IAI INVESTMENT FUND I INC, 497, 1996-04-04

IAI INVESTMENT FUND I INC
497, 1996-04-04

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FIXED INCOME FUNDS

IAI Bond Fund, IAI Government Fund,
IAI Minnesota Tax Free Fund

April 1, 1996

Includes Brochure and Prospectus

[LOGO]
Mutual Funds
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[ART]

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IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

Fund Information

Low Minimum Investment

You can open an account with IAI for only $5,000 ($2,000 for an IRA). The
minimum investment per Fund is $1,000. Subsequent investments can be made for
only $100 per Fund.

No-Load

With IAI, you pay no commissions to buy, sell, or exchange shares.

No-Fee IRA

Unlike many others, IAI charges no annual fee for maintaining your IRA.

Family of Funds

Whatever your investment needs, IAI's diverse Mutual Fund family has the right
Fund for you. Call for a free Prospectus for IAI Capital Appreciation Fund, IAI
Developing Countries Fund, IAI International Fund, IAI Midcap Growth Fund, IAI
Regional Fund, IAI Growth Fund, IAI Value Fund, IAI Growth and Income Fund, IAI
Balanced Fund, IAI Bond Fund, IAI Minnesota Tax Free Fund, IAI Government Fund,
IAI Reserve Fund and IAI Money Market Fund. Read the Prospectus carefully before
investing or sending money.

Free Exchanges

Money can be exchanged between IAI Mutual Funds free of charge.

Automatic Investment Program

Regular monthly investments ($100 minimum) can be made automatically into the
Fund from your checking or savings account. Shareholders in other Funds may
arrange to invest regularly through monthly exchanges into any of the IAI Mutual
Funds.

Liquidity

You can redeem part or all of your Fund shares at any time at the then current
share price (which may be more or less than your original cost). Special rules
apply to IRAs.

Retirement Programs

IAI offers a variety of retirement investment programs including Individual
Retirement Accounts (IRAs), Direct Rollovers for persons receiving distributions
from Qualified Retirement Plans, and SEP (Simplified Employee Pension) Plans for
small business owners.

Toll-Free Telephone Transactions

IAI offers a convenient toll-free telephone service for investors to find out
more about IAI Mutual Funds and services and to carry out transactions such as
buying or selling shares or exchanging assets from one fund to another. The
toll-free number, 1-800-945-3863, is available from anywhere in the United
States, weekdays from 7:30 a.m. - 5:30 p.m. Central Time.

IAI Investor Library

The IAI Investor Library provides free practical and objective information on
investing and investment strategies to investors who call 1-800-945-3863 and
request the Adviser Special Reports.

Quarterly Newsletter

IAI's free quarterly newsletter keeps shareholders up to date on IAI Mutual
Funds' performance and economic conditions, and provides helpful tips on
investing.

Checkwriting

Investors in IAI Money Market Fund or IAI Reserve Fund receive free checkwriting
privileges, for checks written for $500 or more, with no check printing fees.

IAI Preferred

Shareholders with balances in excess of $100,000 receive unique privileges,
including an exclusive toll-free telephone number, an individually assigned
account representative, an "Investing for Retirement" brochure and an IAI
Preferred portfolio organizer to conveniently house all IAI correspondence.

Easy-to-Read Statements

IAI provides complete, easy to read quarterly account statements which include
summaries of all transactions and portfolio allocations for all of your IAI Fund
holdings on one report.

Dividend Options

Shareholders may receive dividends in cash, have them electronically directed to
their personal bank account or arrange to automatically reinvest them in
additional IAI Mutual Fund shares.

Information and Assistance

Our knowledgeable investment representatives are available to help you-with no
sales pressure.

This text is not part of the prospectus. Additional information, including
management fees and expenses, is included in the attached prospectus. Please
read it carefully before investing or sending money.
<PAGE>

IAI Mutual Funds

IAI Bond Fund

Fund Information

High Current Income

IAI Bond Fund is designed for investors who want a high level of current income
consistent with capital preservation. The Fund seeks to achieve its objective by
investing primarily in a diversified portfolio of investment grade bonds and
other debt securities of similar quality.

Corporate and
Government Bonds

The Fund invests primarily in corporate, government, and mortgage-backed
securities, which vary in proportion depending on market conditions. The
maturity of the portfolio is also varied.

Diversified Portfolio

The Fund's portfolio is fully diversified with holdings spread across a wide
range of securities to minimize risk. Please see the Fund's prospectus, which
accompanies this material, for more information on the Fund's investment
policies and techniques, as well as the risks associated with investing in the
Fund.

Monthly Dividends

Dividends are paid monthly. You may receive your dividends in cash or
automatically reinvest them in additional shares which compounds your return.

Professional Management

IAI Bond Fund is a member of the IAI Mutual Fund family. Founded in 1947, IAI
manages more than $14.5 billion for thousands of individual investors, as well
as FORTUNE 500/(R)/ companies, leading colleges, universities, and religious
organizations. IAI's bond experts monitor the market daily and select the most
appropriate issues available for the Fund's portfolio.

It's Easy to Start

To open an account, simply complete the enclosed application and return it in
the postage-paid envelope with a check payable to "IAI Mutual Funds." If you are
a current shareholder in any IAI Mutual Fund, the minimum investment is $1,000.
If not, the minimum investment is $5,000 (this can be allocated among our Funds,
with a $1,000 minimum per Fund).

call 1-800-945-3863

[PHOTO OF]
Larry R. Hill, CFA
Fund Manager

[PHOTO OF]
Scott A. Bettin, CFA
Fund Manager

[PHOTO OF]
Livingston G. Douglas, CFA
Fund Manager

IAI Mutual Funds

IAI Bond Fund

IAI Bond Fund's portfolio managers actively vary the composition of the Fund's
portfolio to take advantage of market opportunities. While always maintaining a
fully diversified portfolio to minimize risk, IAI varies the sectors and the
maturities in which the Fund invests.

Choosing the Best Sectors

IAI Bond Fund invests in a variety of high quality fixed-income securities.
These are typically investment grade or similar quality, to minimize credit
risk, and can include a limited amount of foreign issues. The Fund invests in
three broad sectors:

. Corporate

. Government

. Mortgage-Backed Securities

The weighting of the sectors changes as the Fund's managers invest in the
sectors which offer the greatest potential return with the least potential risk.
Further, within each sector, the Fund's managers conduct a rigorous analysis to
identify the most promising individual securities.

Varying Maturities

The Fund's managers actively manage the Fund's maturity depending on economic
conditions and market outlook. For example, if interest rates are expected to
fall, maturity might be lengthened because bond prices tend to rise as interest
rates fall, and longer-term bonds are the most sensitive to interest rate
changes. Shown in the chart below is the change in value of various maturity
bonds when interest rates change by 1%. The chart assumes an 8% coupon for each
bond.

Active asset
management... to
maximize return and
minimize risk

Bond Prices vs. Interest Rates

<TABLE>
<CAPTION>
- ---------------------------------------------------------
Bond Bond Price Change
Maturity if Interest Rates
- ---------------------------------------------------------
<S> <C> <C>
Fall 1% Rise 1%
--------------------------------
1 year 1.0% (.9%)
5 year 4.2% (4.0%)
10 year 10.3% (6.5%)
</TABLE>
Source: IAI

IAI Mutual Funds

IAI Government Fund

Fund Information

High Current Income

The Fund seeks to provide shareholders with a high level of current income and
with preservation of capital. The Fund seeks to achieve its objectives by
investing primarily in U.S. Government securities.

Income/Preservation of Capital

The Fund strives to achieve these objectives in two ways:

1. High Quality
The Fund invests primarily in U.S. Government securities, among the highest
quality securities in the world.

2. Intermediate maturity
The dollar-weighted average maturity of the Fund's portfolio will generally
not exceed seven years. Intermediate-term securities generally provide higher
income than short-term fixed income securities without the volatility of
longer-term bonds.

Please see the Fund's prospectus, which accompanies this material, for more
information on the Fund's investment policies and techniques, as well as the
risks associated with investing in the Fund.

Monthly Dividends

Dividends are paid monthly. You may receive your dividends in cash or
automatically reinvest them in additional shares which compounds your return.

Professional Management

IAI Government Fund is a member of the IAI Mutual Fund family. Founded in 1947,
IAI currently manages more than $14.5 billion in assets for thousands of
individual investors, as well as FORTUNE 500/(R)/ companies, leading colleges,
universities, and religious organizations. IAI's fixed income experts monitor
the market daily and select the best issues available for the Fund's portfolio.

It's Easy to Start

call 1-800-945-3863

[PHOTO OF]
Scott A. Bettin, CFA
Fund Manager

[PHOTO OF]
Stephen C. Coleman, CFA
Fund Manager

IAI Mutual Funds

IAI Government Fund

U.S. Government Securities

U.S. Government securities are popular with investors because they offer both
income and high credit quality. To maximize return and minimize price
fluctuation, IAI Government Fund invests in a variety of U.S. Government
securities. Under normal market conditions, the Fund invests at least 65% of its
assets in U.S. Government securities, including the following obligations:

U.S. Treasury--these include:

. Treasury Bills
(original maturities up to one year)

. Treasury Notes
(original maturities of one to ten years)

. Treasury Bonds
(original maturities generally over ten years)

U.S. Government Agencies and Instrumentalities - these include securities such
as those issued by:

. Government National Mortgage Association ("Ginnie Mae")

. Federal National Mortgage Association ("Fannie Mae")

. Federal Home Loan Mortgage Corporation ("Freddie Mac")

. Farm Credit Banks

. Resolution Funding Corporation

The securities above are all backed by either the "full faith and credit" of the
U.S. Government, or by the right of the issuing agency to borrow from the U.S.
Treasury. This backing helps ensure timely payment of principal and interest. Of
course, shares of the Fund itself are not guaranteed, and the Fund's yield,
return and share value will fluctuate with market conditions.

Intermediate-Term Bonds

For investors who can tolerate a moderate amount of share price fluctuation,
intermediate-term bonds may offer the best combination of return and risk. That
is why IAI Government Fund's portfolio generally maintains an average maturity
of seven years or less.

Higher Returns

Historically, intermediate-term bonds have higher returns than short-term
instruments, as shown in the chart below.

Average Annual Historical Returns*

<TABLE>
<CAPTION>
Periods ending 12/31/95
- --------------------------------------------------------------
25 yrs. 10 yrs. 5 yrs.
- --------------------------------------------------------------
<S> <C> <C> <C>
Intermediate-term
U.S. Government Bonds 8.9% 8.9% 8.4%

Treasury Bills 7.0% 5.5% 4.3%
</TABLE>

*These returns are historical returns and do not represent projected or
anticipated returns from the Fund. Actual returns may be higher or lower than
the historical returns. Intermediate-term bonds may be more volatile than
Treasury Bills.
Source: Ibbotson Associates. Intermediate-term bond maturity approximates five
years.

Lower Volatility

Intermediate-term bonds are less volatile than long-term bonds in response to
interest rate changes. The chart below shows the percentage change in principal
value for bonds of various maturities when interest rates rise by one percentage
point. The chart assumes an 8% coupon for each bond.

Bond Prices vs. Interest Rates

<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------
Maturity in yrs. If rates rise 1% bond price falls by:
- -----------------------------------------------------------------------------
<S> <C> <C>
Treasury Bill 1 (.9%)

Intermediate Bond 5 (4.0%)

Long-term Bond 30 (11.0%)
</TABLE>

Source: IAI

Income
and low credit risk
from U.S. government
securities

IAI Mutual Funds

IAI Minnesota Tax Free Fund

Fund Information

Tax Free Income

Many Americans pay a significant portion of their investment income in federal
income taxes. IAI Minnesota Tax Free Fund seeks to provide shareholders with
current income exempt from federal and Minnesota income taxes. Depending upon
your tax status, a portion of the Fund's earnings may be subject to the
Alternative Minimum Tax.

Investment Grade Bonds

The Fund seeks to achieve its objective by investing primarily in investment
grade bonds, bonds rated BBB or better by Standard & Poor's or Baa or better by
Moody's, issued by the state of Minnesota and related governmental authorities.
Please see the Fund's prospectus, which accompanies this material, for more
information on the Fund's investment policies and techniques, as well as the
risks associated with investing in the Fund.

Diversified Portfolio

The Fund's portfolio is fully diversified and spreads its holdings across a wide
range of securities. Issues have included state agencies, utilities,
universities, and airports from around the state of Minnesota.

Monthly Dividends

Dividends are paid monthly. You may receive your dividends in cash or
automatically reinvest them in additional shares, which provides the benefits of
tax free compounding (see chart on next page).

Professional Management

IAI Minnesota Tax Free Fund is a member of the IAI Mutual Fund family. Founded
in 1947, IAI manages more than $14.5 billion for thousands of individual
investors, as well as FORTUNE 500/(R)/ companies, leading colleges,
universities, and religious organizations. IAI's municipal bond experts monitor
the market daily and select the best issues available for the Fund's portfolio.

It's Easy to Start

call 1-800-945-3863

[PHOTO OF]
Stephen C. Coleman, CFA
Fund Manager

[PHOTO OF]
Livingston G. Douglas, CFA
Fund Manager

IAI Mutual Funds

IAI Minnesota Tax Free Fund

The Tax Free Advantage

The benefit of tax free investing grows with your tax bracket. In fact, you may
find that a tax exempt investment yields more after tax than a taxable
investment. The chart below shows you how much you would need to earn in various
tax brackets (columns 2-5) to equal the after-tax return from the tax-free
yields shown in the first column. For example, a return of 4% in a tax-free fund
would be the equivalent of a 6.04% after-tax return in a taxable fund in the
33.8% combined federal and Minnesota state income tax bracket.

Tax Free vs. Taxable Income

<TABLE>
<CAPTION>
Taxable Equivalent Yields
-----------------------------------
Combined Federal & Minnesota Tax Brackets
----------------------------------------------------------
Tax Free Yields 33.8% 36.9% 41.4% 44.7%
===============================================================================
<S> <C> <C> <C> <C>
4.0% 6.04% 6.34% 6.83% 7.23%
4.5% 6.80% 7.13% 7.68% 8.14%
5.0% 7.55% 7.92% 8.53% 9.04%
5.5% 8.31% 8.72% 9.39% 9.95%
6.0% 9.06% 9.51% 10.24% 10.85%
6.5% 9.82% 10.30% 11.09% 11.75%
7.0% 10.57% 11.09% 11.95% 12.66%
7.5% 11.33% 11.89% 12.80% 13.56%
8.0% 12.08% 12.68% 13.65% 14.47%
</TABLE>

[CHART APPEARS HERE]
<TABLE>
<CAPTION>
Initial Investment 5 Years 10 Years 15 Years 20 Years
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Tax Free Investment $100,000 $138,262 $191,218 $264,420 $365,645

Taxable Investment $100,000 $125,086 $156,465 $195,716 $244,814
</TABLE>

Your Investment Grows
Faster

This example assumes a constant hypothetical yield of 6.50% compounded monthly
on an initial $100,000 investment. The example assumes that an investor is in
the 31% federal income tax bracket. This example is for illustrative purposes
only and is not intended to predict the performance of any particular
investment. Taxable and non-taxable rates should not be assumed to be equal. The
share price and yield of a mutual fund will fluctuate, and there can be no
guarantee that any particular return will be achieved.

With tax free
investing, all of your
income compounds, rather
than part going to taxes each
year! The difference can
be remarkable, as shown
in this chart.
<PAGE>

<TABLE>
<CAPTION>
Table of Contents

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

<S> <C>
Fund Expense Information.............................................. 2

Fund Directors........................................................ 2

Financial Highlights.................................................. 3

Investment Performance................................................ 6

Investment Objectives and Policies.................................... 7

IAI Bond Fund....................................................... 7

IAI Government Fund................................................. 8

IAI Minnesota Tax Free Fund......................................... 11

Other Fund Investment Techniques...................................... 13

Fund Risk Factors..................................................... 15

Management............................................................ 20

Computation of Net Asset
Value and Pricing..................................................... 22

Purchase of Shares.................................................... 22

Retirement Plans...................................................... 23

Automatic Investment Plan............................................. 23

Redemption of Shares.................................................. 24

Exchange Privilege.................................................... 25

Automatic Exchange Plan............................................... 25

Authorized Telephone Trading.......................................... 26

Systematic Cash Withdrawal Plan....................................... 26

Dividends, Distributions and
Tax Status............................................................ 27

Description of Common Stock........................................... 30

Counsel and Auditors.................................................. 30

Custodian, Transfer Agent and
Dividend Disbursing Agent............................................. 31

Tax-Exempt vs. Taxable Income......................................... 31

Additional Information................................................ 32
</TABLE>
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

Prospectus Dated April 1, 1996

IAI Bond Fund ("Bond Fund") is a separate portfolio of IAI Investment Funds I,
Inc. IAI Government Fund ("Government Fund") and IAI Minnesota Tax Free Fund
("Minnesota Tax Free Fund") are separate portfolios of IAI Investment Funds VI,
Inc. Each of IAI Investment Funds I, Inc. and IAI Investment Funds VI, Inc. is a
registered investment company authorized to issue its shares of common stock in
more than one series.

Bond Fund's investment objective is to provide shareholders with a high level of
current income consistent with preservation of capital. Bond Fund pursues its
objective by investing primarily in a diversified portfolio of investment grade
bonds and other debt securities of similar quality.

Government Fund's investment objectives are to provide shareholders with a high
level of current income and with preservation of capital. Government Fund
pursues its objectives by investing its assets primarily in securities issued,
guaranteed or collateralized by the United States Government, its agencies or
instrumentalities, whether or not backed by the "full faith and credit" pledge
of the United States Government, and in repurchase agreements pertaining to such
securities.

Minnesota Tax Free Fund's investment objective is to provide shareholders with
as high a level of current income exempt from federal income tax as is
consistent with preservation of capital. Minnesota Tax Free Fund pursues its
objective by investing at least 70% of its net assets in investment grade
Minnesota Obligations.

This Prospectus sets forth concisely the information which a prospective
investor should know about each Fund before investing and it should be retained
for future reference. A "Statement of Additional Information" dated April 1,
1996, which provides a further discussion of certain areas in this Prospectus
and other matters which may be of interest to some investors, has been filed
with the Securities and Exchange Commission and is incorporated herein by
reference. For a free copy, call or write the Funds at the address or telephone
number shown on the inside back cover of this Prospectus.

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.

1
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IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

Fund Expense Information

<TABLE>
<CAPTION>
Shareholder Transaction Expenses

- -------------------------------------------------------------------------------------------------------------------------
IAI Bond Fund IAI Government Fund IAI Minnesota Tax Free Fund
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Sales Load Imposed on Purchases None None None
Sales Load Imposed on Reinvested Dividends None None None
Redemption Fees None None None
Exchange Fees None None None
</TABLE>

<TABLE>
<CAPTION>
Annual Fund Operating Expenses (net of reimbursements)
(as a percentage of average daily net assets)
- -------------------------------------------------------------------------------------------------------------------------
IAI Bond Fund IAI Government Fund IAI Minnesota Tax Free Fund
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Sales Load Imposed on Purchases None None None
Management Fee 1.10% 1.10% .95%
Rule 12b-1 Fee None None None
Other Expenses None None None
---------------------------------------------------------------------
Total Fund Operating Expenses 1.10% 1.10% .95%
=====================================================================
</TABLE>

Example: Based upon the levels of Total Fund Operating Expenses listed above,
you would pay the following expenses on a $1,000 investment, assuming a five
percent annual return and redemption at the end of each period:

<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
<S> <C> <C> <C> <C>
IAI BOND FUND $11 $35 $61 $134

IAI GOVERNMENT FUND $11 $35 $61 $134

IAI MINNESOTA TAX FREE FUND $10 $30 $53 $117
</TABLE>

The purpose of the above table is to assist you in understanding the various
costs and expenses that an investor in the Funds will bear directly or
indirectly. Because of a change in each Fund's fee structure effective April 1,
1996, the information in the table has been restated to reflect each Fund's
current fees under the new structure. The example should not be considered a
representation of past or future expenses. Actual expenses may be greater or
less than those shown. For the period from April 1, 1996 through June 30, 1996,
IAI has agreed to waive its Management Fee in excess of .25% of Minnesota Tax
Free Fund's average daily net assets.

Further information concerning fees paid by the Funds is set forth in the
Statement of Additional Information.

Fund Directors

Madeline Betsch
W. William Hodgson
George R. Long
Noel P. Rahn
Richard E. Struthers
J. Peter Thompson
Charles H. Withers

2
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

Financial Highlights

The following information has been audited by KMPG Peat Marwick LLP, independent
auditors, whose report is included in the Fund's Annual Report. The financial
statements in the Annual Report are incorporated by reference in (and are a part
of) the Statement of Additional Information. Such Annual Report may be obtained
by shareholders on request from the Fund at no charge.

Bond Fund

<TABLE>
<CAPTION>
Year ended Period from Years Ended March 31,
November 30, April 1, 1994+ to ------------------------------------------
1995 November 30, 1994 1994 1993 1992 1991
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value:
Beginning of period $ 8.65 $ 9.32 $ 10.42 $ 10.25 $ 10.02 $ 9.66
-----------------------------------------------------------------------------
Operations:
Net investment income .58 .36 .62 .64 .73 .73
Net realized and unrealized
gains (losses) .72 (.55) (.25) .93 .34 .43
-----------------------------------------------------------------------------
Total from operations 1.30 (.19) .37 1.57 1.07 1.16
-----------------------------------------------------------------------------
Distributions to shareholders from:
Net investment income (.61) (.35) (.66) (.64) (.74) (.80)

Net realized gains - (.13) (.81) (.76) (.10) -
-----------------------------------------------------------------------------
Total distributions (.61) (.48) (1.47) (1.40) (.84) (.80)
-----------------------------------------------------------------------------
Net Asset Value:
End of period $ 9.34 $ 8.65 $ 9.32 $ 10.42 $ 10.25 $ 10.02
==============================================================================

Total investment return* 15.46% (2.10%) 3.16% 16.44% 10.80% 12.62%

Net assets at end of period
(000's omitted) $77,526 $ 80,622 $97,139 $119,371 $107,634 $108,589

Ratios:
Expenses to average net assets 1.09% 1.10%** 1.09% 1.10% 1.10% .88%

Net investment income
to average net assets 6.32% 6.03%** 5.63% 6.03% 7.43% 7.56%

Portfolio turnover rate
(excluding short-term securities) 424.7% 226.70% 333.10% 160.80% 126.20% 43.00%
</TABLE>
<TABLE>
<CAPTION>

----------------------------------------
1990 1989 1988 1987
----------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value:
Beginning of period $ 9.31 $ 9.63 $ 10.29 $ 10.72
----------------------------------------
Operations:
Net investment income .73 .72 .76 .85
Net realized and unrealized
gains (losses) .32 (.32) (.37) (.11)
----------------------------------------
Total from operations 1.05 .40 .39 .74
----------------------------------------
Distributions to shareholders from:
Net investment income (.67) (.72) (.95) (.89)

Net realized gains (.03) - (.10) (.28)
----------------------------------------
Total distributions (.70) (.72) (1.05) (1.17)
----------------------------------------
Net Asset Value:
End of period $ 9.66 $ 9.31 $ 9.63 $ 10.29
========================================

Total investment return* 11.18% 4.29% 4.19% 7.39

Net assets at end of period
(000's omitted) $79,982 $50,187 $41,080 $46,089

Ratios:
Expenses to average net assets .89% .90% .80% .70%

Net investment income
to average net assets 7.50% 7.70% 7.70% 8.50%

Portfolio turnover rate
(excluding short-term securities) 78.30% 115.30% 20.20% 35.40%
</TABLE>

* Total investment return is based on the change in net asset value of a share
during the period and assumes reinvestment of distributions at net asset
value.
** Annualized.
+ Reflects fiscal year-end change from April 1, 1994 to November 30, 1994.

3
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund
<TABLE>
<CAPTION>

Government Fund
<S> <C> <C> <C> <C> <C>

Year ended Period from Year ended Year ended Period from
November 30, April 1, 1994+ to March 31, March 31, August 8, 1991***
1995 November 30, 1994 1994 1993 to March 31, 1992
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value:
Beginning of period $ 9.62 $ 9.98 $ 10.46 $ 10.22 $ 10.00
------------------------------------------------------------------------------
Operations:
Net investment income .60 .33 .47 .57 .30
Net realized and unrealized gains
(losses) .43 (.34) (.24) .59 .24
------------------------------------------------------------------------------
Total from operations 1.03 (.01) .23 1.16 .54
------------------------------------------------------------------------------
Distributions to shareholders from:
Net investment income (.59) (.32) (.49) (.58) (.30)
Net realized gains - (.03) (.22) (.34) (.02)
------------------------------------------------------------------------------
Total distributions (.59) (.35) (.71) (.92) (.32)
------------------------------------------------------------------------------
Net Asset Value:
End of period $ 10.06 $ 9.62 $ 9.98 $ 10.46 $ 10.22
==============================================================================
Total investment return*** 10.99% (0.09%) 2.02% 11.70% 5.51%
Net assets at end of period
(000's omitted) $48,121 $ 38,438 $41,027 $43,704 $ 30,707
Ratios:
Expenses to average net assets 1.10% 1.10%** 1.10% 1.10% 1.10%**
Net investment income
to average net assets 5.97% 5.12%** 4.40% 5.40% 5.16%**
Portfolio turnover rate
(excluding short-term securities) 284.10% 121.50% 641.00% 236.30% 169.60%
</TABLE>
* Total investment return is based on the change in net asset value of a
share during the period and assumes reinvestment of distributions at net
asset value.
** Annualized.
*** Commencement of operations.
+ Reflects fiscal year-end change from March 31 to November 30.

