the transaction, you will be
given a transaction number confirming your request, and written confirmation of
your transaction will be mailed the next business day. Your telephone
instructions will be recorded. Redemptions by telephone are allowed only if the
address and bank account of record have been the same for a minimum period of 30
days. If you cannot reach the Fund by telephone, you should follow the
procedures for redeeming by mail or through a broker as set forth above.
SMALL ACCOUNTS
Because of the high cost of maintaining small accounts, the Fund reserves the
right to redeem your account if its value has fallen below $1,000, the current
minimum investment level, as a result of your redemptions (but not as a result
of market action). You will be notified in writing and allowed 60 days to
increase the value of your account to the minimum investment level. No deferred
sales charges are applied to such redemptions.
REDEMPTIONS IN KIND
If conditions arise that would make it undesirable for the Fund to pay for all
redemptions in cash, the Fund may authorize payment to be made in portfolio
securities or other property. The Fund has obligated itself, however, under the
1940 Act to redeem for cash all shares of the Fund presented for redemption by
any one shareholder in any 90 day period up to the lesser of $250,000 or 1% of
the Fund's net assets at the beginning of such period. Securities delivered in
payment of redemptions would be valued at the same value assigned to them in
computing the net asset value per share and would, to the extent permitted by
law, be readily marketable. Shareholders receiving such securities would incur
brokerage costs when these securities are sold.
GENERAL
The Fund reserves the right, at any time, to terminate, suspend or change the
terms of any redemption method described in this prospectus, except redemption
by mail, and to impose fees.
Except as otherwise noted, neither the Fund, KIRC nor the Principal
Underwriter assumes responsibility for the authenticity of any instructions
received by any of them from a shareholder in writing, over the Keystone
Automated Response Line ("KARL") or by telephone. KIRC will employ reasonable
procedures to confirm that instructions received over KARL or by telephone are
genuine. Neither the Fund, KIRC nor the Principal Underwriter will be liable
when following instructions received over KARL or by telephone that KIRC
reasonably believes to be genuine.
The Fund may temporarily suspend the right to redeem its shares when (1) the
Exchange is closed, other than customary weekend and holiday closings; (2)
trading on the Exchange is restricted; (3) an emergency exists and the Fund
cannot dispose of its investments or fairly determine their value; or (4) the
Securities and Exchange Commission so orders.
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SHAREHOLDER SERVICES
- ------------------------------------------------------------------------------
Details on all shareholder services may be obtained from KIRC, by writing or
by calling toll free 1-800-343-2898.
KEYSTONE AUTOMATED RESPONSE LINE
KARL offers you specific fund account information and price and yield
quotations as well as the ability to effect account transactions, including
investments, exchanges and redemptions. You may access KARL by dialing toll-
free 1-800-346-3858 on any touch-tone telephone, 24 hours a day, seven days a
week.
EXCHANGES
A shareholder who has obtained the appropriate prospectus may exchange shares
of the Fund for shares of certain funds in the Keystone Fund Family, Keystone
Precious Metals Holdings, Inc., ("KPMH"), Keystone International Fund Inc.
("KIF"), Keystone Tax Exempt Trust ("KTET") or Keystone Liquid Trust ("KLT") on
the basis of their respective net asset values by calling toll free
1-800-343-2898 or by writing KIRC at Box 2121, Boston, Massachusetts 02106-
2121. (See "How to Redeem Shares" for additional information on telephone
transactions.)
Fund shares purchased by check may be exchanged for shares of the named funds,
other than KPMH or KTET, after 15 days. In order to exchange Fund shares for
shares of KPMH or KTET, a shareholder must have held Fund shares for a period of
at least six months. There is a $10.00 exchange fee for each exchange; however,
there is no fee for exchange orders received by the Fund from an individual
shareholder over KARL. If the shares being tendered for exchange have been held
for less than four years and are still subject to a deferred sales charge, such
charge will carry over to the shares being acquired in the exchange transaction.
The Fund reserves the right, after providing the required notice to
shareholders, to terminate this exchange offer or to change its terms, including
the right to change the fee for any exchange.
Orders to exchange shares of the Fund for shares of KLT will be executed by
redeeming the shares of the Fund and purchasing shares of KLT at the net asset
value of KLT shares determined after the proceeds from such redemption become
available, which may be up to seven days after such redemption. In all other
cases, orders for exchanges received by the Fund prior to 4:00 p.m. eastern time
on any day the funds are open for business will be executed at the respective
net asset values determined as of the close of business that day. Orders for
exchanges received after 4:00 p.m. eastern time on any business day will be
executed at the respective net asset values determined at the close of the next
business day.
An excessive number of exchanges may be disadvantageous to the Fund.
Therefore, the Fund, in addition to its right to reject any exchange, reserves
the right to terminate the exchange privilege of any shareholder who makes more
than five exchanges of shares of the funds in a year or three in a calendar
quarter.
An exchange order must comply with the requirements for a redemption or
repurchase order and must specify the dollar value or number of shares to be
exchanged. Exchanges are subject to the minimum initial purchase requirements of
the fund being acquired. An exchange constitutes a sale for federal income tax
purposes.
The exchange privilege is available only in states where shares of the fund
being acquired may legally be sold.
AUTOMATIC WITHDRAWAL PLAN
Under an Automatic Withdrawal Plan, shareholders may arrange for regular
monthly or quarterly fixed withdrawal payments. Each payment must be at least
$100 and may be as much as 1% per month or 3% per quarter of the total net asset
value of the Fund shares in the shareholder's account when the Automatic
Withdrawal Plan is opened. Fixed withdrawal payments are not subject to a
deferred sales charge. Excessive withdrawals may decrease or deplete the value
of a shareholder's account.
OTHER SERVICES
Under certain circumstances shareholders may, within 30 days after a
redemption, reinstate their accounts at current net asset value.
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PERFORMANCE DATA
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From time to time, the Fund may advertise "total return," "current yield" and
"tax equivalent yield." ALL FIGURES ARE BASED ON HISTORICAL EARNINGS AND ARE NOT
INTENDED TO INDICATE FUTURE PERFORMANCE. Total return refers to the Fund's
average annual compounded rates of return over specified periods determined by
comparing the initial amount invested to the ending redeemable value of that
amount. The resulting equation assumes reinvestment of all dividends and
distributions and deduction of all recurring charges applicable to all
shareholder accounts. The deduction of the contingent deferred sales charge is
reflected in the applicable years. The exchange fee is not included in the
calculation.
Current yield quotations represent the yield on an investment for a stated
30-day period computed by dividing net investment income earned per share during
the base period by the maximum offering price per share on the last day of the
base period.
Tax equivalent yield is, in general, the current yield divided by a factor
equal to one minus a stated income tax rate and reflects the yield a taxable
investment would have to achieve in order to equal on an after-tax basis a tax
exempt yield.
The Fund may also include comparative performance and general mutual fund
industry information in advertising or marketing the Fund's shares, such as data
from Lipper Analytical Services, Inc., Morningstar, Inc., CDS- Weisenberger and
Value Line or other financial and industry publications.
<PAGE>
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FUND SHARES
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The Fund currently issues one class of shares, which participate equally in
dividends and distributions and have equal voting, liquidation and other rights.
When issued and paid for, the shares will be fully paid and nonassessable by the
Fund. Shares may be exchanged as explained under "Shareholder Services," but
will have no other preference, conversion, exchange or preemptive rights. Shares
are redeemable, transferable and freely assignable as collateral. There are no
sinking fund provisions. The Fund may establish additional classes or series of
shares.
Shareholders of the Fund are entitled to one vote for each full share owned
and fractional votes for fractional shares. The Fund will have special meetings
from time to time as required under its Declaration of Trust and under the 1940
Act. As provided in the Fund's Declaration of Trust, shareholders have the right
to remove Trustees by an affirmative vote of two-thirds of the outstanding
shares. A special meeting of the shareholders will be held when 10% of the
outstanding shares request a meeting for the purpose of removing a Trustee. As
prescribed by Section 16(c) of the 1940 Act, shareholders may be eligible for
shareholder communication assistance in connection with the special meeting.
Under Massachusetts law it is possible that a Fund shareholder may be held
personally liable for the Fund's obligations. However, the Fund's Declaration of
Trust provides that shareholders shall not be subject to any personal liability
for the Fund's obligations and provides indemnification from Fund assets for any
shareholder held personally liable for the Fund's obligations. Disclaimers of
such liability are included in each Fund agreement.
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ADDITIONAL INFORMATION
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KIRC, located at 101 Main Street, Cambridge, Massachusetts 02142-1515, is a
wholly owned subsidiary of Keystone and serves as the Fund's transfer agent and
dividend disbursing agent.
When the Fund determines from its records that more than one account in the
Fund is registered in the name of a shareholder or shareholders having the same
address, upon written notice to those shareholders the Fund intends, when an
annual report or semi-annual report of the Fund is required to be furnished, to
mail one copy of such report to that address.
Except as otherwise stated in this prospectus or required by law, the Fund
reserves the right to change the terms of the offer stated in this prospectus
without shareholder approval, including the right to impose or change fees for
services provided.
<PAGE>
ADDITIONAL INVESTMENT INFORMATION
CORPORATE AND MUNICIPAL BOND RATINGS
S&P CORPORATE AND MUNICIPAL BOND RATINGS
A. MUNICIPAL NOTES
An S&P note rating reflects the liquidity concerns and market access risks
unique to notes. Notes due in three years or less will likely receive a note
rating. Notes maturing beyond three years will most likely receive a long-term
debt rating. The following criteria are used in making that assessment:
1. amortization schedule (the larger the final maturity relative to other
maturities the more likely it will be treated as a note); and
2. source of payment (the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note).
Note ratings are as follows:
1. SP-1 -- Strong capacity to pay principal and interest. Those issues
determined to possess a very strong capacity to pay debt service are given a
plus (+) designation.
2. SP-2 -- Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the terms of the
notes.
3. SP-3 -- Speculative capacity to pay principal and interest.
<PAGE>
B. TAX EXEMPT DEMAND BONDS
S&P assigns "dual" ratings to all long-term debt issues that have as part of
their provisions a demand or double feature.
The first rating addresses the likelihood of repayment of principal and
interest as due, and the second rating addresses only the demand feature. The
long-term debt rating symbols are used for bonds to denote the long-term
maturity and the commercial paper rating symbols are used to denote the put
option (for example, "AAA/A-1+"). For the newer "demand notes," S&P note rating
symbols, combined with the commercial paper symbols, are used (for example, "SP
- -- 1+/A-1+").
C. CORPORATE AND MUNICIPAL BOND RATINGS
An S&P corporate or municipal bond rating is a current assessment of the
creditworthiness of an obligor, including obligors outside the U.S., with
respect to a specific obligation. This assessment may take into consideration
obligors such as guarantors, insurers or lessees. Ratings of foreign obligors do
not take into account currency exchange and related uncertainties. The ratings
are based on current information furnished by the issuer or obtained by S&P from
other sources it considers reliable.
The ratings are based, in varying degrees, on the following considerations:
1. likelihood of default capacity and willingness of the obligor as to the
timely payment of interest and repayment of principal in accordance with the
terms of the obligation;
2. nature of and provisions of the obligation; and
3. protection afforded by and relative position of the obligation in the event
of bankruptcy, reorganization or other arrangement under the laws of bankruptcy
and other laws affecting creditors' rights.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit quality,
ratings from "AA" to "BBB" may be modified by the addition of a plus or minus
sign to show relative standing within the major rating categories.
A provisional rating is sometimes used by S&P. It assumes the successful
completion of the project being financed by the debt being rated and indicates
that payment of debt service requirements is largely or entirely dependent upon
the successful and timely completion of the project. This rating, however, while
addressing credit quality subsequent to completion of the project, makes no
comment on the likelihood of, or the risk of default upon, failure of such
completion.
D. BOND RATINGS
Bond ratings are as follows:
1. AAA -- Debt rated AAA has the highest rating assigned by S&P. Capacity to
pay interest and repay principal is extremely strong.
2. AA -- Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
3. A -- Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
4. BBB -- Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
MOODY'S CORPORATE AND MUNICIPAL BOND RATINGS
A. MUNICIPAL NOTES
A Moody's rating for municipal short-term obligations will be designated
Moody's Investment Grade or ("MIG"). These ratings recognize the difference
between short-term credit risk and long-term risk. Factors affecting the
liquidity of the borrower and the short-term cyclical elements are critical in
short-term ratings.
A short-term rating may also be assigned on issues with a demand feature --
variable rate demand obligation ("VRDO"). Such ratings will be designated as
VMIG. Short-term ratings on issues with demand features are differentiated by
the use of the VMIG symbol to reflect such characteristics as payment upon
periodic demand rather than fixed maturity dates and payment relying on the
external liquidity.
The note ratings are as follows:
1. MIG1/VMIG1 This designation denotes the best quality. There is present
strong protection by established cash flows, superior liquidity support or
demonstrated broadbased access to the market for refinancing.
2. MIG2/VMIG2 This designation denotes high quality. Margins of protection are
ample although not so large as in the preceding group.
3. MIG3/VMIG3 This designation denotes favorable quality. All security
elements are accounted for but there is lacking the undeniable strength of the
preceding grades. Liquidity and cash flow protection may be narrow and market
access for refinancing is likely to be less well established.
4. MIG4/VMIG4 This designation denotes adequate quality. Protection commonly
regarded as required of an investment security is present and although not
distinctly or predominantly speculative, there is specific risk.
B. CORPORATE AND MUNICIPAL BOND RATINGS
1. Aaa -- Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt-
edge." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
2. 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. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present that
make the long term risks appear somewhat larger than in Aaa securities.
3. A -- Bonds rated A possess many favorable investment attributes and are to
be considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present that
suggest a susceptibility to impairment sometime in the future.
4. Baa -- Bonds rated Baa are considered to be 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.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through Baa in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
Con. (--) -- Municipal bonds for which the security depends upon the
completion of some act or the fulfillment of some condition are rated
conditionally. These are bonds secured by (1) earnings of projects under
construction, (2) earnings of projects unseasoned in operation experience, (3)
rentals that begin when facilities are completed, or (4) payments to which some
other limiting condition attaches. Parenthetical rating denotes probable credit
stature upon completion of construction or elimination of basis of condition.
Those municipal bonds in the Aa, A, and Baa groups that Moody's believes
possess the strongest investment attributes are designated by the symbols Aa 1,
A 1, and Baa 1.
FITCH CORPORATE AND MUNICIPAL RATINGS
A. MUNICIPAL NOTES
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally three years or less. These
include commercial paper, certificates of deposit, medium-term notes, and
municipal and investment notes. The short-term rating places greater emphasis on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
The note ratings are as follows:
1. F-1+ Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
2. F-1 Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated F-
1+.
3. F-2 Good Credit Quality. Issues assigned this rating have a satisfactory
degree of assurance for timely payment, but the margin of safety is not as great
as for issues assigned the two higher ratings.
4. F-3 Fair Credit Quality. Issues assigned this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate, however,
near-term adverse changes could cause these securities to be rated below
investment grade.
B. CORPORATE AND MUNICIPAL BOND RATINGS
AAA -- Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
AA -- Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated AAA.
A -- Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB -- Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is considered
to be adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have adverse impact on these bonds, and therefore
impair timely payment. The likelihood that the ratings of these bonds will fall
below investment grade is higher than for bonds with higher ratings.
PLUS (+) OR MINUS (-) signs are used with a rating symbol to indicate the
relative position of a credit within the rating category. Plus and minus signs,
however, are not used in the AAA category.
A CONDITIONAL rating is premised on the successful completion of a project or
the occurrence of a specific event.
Debt rated BB, B, CCC, CC and C by S&P is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and C the highest degree of speculation. While such
debt will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse conditions.
Debt rated C1 by S&P is debt (income bonds) on which no interest is being paid.
Debt rated D by S&P is in default and payment of interest and/or repayment of
principal is in arrears. Bonds that are rated Caa by Moody's are of poor
standing. Such issues may be in default or there may be present elements of
danger with respect to principal or interest. Bonds that are rated Ca by Moody's
represent obligations that are speculative in a high degree. Such issues are
often in default or have other market shortcomings. Bonds that are rated C by
Moody's are the lowest rated bonds, and issues so rated can be regarded as
having extremely poor prospects of ever attaining any real investment standing.
Debt rated BB, B, CCC, CC, and C by Fitch is regarded as speculative with
respect to capacity to pay interest and repay principal in accordance with the
terms of the obligation. BB indicates the lowest degree of speculation and C
represents the highest degree of speculation. Debt rated DDD, DD, and D are in
default on interest and/or principal payments.
DESCRIPTIONS OF CERTAIN TYPES OF INVESTMENTS AND INVESTMENT TECHNIQUES
AVAILABLE TO THE FUND
OBLIGATIONS OF FOREIGN BRANCHES OF UNITED STATES BANKS
The obligations of foreign branches of U.S. banks may be general obligations
of the parent bank in addition to the issuing branch, or may be limited by the
terms of a specific obligation and by government regulation. Payment of interest
and principal upon these obligations may also be affected by governmental action
in the country of domicile of the branch (generally referred to as sovereign
risk). In addition, evidences of ownership of such securities may be held
outside the U.S. and the Fund may be subject to the risks associated with the
holding of such property overseas. Examples of governmental actions would be the
imposition of currency controls, interest limitations, withholding taxes,
seizure of assets or the declaration of a moratorium. Various provisions of
federal law governing domestic branches do not apply to foreign branches of
domestic banks.
OBLIGATIONS OF UNITED STATES BRANCHES OF FOREIGN BANKS
Obligations of U.S. branches of foreign banks may be general obligations of
the parent bank in addition to the issuing branch, or may be limited by the
terms of a specific obligation and by federal and state regulation as well as by
governmental action in the country in which the foreign bank has its head
office. In addition, there may be less publicly available information about a
U.S. branch of a foreign bank than about a domestic bank.
MASTER DEMAND NOTES
Master demand notes are unsecured obligations that permit the investment of
fluctuating amounts by the Fund at varying rates of interest pursuant to direct
arrangements between the Fund, as lender, and the issuer as borrower. Master
demand notes may permit daily fluctuations in the interest rate and daily
changes in the amounts borrowed. The Fund has the right to increase the amount
under the note at any time up to the full amount provided by the note agreement,
or to decrease the amount. The borrower may repay up to the full amount of the
note without penalty. Notes acquired by the Fund permit the Fund to demand
payment of principal and accrued interest at any time (on not more than seven
days' notice). Notes acquired by the Fund may have maturities of more than one
year, provided that (1) the Fund is entitled to payment of principal and accrued
interest upon not more than seven days notice, and (2) the rate of interest on
such notes is adjusted automatically at periodic intervals which normally will
not exceed 31 days, but may extend up to one year. The notes will be deemed to
have a maturity equal to the longer of the period remaining to the next interest
rate adjustment or the demand notice period. Because these types of notes are
direct lending arrangements between the lender and borrower, such instruments
are not normally traded and there is no secondary market for these notes,
although they are redeemable and thus repayable by the borrower at face value
plus accrued interest at any time. Accordingly, the Fund's right to redeem is
dependent on the ability of the borrower to pay principal and interest on
demand. In connection with master demand note arrangements, Keystone considers,
under standards established by the Board of Trustees, earning power, cash flow
and other liquidity ratios of the borrower and will monitor the ability of the
borrower to pay principal and interest on demand. These notes are not typically
rated by credit rating agencies. Unless rated, the Fund may invest in them only
if at the time of an investment the issuer meets the criteria established for
commercial paper discussed in the statement of additional information.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements with member banks of the Federal
Reserve System having at least $1 billion in assets, primary dealers in U.S.
government securities or other financial institutions believed by Keystone to be
creditworthy. Such persons must be registered as U.S. government securities
dealers with appropriate regulatory organizations. Under such agreements, the
bank, primary dealer or other financial institution agrees upon entering into
the contract to repurchase the security at a mutually agreed upon date and
price, thereby determining the yield during the term of the agreement. This
results in a fixed rate of return insulated from market fluctuations during such
period. Under a repurchase agreement, the seller must maintain the value of the
securities subject to the agreement at not less than the repurchase price, such
value being determined on a daily basis by marking the underlying securities to
their market value. Although the securities subject to the repurchase agreement
might bear maturities exceeding a year, the Fund only intends to enter into
repurchase agreements that provide for settlement within a year and usually
within seven days. Securities subject to repurchase agreements will be held by
the Fund's custodian or in the Federal Reserve book entry system. The Fund does
not bear the risk of a decline in the value of the underlying security unless
the seller defaults under its repurchase obligation. In the event of a
bankruptcy or other default of a seller of a repurchase agreement, the Fund
could experience both delays in liquidating the underlying securities and
losses, including (1) possible declines in the value of the underlying
securities during the period while the Fund seeks to enforce its rights thereto;
(2) possible subnormal levels of income and lack of access to income during this
period; and (3) expenses of enforcing its rights. The Board of Trustees has
established procedures to evaluate the creditworthiness of each party with whom
the Fund enters into repurchase agreements by setting guidelines and standards
of review for Keystone and monitoring Keystone's actions with regard to
repurchase agreements.
REVERSE REPURCHASE AGREEMENTS
Under a reverse repurchase agreement, the Fund would sell securities and agree
to repurchase them at a mutually agreed upon date and price. The Fund intends to
enter into reverse repurchase agreements to avoid otherwise having to sell
securities during unfavorable market conditions in order to meet redemptions. At
the time the Fund enters into a reverse repurchase agreement, it will establish
a segregated account with the Fund's custodian containing liquid assets such as
U.S. government securities or other high grade debt securities having a value
not less than the repurchase price (including accrued interest) and will
subsequently monitor the account to ensure such value is maintained. Reverse
repurchase agreements involve the risk that the market value of the securities
that the Fund is obligated to repurchase may decline below the repurchase price.
Borrowing and reverse repurchase agreements magnify the potential for gain or
loss on the portfolio securities of the Fund and, therefore, increase the
possibility of fluctuation in the Fund's net asset value. Such practices may
constitute leveraging. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, such buyer or
its trustee or receiver may receive an extension of time to determine whether to
enforce the Fund's obligation to repurchase the securities and the Fund's use of
the proceeds of the reverse repurchase agreement may effectively be restricted
pending such determination. The staff of the Securities and Exchange Commission
("SEC") has taken the position that the 1940 Act treats reverse repurchase
agreements as being included in the percentage limit on borrowings imposed on a
fund.
"WHEN ISSUED" SECURITIES
The Fund may also purchase and sell securities and currencies on a when issued
and delayed delivery basis. When issued or delayed delivery transactions arise
when securities or currencies are purchased or sold by the Fund with payment and
delivery taking place in the future in order to secure what is considered to be
an advantageous price and yield to the Fund at the time of entering into the
transaction. When the Fund engages in when issued and delayed delivery
transactions, the Fund relies on the buyer or seller, as the case may be, to
consummate the sale. Failure to do so may result in the Fund missing the
opportunity to obtain a price or yield considered to be advantageous. When
issued and delayed delivery transactions may be expected to occur a month or
more before delivery is due. However, no payment or delivery is made by the Fund
until it receives payment or delivery from the other party to the transaction. A
separate account of liquid assets equal to the value of such purchase
commitments will be maintained until payment is made. When issued and delayed
delivery agreements are subject to risks from changes in value based upon
changes in the level of interest rates, currency rates and other market factors,
both before and after delivery. The Fund does not accrue any income on such
securities or currencies prior to their delivery. To the extent the Fund engages
in when issued and delayed delivery transactions, it will do so consistent with
its investment objective and policies and not for the purpose of investment
leverage.
LOANS OF SECURITIES TO BROKER-DEALERS
The Fund may lend securities to brokers and dealers pursuant to agreements
requiring that the loans be continuously secured by cash or securities of the
U.S. government, its agencies or instrumentalities, or any combination of cash
and such securities, as collateral equal at all times in value to at least the
market value of the securities loaned. Such securities loans will not be made
with respect to the Fund if as a result the aggregate of all outstanding
securities loans exceeds 15% of the value of the Fund's total assets taken at
their current value. The Fund continues to receive interest or dividends on the
securities loaned and simultaneously earns interest on the investment of the
cash loan collateral in U.S. Treasury notes, certificates of deposit, other
high-grade, short-term obligations or interest bearing cash equivalents.
Although voting rights attendant to securities loaned pass to the borrower, such
loans may be called at any time and will be called so that the securities may be
voted by the Fund if, in the opinion of the Fund, a material event affecting the
investment is to occur. There may be risks of delay in receiving additional
collateral or in recovering the securities loaned or even loss of rights in the
collateral should the borrower of the securities fail financially. Loans may
only be made to borrowers deemed to be of good standing, under standards
approved by the Board of Trustees, when the income to be earned from the loan
justifies the attendant risks.
DERIVATIVES
The Fund may use derivatives in furtherance of its investment objective.
Derivatives are financial contracts whose value depends on, or is derived from,
the value of an underlying asset, reference rate or index. These assets, rates,
and indices may include bonds, stocks, mortgages, commodities, interest rates,
currency exchange rates, bond indices and stock indices. Derivatives can be used
to earn income or protect against risk, or both. For example, one party with
unwanted risk may agree to pass that risk to another party who is willing to
accept the risk, the second party being motivated, for example, by the desire
either to earn income in the form of a fee or premium from the first party, or
to reduce its own unwanted risk by attempting to pass all or part of that risk
to the first party.
Derivatives can be used by investors such as the Fund to earn income and
enhance returns, to hedge or adjust the risk profile of the portfolio, and
either in place of more traditional direct investments or to obtain exposure to
otherwise inaccessible markets. The Fund is permitted to use derivatives for one
or more of these purposes. Each of these uses entails greater risk than if
derivatives were used solely for hedging purposes. The Fund uses futures
contracts and related options for hedging purposes. Derivatives are a valuable
tool which, when used properly, can provide significant benefit to Fund
shareholders. Keystone is not an aggressive user of derivatives with respect to
the Fund. However, the Fund may take positions in those derivatives that are
within its investment policies if, in Keystone's judgement, this represents an
effective response to current or anticipated market conditions. Keystone's use
of derivatives is subject to continuous risk assessment and control from the
standpoint of the Fund's investment objective and policies.
