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[LOGO OF VANGUARD APPEARS HERE] A Member of The Vanguard Group
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PROSPECTUS--DECEMBER 14, 1994
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NEW ACCOUNT INFORMATION: INVESTOR INFORMATION DEPARTMENT--1-800-662-7447 (SHIP)
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SHAREHOLDER ACCOUNT SERVICES: CLIENT SERVICES DEPARTMENT--1-800-662-2739 (CREW)
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INVESTMENT Vanguard Municipal Bond Fund, Inc. (the "Fund") is an open-
OBJECTIVE AND end diversified investment company whose objective is to pro-
POLICIES vide investors with the highest level of income that is ex-
empt from federal income tax and consistent with preservation
of capital. The Fund consists of seven different Portfolios,
each of which invests primarily in municipal securities
within prescribed maturity and quality standards.
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OPENING AN Please complete and return the Account Registration Form. If
ACCOUNT you need assistance in completing this Form, please call our
Investor Information Department at 1-800-662-7447, Monday
through Friday, from 8:00 a.m. to 9:00 p.m. and Saturday from
9:00 a.m. to 4:00 p.m. (Eastern time). The minimum initial
investment is $3,000 for each Portfolio or $500 for Uniform
Gifts/Transfers to Minors Act accounts. The Fund is offered
on a no-load basis (i.e., there are no sales commissions or
12b-1 fees). However, the Fund incurs expenses for investment
advisory, management, administrative and distribution servic-
es.
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ABOUT THIS This Prospectus is designed to set forth concisely the
PROSPECTUS information you should know about the Fund before you invest.
It should be retained for future reference. A "Statement of
Additional Information" containing additional information
about the Fund has been filed with the Securities and
Exchange Commission. Such Statement is dated December 14,
1994, and is hereby incorporated by reference into this
Prospectus. It may be obtained, without charge, by writing to
the Fund or by calling the Investor Information Department.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Highlights............................................................ 2
Fund Expenses......................................................... 5
Financial Highlights.................................................. 6
Yield and Total Return................................................ 10
FUND INFORMATION
Investment Objective.................................................. 10
Investment Policies................................................... 10
Investment Risks...................................................... 13
Who Should Invest..................................................... 15
<CAPTION>
Page
<S> <C>
How to Compare Tax-Free and
Taxable Yields...................................................... 16
Implementation of Policies............................................ 17
Investment Limitations................................................ 21
Management of the Fund................................................ 22
Investment Adviser.................................................... 22
Dividends, Capital Gains and
Taxes............................................................... 23
The Share Price of Each Portfolio..................................... 25
General Information................................................... 26
<CAPTION>
Page
<S> <C>
SHAREHOLDER GUIDE
Opening an Account and Purchasing Shares.............................. 27
When Your Account Will Be Credited.................................... 30
Selling Your Shares................................................... 31
Exchanging Your Shares................................................ 34
Important Information About Telephone Transactions.................... 35
Transferring Registration............................................. 36
Other Vanguard Services............................................... 36
</TABLE>
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE COMMISSION PASSED UPON THE ACCURACY OR AD-
EQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OF-
FENSE.
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<PAGE>
HIGHLIGHTS
OBJECTIVE AND Vanguard Municipal Bond Fund, Inc. (the "Fund") is an open-
POLICIES end diversified investment company whose objective is to pro-
vide investors with the highest level of income that is ex-
empt from federal income tax. The Fund consists of seven sep-
arate Portfolios, each of which invests in municipal securi-
ties within prescribed maturity and credit quality standards.
There is no assurance, however, that the Fund will achieve
its stated objective.