4
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund
<TABLE>
<CAPTION>

Minnesota Tax Free Fund

Year ended Period from Year ended Period from
November 30, April 1, 1994+ to March 31, April 6, 1992***
1995 November 30, 1994 1994 to March 31, 1993
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value:
Beginning of period $ 9.53 $ 10.27 $10.67 $ 10.00
--------------------------------------------------------------------
Operations:
Net investment income .52 .39 .58 .41
Net realized and unrealized
gains on investments .71 (.69) (.35) .67
---------------------------------------------------------------------
Total from operations 1.23 (.30) .23 1.08
---------------------------------------------------------------------
Distributions to shareholders from:
Net investment income (.52) (.39) (.56) (.41)
Net realized gains - (.05) (.07) -
---------------------------------------------------------------------
Total distributions (.52) (.44) (.63) (.41)
---------------------------------------------------------------------
Net Asset Value:
End of period $10.24 $ 9.53 $10.27 $ 10.67
=====================================================================
Total investment return* 13.17% (3.10%) 1.89% 11.00%
Net assets at end of period (000's omitted) $6,630 $ 6,942 $7,738 $ 5,045
Ratios:
Expenses to average net assets**** .25% .25%** .25% .95%**
Net investment income
to average net assets**** 5.15% 5.76%** 5.28% 4.36%**
Portfolio turnover rate
(excluding short-term securities) 94.0% 57.80% 16.00% 4.80%
</TABLE>
* Total investment return is based on the change in net asset value of a
share and assumes reinvestment of distributions at net asset value.
** Annualized.
*** Commencement of operations.
**** The Fund's adviser voluntarily absorbed $49,686, $35,252 and $53,108 in
expenses for the period ended November 30, 1995, the period ended November
30, 1994 and the year ended March 31, 1994, respectively. If the Fund had
been charged for these expenses, the ratio of expenses to average net
assets would have been .95% for each of the periods stated above and the
ratio of net investment income to average net assets would have been 4.45%,
5.06% and 4.58%, respectively.
+ Reflects fiscal year-end change from March 31 to November 30.

5
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

Investment Performance

From time to time the Funds may advertise performance data including monthly,
quarterly, yearly or cumulative total return, average annual total return and
yield figures. All such figures are based on historical earnings and performance
and are not intended to be indicative of future performance. On December 15,
1994, IAI Tax Free Fund was converted to IAI Minnesota Tax Free Fund, so
performance figures prior to that time may not provide a basis for evaluating
the past investment results of such Fund. The investment return on and principal
value of an investment in a Fund will fluctuate, so that an investor's shares,
when redeemed, may be worth more or less than their original cost.

Total return is the change in value of an investment in a Fund over a given
period, assuming reinvestment of any dividends and capital gains. A cumulative
total return reflects actual performance over a stated period of time. An
average-annual total return is a hypothetical rate of return that, if achieved
annually, would have produced the same cumulative total return if performance
had been constant over the entire period.

Yield refers to the income generated by an investment in a Fund over a given
period of time, expressed as an annual percentage rate. Yields are calculated
according to a standard that is required for all bond funds. Because this
differs from other accounting methods, the quoted yield may not equal the income
actually paid to shareholders. The tax equivalent yield is computed by dividing
the portion of the yield that is tax-exempt by one minus a stated income tax
rate and adding the product to that portion, if any, of the yield that is not
tax-exempt.

For additional information regarding the calculation of such total return and
yield figures, see "Investment Performance" in the Statement of Additional
Information. Further information about the performance of the Funds is contained
in the Funds' Annual Report to shareholders which may be obtained without charge
from the Funds.

Comparative performance information may be used from time to time in advertising
or marketing a Fund's shares, including data on the performance of other mutual
funds, indexes or averages of other mutual funds, indexes of related financial
assets or data, and other competing investment and deposit products available
from or through other financial institutions. The composition of these indexes,
averages or products differs from that of the Funds. The comparison of a Fund to
an alternative investment should be made with consideration of differences in
features and expected performance. A Fund may also note its mention in
newspapers, magazines, or other media from time to time. The Funds assume no
responsibility for the accuracy of such data. For additional information on the
types of indexes, averages and periodicals that might be utilized by the Funds
in advertising and sales literature, see the section "Investment Performance" in
the Statement of Additional Information.

6
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

Investment Objectives and Policies

Bond Fund

Bond Fund's investment objective is to provide a high level of current income
consistent with preservation of capital. Such objective may not be changed
without shareholder approval. There can be no assurance that Bond Fund's
investment objective will be attained.

Bond Fund pursues its objective by investing primarily in a diversified
portfolio of investment grade bonds and other debt securities of similar
quality. Investment grade securities are those securities rated within the four
highest grades assigned by Moody's Investors Service, Inc. ("Moody's") or
Standard & Poor's Corporation ("S&P").

Bond Fund may also invest in below investment grade securities. Such securities
are commonly referred to as junk bonds. Bond Fund currently intends to limit
such investments to 15% of its total assets and not to invest in junk bonds
rated lower than B by Moody's or S&P. Securities rated in the medium to lower
rating of categories of nationally recognized statistical rating organizations
and unrated securities of comparable quality are predominately speculative with
respect to the capacity to pay interest and repay principal in accordance with
the terms of the security and generally involve a greater volatility of price
than securities in higher rating categories.

See "Investment Objectives and Policies" in the Statement of Additional
Information for additional information regarding ratings of debt securities. In
purchasing such securities, Bond Fund will rely on IAI's judgment, analysis and
experience in evaluating the creditworthiness of an issuer of such securities.
IAI will take into consideration, among other things, the issuer's financial
resources, its sensitivity to economic conditions and trends, its operating
history, the quality of the issuer's management and regulatory matters.

Other debt securities in which Bond Fund may invest include, but are not limited
to, securities of, or guaranteed by, the United States Government, its agencies
or instrumentalities, bank certificates of deposit, bankers' acceptances, debt
securities of foreign issuers, and commercial paper rated at least Prime-2 by
Moody's or A-2 by S&P or otherwise issued by companies having an outstanding
unsecured debt issue currently rated A or better by Moody's or S&P. Under normal
market conditions, at least 65% of Bond Fund's total assets will be invested in
debt obligations and government securities with maturities at the time of
acquisition of one year or more.

Although Bond Fund generally will not make direct purchases of common stock,
Bond Fund may purchase preferred stock and convertible securities. Preferred
stocks are securities that represent an ownership interest in a corporation and
that give the owner a prior claim over common stock on the company's earnings or
assets. Convertible securities are debt obligations of corporations convertible
into or exchangeable for equity

7
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

securities or debt obligations that carry with them the right to acquire equity
securities, as evidenced by warrants attached to such securities, or acquired as
part of units of the securities. The risks associated with investing in
preferred stock and convertible securities are different from those
traditionally associated with investments in debt securities. Such risks are
similar instead to the risks associated with investments in equity securities,
including the risk that the value of the equity security will fluctuate in
response to the activities of the issuing company or in response to general
market and/or economic conditions. Bond Fund will limit its investments in such
securities to a maximum of 10% of its net assets.

Bond Fund may invest in securities issued by foreign issuers, whether dollar-
denominated or not, including securities issued or guaranteed by one or more
foreign governments or any of their political subdivisions, agencies or
instrumentalities, including obligations of supranational entities, that are
determined by IAI to be of comparable quality to the other obligations in which
Bond Fund may invest. Bond Fund currently intends to invest no more than 25% of
the value of its total assets in non-dollar denominated securities of foreign
issuers.

Bond Fund may employ certain other investment techniques, as described in the
section "Other Fund Investment Techniques." Please see the Prospectus section
"Fund Risk Factors" and the Statement of Additional Information section
"Investment Objectives and Policies" for a discussion of the risks associated
with investing in Bond Fund.

Government Fund

The investment objectives of Government Fund are to provide shareholders with a
high level of current income and with preservation of capital. In seeking to
achieve its objectives, Government Fund will invest its assets primarily in
securities issued, guaranteed or collateralized by the United States Government,
its agencies or instrumentalities whether or not backed by the "full faith and
credit" pledge of the United States Government and in repurchase agreements
pertaining to such securities. IAI anticipates that each of Government Fund's
objectives will be given approximately equal consideration in the selection of
Fund investments. Government Fund's investment objectives may not be changed
without shareholder approval. There can be no assurance that Government Fund's
investment objectives will be attained.

Under normal market conditions, Government Fund will invest at least 65% of its
total assets in securities issued, guaranteed or collateralized by the United
States Government, its agencies or instrumentalities (excluding, for purposes of
calculating this minimum, CMOs as described below, which are secured by
obligations of the U.S. Government, its agencies or instrumentalities but are
issued by private issuers), including:

8
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

1. United States Treasury obligations, such as Treasury Bills (which have
original maturities of one year or less), Treasury Notes (which have original
maturities of one to ten years) and Treasury Bonds (which have original
maturities generally greater than ten years);

2. Obligations of United States Government agencies and instrumentalities which
are secured by the full faith and credit of the United States Treasury, such
as Government National Mortgage Association ("Ginnie Mae") modified pass-
through certificates;

3. Obligations which are secured by the right of the issuer to borrow from the
United States Treasury, such as securities issued by the Federal Financing
Bank or the United States Postal Service; and

4. Obligations which are supported by the credit of the government agency or
instrumentality itself (but are not backed by the full faith and credit of
the United States Government) such as securities of the Federal Home Loan
Mortgage Corporation ("Freddie Mac") or the Federal National Mortgage
Association ("Fannie Mae"), including pass-through securities and
participation certificates thereof.

Guarantees as to the timely payment of principal and interest do not extend to
the value or yield of such securities nor do they extend to the value of
Government Fund's shares. In the case of securities invested in by Government
Fund which are not backed by the "full faith and credit" of the United States
Government, the investor must look principally to the agency issuing or
guaranteeing the obligation for ultimate repayment and may not be able to assert
a claim against the United States Government itself in the event the agency or
instrumentality does not meet its commitment. Except as specifically set forth
below, there are no percentage limitations with regard to the purchase of any of
Government Fund's investments.

The dollar-weighted average maturity of Government Fund's portfolio will
generally not exceed, and may be substantially less than, seven years. As
discussed below, mortgage-related securities generally have an average life less
than their maturity. Because of variations in prepayment rights, it is not
possible to accurately predict the life of a particular mortgage-related
investment. For purposes of determining the dollar-weighted average maturity of
Government Fund's portfolio, IAI will consider the statistical average remaining
life of mortgage-related securities.

The mortgage-related securities in which Government Fund may invest include
pass-through securities. Mortgage pass-through securities are issued by
government agencies such as Ginnie Mae, Freddie Mac and Fannie Mae. Such
securities are formed when mortgages are pooled together and undivided interests
in the pool are sold to investors (such as Government Fund) by various
governmental and government-related organizations. The cash flow from the
underlying mortgages is "passed through" to the holders of the securities in the
form of

9
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

monthly payments of interest, principal and prepayments. Timely payment of the
principal and interest on such securities is guaranteed either by the full faith
and credit of the United States Government (as in the case of Ginnie Mae
securities) or by the agency itself (as in the case of Freddie Mac and Fannie
Mae securities). In addition, Government Fund may invest up to 35% of its assets
in securities of private issuers that are collateralized by pools of mortgages
issued or guaranteed by the United States Government, its agencies or
instrumentalities, called collateralized mortgage obligations ("CMOs"). CMOs of
private issuers, even though collateralized by Government securities, are not
guaranteed by the U.S. Government or any agency or instrumentality of the U.S.
Government. Government Fund will invest in privately issued CMOs only if rated
at the time of investment Aaa by Moody's Investors Service, Inc. ("Moody's"), or
AAA by Standard & Poor's Corporation ("S&P"). CMOs are more fully described in
the Statement of Additional Information under "Investment Objectives and
Policies--Mortgage-Backed Securities."

The average life of such mortgage pools varies with the maturities of the
underlying mortgage instruments. In addition, a pool's term may be shortened by
unscheduled or early payments of principal and interest on the underlying
mortgages. The occurrence of mortgage prepayment is affected by factors
including the level of interest rates, general economic conditions, the location
and age of the mortgage and other social and demographic conditions.
Accordingly, the life of an individual mortgage-related security is likely to be
substantially shorter than the stated maturity of the mortgages in the
underlying pool. Yields on mortgage-related securities are typically quoted
based on the maturity of the underlying instruments and the associated average
life assumption. Actual prepayment experience may cause the yield to differ from
the assumed average life yield. See the Statement of Additional Information for
more information about the characteristics of these instruments.

Instrumentalities of the United States Government which issue or guarantee
securities in which Government Fund may invest include, but are not limited to,
the Federal Farm Credit System, the Student Loan Marketing Association, Federal
Home Loan Banks, Federal Land Banks, Freddie Mac and Fannie Mae. Since the
United States Treasury is not obligated by law to provide support to all United
States Government instrumentalities and agencies, Government Fund will invest in
securities issued by such instrumentalities and agencies only when IAI
determines that the credit risk with respect to the instrumentality or agency
does not make its securities unsuitable investments for Government Fund.

Government Fund may also invest in non-U.S. Government bonds and other fixed
income securities including fixed income securities issued by corporations and
foreign entities, whether dollar-denominated or not, securities issued or
guaranteed by one or more foreign governments or any of their political subdivi-

10
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

sions, agencies or instrumentalities, and obligations of supranational entities,
that are rated within the four highest grades by Moody's or S&P or are
determined by IAI to be of comparable quality. For a description of Moody's and
S&P ratings, see Appendix A to the Statement of Additional Information.

Government Fund may employ certain other investment techniques, as described in
the section "Other Fund Investment Techniques." Please see the Prospectus
section "Fund Risk Factors" and the Statement of Additional Information section
"Investment Objectives and Policies" for a discussion of the risks associated
with investing in Government Fund.

Minnesota Tax Free Fund

The investment objective of Minnesota Tax Free Fund is to provide shareholders
with as high a level of current income exempt from federal income tax as is
consistent with preservation of capital. Minnesota Tax Free Fund will seek to
achieve its objective by investing primarily in investment grade municipal bonds
issued by the State of Minnesota and its political or governmental subdivisions,
municipalities, governmental agencies or instrumentalities (collectively,
"Minnesota Obligations"). Minnesota Tax Free Fund's investment objective may not
be changed without shareholder approval. There can be no assurance that
Minnesota Tax Free Fund's objective will be met.

Under normal market conditions, Minnesota Tax Free Fund expects to invest at
least 80% of its net assets in Minnesota Obligations that produce income that is
exempt from Minnesota and federal personal income tax. If an unusual disparity
between after-tax income on taxable and municipal securities makes it advisable,
up to 20% of Minnesota Tax Free Fund's assets may be held in cash or invested in
tax-exempt securities subject to the alternative minimum tax or short-term
taxable investments including U.S. Government obligations and money market
instruments. Minnesota Tax Free Fund may temporarily invest up to 50% of its
assets in cash, high-quality tax exempt securities subject to the alternative
minimum tax or high-quality taxable securities during periods which, in IAI's
opinion, require a defensive position. To the extent that Minnesota Tax Free
Fund invests in taxable securities, a portion of the Fund's income may be
subject to federal and state income taxes.

Minnesota Tax Free Fund will invest primarily in municipal securities the
interest on which is exempt from Minnesota and federal personal income tax. The
two principal classifications of municipal securities are general obligation and
revenue bonds. General obligation bonds are secured by the governmental issuer's
pledge of its faith, credit and taxing power for the payment of principal and
interest. They are usually paid from the general revenues of the issuing
governmental entity. Revenue bonds, on the other hand, are usually payable only
out of a specific revenue source rather than from general revenues. Revenue
bonds

11
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

ordinarily are not backed by the faith, credit or general taxing power of the
issuing governmental entity.

The principal and interest on revenue bonds for private facilities are typically
paid out of rents or other specified payments made to the issuing governmental
entity by a private company which uses or operates the facilities. Examples of
these types of obligations are industrial revenue bonds and pollution control
revenue bonds. Industrial revenue bonds are issued by governmental entities to
provide financing aid to community facilities such as hospitals, hotels,
business or residential complexes, convention halls and sports complexes.
Pollution control revenue bonds are issued to finance air, water and solid waste
pollution control systems for privately operated industrial or commercial
facilities.

There are, in addition, a variety of hybrid and special types of municipal
securities, including variable rate securities and municipal notes. Variable
rate securities bear rates of interest that are adjusted periodically according
to formulae intended to minimize fluctuation in values of the instruments.
Municipal notes include tax, revenue and bond anticipation notes of short
maturity, generally less than three years, which are issued to obtain temporary
funds for various public purposes. Some municipal securities may not be backed
by the faith, credit, and taxing power of the issuer. Other municipal securities
in which Minnesota Tax Free Fund may invest include municipal lease obligations,
resource recovery bonds, zero coupon and asset-backed securities, tax, revenue
or bond anticipation notes and tax exempt commercial paper. For additional
information regarding certain of such municipal securities, see "Investment
Objectives and Policies" in the Statement of Additional Information.

Minnesota Tax Free Fund will invest at least 70% of its net assets in municipal
securities that are of investment grade or of equivalent quality as determined
by IAI. Investment grade securities are those rated within the four highest
grades assigned by Moody's Investors Service, Inc. ("Moody's") or Standard &
Poor's Corporation ("S&P"). Minnesota Tax Free Fund also may invest in short-
term municipal obligations which are rated in the two highest rating categories
by Moody's or S&P. Up to 30% of Minnesota Tax Free Fund's net assets may be
invested in securities rated below investment grade. Minnesota Tax Free Fund
does not, however, currently intend to invest in securities rated lower than B
by Moody's or S&P.

Securities rated in the medium to lower rating categories of nationally
recognized statistical rating organizations and unrated securities of comparable
quality are predominantly speculative with respect to the capacity to pay
interest and repay principal in accordance with the terms of the security and
generally involve a greater volatility of price than securities in higher rating
categories. See "Investment Objectives and Policies" in the Statement of
Additional Information for additional information

12
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

regarding ratings of debt securities. In purchasing such securities, Minnesota
Tax Free Fund will rely on IAI's judgment, analysis and experience in evaluating
the creditworthiness of an issuer of such securities. IAI will take into
consideration, among other things, the issuer's financial resources, its
sensitivity to economic conditions and trends, its operating history, the
quality of the issuer's management and regulatory matters.

Minnesota Tax Free Fund may also invest in state or municipal leases and
participation interests therein. Municipal leases are obligations issued by
state and local governments or authorities to finance the acquisition of
equipment and facilities such as fire, sanitation or police vehicles or
telecommunications equipment, buildings or other capital assets.

Although Minnesota Tax Free Fund may invest in securities of any maturity, the
dollar-weighted average maturity of Minnesota Tax Free Fund's investment
portfolio is expected to be approximately 10-20 years.

Minnesota Tax Free Fund may employ certain other investment techniques, as
described in the section "Other Fund Investment Techniques." Please see the
Prospectus sections "Fund Risk Factors" and "Special Risk Factors Associated
with Minnesota Tax Free Fund" as well as the Statement of Additional Information
section "Investment Objectives and Policies" for a discussion of the risks
associated with investing in Minnesota Tax Free Fund.

Other Fund Investment Techniques

Repurchase Agreements

Each Fund may invest in repurchase agreements relating to the securities in
which it may invest. In a repurchase agreement, a Fund buys a security at one
price and simultaneously agrees to sell it back at a higher price. Delays or
losses could result if the other party to the agreement defaults or becomes
bankrupt.

When-Issued/Delayed Delivery Transactions

Each Fund may purchase securities on a "when-issued" or delayed delivery basis
and purchase or sell securities on a "forward commitment" basis. When such
transactions are negotiated, the price is fixed at the time the commitment is
made, but delivery and payment for the securities take place at a later date.
Normally, the settlement date occurs within two months after the transaction,
but delayed settlements beyond two months may be negotiated. At the time a Fund
enters into a transaction on a when-issued or forward commitment basis, a
segregated account consisting of cash, government securities or liquid high-
grade debt securities equal to the value of the when-issued or forward
commitment securities will be established and maintained with the custodian and
will be marked to the market daily. During the period between a commitment and a
settlement, no payment is made for the securities and, thus, no

13
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

interest accrues to the purchaser from the transaction. If a Fund disposes of
the right to acquire a when-issued security prior to its acquisition or disposes
of its right to deliver or receive against a forward commitment, it can incur a
gain or loss due to market fluctuation. The use of when-issued transactions and
forward commitments enables a Fund to hedge against anticipated changes in
interest rates and prices. A Fund may also enter into such transactions to
generate incremental income. In some instances, the third-party seller of when-
issued or forward commitment securities may determine prior to the settlement
date that it will be unable or unwilling to meet its existing transaction
commitments without borrowing securities. If advantageous from a yield
perspective, a Fund may, in that event, agree to resell its purchase commitment
to the third-party seller at the current market price on the date of sale and
concurrently enter into another purchase commitment for such securities at a
later date. As an inducement for a Fund to "roll over" its purchase commitment,
a Fund may receive a negotiated fee. As to each Fund, no more than 20% of its
net assets may be invested in when-issued, delayed delivery or forward
commitment transactions, and of such 20%, no more than one-half (i.e. 10% of its
net assets) may be invested in when-issued, delayed delivery or forward
commitment transactions without the intention of actually acquiring securities
(i.e. dollar rolls or "roll" transactions). For additional information on roll
transactions, see "Investment Objectives and Policies--Dollar Rolls" in the
Statement of Additional Information.

Illiquid Securities

Each Fund may invest up to 15% of its net assets in securities that are
considered illiquid because of the absence of a readily available market or due
to legal or contractual restrictions. However, certain restricted securities
that are not registered for sale to the general public but that can be resold to
institutional investors may be considered liquid pursuant to guidelines adopted
by the Board of Directors. The institutional trading market is relatively new,
and the liquidity of the Fund's investments could be impaired if trading does
not develop or declines.

Zero Coupon Obligations

Each Fund may also invest in zero coupon obligations of the U.S. Government or
its agencies, tax exempt issuers and corporate issuers, including rights to
stripped coupon and principal payments ("STRIPS"). Zero coupon bonds do not make
regular interest payments; rather, they are sold at a discount from face value.
Principal and accreted discount (representing interest accrued but not paid) are
paid at maturity. STRIPS are debt securities that are stripped of their interest
after the securities are issued, but otherwise are comparable to zero coupon
bonds. The market values of strips and zero coupon bonds generally fluctuate in
response to changes in interest rates to a greater degree than do interest-
paying securities of comparable term and quality.

14
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

Adjusting Investment
Exposure

Each Fund can use various techniques to increase or decrease its exposure to
changing security prices, interest rates, currency exchange rates, commodity
prices, or other factors that affect security values. These techniques include
buying and selling options and futures contracts, entering into currency
exchange contracts or swap agreements, purchasing indexed securities, and
selling securities short.

Borrowing

Each Fund may borrow from banks (or through reverse repurchase agreements) for
temporary or emergency purposes. If a Fund borrows money, its share price may be
subject to greater fluctuation until the borrowing is paid off. If a Fund makes
additional investments while borrowings are outstanding, this may be considered
a form of leverage.

Portfolio Turnover

Each Fund will dispose of securities without regard to the time they have been
held when such action appears advisable to management either as a result of
securities having reached a price objective, or by reason of developments not
foreseen at the time of the investment decision. Since investment changes
usually will be made without reference to the length of time a security has been
held, a significant number of short-term transactions may result. Accordingly, a
Fund's annual portfolio turnover rate cannot be anticipated and may be
relatively high, as the rates were for Bond and Government Funds for the last
fiscal year. High turnover rates (100% or more) increase transaction costs, and
may increase taxable capital gains. Each Fund's historical portfolio turnover
rates are set forth in the section "Financial Highlights."

Further information regarding these and other techniques is contained in the
Statement of Additional Information.