Derivatives may be (1) standardized, exchange-traded contracts or (2)
customized, privately negotiated contracts. Exchange-traded derivatives tend to
be more liquid and subject to less credit risk than those that are privately
negotiated.
There are four principal types of derivative instruments -- options, futures,
forwards and swaps -- from which virtually any type of derivative transaction
can be created. Further information regarding options and futures, is provided
later in this section and is provided in the Fund's statement of additional
information.
Debt instruments that incorporate one or more of these building blocks for the
purpose of determining the principal amount of and/or rate of interest payable
on the debt instruments are often referred to as "structured securities." An
example of this type of structured security is indexed commercial paper. The
term is also used to describe certain securities issued in connection with the
restructuring of certain foreign obligations. See "Structured Securities" below.
The term "derivative" is also sometimes used to describe securities involving
rights to a portion of the cash flows from an underlying pool of mortgages or
other assets from which payments are passed through to the owner of, or that
collateralize, the securities.
While the judicious use of derivatives by experienced investment managers such
as Keystone can be beneficial, derivatives also involve risks different from,
and, in certain cases, greater than, the risks presented by more traditional
investments. Following is a general discussion of important risk factors and
issues concerning the use of derivatives that investors should understand before
investing in the Fund.
* Market Risk -- This is the general risk attendant to all investments that the
value of a particular investment will decline or otherwise change in a way
detrimental to the Fund's interest.
* Management Risk -- Derivative products are highly specialized instruments that
require investment techniques and risk analyses different from those
associated with stocks and bonds. The use of a derivative requires an
understanding not only of the underlying instrument, but also of the
derivative itself, without the benefit of observing the performance of the
derivative under all possible market conditions. In particular, the use and
complexity of derivatives require the maintenance of adequate controls to
monitor the transactions entered into, the ability to assess the risk that a
derivative adds to the Fund's portfolio and the ability to forecast price,
interest rate or currency exchange rate movements correctly.
* Credit Risk -- This is the risk that a loss may be sustained by the Fund as a
result of the failure of another party to a derivative (usually referred to as
a "counterparty") to comply with the terms of the derivative contract. The
credit risk for exchange traded derivatives is generally less than for
privately negotiated derivatives, since the clearing house, which is the
issuer or counterparty to each exchange-traded derivative, provides a
guarantee of performance. This guarantee is supported by a daily payment
system (i.e., margin requirements) operated by the clearing house in order to
reduce overall credit risk. For privately negotiated derivatives, there is no
similar clearing agency guarantee. Therefore, the Fund considers the
creditworthiness of each counterparty to a privately negotiated derivative in
evaluating potential credit risk.
* Liquidity Risk -- Liquidity risk exists when a particular instrument is
difficult to purchase or sell. If a derivative transaction is particularly
large or if the relevant market is illiquid (as is the case with many
privately negotiated derivatives), it may not be possible to initiate a
transaction or liquidate a position at an advantageous price.
* Leverage Risk -- Since many derivatives have a leverage component, adverse
changes in the value or level of the underlying asset, rate or index can
result in a loss substantially greater than the amount invested in the
derivative itself. In the case of swaps, the risk of loss generally is related
to a notional principal amount, even if the parties have not made any initial
investment. Certain derivatives have the potential for unlimited loss,
regardless of the size of the initial investment.
* Other Risks -- Other risks in using derivatives include the risk of mispricing
or improper valuation and the inability of derivatives to correlate perfectly
with underlying assets, rates and indices. Many derivatives, in particular
privately negotiated derivatives, are complex and often valued subjectively.
Improper valuations can result in increased cash payment requirements to
counterparties or a loss of value to a Fund. Derivatives do not always
perfectly or even highly correlate or track the value of the assets, rates or
indices they are designed to closely track. Consequently, the Fund's use of
derivatives may not always be an effective means of, and sometimes could be
counterproductive to, furthering the Fund's investment objective.
OPTIONS TRANSACTIONS
WRITING COVERED OPTIONS. The Fund may write (i.e., sell) covered call and put
options. By writing a call option, the Fund becomes obligated during the term of
the option to deliver the securities underlying the option upon payment of the
exercise price. By writing a put option, the Fund becomes obligated during the
term of the option to purchase the securities underlying the option at the
exercise price if the option is exercised. The Fund also may write straddles
(combinations of covered puts and calls on the same underlying security).
The Fund may only write "covered" options. This means that so long as the Fund
is obligated as the writer of a call option, it will own the underlying
securities subject to the option or, in the case of call options on U.S.
Treasury bills, the Fund might own substantially similar U.S. Treasury bills. If
the Fund has written options against all of its securities which are available
for writing options, the Fund may be unable to write additional options unless
it sells a portion of its portfolio holdings to obtain new securities against
which it can write options. If this were to occur, higher portfolio turnover and
correspondingly greater brokerage commissions and other transaction costs may
result. However, the Fund does not expect that this will occur.
The Fund will be considered "covered" with respect to a put option it writes
if, so long as it is obligated as the writer of the put option, it deposits and
maintains with its custodian in a segregated account liquid assets having a
value equal to or greater than the exercise price of the option.
The principal reason for writing call or put options is to obtain, through a
receipt of premiums, a greater current return than would be realized on the
underlying securities alone. The Fund receives a premium from writing a call or
put option, which it retains whether or not the option is exercised. By writing
a call option, the Fund might lose the potential for gain on the underlying
security while the option is open, and by writing a put option the Fund might
become obligated to purchase the underlying security for more than its current
market price upon exercise.
PURCHASING OPTIONS. The Fund may purchase put or call options, including
purchasing put or call options for the purpose of offsetting previously written
put or call options of the same series.
If the Fund is unable to effect a closing purchase transaction with respect to
covered options it has written, the Fund will not be able to sell the underlying
security or dispose of assets held in a segregated account until the options
expire or are exercised.
An option position may be closed out only in a secondary market for an option
of the same series. Although the Fund generally will write only those options
for which there appears to be an active secondary market, there is no assurance
that a liquid secondary market will exist for any particular option at any
particular time, and for some options no secondary market may exist. In such
event, it might not be possible to effect a closing transaction in a particular
option.
Options on some securities are relatively new, and it is impossible to predict
the amount of trading interest that will exist in such options. There can be no
assurance that viable markets will develop or continue. The failure of such
markets to develop or continue could significantly impair the Fund's ability to
use such options to achieve its investment objective.
OPTIONS TRADING MARKETS. Options in which the Fund will trade generally are
listed on national securities exchanges. Exchanges on which such options
currently are traded include the Chicago Board Options Exchange and the New
York, American, Pacific and Philadelphia Stock Exchanges. Options on some
securities may not be listed on any Exchange, but traded in the over-the-counter
market. Options traded in the over-the-counter market involve the additional
risk that securities dealers participating in such transactions could fail to
meet their obligations to the Fund. The use of options traded in the
over-the-counter market may be subject to limitations imposed by certain state
securities authorities. In addition to the limits on its use of options
discussed herein, the Fund is subject to the investment restrictions described
in this prospectus and in the statement of additional information.
The staff of the SEC is of the view that the premiums that the Fund pays for
the purchase of unlisted options, and the value of securities used to cover
unlisted options written by the Fund, are considered to be invested in illiquid
securities or assets for the purpose of calculating whether the Fund is in
compliance with its investment restriction relating to illiquid investments.
FUTURES TRANSACTIONS
The Fund may enter into currency and other financial futures contracts and
write options on such contracts. The Fund intends to enter into such contracts
and related options for hedging purposes. The Fund will enter into futures on
securities or currencies or index-based futures contracts in order to hedge
against changes in interest or exchange rates or securities prices. A futures
contract on securities or currencies is an agreement to buy or sell securities
or currencies at a specified price during a designated month. A futures contract
on a securities index does not involve the actual delivery of securities, but
merely requires the payment of a cash settlement based on changes in the
securities index. The Fund does not make payment or deliver securities upon
entering into a futures contract. Instead, it puts down a margin deposit, which
is adjusted to reflect changes in the value of the contract and which continues
until the contract is terminated.
The Fund may sell or purchase futures contracts. When a futures contract is
sold by the Fund, the value of the contract will tend to rise when the value of
the underlying securities or currencies declines and to fall when the value of
such securities or currencies increases. Thus, the Fund sells futures contracts
in order to offset a possible decline in the value of its securities or
currencies. If a futures contract is purchased by the Fund, the value of the
contract will tend to rise when the value of the underlying securities or
currencies increases and to fall when the value of such securities or currencies
declines. The Fund intends to purchase futures contracts in order to establish
what is believed by Keystone to be a favorable price and rate of return for
securities or favorable exchange rate for currencies the Fund intends to
purchase.
The Fund also intends to purchase put and call options on futures contracts
for hedging purposes. A put option purchased by the Fund would give it the right
to assume a position as the seller of a futures contract. A call option
purchased by the Fund would give it the right to assume a position as the
purchaser of a futures contract. The purchase of an option on a futures contract
requires the Fund to pay a premium. In exchange for the premium, the Fund
becomes entitled to exercise the benefits, if any, provided by the futures
contract, but is not required to take any action under the contract. If the
option cannot be exercised profitably before it expires, the Fund's loss will be
limited to the amount of the premium and any transaction costs.
The Fund may enter into closing purchase and sale transactions in order to
terminate a futures contract and may sell put and call options for the purpose
of closing out its options positions. The Fund's ability to enter into closing
transactions depends on the development and maintenance of a liquid secondary
market. There is no assurance that a liquid secondary market will exist for any
particular contract or at any particular time. As a result, there can be no
assurance that the Fund will be able to enter into an offsetting transaction
with respect to a particular 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 contract and to complete the
contract according to its terms, in which case it would continue to bear market
risk on the transaction.
Although futures and options transactions are intended to enable the Fund to
manage market, interest rate or exchange rate risk, unanticipated changes in
interest rates, exchange rates or market prices could result in poorer
performance than if it had not entered into these transactions. Even if Keystone
correctly predicts interest or exchange rate movements, a hedge could be
unsuccessful if changes in the value of the Fund's futures position did not
correspond to changes in the value of its investments. This lack of correlation
between the Fund's futures and securities or currencies positions may be caused
by differences between the futures and securities or currencies markets or by
differences between the securities or currencies underlying the Fund's futures
position and the securities or currencies held by or to be purchased for the
Fund. Keystone will attempt to minimize these risks through careful selection
and monitoring of the Fund's futures and options positions.
The Fund does not intend to use futures transactions for speculation or
leverage. The Fund has the ability to write options on futures, but intends to
write such options only to close out options purchased by the Fund. The Fund
will not change these policies without supplementing the information in its
prospectus and statement of additional information.
FOREIGN CURRENCY TRANSACTIONS
As discussed above, if permitted by its investment policies, the Fund may
invest in securities of foreign issuers. When the Fund invests in foreign
securities they usually will be denominated in foreign currencies, and the Fund
temporarily may hold funds in foreign currencies. Thus, the value of Fund shares
will be affected by changes in exchange rates.
As one way of managing exchange rate risk, in addition to entering into
currency futures contracts, the Fund may enter into forward currency exchange
contracts (agreements to purchase or sell currencies at a specified price and
date). The exchange rate for the transaction (the amount of currency the Fund
will deliver or receive when the contract is completed) is fixed when the Fund
enters into the contract. The Fund usually will enter into these contracts to
stabilize the U.S. dollar value of a security it has agreed to buy or sell. The
Fund intends to use these contracts to hedge the U.S. dollar value of a security
it already owns, particularly if the Fund expects a decrease in the value of the
currency in which the foreign security is denominated. Although the Fund will
attempt to benefit from using forward contracts, the success of its hedging
strategy will depend on Keystone's ability to predict accurately the future
exchange rates between foreign currencies and the U.S. dollar. The value of the
Fund's investments denominated in foreign currencies will depend on the relative
strength of those currencies and the U.S. dollar, and the Fund may be affected
favorably or unfavorably by changes in the exchange rates or exchange control
regulations between foreign currencies and the dollar. Changes in foreign
currency exchange rates also may affect the value of dividends and interest
earned, gains and losses realized on the sale of securities and net investment
income and gains, if any, to be distributed to shareholders by the Fund. The
Fund may also purchase and sell options related to foreign currencies in
connection with hedging strategies.
VARIABLE AND FLOATING RATE INSTRUMENTS. Fixed-income securities may have fixed,
variable or floating rates of interest. Variable and floating rate securities
pay interest at rates that are adjusted periodically, according to a specified
formula. A "variable" interest rate adjusts at predetermined intervals (e.g.,
daily, weekly or monthly), while a "floating" interest rate adjusts whenever a
specified benchmark rate (such as the bank prime lending rate) changes.
If permitted by its investment policies the Fund may invest in fixed-income
securities that pay interest at a coupon rate equal to a base rate, plus
additional interest for a certain period of time if short-term interest rates
rise above a predetermined level or "cap." The amount of such an additional
interest payment typically is calculated under a formula based on a short-term
interest rate index multiplied by a designated factor.
INVERSE FLOATING RATE SECURITIES. If permitted by its investment policies, the
Fund may also invest in securities with rates that move inversely to market
rates ("inverse floaters"). An inverse floater bears an interest rate that
resets in the opposite direction of the change in a specified interest rate
index. As market interest rates rise, the interest rate on the inverse floater
goes down, and vice versa. Inverse floaters tend to exhibit greater price
volatility than fixed-rate bonds of similar maturity and credit quality. The
interest rates on inverse floaters may be significantly reduced, even to zero,
if interest rates rise. Moreover, the secondary market for inverse floaters may
be limited in rising interest rate environments.
An inverse floater may be considered to be leveraged to the extent that its
interest rate varies by a magnitude that exceeds the magnitude of the change in
the index rate of interest. The higher degree of leverage inherent in inverse
floaters is associated with greater volatility in market value.
STRUCTURED SECURITIES. Structured securities generally represent interests in
entities organized and operated solely for the purpose of restructuring the
investment characteristics of debt obligations. This type of restructuring
involves the deposit with or purchase by an entity, such as a corporation or
trust, of specified instruments (such as commercial bank loans) and the issuance
by that entity of one or more classes of structured securities backed by, or
representing interests in, the underlying instruments. The cash flow on the
underlying instruments may be apportioned among the newly issued structured
securities to create securities with different investment characteristics such
as varying maturities, payment priorities and interest rate provisions, and the
extent of the payments made with respect to structured securities is dependent
on the extent of the cash flow on the underlying instruments. Because structured
securities typically involve no credit enhancement, their credit risk generally
will be equivalent to that of the underlying instruments. Structured securities
of a given class may be either subordinated or unsubordinated to the right of
payment of another class. Subordinated structured securities typically have
higher yields and present greater risks than unsubordinated structured
securities.
<PAGE>
KEYSTONE
FUND FAMILY
Quality Bond Fund (B-1)
Diversified Bond Fund (B-2)
High Income Bond Fund (B-4)
Balanced Fund (K-1)
Strategic Growth Fund (K-2)
Growth and Income Fund (S-1)
Mid-Cap Growth Fund (S-3)
Small Company Growth
Fund (S-4)
International Fund
Precious Metals Holdings
Tax Free Fund
Tax Exempt Trust
Liquid Trust
[LOGO] KEYSTONE
INVESTMENTS
200 Berkeley Street
Boston, Massachusetts 02116-5034 [Recycle Logo]
KEYSTONE
[Photo of Mother with Infant on Porch]
TAX FREE
FUND
[LOGO]
PROSPECTUS AND
APPLICATION
<PAGE>
KEYSTONE TAX FREE FUND
PART B
STATEMENT OF ADDITIONAL INFORMATION
<PAGE>
KEYSTONE TAX FREE FUND
STATEMENT OF ADDITIONAL INFORMATION
APRIL 28, 1995
This statement of additional information is not a prospectus, but
relates to, and should be read in conjunction with, the prospectus of Keystone
Tax Free Fund dated April 28, 1995. A copy of the prospectus may be obtained
from Keystone Investment Distributors Company (formerly known as Keystone
Distributors, Inc.) the Fund's principal underwriter, ("Principal Underwriter"),
200 Berkeley Street, Boston, Massachusetts 02116-5034 or your broker-dealer.
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TABLE OF CONTENTS
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Page
The Fund's Objective and Policies 2
Investment Restrictions 2
Valuation of Securities 5
Sales Charges 5
Distribution Plan 7
Principal Underwriter 10
Trustees and Officers 12
Declaration of Trust 16
Investment Manager 17
Investment Adviser 19
Brokerage 21
Standardized Total Return
and Yield Quotations 23
Additional Information 24
Appendix A-1
Financial Statements F-1
Independent Auditors' Report F-21
<PAGE>
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THE FUND'S OBJECTIVE AND POLICIES
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The Fund's investment objective is to provide shareholders with the
highest possible current income, exempt from federal income taxes, while
preserving capital. The Fund invests primarily in municipal bonds, but also may
invest in certain other securities as described in the Appendix hereto and the
"Additional Investment Information" section of the Fund's prospectus.
FUNDAMENTAL NATURE OF INVESTMENT OBJECTIVE
The investment objective of the Fund is fundamental and may not be
changed without approval of the holders of a majority, as defined in the
Investment Company Act of 1940 (the "1940 Act"), of the Fund's outstanding
shares (which means the lesser of (1) 67% of the shares represented at a meeting
at which more than 50% of the outstanding shares are represented or (2) more
than 50% of the outstanding shares).
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INVESTMENT RESTRICTIONS
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None of the restrictions enumerated in this paragraph may be changed
without a vote of the holders of a 1940 Act majority of the Fund's outstanding
shares. The Fund will not do the following:
(1) purchase securities on margin, but the Fund may obtain such
short-term credits as may be necessary for the clearance of purchases and sales
of securities;
(2) make short sales of securities or maintain a short position, unless
at all times when a short position is open it owns an equal amount of such
securities or of securities that without payment of any further consideration
are convertible into or exchangeable for securities of the same issue as, and
equal in amount to, the securities sold short;
(3) borrow money, except that the Fund may (a) borrow money from banks
for emergency or extraordinary purposes in aggregate amounts up to one-third of
its net assets, and (b) enter into reverse repurchase agreements;
(4) pledge, mortgage or hypothecate its assets except to secure
indebtedness permitted by subparagraph (3) above, with pledged assets to be no
more than 15% of its total assets; the Fund understands that pledges in excess
of approximately 6% of its net assets would result in its inability to sell
additional shares in one state; however, the Fund has no present intention of
exceeding this limit;
(5) purchase any security other than United States ("U.S.") government
securities of any issuer if as a result more than 25% of its total assets would
be invested in a single industry, including industrial development bonds from
the same facility or similar types of facilities; governmental issuers of
municipal bonds are not regarded as members of an industry and the Fund may
invest more than 25% of its assets in industrial development bonds;
(6) purchase any security, other than U.S. government securities, if as
a result more than 5% of the Fund's total assets would be invested in securities
of the issuer, or the Fund would hold more than 10% of the voting securities of
the issuer;
(7) invest for the purpose of exercising control over or management of
any company;
(8) invest in securities of other investment companies, except as part
of a merger, consolidation, purchase of assets or similar transaction approved
by the Fund's shareholders;
(9) purchase or sell commodities or commodity contracts or real estate,
except that it may purchase and sell securities secured by real estate and
securities of companies that invest in real estate, and may engage in currency
or other financial futures and related options transactions;
(10) act as an underwriter except to the extent that, in connection
with the disposition of its portfolio investments, it may be deemed to be an
underwriter under federal securities laws; or purchase securities that are not
readily marketable except for repurchase agreements;
(11) purchase or retain securities of an issuer if, to the knowledge of
the Fund, an officer, Trustee or Director of the Fund or Keystone owns
beneficially more than 1/2 of 1% of the shares or securities of such issuer and
all such officers, Trustees and Directors owning more than 1/2 of 1% of such
shares or securities together own more than 5% of such shares or securities;
(12) purchase securities of any issuer if the person responsible for
payment, together with any predecessor, has been in operation for less than
three years if, as a result, the aggregate of such investments would exceed 5%
of the Fund's total assets; provided, however, that this restriction shall not
apply to U.S. government securities or to any obligation the payment of which
involves the credit and taxing power of any person authorized to issue municipal
bonds;
(13) invest in interests in oil, gas or other mineral exploration or
development programs;
(14) make loans, except to the extent that the purchase of debt
instruments or repurchase agreements may be deemed to be loans; repurchase
agreements maturing in more than seven days will not exceed 10% of the Fund's
total assets; and
(15) purchase securities of foreign issuers.
The foregoing percentage restrictions will apply at the time of the
purchase of a security and shall not be considered violated unless an excess or
deficiency occurs or exists immediately after and as a result of a purchase of
such security. For the purpose of limitations (5) and (6), the Fund will treat
each state, territory and possession of the U.S., the District of Columbia and,
if its assets and revenues are separate from those of the entity or entities
creating it, each political subdivision, agency and instrumentality of any one
(or more, as in the case of a multistate authority or agency) of the foregoing
as an issuer of all securities that are backed primarily by its assets or
revenues; each company as an issuer of all securities that are backed primarily
by its assets or revenues; and each of the foregoing entities as an issuer of
all securities that it guarantees; provided, however, that for the purpose of
limitation (6) no entity shall be deemed to be an issuer of a security that it
guarantees so long as no more than 10% of the Fund's total assets (taken at
current value) are invested in securities guaranteed by the entity and
securities of which it is otherwise deemed to be an issuer.
The Fund does not presently intend to invest more than 25% of its total
assets in (1) municipal bonds of a single state and its subdivisions, agencies
and instrumentalities; of a single territory or possession of the U.S. and its
subdivisions, agencies or instrumentalities; or of the District of Columbia and
any subdivision, agency or instrumentality thereof; or (2) municipal bonds the
payment of which depends on revenues derived from a single facility or similar
types of facilities. Since certain municipal bonds may be related in such a way
that an economic, business or political development or change affecting one such
security could likewise affect the other securities, a change in this policy
could result in increased investment risk, but no change is presently
contemplated. The Fund may invest more than 25% of its total assets in
industrial development bonds.
Notwithstanding limitation 8 or any of the other limitations above, the
Fund may invest all of its assets in the securities of a single open-end
management investment company with substantially the same fundamental investment
objectives, policies, and restrictions as the Fund. See "Fund Objective and
Policies" in the prospectus.
<PAGE>
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VALUATION OF SECURITIES
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The Fund believes that reliable market quotations generally are not
readily available for purposes of valuing municipal bonds. As a result,
depending on the particular municipal bonds owned by the Fund, it is likely that
most of the valuations for such bonds will be based upon their fair value
determined under procedures that have been approved by the Board of Trustees.
Non-tax exempt securities for which market quotations are readily available are
valued on a consistent basis at that price quoted that, in the opinion of the
Board of Trustees or the person designated by the Board of Trustees to make the
determination, most nearly represents the market value of the particular
security. Short-term investments that are purchased with maturities of sixty
days or less are valued at amortized cost (original purchase cost as adjusted
for amortization of premium or accretion of discount), which, when combined with
accrued interest, approximates market; short-term investments maturing in more
than sixty days for which market quotations are readily available are valued at
current market value; and short-term investments maturing in more than sixty
days when purchased that are held on the sixtieth day prior to maturity are
valued at amortized cost (market value on the sixtieth day adjusted for
amortization of premium or accretion of discount), which, when combined with
accrued interest, approximates market and which, in any case, reflects fair
value as determined by the Board of Trustees. All other investments are valued
at market value or, where market quotations are not readily available, at fair
value as determined in good faith using methods prescribed by the Fund's Board
of Trustees.
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SALES CHARGES
- --------------------------------------------------------------------------------
In order to reimburse the Fund for certain expenses relating to the
sale of its shares (see "Distribution Plan"), a contingent deferred sales charge
may be imposed at the time of redemption of certain Fund shares within four
calendar years after their purchase. If imposed, the contingent deferred sales
charge is deducted from the redemption proceeds otherwise payable to the
shareholder. Since July 8, 1992, the deferred sales charge attributable to
shares purchased prior to January 1, 1992 has been retained by the Fund, and the
deferred sales charge attributable to shares purchased after January 1, 1992 is,
to the extent permitted by the National Association of Securities Dealers, Inc.
("NASD") rules, paid to the Principal Underwriter. Accordingly, for the fiscal
year ended December 31, 1994, the Fund retained $97,865 and the Principal
Underwriter received $745,076 in deferred sales charges.
The contingent deferred sales charge is a declining percentage of the
lesser of (1) the net asset value of the shares redeemed or (2) the total cost
of such shares. No contingent deferred sales charge is imposed when the
shareholder redeems amounts derived from (1) increases in the value of his
account above the total cost of such shares due to increases in the net asset
value per share of the Fund; (2) certain shares with respect to which the Fund
did not pay a commission on issuance, including shares acquired through
reinvestment of dividend income and capital gains distributions; or (3) shares
held in all or part of more than four consecutive calendar years.
Subject to the limitations stated above, the Fund imposes a contingent
deferred sales charge according to the following schedule: 4% of amounts
redeemed during the calendar year of purchase; 3% of amounts redeemed during the
calendar year after the year of purchase; 2% of amounts redeemed during the
second calendar year after the year of purchase; and 1% of amounts redeemed
during the third calendar year after the year of purchase. No contingent
deferred sales charge is imposed on amounts redeemed thereafter.