PAGE 10
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SEVEN SEPARATE Investors may choose to invest in any of seven Portfolios of
PORTFOLIOS the Fund:
MONEY MARKET PORTFOLIO--invests in high-quality municipal se-
curities with a dollar-weighted average maturity of 90 days
or less and seeks to maintain a stable $1.00 share price. AN
INVESTMENT IN THE MONEY MARKET PORTFOLIO IS NEITHER INSURED
NOR GUARANTEED BY THE U.S. GOVERNMENT. ALSO, THERE IS NO AS-
SURANCE THAT THE PORTFOLIO WILL BE ABLE TO MAINTAIN A STABLE
NET ASSET VALUE OF $1.00 PER SHARE.
SHORT-TERM PORTFOLIO--invests in high-quality municipal secu-
rities with a dollar-weighted average maturity of 1 to 2
years.
LIMITED-TERM PORTFOLIO--invests in high-quality municipal se-
curities with a dollar-weighted average maturity of 2 to 5
years.
INTERMEDIATE-TERM PORTFOLIO--invests in high-quality munici-
pal securities with a dollar-weighted average maturity of 7
to 12 years.
LONG-TERM PORTFOLIO--invests in high-quality municipal secu-
rities with a dollar-weighted average maturity of 15 to 25
years.
INSURED LONG-TERM PORTFOLIO--invests in insured municipal se-
curities with a dollar-weighted average maturity of 15 to 25
years.
HIGH-YIELD PORTFOLIO--invests in medium-grade municipal secu-
rities with a dollar-weighted average maturity of 15 to 25
years. PAGE 11
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RISK The seven Portfolios of the Fund differ significantly in
CHARACTERISTICS terms of interest rate and credit risk. INTEREST RATE RISK is
the potential for fluctuations in the principal value of a
bond investment caused by changes in market interest rates.
It depends chiefly on the average maturity of a Portfolio's
municipal securities. CREDIT RISK is the possibility that a
municipal bond issuer will fail to make timely payments of
principal and interest to a Portfolio. It is a function of
the credit quality of a Portfolio's securities.
Five Portfolios of the Fund--the Money Market, Short-Term,
Limited-Term, Intermediate-Term and Long-Term Portfolios--
provide varying degrees of interest rate risk for a similar
level of credit quality. The Money Market Portfolio, which is
expected to maintain a stable $1.00 share price, provides
minimal exposure to interest rate risk. In contrast, share
prices for the Short-Term, Limited-Term, Intermediate-Term
and Long-Term Portfolios will generally fluctuate
2
2
2
<PAGE>
as interest rates change. In relative terms, share price
fluctuations are expected to be modest for the Short-Term
Portfolio, moderate for the Limited-Term Portfolio, reasona-
bly high for the Intermediate-Term Portfolio and highest for
the Long-Term Portfolios.
Two Portfolios--the Insured Long-Term and High-Yield Portfo-
lios--are similar to the Long-Term Portfolio in terms of in-
terest rate risk, but are different in terms of credit risk.
The Insured Long-Term Portfolio seeks a higher degree of
credit protection by investing in insured securities. In con-
trast, the High-Yield Portfolio is exposed to a substantial
degree of credit risk because the Portfolio seeks higher
yields by investing in medium-grade quality securities. PAGE
13
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THE VANGUARD The Fund is a member of The Vanguard Group of Investment Com-
GROUP panies, a group of more than 30 investment companies with
more than 80 distinct investment portfolios and total assets
in excess of $130 billion. The Vanguard Group, Inc.