Fund Risk Factors

Interest Rate Risk

As a mutual fund investing in fixed-income securities, each Fund is subject to
interest rate risk. Interest rate risk is the potential for a decline in bond
prices due to rising interest rates. In general, bond prices vary inversely with
interest rates. When interest rates rise, bond prices generally fall.
Conversely, when interest rates fall, bond prices generally rise. The change in
price depends on several factors, including the bond's maturity date. In
general, bonds with longer maturities are more sensitive to changes in interest
rates than bonds with shorter maturities. In managing a Fund, IAI will adjust
the duration of the investment portfolio in response to economic and market
conditions. Duration is generally considered a better measure of interest rate
risk than is maturity. Duration is a measure of the expected change in value of
a fixed income security (or portfolio) for a given change in interest rates. For
example, if interest rates rise by one percent, the market value of a security
(or portfolio) having a duration of two generally will fall by

15
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

approximately two percent. Duration is generally considered a better measure of
interest rate risk than is maturity. In some situations, the standard duration
calculation does not properly reflect the interest rate risk of a security. In
such situations, IAI will use more sophisticated analytical techniques, such as
modeling principal and interest payments based upon historical experience or
expected volatility, to arrive at an effective duration that incorporates the
additional variables into the determination of interest rate risk. These
techniques may involve estimates of future economic parameters which may vary
from actual future outcomes. IAI anticipates the following duration ranges for
the Funds: Bond Fund-3.5 to 7 years; Government Fund-2.5 to 4.5 years; and
Minnesota Tax Free Fund-3.5 to 8 years. These ranges are merely expectations as
of the date of this Prospectus. Such ranges may change due to market conditions
and other economic factors. Therefore, the expected duration ranges do not limit
IAI in how it manages the Funds.

These principals of interest rate risk also apply to U.S. Treasury and U.S.
Government agency securities. As with other bond investments, U.S. Government
securities will rise and fall in value as interest rates change. A security
backed by the U.S. Treasury or the full faith and credit of the United States is
guaranteed only as to the timely payment of interest and principal when held to
maturity. The current market prices for such securities are not guaranteed and
will fluctuate.

Credit Risk

Each Fund is also subject to credit risk. Credit risk, also known as default
risk, is the possibility that a bond issuer will fail to make timely payments of
interest or principal to the Fund. The credit risk of a Fund depends on the
quality of its investments. Reflecting their higher risks, lower-quality bonds
generally offer higher yields (all other factors being equal).

Call Risk

Each Fund is also subject to call risk. Call risk is the possibility that
corporate bonds held by a Fund will be repaid prior to maturity. Call
provisions, common in many corporate bonds held by a Fund, allow bond issuers to
redeem bonds prior to maturity (at a specified price). When interest rates are
falling, bond issuers often exercise these call provisions, paying off bonds
that carry high stated interest rates and often issuing new bonds at lower
rates. For a Fund, the result would be that bonds with high interest rates are
"called" and must be replaced with lower-yielding instruments. In these
circumstances, the income of a Fund would decline.

Foreign Investment
Risk Factors

Investments in foreign securities involve risks that are different in some
respects from investments in securities of U.S. issuers, such as the risk of
fluctuations in the value of the currencies in which they are denominated, the
risk of adverse political and economic developments

16
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

and, with respect to certain countries, the possibility of expropriation,
nationalization or confiscatory taxation or limitations on the removal of funds
or other assets of a Fund. Securities of some foreign companies are less liquid
and more volatile than securities of comparable domestic companies. There also
may be less publicly available information about foreign issuers than domestic
issuers, and foreign issuers generally are not subject to the uniform
accounting, auditing and financial reporting standards, practices and
requirements applicable to domestic issuers. Because a Fund can invest in
securities denominated or quoted in currencies other than the U.S. dollar,
changes in foreign currency exchange rates may affect the value of securities in
the portfolio. Foreign currency exchange rates are determined by forces of
supply and demand in the foreign exchange markets and other economic and
financial conditions affecting the world economy. A decline in the value of any
particular currency against the U.S. dollar will cause a decline in the U.S.
dollar value of a Fund's holdings of securities denominated in such currency
and, therefore, will cause an overall decline in a Fund's net asset value and
net investment income and capital gains, if any, to be distributed in U.S.
dollars to shareholders by a Fund. Delays may be encountered in settling
securities transactions in certain foreign markets, and a Fund will incur costs
in converting foreign currencies into U.S. dollars. Custody charges are
generally higher for foreign securities.

Risks of Transactions in
Derivatives

Each Fund will spread investment risk by limiting its holdings in any one
company or industry. IAI may use futures, options, swap and currency exchange
agreements as well as short sales to adjust the risk and return characteristics
of a Fund's portfolio of investments. If IAI judges market conditions
incorrectly or employs a strategy that does not correlate well with a Fund's
investments, use of these techniques could result in a loss, regardless of
whether the intent was to reduce risk or increase return. Use of these
techniques may increase the volatility of a Fund and may involve a small
investment of cash relative to the magnitude of risk assumed. In addition, these
techniques could result in a loss if the counterparty to the transaction is
unable to perform as promised. Moreover, a liquid secondary market for any
futures or options contract may not be available when a futures or options
position is sought to be closed. Please refer to the Statement of Additional
Information which further describes these risks.

Manager Risk

IAI manages each Fund according to the traditional methods of "active"
investment management, which involve the buying and selling of securities based
upon economic, financial and market analysis and investment judgement. Manager
risk refers to the possibility that IAI may fail to execute each Fund's
investment strategy effectively. As a result, each Fund may fail to achieve its
stated objective.

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Prepayment Risks

Government Fund is subject to prepayment risk. Prepayment risk is the
possibility that, as interest rates fall, homeowners are more likely to
refinance their home mortgages. When home mortgages are refinanced, the
principal on GNMA certificates held by the Fund is "prepaid" earlier than
expected. Government Fund must then reinvest the unanticipated principal in new
GNMA certificates, just at a time when interest rates on new mortgage
investments are falling.

Prepayment risk has two important effects on Government Fund:

. When interest rates fall and additional mortgage prepayments must be
reinvested at lower interest rates, the income of Government Fund will be
reduced.

. When interest rates fall, prices on GNMA securities will not rise as much as
comparable Treasury bonds, as bond market investors anticipate an increase in
mortgage prepayments and a likely decline in income.

Risks of Lower-Rated
Debt Securities

Bond and Minnesota Tax-Free Funds may invest in debt securities commonly known
as "junk" bonds. Such securities are subject to higher risks and greater market
fluctuations than are lower-yielding, higher-rated securities. The price of junk
bonds has been found to be less sensitive to changes in prevailing interest
rates than higher-rated investments, but is likely to be more sensitive to
adverse economic changes or individual corporate developments. During an
economic downturn or substantial period of rising interest rates, highly
leveraged issuers may experience financial stress which would adversely affect
their ability to service their principal and interest payment obligations, to
meet their projected business goals or to obtain additional financing. If the
issuers of a fixed-income security owned by a Fund were to default, such Fund
might incur additional expenses to seek recovery. The risk of loss due to
default by issuers of junk bonds is significantly greater than that associated
with higher-rated securities because such securities generally are unsecured and
frequently are subordinated to the prior payment of senior indebtedness. In
addition, periods of economic uncertainty and change can be expected to result
in an increased volatility of market prices of junk bonds and a concomitant
volatility in the net asset value of a share of a Fund.

The secondary market for junk bonds is less liquid than the markets for higher
quality securities and, as such, may have an adverse effect on the market prices
of certain securities. The limited liquidity of the market may also adversely
affect the ability of a Fund to arrive at a fair value for certain junk bonds at
certain times and could make it difficult for a Fund to sell certain securities.
For a description of Moody's and S&P ratings, see Appendix A to the Statement of
Additional Information.

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IAI Mutual Funds

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Special Risk Factors
Associated with Minnesota
Tax Free Fund

To the extent Minnesota Tax Free Fund's investments are primarily concentrated
in issuers located in Minnesota, the value of Minnesota Tax Free Fund's shares
may be especially affected by factors pertaining to Minnesota's economy and
other factors specifically affecting the ability of Minnesota issuers to meet
their obligations. As a result, the value of Minnesota Tax Free Fund's assets
may fluctuate more widely than the value of shares of a portfolio investing in
securities relating to a number of different states. The ability of state,
county or local governments and quasi-government agencies to meet their
obligations will depend primarily on the availability of tax and other revenues
to those governments and on their fiscal conditions generally. The amounts of
tax and other revenues available to governmental issuers may be affected from
time to time by economic, political and demographic conditions within Minnesota.
The availability of federal, state and local aid to governmental issuers may
also affect their ability to meet obligations. Further information relating to
investments in Minnesota tax-exempt obligations is contained in the Statement of
Additional Information.

As mentioned above, revenue bonds for private facilities usually do not
represent a pledge of the credit, general revenues or taxing powers of the
issuing governmental entity. Instead, the private company operating the facility
is the sole source of payment of the obligation. Sometimes, the funds for
payment of revenue bonds come solely from revenue generated by operation of the
facility. Revenue bonds which are not backed by the credit of the issuing
governmental entity frequently provide a higher rate of return than other
municipal obligations, but they entail greater risk than obligations that are
guaranteed by a governmental unit with taxing power. Federal income tax laws
place substantial limitations on industrial revenue bonds, and particularly
certain private activity bonds issued after August 7, 1986. In the future,
legislation could be enacted which could further restrict or eliminate the
income tax exemption for interest on debt obligations in which Minnesota Tax
Free Fund may invest.

As described above, the revenue bonds in which Minnesota Tax Free Fund invests
may entail greater credit risk than the general obligation bonds in which it
invests. This is because revenue bonds generally are not backed by the faith,
credit or general taxing power of the issuing governmental entity. Investors
should also note that even general obligation bonds are not free from the risk
of default. The ratings and certain other requirements which apply to Minnesota
Tax Free Fund's permitted investments, as described elsewhere in this
prospectus, are intended to limit the amount of credit risk undertaken by
Minnesota Tax Free Fund. Nevertheless, shareholders in Minnesota Tax Free Fund
bear the risk that payment defaults could

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IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

cause the value of Minnesota Tax Free Fund's investment portfolio to decline.

From time to time, Minnesota Tax Free Fund may invest more than 25% of its
assets in municipal securities which are related in such a way that an economic,
business, or political development or change affecting one such security could
also affect the other securities; for example, securities the interest upon
which is paid from revenues of similar types of projects. As a result, Minnesota
Tax Free Fund may be subject to greater risk as compared to a fund that does not
follow this practice.

The 1995 Minnesota Legislature enacted a statement of legislative intent
specifying certain circumstances under which interest on the Minnesota municipal
obligations held by Minnesota Tax Free Fund might become taxable for Minnesota
state income tax purposes. See "Dividends, Distributions and Tax Status -
Minnesota Income Taxation: Minnesota Tax Free Fund" below.

Investment Restrictions

Each Fund is subject to certain other investment policies and restrictions
described in the Statement of Additional Information, some of which are
fundamental and may not be changed without the approval of the shareholders of a
Fund. Each Fund is a diversified investment company and has a fundamental policy
that, with respect to 75% of its total assets, it may not invest more than 5% of
its total assets to any one issuer. Each Fund, also as fundamental policies, may
not invest 25% or more of its assets in any one industry and may borrow only for
temporary or emergency purposes in an amount not exceeding one-third of its
total assets. Please refer to the Statement of Additional Information for a
further discussion of each Fund's investment restrictions.

Management

Bond Fund was created on August 18, 1977, as a separate portfolio represented by
a separate class of common stock of IAI Investment Funds I, Inc., a Minnesota
corporation created on April 22, 1977. Government and Minnesota Tax Free Funds
were created on April 6, 1992 and August 8, 1991, respectively, as separate
portfolios represented by separate classes of common stock of IAI Investment
Funds VI, Inc., a Minnesota corporation created on April 30, 1991. Under
Minnesota law, each Fund's Board of Directors is generally responsible for the
overall management and operation of each Fund. IAI serves as the investment
adviser of each Fund. IAI also furnishes investment advice to other concerns
including other investment companies, pension and profit sharing plans,
foundations, religious, educational and charitable institutions, trusts,
municipalities and individuals, having total assets in excess of $14.5 billion.
IAI's ultimate corporate parent is Lloyds TSB Group plc, a publicly-held
financial services organization headquartered in London, England. Lloyds TSB
Group plc is one of the largest personal and corporate financial services groups
in the

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IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

United Kingdom and is engaged in a wide range of activities including commercial
and retail banking. The address of IAI is that of the Funds.

Pursuant to a written agreement with each Fund (the "Management Agreement"), IAI
provides each Fund with investment advisory services and is responsible for the
overall management of each Fund's business affairs subject to the authority of
the Board of Directors. The Management Agreement also provides that, except for
brokerage commissions and other expenditures in connection with the purchase and
sale of portfolio securities, interest and, in certain circumstances, taxes and
extraordinary expenses, IAI shall pay all of a Fund's operating expenses. As
compensation under the Management Agreement, each of Bond Fund and Government
Fund will pay IAI 1.10% of its average daily net assets and Minnesota Tax Free
Fund will pay IAI .95% of its average daily net assets. Because IAI is paying
Fund operating expenses, these fees represent each Fund's total expenses. Until
June 30, 1996, IAI has voluntarily agreed to waive the fee due under the
Management Agreement in excess of .25% of Minnesota Tax Free Fund's average
daily net assets. With respect to certain of the services for which it is
responsible under the Management Agreement, IAI may also pay qualifying broker-
dealers, financial institutions and other entities for providing such services
to Fund shareholders. IAI shall not be liable for any loss suffered by a Fund in
the absence of willful misfeasance, bad faith or negligence in the performance
of its duties and obligations.

Each Fund is managed by a team of IAI investment professionals which is
responsible for making the day-to-day investment decisions for such Fund. The
teams managing the Funds are as follows.

Larry Hill, Scott Bettin and Livingston Douglas have responsibility for the
management of Bond Fund. Mr. Hill is IAI's Chief Fixed Income Officer and a
member of its Board of Directors. Mr. Hill has managed Bond Fund since joining
IAI in 1984. Mr. Bettin is a Senior Vice President of IAI and has managed Bond
Fund since joining IAI as a fixed income portfolio manager in 1987. Mr. Douglas
is a Vice President of IAI and has managed Bond Fund since joining IAI as a
fixed income portfolio manager in 1993. Prior to joining IAI, Mr. Douglas served
as a fixed income portfolio manager for Mackey-Shields Financial Corporation.

Scott Bettin and Stephen Coleman have responsibility for the management of
Government Fund. Mr. Bettin has managed Government Fund since its inception. Mr.
Coleman is a Senior Vice President of IAI and has served as a fixed income
portfolio manager since joining IAI in 1991. Mr. Coleman commenced managing
Government Fund in January 1995.

Stephen Coleman and Livingston Douglas have responsibility for the management of
Minnesota Tax Free Fund. Mr. Coleman has managed Minnesota Tax Free Fund since
inception. Mr. Douglas commenced

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IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

managing Minnesota Tax Free Fund in January 1995.

Consistent with the Rules of Fair Practice of the National Association of
Securities Dealers, Inc., IAI may consider sales of shares of a Fund as a factor
in the selection of broker-dealers to execute a Fund's securities transactions.

Computation of Net Asset Value and Pricing

Each Fund is open for business each day the New York Stock Exchange ("NYSE") is
open. IAI normally calculates a Fund's net asset value ("NAV") as of the close
of business of the NYSE, normally 3 p.m. Central time.

A Fund's NAV is the value of a single share. The NAV is computed by adding up
the value of a Fund's investments, cash, and other assets, subtracting its
liabilities, and then dividing the result by the number of shares outstanding.

A Fund's investments with remaining maturities of 60 days or less may be valued
on the basis of amortized cost. This method minimizes the effect of changes in a
security's market value. Other portfolio securities and assets are valued
primarily on the basis of market quotations or, if quotations are not readily
available, by a method that the Board of Directors believes accurately reflects
fair value. Foreign securities are valued on the basis of quotations from the
primary market in which they are traded, and are translated from the local
currency into U.S. dollars using current exchange rates.

The offering price (price to buy one share) and redemption price (price to sell
one share) are a Fund's NAV.

Purchase of Shares

Each Fund offers its shares continually to the public at the net asset value of
such shares. Shares may be purchased directly from a Fund or through certain
security dealers who have responsibility to promptly transmit orders and may
charge a processing fee, provided that the Fund whose shares are being purchased
is duly registered in the state of the purchaser's residence, if required, and
the purchaser otherwise satisfies the Fund's purchase requirements. No sales
load or commission is charged investors in connection with the purchase of Fund
shares.

The minimum initial investment to establish a retail account with the IAI Family
of Funds is $5,000. Such initial investment may be allocated among a Fund and
other funds in the IAI Family of Funds as desired, provided that no less than
$1,000 is allocated to any one fund. The minimum initial investment for IRA
accounts is $2,000, provided that the minimum amount that may be allocated to
any one fund is $1,000. Once the account minimum has been met, subsequent
purchases can be made in a Fund for $100 or more. Such minimums may be waived
for participants in the IAI Investment Club.

Investors may satisfy the minimum investment requirement by participating in the
STAR Program. Participation in the STAR Program requires an initial investment
of $1,000 per Fund and a

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IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

commitment to invest an aggregate of $5,000 within 24 months. If a STAR Program
participant does not invest an aggregate of $5,000 in the IAI Family of Funds
within 24 months, IAI may, at its option, redeem such shareholder's interest.
Investors wishing to participate in the STAR Program should contact a Fund to
obtain a STAR Program application.

To purchase shares, forward the completed application and a check payable to
"IAI Funds" to a Fund. Upon receipt, your account will be credited with the
number of full and fractional shares which can be purchased at the net asset
value next determined after receipt of the purchase order by a Fund.

Purchases of shares are subject to acceptance or rejection by a Fund on the same
day the purchase order is received and are not binding until so accepted. It is
the policy of the Funds to keep confidential information contained in the
application and regarding the account of an investor or potential investor in
the Funds.

All correspondence relating to the purchase of shares should be directed to the
office of the Funds, P.O. Box 357, Minneapolis, Minnesota 55440 or, if using
overnight delivery, to 3700 First Bank Place, 601 Second Ave. South,
Minneapolis, Minnesota 55402. For assistance in completing the application
please contact IAI Mutual Fund Shareholder Services at 1-800-945-3863.

Retirement Plans

Shares of Bond and Government Funds may be an appropriate investment medium for
various retirement plans. Persons desiring information about establishing an
Individual Retirement Account (IRA) (for employed persons and their spouses) or
other retirement plans should contact the Fund at 1-800-945-3863. All retirement
plans involve a long-term commitment of assets and are subject to various legal
requirements and restrictions. The legal and tax implications may vary according
to the circumstances of the individual investor. Therefore, you are urged to
consult with an attorney or tax advisor prior to the establishment of such a
plan.

Automatic
Investment Plan

Investors may arrange to make regular investments of $100 or more per fund on a
monthly basis, effective as of the 4th and/or 18th day of each month (or the
next business day), through automatic deductions from their checking or savings
accounts. Such investors may, of course, terminate their participation in the
Automatic Investment Plan at any time upon written notice to a Fund. Any changes
or instructions to terminate existing Automatic Investment Plans must be
received by the last business day of the preceding month in which the change or
termination is to take place. Investors interested in participating in the
Automatic Investment Plan should complete the Automatic Investment Plan
application and return it to a Fund.

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IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

Redemption of Shares

Registered holders of Fund shares may at any time require a Fund to redeem their
shares upon their written request accompanied by surrender of the stock
certificates in proper form for transfer or, if the certificates are held by
such Fund, through written instructions requesting that such Fund redeem such
shares. Shareholders may redeem shares by phone (subject to a limit of $50,000)
provided such shareholders have authorized such Fund to accept telephone
instructions.

Certificates presented for redemption must be endorsed on the back with the
signature of the person whose name appears on the certificate. If no certificate
has been issued, redemption instructions must be signed by the person(s) in
whose name the shares are registered. If the redemption proceeds are to be paid
or mailed to any person other than the shareholder of record or if redemption
proceeds are in excess of $50,000, a Fund will require that the signature on the
written instructions be guaranteed by a participant in a signature guarantee
program, which may include certain national banks or trust companies or certain
member firms of national securities exchanges. (Notarization by a Notary Public
is NOT ACCEPTED.) If the shares are held of record in the name of a corporation,
partnership, trust or fiduciary, a Fund may require additional evidence of
authority prior to accepting a request for redemption. A Fund will not send
redemption proceeds until checks (including certified checks or cashiers checks)
received in payment for shares have cleared.

The redemption proceeds received by the investor are based on the net asset
value next determined after redemption instructions in good order are received
by a Fund. Since the value of shares redeemed is based upon the value of a Fund
investment at the time of redemption, it may be more or less than the price
originally paid for the shares.

Payment for shares redeemed will ordinarily be made within seven days after a
request for redemption has been made. Normally a Fund will mail payment for
shares redeemed on the business day following receipt of the redemption request.

Following a redemption or transfer request, if the value of a shareholder's
interest in a Fund falls below $500, such Fund reserves the right to redeem such
shareholder's entire interest and remit such amount. Such a redemption will only
be effected following: (a) a redemption or transfer by a shareholder which
causes the value of such shareholder's interest in such Fund to fall below $500;
(b) the mailing by such Fund to such shareholder of a notice of intention to
redeem; and (c) the passage of at least six months from the date of such
mailing, during which time the investor will have the opportunity to make an
additional investment in such Fund to increase the value of such investor's
account to at least $500.

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IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

Exchange Privilege

The Exchange Privilege enables shareholders to purchase, in exchange for shares
of a Fund, shares of certain other funds managed by IAI. These funds have
different investment objectives from the Funds. Shareholders may exchange shares
of a Fund for shares of another fund managed by IAI, provided that the fund
whose shares will be acquired is duly registered in the state of the
shareholder's residence, if required, and the shareholder otherwise satisfies
the fund's purchase requirements. Although the Funds do not currently charge a
fee for use of the Exchange Privilege, they reserve the right to do so in the
future.

Because excessive trading can hurt Fund performance and shareholders, there is a
limit of four exchanges out of each Fund per calendar year per account. Accounts
under common ownership or control, including accounts with the same taxpayer
identification number, will be counted together for purposes of the four
exchange limit. Each Fund reserves the right to temporarily or permanently
terminate the Exchange Privilege of any investor who exceeds this limit. The
limit may be modified for certain retirement plan accounts, as required by the
applicable plan document and/or relevant Department of Labor regulations, and
for Automatic Exchange Plan participants. Each Fund also reserves the right to
refuse or limit exchange purchases by any investor if, in IAI's judgment, such
Fund would be unable to invest the money effectively in accordance with its
investment objectives and policies, or would otherwise potentially be adversely
affected.

Fund shareholders wishing to exercise the Exchange Privilege should notify a
Fund in writing or, provided such shareholders have authorized a Fund to accept
telephone instructions, by telephone. At the time of the exchange, if the net
asset value of the shares redeemed in connection with the exchange is greater
than the investor's cost, a taxable capital gain will be realized. A capital
loss will be realized if at the time of the exchange the net asset value of the
shares redeemed in the exchange is less than the investor's cost. Each Fund
reserves the right to terminate or modify the Exchange Privilege in the future.

Automatic
Exchange Plan

Investors may arrange to make regular exchanges of $100 or more between any of
the funds in the IAI Mutual Fund Family on a monthly basis. Exchanges will take
place at the closing price of the fifth day of each month (or the next business
day). Shareholders are responsible for making sure sufficient shares exist in
the Fund account from which the exchange takes place. If there are not
sufficient funds in a Fund account to meet the requested exchange amount, the
Automatic Exchange Plan will be suspended. Shareholders may not close Fund
accounts through the Automatic Exchange Plan. Investors interested in

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IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

participating in the Automatic Exchange Plan should complete the Automatic
Exchange Plan portion of their application. For assistance in completing the
application contact IAI Mutual Fund Shareholder Services at 1-800-945-3863.

Authorized Telephone Trading

Investors can transact account exchanges and redemptions via the telephone by
completing the Authorized Telephone Trading section of the IAI Mutual Fund
application and returning it to the Fund. Investors requesting telephone trading
privileges will be provided with a personal identification number ("PIN") that
must accompany any instructions by phone. Shares will be redeemed or exchanged
at the next determined net asset value. Telephone redemption proceeds are
subject to a $50,000 limit and must be made payable to the owner(s) of record
and delivered to the address of record.

In order to confirm that telephone instructions for redemptions and exchanges
are genuine, the Fund have established reasonable procedures, including the
requirement that a personal identification number accompany telephone
instructions. If a Fund or the transfer agent fails to follow these procedures,
such Fund may be liable for losses due to unauthorized or fraudulent
instructions. To the extent the reasonable procedures are followed, none of the
Funds, their transfer agent, IAI or any affiliated broker/dealer will be liable
for any loss, injury, damage, or expense for acting upon telephone instructions
believed to be genuine, and will otherwise not be responsible for the
authenticity of any telephone instructions, and, accordingly, the investor bears
the risk of loss resulting from telephone instructions. All telephone
redemptions and exchanges will be tape recorded.