The following example will illustrate the operation of the contingent
deferred sales charge. Assume that an investor makes a purchase payment of
$10,000 during the calendar year 1995 and on a given date in 1996 the value of
the investor's account has grown through investment performance and reinvestment
of distributions to $12,000. On such date in 1996, the investor could redeem up
to $2,000 ($12,000 minus $10,000) without incurring a deferred sales charge. If,
on such date, the investor should redeem $3,000, a deferred sales charge would
be imposed on $1,000 of the redemption (the amount by which the investor's
account was reduced by the redemption below the amount of the initial purchase
payment). The charge would be imposed at the rate of 3% because the redemption
is made during the calendar year after the calendar year of purchase, for a
total deferred sales charge of $30.
In determining whether a contingent deferred sales charge is payable
and, if so, the percentage charge applicable, it is assumed that shares held the
longest are the first to be redeemed. There is no contingent deferred sales
charge imposed on permitted exchanges of shares between funds in the Keystone
Investments Family of Funds that have adopted distribution plans pursuant to
Rule 12b-1 under the 1940 Act. Moreover, when shares of one such fund have been
exchanged for shares of another such fund, for purposes of any future contingent
deferred sales charge, the calendar year of the purchase of the shares of the
fund exchanged into is assumed to be the year shares tendered for exchange were
originally purchased.
Shares also may be sold, to the extent permitted by applicable law,
regulations, interpretations or exemptions, at net asset value without the
imposition of a deferred sales charge upon redemption of shares to (1) officers,
Directors, Trustees, full-time employees and sales representatives of Keystone
Management, Inc. ("Keystone Management"), Keystone Investment Management Company
(formerly known as Keystone Custodian Funds, Inc.) ("Keystone"), Keystone
Investments, Inc. (formerly known as Keystone Group, Inc.) ("Keystone
Investments"), Harbor Capital Management Company, Inc., their subsidiaries and
the Principal Underwriter who have been such for not less than ninety days; and
(2) the pension and profit-sharing plans established by said companies, their
subsidiaries and affiliates, for the benefit of their officers, Directors,
Trustees, full-time employees and sales representatives, provided all such sales
are made upon the written assurance of the purchaser that the purchase is made
for investment purposes and that the securities will not be resold except
through redemption by the Fund.
In addition, no contingent deferred sales charge is imposed on a
redemption of shares of the Fund purchased by a bank or trust company in a
single account in the name of such bank or trust company as trustee, if the
initial investment in shares of the Fund, any fund in the Keystone Fund Family,
Keystone Precious Metals Holdings, Inc., Keystone International Fund Inc.,
Keystone Tax Exempt Trust, Keystone Liquid Trust and/or any fund in the Keystone
America Fund Family is at least $500,000 and any commission paid by the Fund and
such other funds at the time of such purchase is not more than 1% of the amount
invested.
In addition, no contingent deferred sales charge is imposed on a
redemption of shares of the Fund in the event of (1) death or disability of the
shareholder; (2) a lump sum distribution from a 401(k) plan or other benefit
plan qualified under the employee Retirement Income Security Act of 1974
("ERISA"); (3) automatic withdrawals from ERISA plans if the shareholder is at
least 59-1/2 years old; (4) involuntary redemptions of accounts having an
aggregate net asset value of less than $1,000; (5) automatic withdrawals under
an automatic withdrawal plan of up to 1-1/2% per month of the shareholder's
initial account balance; (6) withdrawals consisting of loan proceeds to a
retirement plan participant; (7) financial hardship withdrawals made by a
retirement plan participant; or (8) withdrawals consisting of returns of excess
contributions or excess deferral amounts made to a retirement plan participant.
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DISTRIBUTION PLAN
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Rule 12b-1 under the 1940 Act permits investment companies, such as the
Fund, to use their assets to bear expenses of distributing their shares if they
comply with various conditions, including adoption of a distribution plan
containing certain provisions set forth in Rule 12b-1. On January 19, 1983, the
Fund's Distribution Plan described below was approved by the Fund's Board of
Trustees, including a majority of the Trustees who are not interested persons of
the Fund as defined in the 1940 Act ("Independent Trustees") and the Trustees
who have no direct or indirect financial interest in the Distribution Plan or
any agreement related thereto (the "Rule 12b-1 Trustees" who are the same as the
Independent Trustees). On May 27, 1983, the Distribution Plan was approved by
the Fund's shareholders, and it became effective on June 1, 1983.
The Fund's Distribution Plan provides that the Fund may expend up to
0.3125% quarterly (approximately 1.25% annually) of average daily net asset
value of its shares to pay distribution costs for sales of its shares and to pay
shareholder service fees. The NASD currently limits such annual expenditures to
1%, of which 0.75% may be used to pay such distribution costs and 0.25% may be
used to pay shareholder service fees. The aggregate amount that the Fund may pay
for such distribution costs is limited to 6.25% of gross share sales since the
inception of the Fund's Distribution Plan plus interest at the prime rate plus
1% on unpaid amounts thereof (less any contingent deferred sales charge paid by
shareholders to the Principal Underwriter). The Fund operates its Distribution
Plan in accordance with both the Distribution Plan and the NASD rules.
In connection with the Distribution Plan, Fund shares are offered for
sale at net asset value without any initial sales charge, and the Fund pays or
accrues to the Principal Underwriter a commission for each sale. Specifically,
payments under the Distribution Plan are currently made to the Principal
Underwriter (which may reallow all or part to others such as dealers) (1) as
commissions for Fund shares sold and (2) as shareholder service fees in respect
to shares maintained by the recipients outstanding on the Fund's books for
specified periods. Amounts paid or accrued to the Principal Underwriter under
(1) and (2) in the aggregate may not exceed the annual limitations referred to
above. The Principal Underwriter generally reallows to brokers or others a
commission equal to 3% of the price paid for each Fund share sold as well as a
shareholder service fee at a rate of 0.25% per annum of the net asset value of
shares maintained by such recipients outstanding on the books of the Fund for
specified periods. Such commissions and service fees are included in the Fund's
operating expenses.
Beginning May 1, 1995 until July 31, 1995 or until the Fund attains
$50,000,000 in aggregate sales whichever occurs first, (the "Special Offering
Period"), the Fund will reopen to new investors. During the Special Offering
Period, the Principal Underwriter will reallow to those brokers or others an
increased commission equal to 4% of the price paid for each Fund share sold who
allow their individual selling representatives to participate in the additional
1% commission.
In connection with the reopening of the Fund during the Special
Offering Period, the maximum annual expenditures permitted under the Fund's
Distribution Plan have been temporarily fixed at 0.65% of the Fund's average
daily net assets until such time as the Principal Underwriter shall have been
fully paid all amounts due Keystone that may have arisen from sales during the
Special Offering Period. The Fund's Board of Trustees, in its sole discretion,
may increase or otherwise modify or eliminate the temporary maximum percentage
rate.
If the Fund is unable to pay the Principal Underwriter a commission on
a new sale because the annual maximum has been reached, the Principal
Underwriter intends, but is not obligated, to continue to accept new orders for
the purchase of Fund shares and to pay commissions and service fees to dealers
in excess of the amount it currently receives from the Fund. While the Fund is
under no contractual obligation to reimburse the Principal Underwriter for
advances made by the Principal Underwriter in excess of the Distribution Plan
limitation, the Principal Underwriter intends to seek full payment of such
charges from the Fund (together with interest at the rate of prime plus one
percent) at such time in the future as, and to the extent that, payment thereof
by the Fund would be within permitted limits. The Principal Underwriter
currently intends to seek payment of interest only on such charges paid or
accrued by the Principal Underwriter subsequent to July 7, 1992. If the
Independent Trustees authorize such payments, the effect will be to extend the
period of time during which the Fund incurs the maximum amount of costs allowed
by the Distribution Plan. The Independent Trustees have agreed to cause the Fund
to reimburse the Principal Underwriter such portion of this amount at such
future time when the payment of such amounts would not cause the Fund to exceed
the Distribution Plan limitation. If the Distribution Plan is terminated, the
Principal Underwriter will ask the Independent Trustees to take whatever action
they deem appropriate under the circumstances with respect to payment of such
amounts.
The total amounts paid by the Fund under the foregoing arrangements may
not exceed the maximum Distribution Plan limit specified above, and the amounts
and purposes of expenditures under the Distribution Plan must be reported to the
Fund's Rule 12b-1 Trustees quarterly. The Fund's Rule 12b-1 Trustees may require
or approve changes in the implementation or operation of the Distribution Plan,
and may also require that total expenditures by the Fund under the Distribution
Plan be kept within limits lower than the maximum amount permitted by the
Distribution Plan as stated above. If such costs are not limited by the
Independent Trustees, such costs could, for some period of time, be higher than
such costs permitted by most other plans presently adopted by other investment
companies.
The Distribution Plan may be terminated at any time by vote of the Rule
12b-1 Trustees, or by vote of a majority of the outstanding voting securities of
the Fund. Any change in the Distribution Plan that would materially increase the
distribution expenses of the Fund provided for in the Distribution Plan requires
shareholder approval. Otherwise, the Distribution Plan may be amended by the
Trustees, including the Fund's Rule 12b-1 Trustees.
While the Distribution Plan is in effect, the Fund will be required to
commit the selection and nomination of candidates for Independent Trustees to
the discretion of the Independent Trustees.
The Fund is subject to certain state annual expense limitations, the
most restrictive of which is as follows:
2.5% of the first $30 million of Fund average net assets; 2.0% of the
next $70 million of Fund average net assets; and 1.5% of Fund average
net assets over $100 million.
Capital charges and certain expenses, including a portion of the Fund's
Distribution Plan expenses, are not included in the calculation of the state
expense limitations. This limitation may be modified or eliminated in the
future.
Whether any expenditure under the Distribution Plan is subject to a
state expense limit will depend upon the nature of the expenditure and the terms
of the state law, regulation or order imposing the limit. Any expenditure
subject to such a limit will be included in the Fund's total operating expenses
for purposes of determining compliance with the expense limit. A portion of the
Fund's Distribution Plan expenses may be includable in the Fund's total
operating expenses for purposes of determining compliance with state expense
limits.
The Independent Trustees of the Fund have determined that the sales of
the Fund's shares resulting from payments under the Distribution Plan have
benefited the Fund.
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PRINCIPAL UNDERWRITER
- --------------------------------------------------------------------------------
Pursuant to a Principal Underwriting Agreement (the "Underwriting
Agreement"), Keystone Investment Distributors Company acts as the Fund's
principal underwriter. The Principal Underwriter, located at 200 Berkeley
Street, Boston, Massachusetts 02116-5034, is a Delaware corporation wholly-owned
by Keystone. The Principal Underwriter, as agent, has agreed to use its best
efforts to find purchasers for the shares. The Principal Underwriter may retain
and employ representatives to promote distribution of the shares and may obtain
orders from brokers, dealers and others, acting as principals, for sales of
shares to them. The Underwriting Agreement provides that the Principal
Underwriter will bear the expense of preparing, printing and distributing
advertising and sales literature and prospectuses used by it. In its capacity as
principal underwriter, the Principal Underwriter may receive payments from the
Fund pursuant to the Fund's Distribution Plan.
The Underwriting Agreement provides that it will remain in effect as
long as its terms and continuance are approved by a majority of the Fund's
Independent Trustees at least annually at a meeting called for that purpose and
if its continuance is approved annually by vote of a majority of Trustees or by
vote of a majority of the outstanding shares.
The Underwriting Agreement may be terminated, without penalty, on 60
days' written notice by the Board of Trustees or by a vote of a majority of
outstanding shares. The Underwriting Agreement will terminate automatically upon
its "assignment" as that term is defined in the 1940 Act.
From time to time, if in the Principal Underwriter's judgment it could
benefit the sales of Fund shares, the Principal Underwriter may use its
discretion in providing to selected dealers promotional materials and selling
aids, including, but not limited to, personal computers, related software and
Fund data files.
For the fiscal years ended December 31, 1992 and 1993 the Principal
Underwriter earned commissions of $7,972,003 and $4,969,409 (amount represents
commissions earned during the fiscal year ended December 31, 1993 and excludes
recapture by the Principal Underwriter during said fiscal year of $4,272,087 in
advances made during previous fiscal years), respectively, after paying
commissions of $7,260,876 and $3,705,342 (amount represents sales commissions
only and excludes $3,661,327 in maintenance fees paid during the fiscal year),
respectively, to retail dealers under the Distribution Plan. During the fiscal
year ended December 31, 1994, the Fund paid the Principal Underwriter
$13,324,192 under the Distribution Plan. The amount paid by the Fund under its
Distribution Plan, net of deferred sales charges, was $13,226,327 (0.97% of the
Fund's average daily net asset value during the period). During the year, the
Principal Underwriter received $9,126,418 after payments of commissions on new
sales and service fees to dealers and others of $4,197,774. See the
"Distribution Plan".
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TRUSTEES AND OFFICERS
- --------------------------------------------------------------------------------
The Trustees of the Fund, their principal occupations and some of their
affiliations over the last five years, and the officers of the Fund are as
follows:
*ALBERT H. ELFNER, III: President, Trustee and Chief Executive Officer of the
Fund; Chairman of the Board, President, Director and Chief Executive
Officer of Keystone Investments; President and Trustee or Director of
Keystone Capital Preservation and Income Fund, Keystone Intermediate Term
Bond Fund, Keystone Strategic Income Fund, Keystone World Bond Fund,
Keystone Tax Free Income Fund, Keystone State Tax Free Fund, Keystone State
Tax Free Fund-Series II, Keystone Fund for Total Return, Keystone Global
Opportunities Fund, Keystone Hartwell Emerging Growth Fund, Inc., Keystone
Hartwell Growth Fund, Inc., Keystone Omega Fund, Inc., Keystone Fund of the
Americas-Luxembourg and Keystone Fund of the Americas-U.S., Keystone
Strategic Development Fund (collectively, "Keystone America Fund Family");
Keystone Quality Bond Fund (B-1), Keystone Diversified Bond Fund (B-2),
Keystone High Income Bond Fund (B-4), Keystone Balanced Fund (K-1),
Keystone Strategic Growth Fund (K-2), Keystone Growth and Income Fund
(S-1), Keystone Mid-Cap Growth Fund (S-3), Keystone Small Company Growth
Fund (S-4); Keystone International Fund, Keystone Precious Metals Holdings,
Inc., Keystone Tax Exempt Trust, Keystone Liquid Trust (together with the
Fund, collectively, "Keystone Fund Family"); Keystone Institutional
Adjustable Rate Fund and Master Reserves Trust (all such funds,
collectively, "Keystone Investments Family of Funds"); Director and
Chairman of the Board, Chief Executive Officer and Vice Chairman of
Keystone; Chairman of the Board and Director of Keystone Institutional
Company, Inc. ("Keystone Institutional") and Keystone Fixed Income Advisors
("KFIA"); Director, Chairman of the Board, Chief Executive Officer and
President of Keystone Management and Keystone Software Inc. ("Keystone
Software"); Director and President of Hartwell Keystone Advisers, Inc.
("Hartwell Keystone"), Keystone Asset Corporation, Keystone Capital
Corporation, and Keystone Trust Company; Director of the Principal
Underwriter, Keystone Investor Resource Center, Inc. ("KIRC"), and
Fiduciary Investment Company, Inc. ("FICO"); Director and Vice President of
Robert Van Partners, Inc.; Director of Boston Children's Services
Association; Trustee of Anatolia College, Middlesex School, and Middlebury
College; Member, Board of Governors of New England Medical Center; and
former Trustee of Neworld Bank.
FREDERICK AMLING: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of Funds; Professor, Finance Department,
George Washington University; President, Amling & Company (investment
advice); Member, Board of Advisers, Credito Emilano (banking); and former
Economics and Financial Consultant, Riggs National Bank.
CHARLES A. AUSTIN III: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of Funds; Investment Counselor to
Appleton Partners, Inc.; former Managing Director, Seaward Management
Corporation (investment advice); and former Director, Executive Vice
President and Treasurer, State Street Research & Management Company
(investment advice).
*GEORGE S. BISSELL: Chairman of the Board and Trustee of the Fund; Director of
Keystone Investments; Chairman of the Board and Trustee or Director of all
other funds in the Keystone Investments Family of Funds; Director and
Chairman of the Board of Hartwell Keystone; Chairman of the Board and
Trustee of Anatolia College; Trustee of University Hospital (and Chairman
of its Investment Committee); former Chairman of the Board and Chief
Executive Officer of Keystone Investments; and former Chief Executive
Officer of the Fund.
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Investments Family of Funds; Executive Director, Coalition
of Essential Schools, Brown University; Director and former Executive Vice
President, National Alliance of Business; former Vice President,
Educational Testing Services; and former Dean, School of Business, Adelphi
University.
CHARLES F. CHAPIN: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Investments Family of Funds; former Group Vice President,
Textron Corp.; and former Director, Peoples Bank (Charlotte, N.C).
LEROY KEITH, JR.: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of Funds; Director of Phoenix Total Return
Fund and Equifax, Inc.; Trustee of Phoenix Series Fund, Phoenix
Multi-Portfolio Fund and The Phoenix Big Edge Series Fund; and former
President, Morehouse College.
K. DUN GIFFORD: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of Funds; Chairman of the Board, Director
and Executive Vice President, The London Harness Company; Managing Partner,
Roscommon Capital Corp.; Trustee, Cambridge College; Chairman Emeritus and
Director, American Institute of Food and Wine; Chief Executive Officer,
Gifford Gifts of Fine Foods; Chairman, Gifford, Drescher & Associates
(environmental consulting); President, Oldways Preservation and Exchange
Trust (education); and former Director, Keystone Investments and Keystone.
F. RAY KEYSER, JR.: Trustee of the Fund; Trustee or Director of all other
funds in the Keystone Investments Family of Funds; Of Counsel, Keyser,
Crowley & Meub, P.C.; Member, Governor's (VT) Council of Economic Advisers;
Chairman of the Board and Director, Central Vermont Public Service
Corporation and Hitchcock Clinic; Director, Vermont Yankee Nuclear Power
Corporation, Vermont Electric Power Company, Inc., Grand Trunk Corporation,
Central Vermont Railway, Inc., S.K.I. Ltd., Sherburne Corporation, Union
Mutual Fire Insurance Company, New England Guaranty Insurance Company, Inc.
and the Investment Company Institute; former Governor of Vermont; former
Director and President, Associated Industries of Vermont; former Chairman
and President, Vermont Marble Company; former Director of Keystone; and
former Director and Chairman of the Board, Green Mountain Bank.
DAVID M. RICHARDSON: Trustee of the Fund; Trustee or Director of all other funds
in the Keystone Investments Family of Funds; Executive Vice President, DHR
International, Inc. (executive recruitment); former Senior Vice President,
Boyden International Inc. (executive recruitment); and Director, Commerce
and Industry Association of New Jersey, 411 International, Inc. and J & M
Cumming Paper Co.
RICHARD J. SHIMA: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of Funds; Chairman, Environmental Warranty,
Inc., and Consultant, Drake Beam Morin, Inc. (executive outplacement);
Director of Connecticut Natural Gas Corporation, Trust Company of
Connecticut, Hartford Hospital, Old State House Association and Enhanced
Financial Services, Inc.; Member, Georgetown College Board of Advisors;
Chairman, Board of Trustees, Hartford Graduate Center; Trustee,
Kingswood-Oxford School and Greater Hartford YMCA; former Director,
Executive Vice President and Vice Chairman of The Travelers Corporation;
and former Managing Director of Russell Miller, Inc.
ANDREW J. SIMONS: Trustee of the Fund; Trustee or Director of all other funds in
the Keystone Investments Family of Funds; Partner, Farrell, Fritz,
Caemmerer, Cleary, Barnosky & Armentano, P.C.; President, Nassau County Bar
Association; former Associate Dean and Professor of Law, St. John's
University School of Law.
EDWARD F. GODFREY: Senior Vice President of the Fund; Senior Vice President of
all other funds in the Keystone Investments Family of Funds; Director,
Senior Vice President, Chief Financial Officer and Treasurer of Keystone
Investments, the Principal Underwriter, Keystone Asset Corporation,
Keystone Capital Corporation, Keystone Trust Company; Treasurer of Keystone
Institutional, Robert Van Partners, Inc., and FICO; Treasurer and Director
of Keystone Management, Keystone Software, Inc., and Hartwell Keystone;
Vice President and Treasurer of KFIA; and Director of KIRC.
JAMES R. McCALL: Senior Vice President of the Fund; Senior Vice President of all
other funds in the Keystone Investments Family of Funds; and President of
Keystone.
BETSY A. BLACHER: Vice President of the Fund; Vice President of certain other
funds in the Keystone Investments Family of Funds; and Senior Vice
President of Keystone.
KEVIN J. MORRISSEY: Treasurer of the Fund; Treasurer of all other funds in the
Keystone Investments Family of Funds; Vice President of Keystone
Investments; Assistant Treasurer of FICO and Keystone; and former Vice
President and Treasurer of KIRC.
ROSEMARY D. VAN ANTWERP: Senior Vice President and Secretary of the Fund; Senior
Vice President and Secretary of all other funds in the Keystone Investments
Family of Funds; Senior Vice President, General Counsel and Secretary of
Keystone; Senior Vice President, General Counsel, Secretary and Director of
the Principal Underwriter, Keystone Management and Keystone Software;
Senior Vice President and General Counsel of Keystone Institutional; Senior
Vice President, General Counsel and Director of FICO and KIRC; Senior Vice
President and Secretary of Hartwell Keystone and Robert Van Partners, Inc.;
Vice President and Secretary of KFIA; and Senior Vice President, General
Counsel and Secretary of Keystone Investments, Keystone Asset Corporation,
Keystone Capital Corporation and Keystone Trust Company.
* This Trustee may be considered an "interested person" within the meaning of
the 1940 Act.
Mr. Elfner and Mr. Bissell are "interested persons" by virtue of their
positions as officers and/or Directors of Keystone Investments and several of
its affiliates including Hartwell Keystone, the Principal Underwriter and KIRC.
Mr. Elfner and Mr. Bissell own shares of Keystone Investments. Mr. Elfner is
Chairman of the Board, Chief Executive Officer and Director of Keystone
Investments. Mr. Bissell is a Director of Keystone Investments.
During the fiscal year ended December 31, 1994, none of the affiliated
Trustees and officers of the Fund received any direct remuneration from the
Fund. During this same period, the nonaffiliated Trustees received $56,308 in
retainers and fees. For the year ending December 31, 1994, fees paid to
Independent Trustees on a fund complex wide basis were approximately $585,990.
On March 31, 1995, the Trustees and officers of the Fund, as a group,
beneficially owned less than 1% of the Fund's then outstanding shares.
The address of all the Fund's Trustees and officers is 200 Berkeley
Street, Boston, Massachusetts 02116-5034.
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DECLARATION OF TRUST
- --------------------------------------------------------------------------------
The Fund is a Massachusetts business trust originally established under
a Declaration of Trust dated April 12, 1977. On July 27, 1993, the Fund's
Declaration of Trust was amended and restated in its entirety (the "Declaration
of Trust"). The Fund is similar in most respects to a business corporation. The
principal distinction between the Fund and a corporation relates to the
shareholder liability described below. This summary is qualified in its entirety
by reference to the Declaration of Trust.
SHAREHOLDER LIABILITY
Pursuant to certain decisions of the Supreme Judicial Court of
Massachusetts, shareholders of a Massachusetts business trust may, under certain
circumstances, be held personally liable as partners for the obligations of the
trust. Even if, however, the Fund were held to be a partnership, the possibility
of the shareholders incurring financial loss for that reason appears remote
because the Fund's Declaration of Trust contains an express disclaimer of
shareholder liability for obligations of the Fund and requires that notice of
such disclaimer be given in each agreement, obligation or instrument entered
into or executed by the Fund or the Trustees, and because the Declaration of
Trust provides for indemnification out of the trust property for any shareholder
held personally liable for the obligations of the Fund.
VOTING RIGHTS
Under the terms of the Declaration of Trust, shares are entitled to
vote in the election of Trustees and on other matters and no amendment may be
made to the Declaration of Trust without the approval of the shareholders of the
Fund. Shares have non-cumulative voting rights, which means that the holders of
more than 50% of the shares voting for the election of Trustees can elect 100%
of the Trustees to be elected at a meeting, and, in such event, the holders of
the remaining less than 50% of the shares will not be able to elect any
Trustees.
LIMITATION OF TRUSTEES' LIABILITY
The Declaration of Trust provides that a Trustee shall be liable only
for his own willful defaults and, if reasonable care has been exercised in the
selection of officers, agents, employees or investment advisers, shall not be
liable for any neglect or wrongdoing of any such person; provided, however, that
nothing in the Declaration of Trust shall protect a Trustee against any
liability for his willful misfeasance, bad faith, gross negligence or reckless
disregard of his duties.
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INVESTMENT MANAGER
- --------------------------------------------------------------------------------
Subject to the general supervision of the Fund's Board of Trustees,
Keystone Management, located at 200 Berkeley Street, Boston, Massachusetts
02116-5034, serves as investment manager to the Fund and is responsible for the
overall management of the Fund's business and affairs. Keystone Management,
organized in 1989, is a wholly-owned subsidiary of Keystone and its directors
and principal executive officers have been affiliated with Keystone, a seasoned
investment adviser, for a number of years. Keystone Management also serves as
investment manager to each of the funds in the Keystone Fund Family and to
certain other funds in the Keystone Investments Family of Funds.