("Vanguard"), a subsidiary jointly owned by the Vanguard
Funds, provides all corporate management, administrative,
distribution and shareholder accounting services on an at-
cost basis to the Funds in the Group. PAGE 22
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INVESTMENT The Fund receives investment advisory services on an at-cost
ADVISER basis from an experienced investment management staff em-
ployed directly by Vanguard. As a result, the Fund receives
its investment advisory services at a substantially lower
cost than would be possible if the Fund paid an investment
advisory fee to an external investment adviser. PAGE 22
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DIVIDEND Each Portfolio declares a dividend based on its ordinary in-
POLICY come each business day. Dividends are paid monthly and may be
received in cash or reinvested in additional shares. PAGE 23
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TAXES Shareholders pay no federal income tax on tax-exempt divi-
dends paid by the Fund's Portfolios. However, tax-exempt div-
idends may be subject to state and local income taxes, de-
pending on state and local tax law. Capital gains distribu-
tions from the Fund are subject to federal income tax, as
well as state and local taxes if applicable. The disposition
of securities at a gain, which the Fund purchased at a market
discounted price above a certain nominal or de minimus
amount, will be subject to federal income taxation as ordi-
nary income. Although the Fund seeks to avoid taxable income,
shareholders would be responsible for any taxes due if tax-
able income were realized. A portion of the tax-exempt divi-
dends from the High-Yield Portfolio may be a tax preference
item for purposes of the alternative minimum tax. PAGE 23
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PURCHASING You may purchase shares by mail, wire or exchange from an-
SHARES other Vanguard Fund. The minimum initial investment is $3,000
per Portfolio; the minimum for subsequent investments is
$100. There are no sales commissions or 12b-1 fees.
PAGE 27
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3
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You may redeem shares of each Portfolio by mail, telephone,
SELLING SHARES wire or check. There is no charge for redemptions, except for
wire withdrawals under $5,000, which are subject to a $5
charge. (Your bank may also impose a fee upon receipt of a
wire.) Each Portfolio's share price (except the Money Market
Portfolio's) is expected to fluctuate, and may at redemption
be more or less than at the time of initial purchase, result-
ing in a gain or loss. Capital gains incurred by redeeming
shares may be taxable. PAGE 31
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SERVICES TO The Fund offers free checkwriting services (minimum $250 per
SHAREHOLDERS check) for easy access to your account balance. PAGE 31
The Fund also offers two special services: Fund Express, for
electronic transfers between the Fund and your bank account;
and Tele-Account, for 24-hour telephone access to your Fund
account balance and certain transactions. PAGE 36
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SPECIAL (1) The value of a Portfolio's municipal securities is ex-
CONSIDERATIONS pected to fluctuate inversely with interest rates. In gener-
al, if interest rates rise, municipal bond prices fall; if
interest rates fall, bond prices rise. In addition, for a
given change in interest rates, bonds of longer maturities
fluctuate more in value than bonds of shorter maturities.
Thus, you should expect that each Portfolio's share price
(except the Money Market Portfolio's) will vary as interest
rates change, and that a Portfolio with a longer maturity
will fluctuate more than a Portfolio with a shorter maturity.
PAGE 14
(2) From time to time Congress has considered proposals to
restrict or eliminate the tax-exempt status of municipal se-
curities. If such proposals were enacted in the future, each
Portfolio would reconsider its investment objective and poli-
cies.
PAGE 13
(3) Each Portfolio (except the Money Market Portfolio) may
invest a portion of its assets in futures contracts and
options. PAGE 18
(4) Each Portfolio may invest up to 20% of its assets in
short-term municipal securities or in taxable short-term
securities. PAGE 21
(5) Each Portfolio may purchase municipal obligations on a
when-issued basis. Securities purchased on a when-issued ba-
sis may decline or appreciate in market value prior to their
actual delivery to a Portfolio. PAGE 21
(6) Each Portfolio may lend its investment securities. PAGE
21
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4
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FUND EXPENSES The following table illustrates ALL expenses and fees that
you would incur as a shareholder of the Fund. The expenses
set forth below are for the 1994 fiscal year.