Systematic Cash
Withdrawal Plan

Each Fund has available a Systematic Cash Withdrawal Plan for any investor
desiring to follow a program of systematically withdrawing a fixed amount of
money from an investment in shares of a Fund. Payments under the plan will be
made monthly or quarterly in amounts of $100 or more. Shares will be sold with
the closing price of the 15th of the applicable month (or the next business
day). To provide funds for payment, a Fund will redeem as many full and
fractional shares as necessary at the redemption price, which is Net Asset
Value. The holder of a Systematic Cash Withdrawal Plan must have income
dividends and any capital gains distributions reinvested in full and fractional
shares at net asset value.

Payments under this plan, unless pursuant to a retirement plan, should not be
considered income. Withdrawal payments may exceed dividends and distributions
and, to this extent, there will be a reduction in the investor's equity. An
investor should also understand that this plan cannot insure profit, nor does it
protect against any loss in a declining market. Careful consideration should be
given to the amount withdrawn each

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IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

month. Excessive withdrawals could lead to a serious depletion of equity,
especially during periods of declining market values. Fund management will be
available for consultation in this matter.

Plan application forms are available through the Funds. If you would like
assistance in completing the application contact IAI Mutual Fund Shareholder
Services at 1-800-945-3863.

Dividends,
Distributions
and Tax Status

Dividends

The policy of each Fund is to pay dividends from net investment income monthly
and to make distributions of realized capital gains, if any, annually. However,
provisions in the Internal Revenue Code of 1986, as amended (the "Code"), may
result in additional net investment income and capital gains distributions by a
Fund. When you open an account, you should specify on your application how you
want to receive your distributions. Each Fund offers three options: Full
Reinvestment-your dividend and capital gain distributions will be automatically
reinvested in additional shares of such Fund; Capital Gains Reinvestment-your
capital gain distributions will be automatically reinvested, but your income
dividend distribution will be paid in cash; and Cash-your income dividends and
capital gain distributions will be paid in cash. Distributions taken in cash can
be sent via check or transferred directly to your account at any bank, savings
and loan or credit union that is a member of the Automated Clearing House (ACH)
network. Unless indicated otherwise by the shareholder, the Fund will
automatically reinvest all such distributions into full and fractional shares at
net asset value.

The Funds' Directed Dividend service allows you to invest your dividends and/or
capital gain distributions directly into another IAI Mutual Fund. Contact IAI
Mutual Fund Shareholder Services at 1-800-945-3863 for details.

Tax Status of the Funds

Each Fund intends to qualify as a regulated investment company under Subchapter
M of the Internal Revenue Code during the current taxable year. If so qualified,
each Fund will not be subject to federal income tax on income that it
distributes to its shareholders.

Federal Income Taxation:
Bond and Government Funds

Distributions are subject to federal income tax, and may also be subject to
state or local taxes. If you live outside the United States, your distributions
could also be taxed by the country in which you reside. Your distributions are
taxable when they are paid, whether you take them in cash or reinvest them in
additional shares.

For federal income tax purposes, each Fund's income and short-term capital gain
distributions are taxed as dividends; long-term capital gain distributions
designated as capital gain dividends are taxed as long-term capital gains.

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IAI Mutual Funds

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Upon redemption of shares of a Fund the shareholder will generally recognize a
capital gain or loss equal to the difference between the amount realized on the
redemption and the shareholder's adjusted basis in such shares. Such gain or
loss will be long-term if the shares have been held for more than one year.
Under the Code, the deductibility of capital losses is subject to certain
limitations.

Federal Income Taxation:
Minnesota Tax Free Fund

The Fund anticipates that substantially all dividends from net investment income
paid by the Fund will be designated as "exempt-interest dividends" and therefore
will not be subject to federal income tax. Dividends derived from taxable
investments, together with distributions from any net realized short-term gains,
will be taxable as ordinary income whether or not reinvested. Distributions from
net realized long-term gains that are designated as capital gain dividends
generally will be taxable as long-term capital gains for federal income tax
purposes, regardless of the length of time for which the shareholder has held
the shares. The Fund will advise shareholders of the percentage, if any, of the
dividends not exempt from federal income tax, and the percentage, if any,
subject to the alternative minimum tax imposed on individuals, estates and
trusts.

For federal income tax purposes, an alternative minimum tax ("AMT") is imposed
on taxpayers to the extent that such tax exceeds a taxpayer's regular income tax
liability (with certain adjustments). Exempt-interest dividends attributable to
interest income on certain tax-exempt obligations issued after August 7, 1986,
to finance certain private activities are treated as an item of tax preference
that is included in alternative minimum taxable income for purposes of computing
the federal AMT for all taxpayers. The Fund may invest in securities that
generate interest that is treated as an item of tax preference. In addition, all
other tax-exempt interest received by a corporation, including exempt-interest
dividends, will be included in adjusted current earnings for purposes of
determining the federal corporate AMT.

Because liability for the AMT will depend upon the regular tax liability and tax
preference items of a specific taxpayer, the extent, if any, to which any tax
preference items resulting from investment in the Fund would be subject to the
tax will depend upon each shareholder's individual situation. Each shareholder
is advised to consult his or her tax advisor with respect to the possible
effects of such tax preference items.

Minnesota Income Taxation:
Minnesota Tax Free Fund

The portion of exempt-interest dividends that is derived by the Fund from
interest on Minnesota tax exempt obligations is excluded from the Minnesota
taxable net income of individuals, estates, and trusts, provided that the
portion of the exempt-interest dividends from such Minnesota sources paid to all
shareholders represents 95% or more of the

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IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

exempt-interest dividends the Fund pays. The remaining portion of such
dividends, and dividends that are not exempt-interest dividends or capital gain
dividends, is included in the Minnesota taxable net income of individuals,
estates and trusts, except for dividends directly attributable to interest on
obligations of the U.S. government or its possessions or territories. Exempt-
interest dividends are not excluded from the Minnesota taxable income of
corporations and financial institutions. Dividends qualifying for federal income
tax purposes as capital gain dividends are to be treated by shareholders as
long-term capital gains for Minnesota income tax purposes. Minnesota has
repealed the favorable treatment of long-term capital gains, while retaining
restrictions on the deductibility of capital losses.

Exempt-interest dividends attributable to interest on certain private activity
bonds issued after August 7, 1986, will be included in the Minnesota alternative
minimum taxable income of individuals, estates and trusts for purposes of
computing Minnesota's alternative minimum tax. Dividends generally will not
qualify for the dividends-received deduction for corporations and financial
institutions.

The 1995 Minnesota Legislature enacted a statement of intent that interest on
obligations of Minnesota governmental units and Indian tribes be included in net
income of individuals, estates and trusts for Minnesota income tax purposes if a
court determines that Minnesota's exemption of such interest unlawfully
discriminates against interstate commerce because interest on obligations of
governmental issuers located in other states is so included. This provision
applies to taxable years that begin during or after the calendar year in which
any such court decision become final, irrespective of the date on which the
obligations were issued. Minnesota Tax Free Fund is not aware of any decision in
which a court has held that a state's exemption of interest on its own bonds or
those of its political subdivisions or Indian tribes, but not of interest on the
bonds of other states or their political subdivisions or Indian tribes,
unlawfully discriminates against interstate commerce or otherwise contravenes
the United States Constitution. Nevertheless, Minnesota Tax Free Fund cannot
predict the likelihood that interest on the Minnesota bonds held by the Fund
would become taxable under this Minnesota statutory provision.

Miscellaneous

Annually, IAI will send you and the IRS a statement showing the amount of each
taxable distribution you received in the previous year. Whenever you sell shares
of a Fund, IAI will send you a confirmation statement showing how many shares
you sold and at what price. You will also receive an account statement quarterly
and a consolidated transaction statement annually. However, it is up to you or
your tax preparer to determine whether this sale resulted in a capital gain and,
if so, the amount of tax to be paid. Be sure to keep your regular account
statements;

29
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

the information they contain will be essential in calculating the amount of your
capital gains.

The foregoing relates to federal and Minnesota income taxation as in effect as
of the date of this Prospectus. For a more detailed discussion of the federal
income tax consequences of investing in shares of the Funds, see "Tax Status" in
the Statement of Additional Information.

Description of
Common Stock

All shares of each Fund have equal rights as to redemption, dividends and
liquidation, and will be fully paid and nonassessable when issued and will have
no preemptive or conversion rights.

The shares of each Fund have noncumulative voting rights, which means that the
holders of more than 50% of the shares voting for the election of directors can
elect 100% of the directors if they choose to do so. On some issues, such as the
election of directors, all shares of each corporation vote together as one
series. On an issue affecting only a particular series, such as voting on the
Advisory Agreement, only the approval of a particular series is required to make
the agreement effective with respect to such series.

Annual or periodically scheduled regular meetings of shareholders will not be
held except as required by law. Minnesota corporation law does not require an
annual meeting; instead, it provides for the Board of Directors to convene
shareholder meetings when it deems appropriate. In addition, if a regular
meeting of shareholders has not been held during the immediately preceding
fifteen months, shareholders holding three percent or more of the voting shares
of each Fund may demand a regular meeting of shareholders of such Fund by
written notice of demand given to the Chief Executive Officer or the Chief
Financial Officer of such Fund. Within thirty days after receipt of the demand
by one of those officers, the Board of Directors shall cause a regular meeting
of shareholders to be called and held no later than ninety days after receipt of
the demand, all at the expense of such Fund. An annual meeting will be held on
the removal of a director or directors of a Fund if requested in writing by
holders of not less than 10% of the outstanding shares of a Fund.

The shares of each Fund are transferable by endorsement of the certificate if
held by the shareholders, or if the certificate is held by such Fund, by
delivery to such Fund of transfer instructions. Transfer instructions or
certificates should be delivered to the office of such Fund. A Fund is not bound
to recognize any transfer until it is recorded on the stock transfer books
maintained by such Fund.

Counsel and Auditors

The firm of Dorsey & Whitney LLP, 220 South Sixth Street, Minneapolis, Minnesota
55402, provides legal counsel for the Funds. KPMG Peat Marwick LLP, 4200 Norwest
Center, Minneapolis, Minnesota 55402, serves as the independent auditors for the
Funds.

30
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Minnesota Tax Free Fund

Custodian, Transfer
Agent and Dividend
Disbursing Agent

The Custodian for each Fund is Norwest Bank Minnesota, N.A., Norwest Center,
Sixth and Marquette, Minneapolis, Minnesota 55479. With respect to the Bond and
Government Funds, Norwest employs foreign subcustodians and depositories, which
were approved by such Fund's Board of Directors in accordance with the rules and
regulations of the Securities and Exchange Commission, for the purpose of
providing custodial services for such Funds' assets held outside the United
States. For a listing of the subcustodians and depositories currently employed
by such Funds, see the Statement of Additional Information. IAI acts as each
Fund's transfer agent, dividend disbursing agent and IRA Custodian, at P.O. Box
357, Minneapolis, Minnesota 55440.

Tax-Exempt vs.
Taxable Income

The table below shows the approximate yields that taxable securities must earn
to equal yields that are exempt from both federal and Minnesota income taxes
under selected combined federal/Minnesota income tax brackets, which reflect
effective combined rates after deducting Minnesota taxes from federal income.
The 33.8% combined federal/Minnesota bracket assumes that the investor is
subject to a 28% marginal federal income tax rate and an 8% marginal Minnesota
income tax rate. The 36.9% combined federal/Minnesota bracket assumes that the
investor is subject to a 31% marginal federal income tax bracket and an 8.5%
marginal Minnesota income tax rate. The 41.4% combined federal/Minnesota bracket
assumes that the investor is subject to a 36% marginal federal income tax rate
and an 8.5% marginal Minnesota income tax rate. The 44.7%

Taxable Equivalent Yields
-----------------------------------
Combined Federal & Minnesota Tax Brackets
--------------------------------------------------
Tax Free Yields 33.8% 36.9% 41.4% 44.7%
=====================================================================
<S> <C> <C> <C> <C>
4.0% 6.04% 6.34% 6.83% 7.23%
4.5% 6.80% 7.13% 7.68% 8.14%
5.0% 7.55% 7.92% 8.53% 9.04%
5.5% 8.31% 8.72% 9.39% 9.95%
6.0% 9.06% 9.51% 10.24% 10.85%
6.5% 9.82% 10.30% 11.09% 11.75%
7.0% 10.57% 11.09% 11.95% 12.66%
7.5% 11.33% 11.89% 12.80% 13.56%
8.0% 12.08% 12.68% 13.65% 14.47%
</TABLE>
31
<PAGE>

IAI Mutual Funds

IAI Bond Fund, IAI Government Fund, IAI Tax Free Fund

combined federal/Minnesota bracket assumes that the investor is subject to a
39.6% marginal federal income tax rate and an 8.5% marginal Minnesota income tax
rate. The 39.6% federal rate and 8.5% Minnesota rate are the highest rates
currently in effect.

This table does not take into consideration any federal or Minnesota alternative
minimum tax. In addition, the table is based upon yields that are derived solely
from tax-exempt income. To the extent Minnesota Tax Free Fund's actual yield is
derived from taxable income, such Fund's equivalent taxable yield will be less
than set forth in the table. The tax-free yields used in the table should not be
considered as representations of any particular rates of return and are for
purposes of illustration only.

Additional Information

Each Fund sends to its shareholders a six-month unaudited and an annual audited
financial report, each of which includes a list of investment securities held.
To reduce the volume of mail you receive, only one copy of most Fund reports,
such as a Fund's Annual Report, may be mailed to your household (same surname
and address). Please call IAI Mutual Fund Shareholder Services at 1-800-945-3863
if you wish to receive additional shareholder reports.

In the opinion of the staff of the Securities and Exchange Commission, the use
of this combined Prospectus may possibly subject all Funds to a certain amount
of liability for any losses arising out of any statement or omission in this
Prospectus regarding a particular Fund. In the opinion of the Funds' management,
however, the risk of such liability is not materially increased by the use of a
combined Prospectus.

Shareholder inquiries should be directed to the Funds at the telephone number or
mailing address listed on the inside back cover of this Prospectus.

The following table sets forth the percentage of securities holdings by rating
category based upon a weighted monthly average for the fiscal year ended
November 30, 1995 for IAI Bond Fund. The other Funds did not hold 5% or more of
their assets in bonds rated below investment grade for the most recent fiscal
year.

<TABLE>
<CAPTION>
Bonds - Moody's Rating IAI Bond Fund
- ---------------------------------------------------------------
<S> <C>
Aaa 20%

Aa 4%

A 10%

Baa 8%

Ba 2%

B 4%

Caa 0%

Ca 0%

C 0%

U.S. Government 52%
- ---------------------------------------------------------------
Total 100%
===============================================================
</TABLE>

32
<PAGE>

To Open An

Account

1.800.945.3863

612.376.2700

IAI

P.O. Box 357

Minneapolis, MN 55440

Overnight

Delivery Address

IAI

3700 First Bank Place

601 Second Avenue South

Minneapolis, MN 55402

Distributed by IAI Securities, Inc.
<PAGE>

[LOGO]

Mutual Funds

Investment Advisers, Inc.
3700 First Bank Place, P.O. Box 357, Minneapolis, Minnesota 55440-0357
USA fax 612.376.2737

800.945.3863
612.376.2700
<PAGE>

IAI BOND FUND
IAI GOVERNMENT FUND
IAI MINNESOTA TAX FREE FUND

STATEMENT OF ADDITIONAL INFORMATION
DATED APRIL 1, 1996

THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS. THIS
STATEMENT OF ADDITIONAL INFORMATION RELATES TO A PROSPECTUS DATED APRIL 1, 1996,
AND SHOULD BE READ IN CONJUNCTION THEREWITH. A COPY OF THE PROSPECTUS MAY BE
OBTAINED FROM THE FUND, 3700 FIRST BANK PLACE, P.O. BOX 357, MINNEAPOLIS,
MINNESOTA 55440 (TELEPHONE: 1-612-376-2700 OR 1-800-945-3863).

<PAGE>

TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
INVESTMENT OBJECTIVE AND POLICIES........................ 3
Repurchase Agreements............................... 3
Reverse Repurchase Agreements....................... 3
Securities of Foreign Issuers....................... 3
Lending Portfolio Securities........................ 4
Illiquid Securities................................. 4
Variable or Floating Rate Instruments............... 4
Delayed-Delivery Transactions....................... 4
Dollar Rolls........................................ 5
Mortgage-Backed Securities.......................... 5
Stripped Mortgage-Backed Securities................. 5
Asset-Backed Securities............................. 6
Zero Coupon Bonds................................... 6
Lower-Rated Debt Securities......................... 6
Swap Agreements..................................... 7
Indexed Securities.................................. 7
Loans and Other Direct Debt Instruments............. 8
State or Municipal Lease Obligations................ 9
Foreign Currency Transactions....................... 10
Limitations on Futures and Options Transactions..... 11
Futures Contracts................................... 11
Futures Margin Payments............................. 11
Purchasing Put and Call Options..................... 12
Writing Put and Call Options........................ 12
Combined Positions.................................. 12
Correlation of Price Changes........................ 13
Liquidity of Options and Futures Contracts.......... 13
OTC Options......................................... 13
Options and Futures Relating to Foreign Currencies.. 13
Asset Coverage for Futures and Options Positions.... 14
SPECIAL CONSIDERATIONS REGARDING INVESTMENT.............. 14
IN MINNESOTA TAX-EXEMPT OBLIGATIONS...................... 14
INVESTMENT RESTRICTIONS.................................. 15
Portfolio Turnover.................................. 17
INVESTMENT PERFORMANCE................................... 17
MANAGEMENT............................................... 20
History............................................. 22
Management Agreement................................ 23
Investment Advisory Agreement....................... 24
Administrative Agreement............................ 25
Allocation of Expenses.............................. 25
Duration of Agreements.............................. 25
PLAN OF DISTRIBUTION..................................... 26
CUSTODIAL SERVICE........................................ 27
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE....... 31
CAPITAL STOCK............................................ 32
NET ASSET VALUE AND PUBLIC OFFERING PRICE................ 33
PURCHASES AND REDEMPTIONS IN KIND........................ 34
TAX STATUS............................................... 34
LIMITATION OF DIRECTOR LIABILITY......................... 35
FINANCIAL STATEMENTS..................................... 36
Appendix A--Ratings of Debt Securities................... A-1
</TABLE>

<PAGE>

INVESTMENT OBJECTIVE AND POLICIES

The investment objective and policies of IAI Bond Fund (the "Bond Fund"),
IAI Government Fund ("Government Fund"), and IAI Minnesota Tax Free Fund
("Minnesota Tax Free Fund") are summarized on the front page of the Prospectus
and in the text of the Prospectus under "Investment Objectives and Policies."
Investors should understand that all investments have a risk factor. There can
be no guarantee against loss resulting from an investment in the Funds, and
there can be no assurance that a Fund's investment policies will be successful,
or that its investment objective will be attained. Certain of the investment
practices of the Funds are further explained below.

REPURCHASE AGREEMENTS

The Funds may invest in repurchase agreements relating to the securities in
which it may invest. A repurchase agreement involves the purchase of securities
with the condition that, after a stated period of time, the original seller will
buy back the securities at a predetermined price or yield. A Fund's custodian
will have custody of, and will hold in a segregated account, securities acquired
by such Fund under a repurchase agreement or other securities as collateral. In
the case of a security registered on a book entry system, the book entry will be
maintained in a Fund's name or that of its custodian. Repurchase agreements
involve certain risks not associated with direct investments in securities. For
example, if the seller of the agreement defaults on its obligation to repurchase
the underlying securities at a time when the value of the securities has
declined, a Fund may incur a loss upon disposition of such securities. In the
event that bankruptcy proceedings are commenced with respect to the seller of
the agreement, a Fund's ability to dispose of the collateral to recover its
investment may be restricted or delayed. While collateral will at all times be
maintained in an amount equal to the repurchase price under the agreement
(including accrued interest due thereunder), to the extent proceeds from the
sale of collateral were less than the repurchase price, a Fund could suffer a
loss.

REVERSE REPURCHASE AGREEMENTS

The Funds may invest in reverse repurchase agreements as a form of
borrowing. In a reverse repurchase agreement, a fund sells a portfolio
instrument to another party, such as a bank or broker-dealer, in return for cash
and agrees to repurchase the instrument at a particular price and time. While a
reverse repurchase agreement is outstanding, a Fund will maintain appropriate
liquid assets in a segregated custodial account to cover its obligation under
the agreement. The Funds will enter into reverse repurchase agreements only with
parties whose creditworthiness has been found satisfactory by Investment
Advisers, Inc. ("IAI"), the Funds' investment adviser and manager. As a result,
such transactions may increase fluctuations in the market value of the Fund's
assets and may be viewed as a form of leverage.

SECURITIES OF FOREIGN ISSUERS

Each of Bond and Government Funds may invest in securities of foreign
issuers in accordance with its investment objectives and policies. Investing in
foreign securities may result in greater risk than that incurred by investing in
domestic securities. There is generally less publicly available information
about foreign issuers comparable to reports and ratings that are published about
companies in the United States. Also, foreign issuers are not subject to uniform
accounting and auditing and financial reporting standards, practices and
requirements comparable to those applicable to United States companies.
Furthermore, volume and liquidity in most foreign bond markets is less than in
the United States and at times volatility of price can be greater than in the
United States. There is generally less government supervision and regulation of
foreign bond markets, brokers and companies than in the United States.

With respect to certain foreign countries, there is the possibility of
adverse changes in investment or exchange control regulations, expropriation or
confiscatory taxation, limitations on the removal of funds or other assets of a
Fund, political or social instability, or diplomatic developments which could
affect United States investments in those countries. Moreover, individual
foreign economies may differ favorably or unfavorably from the United States'
economy in such respects as growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments
position.

3
<PAGE>

Bond and Government Funds are not aware at this time of the existence of
any investment or exchange control regulations which might substantially impair
their operations as described in the Prospectus and this Statement of Additional
Information. It should be noted, however, that this situation could change at
any time.

The dividends and interest payable on certain of a Fund's foreign portfolio
securities may be subject to foreign withholding taxes, thus reducing the net
amount of income available for distribution to such Fund's shareholders. The
expense ratio of a Fund should not be materially affected by such Fund's
investment in foreign securities.

LENDING PORTFOLIO SECURITIES

In order to generate additional income, the Funds may lend portfolio
securities to broker-dealers, banks or other financial borrowers of securities.
As with other extensions of credit, there are risks of delay in recovery or even
loss of rights in the collateral should the borrower of the securities fail
financially. However, a Fund will only enter into loan arrangements with broker-
dealers, banks or other institutions which IAI has determined are creditworthy
under guidelines established by the Funds' Board of Directors. The Funds may
also experience a loss if, upon the failure of a borrower to return loaned
securities, the collateral is not sufficient in value or liquidity to cover the
value of such loaned securities (including accrued interest thereon). However, a
Fund will receive collateral in the form of cash, United States Government
securities, certificates of deposit or other high-grade, short-term obligations
or interest-bearing cash equivalents equal to at least 102% of the value of the
securities loaned. The value of the collateral and of the securities loaned will
be marked to market on a daily basis. During the time portfolio securities are
on loan, the borrower pays a Fund an amount equivalent to any dividends or
interest paid on the securities and a Fund may invest the cash collateral and
earn additional income or may receive an agreed upon amount of interest income
from the borrower. However, the amounts received by a Fund may be reduced by
finders' fees paid to broker-dealers and related expenses.

ILLIQUID SECURITIES

Each Fund may also invest up to 15% of its net assets in securities that
are considered illiquid because of the absence of a readily available market or
due to legal or contractual restrictions. However, certain restricted securities
that are not registered for sale to the general public but that can be resold to
institutional investors may be considered liquid pursuant to guidelines adopted
by the Board of Directors. It is not possible to predict with assurance the
maintenance of an institutional trading market for such securities and the
liquidity of a Fund's investments could be impaired if trading declines.

VARIABLE OR FLOATING RATE INSTRUMENTS

Each Fund may invest in variable or floating rate instruments. Such
instruments (including notes purchased directly from issuers) bear variable or
floating interest rates and carry rights that permit holders to demand payment
of the unpaid principal balance plus accrued interest from the issuers or
certain financial intermediaries. Floating rate securities have interest rates
that change whenever there is a change in a designated base rate while variable
rate instruments provide for a specified periodic adjustment in the interest
rate. These formulas are designed to result in a market value for the instrument
that approximates its par value.

DELAYED-DELIVERY TRANSACTIONS

Each Fund may buy and sell securities on a delayed-delivery or when-issued
basis. These transactions involve a commitment by a Fund to purchase or sell
specific securities at a predetermined price or yield, with payment and delivery
taking place after the customary settlement period for that type of security
(and more than seven days in the future). Typically, no interest accrues to the
purchaser until the security is delivered. Each Fund may receive fees for
entering into delayed-delivery transactions.