Except as otherwise noted below, pursuant to an Investment Management
Agreement with the Fund (the "Management Agreement") and subject to the
supervision of the Fund's Board of Trustees, Keystone Management manages and
administers the operation of the Fund and manages the investment and
reinvestment of the Fund's assets in conformity with the Fund's investment
objectives and restrictions. The Management Agreement stipulates that Keystone
Management shall provide office space, all necessary office facilities,
equipment and personnel in connection with its services under the Management
Agreement and pay or reimburse the Fund for the compensation of Fund officers
and trustees who are affiliated with the investment manager as well as pay all
expenses of Keystone Management incurred in connection with the provision of its
services. All charges and expenses other than those specifically referred to as
being borne by Keystone Management will be paid by the Fund, including, but not
limited to, custodian charges and expenses; bookkeeping and auditors' charges
and expenses; transfer agent charges and expenses; fees of Independent Trustees;
brokerage commissions, brokers' fees and expenses; issue and transfer taxes;
costs and expenses under the Distribution Plan; taxes and trust fees payable to
governmental agencies; the cost of share certificates; fees and expenses of the
registration and qualification of the Fund and its shares with the Securities
and Exchange Commission (sometimes referred to herein as the "SEC" or the
"Commission") or under state or other securities laws; expenses of preparing,
printing and mailing prospectuses, statements of additional information,
notices, reports and proxy materials to shareholders of the Fund; expenses of
shareholders' and Trustees' meetings; charges and expenses of legal counsel for
the Fund and for the Trustees of the Fund on matters relating to the Fund;
charges and expenses of filing annual and other reports with the SEC and other
authorities; and all extraordinary charges and expenses of the Fund; provided,
however that Keystone Management pays all charges and expenses relating to these
items subject to reimbursement by the Fund.
The Management Agreement permits Keystone Management to enter into an
agreement with Keystone or another investment adviser, under which Keystone or
such other investment adviser, as investment adviser, will provide substantially
all the services to be provided by Keystone Management under the Management
Agreement. The Management Agreement also permits Keystone Management to delegate
to Keystone or another investment adviser substantially all of the investment
manager's rights, duties and obligations under the Management Agreement.
Keystone Management provides the Fund with certain administrative and management
services, which services include (1) performing research and planning with
respect to (a) the Fund's qualification as a regulated investment company under
Subchapter M of the Internal Revenue Code, (b) tax treatment of the Fund's
portfolio investments, (c) tax treatment of special corporate actions (such as
reorganizations), (d) state tax matters affecting the Fund, and (e) the Fund's
distributions of income and capital gains; (2) preparing the Fund's federal and
state tax returns; (3) providing services to the Fund's shareholders in
connection with federal and state taxation and distributions of income and
capital gains; and (4) storing documents relating to the Fund's activities.
The Fund pays Keystone Management at the end of each calendar month a
fee for its services consisting of (1) an amount calculated as set forth below:
ANNUAL AGGREGATE NET
MANAGEMENT ASSET VALUE OF THE
FEE INCOME SHARES OF THE FUND
- --------------------------------------------------------------------------------
2.0% of
Gross Dividend and
Interest Income
Plus
0.50% of the first $100,000,000, plus
0.45% of the next $100,000,000, plus
0.40% of the next $100,000,000, plus
0.35% of the next $100,000,000, plus
0.30% of the next $100,000,000, plus
0.25% of amounts over $500,000,000; and
(2) an amount equal to Keystone Management's reimbursable expenses accrued
during such calendar month.
As a continuing condition of registration of shares in a state,
Keystone Management has agreed to reimburse the Fund annually for certain
operating expenses incurred by the Fund in excess of certain percentages of the
Fund's average daily net assets. However, Keystone Management is not required to
make such reimbursements to an extent which would result in the Fund's inability
to qualify as a regulated investment company under provisions of the Internal
Revenue Code. This condition may be modified or eliminated in the future.
The Management Agreement continues in effect from year to year only if
approved at least annually by the Fund's Board of Trustees or by a vote of a
majority of the outstanding shares, and such renewal has been approved by the
vote of a majority of the Independent Trustees cast in person at a meeting
called for the purpose of voting on such approval. The Management Agreement may
be terminated, without penalty, by the Fund's Board of Trustees or by a vote of
a majority of outstanding shares on 60 days' written notice to Keystone, and by
Keystone on 90 days' written notice to the Fund. The Management Agreement will
terminate automatically upon its "assignment" as that term is defined in the
1940 Act.
For additional discussion of fees paid to Keystone Management, see
"Investment Adviser" below.
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INVESTMENT ADVISER
- --------------------------------------------------------------------------------
Pursuant to the Management Agreement, Keystone Management has delegated
its investment management functions, except for certain administrative and
management services, to Keystone and has entered into an Investment Advisory
Agreement (the "Advisory Agreement") with Keystone under which Keystone provides
investment advisory and management services to the Fund.
Keystone, located at 200 Berkeley Street, Boston, Massachusetts
02116-5034, has provided investment advisory and management services to
investment companies and private accounts since it was organized in 1932.
Keystone is a wholly-owned subsidiary of Keystone Investments, 200 Berkeley
Street, Boston, Massachusetts 02116-5034.
Keystone Investments is a corporation predominantly owned by current
and former members of Keystone's management and its affiliates. The shares of
Keystone Investments common stock beneficially owned by management are held in a
number of voting trusts, the trustees of which are George S. Bissell, Albert H.
Elfner, III, Edward F. Godfrey and Ralph J. Spuehler, Jr. Keystone Investments
provides accounting, bookkeeping, legal, personnel and general corporate
services to Keystone Management, Keystone, their affiliates and the Keystone
Investments Family of Funds.
Pursuant to the Advisory Agreement, Keystone receives for its services
an annual fee representing 85% of the management fee received by Keystone
Management under the Management Agreement.
Under the terms of the Advisory Agreement and subject to the
supervision of the Fund's Board of Trustees, Keystone manages and administers
the operation of the Fund, and manages the investment and reinvestment of the
Fund's assets in conformity with the Fund's investment objective and
restrictions. The Advisory Agreement stipulates that Keystone shall provide
office space, all necessary office facilities, equipment and personnel in
connection with its services under the Advisory Agreement and pay or reimburse
the Fund for the compensation of Fund officers and Trustees who are affiliated
with the investment manager and pay all expenses of Keystone incurred in
connection with the provision of its services. All charges and expenses other
than those specifically referred to as being borne by Keystone will ultimately
be paid by the Fund, including, but not limited to, custodian charges and
expenses; bookkeeping and auditors' charges and expenses; transfer agent charges
and expenses; fees of Independent Trustees; brokerage commissions, brokers' fees
and expenses; issue and transfer taxes; costs and expenses under the
Distribution Plan; taxes and trust fees payable to governmental agencies; the
cost of share certificates, fees and expenses of the registration and
qualification of the Fund and its shares with the SEC or under state or other
securities laws; expenses of preparing, printing and mailing prospectuses,
statements of additional information, notices, reports and proxy materials to
shareholders of the Fund; expenses of shareholders' and Trustees' meetings;
charges and expenses of legal counsel for the Fund and for the Trustees of the
Fund on matters relating to the Fund; charges and expenses of filing annual and
other reports with the SEC and other authorities; and all extraordinary charges
and expenses of the Fund.
During the fiscal year ended December 31, 1992, the Fund paid or
accrued to Keystone Management investment management fees of $5,483,861, which
represented 0.46% of the Fund's average net assets. Of such amount paid to
Keystone Management, $4,661,282 was paid to Keystone for its services to the
Fund. In addition, the Fund reimbursed Keystone Management $1,570,163, which
represented 0.13% of the Fund's average net assets, in connection with
reimbursable expenses paid by Keystone Management on behalf of the Fund. For the
fiscal year ended December 31, 1992, the total fee paid to Keystone Management
by the Fund for investment management and administrative services fees was
$7,054,024, which represented 0.59% of the Fund's average net assets.
During the fiscal year ended December 31, 1993, the Fund paid or
accrued to Keystone Management investment management fees of $6,507,055, which
represented 0.43% of the Fund's average net assets. Of such amount paid to
Keystone Management, $5,530,997 was paid to Keystone for its services to the
Fund. In addition, the Fund reimbursed Keystone Management $2,488,890, which
represented 0.16% of the Fund's average net assets, in connection with
reimbursable expenses paid by Keystone Management on behalf of the Fund. For the
fiscal year ended December 31, 1993, the total fee paid to Keystone Management
by the Fund for investment management and administrative services fees was
$8,995,945, which represented 0.59% of the Fund's average net assets.
During the fiscal year ended December 31, 1994, the Fund paid or
accrued to Keystone Management investment management fees of $5,941,545 which
represented 0.43% of the Fund's average net assets. Of such amount paid to
Keystone Management, $5,050,313 was paid to Keystone for its services to the
Fund. In addition, the Fund reimbursed Keystone Management $2,029,000, which
represented 0.15% of the Fund's average net assets, in connection with
reimbursable expenses paid by Keystone Management on behalf of the Fund. For the
fiscal year ended December 31, 1994, the total fee paid to Keystone Management
by the Fund for investment management and administrative services fees was
$7,970,545, which represented 0.58% of the Fund's average net assets.
- --------------------------------------------------------------------------------
BROKERAGE
- --------------------------------------------------------------------------------
It is the policy of the Fund, in effecting transactions in portfolio
securities, to seek best execution of orders at the most favorable prices. The
determination of what may constitute best execution and price in the execution
of a securities transaction by a broker involves a number of considerations,
including, without limitation, the overall direct net economic result to the
Fund, involving both price paid or received and any commissions and other costs
paid, the efficiency with which the transaction is effected, the ability to
effect the transaction at all where a large block is involved, the availability
of the broker to stand ready to execute potentially difficult transactions in
the future and the financial strength and stability of the broker. Such
considerations are judgmental and are weighed by management in determining the
overall reasonableness of brokerage commissions paid.
Subject to the foregoing, a factor in the selection of brokers is the
receipt of research services, such as analyses and reports concerning issuers,
industries, securities, economic factors and trends and other statistical and
factual information. Any such research and other statistical and factual
information provided by brokers to the Fund, Keystone Management or Keystone is
considered to be in addition to and not in lieu of services required to be
performed by Keystone Management under the Management Agreement or Keystone
under the Advisory Agreement. The cost, value and specific application of such
information are indeterminable and cannot be practically allocated among the
Fund and other clients of Keystone Management or Keystone who may indirectly
benefit from the availability of such information. Similarly, the Fund may
indirectly benefit from information made available as a result of transactions
effected for such other clients. Under the Management Agreement and the Advisory
Agreement, Keystone Management and Keystone are permitted to pay higher
brokerage commissions for brokerage and research services in accordance with
Section 28(e) of the Securities Exchange Act of 1934. In the event Keystone
Management and Keystone do follow such a practice, they will do so on a basis
that is fair and equitable to the Fund.
The Fund's securities transactions are generally principal transactions
with the issuer of the security or with major underwriters and dealers for
municipal bonds. Accordingly, the Fund does not pay significant brokerage
commissions. The cost of securities purchased from underwriters includes an
underwriting commission or concession and the prices at which securities are
purchased from and sold to dealers include a dealer's mark-up or mark-down.
Purchases from underwriters will include the underwriting commission or
concession and purchases from dealers serving as market makers will include the
spread between the bid and asked prices. Where transactions are made in the
over-the-counter market, the Fund will deal with primary market makers unless
more favorable prices are otherwise obtainable.
The Fund may participate, if and when practicable, in group bidding for
the purchase directly from an issuer of certain securities for the Fund's
portfolio in order to take advantage of the lower purchase price available to
members of such a group.
Neither Keystone Management, Keystone nor the Fund intend to place
securities transactions with any particular broker-dealer or group thereof.
However, the Fund's Board of Trustees has determined that the Fund may follow a
policy of considering sales of shares as a factor in the selection of
broker-dealers to execute portfolio transactions, subject to the requirements of
best execution, including best price, described above.
The policy of the Fund with respect to brokerage is and will be
reviewed by the Fund's Board of Trustees from time to time. Because of the
possibility of further regulatory developments affecting the securities
exchanges and brokerage practices generally, the foregoing practices may be
changed, modified or eliminated.
Investment decisions for the Fund are made independently by Keystone
Management or Keystone from those of the other funds and investment accounts
managed by Keystone Management or Keystone. It may frequently develop that the
same investment decision is made for more than one fund. Simultaneous
transactions are inevitable when the same security is suitable for the
investment objective of more than one account. When two or more funds or
accounts are engaged in the purchase or sale of the same security, the
transactions are allocated as to amount in accordance with a formula that is
equitable to each fund or account. It is recognized that in some cases this
system could have a detrimental effect on the price or volume of the security as
far as the Fund is concerned. In other cases, however, it is believed that the
ability of the Fund to participate in volume transactions will produce better
executions for the Fund.
For the fiscal years ended December 31, 1992, 1993 and 1994, the Fund
did not pay any brokerage commissions for securities transactions.
In no instance are portfolio securities purchased from or sold to
Keystone Management, Keystone, the Principal Underwriter or any of their
affiliated persons, as defined in the 1940 Act and rules and regulations issued
thereunder.
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STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
- --------------------------------------------------------------------------------
Total return quotations for the Fund as they may appear from time to
time in advertisements are calculated by finding the average annual compounded
rates of return over the one, five and ten year periods on a hypothetical $1,000
investment that would equate the initial amount invested to the ending
redeemable value. To the initial investment all dividends and distributions are
added, and all recurring fees charged to all shareholder accounts are deducted.
The ending redeemable value assumes a complete redemption at the end of the one,
five or ten year periods.
The cumulative total returns of the Fund for the one, five and ten
years ended December 31, 1994 were (9.96)% (including contingent deferred sales
charge), 30.92% and 124.42%, respectively. The average annual total returns for
the one, five and ten year periods ended December 31, 1994 were (9.96)%, 5.54%
and 8.42%, respectively.
Current yield quotations as they may appear from time to time in
advertisements will consist of a quotation based on a 30-day period ended on the
date of the most recent balance sheet of the Fund, computed by dividing the net
investment income per share earned during the period by the maximum offering
price per share on the last day of the base period. The current yield for the
30-day period ended December 31, 1994 was 5.59%.
Tax equivalent yield is, in general, the current yield divided by a
factor equal to one minus a stated income tax rate and reflects the yield a
taxable investment would have to achieve in order to equal on an after tax-basis
a tax exempt yield. The tax equivalent yield for an investor in the 31% federal
tax bracket for the 30-day period ended December 31, 1994 was 8.10%.
Any given yield or total return quotation should not be considered
representative of the Fund's yield or total return for any future period.
<PAGE>
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ADDITIONAL INFORMATION
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State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, is the custodian ("Custodian") of all securities and cash
of the Fund. The Custodian performs no investment management functions for the
Fund, but, in addition to its custodial services, is responsible for accounting
and related recordkeeping on behalf of the Fund.
KPMG Peat Marwick LLP, One Boston Place, Boston, Massachusetts 02108,
Certified Public Accountants, are the independent auditors for the Fund.
KIRC, located at 101 Main Street, Cambridge, Massachusetts 02142, is a
wholly-owned subsidiary of Keystone, and acts as transfer agent and dividend
disbursing agent for the Fund.
Except as otherwise stated in its prospectus or required by law, the
Fund reserves the right to change the terms of the offer stated in its
prospectus without shareholder approval, including the right to impose or change
fees for services provided.
No dealer, salesman or other person is authorized to give any
information or to make any representation not contained in the Fund's
prospectus, this statement of additional information, or in supplemental sales
literature issued by the Fund or the Principal Underwriter, and no person is
entitled to rely on any information or representation not contained therein.
The Fund's prospectus and this statement of additional information omit
certain information contained in the registration statement filed with the
Securities and Exchange Commission, which may be obtained from the Commission's
principal office in Washington, D.C. upon payment of the fee prescribed by the
rules and regulations promulgated by the Commission.
As of March 31, 1995, Merrill Lynch Pierce Fenner & Smith, Attn: Book
Entry, 4800 Deer Lake Dr. E., 3rd Floor, Jacksonville, FL 32246-6484 owned of
record 18.3% of the Fund's outstanding shares.
<PAGE>
APPENDIX
MUNICIPAL BONDS
Municipal bonds include debt obligations issued by or on behalf of a
state, a territory, or a possession of the United States, the District of
Columbia or any political subdivision, agency or instrumentality thereof (for
example, counties, cities, towns, villages, districts, authorities) to obtain
funds for various public purposes, including the construction of a wide range of
public facilities such as airports, bridges, highways, housing, hospitals, mass
transportation, schools, streets and water and sewer works. Other public
purposes for which municipal bonds may be issued include the refunding of
outstanding obligations, obtaining funds for general operating expenses and
obtaining funds to lend to public or private institutions for the construction
of facilities such as educational, hospital and housing facilities. In addition,
certain types of industrial development bonds have been or may be issued by or
on behalf of public authorities to finance certain privately operated facilities
and certain local facilities for water supply, gas, electricity or sewage or
solid waste disposal. Such obligations are included within the term municipal
bonds if the interest paid thereon qualifies as exempt from federal income tax.
The income of certain types of industrial development bonds used to finance
certain privately operated facilities (qualified "private activity" bonds)
issued after August 7, 1986, while exempt from federal income tax, is includable
for purposes of the calculation of the alterative minimum tax. Other types of
industrial development bonds, the proceeds of which are used for the
construction, equipment, repair or improvement of privately operated industrial
or commercial facilities, may constitute municipal bonds, although the current
federal tax laws place substantial limitations on the size of such issues.
The two principal classifications of municipal bonds are "general
obligation" and "limited obligation" or "revenue" bonds. General obligation
bonds are obligations involving the credit of an issuer possessing taxing power
and are payable from the issuer's general unrestricted revenues and not from any
particular fund or revenue source. Their payment may be dependent upon an
appropriation by the issuer's legislative body and may be subject to
quantitative limitations on the issuer's taxing power. The characteristics and
methods of enforcement of general obligation bonds vary according to the law
applicable to the particular issuer. Limited obligation or revenue bonds are
payable only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise or other
specific revenue source, such as the user of the facility. Industrial
development bonds that are municipal bonds are in most cases revenue bonds and
generally are not payable from the unrestricted revenues of the issuer. The
credit quality of industrial development revenue bonds is usually directly
related to the credit standing of the owner or user of the facilities. There
are, of course, variations in the security of municipal bonds, both within a
particular classification and between classifications, depending on numerous
factors.
The yields on municipal bonds are dependent on a variety of factors,
including general money market conditions, the financial condition of the
issuer, general conditions of the municipal bond market, size of a particular
offering, the maturity of the obligation and rating of the issue. The ratings of
Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's Corporation
("S&P") and Fitch Investor Services, Inc. ("Fitch"), as described herein and in
the prospectus, represent their opinions as to the quality of the municipal
bonds that they undertake to rate. It should be emphasized, however, that
ratings are general and are not absolute standards of quality. Consequently,
municipal bonds with the same maturity, interest rate and rating may have
different yields while municipal bonds of the same maturity and interest rate
with different ratings may have the same yield. It should also be noted that the
standards of disclosure applicable to and the amount of information relating to
the financial condition of issuers of municipal bonds are not as extensive as
those generally relating to corporations.
Subsequent to its purchase by the Fund, an issue of municipal bonds or
other investment may cease to be rated or its rating may be reduced below the
minimum rating required for purchase by the Fund. Neither event requires the
elimination of such obligation from the Fund's portfolio, but Keystone will
consider such an event in its determination of whether the Fund should continue
to hold such obligation in its portfolio.
The ability of the Fund to achieve its investment objective is
dependent upon the continuing ability of issuers of municipal bonds to meet
their obligations to pay interest and principal when due. Obligations of issuers
of municipal bonds, including municipal bonds issued by them, are subject to the
provisions of bankruptcy, insolvency and other laws affecting the rights and
remedies of creditors, such as the federal Bankruptcy Act, and laws, if any,
that may be enacted by Congress or state legislatures extending the time for
payment of principal or interest, or both, or imposing other constraints upon
enforcement of such obligations. There is also the possibility that as a result
of litigation or other conditions, the power or ability of any one or more
issuers to pay, when due, principal of and interest on its or their municipal
bonds may be materially affected. In addition the market for municipal bonds is
often thin and can be temporarily affected by large purchases and sales
including those by the Fund.
From time to time, proposals have been introduced before Congress for
the purpose of restricting or eliminating the federal income tax exemption for
interest on municipal bonds, and similar proposals may well be introduced in the
future. If such a proposal were enacted, the availability of municipal bonds for
investment by the Fund and the value of the Fund's portfolio could be materially
affected; in which event, the Fund would reevaluate its investment objective and
policies and consider changes in the structure of the Fund or dissolution.
DESCRIPTION OF BOND RATINGS
The Tax Reform Act of 1986 made significant changes in the federal tax
status of certain obligations that were previously fully federally tax exempt.
As a result, three categories of such obligations issued after August 7, 1986
now exist: (1) "public purpose" bonds, the income of which remains fully exempt
from federal income tax; (2) qualified "private activity" industrial development
bonds, the income of which, while exempt from federal income tax under Section
103 of the Internal Revenue Code, as amended (the "Code") is includable in the
calculation of the federal alternative minimum tax; and (3) "private activity"
(private purpose) bonds, the income of which is not exempt from federal income
tax. The Fund will not invest in private activity (private purpose) bonds, and,
except as described under "Other Eligible Securities," will not invest in
qualified "private activity" industrial development bonds.
CORPORATE AND MUNICIPAL BOND RATINGS
S&P CORPORATE AND MUNICIPAL BOND RATINGS
A. MUNICIPAL NOTES
An S&P note rating reflects the liquidity concerns and market access
risks unique to notes. Notes due in 3 years or less will likely receive a note
rating. Notes maturing beyond 3 years will most likely receive a long term debt
rating. The following criteria are used in making that assessment:
a. Amortization schedule (the larger the final maturity relative to
other maturities the more likely it will be treated as a note); and
b. Source of payment (the more dependent the issue is on the market for
its refinancing, the more likely it will be treated as a note).
Note ratings are as follows:
1. 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.
2. SP-2 Satisfactory capacity to pay principal and interest.
3. SP-3 Speculative capacity to pay principal and interest.
<PAGE>
B. TAX EXEMPT DEMAND BONDS
S&P assigns "dual" ratings to all long-term debt issues that have as
part of their provisions a demand or double feature.
The first rating addresses the likelihood of repayment of principal and
interest as due, and the second rating addresses only the demand feature. The
long-term debt rating symbols are used for bonds to denote the long-term
maturity and the commercial paper rating symbols are used to denote the put
option (for example, "AAA/A-1+"). For the newer "demand notes," S&P note rating
symbols, combined with the commercial paper symbols, are used (for example,
"SP-1+/A-1+").
C. CORPORATE AND MUNICIPAL BOND RATINGS
An S&P corporate or municipal bond rating is a current assessment of
the creditworthiness of an obligor, including obligors outside the U.S., with
respect to a specific obligation. This assessment may take into consideration
obligors such as guarantors, insurers, or lessees. Ratings of foreign obligors
do not take into account currency exchange and related uncertainties. The
ratings are based on current information furnished by the issuer or obtained by
S&P from other sources it considers reliable.
The ratings are based, in varying degrees, on the following
considerations:
a. Likelihood of default - capacity and willingness of the
obligor as to the timely payment of interest and repayment of
principal in accordance with the terms of the obligation;
b. Nature of and provisions of the obligation; and
c. Protection afforded by and relative position of the obligation
in the event of bankruptcy reorganization or other arrangement
under the laws of bankruptcy and other laws affecting
creditors' rights.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, ratings from "AA" TO "BBB" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
A provisional rating is sometimes used by S&P. It assumes the
successful completion of the project being financed by the debt being rated and
indicates that payment of debt service requirements is largely or entirely
dependent upon the successful and timely completion of the project. This rating,
however, while addressing credit quality subsequent to completion of the
project, makes no comment on the likelihood of, or the risk of
default upon failure of, such completion.
Bond ratings are as follows:
1. AAA - Debt rated AAA has the highest rating assigned by S&P.
Capacity to pay interest and repay principal is extremely strong.
2. AA - Debt rated AA has a very strong capacity to pay interest and
repay principal and differs from the higher rated issues only in small degree.
3. A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
4. BBB - Debt rated BBB is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher rated categories.
MOODY'S CORPORATE AND MUNICIPAL BOND RATINGS
Moody's ratings are as follows:
1. Aaa - Bonds that are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt-edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
2. Aa - Bonds that are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present that
make the long-term risks appear somewhat larger than in Aaa securities.
3. A - Bonds that are rated A possess many favorable investment
attributes and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate but elements
may be present that suggest a susceptibility to impairment sometime in the
future.
4. Baa - Bonds that are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through Baa in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
Con. (---) - Municipal bonds for which the security depends upon the
completion of some act or the fulfillment of some condition are rated
conditionally. These are bonds secured by (a) earnings of projects under
construction, (b) earnings of projects unseasoned in operation experience, (c)
rentals that begin when facilities are completed, or (d) payments to which some
other limiting condition attaches. Parenthetical rating denotes probable credit
stature upon completion of construction or elimination of basis of condition.
Those municipal bonds in the Aa, A, and Baa groups that Moody's
believes possess the strongest investment attributes are designated by the
symbols Aa 1, A 1, and Baa 1.
MONEY MARKET INSTRUMENTS
The Fund's investments in commercial paper are limited to those rated
A-1 by S&P, Prime-1 by Moody's, or F-1 by Fitch. These ratings and other money
market instruments are described as follows:
COMMERCIAL PAPER RATINGS
Commercial paper rated A-1 by S&P has the following characteristics.
Liquidity ratios are adequate to meet cash requirements. The issuer's long-term
senior debt is rated "A" or better, although in some cases "BBB" credits may be
allowed. The issuer has access to at least two additional channels of borrowing.
Basic earnings and cash flow have an upward trend with allowance made for
unusual circumstances. Typically, the issuer's industry is well established and
the issuer has a strong position within the industry.
Commercial paper rated A-2 by S&P has the same characteristics as that
rated A-1 except that the relative degree of safety is not as overwhelming.
Commercial paper rated A-3 has a satisfactory capacity for timely
payment. However, it is somewhat more vulnerable to the adverse effects of
changes in circumstances than obligations rated A-1 or A-2.