<TABLE>
<CAPTION>
SHORT- LIMITED- INTERMEDIATE- INSURED HIGH-
SHAREHOLDER TRANSACTION MONEY MARKET TERM TERM TERM LONG-TERM LONG-TERM YIELD
EXPENSES PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
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<S> <C> <C> <C> <C> <C> <C> <C>
Sales Load Imposed on
Purchases.............. None None None None None None None
Sales Load Imposed on
Reinvested Dividends... None None None None None None None
Redemption Fees*........ None None None None None None None
Exchange Fees........... None None None None None None None
<CAPTION>
SHORT- LIMITED- INTERMEDIATE- LONG- INSURED HIGH-
ANNUAL FUND OPERATING MONEY MARKET TERM TERM TERM TERM LONG-TERM YIELD
EXPENSES PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
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<S> <C> <C> <C> <C> <C> <C> <C>
Management &
Administrative
Expenses............... 0.15% 0.15% 0.15% 0.15% 0.15% 0.15% 0.15%
Investment Advisory
Fees................... 0.01 0.01 0.01 0.01 0.01 0.01 0.01
12b-1 Fees.............. None None None None None None None
Other Expenses
Distribution Costs..... 0.03 0.03 0.02 0.02 0.02 0.02 0.02
Miscellaneous Expenses. 0.01 0.01 0.02 0.02 0.02 0.02 0.02
---- ---- ---- ---- ---- ---- ----
Total Other Expenses.... 0.04 0.04 0.04 0.04 0.04 0.04 0.04
---- ---- ---- ---- ---- ---- ----
TOTAL OPERATING
EXPENSES............. 0.20% 0.20% 0.20% 0.20% 0.20% 0.20% 0.20%
==== ==== ==== ==== ==== ==== ====
</TABLE>
*Wire redemptions of less than $5,000 are subject to a $5.00 charge.
The purpose of this table is to assist you in understanding
the various expenses that you would bear directly or indi-
rectly as an investor in the Fund.
The following example illustrates the expenses that you would
incur on a $1,000 investment over various periods, assuming
(1) a 5% annual rate of return and (2) redemption at the end
of each period.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
Money Market Portfolio............. $2 $6 $11 $26
Short-Term Portfolio............... $2 $6 $11 $26
Limited-Term Portfolio............. $2 $6 $11 $26
Intermediate-Term Portfolio........ $2 $6 $11 $26
Long-Term Portfolio................ $2 $6 $11 $26
Insured Long-Term Portfolio........ $2 $6 $11 $26
High-Yield Portfolio............... $2 $6 $11 $26
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE EXPENSES OR PERFORMANCE. ACTUAL EXPENSES MAY
BE HIGHER OR LOWER THAN THOSE SHOWN.
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5
<PAGE>
FINANCIAL The following financial highlights information for a share
HIGHLIGHTS outstanding throughout each period, insofar as they relate to
each of the five years in the period ended August 31, 1994,
have been audited by Price Waterhouse LLP, independent ac-
countants, whose report thereon was unqualified. This infor-
mation should be read in conjunction with the Fund's finan-
cial statements and notes thereto, which are incorporated by
reference in the Statement of Additional Information and this
Prospectus, and which appear, along with the report of Price
Waterhouse LLP, in the Fund's 1994 Annual Report to Share-
holders. For a more complete discussion of the Fund's perfor-
mance, please see the Fund's 1994 Annual Report to Sharehold-
ers which may be obtained without charge by writing to the
Fund or by calling our Investor Information Department at 1-
800-662-7447.