When purchasing securities on a delayed-delivery basis, each Fund assumes
the rights and risks of ownership, including the risk of price and yield
fluctuations. Because a Fund is not required to pay for securities until the
delivery date, these risks are in addition to the risks associated with such
Fund's other investments. If a Fund remains substantially fully invested at a
time when delayed delivery purchases are outstanding, the

4
<PAGE>

delayed-delivery purchases may result in a form of leverage. When delayed-
delivery purchases are outstanding, a Fund will set aside appropriate liquid
assets in a segregated custodial account to cover its purchase obligations. When
a Fund has sold a security on a delayed-delivery basis, such Fund does not
participate in further gains or losses with respect to the security. If the
other party to a delayed-delivery transaction fails to deliver or pay for the
securities, a Fund could miss a favorable price or yield opportunity, or could
suffer a loss.

Each Fund may renegotiate delayed-delivery transactions after they are
entered into, and may sell underlying securities before they are delivered,
which may result in capital gains or losses.

DOLLAR ROLLS

In connection with its ability to purchase securities on a when-issued or
forward commitment basis, a Fund may enter into "dollar rolls" in which such
Fund sells securities for delivery in the current month and simultaneously
contracts with the same counterparty to repurchase similar (same type, coupon
and maturity) but not identical securities on a specified future date. A Fund
gives up the right to receive principal and interest paid on the securities
sold. However, a Fund would benefit to the extent of any difference between the
price received for the securities sold and lower forward price for the futures
purchase plus any fee income received. Unless such benefits exceed the income
and capital appreciation that would have been realized on the securities sold as
part of the dollar roll, the use of this technique will diminish the investment
performance of a Fund compared with what such performance would have been
without the use of dollar rolls. Each Fund will hold and maintain in a
segregated account until the settlement date cash, government securities, or
liquid high-grade debt securities in an amount equal to the value of the when-
issued or forward commitment securities. The benefits derived from the use of
dollar rolls may depend, among other things, upon IAI's ability to predict
interest rates correctly. There is no assurance that dollar rolls can be
successfully employed. In addition, the use of dollar rolls by a Fund while
remaining substantially fully invested increases the amount of a Fund's assets
that are subject to market risk to an amount that is greater than such Fund's
net asset value, which could result in increased volatility of the price of such
Fund's shares.

MORTGAGE-BACKED SECURITIES

Each Fund may purchase mortgage-backed securities issued by government and
non-government entities such as banks, mortgage lenders, or other financial
institutions. A mortgage-backed security may be an obligation of the issuer
backed by a mortgage or pool of mortgages or a direct interest in an underlying
pool of mortgages. Some mortgage-backed securities, such as collateralized
mortgage obligations or CMOs, make payments of both principal and interest at a
variety of intervals; others make semiannual interest payments at a
predetermined rate and repay principal at maturity (like a typical bond).
Mortgage-backed securities are based on different types of mortgages including
those on commercial real estate or residential properties. Other types of
mortgage-backed securities will likely be developed in the future, and a Fund
may invest in them if IAI determines they are consistent with such Fund's
investment objective and policies.

The value of mortgage-backed securities may change due to shifts in the
market's perception of issuers. In addition, regulatory or tax changes may
adversely affect the mortgage securities market as a whole. Non-government
mortgage-backed securities may offer higher yields than those issued by
government entities, but also may be subject to greater price changes than
government issues. Mortgage-backed securities are subject to prepayment risk.
Prepayment, which occurs when unscheduled or early payments are made on the
underlying mortgages, may shorten the effective maturities of these securities
and may lower their total returns.

STRIPPED MORTGAGE-BACKED SECURITIES

Government and Bond Funds may invest in stripped mortgage-backed
securities. Such securities are created when a U.S. government agency or a
financial institution separates the interest and principal components of a
mortgage-backed security and sells them as individual securities. The holder of
the "principal-only" security (PO) receives the principal payments made by the
underlying mortgage-backed security, while the holder of the "interest-only"
security (IO) receives interest payments from the same underlying security. The
prices of stripped mortgage-backed securities may be particularly affected by
changes in interest rates. As interest rates fall,

5
<PAGE>

prepayment rates tend to increase, which tends to reduce prices of IOs and
increase prices of POs. Rising interest rates can have the opposite effect.

ASSET-BACKED SECURITIES

Government and Bond Funds may invest in stripped asset-backed securities.
Asset-backed securities represent interests in pools of consumer loans
(generally unrelated to mortgage loans) and most often are structured as pass-
through securities. Interest and principal payments alternately depend upon
payment of the underlying loans by individuals, although the securities may be
supported by letters of credit or other credit enhancements. The value of asset-
backed securities may also depend on the creditworthiness of the servicing agent
for the loan pool, the originator of the loans, or the financial institution
providing the credit enhancement.

ZERO COUPON BONDS

Each Fund may invest in zero coupon bonds. Zero coupon bonds do not make
interest payments; instead, they are sold at a deep discount from their face
value and are redeemed at face value when they mature. Because zero coupon bonds
do not pay current income, their prices can be very volatile when interest rates
change. In calculating its dividends, a Fund takes into account as income a
portion of the difference between a zero coupon bond's purchase price and its
face value.

A broker-dealer creates a derivative zero by separating the interest and
principal components of a U.S. Treasury security and selling them as two
individual securities. CATS (Certificates of Accrual on Treasury Securities),
TIGRs (Treasury Investment Growth Receipts), and TRs (Treasury Receipts) are
examples of derivative zeros.

The Federal Reserve Bank creates STRIPS (Separate Trading of Registered
Interest and Principal of Securities) by separating the interest and principal
components of an outstanding U.S. Treasury bond and selling them as individual
securities. Bonds issued by the Resolution Funding Corporation (REFCORP) and the
Financing Corporation (FICO) can also be separated in this fashion. Original
issue zeroes are zero coupon securities originally issued by the U.S.
government, a government agency, or a corporation in zero coupon form.

LOWER-RATED DEBT SECURITIES

Issuers of high yield securities may be highly leveraged and may not have
available to them more traditional methods of financing. Therefore, the risks
associated with acquiring the securities of such issuers generally are greater
than is the case with higher rated securities. For example, during an economic
downturn or a sustained period of rising interest rates, issuers of high yield
securities may be more likely to experience financial stress, especially if such
issuers are highly leveraged. During such periods, such issuers may not have
sufficient revenues to meet their interest payment obligations. The issuer's
ability to service its debt obligations also may be adversely affected by
specific issuer developments or the issuer's inability to meet specific
projected business forecasts or the unavailability of additional financing. The
risk of loss due to default by the issuer is significantly greater for the
holders of high yield securities because such securities may be unsecured and
may be subordinated to other creditors of the issuer.

High yield securities frequently have call or redemption features which
would permit an issuer to repurchase the security from a Fund. If a call were
exercised by the issuer during a period of declining interest rates, a Fund
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to a Fund and dividends to
shareholders.

A Fund may have difficulty disposing of certain high yield securities
because there may be a thin trading market for such securities. The secondary
trading market for high yield securities is generally not as liquid as the
secondary market for higher rated securities. Reduced secondary market liquidity
may have an adverse impact on market price and a Fund's ability to dispose of
particular issues when necessary to meet such Fund's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the issuer.

6
<PAGE>

Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely affecting
the market value of high yield securities are likely to adversely affect a
Fund's net asset value. In addition, a Fund may incur additional expenses to the
extent it is required to seek recovery upon a default on a portfolio holding or
participate in the restructuring of the obligation.

SWAP AGREEMENTS

Each Fund may enter into swap agreements. Swap agreements can be
individually negotiated and structured to include exposure to a variety of
different types of investments or market factors. Depending on their structure,
swap agreements may increase or decrease a Fund's exposure to long- or short-
term interest rates (in the U.S. or abroad), foreign currency values, mortgage
securities, corporate borrowing rates, or other factors such as security prices
or inflation rates. Swap agreements can take many different forms and are known
by a variety of names. A Fund is not limited to any particular form of swap
agreement if IAI determines it is consistent with such Fund's investment
objectives and policies.

Swap agreements will tend to shift a Fund's investment exposure from one
type of investment to another. For example, if a Fund agrees to exchange
payments in dollars for payments in foreign currency, the swap agreement would
tend to decrease a Fund's exposure to U.S. interest rates and increase its
exposure to foreign currency and interest rates. Depending on how they are used,
swap agreements may increase or decrease the overall volatility of a Fund's
investments and its share price.

The most significant factor in the performance of swap agreements is the
change in the specific interest rate, currency, or other factors that determine
the amounts of payments due to and from a Fund. If a swap agreement calls for
payments by a Fund, such Fund must be prepared to make such payments when due.
In addition, if the counterparty's creditworthiness declined, the value of a
swap agreement would be likely to decline, potentially resulting in losses. Each
Fund expects to be able to eliminate its exposure under swap agreements either
by assignment or other disposition, or by entering into an offsetting swap
agreement with the same party or a similarly creditworthy party.

Each Fund will maintain appropriate liquid assets in a segregated custodial
account to cover its current obligations under swap agreements. If a Fund enters
into a swap agreement on a net basis, it will segregate assets with a daily
value at least equal to the excess, if any, of such Fund's accrued obligations
under the swap agreement over the accrued amount such Fund is entitled to
receive under the agreement. If a Fund enters into a swap agreement on other
than a net basis, it will segregate assets with a value equal to the full amount
of such Fund's accrued obligations under the agreement.

INDEXED SECURITIES

Bond and Government Funds may purchase securities whose prices are indexed
to the prices of other securities, securities indexes, currencies, precious
metals or other commodities, or other financial indicators. Indexed securities
typically, but not always, are debt securities or deposits whose value at
maturity or coupon rate is determined by reference to a specific instrument or
statistic. Gold-indexed securities, for example, typically provide for a
maturity value that depends on the price of gold, resulting in a security whose
price tends to rise and fall together with gold prices. Currency-indexed
securities typically are short-term to intermediate-term debt securities whose
maturity values or interest rates are determined by reference to the values of
one or more specified foreign currencies, and may offer higher yields than U.S.
dollar-denominated securities of equivalent issuers. Currency-indexed securities
may be positively or negatively indexed; that is, their maturity value may
increase when the specified currency value increases, resulting in a security
that performs similarly to a foreign-denominated instrument, or their maturity
value may decline when foreign currencies increase, resulting in a security
whose price characteristics are similar to a put on the underlying currency.
Currency-indexed securities may also have prices that depend on the values of a
number of different foreign currencies relative to each other.

The performance of indexed securities depends to a great extent on the
performance of the security, currency, or other instrument to which they are
indexed, and may also be influenced by interest rate changes in the U.S. and
abroad. At the same time, indexed securities are subject to the credit risks
associated with the issuer of

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the security, and their values may decline substantially if the issuer's
creditworthiness deteriorates. Recent issuers of indexed securities have
included banks, corporations, and certain U.S. government agencies. IAI will use
its judgment in determining whether indexed securities should be treated as
short-term instruments, bonds, stocks, or as a separate asset class for purposes
of a Fund's investment policies, depending on the individual characteristics of
the securities. Indexed securities may be more volatile than the underlying
instruments.

LOANS AND OTHER DIRECT DEBT INSTRUMENTS

Bond and Government Funds may invest in loans and other direct debt
instruments. Direct debt instruments are interests in amounts owed by a
corporate, governmental, or other borrower to lenders or lending syndicates
(loans and loan participations), to suppliers of goods or services (trade claims
or other receivable), or to other parties. Direct debt instruments are subject
to a Fund's policies regarding the quality of debt securities.

Purchasers of loans and other forms of direct indebtedness depend primarily
upon the creditworthiness of the borrower for payment of principal and interest.
Direct debt instruments may not be rated by any nationally recognized rating
service. If a Fund does not receive scheduled interest or principal payments on
such indebtedness, a Fund's share price and yield could be adversely affected.
Loans that are fully secured offer a Fund more protection than an unsecured loan
in the event of non-payment of scheduled interest or principal. However, there
is no assurance that the liquidation of collateral from a secured loan would
satisfy the borrower's obligation, or that the collateral can be liquidated.
Indebtedness of borrowers whose creditworthiness is poor involves substantially
greater risks, and may be highly speculative. Borrowers that are in bankruptcy
or restructuring may never pay off their indebtedness, or may pay only a small
fraction of the amount owed. Direct indebtedness of developing countries will
also involve a risk that the governmental entities responsible for the repayment
of the debt may be unable, or unwilling, to pay interest and repay principal
when due.

Investments in loans through direct assignment of a financial institution's
interests with respect to a loan may involve additional risks to a Fund. For
example, if a loan is foreclosed, a Fund could become part owner of any
collateral, and would bear the costs and liabilities associated with owning and
disposing of the collateral. In addition, it is conceivable that under emerging
legal theories of lender liability, a Fund could be held liable as a co-lender.
Direct debt instruments may also involve a risk of insolvency of the lending
bank or other intermediaries. Direct debt instruments that are not in the form
of securities may offer less legal protection to the Fund in the event of fraud
or misrepresentation. In the absence of definitive regulatory guidance, a Fund
relies on IAI's research in an attempt to avoid situations where fraud or
misrepresentation could adversely affect such Fund.

A loan is often administered by a bank or other financial institution that
acts as agent for all holders. The agent administers the terms of the loan, as
specified in the loan agreement. Unless, under the terms of the loan or other
indebtedness, a Fund has direct recourse against the borrower, it may have to
rely on the agent to apply appropriate credit remedies against a borrower. If
assets held by the agent for the benefit of a Fund were determined to be subject
to the claims of the agent's general creditors, such Fund might incur certain
costs and delays in rendering payment on the loan or loan participation and
could suffer a loss of principal or interest.

Bond and Government Funds limit the amount of the assets that they invest
in any one issuer or in issuers within the same industry. For purposes of these
limitations, a Fund generally will treat the borrower as the "issuer" of
indebtedness held by such Fund. In the case of loan participations where a bank
or other lending institution serves as financial intermediary between a Fund and
the borrower, if the participation does not shift to such Fund the direct
debtor/creditor relationship with the borrower, SEC interpretations require such
Fund, in appropriate circumstances, to treat both the lending bank or other
lending institution and the borrower as "issuers" for the purpose of determining
whether such Fund has invested more than 5% of its total assets in a single
issuer. Treating the financial intermediary as an issuer of indebtedness may
restrict a Fund's ability to invest in indebtedness related to a single
financial intermediary, or a group of intermediaries engaged in the same
industry, even if the underlying borrowers represent many different companies
and industries.

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EXTENDIBLE NOTES

Government Fund is permitted to invest in extendible notes in accordance
with its investment objectives and policies. An extendible note is a debt
arrangement under which the holder, at its option, may require the issuer to
repurchase the note for a predetermined fixed price at one or more times prior
to the ultimate maturity date of the note. Typically, an extendible note is
issued at an interest rate that can be adjusted at fixed times throughout its
term. At the same times as the interest rate is adjusted by the issuer, the
holder of the note is typically given the option to "put" the note back to the
issuer at a predetermined price (e.g., at 100% of the outstanding principal
amount plus unpaid accrued interest) if the extended interest rate is
undesirable to the holder. This option to put the note back to the issuer (i.e.,
to require the issuer to repurchase the note) provides the holder with an
optional maturity date that is shorter than the actual maturity date of the
note.

Extendible notes may be issued with maturity dates in excess of seven years
from the date of issuance. However, if such extendible notes provide for an
optional maturity date of seven years or less, then such notes are deemed by
Government Fund to have been issued for the shorter optional maturity date.
Accordingly, investment in such extendible notes would not be in contravention
of the fundamental investment policy not to invest in securities having a
maturity date in excess of seven years from the date of acquisition. Investment
in extendible notes is not expected to have a material impact on the effective
portfolio maturity of Government Fund.

An investment in an extendible note is liquid, and the note may be resold
to another investor prior to its optional maturity date at its market value. The
market value of an extendible note with a given optional maturity date is
determined and fluctuates in a similar manner as the market value of a fixed
maturity note with a maturity equivalent to the optional maturity of the
extendible note. Compared to fixed term notes of the same issuer, however,
extendible notes with equivalent optional maturities generally yield higher
returns without a material increase in risk to Government Fund.

The creditworthiness of the issuers of extendible notes is monitored and
rated by Moody's and by S&P. The creditworthiness of such issuers is also
monitored by IAI. Government Fund does not have a current intention of investing
in the coming year more than 5% of its net assets in extendible notes.

STATE OR MUNICIPAL LEASE OBLIGATIONS

Municipal leases may take the form of a lease, an installment purchase
contract, a conditional sales contract or a participation certificate in any of
the above. In determining leases in which Minnesota Tax Free Fund will invest,
IAI will carefully evaluate the outstanding credit rating of the issuer (and the
probable secondary market acceptance of such credit rating). Additionally, IAI
may require that certain municipal lease obligations be issued or backed by a
letter of credit or put arrangement with an independent financial institution.

Municipal leases frequently have special risks not normally associated with
general obligation or revenue bonds. The constitutions and statutes of all
states contain requirements that the state or a municipality must meet to incur
debt. These often include voter referendum, interest rate limits and public sale
requirements. Leases and installment purchase or conditional sale contracts
(which normally provide for title to the leased asset to pass eventually to the
governmental issuer) have evolved as a means for governmental issuers to acquire
property and equipment without meeting the constitutional and statutory
requirements for the issuance of debt. The debt-issuance limitations are deemed
to be inapplicable because of the inclusion in many leases or contracts of
"nonappropriation" clauses that provide that the governmental issuer has no
obligation to make future payments under the lease or contract unless money is
appropriated for such purpose by the appropriate legislative body on a yearly or
other periodic basis.

In addition to the "nonappropriation" risk municipal leases have additional
risk because they represent a relatively new type of financing that has not yet
developed the depth of marketability associated with conventional bonds;
moreover, although the obligations will be secured by the leased equipment, the
disposition of the equipment in the event of non-appropriation or foreclosure
might, in some cases, prove difficult. In addition, in certain instances the
tax-exempt status of the obligations will not be subject to the legal opinion
of a nationally recognized "bond counsel," as is customarily required in larger
issues of municipal securities.

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RESOURCE RECOVERY BONDS

Resource recovery bonds are a type of revenue bond issued to build
facilities such as solid waste incinerators or waste-to-energy plants.
Typically, a private corporation will be involved, at least during the
construction phase. The revenue stream typically is secured by fees or rents
paid by municipalities for use of the facilities. The viability of a resource
recovery project, environmental protection regulations, and project operator tax
incentives may affect the value and credit quality of resource recovery bonds.

TAX AND REVENUE ANTICIPATION NOTES

Tax and revenue anticipation notes are issued by municipalities in
expectation of future tax or other revenues, and are payable from those specific
taxes or revenues. Bond anticipation notes normally provide interim financing in
advance of an issue of bonds or notes, which provide the money to repay the
notes. Tax-exempt commercial paper is issued by municipalities to help finance
short-term capital or operating needs.

FOREIGN CURRENCY TRANSACTIONS

Bond and Government Funds may hold foreign currency deposits from time to
time and may convert dollars and foreign currencies in the foreign exchange
markets. Currency conversion involves dealer spreads and other costs, although
commissions usually are not charged. Currencies may be exchanged on a spot
(i.e., cash) basis, or by entering into forward contracts to purchase or sell
foreign currencies at a future date and price. Forward contracts generally are
traded in an interbank market conducted directly between currency traders
(usually large commercial banks) and their customers. The parties to a forward
contract may agree to offset or terminate the contract before its maturity, or
may hold the contract to maturity and complete the contemplated currency
exchange.

Such Funds may use currency forward contracts to manage currency risks and
to facilitate transactions in foreign securities. The following discussion
summarizes the principal currency management strategies involving forward
contracts that could be used by the Funds.

In connection with purchases and sales of securities denominated in foreign
currencies, a Fund may enter into currency forward contracts to fix a definite
price for the purchase or sale in advance of the trade's settlement date. This
technique is sometimes referred to as a "settlement hedge" or "transaction
hedge." IAI expects to enter into settlement hedges in the normal course of
managing a Fund's foreign investments. A Fund could also enter into forward
contracts to purchase or sell a foreign currency in anticipation of future
purchases or sales of securities denominated in foreign currency, even if the
specific investments have not yet been selected by IAI.

Each Fund may also use forward contracts to hedge against a decline in the
value of existing investments denominated in foreign currency. For example, if a
Fund owned securities denominated in pounds sterling, it could enter into a
forward contract to sell pounds sterling in return for U.S. dollars to hedge
against possible declines in the pound's value. Such a hedge, sometimes referred
to as a "position hedge," would tend to offset both positive and negative
currency fluctuations but would not offset changes in security values caused by
other factors. A Fund could also hedge the position by selling another currency
expected to perform similarly to the pound sterling -- for example, by entering
into a forward contract to sell Deutschemarks or European Currency Units in
return for U.S. dollars. This type of hedge, sometimes referred to as a "proxy
hedge," could offer advantages in terms of cost, yield, or efficiency, but
generally would not hedge currency exposure as effectively as a simple hedge
into U.S. dollars. Proxy hedges may result in losses if the currency used to
hedge does not perform similarly to the currency in which the hedged securities
are denominated.

Under certain conditions, SEC guidelines require mutual funds to set aside
appropriate liquid assets in a segregated custodial account to cover currency
forward contracts. As required by SEC guidelines, each Fund will segregate
assets to cover currency forward contracts, if any, whose purpose is essentially
speculative. Each Fund will not segregate assets to cover forward contracts
entered into for hedging purposes, including settlement hedges, position hedges,
and proxy hedges.

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Successful use of forward currency contracts will depend on IAI's skill in
analyzing and predicting currency values. Forward contracts may substantially
change a Fund's investment exposure to changes in currency exchange rates, and
could result in losses to a Fund if currencies do not perform as IAI
anticipates. For example, if a currency's value rose at a time when IAI had
hedged a Fund by selling that currency in exchange for dollars, such Fund would
be unable to participate in the currency's appreciation. If IAI hedges currency
exposure through proxy hedges, a Fund could realize currency losses from the
hedge and the security position at the same time if the two currencies do not
move in tandem. Similarly, if IAI increases a Fund's exposure to a foreign
currency, and that currency's value declines, such Fund will realize a loss.
There is no assurance that IAI's use of forward currency contracts will be
advantageous to a Fund or that it will hedge at an appropriate time. The
policies described in this section are non-fundamental policies of the Funds.

LIMITATIONS ON FUTURES AND OPTIONS TRANSACTIONS

Each Fund has filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with the Commodity Futures
Trading Commission (CFTC) and the National Futures Association, which regulate
trading in the futures markets, before engaging in any purchases or sales of
futures contracts or options on futures contracts. Each Fund intends to comply
with Section 4.5 of the regulations under the Commodity Exchange Act, which
limits the extent to which a Fund can commit assets to initial margin deposits
and option premiums.

The above limitations on a Fund's investments in futures contracts and
options, and such Fund's policies regarding futures contracts and options
discussed elsewhere in this Statement of Additional Information may be changed
as regulatory agencies permit.

FUTURES CONTRACTS

When a Fund purchases a futures contract, it agrees to purchase a specified
underlying instrument at a specified future date. When a Fund sells a futures
contract, it agrees to sell the underlying instrument at a specified future
date. The price at which the purchase and sale will take place is fixed when a
Fund enters into the contract. Some currently available futures contracts are
based on specific securities, such as U.S. Treasury bonds or notes, and some are
based on indexes of securities prices, such as the Standard & Poor's 500
Composite Stock Price Index (S&P 500). Futures can be held until their delivery
dates, or can be closed out before then if a liquid secondary market is
available.

The value of a futures contract tends to increase and decrease in tandem
with the value of its underlying instrument. Therefore, purchasing futures
contracts will tend to increase a Fund's exposure to positive and negative price
fluctuations in the underlying instrument, much as if it had purchased the
underlying instrument directly. When a Fund sells a futures contract, by
contrast, the value of its futures position will tend to move in a direction
contrary to the market. Selling futures contracts, therefore, will tend to
offset both positive and negative market price changes, much as if the
underlying instrument had been sold.

FUTURES MARGIN PAYMENTS

The purchaser or seller of a futures contract is not required to deliver or
pay for the underlying instrument unless the contract is held until the delivery
date. However, both the purchaser and seller are required to deposit "initial
margin" with a futures broker, known as a futures commission merchant (FCM),
when the contract is entered into. Initial margin deposits are typically equal
to a percentage of the contract's value. If the value of either party's position
declines, that party will be required to make additional "variation margin"
payments to settle the change in value on a daily basis. The party that has a
gain may be entitled to receive all or a portion of this amount. Initial and
variation margin payments do not constitute purchasing securities on margin for
purposes of a Fund's investment limitations. In the event of the bankruptcy of
an FCM that holds margin on behalf of a Fund, such Fund may be entitled to
return of margin owed to it only in proportion to the amount received by the
FMC's other customers, potentially resulting in losses to such Fund.

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PURCHASING PUT AND CALL OPTIONS

By purchasing a put option, a Fund obtains the right (but not the
obligation) to sell the option's underlying instrument at a fixed strike price.
In return for this right, a Fund pays the current market price for the option
(known as the option premium). Options have various types of underlying
instruments, including specific securities, indexes of securities prices, and
futures contracts. A Fund may terminate its position in a put option it has
purchased by allowing it to expire or by exercising the option. If the option is
allowed to expire, a Fund will lose the entire premium it paid. If a Fund
exercises the option, it completes the sale of the underlying instrument at the
strike price. A Fund may also terminate a put option position by closing it out
in the secondary market at its current price, if a liquid secondary market
exists.