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Among the factors considered by Moody's in assigning ratings are the
following: (1) evaluation of the management of the issuer; (2) economic
evaluation of the issuer's industry or industries and an appraisal of
speculative-type risks which may be inherent in certain areas; (3) evaluation of
the issuer's products in relation to competition and customer acceptance; (4)
liquidity; (5) amount and quality of long-term debt; (6) trend of earnings over
a period of ten years; (7) financial strength of a parent company and the
relationships that exist with the issuer; and (8) recognition by the management
of obligations that may be present or may arise as a result of public
preparations to meet such obligations. Relative strength or weakness of the
above factors determines how the issuer's commercial paper is rated within
various categories.
Commercial paper rated Prime-2 by Moody's is considered somewhat lower
than the best commercial paper because margins of protection may not be as large
or because fluctuations of protective elements over the near or intermediate
term may be of greater amplitude.
UNITED STATES GOVERNMENT SECURITIES
Securities issued or guaranteed by the U.S. Government include a
variety of Treasury securities that differ only in their interest rates,
maturities and dates of issuance. Treasury bills have maturities of one year or
less. Treasury notes have maturities of one to ten years and Treasury bonds
generally have maturities of greater than ten years at the date of issuance.
Securities issued or guaranteed by the U.S. Government or its agencies
or instrumentalities include direct obligations of the United States Treasury
and securities issued or guaranteed by the Federal Housing Administration,
Farmers Home Administration, Export-Import Bank of the United States, Small
Business Administration, Government National Mortgage Association, General
Services Administration, Central Bank for Cooperatives, Federal Home Loan Banks,
Federal Loan Mortgage Corporation, Federal Intermediate Credit Banks, Federal
Land Banks, Maritime Administration, The Tennessee Valley Authority, District of
Columbia Armory Board and Federal National Mortgage Association.
Some obligations of U.S. Government agencies and instrumentalities,
such as Treasury bills and Government National Mortgage Association ("GNMA")
pass-through certificates, are supported by the full faith and credit of the
United States; others, such as securities of Federal Home Loan Banks, by the
right of the issuer to borrow from the Treasury; still others, such as bonds
issued by the Federal National Mortgage Association, a private corporation, are
supported only by the credit of the instrumentality. Because the U.S. Government
is not obligated by law to provide support to an instrumentality it sponsors,
the Fund will invest in the securities issued by such an instrumentality only
when Keystone determines that the credit risk with respect to the
instrumentality does not make its securities unsuitable investments. U.S.
Government securities will not include international agencies or
instrumentalities in which the U.S. Government, its agencies or
instrumentalities participate, such as the International Bank for Reconstruction
and Development (the "World Bank"), the Asian Development Bank or the
Inter-American Development Bank, or issues insured by the Federal Deposit
Insurance Corporation.
CERTIFICATES OF DEPOSITS
Certificates of deposit are receipts issued by a bank in exchange for
the deposit of funds. The issuer agrees to pay the amount deposited plus
interest to the bearer of the receipt on the date specified on the certificate.
The certificate usually can be traded in the secondary market prior to maturity.
Certificates of deposit will be limited to U.S. dollar-denominated
certificates of U.S. banks (including their branches abroad) and of U.S.
branches of foreign banks that are members of the Federal Reserve System or the
Federal Deposit Insurance Corporation, and have at least $1 billion in deposits
as of the date of their most recently published financial statements.
The Fund will not acquire time deposits or obligations issued by the
World Bank, the Asian Development Bank or the Inter-American Development Bank.
Additionally, the Fund does not currently intend to purchase foreign securities
(except to the extent that certificates of deposit of foreign branches of U.S.
banks may be deemed foreign securities) or purchase certificates of deposit,
bankers' acceptances or other similar obligations issued by foreign banks.
BANKERS' ACCEPTANCES
Bankers' acceptances typically arise from short-term credit
arrangements designed to enable businesses to obtain funds to finance commercial
transactions. Generally, an acceptance is a time draft drawn on a bank by an
exporter or an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by the bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
earning asset or it may be sold in the secondary market at the going rate of
discount for a specific maturity. Although maturities for acceptances can be as
long as 270 days, most acceptances have maturities of six months or less.
Bankers' acceptances acquired by the Fund must have been accepted by U.S.
commercial banks, including foreign branches of U.S. commercial banks, having
total deposits at the time of purchase in excess of $1 billion and must be
payable in U.S. dollars.
OPTIONS TRANSACTIONS
The Fund may enter into options transactions. Any premium paid by the
Fund in connection with an option transaction may be forfeited if the option
expires unexercised.
WRITING COVERED OPTIONS. The Fund writes only covered options. Options
written by the Fund will normally have expiration dates of not more than nine
months from the date written. The exercise price of the options may be below,
equal to, or above the current market values of the underlying securities at the
times the options are written.
Unless the option has been exercised, the Fund may close out an option
it has written by effecting a closing purchase transaction, whereby it purchases
an option covering the same underlying security and having the same exercise
price and expiration date (of the same series) as the one it has written. If the
Fund desires to sell a particular security on which it has written a call
option, it will effect a closing purchase transaction prior to or concurrently
with the sale of the security. If the Fund is able to enter into a closing
purchase transaction, the Fund will realize a profit (or loss) from such
transaction if the cost of such transaction is less (or more) than the premium
received from the writing of the option.
An option position may be closed out only in a secondary market for an
option of the same series. Although the Fund will generally write only those
options for which there appears to be an active secondary market, there is no
assurance that a liquid secondary market will exist for any particular option at
any particular time, and for some options no secondary market may exist. In such
event it might not be possible to effect a closing purchase transaction in a
particular option. If the Fund as a covered call option writer is unable to
effect a closing purchase transaction, it will not be able to sell the
underlying securities until the option expires or it delivers the underlying
securities upon exercise.
Because the Fund intends to qualify as a regulated investment company
under the Code, the extent to which the Fund may write covered call options and
enter into so-called "straddle" transactions involving put and call options may
be limited.
Many options are traded on registered securities exchanges. Options
traded on such exchanges are issued by the Options Clearing Corporation ("OCC"),
a clearing corporation that assumes responsibility for the completion of options
transactions.
PURCHASING PUT AND CALL OPTIONS. The Fund can close out a put option it
has purchased by effecting a closing sale transaction; for example, the Fund may
close out a put option it has purchased by selling a put option. If, however, a
secondary market does not exist at a time the Fund wishes to effect a closing
sale transaction, the Fund will have to exercise the option to realize any
profit. In addition, in a transaction in which the Fund does not own the
security underlying a put option it has purchased, the Fund would be required,
in the absence of a secondary market, to purchase the underlying security before
it could exercise the option. In each such instance, the Fund would incur
additional transaction costs.
The Fund may purchase call options for the purpose of offsetting
previously written call options of the same series. The Fund also may purchase
call options to fix the interest rates of obligations held by it.
The Fund will not purchase a put option if, as a result of such
purchase, more than 10% of its total assets would be invested in premiums for
such options. The Fund's ability to purchase put and call options may be limited
by the Code's requirements for qualification as a regulated investment company.
OPTION WRITING AND RELATED RISKS
The Fund may write covered call and put options. A call option gives
the purchaser of the option the right to buy, and the writer the obligation to
sell, the underlying security at the exercise price during the option period.
Conversely, a put option gives the purchaser the right to sell, and the writer
the obligation to buy, the underlying security at the exercise price during the
option period.
So long as the obligation of the writer continues, the writer may be
assigned an exercise notice by the broker-dealer through whom the option was
sold. The exercise notice would require the writer to deliver, in the case of a
call, or take delivery of, in the case of a put, the underlying security against
payment of the exercise price. This obligation terminates upon expiration of the
option, or at such earlier time as the writer effects a closing purchase
transaction by purchasing an option of the same series as the one previously
sold. Once an option has been exercised, the writer may not execute a closing
purchase transaction. For options traded on national securities exchanges
("Exchanges"), to secure the obligation to deliver the underlying security in
the case of a call option, the writer of the option is required to deposit in
escrow the underlying security or other assets in accordance with the rules of
the OCC, an institution created to interpose itself between buyers and sellers
of options. Technically, the OCC assumes the order side of every purchase and
sale transaction on an Exchange and, by doing so, gives its guarantee to the
transaction.
The principal reason for writing options on a securities portfolio is
to attempt to realize, through the receipt of premiums, a greater return than
would be realized on the underlying securities alone. In return for the premium,
the covered call option writer has given up the opportunity for profit from a
price increase in the underlying security above the exercise price so long as
the option remains open, but retains the risk of loss should the price of the
security decline. Conversely, the put option writer gains a profit, in the form
of a premium, so long as the price of the underlying security remains above the
exercise price, but must purchase the underlying security from the buyer of the
put option at the exercise price, even though the price of the security may fall
below the exercise price, at any time during the option period. If an option
expires, the writer realizes a gain in the amount of the premium. Such a gain
may, in the case of a covered call option, be offset by a decline in the market
value of the underlying security during the option period. If a call option is
exercised, the writer realizes a gain or loss from the sale of the underlying
security. If a put option is exercised, the writer must fulfill his obligation
to purchase the underlying security at the exercise price, which will usually
exceed the then market value of the underlying security. In addition, the
premium paid for the put effectively increases the cost of the underlying
security, thus reducing the yield otherwise available from such securities.
Because the Fund can write only covered options, it may at times be
unable to write additional options unless it sells a portion of its portfolio
holdings to obtain new securities against which it can write options. This may
result in higher portfolio turnover and correspondingly greater brokerage
commissions and other transaction costs.
To the extent that a secondary market is available, the covered option
writer may close out options it has written prior to the assignment of an
exercise notice by purchasing, in a closing purchase transaction, an option of
the same series as the option previously written. If the cost of such a closing
purchase plus transaction costs is greater than the premium received upon
writing the original option, the writer will incur a loss in the transaction.
OPTIONS TRADING MARKETS
Options that the Fund will trade are generally listed on national
securities exchanges. Exchanges on which such options currently are traded are
the Chicago Board Options Exchange and the New York, American, Pacific, and
Philadelphia Stock Exchanges. Options on some securities may not be listed on
any Exchange but traded in the over-the-counter market. Options traded in the
over-the-counter market involve the additional risk that securities dealers
participating in such transactions would fail to meet their obligations to the
Fund. The use of options traded in the over-the-counter market may be subject to
limitations imposed by certain state securities authorities. In addition to the
limits on its use of options discussed herein, the Fund is subject to the
investment restrictions described in the prospectus and statement of additional
information.
The staff of the Securities and Exchange Commission ("Commission")
currently is of the view that the premiums that the Fund pays for the purchase
of unlisted options, and the value of securities used to cover unlisted options
written by the Fund, are considered to be invested in illiquid securities or
assets for the purpose of calculating whether the Fund is in compliance with its
investment restrictions pertaining to illiquid assets and securities.
SPECIAL CONSIDERATIONS APPLICABLE TO OPTIONS
ON TREASURY BONDS AND NOTES. Because trading interest in U.S. Treasury
bonds and notes tends to center on most recently auctioned issues, new series of
options with expirations to replace expiring options on particular issues will
not be introduced indefinitely. Instead, the expirations introduced at the
commencement of options trading on a particular issue will be allowed to run
their course, with the possible addition of a limited number of new expirations
as the original ones expire. Options trading on each series of bonds or notes
will thus be phased out as new options are listed on the more recent issues, and
a full range of expiration dates will not ordinarily be available for every
series on which options are traded.
ON TREASURY BILLS. Because the deliverable U.S. Treasury bill changes
from week to week, writers of U.S. Treasury bills call options cannot provide in
advance for their potential exercise settlement obligations by acquiring and
holding the underlying security. However, if the Fund holds a long position in
U.S. Treasury bills with a principal amount corresponding to the option contract
size, the Fund may be hedged from a risk standpoint. In addition, the Fund will
maintain in a segregated account with its custodian able in the event of an
assignment of an exercise notice to ensure that it can meet its open option
obligations.
ON GNMA CERTIFICATES. Options on GNMA certificates are not currently
traded on any Exchange. However, the Fund may purchase and write such options in
the over the counter market, or should they commence trading, on any Exchange.
Since the remaining principal balance of GNMA certificates declines
each month as a result of mortgage payments, the Fund, as a writer of a covered
GNMA call holding GNMA certificates as "cover" to satisfy its delivery
obligation in the event of assignment of an exercise notice, may find that its
GNMA certificates no longer have a sufficient remaining principal balance for
this purpose. Should this occur, the Fund will enter into a closing purchase
transaction or will purchase additional GNMA certificates from the same pool (if
obtainable) or replacement GNMA certificates in the cash market in order to
remain covered.
A GNMA certificate held by the Fund to cover an option position in any
but the nearest expiration month may cease to present cover for the option in
the event of a decline in the GNMA coupon rate at which new pools are originated
under the FHA/VA loan ceiling in effect at any given time. Should this occur,
the Fund will no longer be covered, and the Fund will either enter into a
closing purchase transaction or replace the GNMA certificate with a certificate
which represents cover. When the Fund closes its position or replaces the GNMA
certificate, it may realize an unanticipated loss and incur transaction costs.
RISKS PERTAINING TO THE SECONDARY MARKET. An option position may be
closed out only in a secondary market for an option of the same series. Although
the Fund will generally purchase or write only those options for which there
appears to be an active secondary market, there is no assurance that a liquid
secondary market will exist for any particular option at any particular time,
and for some options no secondary market may exist. In such event, it might not
be possible to effect closing transactions in particular options, with the
result that the Fund would have to exercise its options in order to realize any
profit and might incur transaction costs in connection therewith. If the Fund as
a covered call option writer is unable to effect a closing purchase transaction
in a secondary market, it will not be able to sell the underlying security until
the option expires or it delivers the underlying security upon exercise.
Reasons for the absence of a liquid secondary market include the
following: (i) insufficient trading interest in certain options; (ii)
restrictions imposed on transactions; (iii) trading halts, suspensions or other
restrictions imposed with respect to particular classes or series of options or
underlying securities; (iv) interruption of the normal operations on an Exchange
or by a broker; (v) inadequacy of the facilities of an Exchange, the OCC or a
broker to handle current trading volume; or (vi) a decision by one or more
Exchanges or a broker to discontinue the trading of options (or a particular
class or series of options), in which event the secondary market in that class
or series of options would cease to exist, although outstanding options that had
been issued as a result of trades would generally continue to be exercisable in
accordance with their terms.
The hours of trading for options on U.S. government securities may not
conform to the hours during which the underlying securities are traded. To the
extent that the option markets close before the markets for the underlying
securities, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
FUTURES CONTRACTS AND RELATED OPTIONS TRANSACTIONS
The Fund intends to enter into currency and other financial futures
contracts as a hedge against changes in prevailing levels of interest or
currency exchange rates to seek relative stability of principal and to establish
more definitely the effective return on securities held or intended to be
acquired by the Fund or as a hedge against changes in the prices of securities
or currencies held by the Fund or to be acquired by the Fund. The Fund's hedging
may include sales of futures as an offset against the effect of expected
increases in interest or currency exchange rates or securities prices and
purchases of futures as an offset against the effect of expected declines in
interest or currency exchange rates.
For example, when a fund anticipates a significant market or market
sector advance, it will purchase a stock index futures contract as a hedge
against not participating in such advance at a time when a fund is not fully
invested. The purchase of a futures contract serves as a temporary substitute
for the purchase of individual securities, which may then be purchased in an
orderly fashion. As such purchases are made, an equivalent amount of index based
futures contracts would be terminated by offsetting sales. In contrast, a fund
would sell stock index futures contracts in anticipation of or in a general
market or market sector decline that may adversely affect the market value of a
fund's portfolio. To the extent that the Fund's portfolio changes in value in
correlation with a given index, the sale of futures contracts on that index
would substantially reduce the risk to the portfolio of a market decline or
change in interest rates, and, by so doing, provide an alternative to the
liquidation of the Fund's securities positions and the resulting transaction
costs.
The Fund intends to engage in options transactions that are related to
commodity futures contracts for hedging purposes and in connection with the
hedging strategies described above.
Although techniques other than sales and purchases of futures contracts
and related options transactions could be used to reduce the Fund's exposure to
interest rate and/or market fluctuations, the Fund may be able to hedge its
exposure more effectively and perhaps at a lower cost through using futures
contracts and related options transactions. The Fund does not intend to take
delivery of the instruments underlying futures contracts it holds and does not
intend to engage in such futures contracts for speculation.
FUTURES CONTRACTS
Futures contracts are transactions in the commodities markets rather
than in the securities markets. A futures contract creates an obligation by the
seller to deliver to the buyer the commodity specified in the contract at a
specified future time for a specified price. The futures contract creates an
obligation by the buyer to accept delivery from the seller of the commodity
specified at the specified future time for the specified price. In contrast, a
spot transaction creates an immediate obligation for the seller to deliver and
the buyer to accept delivery of and pay for an identified commodity. In general,
futures contracts involve transactions in fungible goods, such as wheat, coffee
and soybeans. However, in the last decade an increasing number of futures
contracts have been developed that specify currencies, financial instruments or
financially based indexes as the underlying commodity.
U.S. futures contracts are traded only on national futures exchanges
and are standardized as to maturity date and underlying financial instrument.
The principal financial futures exchanges in the United States are The Board of
Trade of the City of Chicago, the Chicago Mercantile Exchange, the International
Monetary Market (a division of the Chicago Mercantile Exchange), the New York
Futures Exchange and the Kansas City Board of Trade. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership, which is also
responsible for handling daily accounting of deposits or withdrawals of margin.
A futures commission merchant ("Broker") effects each transaction in connection
with futures contracts for a commission. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission ("CFTC") and National Futures Association ("NFA").
INTEREST RATE FUTURES CONTRACTS
The sale of an interest rate futures contract creates an obligation by
the Fund, as seller, to deliver the type of financial instrument specified in
the contract at a specified future time for a specified price. The purchase of
an interest rate futures contract creates an obligation by the Fund, as
purchaser, to accept delivery of the type of financial instrument specified at a
specified future time for a specified price. The specific securities delivered
or accepted, respectively, at settlement date, are not determined until at or
near that date. The determination is in accordance with the rules of the
exchange on which the futures contract sale or purchase was made.
Currently, interest rate futures contracts can be purchased or sold on
90-day U.S. Treasury bills, U.S. Treasury bonds, U.S. Treasury notes with
maturities between 6 1/2 and 10 years, certificates, and 90-day Eurodollar
certificates of deposit. It is expected that futures contracts trading in
additional financial instruments will be authorized. The standard contract size
is $100,000 for futures contracts in U.S. Treasury bonds, and U.S. Treasury
notes and $1,000,000 for the other designated contracts. While U.S. Treasury
bonds, U.S. Treasury bills and U.S. Treasury notes are backed by the full faith
and credit of the U.S. government; the futures contracts in U.S. government
securities are not obligations of the U.S. Treasury.
INDEX BASED FUTURES CONTRACTS
It is expected that bond index and other financially based index
futures contracts will be developed in the future. It is anticipated that such
index based futures contracts will be structured in the same way as stock index
futures contracts, but will be measured by changes in interest rates, related
indexes or other measures, such as the consumer price index. In the event that
such futures contracts are developed, the Fund will sell interest rate index and
other index based futures contracts to hedge against changes which are expected
to affect the Fund's portfolio.
The purchase or sale of a futures contract differs from the purchase or
sale of a security, in that no price or premium is paid or received. Instead, to
initiate trading an amount of cash, cash equivalents, money market instruments,
or U.S. Treasury bills equal to approximately 1 1/2% (up to 5%) of the contract
amount must be deposited by the Fund with the Broker. This amount is known as
initial margin. The nature of initial margin in futures transactions is
different from that of margin in security transactions. Futures contract margin
does not involve the borrowing of funds by the customer to finance the
transactions. Rather, the initial margin is in the nature of a performance bond
or good faith deposit on the contract which is returned to the Fund upon
termination of the futures contract assuming all contractual obligations have
been satisfied. 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.
Subsequent payments, called variation margin, to the Broker and from
the Broker, are made on a daily basis as the value of the underlying instrument
or index fluctuates making the long and short positions in the futures contract
more or less valuable, a process known as mark-to-market. For example, when the
Fund has purchased a futures contract and the price of the underlying financial
instrument or index has risen, that position will have increased in value and
the Fund will receive from the Broker a variation margin payment equal to that
increase in value. Conversely, where the Fund has purchased a futures contract
and the price of the underlying financial instrument or index has declined, the
position would be less valuable and the Fund would be required to make a
variation margin payment to the Broker. At any time prior to expiration of the
futures contract, the Fund may elect to close the position. A final
determination of variation margin is then made, additional cash is required to
be paid to or released by the Broker, and the Fund realizes a loss or gain.
The Fund intends to enter into arrangements with its custodian and with
Brokers to enable its initial margin and any variation margin to be held in a
segregated account by its custodian on behalf of the Broker.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of financial instruments, and index based futures
contracts call for the delivery of cash equal to the difference between the
closing value of the index on the expiration date of the contract and the price
at which the futures contract is originally made, in most cases such futures
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out a futures contract sale is effected by an offsetting
transaction in which the Fund enters into a futures contract purchase for the
same aggregate amount of the specific type of financial instrument or index and
same delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is paid the difference and thus realizes a gain. If the
offsetting purchase price exceeds the sale price, the Fund pays the difference
and realizes a loss. Similarly, the closing out of a futures contract purchase
is effected by an offsetting transaction in which the Fund enters into a futures
contract sale. If the offsetting sale price exceeds the purchase price, the Fund
realizes a gain. If the purchase price exceeds the offsetting sale price, the
Fund realizes a loss. The amount of the Fund's gain or loss on any transaction
is reduced or increased, respectively, by the amount of any transaction costs
incurred by the Fund.
As an example of an offsetting transaction, the contractual obligations
arising from the sale of one contract of September U.S. Treasury bills 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 U.S. Treasury bills 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.
There can be no assurance, however, that the Fund will be able to enter
into an offsetting transaction with respect to a particular 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 contract and to complete the contract according to its terms.
<PAGE>
OPTIONS ON CURRENCY AND OTHER FINANCIAL FUTURES
The Fund intends to purchase call and put options on currency and other
financial futures contracts and sell such options to terminate an existing
position. Options on currency and other financial futures contracts are similar
to options on stocks except that an option on a currency or other financial
futures contract gives the purchaser the right, in 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 stock, currency or other financial instruments 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. This amount 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. If an option is exercised the last trading day prior to the
expiration date of the option, the settlement will be made entirely in cash
equal to the difference between the exercise price of the option and value of
the futures contract.
The Fund intends to use options on currency and other financial futures
contracts in connection with hedging strategies. In the future the Fund may use
such options for other purposes.
PURCHASE OF PUT OPTIONS ON FUTURES CONTRACTS
The purchase of protective put options on a currency or other financial
futures contract is analogous to the purchase of protective puts on individual
stocks, where an absolute level of protection is sought below which no
additional economic loss would be incurred by the Fund. Put options may be
purchased to hedge a portfolio of stocks or debt instruments or a position in
the futures contract upon which the put option is based.
PURCHASE OF CALL OPTIONS ON FUTURES CONTRACTS
The purchase of a call option on a currency or other financial futures
contract represents a means of obtaining temporary exposure to market
appreciation at limited risk. It is analogous to the purchase of a call option
on an individual stock which can be used as a substitute for a position in the
stock itself. Depending on the pricing of the option compared to either the
futures contract upon which it is based, or upon the price of the underlying
financial instrument or index itself, the purchase of a call option may be less
risky than the ownership of the interest rate or index based futures contract or
the underlying securities. Call options on currency and other financial futures
contracts may be purchased to hedge against an interest rate increase or a
market advance when the Fund is not fully invested.
USE OF NEW INVESTMENT TECHNIQUES INVOLVING COMMODITY FUTURES CONTRACTS OR
RELATED OPTIONS
The Fund may employ new investment techniques involving currency and
other financial futures contracts and related options. The Fund intends to take
advantage of new techniques in these areas that may be developed from time to
time and that are consistent with the Fund's investment objective. The Fund
believes that no additional techniques have been identified for employment by
the Fund in the foreseeable future other than those described above.
LIMITATIONS ON PURCHASE AND SALE OF FUTURES CONTRACTS AND RELATED OPTIONS ON
SUCH FUTURES CONTRACTS
The Fund will not enter into a futures contract if, as a result
thereof, more than 5% of the Fund's total assets (taken at market value at the
time of entering into the contract) would be committed to margin deposits on
such futures contracts.
The Fund intends that its futures contracts and related options
transactions will be entered into for traditional hedging purposes. That is,
futures contracts will be sold to protect against a decline in the price of
securities that the Fund owns or futures contracts will be purchased to protect
the Fund against an increase in the price of securities it intends to purchase.
The Fund does not intend to enter into futures contracts for speculation.
In instances involving the purchase of futures contracts by the Fund,
an amount of cash and cash equivalents equal to the market value of the futures
contracts will be deposited in a segregated account with the Fund's custodian
and/or in a margin account with a Broker to collateralize the position and
thereby insure that the use of such futures is unleveraged.
FEDERAL INCOME TAX TREATMENT
For federal income tax purposes, the Fund is required 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. Any gain or loss recognized with respect to a futures contract is
considered to be 60% long term and 40% short term, without regard to the holding
period of the contract. In the case of a futures transaction classified as a
"mixed straddle," the recognition of losses may be deferred to a later taxable
year. The federal income tax treatment of gains or losses from transactions in
options on futures is unclear.
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. Any net gain realized
from the closing out of futures contracts, for purposes of the 90% requirement,
will be qualifying income. In addition, gains realized on the sale or other
disposition of securities held for less than three months must be limited to
less than 30% of the Fund's annual gross income. The 1986 Tax Act added a
provision which effectively treats both positions in certain hedging
transactions as a single transaction for the purpose of the 30% requirement. The
provision provides that, in the case of any "designated hedge," increases and
decreases in the value of positions of the hedge are to be netted for the
purposes of the 30% requirement. However, in certain situations, in order to
avoid realizing again within a three month period, the Fund may be required to
defer the closing out of a contract beyond the time when it would otherwise be
advantageous to do so.