<TABLE>
<CAPTION>
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MONEY MARKET PORTFOLIO
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YEAR ENDED AUGUST 31,
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1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
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<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF YEAR...... $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00
------ ------ ------ ------ ------ ------ ------ ------ ------ -----
INVESTMENT OPERATIONS
Net Investment Income.. .024 .025 .035 .050 .057 .060 .048 .042 .049 .055
Net Realized and
Unrealized Gain (Loss)
on Investments........ -- -- -- -- -- -- -- -- -- --
------ ------ ------ ------ ------ ------ ------ ------ ------ -----
TOTAL FROM INVESTMENT
OPERATIONS........... .024 .025 .035 .050 .057 .060 .048 .042 .049 .055
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DISTRIBUTIONS
Dividends from Net
Investment Income..... (.024) (.025) (.035) (.050) (.057) (.060) (.048) (.042) (.049) (.055)
Distributions from
Realized Capital
Gains................. -- -- -- -- -- -- -- -- -- --
------ ------ ------ ------ ------ ------ ------ ------ ------ -----
TOTAL DISTRIBUTIONS .. (.024) (.025) (.035) (.050) (.057) (.060) (.048) (.042) (.049) (.055)
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NET ASSET VALUE, END OF
YEAR................... $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00 $1.00
- --------------------------------------------------------------------------------------------------------
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TOTAL RETURN............ 2.43% 2.51% 3.54% 5.08% 5.90% 6.18% 4.91% 4.26% 5.02% 5.62%
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RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year
(Millions)............. $4,164 $3,538 $3,165 $2,709 $2,488 $2,109 $2,150 $1,886 $1,129 $710
Ratio of Expenses to
Average Net Assets..... .20% .20% .23% .25% .25% .27% .29% .26% .33% .39%
Ratio of Net Investment
Income to Average Net
Assets................. 2.41% 2.48% 3.45% 4.94% 5.72% 5.99% 4.78% 4.21% 4.83% 5.34%
Portfolio Turnover Rate. N/A N/A N/A N/A N/A N/A N/A N/A N/A N/A
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
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SHORT-TERM PORTFOLIO
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YEAR ENDED AUGUST 31,
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1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
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<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF YEAR...... $15.63 $15.64 $15.53 $15.35 $15.30 $15.21 $15.37 $15.39 $15.24 $15.08
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income.. .534 .609 .720 .861 .906 .880 .785 .782 .896 .991
Net Realized and
Unrealized Gain (Loss)
on Investments........ (.150) .033 .171 .180 .050 .090 (.056) (.020) .160 .160
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
TOTAL FROM INVESTMENT
OPERATIONS........... .384 .642 .891 1.041 .956 .970 .729 .762 1.056 1.151
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DISTRIBUTIONS
Dividends from Net
Investment Income..... (.534) (.609) (.720) (.861) (.906) (.880) (.785) (.782) (.896) (.991)
Distributions from
Realized Capital
Gains................. (.020) (.043) (.061) -- -- -- (.104) -- (.010) --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
TOTAL DISTRIBUTIONS... (.554) (.652) (.781) (.861) (.906) (.880) (.889) (.782) (.906) (.991)
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NET ASSET VALUE, END OF
YEAR................... $15.46 $15.63 $15.64 $15.53 $15.35 $15.30 $15.21 $15.37 $15.39 $15.24
- -------------------------------------------------------------------------------------------------------------
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TOTAL RETURN............ 2.49% 4.18% 5.87% 6.96% 6.42% 6.56% 4.89% 5.05% 7.13% 7.83%
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RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year
(Millions)............. $1,561 $1,329 $1,061 $841 $751 $700 $841 $1,105 $906 $536
Ratio of Expenses to
Average Net Assets..... .20% .20% .23% .25% .25% .27% .29% .26% .33% .39%