The buyer of a typical put option can expect to realize a gain if security
prices fall substantially. However, if the underlying instrument's price does
not fall enough to offset the cost of purchasing the option, a put buyer can
expect to suffer a loss (limited to the amount of the premium paid, plus related
transaction costs).

The features of call options are essentially the same as those of put
options, except that the purchaser of a call option obtains the right to
purchase, rather than sell, the underlying instrument at the option's strike
price. A call buyer typically attempts to participate in potential price
increases of the underlying instrument with risk limited to the cost of the
option if security prices fall. At the same time, the buyer can expect to suffer
a loss if security prices do not rise sufficiently to offset the cost of the
option.

WRITING PUT AND CALL OPTIONS

When a Fund writes a put option, it takes the opposite side of the
transaction from the option's purchaser. In return for receipt of the premium,
such Fund assumes the obligation to pay the strike price for the option's
underlying instrument if the other party to the option chooses to exercise it.
When writing an option on a futures contract a Fund would be required to make
margin payments to an FCM as described above for futures contracts. A Fund may
seek to terminate its position in a put option it writes before exercise by
closing out the option in the secondary market at its current price. If the
secondary market is not liquid for a put option a Fund has written, however,
such Fund must continue to be prepared to pay the strike price while the option
is outstanding, regardless of price changes, and must continue to set aside
assets to cover its position. If security prices rise, a put writer would
generally expect to profit, although its gain would be limited to the amount of
the premium it received.

If security prices remain the same over time, it is likely that the writer
will also profit, because it should be able to close out the option at a lower
price. If security prices fall, the put writer would expect to suffer a loss.
This loss should be less than the loss from purchasing the underlying instrument
directly, however, because the premium received for writing the option should
mitigate the effects of the decline.

Writing a call option obligates a Fund to sell or deliver the option's
underlying instrument, in return for the strike price, upon exercise of the
option. The characteristics of writing call options are similar to those of
writing put options, except that writing calls generally is a profitable
strategy if prices remain the same or falls. Through receipt of the option
premium, a call writer mitigates the effects of a price decline. At the same
time, because a call writer must be prepared to deliver the underlying
instrument in return for the strike price, even if its current value is greater,
a call writer gives up some ability to participate in security price increases.

COMBINED POSITIONS

Each Fund may purchase and write options in combination with each other, or
in combination with futures or forward contracts, to adjust the risk and return
characteristics of the overall position. For example, a Fund may purchase a put
option and write a call option on the same underlying instrument, in order to
construct a combined position whose risk and return characteristics are similar
to selling a futures contract. Another possible combined position would involve
writing a call option at one strike price and buying a call option at a lower
price, in order to reduce the risk of the written call option in the event of a
substantial price increase. Because combined options positions involve multiple
trades, they result in higher transaction costs and may be more difficult to
open and close out.

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CORRELATION OF PRICE CHANGES

Because there are a limited number of types of exchange-traded options and
futures contracts, it is likely that the standardized contracts available will
not match a Fund's current or anticipated investments exactly. Each Fund may
invest in options and futures contracts based on securities with different
issuers, maturities, or other characteristics from the securities in which it
typically invests, which involves a risk that the options or futures position
will not track the performance of such Fund's other investments.

Options and futures prices can also diverge from the prices of their
underlying instruments, even if the underlying instruments match a Fund's
investments well. Options and futures prices are affected by such factors as
current and anticipated short-term interest rates, changes in volatility of the
underlying instrument, and the time remaining until expiration of the contract,
which may not affect security prices the same way. Imperfect correlation may
also result from differing levels of demand in the options and futures markets
and the securities markets, from structural differences in how options and
futures and securities are traded, or from imposition of daily price fluctuation
limits or trading halts. A Fund may purchase or sell options and futures
contracts with a greater or lesser value than the securities it wishes to hedge
or intends to purchase in order to attempt to compensate for differences in
volatility between the contract and the securities, although this may not be
successful in all cases. If price changes in a Fund's options or futures
positions are poorly correlated with its other investments, the positions may
fail to produce anticipated gains or result in losses that are not offset by
gains in other investments.

LIQUIDITY OF OPTIONS AND FUTURES CONTRACTS

There is no assurance a liquid secondary market will exist for any
particular options or futures contract at any particular time. Options may have
relatively low trading volume and liquidity if their strike prices are not close
to the underlying instrument's current price. In addition, exchanges may
establish daily price fluctuation limits for options and futures contracts, and
may halt trading if a contract's price moves upward or downward more than the
limit in a given day. On volatile trading days when the price fluctuation limit
is reached or a trading halt is imposed, it may be impossible for a Fund to
enter into new positions or close out existing positions. If the secondary
market for a contract is not liquid because of price fluctuation limits or
otherwise, it could prevent prompt liquidation of unfavorable positions, and
potentially could require a Fund to continue to hold a position until delivery
or expiration regardless of changes in its value. As a result, a Fund's access
to other assets held to cover its options or futures positions could also be
impaired.

OTC OPTIONS

Bond and Government Funds may engage in OTC options transactions. Unlike
exchange-traded options, which are standardized with respect to the underlying
instrument, expiration date, contract size, and strike price, the terms of over-
the-counter options (options not traded on exchanges) generally are established
through negotiation with the other party to the option contract. While this type
of arrangement allows a Fund greater flexibility to tailor an option to its
needs, OTC options generally involve greater credit risk than exchange-traded
options, which are guaranteed by the clearing organization of the exchanges
where they are traded.

OPTIONS AND FUTURES RELATING TO FOREIGN CURRENCIES

Bond and Government Funds may engage in options and futures transactions
relating to foreign currencies. Currency futures contracts are similar to
forward currency exchange contracts, except that they are traded on exchanges
(and have margin requirements) and are standardized as to contract size and
delivery date. Most currency futures contracts call for payment or delivery in
U.S. dollars. The underlying instrument of a currency option may be a foreign
currency, which generally is purchased or delivered in exchange for U.S.
dollars, or may be a futures contract. The purchaser of a currency call obtains
the right to purchase the underlying currency, and the purchaser of a currency
put obtains the right to sell the underlying currency.

The uses and risks of currency options and futures are similar to options
and futures relating to securities or indexes, as discussed above. A Fund may
purchase and sell currency futures and may purchase and write currency options
to increase or decrease its exposure to different foreign currencies. A Fund may
also purchase
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and write currency options in conjunction with each other or with currency
futures or forward contracts. Currency futures and options values can be
expected to correlate with exchange rates, but may not reflect other factors
that affect the value of a Fund's investments. A currency hedge, for example,
should protect a yen-denominated security from a decline in the yen, but will
not protect a Fund against a price decline resulting from deterioration in the
issuer's creditworthiness. Because the value of a Fund's foreign-denominated
investments changes in response to many factors other than exchange rates, it
may not be possible to match the amount of currency options and futures to the
value of a Fund's investments exactly over time.

ASSET COVERAGE FOR FUTURES AND OPTIONS POSITIONS

Each Fund will comply with guidelines established by the Securities and
Exchange Commission with respect to coverage of options and futures strategies
by mutual funds, and if the guidelines so require will set aside appropriate
liquid assets in a segregated custodial account in the amount prescribed.
Securities held in a segregated account cannot be sold while the futures or
option strategy is outstanding, unless they are replaced with other suitable
assets. As a result, there is a possibility that segregation of a large
percentage of a Fund's assets could impede portfolio management or a Fund's
ability to meet redemption requests or other current obligations.

SPECIAL CONSIDERATIONS REGARDING INVESTMENT
IN MINNESOTA TAX-EXEMPT OBLIGATIONS

RISK FACTORS RELATING TO MINNESOTA TAX-EXEMPT OBLIGATIONS

The State relies heavily on a progressive individual income tax and a
retail sales tax for revenue, which results in a fiscal system that is sensitive
to economic conditions. Frequently in recent years, legislation has been
required to eliminate projected budget deficits by raising additional revenue,
reducing expenditures, including aids to political subdivisions and higher
education, reducing the State's budget reserve, imposing a sales tax on
purchases by local governmental units, and making other budgetary adjustments.
The Minnesota Department of Finance February 1996 Forecast has projected that,
under current laws, the State will complete its current biennium June 30, 1997
with a $64 million surplus, plus a $350 million cash flow account balance, plus
a $220 million budget reserve. Total General Fund expenditures and transfers for
the biennium are projected to be $18.8 billion. State expenditures for education
finance (K-12), post-secondary education, and human services in the biennium
ending June 30, 1997 are not anticipated to be sufficient to maintain program
levels of the previous biennium.

The State is party to a variety of civil actions that could adversely
affect the State's General Fund, and the State's fiscal condition is affected by
federal tax and expenditure policies. In addition, substantial portions of State
and local revenues are derived from federal expenditures, and reductions in
federal aid to the State and its political subdivisions and other federal
spending cuts may have substantial adverse effects on the economic and fiscal
condition of the State and its local governmental units. The February 1996
Forecast states that pending federal legislation could reduce federal aid to
Minnesota's state and local governments by a total of $3.2 billion over several
years. Risks are inherent in making revenue and expenditure forecasts. Economic
or fiscal conditions less favorable than those reflected in State budget
forecasts and planning estimates may create additional budgetary pressures.

State grants and aids represent a large percentage of the total revenues of
cities, towns, counties and school districts in Minnesota. Even with respect to
revenue obligations, no assurance can be given that economic or other fiscal
difficulties and the resultant impact on State and local government finances
will not adversely affect the market value of Minnesota tax-exempt obligations
held by Minnesota Tax Free Fund and the ability of the respective obligors to
make timely payment of the principal and interest on such obligations.

MINNESOTA ECONOMY

Diversity and a significant natural resource base are two important
characteristics of the Minnesota economy. Generally, the structure of the
State's economy parallels the structure of the United States economy as a whole.
There are, however, employment concentrations in durable goods and non-durable
goods manufacturing, particularly industrial machinery, instruments and
miscellaneous, food, paper and related industries, and printing

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and publishing. During the period from 1980 to 1990, overall employment growth
in Minnesota lagged behind national employment growth, in large part due to
declining agricultural employment. The rate of employment growth in Minnesota
exceeded the rate of national growth, however, in the period of 1990 to 1994.
Since 1980, Minnesota per capita income generally has remained above the
national average, but tightness in local labor markets may reduce the rate of
personal income growth below that of the national average in the future.
Minnesota personal income growth in 1993 was slowed by a decline in farm income
as a result of cool, wet weather. During 1993, 1994 and 1995, the State's
monthly unemployment rate was generally less than the national unemployment
rate.

DIVERSIFICATION

Minnesota Tax Free Fund intends to conduct its operations so that it will
comply with diversification requirements and qualify under the Internal Revenue
Code of 1986 as a "regulated investment company". In order to qualify as a
regulated investment company, Minnesota Tax Free Fund must limit its investments
so that, at the close of each quarter of the taxable year, with respect to at
least 50% of its total assets, not more than 5% of its total assets will be
invested in securities of a single issuer. In addition, the Code requires that
not more than 25% in value of Minnesota Tax Free Fund's total assets may be
invested in the securities of a single issuer at the close of each quarter of
the taxable year.

For purposes of such diversification, the identification of the issuer of
municipal securities depends on the terms and conditions of the security. If
Minnesota or a political subdivision thereof pledges its full faith and credit
to payment of a security, Minnesota or the political subdivision, respectively,
is deemed the sole issuer of the security. If the assets and revenues of an
agency, authority or instrumentality of Minnesota or a political subdivision
thereof are separate from those of Minnesota or political subdivision and the
security is based only by the assets and revenues of the agency, authority or
instrumentality, such agency, authority or instrumentality is deemed to be the
sole issuer. Moreover, if the security is backed only by revenues of an
enterprise or specific projects of Minnesota, a political subdivision or agency,
authority or instrumentality, such as utility revenue bonds, and the full faith
and credit of the governmental unit is not pledged to the payment thereof, such
enterprise or specific project is deemed the sole issuer. Similarly, in the case
of an industrial development bond, if that bond is backed only by certain
revenues to be received from the non-governmental user of the project financed
by the bond, then such non-governmental user is deemed to be the sole issuer.
If, however, in any of the above cases, Minnesota, its political subdivisions or
some other entity guarantees a security and the value of all securities issued
or guaranteed by the guarantor and owned by Minnesota Tax Free Fund exceeds 10%
of the value of such Fund's total assets, the guarantee is considered a separate
security and is treated as an issue of the guarantor. Investments in municipal
obligations refunded with escrowed U.S. Government securities will be treated as
investments in U.S. Government securities for purposes of determining a Fund's
compliance with the 1940 Act diversification requirements.

INVESTMENT RESTRICTIONS

As indicated in the Prospectus, each Fund is subject to certain policies
and restrictions which are "fundamental" and may not be changed without
shareholder approval. Shareholder approval consists of the approval of the
lesser of (i) more than 50% of the outstanding voting securities of a Fund, or
(ii) 67% or more of the voting securities present at a meeting if the holders of
more than 50% of the outstanding voting securities of the Fund are present or
represented by proxy. Limitations 1 through 8 below are deemed fundamental
limitations. The remaining limitations set forth below serve as operating
policies of each Fund and may be changed by the Board of Directors without
shareholder approval.

Each Fund may not:

1. Purchase the securities of any issuer if such purchase would cause the
Fund to fail to meet the requirements of a "diversified company" as defined
under the Investment Company Act of 1940, as amended (the "1940 Act").

15
<PAGE>

2. Purchase the securities of any issuer (other than "Government
securities" as defined under the 1940 Act) if, as a result, more than 25% of the
value of the Fund's total assets would be invested in the securities of
companies whose principal business activities are in the same industry.

For purposes of applying this restriction, a Fund will not purchase
securities, as defined above, such that 25% or more of the value of the Fund's
total assets are invested in the securities of companies whose principal
business activities are in the same industry.

3. Issue any senior securities, except as permitted by the 1940 Act or
the Rules and Regulations of the Securities and Exchange Commission.

4. Borrow money, except from banks for temporary or emergency purposes
provided that such borrowings may not exceed 33-1/3% of the value of the Fund's
net assets (including the amount borrowed). Any borrowings that come to exceed
this amount will be reduced within three days (not including Sundays and
holidays) to the extent necessary to comply with the 33-1/3% limitation. This
limitation shall not prohibit the Fund from engaging in reverse repurchase
agreements, making deposits of assets to margin or guarantee positions in
futures, options, swaps or forward contracts, or segregating assets in
connection with such agreements or contracts.

To the extent a Fund engages in reverse repurchase agreements, because
such transactions are considered borrowing, reverse repurchase agreements are
included in the 33-1/3% limitation.

5. Act as an underwriter of securities of other issuers, except to the
extent that in connection with the disposition of portfolio securities the Fund
may be deemed to be an underwriter under applicable laws.

6. Purchase or sell real estate unless acquired as a result of ownership
of securities or other instruments. This restriction shall not prevent the Fund
from investing in securities or other instruments backed by real estate or
securities of companies engaged in the real estate business.

7. Purchase or sell commodities other than foreign currencies unless
acquired as a result of ownership of securities. This limitation shall not
prevent the Fund from purchasing or selling options, futures, swaps and forward
contracts or from investing in securities or other instruments backed by
commodities.

For purposes of applying this restriction, "commodities" shall be
deemed to include commodity contracts.

8. Make loans to other persons except to the extent not inconsistent with
the 1940 Act or the Rules and Regulations of the Securities and Exchange
Commission. This limitation does not apply to purchases of commercial paper,
debt securities or repurchase agreements, or to the lending of portfolio
securities.

9. Purchase securities on margin, except that the Fund may obtain such
short-term credits as may be necessary for the clearance of purchases or sales
of securities and provided that margin payments in connection with transactions
in options, futures, swaps and forward contracts shall not be deemed to
constitute purchasing securities on margin.

10. Sell securities short, unless it owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short, and
provided that transactions in options, swaps and forward futures contracts are
not deemed to constitute selling securities short.

For purposes of applying this restriction, a Fund will not sell
securities short except to the extent that it contemporaneously owns or has the
right to obtain at no added cost securities identical to those sold short.

11. Except as part of a merger, consolidation, acquisition, or
reorganization, invest more than 5% of the value of its total assets in the
securities of any one investment company or more than 10% of the value of its
total assets, in the aggregate, in the securities of two or more investment
companies, or acquire more than 3% of the total outstanding voting securities of
any one investment company.

16
<PAGE>

12. Mortgage, pledge or hypothecate its assets except to the extent
necessary to secure permitted borrowings. This limitation does not apply to
reverse repurchase agreements or in the case of assets deposited to margin or
guarantee positions in futures, options, swaps or forward contracts or placed in
a segregated account in connection with such contracts.

13. Participate on a joint or a joint and several basis in any
securities trading account.

14. Invest more than 15% of its net assets in illiquid investments.

15. Invest directly in interests (including partnership interests) in
oil, gas or other mineral exploration or development leases or programs, except
the Fund may purchase or sell securities issued by corporations engaging in oil,
gas or other mineral exploration or development business.

Any of a Fund's investment policies set forth under "Investment Objective
and Policies" in the Prospectus, or any restriction set forth above under
"Investment Restrictions" which involves a maximum percentage of securities or
assets shall not be considered to be violated unless an excess over the
percentage occurs immediately after an acquisition of securities or utilization
of assets and results there from. With respect to Restriction 14, each Fund is
under a continuing obligation to ensure that it does not violate the maximum
percentage either by acquisition or by virtue of a decrease in the value of a
Fund's liquid assets.

PORTFOLIO TURNOVER

The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the particular fiscal year by the
monthly average of the value of portfolio securities owned by the Fund during
the same fiscal year. "Portfolio securities" for purposes of this calculation
do not include securities with a maturity date of less than twelve (12) months
from the date of investment. A 100% portfolio turnover rate would occur, for
example, if the lesser of the value of purchases or sales of portfolio
securities for a particular year were equal to the average monthly value of the
portfolio securities owned during such year. Each Fund's historical portfolio
turnover rates are set forth in the Prospectus section "Financial Highlights".
The increases in the portfolio turnover rates for Bond Fund and Government Fund
for the last fiscal year were due to increased bond market volatility and
falling interest rates.

INVESTMENT PERFORMANCE

Advertisements and other sales literature for each Fund may refer to
monthly, quarterly, yearly, cumulative and average annual total return. Each
such calculation assumes all dividends and capital gain distributions are
reinvested at net asset value on the appropriate reinvestment dates as described
in the Prospectus, and includes all recurring fees, such as investment advisory
and management fees, charged as expenses to all shareholder accounts. Each of
monthly, quarterly and yearly total return are computed in the same manner as
cumulative total return, as set forth below.

Cumulative total return is computed by finding the cumulative rate of
return over the period indicated in the advertisement that would equate the
initial amount invested to the ending redeemable value, according to the
following formula:

CTR = (ERV-P) 100
-----
P

Where: CTR = Cumulative total return;
ERV = ending redeemable value at the end of the
period of a hypothetical $1,000 payment made
at the beginning of such period; and
P = initial payment of $1,000

Average annual total return is computed by finding the average annual
compounded rates of return over the periods indicated in the advertisement that
would equate the initial amount invested to the ending redeemable value,
according to the following formula:

17
<PAGE>

P(1+T)n = ERV

Where: P = a hypothetical initial payment of $1,000;
T = average annual total return;
n = number of years; and
ERV = ending redeemable value at the end of the period
of a hypothetical $1,000 payment made at the
beginning of such period.

The Fund may quote yield figures from time to time. The "yield" is
computed by dividing the net investment income per share earned during a 30-day
period (using the average number of shares entitled to receive dividends) by the
net asset value per share on the last day of the period. The yield formula
provides for semiannual compounding which assumes that net investment income is
earned and reinvested at a constant rate and annualized at the end of a six-
month period. A "tax-equivalent yield" is computed by dividing the portion of
the yield that is tax-exempt by one minus a stated income tax rate and adding
the product to that portion, if any, of the yield that is not tax-exempt.

The yield formula is as follows:

YIELD = 2[(a-b + 1)6 -1]
---
cd

Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends.
d = the net asset value of the Fund.

The table below shows the yearly total return for the Funds for the periods
indicated.

<TABLE>
<CAPTION>
Bond Fund Government Fund Minnesota Tax Free Fund
Year Yearly Yearly Yearly
Ended 12/31 Total Return Total Return Total Return
------------ ------------ --------------- ------------

<S> <C> <C> <C>
1981..................................... 3.0%
1982..................................... 32.6%
1983..................................... 8.0%
1984..................................... 15.9%
1985..................................... 20.2%
1986..................................... 12.2%
1987..................................... 2.0%
1988..................................... 6.4%
1989..................................... 15.9%
1990..................................... 7.1%
1991..................................... 17.3%...................... 7.7%*
1992..................................... 6.8%...................... 5.7%............................... 6.9%**
1993..................................... 12.32%...................... 8.54%.............................. 13.62%
1994..................................... (4.92%)..................... (2.27%)............................. (8.29%)
1995..................................... 16.25% ..................... 11.54% ............................. 12.18%
</TABLE>
* For the period commencing August 8, 1991.
** For the period commencing April 1, 1992.

The average annual total returns of Bond Fund for the one, five and ten
year periods ended November 30, 1995 were 15.46%, 9.36% and 9.05%, respectively.
Bond Fund's yield for the thirty-day period ended November 30, 1995 was 5.71%.

18
<PAGE>

The average annual total returns of Government Fund for the year ended
November 30, 1995 and from inception of the Government Fund through November 30,
1995, were 10.99% and 6.89%, respectively. Government Fund's yield for the
thirty-day period ended November 30, 1995 was 5.36%.

Minnesota Tax Free Fund's average annual total returns for the one-year
period ended November 30, 1995, and from inception through November 30, 1995,
were 13.17% and 6.07%, respectively. For the 30-day period ended November 30,
1995, Minnesota Tax Free Fund's yield and its tax equivalent yield, using a 31%
tax rate, were 4.51% and 6.54%, respectively; (at a 39.6% tax rate such tax
equivalent yield would be 7.15%). On December 15, 1994, Minnesota Tax Free Fund
was converted from IAI Tax Free Fund to IAI Minnesota Tax Free Fund. Because of
this, past performance data may not provide a basis for evaluating the
investment results of the Fund.

In advertising and sales literature, each Fund may compare its performance
with that of other mutual funds, indexes or averages of other mutual funds,
indexes of related financial assets or data, and other competing investment and
deposit products available from or through other financial institutions. The
composition of these indexes, averages or products differs from that of a Fund.
The comparison of a Fund to an alternative investment should be made with
consideration of differences in features and expected performance.

The indexes and averages noted below will be obtained from the indicated
sources or reporting services, which the Fund believes to be generally accurate.
Each Fund may also note its mention in newspapers, magazines, or other media
from time to time. However, each Fund assumes no responsibility for the
accuracy of such data.

For example, (1) a Fund's performance or P/E ratio may be compared to any
one or a combination of the following: (i) other groups of mutual funds,
including the IAI Funds, tracked by: (A) Lipper Analytical Services, Inc., a
widely used independent research firm which ranks mutual funds by overall
performance, investment objectives, and assets; (B) Morningstar, Inc., another
widely used independent research firm which rates mutual funds; or (C) other
financial or business publications, which may include, but are not limited to,
Business Week, Money Magazine, Forbes and Barron's, which provide similar
information; (ii) the Salomon Brothers Broad Investment Grade Index; (iii) the
Shearson Lehman Brothers Government/Corporate Bond Index; and (iv) the
performance of U.S. government and corporate bonds, notes and bills. (The
purpose of these comparisons would be to illustrate historical trends in
different market sectors so as to allow potential investors to compare different
investment strategies.); (2) the Consumer Price Index (measure for inflation)
may be used to assess the real rate of return from an investment in a Fund; (3)
other U.S. government statistics such as GNP, and net import and export figures
derived from governmental publications, e.g., The Survey of Current Business,
may be used to illustrate investment attributes of a Fund or the general
economic business, investment, or financial environment in which a Fund
operates; (4) the effect of tax-deferred compounding on a Fund's investment
returns, or on returns in general, may be illustrated by graphs, charts, etc.
where such graphs or charts would compare, at various points in time, the return
from an investment in a Fund (or returns in general) on a tax-deferred basis
(assuming reinvestment of capital gains and dividends and assuming one or more
tax rates) with the return on a taxable basis; and (5) the instruments in which
a Fund invests may be compared to relevant indices or surveys in order to
evaluate a Fund's historical performance or current or potential value with
respect to the particular instruments.

19
<PAGE>

MANAGEMENT

The names, addresses, positions and principal occupations of the directors
and executive officers of the Funds are given below.