RISKS OF FUTURES CONTRACTS
Currency and other financial futures contracts prices are volatile and
are influenced, among other things, by changes in stock prices, market
conditions, prevailing interest rates and anticipation of future stock prices,
market movements or interest rate changes, all of which in turn are affected by
economic conditions, such as government fiscal and monetary policies and
actions, and national and international political and economic events.
At best, the correlation between changes in prices of futures contracts
and of the securities being hedged can be only approximate. The degree of
imperfection of correlation depends upon circumstances, such as variations in
speculative market demand for futures contracts and for securities, including
technical influences in futures contracts trading; and differences between the
securities being hedged and the financial instruments and indexes underlying the
standard futures contracts available for trading, in such respects as interest
rate levels, maturities and creditworthiness of issuers, or identities of
securities comprising the index and those in the Fund's portfolio. A decision of
whether, when and how to hedge involves the exercise of skill and judgment, and
even a well-conceived hedge may be unsuccessful to some degree because of market
behavior or unexpected interest rate trends.
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 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, and a 15% decrease would result in a loss equal to 150% of the
original margin deposit. 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 entering into the futures contract, it had invested in the underlying
financial instrument. Furthermore, in order to be certain that the Fund has
sufficient assets to satisfy its obligations under a futures contract, the Fund
will establish a segregated account in connection with its futures contracts
which will hold cash or cash equivalents equal in value to the current value of
the underlying instruments or indices less the margins on deposit.
Most U.S. 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
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.
RISKS OF OPTIONS ON FUTURES CONTRACTS
In addition to the risks described above for currency and other
financial futures contracts, there are several special risks relating to options
on futures contracts. The ability to establish and close out positions on such
options will be subject to the development and maintenance of a liquid secondary
market. There is no assurance that a liquid secondary market will exist for any
particular contract or at any particular time. The Fund will not purchase
options on any futures contract unless and until it believes that the market for
such options has developed sufficiently that the risks in connection with such
options are not greater than the risks in connection with the futures contracts.
Compared to the use of futures contracts, the purchase of options on such
futures involves less potential risk to the Fund because the maximum amount at
risk is the premium paid for the options (plus transaction costs). However,
there may be circumstances when the use of an option on a futures contract would
result in a loss to the Fund, even though the use of a futures contract would
not, such as when there is no movement in the level of the futures contract.
FOREIGN CURRENCY TRANSACTIONS
The Fund may invest in securities denominated in foreign currencies,
and the Fund temporarily may hold funds in foreign currencies. Thus, the Fund's
share value will be affected by changes in exchange rates.
FORWARD CURRENCY CONTRACTS
As one way of managing exchange rate risk, the Fund may engage in
forward currency exchange contracts (agreements to purchase or sell currencies
at a specified price and date). Under the contract, the exchange rate for the
transaction (the amount of currency the Fund will deliver or receive when the
contract is completed) is fixed when the Fund enters into the contract. The Fund
usually will enter into these contracts to stabilize the U.S. dollar value of a
security it has agreed to buy or sell. The Fund also may use these contracts to
hedge the U.S. dollar value of a security it already owns, particularly if the
Fund expects a decrease in the value of the currency in which the foreign
security is denominated. Although the Fund will attempt to benefit from using
forward contracts, the success of its hedging strategy will depend on Keystone's
ability to predict accurately the future exchange rates between foreign
currencies and the U.S. dollar. The value of the Fund's investments denominated
in foreign currencies will depend on the relative strength of those currencies
and the U.S. dollar, and the Fund may be affected favorably or unfavorably by
changes in the exchange rate or exchange control regulations between foreign
currencies and the dollar. Changes in foreign currency exchange rates also may
affect the value of dividends and interest earned, gains and losses realized on
the sale of securities and net investment income and gains, if any, to be
distributed to shareholders by the Fund.
CURRENCY FUTURES CONTRACTS
Currency futures contracts are bilateral agreements under which two
parties agree to take or make delivery of a specified amount of a currency at a
specified future time for a specified price. Trading of currency futures
contracts in the United States is regulated under the Commodity Exchange Act by
the CFTC and NFA. Currently the only national futures exchange on which currency
futures are traded is the International Monetary Market of the Chicago
Mercantile Exchange. Foreign currency futures trading is conducted in the same
manner and subject to the same regulations as trading in interest rate and index
based futures. The Fund intends to only engage in currency futures contracts for
hedging purposes, and not for speculation. The Fund may engage in currency
futures contracts for other purposes if authorized to do so by the Board. The
hedging strategies that will be used by the Fund in connection with foreign
currency futures contracts are similar to those described above for forward
foreign currency exchange contracts.
Currently, currency futures contracts for the British Pound Sterling,
Canadian Dollar, Dutch Guilder, Deutsche Mark, Japanese Yen, Mexican Peso, Swiss
Franc and French Franc can be purchased or sold for U.S. dollars through the
International Monetary Market. It is expected that futures contracts trading in
additional currencies will be authorized. The standard contract sizes are
L125,000 for the Pound, 125,000 for the Guilder, Mark and Swiss Francs,
C$100,000 for the Canadian Dollar, Y12,500,000 for the Yen, and 1,000,000 for
the Peso. In contrast to Forward Currency Exchange Contracts, which can be
traded at any time, only four value dates per year are available, the third
Wednesday of March, June, September and December.
FOREIGN CURRENCY OPTIONS TRANSACTIONS
Foreign currency options (as opposed to futures) are traded in a
variety of currencies in both the United States and Europe. On the Philadelphia
Stock Exchange, for example, contracts for half the size of the corresponding
futures contracts on the Chicago Board Options Exchange are traded with up to
nine months maturity in Marks, Sterling, Yen, Swiss Francs and Canadian Dollars.
Options can be exercised at any time during the contract life and require a
deposit subject to normal margin requirements. Since a futures contract must be
exercised, the Fund must continually make up the margin balance. As a result, a
wrong price move could result in the Fund losing more than the original
investment as it cannot walk away from the futures contract as it can an option
contract.
The Fund will purchase call and put options and sell such options to
terminate an existing position. Options on foreign currency are similar to
options on stocks except that an option on an interest rate and/or index based
futures contract gives the purchaser the right, in return for the premium paid,
to purchase or sell foreign currency, rather than to purchase or sell stock, at
a specified exercise price at any time during the period of the option.
The Fund intends to use foreign currency option transactions in
connection with hedging strategies.
PURCHASE OF PUT OPTIONS ON FOREIGN CURRENCIES
The purchase of protective put options on a foreign currency is
analogous to the purchase of protective puts on individual stocks, where an
absolute level of protection is sought below which no additional economic loss
would be incurred by the Fund. Put options may be purchased to hedge a portfolio
of foreign stocks or foreign debt instruments or a position in the foreign
currency upon which the put option is based.
PURCHASE OF CALL OPTIONS ON FOREIGN CURRENCIES
The purchase of a call option on foreign currency represents a means of
obtaining temporary exposure to market appreciation at limited risk. It is
analogous to the purchase of a call option on an individual stock which can be
used as a substitute for a position in the stock itself. Depending on the
pricing of the option compared to either the foreign currency upon which it is
based, or upon the price of the foreign stock or foreign debt instruments, the
purchase of a call option may be less risky than the ownership of the foreign
currency or the foreign securities. The Fund would purchase a call option on a
foreign currency to hedge against an increase in the foreign currency or a
foreign market advance when the Fund is not fully invested.
The Fund may employ new investment techniques involving forward foreign
currency exchange contracts, foreign currency futures contracts and options on
foreign currencies in order to take advantage of new techniques in these areas
that may be developed from time to time and that are consistent with the Fund's
investment objective. The Fund believes that no additional techniques have been
identified for employment by the Fund in the foreseeable future other than those
described above.
CURRENCY TRADING RISKS
Currency exchange trading may involve significant risks. The four major
types of risk the Fund faces are exchange rate risk, interest rate risk, credit
risk and country risk.
EXCHANGE RATE RISK
Exchange rate risk results from the movement up and down of foreign
currency values in response to shifting market supply and demand. When the Fund
buys or sells a foreign currency, an exposure called an open position is
created. Until the time that position can be "covered" by selling or buying an
equivalent amount of the same currency, the Fund is exposed to the risk that the
exchange rate might move against it. Since exchange rate changes can readily
move in one direction, a position carried overnight or over a number of days
involves greater risk than one carried a few minutes or hours. Techniques such
as foreign currency forward and futures contracts and options on foreign
currency are intended to be used by the Fund to reduce exchange rate risk.
MATURITY GAPS AND INTEREST RATE RISK
Interest rate risk arises whenever there are mismatches or gaps in the
maturity structure of the Fund's foreign exchange currency holdings, which is
the total of its outstanding spot and forward or futures contracts.
Foreign currency transactions often involve borrowing short term and
lending longer term to benefit from the normal tendency of interest rates to be
higher for longer maturities. However in foreign exchange trading, while the
maturity pattern of interest rates for one currency is important, it is the
differential between interest rates for two currencies that is decisive.
CREDIT RISK
Whenever the Fund enters into a foreign exchange contract, it faces a
risk, however small, that the counterparty will not perform under the contract.
As a result there is a credit risk, although no extension of "credit" is
intended. To limit credit risk, the Fund intends to evaluate the
creditworthiness of each other party. The Fund does not intend to trade more
than 5% of its net assets under foreign exchange contracts with one party.
Credit risk exists because the Fund's counterparty may be unable or
unwilling to fulfill its contractual obligations as a result of bankruptcy or
insolvency or when foreign exchange controls prohibit payment. In any foreign
exchange transaction, each party agrees to deliver a certain amount of currency
to the other on a particular date. In establishing its hedges the Fund relies on
each contract being completed. If the contract is not performed, then the Fund's
hedge is eliminated, and the Fund is exposed to any changes in exchange rates
since the contract was originated. To put itself in the same position it would
have been in had the contract been performed, the Fund must arrange a new
transaction. However, the new transaction may have to be arranged at an adverse
exchange rate. The trustee for a bankrupt company may elect to perform those
contracts that are advantageous to the company but disclaim those contracts that
are disadvantageous, resulting in losses to the Fund.
Another form of credit risk stems from the time zone differences
between the U.S. and foreign nations. If the Fund sells sterling it generally
must pay pounds to a counterparty earlier in the day than it will be credited
with dollars in New York. In the intervening hours, the buyer can go into
bankruptcy or can be declared insolvent. Thus, the dollars may never be credited
to the Fund.
COUNTRY RISK
At one time or another, virtually every country has interfered with
international transactions in its currency. Interference has taken the form of
regulation of the local exchange market, restrictions on foreign investment by
residents or limits on inflows of investment funds from abroad. Governments take
such measures for example to improve control over the domestic banking system or
to influence the pattern of receipts and payments between residents and
foreigners. In those cases, restrictions on the exchange market or on
international transactions are intended to affect the level or movement of the
exchange rate. Occasionally a serious foreign exchange shortage may lead to
payment interruptions or debt servicing delays, as well as interference in the
exchange market. It has become increasingly difficult to distinguish foreign
exchange or credit risk from country risk.
Changes in regulations or restrictions usually do have an important
exchange market impact. Most disruptive are changes in rules that interfere with
the normal payments mechanism. If government regulations change and a
counterparty is either forbidden to perform or is required to do something
extra, then the Fund might be left with an unintended open position or an
unintended maturity mismatch. Dealing with such unintended long or short
positions could result in unanticipated costs to the Fund.
Other changes in official regulations influence international
investment transactions. If one of the factors affecting the buying or selling
of a currency changes, the exchange rate is likely to respond. Changes in such
controls often are unpredictable and can create a significant exchange rate
response.
Many major countries have moved toward liberalization of exchange and
payments restrictions in recent years or accepted the principle that
restrictions should be relaxed. A few industrial countries have moved in the
other direction. Important liberalizations were carried out by Switzerland, the
United Kingdom and Japan. They dismantled mechanisms for restricting either
foreign exchange inflows (Switzerland), outflows (Britain) or elements of both
(Japan). By contrast, France and Mexico have recently tightened foreign exchange
controls.
Overall, many exchange markets are still heavily restricted. Several
countries limit access to the forward market to companies financing documented
export or import transactions in an effort to insulate the market from purely
speculative activities. Some of these countries permit local traders to enter
into forward contracts with residents but prohibit certain forward transactions
with nonresidents. By comparison, other countries have strict controls on
exchange transactions by residents, but permit free exchange transactions
between local traders and non-residents. A few countries have established tiered
markets, funneling commercial transactions through one market and financial
transactions through another. Outside the major industrial countries, relatively
free foreign exchange markets are rare and controls on foreign currency
transactions are extensive.
Another aspect of country risk has to do with the possibility that the
Fund may be dealing with a foreign trader whose home country is facing a
payments problem. Even though the foreign trader intends to perform on its
foreign exchange contracts, the contracts are tied to other external liabilities
the country has incurred. As a result performance may be delayed, and can result
in unanticipated cost to the Fund. This aspect of country risk is a major
element in the Fund's credit judgment as to with whom it will deal and in what
amounts.
<PAGE>
Keystone Tax Free Fund
SCHEDULE OF INVESTMENTS--December 31, 1994
<TABLE>
<CAPTION>
Coupon Maturity Principal Market
Rate Date Amount Value
<S> <C> <C> <C> <C>
MUNICIPAL BONDS (98.5%)
ALASKA
Alaska State Housing Finance Corp., Series 1993 A 5.400% 12/01/2023 $ 5,000,000 $ 3,914,000
North Slope Borough, Alaska, General Obligation Refunding,
Series G 8.350 06/30/1998 2,000,000 2,160,340
North Slope Borough, Alaska, General Obligation, Series A
(MBIA) 5.900 06/30/2003 3,000,000 2,975,250
ARIZONA
Chandler, Arizona, Water and Sewer (FGIC) 6.750 07/01/2006 850,000 882,028
Maricopa County, Arizona, Industrial Development Authority,
Hospital Facilities Revenue, Samaritan Health Services
(Crossover refunded) 9.250 12/01/2015 10,715,000 11,293,074
Maricopa County, Arizona, University School District (MBIA) 8.125 01/01/2010 6,000,000 6,763,440
Phoenix, Arizona, Street and Highway User, Series 1992 A
(FGIC) (effective yield 5.95%) (a) 0.000 07/01/2013 2,500,000 708,100
Pima County, Arizona, Industrial Development Authority,
Health Care Corp., Carandolet St. Joseph and St. Mary
Hospitals (MBIA) 8.000 07/01/2013 3,385,000 3,669,679
Pima County, Arizona, Industrial Development Authority,
Irvington Project (FSA) 7.250 07/15/2010 10,000,000 10,389,400
ARKANSAS
Arkansas State Development Finance Authority, SFMR Refunding 8.000 08/15/2011 1,820,000 1,920,209
CALIFORNIA
California Health Facilities Financing, St. Francis Medical
Center, Series A 5.500 10/01/2009 200,000 178,434
California State Public Works Board (AMBAC) 5.250 12/01/2013 1,850,000 1,541,605
California State Public Works Board, Various University
California Projects, Series B 5.500 06/01/2019 350,000 281,271
California State Public Works, Board Lease Department
Correctional State Prison, Series E 5.500 06/01/2015 3,700,000 3,041,548
Eden Township, California, Hospital District 7.400 11/01/2019 5,615,000 5,158,557
Fontana, California, Public Financing Authority, Tax
Allocation, Series A (MBIA) 5.000 09/01/2020 295,000 226,767
Fresno, California, Health Facility, Holy Cross Health
Systems (MBIA) 5.625 12/01/2015 7,000,000 5,976,320
Loma Linda, California, Refunding Loma Linda University
Medical Center C (MBIA) 5.375 12/01/2022 85,000 69,022
Los Angeles County, California, Transportation Commission,
Series A (MBIA) 6.250 07/01/2013 6,000,000 5,678,220
Los Angeles, California, Convention and Exhibition Center
Authority Lease (MBIA) 5.125 08/15/2013 5,000,000 4,107,700
Los Angeles, California, Public Works Finance Authority,
Multi Capital Facilities Project (MBIA) 5.250 12/01/2016 5,000,000 4,054,000
Moulton Niguel, California, Water District Improvement
Authority (MBIA) 5.250 09/01/2013 210,000 173,867
Oakland, California, Pensions, Series A (FGIC) 7.600 08/01/2021 5,015,000 5,256,823
Oakland, California, Redevelopment Agency, Tax Allocation
Central District, Series A (MBIA) 5.000 09/01/2013 2,960,000 2,392,361
See Notes to Schedule of Investments.
<PAGE>
California (continued)
Pittsburg, California, Redevelopment Agency, Tax Allocation
Refunding, Los Medanos Project, Series A (AMBAC) 5.000% 08/01/2013 $ 4,520,000 $ 3,630,916
San Diego, California, Sewer Authority, Series A (AMBAC) 5.000 05/15/2013 975,000 784,270
San Joaquin Hills, California, Transportation Corridor
Agency, Toll Road Revenue 7.000 01/01/2030 5,705,000 4,893,007
San Joaquin Hills, California, Transportation Corridor
Agency, Toll Road Revenue 6.750 01/01/2032 5,000,000 4,137,300
Southern California Public Power Authority, Power Project
Revenue, Series A 5.500 07/01/2012 2,300,000 1,970,916
Southern California Public Power Authority, Power Project
Revenue 5.000 07/01/2015 4,600,000 3,596,878
University of California, Multiple Purpose Projects,
Series C (AMBAC) 5.000 09/01/2013 1,675,000 1,341,725
University of California, Multiple Purpose Projects,
Series C (AMBAC) 5.000 09/01/2014 7,525,000 5,989,373
University of California, Refunding Multiple Purpose
Project, Series B (MBIA) 5.000 09/01/2016 2,000,000 1,569,680
Walnut Creek, California, John Muir Medical Center (MBIA) 5.000 02/15/2016 350,000 274,565
COLORADO
City and County of Denver, Colorado, Airport System,
Series A 8.500 11/15/2023 1,750,000 1,762,390
City and County of Denver, Colorado, Airport System,
Series A 7.000 11/15/1999 2,000,000 1,969,100
City and County of Denver, Colorado, Airport System,
Series A 7.500 11/15/2023 5,625,000 5,184,113
City and County of Denver, Colorado, Airport System,
Series A 8.750 11/15/2023 16,380,000 16,760,671
City and County of Denver, Colorado, Airport System,
Series A 8.000 11/15/2025 525,000 506,819
City and County of Denver, Colorado, Airport System,
Series C 6.650 11/15/2005 5,980,000 5,393,422
City and County of Denver, Colorado, Airport System,
Series C 6.000 12/01/2025 3,000,000 3,017,640
City and County of Denver, Colorado, Airport System,
Series D 7.750 11/15/2021 12,250,000 11,701,812
Colorado Health Facilities Authority, Rocky Mountain
Adventist Health Care 6.625 02/01/2022 3,000,000 2,537,520
Larimer County, Colorado, School District (MBIA) 7.000 12/15/2016 2,250,000 2,363,895
CONNECTICUT
Connecticut Special Tax Obligation, Series B 6.500 10/01/2012 1,600,000 1,582,496
Connecticut State Special Tax Obligation, Series A (FGIC) 5.900 10/01/2008 6,500,000 6,185,725
Connecticut State Special Tax Obligation, Series B (FGIC) 6.000 10/01/2009 5,000,000 4,818,050
Connecticut State Special Tax Obligation, Series B (FGIC) 6.000 10/01/2010 3,980,000 3,791,627
DELAWARE
Delaware Health Facilities Authority, Medical Center of
Delaware (MBIA) 6.250 10/01/2006 6,000,000 6,096,600
DISTRICT OF COLUMBIA
District of Columbia, General Obligation, Series E (FSA) 6.000 06/01/2011 7,000,000 6,427,050
FLORIDA
Broward County, Florida, Resource Recovery, South Project 7.950 12/01/2008 1,920,000 2,054,630
Dade County, Florida, School District (MBIA) 5.000 08/01/2013 4,000,000 3,269,880
Dade County, Florida, Water Sewer Systems, Allegany Health
Systems, St. Mary's (FGIC) 5.000 10/01/2013 11,000,000 9,160,580
(continued on next page)
<PAGE>
Florida (continued)
Escambia County, Florida, Pollution Control, Champion
International Corp. Project 6.900% 08/01/2022 $ 1,500,000 $ 1,425,345
Florida State Board Education Capital Outlay 6.400 06/01/2019 17,000,000 16,708,450
Florida State Board Education, Capital Outlay Public
Education, Series A 5.875 06/01/2012 7,465,000 6,985,971
Jacksonville, Florida, Capital Improvement Revenue
Certificates, Gator Bowl Project (AMBAC) 6.000 10/01/2025 1,880,000 1,729,750
Jacksonville, Florida, Health Facility Authority, Daughters
of Charity Hospital, Series A 5.000 11/15/2015 2,000,000 1,548,580
Jacksonville, Florida, Health Facility Authority, New
Children's Hospital (MBIA) 7.000 06/01/2021 1,800,000 1,829,502
Jacksonville, Florida, Transportation Authority (ETM) 9.200 01/01/2015 2,000,000 2,583,300
Lee County, Florida, School Board, Certificates of
Participation, Series A (FSA) 7.750 08/01/2005 3,490,000 3,836,033
Okaloosa County, Florida, Gas District, Refunding and
Improvement (MBIA) 6.850 10/01/2014 1,550,000 1,589,324
Orlando-Orange County, Florida, Expressway Authority (FGIC) 8.250 07/01/2015 2,960,000 3,496,707
Palm Beach County, Florida, Criminal Justice Facilities
(FGIC) 6.000 06/01/2013 1,000,000 943,410
Port St. Lucie, Florida, Utility Revenue (FGIC) 6.000 09/01/2014 5,465,000 5,180,055
St. Petersburg, Florida, Health Facilities Authority (MBIA) 7.000 12/01/2015 3,250,000 3,345,258
Tampa, Florida, Subordinate Guaranteed Entitlement, Series B
(Pre-refunded) 8.500 10/01/2018 1,825,000 2,005,091
GEORGIA
Atlanta, Georgia, General Obligation, Series A 6.000 12/01/2015 2,790,000 2,573,692
Atlanta, Georgia, General Obligation, Series A 6.000 12/01/2014 2,690,000 2,500,059
Georgia, General Obligation, Series C 5.250 04/01/2011 9,200,000 8,058,464
Metropolitan Atlanta Rapid Transit Authority, Georgia, Sales
Tax (AMBAC) 6.250 07/01/2011 4,255,000 4,159,773
Monroe County, Georgia, Development Authority, Pollution
Control Georgia Power Co. 10.500 09/01/2015 7,100,000 7,466,218
HAWAII
Hawaii State Department of Budget and Finance, Special
Purpose Revenue, Hawaii Electric Co. (MBIA) 7.375 12/01/2020 8,000,000 8,237,120
State of Hawaii, Airport System (MBIA) 6.450 07/01/2013 10,000,000 9,755,500
IDAHO
Idaho Housing Finance Authority, Single Family Mortgage
Bonds, Series D-1 8.000 01/01/2020 1,505,000 1,481,989
ILLINOIS
Chicago, Illinois, Gas Supply Revenue, People's Gas Light
and Coke Co., Series A 8.100 05/01/2020 6,740,000 7,201,758
Chicago, Illinois, Gas Supply Revenue, People's Gas Light
and Coke Co. 7.500 03/01/2015 4,000,000 4,148,360
Chicago, Illinois, Public Building Commerce, Series A (MBIA) 5.750 12/01/2018 4,000,000 3,447,280
Cook County, Illinois, General Obligation (MBIA) 7.700 12/01/2005 5,970,000 6,663,654
See Notes to Schedule of Investments.