Ratio of Net Investment
Income to Average Net
Assets................. 3.42% 3.88% 4.58% 5.55% 5.90% 5.77% 5.13% 5.12% 5.81% 6.47%
Portfolio Turnover Rate. 27% 46% 60% 104% 78% 54% 113% 120% 57% 55%
</TABLE>
<TABLE>
<CAPTION>
-------------------------------------------------------
LIMITED-TERM PORTFOLIO
-------------------------------------------------------
YEAR ENDED AUGUST 31,
-------------------------------------------------------
1994 1993 1992 1991 1990 1989 1988*
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<S> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD.... $10.80 $10.64 $10.43 $10.17 $10.14 $10.10 $10.00
------ ------ ------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income.. .454 .485 .541 .614 .643 .638 .595
Net Realized and
Unrealized Gain (Loss)
on Investments........ (.208) .209 .271 .265 .041 .046 .100
------ ------ ------ ------ ------ ------ ------
TOTAL FROM INVESTMENT
OPERATIONS........... .246 .694 .812 .879 .684 .684 .695
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DISTRIBUTIONS
Dividends from Net
Investment Income..... (.454) (.485) (.541) (.614) (.643) (.638) (.595)
Distributions from
Realized Capital
Gains................. (.022) (.049) (.061) (.005) (.011) (.006) --
------ ------ ------ ------ ------ ------ ------
TOTAL DISTRIBUTIONS... (.476) (.534) (.602) (.619) (.654) (.644) (.595)
- ---------------------------------------------------------------------------------
NET ASSET VALUE, END OF
PERIOD................. $10.57 $10.80 $10.64 $10.43 $10.17 $10.14 $10.10
- ---------------------------------------------------------------------------------
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TOTAL RETURN............ 2.31% 6.68% 8.01% 8.88% 6.93% 6.98% 7.11%
- ---------------------------------------------------------------------------------
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RATIOS/SUPPLEMENTAL DATA
Net Assets, End of
Period (Millions)...... $1,814 $1,625 $873 $420 $245 $166 $162
Ratio of Expenses to
Average Net Assets..... .20% .20% .23% .25% .25% .27% .29%
Ratio of Net Investment
Income to Average Net
Assets................. 4.24% 4.50% 5.08% 5.91% 6.31% 6.33% 5.91%
Portfolio Turnover Rate. 21% 20% 37% 57% 55% 88% 122%
</TABLE>
*Since Commencement of Operations on September 1, 1987.
7
<PAGE>
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------
INTERMEDIATE-TERM PORTFOLIO
-------------------------------------------------------------------------------
YEAR ENDED AUGUST 31,
-------------------------------------------------------------------------------
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF YEAR...... $13.45 $12.85 $12.41 $11.90 $12.08 $11.71 $11.79 $12.15 $10.98 $10.44
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income.. .683 .710 .747 .791 .822 .839 .800 .834 .892 .919
Net Realized and
Unrealized Gain (Loss)
on Investments........ (.354) .721 .516 .605 (.114) .370 .012 (.360) 1.190 .540
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
TOTAL FROM INVESTMENT
OPERATIONS........... .329 1.431 1.263 1.396 .708 1.209 .812 .474 2.082 1.459
- ---------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income..... (.683) (.710) (.747) (.791) (.822) (.839) (.800) (.834) (.892) (.919)
Distributions from
Realized Capital
Gains................. (.076) (.121) (.076) (.095) (.066) -- (.092) -- (.020) --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
TOTAL DISTRIBUTIONS... (.759) (.831) (.823) (.886) (.888) (.839) (.892) (.834) (.912) (.919)
- ---------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF
YEAR................... $13.02 $13.45 $12.85 $12.41 $11.90 $12.08 $11.71 $11.79 $12.15 $10.98
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
TOTAL RETURN............ 2.49% 11.54% 10.52% 12.15% 6.05% 10.63% 7.22% 3.95% 19.65% 14.51%
- ---------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year
(Millions) ............ $5,068 $4,945 $3,102 $2,006 $1,259 $1,005 $794 $920 $812 $412
Ratio of Expenses to
Average Net Assets..... .20% .20% .23% .25% .25% .27% .29% .26% .33% .39%
Ratio of Net Investment
Income to Average Net
Assets................. 5.15% 5.41% 5.91% 6.49% 6.83% 7.03% 6.88% 6.94% 7.66% 8.53%