Principal Occupation(s)
Name and Address Age Position During Past 5 Years
- ---------------- --- -------- -----------------------

Noel P. Rahn* 53 Chairman of Chief Executive Officer and a
3700 First Bank Place the Director of IAI since 1974.
P.O. Box 357 Board Mr. Rahn is also Chairman of
Minneapolis, Minnesota 55440 the other IAI Mutual Funds.

Richard E. Struthers* 43 President, Executive Vice President and a
3700 First Bank Place Director Director of IAI and has
P.O. Box 357 served IAI in many capacities
Minneapolis, Minnesota since 1979. Mr.Struthers is
55440 also President of the other
IAI Mutual Funds.

Madeline Betsch 53 Director Currently retired; until April
19 South 1st Street 1994, was Executive Vice
Minneapolis, Minnesota President, Director of Client
55401 Services, of CME-KHBB
Advertising since May 1985,
and prior thereto was a Vice
President with Campbell-
Mithun, Inc. (advertising
agency) since February 1977.

W. William Hodgson 71 Director Currently retired; served as
1698 Dodd Road information manager for the
Mendota Heights, Minnesota North Central Home Office of
55118 the Prudential Insurance
Company of America from 1961
until 1984.

George R. Long 65 Director Chairman of Mayfield Corp.
29 Las Brisas Way (financial consultants and
Naples, Florida 33963 venture capitalists) since
1973.

J. Peter Thompson 64 Director Grain farmer in southwestern
Route 1 Minnesota since 1974. Prior
Mountain Lake, Minnesota 56159 to that, Mr. Thompson was
employed by Paine Webber,
Jackson & Curtis, Incorporated
(a diversified financial
services concern), most
recently as Senior Vice
President and General Partner.

Charles H. Withers 68 Director Curretly retired; served as
Rochester Post Bulletin Editor of the Rochester
P.O. Box 6118 Post-Bulletin, Rochester,
Rochester, Minnesota 55903 Minnesota from 1960 through
March 31, 1980.

20
<PAGE>

<TABLE>
<CAPTION>
Principal Occupation(s)
Name and Address Age Position During Past 5 Years
- ---------------- --- -------- -----------------------
<S> <C> <C> <C>
Archie C. Black, III 33 Treasurer Senior Vice President and
3700 First Bank Place Chief Financial Officer
P.O. Box 357 of IAI and has served IAI
Minneapolis, Minnesota 55440 in several capacities
since 1987. Mr. Black is
also Treasurer of the
other IAI Mutual Funds.

William C. Joas 33 Secretary Vice President of IAI and
3700 First Bank Place has served as an attorney
P.O. Box 357 for IAI since 1990.
Minneapolis, Minnesota 55440 Mr. Joas is also Secretary
of the other IAI Mutual
Funds.

Larry R. Hill 43 Vice President, Executive Vice President
3700 First Bank Place Investments and a Director of IAI
P.O. Box 357 and has served IAI in
Minneapolis, Minnesota 55440 in various capacities
since 1984.

Scott Bettin 41 Vice President, Senior Vice President of
3700 First Bank Place Investments IAI and has served IAI
P.O. Box 357 in various capacities
Minneapolis, Minnesota 55440 since 1987.

Stephen Coleman 48 Vice President, Senior Vice President of
3700 First Bank Place Investments IAI and has served IAI
P.O. Box 357 in various capacities
Minneapolis, Minnesota 55440 since 1991.

Livingston Douglas 35 Vice President, Vice President of IAI.
3700 First Bank Place Investments Prior to joining IAI in
P.O. Box 357 1993, Mr. Douglas served
Minneapolis, Minnesota 55440 as a fixed income portfolio
manager for Mackay-Shields
Financial Corporation.

Kirk Gove 33 Vice President, Vice President of IAI.
3700 First Bank Place Marketing Prior to joining IAI in
P.O. Box 357 1992, Mr. Gove served as an
Minneapolis, Minnesota 55440 served as an Associate Vice
President of Dain Bosworth,
Incorporated (diversified
financial services concern).
Mr. Gove is also Vice
President, Marketing of the
other IAI Mutual Funds.

Susan J. Haedt 34 Vice President, Vice President of IAI and
3700 First Bank Place Director of Director of Fund Operations.
P.O. Box 357 Operations Prior to joining IAI in
Minneapolis, Minnesota 55440 1992, Ms. Haedt served as a
Senior Manager at KPMG
Peat Marwick LLP (an
international tax,
accounting and consulting
firm.) Ms. Haedt is also
Vice President, Director of
Fund Operations of the other
IAI Mutual Funds.
</TABLE>

- --------------
* Directors of each Fund who are interested persons (as that term is defined
by the Investment Company Act of 1940) of IAI and each Fund.

Each Fund has agreed to reduced initial subscription requirements for
employees and directors of a Fund or IAI, their spouses, children and
grandchildren. With respect to such persons, the minimum initial investment in

<PAGE>

one or more of the IAI Family of Funds is $500; provided that the minimum amount
that can be allocated to any one of the Funds is $250. Subsequent subscriptions
are limited to a minimum of $100 for each of the Funds.

No compensation is paid by the Fund to any of its officers. As of January
1, 1996, directors who are not affiliated with IAI receive from the IAI Mutual
Funds a $15,000 annual retainer, $2,500 for each Board meeting attended, $3,600
for each Audit Committee meeting attended (as applicable) and $1,800 for each
Securities Valuation Committee meeting attended. The Fund will pay its pro rata
share of these fees based on its net assets. Such unaffiliated directors also
are reimbursed for expenses incurred in connection with attending meetings.

<TABLE>
<CAPTION>
Aggregate Compensation Aggregate Compensation Projected Aggregate
Compensation from the Compensation from the
Name of Person, Position from each Fund* 18 IAI Mutual Funds** 19 IAI Mutual Funds***
------------------------ ----------------------- ---------------------- ----------------------
<S> <C> <C> <C>
Betsch, Madeline -- Director $1,950 $28,725 $32,200

Hodgson, W. William -- Director $1,950 $28,725 $32,200

Long, George R. -- Director $1,550 $27,725 $32,200

Thompson, J. Peter -- Director $1,950 $28,725 $32,200

Withers, Charles H. -- Director $1,550 $27,725 $32,200

</TABLE>
- -------------------------
* For the fiscal year ended November 30, 1995.
** For the calendar year ended December 31, 1995.
*** For the calendar year ended December 31, 1996 and includes the
new IAI Capital Appreciation Fund; provided that a director
misses no meetings; excludes expenses incurred in connection
with attending meetings.

The Board of Directors for each of the Funds has approved a Code of Ethics.
The Code permits access persons to engage in personal securities transactions
subject to certain policies and procedures. Such procedures prohibit the
acquiring of any securities in an initial public offering. In addition, all
securities acquired through private placement must be pre-cleared. Procedures
have been adopted which would implement blackout periods for certain securities,
as well as a ban on short-term trading profits. Additional policies prohibit
the receipt of gifts in certain instances. Procedures have been implemented to
monitor employee trading. Each access person of the Adviser is required to
certify annually that they have read and understood the Code of Ethics. An
annual report is provided to the Funds' Board of Directors summarizing existing
procedures and changes, identifying material violations and recommending any
changes needed.

IAI, the Fund's investment adviser, is an affiliate of the Hill Samuel Group
("Hill Samuel"). Hill Samuel is an international merchant banking and financial
services firm headquartered in London, England. In addition to its ownership of
IAI, Hill Samuel owns controlling interests in over seventy insurance, merchant
banking and financial services subsidiaries located in Western Europe, Asia, the
United States, Australia, New Zealand and Great Britain. The principal offices
of Hill Samuel are located at 100 Wood Street, London EC2 P2AJ.

Hill Samuel, in turn, is owned by Lloyds TSB Group, plc ("Lloyds TSB"), a
publicly-held financial services organization headquartered in London, England.
Lloyds TSB is one of the largest personal and corporate financial services
groups in the United Kingdom, engaged in a wide range of activities including
commercial and retail banking. The principal offices of Lloyds TSB are located
at St. George's House, 6 - 8 Eastcheap, London, EC3M 1LL.

HISTORY

Bond Fund is a separate portfolio of IAI Investment Funds I, Inc., a
Minnesota corporation whose shares of common stock are currently issued in one
series (Series A). On June 25, 1993, Bond Fund's shareholders approved amended
and restated Articles of Incorporation, which provided that the registered
investment company

22
<PAGE>

whose corporate name had been IAI Bond Fund, Inc., be renamed IAI Investment
Funds I, Inc. The investment portfolio represented by Series A common shares is
referred to as "IAI Bond Fund."

Government Fund is a separate portfolio of IAI Investment Funds VI, Inc., a
Minnesota corporation whose shares of common stock are currently issued in six
series (Series A through F). On June 25, 1993, Government Fund's shareholders
approved amended and restated Articles of Incorporation, which provided that the
registered investment company whose corporate name had been IAI Series Fund,
Inc., be renamed IAI Investment Funds VI, Inc. The investment portfolio
represented by Series B common shares is referred to as "IAI Government Fund."

Minnesota Tax Free Fund is a separate portfolio of IAI Investment Funds VI,
Inc., a Minnesota corporation whose shares of common stock are currently issued
in six series (Series A through F). On June 25, 1993, Minnesota Tax Free Fund's
shareholders approved amended and restated Articles of Incorporation, which
provided that the registered investment company whose corporate name had been
IAI Series Fund, Inc., be renamed IAI Investment Funds VI, Inc. Until November
9, 1994, the investment portfolio represented by Series D common shares was
referred to as "IAI Tax Free Fund." On November 9, 1994, the Fund's Board of
Directors approved changing the Fund's name to "IAI Minnesota Tax Free Fund."

MANAGEMENT AGREEMENT

Effective April 1, 1996, pursuant to a Management Agreement between each
Fund and IAI, IAI has agreed to provide each Fund with investment advice,
statistical and research facilities, and certain equipment and services,
including, but not limited to, office space and necessary office facilities,
equipment, and the services of required personnel and, in connection therewith,
IAI has the sole authority and responsibility to make and execute investment
decisions for each Fund within the framework of a Fund's investment policies,
subject to review by the directors of a Fund. In addition, IAI has agreed to
provide or arrange for the provision of all required administrative, stock
transfer, redemption, dividend disbursing, accounting, and shareholder services
including, without limitation, the following: (1) the maintenance of a Fund's
accounts, books and records; (2) the calculations of the daily net asset value
in accordance with a Fund's current Prospectus and Statement of Additional
Information; (3) daily and periodic reports; (4) all information necessary to
complete tax returns, questionnaires and other reports requested by a Fund; (5)
the maintenance of stock registry records; (6) the processing of requested
account registration changes, stock certificate issuances and redemption
requests; and (7) the administration of payments and dividends and distributions
declared by a Fund; (8) answering shareholder questions, (9) providing reports
and other information and (10) other services designed to maintain shareholder
accounts. IAI may also pay qualifying broker-dealers, financial institutions
and other entities that provide such services. In return for these services,
each Fund has agreed to pay IAI an annual fee as a percentage of the Fund's
average daily net assets as set forth below:

BOND FUND AND GOVERNMENT FUND

Daily Net Assets Fee IAI Receives Annually
---------------- -------------------------
For the first $250 million 1.10%
For the next $250 million 1.05%
Above $500 million 1.00%

MINNESOTA TAX FREE FUND

Daily Net Assets Fee IAI Receives Annually
---------------- -------------------------
For the first $250 million .95%
For the next $250 million .90%
Above $500 million .85%

Under the Management Agreement, except for brokerage commissions and other
expenditures in connection with the purchase and sale of portfolio securities,
interest expense, and, subject to the specific approval

<PAGE>

of a majority of the disinterested directors of a Fund, taxes and extraordinary
expenses, IAI has agreed to pay all of a Fund's other costs and expenses,
including, for example, costs incurred in the purchase and sale of assets,
taxes, charges of the custodian of a Fund's assets, costs of reports and proxy
material sent to Fund shareholders, fees paid for independent accounting and
legal services, costs of printing Prospectuses for Fund shareholders and
registering a Fund's shares, postage, insurance premiums, and costs of attending
investment conferences. The Management Agreement further provides that IAI will
either reimburse a Fund for the fees and expenses it pays to directors who are
not "interested persons" of a Fund or reduce its fee by an equivalent amount.
IAI is not liable for any loss suffered by a Fund in the absence of willful
misfeasance, bad faith or negligence in the performance of its duties and
obligations.

INVESTMENT ADVISORY AGREEMENT

Effective March 31, 1996, the Investment Advisory Agreement between each
Fund and IAI (the "Advisory Agreements") terminated and was replaced by the
Management Agreement described above. The following material is applicable only
through March 31, 1996.

Under the Advisory Agreements IAI has agreed to provide each Fund with
investment advice, statistical and research facilities, and certain equipment
and services, including, but not limited to, office space and necessary office
facilities, equipment, and the services of required personnel. In return, each
Fund has agreed to pay IAI a monthly fee. Under the Advisory Agreements, IAI
has the sole authority and responsibility to make and execute investment
decisions for each Fund within the framework of each Fund's investment policies,
subject to review by the directors of each Fund.

Each Fund has agreed to pay a monthly fee equivalent, on an annual basis,
to .55% of its respective average month-end net assets. As of November 30, 1995,
Bond, Government and Minnesota Tax Free Funds had net assets of $77,525,666,
$48,121,472 and $6,629,676, respectively.

Pursuant to the Advisory Agreements, the Funds paid IAI advisory fees as
follows:
<TABLE>
<CAPTION>

Bond Fund Government Fund Minnesota Tax Free Fund
--------- --------------- -----------------------

<S> <C> <C> <C>
Fiscal Year Ended
March 31, 1994 $659,524 $228,242 0 *
Fiscal Period Ended
November 30, 1994 $327,730 $144,953 0 *
Fiscal Year Ended
November 30, 1995 $441,516 $238,633 0 *

* Pursuant to expense limitation described below and to IAI's voluntary agreement to absorb Fund expenses
in excess of .25% of average month-end net assets.
</TABLE>

Each Fund's monthly payment of the advisory fee is suspended or reduced
(and reimbursement made by IAI, if necessary) when it appears that the amount of
expenses may exceed the Fund's applicable expense limit (and after the monthly
payment of the distribution fee has been reduced to zero), as set forth in the
section "Allocation of Expenses," below. For the fiscal years ended March 31,
1994, for the fiscal period ended November 30, 1994, and for the fiscal year
ended November 30, 1995, IAI was not obligated to reimburse any advisory fees
pursuant to the expense limit to either Bond or Government Funds. For the fiscal
year ended March 31, 1994, for the fiscal period ended November 30, 1994, and
for the fiscal year ended November 30, 1995, IAI waived $41,726, $27,698, and
$39,038, respectively, in advisory fees pursuant to the expense limit and
voluntary waiver for Minnesota Tax Free Fund.

Although investment decisions for each Fund are made independently from
those of the other funds and accounts as to which IAI gives investment advice,
it may occasionally develop that the same security is suitable for more than one
fund and/or other account. If and when more than one fund or other account
simultaneously purchase or sell the same security, the transactions will be
averaged as to price and allocated as to amount in accordance with arrangements
equitable to such funds and accounts. The simultaneous purchase or sale of the

24
<PAGE>

same securities by more than one fund or by any fund and other accounts may have
detrimental effects on the Fund, as they may affect the price paid or received
by a fund or the size of the position obtainable by a fund.

ADMINISTRATIVE AGREEMENT

Effective March 31, 1996, the Administrative Agreement between each Fund
and IAI (the "Administrative Agreements") terminated and was replaced by the
Management Agreement described above. The following material is applicable only
through March 31, 1996.

Each Fund has engaged IAI to serve as such Fund's administrative, dividend
disbursing, redemption, accounting services and transfer agent pursuant to an
Administrative Agreement. Under the Administrative Agreements, IAI has agreed
to provide to each Fund all required administrative, stock transfer, redemption,
dividend disbursing and accounting services including, without limitation, the
following: (1) the maintenance of accounts, books and records; (2) the
calculations of the daily net asset value in accordance with the Fund's current
Prospectus and Statement of Additional Information; (3) daily and periodic
reports; (4) all information necessary to complete tax returns, questionnaires
and other reports requested by a Fund; (5) the maintenance of stock registry
records; (6) the processing of requested account registration changes, stock
certificate issuances and redemption requests; and (7) the administration of
payments of dividends and distributions declared by each Fund. As compensation
for these services, each Fund has agreed to pay IAI a monthly fee equal to
.01667% of the value of the Fund's net assets on the last day of the month,
which is equivalent on an annual basis to .20% of each Fund's average month-end
net assets. For the fiscal year ended November 30, 1995, Bond and Government
Funds paid IAI $160,551, and $86,776, respectively, pursuant to the
Administrative Agreements. For Minnesota Tax Free Fund, for the fiscal year
ended November 30, 1995, IAI waived $14,196 in administrative fees pursuant to
the expense limitation and/or the voluntary agreement to absorb expenses
described elsewhere.

ALLOCATION OF EXPENSES

In light of the Management Agreement's fee structure as described above and
the termination of the Advisory and Administrative Agreements, the following
material is applicable only through March 31, 1996.

In addition to the advisory and administrative fees paid to IAI, each Fund
pays all its other costs and expenses, including, for example, costs incurred in
the purchase and sale of assets, interest, taxes, charges of the custodian of a
Fund's assets, costs of reports and proxy material sent to Fund shareholders,
fees paid for independent accounting and legal services, costs of printing
Prospectuses for Fund shareholders and registering Fund shares, postage, fees to
directors who are not "interested persons" of a Fund, distribution expenses
pursuant to each Fund's Rule 12b-1 plan, insurance premiums, costs of attending
investment conferences and such other costs which may be designated as
extraordinary. IAI has agreed to reimburse each Fund for expenses (other than
brokerage commissions and other expenditures in connection with the purchase and
sale of portfolio securities, interest expense, and, subject to the specific
approval of a majority of the disinterested directors of the Fund, taxes and
extraordinary expenses) which exceed 1.10% per year of the average month-end net
assets of Bond and Government Funds, and .95% per year of the average month-end
net assets of Minnesota Tax Free Fund (the "expense limit"). Certain state
securities commissions may impose additional limitations on certain of a Fund's
expenses, and IAI may be required by such state commissions to reimburse a Fund
for expenses in excess of any limitations as a requirement to selling shares of
a Fund in those states. IAI is not liable for any loss suffered by a Fund in
the absence of willful misfeasance, bad faith or gross negligence in the
performance of its duties and obligations.

DURATION OF AGREEMENTS

Each Management Agreement will terminate automatically in the event of its
assignment. In addition, each Agreement is terminable at any time without
penalty by the Board of Directors of a Fund or by vote of a majority of a Fund's
outstanding voting securities on not more than 60 days' written notice to IAI,
and by IAI on 60 days' notice to a Fund. Each Agreement shall continue in
effect from year to year only so long as such continuance is specifically
approved at least annually by either the Board of Directors of the Fund or by
vote of a majority of the outstanding voting securities, provided that in either
event such continuance is also approved by the vote of a

25
<PAGE>

majority of directors who are not parties to the Agreement or interested persons
of such parties cast in person at a meeting called for the purpose of voting on
such approval.

PLAN OF DISTRIBUTION

Effective March 31, 1996, each Fund's Plan of Distribution terminated. The
following material is relevant only through March 31, 1996.

Each Fund has adopted a Plan of Distribution relating to the payment of
certain expenses pursuant to Rule 12b-1 under the 1940 Act ("Rule 12b-1 Fees").
The Plans were last approved by the Board of Directors at a meeting on November
8, 1995, by the shareholders of Bond and Government Funds at a meeting on June
25, 1993, and by the shareholders of Minnesota Tax Free Fund at a meeting on
October 30, 1992.

Rule 12b-1(b) provides that any payments made by a fund in connection with
the distribution of its shares may only be made pursuant to a written plan
describing all material aspects of the proposed financing of distribution and
also requires that all agreements with any person relating to implementation of
the plan must be in writing. In addition, Rule 12b-1(b)(1) requires that such
plan be approved by a vote of at least a majority of the fund's outstanding
shares, and Rule 12b-1(b)(2) requires that such plan, together with any related
agreements, be approved by a vote of the board of directors of the company and
the directors of the company who are not interested persons of the company and
have no direct or indirect financial interest in the operation of the plan or in
any agreements related to the plan, cast in person at a meeting called for the
purpose of voting on such plan or agreements. Rule 12b-1(b)(3) requires that the
plan or agreement provide, in substance: (1) that it shall continue in effect
for a period of more than one year from the date of its execution or adoption
only so long as such continuance is specifically approved at least annually in
the manner described in paragraph (b)(2) of Rule 12b-1; (2) that any person
authorized to direct the disposition of monies paid or payable by a fund
pursuant to its plan or any related agreement shall provide to a fund's board of
directors, and the directors shall review, at least quarterly, a written report
of the amount so expended and the purposes for which such expenditures were
made; and (3) in the case of a plan, that it may be terminated at any time by
vote of a majority of the members of the board of directors of a fund who are
not interested persons of the fund and have no direct or indirect financial
interest in the operation of the plan or in any agreements related to the plan
or by vote of a majority of the outstanding voting securities of a fund.

Rule 12b-1(b)(4) requires that such plans may not be amended to increase
materially the amount to be spent for distribution without shareholder approval
and that all material amendments of the plan must be approved in the manner
described in paragraph (b)(2) of Rule 12b-1. Rule 12b-1(c) provides that a fund
may rely upon Rule 12b-1(1) only if selection and nomination of its
disinterested directors are committed to the discretion of such disinterested
directors. Rule 12b-1(e) provides that a fund may implement or continue a plan
pursuant to Rule 12b-1(b) only if the directors who vote to approve such
implementation or continuation conclude, in the exercise of reasonable business
judgment and in light of their fiduciary duties under state law, and under
Section 36(a) and (b) of the 1940 Act, that there is a reasonable likelihood
that the plan will benefit the fund and its shareholders. At the meeting of the
Board of Directors on November 8, 1995, the directors so concluded with respect
to each Fund's Plan of Distribution.

Pursuant to the Plan of Distribution, each Fund has entered into a
Distribution and Shareholder Services Agreement pursuant to which a Fund will
make payments to IAI Securities, Inc. ("IAIS") at an annual rate of 0.25% of a
Fund's average month-end net assets to cover expenses incurred by IAIS in
connection with the servicing of shareholder accounts and the distribution of
such Fund's shares (which amount is paid to IAIS regardless of amounts spent by
IAIS). The 12b-1 Fee payable by a Fund to IAIS may be used by IAIS to pay
advertising and promotional expenses including, without limitation, costs of
printing and providing Prospectuses, Statements of Additional Information,
annual reports and semiannual reports to prospective shareholders, expenses of
preparing and providing sales literature advertising of any type, and
compensation and benefits paid to and expenses incurred by personnel, including
supervisory personnel, involved in direct mail and advertising activities and
activities relating to the direct marketing of shares of the Fund to the public
and compensation to other broker-dealers for their sale of Fund shares. The Rule
12b-1 Fee may also be used to compensate the Underwriter for the provision of
certain services to Fund shareholders. Such services may include answering
shareholder questions, providing reports and other information and other
services designed to maintain
26
<PAGE>

shareholder accounts. IAIS may use the Rule 12b-1 Fee to make payments to
qualifying broker-dealers and financial institutions that provide such
shareholder services.

The Rule 12b-1 Fee payable by each Fund is subject to the expense
limitations set forth in the Advisory Agreements as described above.
Additionally, IAIS, in its sole and absolute discretion, may from time to time
out of its own assets pay for certain additional costs of servicing shareholder
accounts and distributing a Fund's shares. IAIS is an affiliate of IAI.

The net distribution fees paid by Bond and Government Funds pursuant to
their Plans of Distribution during the fiscal year ended November 30, 1995 were
$200,689 and $95,435, respectively. All such distribution fees were paid to,
and retained by, IAIS pursuant to the Distribution and Shareholder Services
Agreements discussed above. During the fiscal year ended November 30, 1995,
such distribution fees (along with amounts paid out of IAIS' own assets) were
paid by IAIS in connection with the distribution of the Funds' shares as
follows:

Bond Fund Government Fund
--------- ---------------
<S> <C> <C>
Advertising $34,117 $16,224

Printing and mailing of prospectuses to
other than current shareholders $24,083 $11,452

Payments to brokers or dealers $38,131 $18,133

Direct payments to sales personnel $86,296 $41,037

Other $18,062 $$8,589
</TABLE>

For Minnesota Tax Free Fund, for the fiscal year ended November 30, 1995,
all such distribution fees were absorbed by IAIS pursuant to the aforementioned
expense limitation.

CUSTODIAL SERVICE

The custodian for the Funds is Norwest Bank Minnesota, N.A. Norwest Center,
Sixth and Marquette, Minneapolis, MN 55479. Norwest has entered into an
agreement with Morgan Stanley Trust Company, 1 Pierrepont Plaza, Brooklyn, New
York ("Morgan Stanley") which enables Bond and Government Funds to utilize the
subcustodian and depository network of Morgan Stanley. Such agreements,
subcustodians and depositories were approved by the Funds' Board of Directors in
accordance with the rules and regulations of the Securities and Exchange
Commission, for the purpose of providing custodial services for the Funds'
assets held outside the United States.