<PAGE>
Illinois (continued)
Illinois Development Finance Authority, Pollution Control
Revenue, Commonwealth Edison Co. 10.625% 03/01/2015 $ 8,500,000 $ 8,733,580
6.500 06/15/2022 9,000,000 8,686,620
Kankakee, Illinois, Sewer Revenue (FGIC) 6.875 05/01/2011 2,965,000 3,016,739
Metropolitan Pier and Exposition Authority, McCormick Place
Expansion Project 7.250 06/15/2005 5,500,000 5,929,110
Robbins, Illinois, Robbins Resources Recovery, Partners A 9.250 08/15/2014 7,500,000 7,691,550
INDIANA
Indianapolis, Indiana, Local Public Improvement Bond Bank,
Series 1992D 6.750 02/01/2020 2,000,000 1,906,680
KANSAS
Kansas City, Kansas, Utility Systems, Refunding and
Improvement (FGIC) 6.250 09/01/2014 3,000,000 2,881,260
Kansas City, Kansas, Utility Systems, Refunding and
Improvement (FGIC) 6.375 09/01/2023 7,150,000 6,889,955
KENTUCKY
Carroll County, Kentucky, Kentucky Utility Company, Series A 7.450 09/15/2016 5,000,000 5,207,350
Jefferson County, Kentucky, Hospital Revenue (MBIA) 6.436 10/23/2014 6,000,000 5,859,720
Kentucky Housing Corp., Housing Revenue Bond, Series C 7.900 01/01/2021 6,295,000 6,388,859
Trimble County, Kentucky, Pollution Control, Louisville Gas
and Electric Co. 7.625 11/01/2020 2,725,000 2,845,554
Trimble County, Kentucky, Pollution Control, Louisville Gas
and Electric Co. Series (Pre-refunded) 7.625 11/01/2020 545,000 598,388
LOUISIANA
Louisiana Public Facilities Authority (Crossover refunded) 8.200 12/01/2015 7,250,000 7,924,322
Louisiana State Offshore Term Authority 6.100 09/01/2002 2,500,000 2,478,450
Louisiana State Offshore Term Authority 6.250 09/01/2004 3,700,000 3,650,864
Louisiana State, Series B (MBIA) 5.625 08/01/2013 3,000,000 2,649,750
Orleans Parish, Louisiana, School Board (ETM) 9.050 02/01/2010 5,175,000 6,372,340
MAINE
Regional Waste System, Maine 8.150 07/01/2011 2,500,000 2,705,225
MARYLAND
Maryland State Community Development Administration,
Multi-Family Housing 8.750 05/15/2012 3,345,000 3,411,432
MASSACHUSETTS
Boston, Massachusetts, Boston City Hospital 5.750 02/15/2023 735,000 616,908
Chelsea, Massachusetts, School Project Loan Act 1948 (AMBAC) 6.000 06/15/2014 750,000 694,560
Massachusetts Bay Transportation Authority 5.400 03/01/2008 12,000,000 10,658,160
Massachusetts Bay Transportation Authority, Series A 7.000 03/01/2011 4,200,000 4,388,454
Massachusetts Bay Transportation Authority, Series A 6.250 03/01/2012 4,000,000 3,859,040
Massachusetts Bay Transportation Authority, Series B 6.200 03/01/2016 1,945,000 1,824,546
Massachusetts General Obligation, Series A 5.250 02/01/2008 8,000,000 6,855,280
Massachusetts General Obligation, Series C (FGIC) (effective
yield 6.90%)(a) 0.000 12/01/2003 6,000,000 3,560,400
(continued on next page)
<PAGE>
Massachusetts (continued)
Massachusetts Industrial Finance Agency, Harvard Community
Health Plan, Inc. 8.125% 10/01/2017 $ 7,250,000 $ 7,575,380
Massachusetts Industrial Finance Agency, Solid Waste
Disposal 9.000 08/01/2016 4,100,000 4,114,145
Massachusetts Municipal Wholesale Electric, Power Supply
Systems 6.750 07/01/2008 4,000,000 4,079,680
Massachusetts State Health and Education Facilities
Authority, Beth Israel Hospital (AMBAC) 5.750 07/01/2012 2,500,000 2,232,325
Massachusetts State Health and Educational Facilities (MBIA) 7.300 10/01/2018 2,000,000 2,066,560
Massachusetts State Health and Educational Facilities
Authority, Cape Cod Health Systems, Series A (Connie Lee) 5.250 11/15/2021 4,000,000 3,155,320
Massachusetts State Health and Educational Facilities
Authority, Children's Hospital 6.200 10/01/2016 3,890,000 3,571,409
Massachusetts State Health and Educational Facilities
Authority, Lahey Clinic Medical Center, Series B 5.375 07/01/2023 1,800,000 1,453,374
Massachusetts State Health and Educational Facilities
Authority, Massachusetts General Hospital, Series G
(AMBAC) 5.375 07/01/2011 1,385,000 1,200,075
Massachusetts State Health and Educational Facilities
Authority, Massachusetts General Hospital, Series F
(AMBAC) 6.250 07/01/2012 1,000,000 958,490
Massachusetts State Health and Educational Facilities
Authority, Massachusetts General Hospital, Series F
(AMBAC) 6.250 07/01/2020 3,000,000 2,776,890
Massachusetts State Health and Educational Facilities
Authority, New England Deaconness Hospital (AMBAC) 6.875 04/01/2022 2,980,000 2,973,116
Massachusetts State Health and Educational Facilities
Authority, Wellesley College 5.375 07/01/2019 1,230,000 1,032,118
Massachusetts State Housing Finance Agency, Series A 6.300 10/01/2013 9,800,000 9,161,236
Massachusetts State Housing Finance Agency, Single Family
Mortgage 9.500 12/01/2016 1,885,000 1,928,958
Massachusetts State Industrial Finance Agency, Pollution
Control, Boston Edison Co., Series A 5.750 02/01/2014 1,000,000 831,170
Massachusetts State Special Obligation Consolidated Loan,
Series B 6.000 08/01/2013 5,400,000 5,009,688
Massachusetts State Water Resources Authority, General
Series A 5.900 08/01/2016 8,445,000 7,517,654
Massachusetts State, General Obligation 6.000 08/01/2014 15,000,000 13,887,750
Massachusetts State, General Obligation Consolidated Loan
Series C (FGIC) 6.600 11/01/2008 8,000,000 8,170,160
Massachusetts Water Resources Authority, Series A (MBIA) 6.000 08/01/2014 1,500,000 1,365,885
Massachusetts Water Resources Authority, Series C 6.000 12/01/2011 6,480,000 6,091,459
Quincy, Massachusetts, Quincy Hospital (FSA) 5.250 01/15/2016 100,000 81,965
MICHIGAN
Michigan State Hospital Finance Authority, Hospital
Refunding (Daughters Charity Health Systems--Providence
Hospital) 10.000 11/01/2015 7,960,000 8,431,550
Monroe County, Michigan, Economic Development Corp., Detroit
Edison Co. (FGIC) 6.950 09/01/2022 6,000,000 6,133,560
MINNESOTA
Dakota County, Minnesota, Housing and Redevelopment
Authority, Single Family Mortgage (FGIC) 9.375 05/01/2018 35,000 35,522
See Notes to Schedule of Investments.
<PAGE>
Minnesota (continued)
Minnesota Housing Finance Agency, Housing Development,
Residential Mortgage, Series H 6.500% 01/01/2026 $3,500,000 $3,283,385
MISSISSIPPI
Mississippi Hospital Equipment and Facilities Authority
(Connie Lee) 6.400 01/01/2007 1,000,000 993,770
MISSOURI
Missouri Health and Educational Facilities Authority, Health
Facility Refunding, Series Aa (MBIA) 6.250 06/01/2016 2,500,000 2,375,175
Missouri State Health and Educational Facilities Authority,
Barnes Jewish Hospital (MBIA) 5.150 05/15/2010 5,000,000 4,330,700
Missouri State Health and Educational Facilities Authority,
Barnes Jewish Hospital 5.250 05/15/2021 2,200,000 1,754,016
Phelps County, Missouri, Phelps County Regional Medical
Center (Connie Lee) 6.000 05/15/2013 125,000 114,802
University of Missouri, University Improvement Systems
Facilities 5.500 11/01/2023 175,000 149,074
NEBRASKA
Nebraska Higher Education Loan Program 6.200 06/01/2013 5,800,000 5,365,522
NEVADA
Clark County, Nevada, General Obligation, Series A (AMBAC) 7.500 06/01/2009 4,000,000 4,363,840
Clark County, Nevada, School District, Series A (MBIA) 6.750 03/01/2007 3,000,000 3,094,470
NEW JERSEY
New Jersey Building Authority, State Building 5.000 06/15/2014 1,250,000 1,016,600
New Jersey Health Care Facilities Financing Authority,
Jersey Shore Medical Center (AMBAC) 6.125 07/01/2012 1,000,000 947,910
New Jersey Health Care Facilities Financing Authority,
Kimball Medical Center, Series C 8.000 07/01/2013 3,000,000 3,050,430
New Jersey Health Care Facilities Financing Authority,
General Hospital Center of Passaic, Inc. (Pre-refunded) 10.375 07/01/2014 3,850,000 4,028,563
New Jersey Health Care Facilities Financing Authority, Our
Lady of Lourdes Medical Center (Pre-refunded) 9.750 02/01/2015 4,350,000 4,457,749
New Jersey Health Care Facilities Financing Authority,
General Hospital Center at Passaic, Inc. (Pre-refunded) 9.625 08/01/2025 7,500,000 7,855,200
New Jersey Health Care Facilities Financing Authority,
General Hospital Center at Passaic, Inc. (Pre-refunded) 10.125 07/01/2002 1,800,000 1,899,684
New Jersey Health Care Facilities Financing Authority,
Jersey Shore Medical Center (AMBAC) 6.250 07/01/2016 3,000,000 2,869,890
New Jersey Health Care Facilities Financing Authority, St.
Elizabeth's Hospital, Series B 7.750 07/01/1998 1,450,000 1,462,180
Newark, New Jersey, Board Education (MBIA) 5.875 12/15/2015 2,500,000 2,284,225
NEW MEXICO
City of Albuquerque, New Mexico, Hospital System, Series A
(MBIA) 6.375 08/01/2007 1,500,000 1,496,115
Santa Fe, New Mexico, Series A (AMBAC) 6.300 06/01/2024 4,000,000 3,775,560
(continued on next page)
<PAGE>
NEW YORK
Battery Park City Authority, New York, Refunding, Series A 5.000% 11/01/2013 $ 3,715,000 $ 2,944,695
Battery Park City Authority, New York, Refunding Bonds 5.250 11/01/2017 1,000,000 797,500
Metropolitan Transportation Authority, New York, Commuter
Facilities, Series A (MBIA) 6.125 07/01/2014 2,990,000 2,809,942
Metropolitan Transportation Authority, New York, Commuter
Facilities, Series O (MBIA) 6.250 07/01/2014 4,000,000 3,813,200
Nassau County, New York, Refunding Combined Sewer Districts,
Series G (MBIA) 5.400 01/15/2012 2,000,000 1,726,040
New York City, New York, General Obligation, Series A 7.750 08/15/2014 5,460,000 5,681,676
New York City, New York, General Obligation, Fiscal 1992,
Series A 7.750 08/15/2008 6,000,000 6,316,140
New York City, New York, General Obligation, Fiscal 1992,
Series A 7.750 08/15/2015 3,250,000 3,365,017
New York City, New York, General Obligation, Series A (FGIC) 5.750 08/01/2010 390,000 351,094
New York City, New York, General Obligation, Series D 7.700 02/01/2009 3,000,000 3,114,810
New York City, New York, General Obligation, Series D (MBIA) 6.000 08/01/2006 285,000 276,869
New York City, New York, General Obligation, Series H 7.000 02/01/2008 2,150,000 2,147,162
New York City, New York, General Obligation, Series S 7.500 02/01/2007 1,800,000 1,879,344
New York City, New York, Industrial Special Facility
Terminal One Group Association Project 6.000 01/01/2015 2,500,000 2,212,875
New York City, New York, Municipal Water Finance Authority 5.625 06/15/2011 5,800,000 5,134,682
New York City, New York, Municipal Water Finance Authority,
Water and Sewer System (FGIC) 7.000 06/15/2015 6,000,000 6,127,800
New York Energy Research and Development Authority
Consolidated Edison Project 7.750 01/01/2024 2,900,000 2,954,752
New York State Care Facilities, New York Hospital, Series A 6.800 08/15/2024 2,000,000 2,007,140
New York State Dormitory Authority, City University
Educational Facilities (FGIC) 7.000 07/01/2009 4,980,000 5,248,123
New York State Dormitory Authority, University of Rochester
Strong Memorial (MBIA) 5.500 07/01/2021 400,000 335,612
New York State Dormitory Authority, City University (AMBAC) 6.250 07/01/2016 5,000,000 4,799,750
New York State Dormitory Authority, State University
Educational Facilities 5.875 05/15/2011 13,100,000 11,749,914
New York State Dormitory Authority, State University
Educational Facilities 6.375 05/15/2014 2,760,000 2,560,397
New York State Energy Research and Development Authority 7.150 02/01/2022 7,250,000 6,538,485
New York State Environmental Facilities Corp., State Water
Pollution Control (New York City Water Finance Authority) 6.875 06/15/2014 16,400,000 14,707,192
New York State Environmental Facilities Corp., State Water
Pollution Control (New York City Water Finance Authority) 6.875 06/15/2010 5,000,000 5,045,900
New York State Housing Finance Agency, Multi-family
Mortgage, Series B (AMBAC) 6.250 08/15/2014 4,440,000 4,148,026
New York State Local Government Assistance Corp.
(Pre-refunded) 6.750 04/01/2021 900,000 961,695
New York State Medical Care Facilities Finance (FGIC) 6.375 08/15/2014 3,550,000 3,416,626
See Notes to Schedule of Investments.
<PAGE>
New York (continued)
New York State Medical Care Facilities, Mental Health (FGIC) 5.500% 08/15/2021 $ 165,000 $ 139,273
New York State Medical Care Facilities, Mental Health
Facility, Series F (FSA) 5.375 02/15/2014 1,000,000 846,600
New York State Mortgage Agency 6.900 04/01/2015 4,500,000 4,506,345
New York State Urban Development Corp., Refunding
Correctional Facilities, Series A 6.500 01/01/2010 10,000,000 9,622,900
New York Urban Development Corp., Correctional Facilities,
Series A 7.500 04/01/2011 8,000,000 8,286,400
Onondaga County, New York, Resource Recovery Agency 6.875 05/01/2006 9,600,000 9,031,776
Port Authority of New York and New Jersey 6.000 12/01/2015 2,060,000 1,883,376
Triborough Bridge and Tunnel Authority, New York, Special
Obligation 6.625 01/01/2012 8,500,000 8,579,985
NORTH CAROLINA
North Carolina Eastern Municipal Power Agency, Power Systems 7.250 01/01/2007 1,000,000 1,028,150
North Carolina Eastern Municipal Power Agency, Power Systems 6.250 01/01/2012 5,100,000 4,609,176
North Carolina Eastern Municipal Power Agency, Power Systems 7.000 01/01/2013 6,000,000 5,902,020
North Carolina Eastern Municipal Power Agency, Power Systems 6.500 01/01/2017 4,050,000 3,713,445
North Carolina Eastern Municipal Power Agency, Power Systems 6.500 01/01/2018 1,210,000 1,117,786
North Carolina Eastern Municipal Power Agency, Power
Systems, Series B 7.000 01/01/2008 5,000,000 4,978,900
North Carolina Eastern Municipal Power Agency, Power
Systems, Series C 7.000 01/01/2007 1,750,000 1,735,790
North Carolina Eastern Municipal Power Agency, Power Systems 7.250 01/01/2007 18,000,000 18,989,280
Raleigh-Durham, North Carolina, Airport Authority, Special
Facility, American Airlines, Inc. Project 9.625 11/01/2015 13,500,000 14,083,065
NORTH DAKOTA
North Dakota State Housing Finance Agency, Single Family
Mortgage 8.375 07/01/2021 710,000 728,985
OHIO
Cleveland, Ohio, Public Power Systems, First Mortgage,
Series A (MBIA) 7.000 11/15/2016 4,000,000 4,114,680
Cleveland, Ohio, Public Power Systems, First Mortgage,
Series A (MBIA) 7.000 11/15/2024 1,000,000 1,024,540
Columbus, Ohio, General Obligation 12.375 02/15/2006 1,285,000 1,890,338
Ohio Housing Finance Agency, Single Family Mortgage (FGIC) 9.000 01/15/2009 45,000 44,819
Ohio State Higher Educational Facility Commission (MBIA) 6.125 11/15/2017 1,000,000 934,070
Ohio State Water Development Authority (Pre-refunded) 9.250 12/01/2012 505,000 528,578
Ohio State Water Development Authority (AMBAC) 9.250 12/01/2012 215,000 224,836
Ohio State Water Development Authority (AMBAC) 9.375 12/01/2018 725,000 755,450
OREGON
Portland, Oregon, Sewer Systems, Series A (FSA) 6.250 06/01/2015 1,000,000 964,070
PENNSYLVANIA
Allegheny County, Pennsylvania, Industrial Development
Authority, Nursing Home 5.700 09/01/2030 2,000,000 1,613,740
Beaver County, Pennsylvania, Ohio Edison (FGIC) 7.000 06/01/2021 4,390,000 4,508,003
Chester County, Pennsylvania, Health and Education
Facilities Authority, Mainline Health System 5.500 05/15/2015 6,240,000 5,116,925
Delaware County, Pennsylvania, Authority Health Care, Mercy
Health Company of Southeastern, PA (Connie Lee) 5.375 11/15/2023 5,000,000 4,028,500
(continued on next page)
<PAGE>
Pennsylvania (continued)
Delaware County, Pennsylvania, Hospital Revenue, Crozier
Chester Medical Center (Pre-refunded) 7.500% 12/15/2020 $2,545,000 $2,822,787
Delaware County, Pennsylvania, Industrial Development
Authority, Resource Recovery Project (LOC Security
Pacific) 8.100 12/01/2013 4,000,000 4,223,080
Guthrie Health Systems, Care Facility of Sayre, Pennsylvania
(AMBAC) 7.100 03/01/2017 1,250,000 1,281,637
Hampden Township, Pennsylvania, Sewer Authority (FGIC)
(effective yield 6.95%) (a) 0.000 04/01/2005 1,410,000 748,104
Lehigh County, Pennsylvania, Pennsylvania Power & Light Co.
Project, Series A (MBIA) 6.400 11/01/2021 1,500,000 1,442,250
North Penn, Pennsylvania, Water Authority (FGIC) 6.875 11/01/2019 2,500,000 2,515,625
Northumberland County, Pennsylvania, Authority Prisons Lease
(Pre-refunded) 7.750 10/15/2004 2,110,000 2,349,759
Pennsylvania Economic Development Financing Authority,
Resources Recovery, Northampton Project 6.400 01/01/2009 4,000,000 3,473,360
Pennsylvania Economic Development Financing Authority,
Resources Recovery, Colver Project, Series D 7.050 12/01/2010 3,000,000 2,832,360
Pennsylvania Economic Development Financing Authority,
Resources Recovery, Northampton Project 6.600 01/01/2019 9,000,000 7,647,930
Pennsylvania Economic Development Financing Authority,
Resources Recovery, Colver Project, Series D 7.125 12/01/2015 1,000,000 934,890
Pennsylvania Economic Development Financing Authority,
Resources Recovery, Northampton Project 6.500 01/01/2013 5,500,000 4,732,420
Pennsylvania Housing Finance Agency, Single Family Mortgage,
Series T 7.750 10/01/2009 4,000,000 4,077,280
Pennsylvania Housing Finance Agency, Single Family Mortgage,
Section 8 8.200 07/01/2024 6,000,000 6,370,680
Pennsylvania Housing Finance Agency, Single Family Mortgage,
Series 34 A 6.850 04/01/2016 500,000 499,350
Pennsylvania Intergovernmental Cooperative Authority,
Philadelphia Funding (FGIC) 6.750 06/15/2021 2,410,000 2,403,879
Pennsylvania State Higher Educational Facilities Authority,
Thomas Jefferson University 5.300 11/01/2015 1,000,000 816,310
Pennsylvania State Industrial Development Authority, Series
1994 (AMBAC) 6.000 01/01/2012 1,000,000 926,460
Pennsylvania State, General Obligation 5.375 05/01/2011 4,000,000 3,497,320
Pennsylvania State, General Obligation 5.375 04/15/2012 3,500,000 3,030,195
Philadelphia, Pennsylvania, Hospital and Higher Education
Facilities, Graduate Health System Education Facilities
Authority, Series A 7.250 07/01/2018 2,500,000 2,306,350
Philadelphia, Pennsylvania, Hospital and Higher Education
Facilities, Albert Einstein Medical Center 7.000 10/01/2021 3,055,000 2,960,753
Philadelphia, Pennsylvania, Hospital and Higher Education
Facilities, Community College, Series B (MBIA) 6.500 05/01/2007 280,000 282,212
Philadelphia, Pennsylvania, Hospital and Higher Education
Facilities, Graduate Health System Education Facilities
Authority, Series A 6.250 07/01/2018 2,000,000 1,634,040
See Notes to Schedule of Investments.
<PAGE>
Pennsylvania (continued)
Philadelphia, Pennsylvania, Hospital and Higher Education
Facilities, Temple University Authority 6.625% 11/15/2023 $ 1,725,000 $ 1,468,389
Philadelphia, Pennsylvania, Hospital and Higher Education,
Chestnut Hill Hospital 6.500 11/15/2022 5,000,000 4,568,550
Philadelphia, Pennsylvania, Municipal Authority
(Pre-refunded) 7.800 04/01/2018 285,000 310,220
Philadelphia, Pennsylvania, Municipal Authority
(Pre-refunded) 7.800 04/01/2018 2,760,000 3,031,529
Philadelphia, Pennsylvania, Municipal Development Authority,
Criminal Justice Center, Series A (MBIA) 7.100 11/15/2006 4,095,000 4,343,280
Philadelphia, Pennsylvania, Water and Wastewater 5.750 06/15/2013 2,700,000 2,297,889
Philadelphia, Pennsylvania, Water and Wastewater (FGIC) 10.000 06/15/2005 7,000,000 8,946,280
Pittsburgh, Pennsylvania, Urban Redevelopment Authority,
Multi-Family Housing Mortgage, 1985 Series A 9.250 12/01/2027 3,190,000 3,269,527
Pottsville, Pennsylvania, Hospital Authority, Daughters of
Charity Health Systems, Inc., Good Samaritan Hospital
(Pre-refunded) 8.250 08/01/2012 2,670,000 2,907,576
Solanco, Pennsylvania, School District (FGIC) 6.300 02/15/2014 1,250,000 1,185,600
PUERTO RICO
Puerto Rico Commonwealth, Refunding (Capital Guaranty) 6.450 07/01/2017 2,000,000 1,932,780
Puerto Rico Commonwealth, General Obligation 7.000 07/01/2010 12,000,000 12,123,720
Puerto Rico Electric Power Authority 6.000 07/01/2016 2,000,000 1,815,620
Puerto Rico Electric Power Authority, Power Revenue,
Series U 6.000 07/01/2014 1,365,000 1,248,743
Puerto Rico Public Buildings Authority, Guaranteed Public
Education and Health Facilities, Series M Health
Facilities 5.700 07/01/2009 6,450,000 5,942,965
Puerto Rico Telephone Authority (MBIA) 5.250 01/01/2005 16,900,000 15,720,887
RHODE ISLAND
Rhode Island State Health and Educational Building Corp.,
Hospital Financing Revenue, Roger Williams General
Hospital 9.500 07/01/2016 4,210,000 4,345,057
Rhode Island State Industrial Facilities Corp., Marine
Terminal 6.000 11/01/2014 5,000,000 4,514,800
SOUTH CAROLINA
South Carolina State Public Service Authority, Santee
Cooper, Series C (AMBAC) 5.000 01/01/2014 2,200,000 1,772,540
Sumter County, South Carolina, Hospital Facilities, The
Tuomey Hospital (Pre-refunded) 10.000 10/01/2004 250,000 259,610
TENNESSEE
Bristol, Tennessee, Health and Education Authority, Bristol
Memorial Hospital (FGIC) 6.750 09/01/2010 4,200,000 4,263,378
Knox County, Tennessee, Health and Educational Facilities,
Fort Sanders Hospital Alliance, Series C (MBIA) 7.250 01/01/2010 3,000,000 3,197,640
Knox County, Tennessee, Health and Educational Facilities,
Fort Sanders Hospital Alliance (MBIA) 5.250 01/01/2015 3,500,000 2,930,970
Tennessee Housing Development Authority, Home Ownership
Program, Issue H 7.825 07/01/2015 5,620,000 5,747,181
(continued on next page)
<PAGE>
TEXAS
Austin, Texas, Utility Systems (MBIA) 5.250% 05/15/2018 $ 7,000,000 $ 5,680,850
Bear County, Texas, Health Facilities Development Corp.,
Revenue Refunding, Incarnate Word Health Services
(Crossover refunded) 9.500 11/01/2015 8,640,000 9,132,998
Bear, Texas, Metropolitan Water District Waterworks Systems
(AMBAC) 6.625 05/01/2014 1,850,000 1,828,577
Fort Bend County, Texas, Levee Improvement (MBIA) 6.900 09/01/2020 1,165,000 1,170,907
Harris County, Texas, Senior Lien Toll Road Series A (MBIA) 6.375 08/15/2024 4,000,000 3,779,040
Harris County, Texas, Flood Control District, Series B
(effective yield 7.20%) (a) 0.000 10/01/2006 4,500,000 2,014,380
Harris County, Texas, Health Facilities Development Corp. 6.600 06/01/2014 5,000,000 4,626,900
Harris County, Texas, Health Facilities Development Corp.,
Hermann Hospital Project (MBIA) 6.375 10/01/2024 3,300,000 3,113,418
Harris County, Texas, Health Facilities Development Corp.,
Hermann Hospital Project (MBIA) 6.375 10/01/2017 2,480,000 2,366,490
Houston, Texas, Airport 8.200 07/01/2017 1,840,000 2,000,356
Houston, Texas, General Obligation 7.000 03/01/2008 3,000,000 3,139,620
Midland County, Texas, Hospital District, Midland Memorial
Hospital 7.500 06/01/2016 600,000 568,938
Port of Corpus Christi, Texas, Industrial Development Corp.,
Valero Refining and Marketing Co. Project, Series A 10.250 06/01/2017 11,050,000 12,121,629
Rio Grande Valley, Texas, Health Facilities Corp., Hospital
Revenue, Baptist Medical Center Project (MBIA) 8.000 08/01/2017 1,085,000 1,172,983
Rio Grande Valley, Texas, Health Facilities Corp., Hospital
Revenue, Baptist Medical Center Project (Pre-refunded) 8.000 08/01/2017 5,915,000 6,498,633
San Antonio, Texas, Electric and Gas 6.000 02/01/2014 2,500,000 2,292,300
San Antonio, Texas, Electric and Gas, Series A 5.000 02/01/2014 250,000 202,685
State of Texas, General Obligation, Series B 5.700 12/01/2014 250,000 215,458
State of Texas, Veterans Housing Assistance, Series 1992,
General Obligation 6.050 12/01/2012 2,695,000 2,634,362
Tarrant County, Texas, Health Facilities Development Corp.,
Health Systems (FGIC) 6.000 09/01/2024 1,500,000 1,349,310
Tarrant County, Texas, Housing Finance Corp., Series A
(MBIA) (effective yield 7.40%) (a) 0.000 09/15/2016 6,415,000 1,383,844
Texas Housing Agency, Residential Development 8.400 01/01/2021 2,950,000 3,069,504
Texas Municipal Power Agency, Refunding Bonds (MBIA) 5.250 09/01/2012 175,000 151,337
Texas National Research Laboratory Commission Financing
Corp. Lease 7.100 12/01/2021 2,390,000 2,383,929
Titus County, Texas, Water District #1, Southwest Electric
Power 8.200 08/01/2011 5,500,000 6,057,370
Tomball, Texas, Hospital Authority, Tomball Regional
Hospital 6.100 07/01/2008 1,860,000 1,600,474
Tomball, Texas, Hospital Authority, Tomball Regional
Hospital 6.125 07/01/2023 8,000,000 6,229,680
Travis County, Texas Health Facilities, Daughters Of Charity 6.000 11/15/2022 2,000,000 1,727,140
University of Texas, University Revenue, Series B 6.750 08/15/2013 2,000,000 2,006,460
UTAH
Intermountain Power Agency, Utah, Power Supply 7.750 07/01/2020 24,000,000 25,273,440
See Notes to Schedule of Investments.