Portfolio Turnover Rate. 18% 15% 32% 27% 54% 56% 89% 57% 13% 26%
</TABLE>
<TABLE>
<CAPTION>
------------------------------------------------------------------------------
LONG-TERM PORTFOLIO
------------------------------------------------------------------------------
YEAR ENDED AUGUST 31,
------------------------------------------------------------------------------
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF YEAR...... $11.38 $10.95 $10.58 $10.13 $10.53 $10.04 $10.38 $10.97 $ 9.79 $9.17
------ ------ ------ ------ ------ ------ ------ ------ ------ -----
INVESTMENT OPERATIONS
Net Investment Income.. .609 .640 .711 .722 .732 .760 .747 .797 .849 .869
Net Realized and
Unrealized Gain (Loss)
on Investments........ (.595) .715 .561 .626 (.233) .490 (.022) (.590) 1.370 .620
------ ------ ------ ------ ------ ------ ------ ------ ------ -----
TOTAL FROM INVESTMENT
OPERATIONS........... .014 1.355 1.272 1.348 .499 1.250 .725 .207 2.219 1.489
- --------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income..... (.609) (.640) (.711) (.722) (.732) (.760) (.747) (.797) (.849) (.869)
Distributions from
Realized Capital
Gains................. (.205) (.285) (.191) (.176) (.167) -- (.318) -- (.190) --
------ ------ ------ ------ ------ ------ ------ ------ ------ -----
TOTAL DISTRIBUTIONS... (.814) (.925) (.902) (.898) (.899) (.760) (1.065) (.797) (1.039) (.869)
- --------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF
YEAR................... $10.58 $11.38 $10.95 $10.58 $10.13 $10.53 $10.04 $10.38 $10.97 $9.79
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
TOTAL RETURN............ 0.08% 13.09% 12.60% 13.86% 4.88% 12.79% 7.57% 1.84% 23.47% 16.95%
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year
(Millions) ............ $1,001 $1,131 $962 $798 $683 $626 $531 $617 $628 $411
Ratio of Expenses to
Average Net Assets..... .20% .20% .23% .25% .25% .27% .29% .26% .33% .39%
Ratio of Net Investment
Income to Average Net
Assets................. 5.56% 5.81% 6.52% 7.09% 7.04% 7.33% 7.48% 7.40% 8.09% 9.13%
Portfolio Turnover Rate. 45% 36% 63% 62% 110% 99% 34% 67% 32% 72%
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------
INSURED LONG-TERM PORTFOLIO
---------------------------------------------------------------------------------------
YEAR ENDED AUGUST 31, OCT. 1, 1984**
----------------------------------------------------------------------- TO
1994 1993 1992 1991 1990 1989 1988 1987 1986 AUG. 31, 1985
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD.... $12.89 $12.28 $11.74 $11.25 $11.67 $11.14 $11.24 $11.73 $10.50 $10.00
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
INVESTMENT OPERATIONS
Net Investment Income.. .699 .718 .768 .775 .805 .833 .827 .848 .901 .831
Net Realized and
Unrealized Gain (Loss)
on Investments........ (.734) .813 .616 .615 (.267) .530 -- (.490) 1.400 .500
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
TOTAL FROM INVESTMENT
OPERATIONS........... (.035) 1.531 1.384 1.390 .538 1.363 .827 .358 2.301 1.331
- -----------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income..... (.699) (.718) (.768) (.775) (.805) (.833) (.827) (.848) (.901) (.831)
Distributions from
Realized Capital
Gains................. (.176) (.203) (.076) (.125) (.153) -- (.100) -- (.170) --
------ ------ ------ ------ ------ ------ ------ ------ ------ ------
TOTAL DISTRIBUTIONS... (.875) (.921) (.844) (.900) (.958) (.833) (.927) (.848) (1.071) (.831)
- -----------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF
PERIOD................. $11.98 $12.89 $12.28 $11.74 $11.25 $11.67 $11.14 $11.24 $11.73 $10.50
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
TOTAL RETURN............ (0.32)% 13.06% 12.22% 12.79% 4.74% 12.57% 7.78% 3.07% 22.73% 13.81%
- -----------------------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of
Period (Millions)...... $1,938 $2,194 $1,947 $1,551 $1,122 $934 $735 $793 $709 $336
Ratio of Expenses to
Average Net Assets..... .20% .20% .23% .25% .25% .27% .29% .26% .33% .36%*
Ratio of Net
InvestmentIncome to
Average Net Assets..... 5.62% 5.77% 6.34% 6.77% 6.99% 7.24% 7.50% 7.35% 7.99% 8.70%*
Portfolio Turnover Rate. 16% 30% 42% 33% 47% 36% 28% 50% 20% 16%
</TABLE>
*Annualized.