The following is a listing of the subcustodians and depositories currently
approved by Bond and Government Funds' directors and the countries in which such
subcustodians and depositories are located:

BRANCHES OF THE CUSTODIAN
AND SUBCUSTODIAN BANKS
----------------------

Argentina Citibank, N.A., Buenos Aires Branch

Australia Australia & New Zealand Banking Group, Ltd.

Austria Credit Austalt Bankverein

Bangladesh Standard Chartered Bank

Belgium Banque Bruxelles Lambert (BBL)

27
<PAGE>

Botswana Barclays Bank of Botswana

Brazil Banco de Boston

Canada Toronto Dominion Bank

Chile Citibank, N.A., Santiago Branch

China Hong Kong & Shanghai Banking, Corp. Ltd.

Columbia Citibank, N.A./Cititrust Columbia S.A.

Cyprus Barclays Bank PLC

Czech Republic ING Bank

Denmark Den Danske Banke

Finland Merita Bank

France Banque Indosuez

Germany Berliner Handels-und-Frankfurter Bank

Ghana Barclays Bank of Ghana

Greece Citibank, N.A., Athens Branch

Hong Kong Hong Kong & Shanghai Banking Corp. Ltd.

Hungary Citibank, N.A., Budapest Branch

India Standard Chartered Bank

Indonesia Hong Kong & Shanghai Banking Corp. Ltd.

Ireland Allied Irish Bank

Israel Bank Leumi

Italy Barclays Bank PLC

Japan The Mitsubishi Bank Limited

Jordan Arab Bank plc

Kenya Barclays Bank Kenya

Korea Standard Chartered Bank

Luxembourg Banque Bruxelles Lambert

Malaysia Oversea Chinese Banking Corporation

Mauritius Hong Kong and Shanghai Bank Corporation

28
<PAGE>

Mexico Citibank, N.A., Mexico City Branch

Morocco Banque Commerciale du Maroc

Netherlands ABN Amro Bank

New Zealand Bank of New Zealand

Norway Den Norske Bank

Pakistan Standard Chartered Bank

Papua New Guinea Australia and New Zealand Banking Group

Peru Citibank N.A., Lima Branch

Philippines Hong Kong & Shanghai Banking Corp. Ltd.

Poland Citibank Poland, S.A.

Portugal Banco Commercial Portugues

Singapore Oversea Chinese Banking Corporation

South Africa First National Bank of Southern Africa

Spain Banco Santader

Sri Lanka Hong Kong & Shanghai Banking, Corp. Ltd.

Swaziland Barclays Bank of Swaziland

Sweden Svenska Handelsbanken

Switzerland Bank Leu Ltd.

Taiwan Hong Kong & Shanghai Banking Corp. Ltd.

Thailand Standard Chartered Bank

Turkey Citibank, N.A., Istanbul Branch

United Kingdom Barclays Bank PLC

Uruguay Citibank, N.A., Montevideo Branch

Venezuela Citibank, N.A., Caracas Branch

Zambia Barclays Bank of Zambia

Zimbabwe Barclays Bank of Zimbabwe

29
<PAGE>

DEPOSITORIES
------------

Argentina Caja de Valores

Australia Clearing House Electronic Subregister System

Austria Wertpapiersammelbank

Belgium Caisse Interprofessionelle de Depot et de Titres

Botswana Stock Exchange Talisman System

Brazil Bolsa de Valores de Sao Paulo
Bolsa de Valores de Rio de Janeiro

Canada The Canadian Depository for Securities

China Shangai Stock Exchange

Czech Republic Center for Securities (SCP)

Denmark Vaerdipapircentralen

France SICOVAM (Societe Interprofessionelle la
Compensacion des Valuers Mobilieres)
Societe de Compensacion des Marches
Conditionnels
Chambre de Compensation des
Instruments Financiers de Paris

Germany Deutscher Kassenverein AG

Greece Central Clearing Office of Athens Stock Exchange

Hong Kong Hong Kong Securities Clearing Company

Ireland Stock Exchange Talisman System

Israel SECH

Italy Monte Titoli, S.p.A

Japan Japan Securities Depository Center

Korea The Korean Central Depository

Malaysia The Malaysian Central Depository

Mexico Instituto para el Deposito de Valores

Morocco Casablanca Stock Exchange

Netherlands NECIGEF (Nederlands Centraal Institut
voor Giraal Effectenverkeer B.V.

New Zealand Austraclear New Zealand System

30
<PAGE>

Norway Verdipapirsentralen

Pakistan The Karachi Stock Exchange Clearinghouse

Papua New Guinea Clearing House Electronic Subregister
System

Poland National Depository of Securities

Portugal Lisbon Stock Exchange (SICOB system)
Oporto Stock Exchange (CAMBIUM system)

Singapore Central Depository Pte Ltd.

South Africa Central Depository (Pty) Ltd.

Spain Servicio de Compensacion y Liquidacion de
Valores

Sri Lanka Central Depository System Piri Ltd.

Sweden Vardepapperscentralen

Switzerland SEGA (Schweizerische Effekten Giro A.G.)

Taiwan Taiwan Securities Depository Co.

Thailand Share Depository Center

United Kingdom Stock Exchange Talisman System

Zimbabwe Stock Exchange Talisman System

PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE

Most of each Fund's portfolio transactions are effected with dealers
without the payment of brokerage commissions but at a net price which usually
includes a spread or markup. In effecting such portfolio transactions on behalf
of a Fund, IAI seeks the most favorable net price consistent with the best
execution. However, frequently IAI selects a dealer to effect a particular
transaction without contacting all dealers who might be able to effect such
transaction because of the volatility of the bond market and the desire of IAI
to accept a particular price for a security because the price offered by the
dealer meets its guidelines for profit, yield or both.

So long as IAI believes that it is obtaining the best net price (including
the spread or markup) consistent with the best execution, as described above, it
gives consideration in placing portfolio transactions to dealers furnishing
research, statistical information, or other services to IAI. This allows IAI to
supplement its own investment research activities and enables IAI to obtain the
views and information of individuals and research staffs of many different
securities firms prior to making investment decisions for a Fund. To the extent
portfolio transactions are effected with dealers who furnish research services
to it, IAI receives a benefit which is not capable of evaluation in dollar
amounts.

Consistent with the Rules of Fair Practice of the National Association of
Securities Dealers, Inc. and subject to the policies set forth in the preceding
paragraphs and such other policies as the Board of Directors of the Fund may
determine, IAI may consider sales of shares of a Fund as a factor in the
selection of broker-dealers to execute the Fund's securities transactions.

31
<PAGE>

IAI believes that most research services obtained by it generally benefit
one or more of the investment companies or other accounts which it manages.
Research services obtained from transactions in fixed income securities would
primarily benefit the managed funds investing such fixed income securities and
managed accounts investing in fixed income securities.

CAPITAL STOCK
BOND FUND

Bond Fund is a separate portfolio of IAI Investment Funds I, Inc., a
Minnesota corporation whose shares of common stock are currently issued in one
series (Series A). Each share of a series is entitled to participate pro rata in
any dividends and other distributions of such series and all shares of a series
have equal rights in the event of liquidation of that series. The Board of
Directors of IAI Investment Funds I, Inc., is empowered under the Articles of
Incorporation of such company to issue other series of the company's common
stock without shareholder approval. IAI Investment Funds I, Inc., has authorized
10,000,000,000 shares of $.01 par value common stock to be issued as Series A
common shares. The investment portfolio represented by such shares is referred
to as IAI Bond Fund. As of November 30, 1995, Bond Fund had 8,302,499 shares
outstanding.

As of March 19, 1996, no person held of record or, to the knowledge of Bond
Fund, beneficially owned more than 5% of the outstanding shares of Bond Fund,
except as set forth in the following table.

================================================================================
Name and Address Number of Percent of
of Shareholder Shares Class
================================================================================
<S> <C> <C>
Charles Schwab & Co., Inc. 541,566.787 6.52%
SPL Custody A/C for excl bnft of Cust
Attn: Mutual Funds Dept. - Bond Rein
101 Montgomery Street
San Francisco, CA 94104

</TABLE>

As of March 19, 1996, the Fund's officers and directors as a group owned
less than 1% of the Fund's outstanding shares.

GOVERNMENT FUND

Government Fund is a separate portfolio of IAI Investment Funds VI, Inc., a
Minnesota corporation whose shares of common stock are currently issued in six
series (Series A through F). Each share of a series is entitled to participate
pro rata in any dividends and other distributions of such series and all shares
of a series have equal rights in the event of liquidation of that series. The
Board of Directors of IAI Investment Funds VI, Inc., is empowered under the
Articles of Incorporation of such company to issue other series of the company's
common stock without shareholder approval. IAI Investment Funds VI, Inc. has
authorized 10,000,000,000 shares of $.01 par value common stock to be issued as
Series B common shares. The investment portfolio represented by such shares is
referred to as IAI Government Fund. As of November 30, 1995, the Fund had
4,783,448 shares outstanding.

As of March 19, 1996, no person held of record or, to the knowledge of
Government Fund, beneficially owned more than 5% of the outstanding shares of
the Fund. As of March 19, 1996, Government Fund's officers and directors as a
group owned less than 1% of the Fund's outstanding shares.

MINNESOTA TAX FREE FUND

Minnesota Tax Free Fund is a separate portfolio of IAI Investment Funds VI,
a Minnesota corporation whose shares of common stock are currently issued in six
series (Series A through F). Each share of a series is entitled to participate
pro rata in any dividends and other distributions of such series and all shares
of a series have equal rights in the event of liquidation of that series. The
Board of Directors of IAI Investment Funds VI, Inc., is empowered under the
Articles of Incorporation of such company to issue other series of the company's
common

32
<PAGE>

stock without shareholder approval. IAI Investment Funds VI, Inc., has
authorized 10,000,000,000 shares of $.01 par value common stock to be issued as
Series D common shares. The investment portfolio represented by such shares is
referred to as IAI Tax Free Fund. As of November 30, 1995, Minnesota Tax Free
Fund had 647,266 shares outstanding.

As of March 19, 1996, no person held of record or, to the knowledge of
Minnesota Tax Free Fund, beneficially owned more than 5% of the outstanding
shares of Minnesota Tax Free Fund, except as set forth in the following table:

================================================================================
Name and Address Number of Percent of
of Shareholder Shares Class
================================================================================
<S> <C> <C>
Noel Rahn 127,002.138 22.49
3700 First Bank Place
P.O. Box 357
Minneapolis, MN 55440

Robert D. Watson 42,670.722 7.56
4900 IDS Center
Minneapolis, MN 55402

</TABLE>

As of March 19, 1996, Minnesota Tax Free Fund's officers and directors,
including Mr. Rahn, as a group owned approximately 141,157.094 shares of
Minnesota Tax Free Fund, representing approximately 25% of Minnesota Tax Free
Fund's outstanding shares.

NET ASSET VALUE AND PUBLIC OFFERING PRICE

The portfolio securities in which each Fund invests fluctuate in value, and
hence, for each Fund, the net asset value per share also fluctuates.

The net asset value per share of a Fund is determined once daily as of the
close of trading on the New York Stock Exchange on each business day on which
the New York Stock Exchange is open for trading, and may be determined on
additional days as required by the Rules of the Securities and Exchange
Commission. The New York Stock Exchange is closed, and the net asset value per
share of a Fund is not determined, on the following national holidays: New
Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day, and Christmas Day.

On November 30, 1995, the net asset value and public offering price per
share of each Fund was calculated as follows:

BOND FUND

NAV = Net Assets ($77,525,666) = $ 9.34
------------------------------
Shares Outstanding (8,302,499)

GOVERNMENT FUND

NAV = Net Assets ($48,121,472) = $10.06
------------------------------
Shares Outstanding (4,783,448)

MINNESOTA TAX FREE FUND

NAV = Net Assets ($6,629,676) = $10.24
------------------------------
Shares Outstanding (647,266)

33
<PAGE>

PURCHASES AND REDEMPTIONS IN KIND

In extraordinary circumstances, Fund shares may be purchased for cash or in
exchange for securities which are permissible investments of a Fund, subject to
IAI's discretion and its determination that the securities are acceptable.
Securities accepted in exchange will be valued on the basis of market
quotations, or if market quotations are not available, by a method that IAI
believes accurately reflects fair value. In addition, securities accepted in
exchange are required to be liquid securities that are not restricted as to
transfer. Also in extraordinary circumstances, if a shareholder so desires, and
IAI so agrees, Fund shares may be redeemed in exchange for securities held by a
Fund. Securities redeemed in exchange will be valued on the basis of market
quotations, or if market quotations are not available, by a method that IAI
believes accurately reflects fair value.

TAX STATUS

The tax status of the Funds and the distributions of the Funds are
summarized in the Prospectus under "Dividends, Distributions and Tax Status."

It is not expected that distributions from any of the Funds will qualify
for the dividends received deduction in the case of corporate shareholders since
the distributions will not be derived from dividends paid by domestic
corporations.

If Fund shares are sold or otherwise disposed of more than one year from
the date of acquisition, the difference between the price paid for the shares
and the sales price will result in long-term capital gain or loss to the Fund
shareholder if, as is usually the case, the Fund shares are a capital asset in
the hands of the Fund shareholder at that time. However, under a special
provision in the Internal Revenue Code of 1986, as amended (the "Code"), if Fund
shares with respect to which a long-term capital gain distribution has been, or
will be, made are held for six months or less, any loss on the sale or other
disposition of such shares will be long-term capital loss to the extent of such
distribution. Moreover, any loss on the sale or exchange of Minnesota Tax Free
Fund shares held for six months or less will be disallowed for federal income
tax purposes to the extent of the amount of any exempt-interest dividend
received with respect to such shares. Similar rules apply in the case of
individuals, trusts, and estates under Minnesota law.

Ordinarily, distributions and redemption proceeds earned by Fund
shareholders are not subject to withholding of federal income tax. However, each
Fund is required to withhold 31% of a shareholder's distributions and redemption
proceeds upon the occurrence of certain events specified in Section 3406 of the
Code and regulations promulgated thereunder. These events include the failure of
a Fund shareholder to supply the Fund with such shareholder's taxpayer
identification number, and the failure of a Fund shareholder who is otherwise
exempt from withholding to properly document such shareholder's status as an
exempt recipient. Additionally, distributions may be subject to state and local
income taxes, and the treatment thereunder may differ from the federal income
tax consequences discussed above.

Under the Code, each Fund will be subject to a non-deductible excise tax
equal to 4% of the excess, if any, of the amount of investment income and
capital gains required to be distributed pursuant to the Code for each calendar
year over the amount actually distributed. In order to avoid this excise tax,
each Fund generally must declare dividends by the end of each calendar year
representing 98% of each Fund's ordinary income for such calendar year and 98%
of its capital gain net income (both long-term and short-term) for the twelve-
month period ending October 31 of the same calendar year. The excise tax is not
imposed, however, on undistributed income that is already subject to corporate
income tax. It is each Fund's policy not to distribute capital gains until
capital loss carryovers, if any, either are utilized or expire.

In the case of Bond and Government Funds, income received from sources
within foreign countries may be subject to withholding and other taxes imposed
by such countries. Tax conventions between certain countries and the United
States may reduce or eliminate such taxes. It is impossible to determine the
effective rate of foreign tax applicable to such income in advance since the
precise amount of a Fund's assets to be invested in various countries is not
known. Any amount of taxes paid by Bond or Government Fund to foreign countries
will reduce the amount of income available to such Fund for distributions to
shareholders.

34
<PAGE>

Under the Code, interest in indebtedness incurred or continued to purchase
or carry shares of an investment company paying tax-exempt dividends, such as
Minnesota Tax Free Fund, will not be deductible by the investor in proportion to
the amount of such Fund's distributions from investment income and short-term
capital gains that is exempt from federal income tax. Minnesota law also
restricts the deductibility of interest on indebtedness incurred or continued to
purchase or carry shares of Minnesota Tax Free Fund. Indebtedness may be
allocated to shares of the Fund even though not strictly traceable to the
purchase of such shares.

Under a special provision of the Revenue Reconciliation Act of 1993, if
Minnesota Tax Free Fund disposes of a municipal obligation that it acquired
after April 30, 1993 at a market discount, it must recognize any gain it
realizes on the disposition as ordinary income (and not as capital gain) to the
extent of the accrued market discount.

The foregoing is a general and abbreviated summary of the Code and Treasury
regulations in effect as of the date of the Funds' Prospectus and this Statement
of Additional Information. The foregoing relates solely to federal income tax
law applicable to "U.S. persons," i.e., U.S. citizens and residents and U.S.
domestic corporations, partnerships, trusts and estates. Shareholders who are
not U.S. persons are encouraged to consult a tax adviser regarding the income
tax consequences of acquiring shares of a Fund.

LIMITATION OF DIRECTOR LIABILITY

Under Minnesota law, each Fund's Board of Directors owes certain fiduciary
duties to the Fund and to its shareholders. Minnesota law provides that a
director "shall discharge the duties of the position of director in good faith,
in a manner the director reasonably believes to be in the best interest of the
corporation, and with the care an ordinarily prudent person in a like position
would exercise under similar circumstances." Fiduciary duties of a director of a
Minnesota corporation include, therefore, both a duty of "loyalty" (to act in
good faith and act in a manner reasonably believed to be in the best interests
of the corporation) and a duty of "care" (to act with the care an ordinarily
prudent person in a like position would exercise under similar circumstances).
Minnesota law authorizes corporations to eliminate or limit the personal
liability of a director to the corporation or its shareholders for monetary
damages for breach of the fiduciary duty of "care." Minnesota law does not,
however, permit a corporation to eliminate or limit the liability of a director
(i) for any breach of the director's duty of "loyalty" to the corporation or its
shareholders, (ii) for acts or omissions not in good faith or that involve
intentional misconduct or a knowing violation of law, (iii) for authorizing a
dividend, stock repurchase or redemption or other distribution in violation of
Minnesota law or for violation of certain provisions of Minnesota securities
laws, or (iv) for any transaction from which the director derived an improper
personal benefit. The Articles of Incorporation of IAI Investment Funds I, Inc.,
and IAI Investment Fund VI, Inc. limit the liability of directors to the fullest
extent permitted by Minnesota statutes, except to the extent that such liability
cannot be limited as provided in the Investment Company Act of 1940 (which Act
prohibits any provisions which purport to limit the liability of directors
arising from such directors' willful misfeasance, bad faith, gross negligence,
or reckless disregard of the duties involved in the conduct of their role as
directors).

Minnesota law does not eliminate the duty of "care" imposed upon a
director. It only authorizes a corporation to eliminate monetary liability for
violations of that duty. Minnesota law, further, does not permit elimination or
limitation of liability of "officers" of the corporation for breach of their
duties as officers (including the liability of directors who serve as officers
for breach of their duties as officers.) Minnesota law does not permit
elimination or limitation of the availability of equitable relief, such as
injunctive or rescissionary relief. Further, Minnesota law does not permit
elimination or limitation of a director's liability under the Securities Act of
1933 or the Securities Exchange Act of 1934, and it is uncertain whether and to
what extent the elimination of monetary liability would extend to violations of
duties imposed on directors by the Investment Company Act of 1940 and the rules
and regulations adopted under such Act.

35
<PAGE>

FINANCIAL STATEMENTS

The financial statements, included as part of the Funds' 1995 Annual Report
to shareholders, are incorporated herein by reference. Such Annual Report may be
obtained by shareholders on request from the Funds at no additional charge.

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APPENDIX A

RATINGS OF DEBT SECURITIES

RATINGS BY MOODY'S
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CORPORATE AND MUNICIPAL BONDS

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.

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
which make the long term risks appear somewhat larger than in Aaa securities.

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
which suggest a susceptibility to impairment sometime in the future.

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

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

B. Bonds rated B generally lack characteristics of the desirable
investment. Assurances of interest and principal payment or maintenance of other
terms of the contract over any long period of time may be small.

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

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

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

Conditional Ratings. The designation "Con." followed by a rating indicates
bonds for which the security depends upon the completion of some act or the
fulfillment of some condition. These are bonds secured by (a) earnings of
projects under construction, (b) earnings or projects unseasoned in operating
experience, (c) rentals which begin when facilities are completed, or (d)
payments to which some other limiting condition attaches. Parenthetical rating
denotes probable credit stature upon completion of construction or elimination
of basis of condition.

Note: Moody's applies numerical modifiers 1, 2, and 3 in the Aa and A
classifications of 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

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generic rating category. With respect to municipal securities, those bonds in
the Aa, A, Baa, Ba, and B groups which Moody's believes possess the strongest
investment attributes are designated by the symbols Aa1, A1, Baa1, Ba1, and B1.

COMMERCIAL PAPER

Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment capacity of rated issuers:

Prime - 1 Superior ability for repayment of senior short-term
debt obligations

Prime - 2 Strong ability for repayment of senior short-term debt
obligations

Prime - 3 Acceptable ability for repayment of senior short-term
debt obligations

If an issuer represents to Moody's that its Commercial Paper obligations
are supported by the credit of another entity or entities, Moody's, in assigning
ratings to such issuers, evaluates the financial strength of the indicated
affiliated corporations, commercial banks, insurance companies, foreign
governments, or other entities, but only as one factor in the total rating
assessment.

MUNICIPAL NOTES

Moody's may assign a separate rating to the demand feature of a
variable rate demand security. Such ratings will be designated as VMIG, SG
(speculative quality) or, if the demand feature is not rated, as NR.

MIG1/VMIG 1. This designation denotes best quality. There is present
strong protection by established cash flows, superior liquidity support or
demonstrated broad-based access to the market for refinancing.

MIG2/VMIG 2. This designation denotes high quality. Margins of
protection are ample although not so large as in the preceding group.

MIG3/VMIG 3. 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.

RATINGS BY S&P
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CORPORATE AND MUNICIPAL BONDS

AAA. Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.

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

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

BBB. Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing

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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.

BB. Debt rated BB has less near-term vulnerability to default than
other speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which could lead
to inadequate capacity to meet timely interest and principal payments.

B. Debt rated B has a greater vulnerability to default but currently
has the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The B rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
BB-rating.

CCC. Debt rated CCC has a currently identifiable vulnerability to
default, and is dependent upon favorable business, financial, and economic
conditions to meet timely payment of interest and repayment of principal. In the
event of adverse business, financial or economic conditions, it is not likely to
have the capacity to pay interest and repay principal.

CC. Debt rated CC is typically applied to debt subordinated to
senior debt which is assigned an actual or implied CCC debt rating.

C. The rating C typically applied to debt subordinated to senior debt
which assigned an actual or implied CCC-debt rating. The C rating may be used to
cover a situation where a bankruptcy petition has been filed but debt service
payments are continued.

C1. The rating C1 is reserved for income bonds on which no interest is
being paid.

D. Debt rated D is in payment default. The D rating category is used
when interest payments or principal payments are not made on the date due even
if the applicable grace period has not expired, unless S & P believes that such
payments will be made during such grace period. The D rating will be used upon
the filing of a bankruptcy petition if debt service payments are jeopardized.

In order to provide more detailed indications of credit quality, S&P's bond
letter ratings described above (except for the AAA category) may be modified by
the addition of a plus or a minus sign to show relative standing within the
rating category.

COMMERCIAL PAPER

A. This highest rating category indicates the greatest capacity for
timely payment. Issues in this category are further defined with the
designations 1, 2, and 3 to indicate the relative degree to safety.

A-1. This designation indicates that the degree of safety regarding
timely payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are designed A-1+.

A-2. Capacity for timely payments on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designed A-1.

A-3. Issues carrying this designation have adequate capacity for timely
repayment. They are, however, more vulnerable to the adverse effects of changes
in circumstances than obligations carrying the higher designations.

MUNICIPAL NOTES

SP-1. Notes rated SP-1 have very strong or strong capacity to pay
principal and interest. Those issues determined to possess overwhelming safety
characteristics are designated as SP-1+.

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SP-2. Notes rated SP-2 have satisfactory capacity to pay principal and
interest.

SP-3. Notes rated SP-3 have a speculative capacity to pay principal and
interest.

Notes due in three years or less normally receive a note rating. Notes
maturing beyond three years normally receive a bond rating, although the
following criteria are used in making that assessment:

- Amortization schedule (the larger the final maturity relative to other
maturities, the more likely the issue will be rated as a note).

- Source of payment (the more dependent the issue is on the market for its
refinancing, the more likely it will be rated as a note).

TAX-EXEMPT DUAL RATINGS

S&P assigns dual ratings to all municipal debt issues that have a demand or
double feature as part of their provisions. 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 (demand) option (for example, AAA/A-1+). With
short-term demand debt, S&P's note rating symbols are used with one commercial
paper symbol (for example, SP-1+/A-1+).

A-1. This highest category indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted with a plus sign (+) designation.

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

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