<PAGE>
Utah (continued)
Intermountain Power Agency, Utah, Power Supply
(Pre-refunded) (effective yield 6.25%) (a) 0.000% 07/01/2012 $20,350,000 $ 17,211,013
Intermountain Power Agency, Utah, Power Supply (ETM)
(effective yield 6.80%) (a) 0.000 07/01/2020 3,000,000 396,150
Intermountain Power Agency, Utah, Power Supply, Series A
(effective yield 7.09%) (a) 0.000 07/01/2004 8,000,000 4,438,000
Intermountain Power Agency, Utah, Special Obligation 7.875 07/01/2014 4,210,000 4,377,684
Utah State Housing Finance Agency, Single Family Mortgage 10.750 07/01/2008 70,000 71,181
Utah State Housing Finance Agency, Single Family Mortgage 7.950 07/01/2010 565,000 594,075
VIRGINIA
Augusta County, Virginia, Industrial Development Authority,
Augusta Hospital Corp. (AMBAC) 5.500 09/01/2015 2,000,000 1,715,040
Fairfax County, Virginia, Water Authority 5.000 04/01/2016 4,000,000 3,230,200
Pittsylvania County, Virginia, Industrial Development,
Series A 7.500 01/01/2014 1,000,000 956,270
Virginia Housing Development Authority, Residential
Mortgage, Series B (effective yield 9.97%) (a) 0.000 09/01/2014 590,000 78,287
WASHINGTON
Washington State Health Care Facilities Authority,
Multi-Care Medical Center of Tacoma (FGIC) 7.875 08/15/2011 1,300,000 1,402,271
WISCONSIN
Wisconsin Health and Education Facilities Authority, Bellin
Memorial Hospital, Inc. (Pre-refunded) 7.625 04/01/2019 5,000,000 5,464,900
Wisconsin Housing and Economic Development Authority, Home
Ownership 8.000 03/01/2021 2,160,000 2,205,662
WYOMING
Wyoming Community Development Authority, Single Family
Mortgage, Series B 8.125 06/01/2021 1,765,000 1,814,049
TOTAL MUNICIPAL BONDS (Cost--$1,205,643,008) 1,179,980,518
TEMPORARY TAX-EXEMPT INVESTMENTS (0.2%)
Dade County, Florida, Water and Sewer Systems (FGIC) (b) 4.950 10/05/2022 375,000 375,000
Sayre County, Pennsylvania, Health Care Facilities
Authority, Variable Rate Demand Hospital Revenue Bonds
(VHA of Pennsylvania Inc. Capital Asset Financing Program)
Series 1985B (AMBAC) (b) 5.250 12/01/2020 1,125,000 1,125,000
Texas State Department Housing and Community Affairs,
Multi-Family Revenue (b) 5.400 02/01/2023 465,000 465,000
TOTAL TEMPORARY TAX-EXEMPT INVESTMENTS (Cost--$1,965,000) 1,965,000
TOTAL INVESTMENTS (Cost--$1,207,608,008) (c) 1,181,945,518
OTHER ASSETS AND LIABILITIES--NET (1.3%) 15,781,378
NET ASSETS (100.0%) $1,197,726,896
</TABLE>
(continued on next page)
<PAGE>
Notes to Schedule of Investments:
(a) Effective yield (calculated at the date of purchase) is the annual yield
at which the bond accretes until its maturity date.
(b) Variable or floating rate instruments with periodic demand features. The
Fund is entitled to full payment of principal and accrued interest upon
surrendering the security to the issuing agent according to the terms of the
demand features.
(c) The cost of investments for federal income tax purpose amounted to
$1,207,894,783. Gross unrealized appreciation and depreciation of investments,
based on identified tax cost, at December 31, 1994, are as follows:
Gross unrealized appreciation $ 20,359,452
Gross unrealized depreciation (46,308,717)
Net unrealized depreciation $(25,949,265)
Legend of Portfolio Abbreviations:
AMBAC--AMBAC Indemnity Corp.
ETM--Escrow to Maturity
FGIC--Federal Guaranty Insurance Co.
LOC--Line of Credit
MBIA--Municipal Bond Investors Assurance Corp.
See Notes to Schedule of Investments.
<PAGE>
Keystone Tax Free Fund
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout the year)
Year Ended December 31,
1994 1993 1992 1991
Net asset
value:
Beginning
of year $ 8.12 $ 8.04 $ 8.07 $ 7.90
Income from
investment
operations:
Investment
income--net 0.37 0.39 0.46 0.46
Net gains
(losses)
on
investments (0.96) 0.48 0.12 0.36
Net
commissions
paid on
fund share
sales(b) -0- -0- -0- -0-
Total from
investment
operations (0.59) 0.87 0.58 0.82
Less
distributions
from(a):
Investment
income--net (0.37) (0.39) (0.46) (0.46)
In excess
of
investment
income--net (0.06) (0.06) (0.04) (0.07)
Realized
capital
gains--net -0- (0.33) (0.11) (0.12)
In excess
of
realized
capital
gains--net -0- (0.01) -0- -0-
Total
distributions (0.43) (0.79) (0.61) (0.65)
Net asset
value: End
of year $ 7.10 $ 8.12 $ 8.04 $ 8.07
Total
return(c) (7.34%) 11.15% 7.55% 10.80%
Ratios/
supplemental
data
Ratios to
average
net
assets:
Operating
and
management
expenses 1.55% 1.66% 1.38% 1.75%
Investment
income--net 4.92% 4.72% 5.71% 5.78%
Portfolio
turnover
rate 84% 76% 78% 77%
Net assets,
end of
year
(thousands) $1,197,727 $1,548,503 $1,453,199 $1,146,185
<TABLE>
<CAPTION>
Year Ended December 31,
1990(d) 1989 1988 1987 1986 1985
<S> <C> <C> <C> <C> <C> <C>
Net asset
value:
Beginning
of year $ 8.06 $ 8.18 $ 8.09 $ 8.85 $ 8.31 $ 7.57
Income from
investment
operations:
Investment
income--net 0.52 0.57 0.55 0.56 0.68 0.70
Net gains
(losses)
on
investments (0.01) 0.15 0.30 (0.58) 0.88 0.81
Net
commissions
paid on
fund share
sales(b) -0- -0- -0- -0- (0.08) (0.07)
Total from
investment
operations 0.51 0.72 0.85 (0.02) 1.48 1.44
Less
distributions
from(a):
Investment
income--net (0.52) (0.60) (0.63) (0.64) (0.68) (0.70)
In excess
of
investment
income--net (0.03) -0- -0- -0- -0- -0-
Realized
capital
gains--net (0.12) (0.24) (0.13) (0.10) (0.26) -0-
In excess
of
realized
capital
gains--net -0- -0- -0- -0- -0- -0-
Total
distributions (0.67) (0.84) (0.76) (0.74) (0.94) (0.70)
Net asset
value: End
of year $ 7.90 $ 8.06 $ 8.18 $ 8.09 $ 8.85 $ 8.31
Total
return(c) 6.66% 9.11% 10.89% (0.14)% 18.26% 19.96%
Ratios/
supplemental
data
Ratios to
average
net
assets:
Operating
and
management
expenses 1.18% 1.23% 1.79% 1.70% 0.83% 0.92%
Investment
income--net 6.54% 6.94% 6.74% 6.80% 7.79% 8.65%
Portfolio
turnover
rate 64% 69% 61% 43% 44% 55%
Net assets,
end of
year
(thousands) $1,060,826 $901,912 $903,132 $894,768 $1,025,084 $863,720
</TABLE>
(a) Effective January 1, 1993 the Fund adopted Statement of Position 93-2:
"Determination, Disclosure, and Financial Statement Presentation of Income
Capital Gain and Return of Capital Distributions by Investment Companies." As
a result, distribution amounts exceeding book basis investment income--net (or
tax basis net income on a temporary basis) are presented as "Distributions in
excess of investment income--net." Similarly, capital gain distributions in
excess of book basis capital gains (or tax basis capital gains on a temporary
basis) are presented as "Distributions in excess of realized capital gains."
For the fiscal years ended December 31, 1992, 1991, and 1990, distributions in
excess of book basis net income were presented as "distribution from paid-in
capital".
(b) Prior to June 30, 1987, net commissions paid on new sales of shares under
the Fund's Rule 12b-1 Distribution Plan had been treated for both financial
statement and tax purposes as capital charges. On June 11, 1987, the
Securities and Exchange Commission adopted a rule which required for financial
statements for the periods ended on or after June 30, 1987, that net
commissions paid under Rule 12b-1 be treated as operating expenses rather than
capital charges. Accordingly, beginning with the year ended December 31, 1987,
the Fund's financial statements reflect 12b-1 Distribution Plan expenses
(i.e., shareholder servicing fees plus commissions paid net of deferred sales
charges received by the Fund) as a component of net investment income.
(c) Excluding contingent deferred sales charges.
(d) Calculation based on average shares outstanding.
See Notes to Financial Statements.
<PAGE>
Keystone Tax Free Fund
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1994
Assets:
Investments at market value
(identified cost--$1,207,608,008) (Note 1) $1,181,945,518
Cash 217,202
Receivable for:
Investments sold 1,617,183
Fund shares sold 283,803
Interest 24,738,850
Other assets 100,602
Total assets 1,208,903,158
Liabilities (Notes 2, 4, and 5):
Payable for:
Income distribution 6,314,436
Investments purchased 1,997,688
Fund shares redeemed 2,777,855
Payable to Investment Adviser 58,863
Accrued reimbursable expenses 2,325
Other accrued expenses 25,095
Total liabilities 11,176,262
Net assets $1,197,726,896
Net assets represented by:
Paid-in capital $1,264,955,468
Accumulated distributions in excess of
investment income--net (Note 1) (3,916,731)
Accumulated realized gains (losses) on
investment transactions--net (37,649,351)
Net unrealized appreciation (depreciation) on
investments (25,662,490)
Total net assets applicable to outstanding
shares of beneficial interest ($7.10 a share on
168,806,043 shares outstanding) (Note 2) $1,197,726,896
STATEMENT OF OPERATIONS
Year Ended December 31, 1994
Investment income (Note 1):
Interest $ 88,670,484
Expenses (Notes 2 and 4):
Investment management fee and
administrative services $ 7,970,545
Accounting services 23,917
Trustees' fees and expenses 56,308
Distribution Plan expenses 13,226,327
Total expenses 21,277,097
Investment income--net (Note 1) 67,393,387
Realized and unrealized gain (loss)
on investments and closed
futures contracts--net
(Notes 1 and 3):
Realized gain (loss) on:
Investments (39,550,582)
Closed futures contracts 1,701,424
Realized loss on investments and closed
futures contracts--net (37,849,158)
Net unrealized appreciation
(depreciation) on investments:
Beginning of year 114,076,321
End of year (25,662,490)
Change in unrealized appreciation or
depreciation on investments--net (139,738,811)
Net loss on investments (177,587,969)
Net decrease in net assets resulting
from operations ($110,194,582)
See Notes to Financial Statements.
<PAGE>
Keystone Tax Free Fund
STATEMENTS OF CHANGES IN NET ASSETS
Year Ended December 31,
1994 1993
Operations:
Investment income--net (Note 1) $ 67,393,387 $ 71,989,777
Realized gain (loss) on investments and
closed futures contracts--net
(Notes 1 and 3) (37,849,158) 61,450,085
Change in unrealized appreciation or
depreciation on investments--net (139,738,811) 27,381,004
Net increase (decrease) in net assets
resulting from operations (110,194,582) 160,820,866
Distributions to shareholders from
(Notes 1 and 5):
Investment income--net (68,740,949) (71,989,777)
In excess of investment income--net (10,297,613) (11,148,339)
Realized capital gains from investment
transactions--net -0- (61,329,277)
In excess of realized capital gains from
investment transactions--net -0- (1,324,888)
Total distributions to shareholders (79,038,562) (145,792,281)
Capital share transactions (Note 2):
Proceeds from shares sold 126,813,101 169,165,502
Payments for shares redeemed (326,066,785) (172,689,849)
Net asset value of shares issued in
reinvestment of distributions from:
Investment income--net and in excess of
investment income--net 37,710,385 43,019,252
Realized gain from investment
transactions--net -0- 40,780,868
Net increase (decrease) in net assets
resulting from capital share
transactions (161,543,299) 80,275,773
Total increase (decrease) in net
assets (350,776,443) 95,304,358
Net assets:
Beginning of year 1,548,503,339 1,453,198,981
End of year [including undistributed
investment income--net (accumulated
distributions in excess of investment
income--net) as follows: December 31,
1994--($3,916,731) December 31,
1993--$1,347,562] $1,197,726,896 $1,548,503,339
See Notes to Financial Statements.
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Keystone Tax Free Fund
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies
Keystone Tax Free Fund (the "Fund") is a Massachusetts business trust for
which Keystone Management, Inc. ("KMI") is the Investment Manager and Keystone
Custodian Funds, Inc. ("Keystone") is the Investment Adviser. The Fund is
registered under the Investment Company Act of 1940 as a diversified open-end
investment company.
Keystone is a wholly-owned subsidiary of Keystone Group, Inc. ("KGI"), a
Delaware corporation. KGI is privately owned by an investor group consisting
of members of current and former management of Keystone. Keystone Investor
Resource Center, Inc. ("KIRC"), a wholly-owned subsidiary of Keystone, is the
Fund's transfer agent.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles.
A. Tax-exempt bonds are stated on the basis of valuations provided by a
pricing service, approved by the Board of Trustees, that uses information with
respect to transactions in bonds, quotations from bond dealers, market
transactions in comparable securities and various relationships between
securities in determining value. Non- tax-exempt securities for which market
quotations are readily available are valued at the price quoted which, in the
opinion of the Board of Trustees or their representative, most nearly
represents their market value.
Short-term investments which are purchased with maturities of sixty days or
less are valued at amortized cost (original purchase cost as adjusted for
amortization of premium or accretion of discount) which when combined with
accrued interest approximates market. Short- term investments maturing in more
than sixty days for which market quotations are readily available are valued
at current market value. Short-term investments maturing in more than sixty
days when purchased which are held on the sixtieth day prior to maturity are
valued at amortized cost (market value on the sixtieth day adjusted for
amortization of premium or accretion of discount) which when combined with
accrued interest approximates market. All other securities and other assets
are valued at fair value as determined in good faith using methods prescribed
by the Board of Trustees.
B. A futures contract is an agreement between two parties to buy and sell a
specific amount of a commodity, security, financial instrument, or, in the
case of a stock index, cash at a set price on a future date. Upon entering
into a futures contract, the Fund is required to deposit with a broker an
amount ("initial margin") equal to a certain percentage of the purchase price
indicated in the futures contract. Subsequent payments ("variation margin")
are made or received by the Fund each day, as the value of the underlying
instrument or index fluctuates, and are recorded for book purposes as
unrealized gains or losses by the Fund. For federal tax purposes, any futures
contracts which remain open at fiscal year-end are marked-to-market and the
resultant net gain or loss is included in federal taxable income. In addition
to market risk the Fund is subject to the credit risk that the other party
will not complete the obligations of the contract.
C. Securities transactions are accounted for on the trade date. Realized gains
and losses are recorded on the identified cost basis. Interest income is
recorded on the accrual basis. All premiums and original issue discounts are
amortized/accreted for both financial reporting and federal income tax
purposes.
D. The Fund has qualified, and intends to qualify in the future, as a
regulated investment company under the Internal Revenue Code of 1986, as
amended ("Internal Revenue Code"). Thus, the Fund expects to
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be relieved of any federal income tax liability by distributing all of its tax
basis income and net capital gains, if any, to its shareholders. The Fund
intends to avoid excise tax liability by making the required distributions
under the Internal Revenue Code.
E. When the Fund enters into a repurchase agreement (a purchase of securities
whereby the seller agrees to repurchase the securities at a mutually agreed
upon date and price) the repurchase price of the securities will generally
equal the amount paid by the Fund plus a negotiated interest amount. The
seller under the repurchase agreement will be required to provide securities
("collateral") to the Fund whose value will be maintained at an amount not
less than the repurchase price, and which generally will be maintained at 101%
of the repurchase price. The Fund monitors the value of collateral on a daily
basis, and if the value of collateral falls below required levels, the Fund
intends to seek additional collateral from the seller or terminate the
repurchase agreement. If the seller defaults, the Fund would suffer a loss to
the extent that the proceeds from the sale of the underlying securities were
less than the repurchase price. Any such loss would be increased by any cost
incurred on disposing of such securities. If bankruptcy proceedings are
commenced against the seller under the repurchase agreement, the realization
on the collateral may be delayed or limited. Repurchase agreements entered
into by the Fund will be limited to transactions with dealers or domestic
banks believed to present minimal credit risks, and the Fund will take
constructive receipt of all securities underlying repurchase agreements until
such agreements expire.
F. The Fund distributes net investment income to shareholders monthly and net
capital gains, if any, annually. Distributions from net investment income are
determined in accordance with income tax regulations. Dividends from net
investment income can exceed the Fund's book basis net investment income.
Effective January 1, 1993, the Fund adopted Statement of Position 93-2:
"Determination, Disclosure, and Financial Statement Presentation of Income,
Capital Gain and Return of Capital Distributions by Investment Companies." As
a result, the Fund changed the financial statement classification of
distributions to shareholders to better disclose the differences between
financial statement amounts available for distribution and amounts distributed
to comply with income tax regulations. The significant difference between
financial statement amounts available for distribution and distributions made
in accordance with income tax regulations is due to the difference in the
treatment of 12b-1 Distribution Plan charges.
2. Capital Share Transactions
The Declaration of Trust authorizes the issuance of an unlimited number of
shares of beneficial interest with no par value. Transactions in shares of the
Fund were as follows:
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Year Ended December 31,
1994 1993
Shares sold 16,871,171 20,470,708
Shares redeemed (43,806,889) (20,802,266)
Shares issued in
reinvestment of:
Distributions from
investment income-- net
and Distributions in
excess of investment
income--net 5,031,307 5,196,577
Distributions from
realized gains--net 0 5,110,384
Net increase (21,904,411) 9,975,403
The Fund bears some of the costs of selling its shares under a Distribution
Plan adopted pursuant to Rule 12b-1 under the Investment Company Act of 1940.
The Distribution Plan provides that the Fund may incur certain expenses which
may not exceed a maximum amount equal to 0.3125% of the Fund's average daily
net assets for any quarter occurring after the inception of the Distribution
Plan. Under the Distribution Plan, the Fund pays Keystone Distributors, Inc.
("KDI"), the principal underwriter and a wholly-owned subsidiary of Keystone,
amounts which in total may not exceed the Distribution Plan maximum.
In connection with the Distribution Plan and subject to the limitations
discussed below, Fund shares are offered for sale at net asset value without
any initial sales charge. From the amounts received by KDI in connection with
the Distribution Plan, and subject to the limitations discussed below, KDI
generally pays brokers or others a commission equal to 3% of the price paid to
the Fund for each sale of Fund shares as well as a shareholder service fee at
a rate of 0.25% per annum of the net asset value of the shares sold by such
brokers or others and remaining outstanding on the books of the Fund for
specified periods.
To the extent Fund shares purchased prior to July 8, 1992 are redeemed within
four calendar years of original issuance, the Fund may be eligible to receive
a deferred sales charge from the investor as partial reimbursement for sales
commissions previously paid on those shares. This charge is based on declining
rates, which begin at 4.0%, applied to the lesser of the net asset value of
shares redeemed or the total cost of such shares.
Since July 8, 1992, contingent deferred sales charges applicable to shares of
the fund issued after January 1, 1992 have, to the extent permitted by the
NASD Rule, been paid to KDI rather than to the Fund. During the fiscal year
ended December 31, 1994, KDI received $745,076 in contingent deferred sales
charges.
A rule of the National Association of Securities Dealers, Inc. ("NASD Rule")
limits the annual expenditures, which the Fund may incur under the
Distribution Plan to 1%, of which 0.75% may be used to pay such distribution
expenses and 0.25% may be used to pay shareholder service fees. The NASD Rule
also limits the aggregate amount which the Fund may pay for such distribution
costs to 6.25% of gross share sales since the inception of the Fund's 12b-1
Distribution Plan, plus interest at the prime rate plus 1% on unpaid amounts
thereof (less any contingent deferred sales charges paid by the shareholders
to KDI).
KDI intends, but is not obligated, to continue to pay or accrue distribution
charges which exceed current annual payments permitted to be received by KDI
from the Fund. KDI intends to seek full pay-
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ment of such charges from the Fund (together with annual interest thereon at
the prime rate plus one percent) at such time in the future as, and to the
extent that, payment thereof by the Fund would be within permitted limits. KDI
currently intends to seek payment of interest only on such charges paid or
accrued by KDI subsequent to January 1, 1992.
During the year ended December 31, 1994, the Fund recovered $97,865 in
contingent deferred sales charges. During the year, the Fund paid KDI
$13,324,192 under the Distribution Plan. The amount paid by the Fund under its
Distribution Plan, net of deferred sales charge, was $13,226,327 (0.97% of the
Fund's average daily net assets). During the year, KDI received $9,126,418,
after payments of commissions on new sales and service fees to dealers and
others of $4,197,774.
3. Securities Transactions
As of December 31, 1994, the Fund had a capital loss carryover for Federal tax
purposes of approximately $25,307,000 which expires in 2002. Additionally, the
Fund has incurred capital losses of approximately $11,617,000 in the current
fiscal year which, under the Tax Reform Act of 1986 are treated for tax
purposes as occurring on the first day of the Fund's next fiscal year and are
available as an offset to capital gains that may be recognized in the next
fiscal year.
For the year ended December 31, 1994, purchases and sales of investment
securities were as follows:
Cost of Proceeds
Purchases from Sales
Tax-exempt investments $1,103,970,118 $1,229,891,567
Short-term commercial and
tax-exempt notes 652,543,980 675,679,000
$1,756,514,098 $1,905,570,567
4. Investment Management and Transactions
with Affiliates
Under the terms of the Investment Management Agreement between KMI and the
Fund, dated December 29, 1989, KMI provides investment management and
administrative services to the Fund, as well as certain additional operating
services, facilities and supplies. In return, KMI is paid monthly, (i) a
management fee calculated daily at a rate of 2.0% of the Fund's gross
investment income plus an amount determined by applying percentage rates
starting at 0.50% and declining as net assets increase, to 0.25% per annum, to
the net asset value of the Fund, and (ii) an amount equal to KMI's
reimbursable expenses accrued during the year in providing such additional
services. KMI has entered into an Investment Advisory Agreement with Keystone,
dated December 30, 1989, under which Keystone provides investment advisory and
management services to the Fund and receives for its services an annual fee
representing 85% of the management fee received by KMI.
During the year ended December 31, 1994, the Fund paid or accrued to KMI
investment management and administrative services fees of $7,970,545. Included
in this amount is the management fee of $5,941,545, which represented 0.43% of
the Fund's average net assets. Of such management fee paid to KMI, $5,050,313
was paid to Keystone for its services to the Fund.
Also included in the total investment management and administrative services
fee paid by the Fund were the following approximate amounts incurred by KMI
(and reimbursed by the Fund) in providing or obtaining for the Fund the
additional operating services, facilities and supplies required by the
Agreement: transfer agent fee, $1,418,400; audit and legal fees,
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$86,200; custodian fees, $264,100; printing and supplies, $43,100;
registration fees, $106,450; and other, $110,750.
During the year ended December 31, 1994, the Fund paid or accrued to KGI
$23,917 for certain accounting services and to KIRC $1,418,000 for transfer
agent fees. This amount for transfer agent fees is included in the payments
made by KMI described in the preceding paragraph.
5. Distributions to Shareholders
The net investment income of the Fund (interest income accrued as earned, less
expenses of the Fund) is determined as of the normal close of trading on the
New York Stock Exchange each business day on which the exchange is open. The
net investment income so determined each day is declared as a dividend to
shareholders of record at the time of such determination and is distributed
promptly after the end of each calendar month. Any net realized short-term and
long- term capital gains in excess of carried-over losses, will be distributed
annually. All distributions of net investment income will be paid in cash
unless the shareholder has directed that they be reinvested, in which case
such reinvestment will be at the net asset value on the last business day of
the month in which declared. Any distributions of capital gains will be
reinvested in additional shares of the Fund at net asset value on the record
date of the month in which declared unless the shareholder has specified that
they wish to receive cash. Shares acquired through reinvestment of net
investment income or capital gains are not subject to contingent deferred
sales charges.
Federal Tax Status--Fiscal 1994
Distributions (Unaudited)
The per-share distributions paid to you for fiscal 1994, whether taken in
shares or cash, are as follows:
Income Dividends
Tax-exempt Taxable
$0.433 $0.000
In January 1995, complete information on the calendar year 1994 distributions
will be forwarded to you to assist you in completing your 1994 federal tax
return.