**Commencement of Operations.
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------
HIGH-YIELD PORTFOLIO
-----------------------------------------------------------------------------
YEAR ENDED AUGUST 31,
-----------------------------------------------------------------------------
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF YEAR...... $11.17 $10.76 $10.32 $ 9.90 $10.27 $ 9.73 $9.94 $10.55 $ 9.56 $8.94
------ ------ ------ ------ ------ ------ ----- ------ ------- -----
INVESTMENT OPERATIONS
Net Investment Income.. .626 .669 .723 .732 .739 .752 .745 .782 .852 .869
Net Realized and
Unrealized Gain (Loss)
on Investments........ (.566) .664 .546 .560 (.259) .540 (.006) (.610) 1.380 .620
------ ------ ------ ------ ------ ------ ----- ------ ------- -----
TOTAL FROM INVESTMENT
OPERATIONS........... .060 1.333 1.269 1.292 .480 1.292 .739 .172 2.232 1.489
- --------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income..... (.626) (.669) (.723) (.732) (.739) (.752) (.745) (.782) (.852) (.869)
Distributions from
Realized Capital
Gains................. (.214) (.254) (.106) (.140) (.111) -- (.204) -- (.390) --
------ ------ ------ ------ ------ ------ ----- ------ ------- -----
TOTAL DISTRIBUTIONS... (.840) (.923) (.829) (.872) (.850) (.752) (.949) (.782) (1.242) (.869)
- --------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF
YEAR................... $10.39 $11.17 $10.76 $10.32 $ 9.90 $10.27 $9.73 $ 9.94 $10.55 $9.56
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
TOTAL RETURN............ 0.52% 13.08% 12.81% 13.66% 4.82% 13.64% 8.00% 1.57% 24.21% 17.47%
- --------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year
(Millions)............. $1,781 $1,931 $1,505 $1,215 $962 $865 $690 $791 $794 $452
Ratio of Expenses to
Average Net Assets..... .20% .20% .23% .25% .25% .27% .29% .26% .33% .39%
Ratio of Net Investment
Income to Average Net
Assets................. 5.83% 6.15% 6.83% 7.34% 7.30% 7.43% 7.74% 7.55% 8.32% 9.37%
Portfolio Turnover Rate. 50% 34% 64% 58% 82% 80% 40% 83% 38% 41%
</TABLE>
- --------------------------------------------------------------------------------
9
<PAGE>
YIELD AND From time to time a Portfolio of the Fund may advertise its
TOTAL RETURN yield and total return. Both yield and total return figures
are based on historical earnings and are not intended to in-
dicate future performance. The "total return" of a Portfolio
refers to the average annual compounded rates of return over
one-, five- and ten-year periods or over the life of a Port-
folio (as stated in the advertisement) that would equate an
initial amount invested at the beginning of a stated period
to the ending redeemable value of the investment, assuming
the reinvestment of all dividend and capital gains distribu-
tions.
In accordance with industry guidelines set forth by the U.S.
Securities and Exchange Commission, the "yield" of the Port-
folio is computed by dividing the net investment income per
share earned during the period stated in the advertisement
(using the average number of shares entitled to receive divi-
dends) by the net asset value per share on the last day of
the period. The yield formula provides for semi-annual com-
pounding, which assumes that net investment income is earned
and reinvested at a constant rate and annualized at the end
of a six-month period. The calculation includes among ex-
penses of the Portfolio, for the purpose of determining net
investment income, all recurring fees that are charged to all
shareholder accounts and any nonrecurring charges for the pe-
riod stated. The current yield of the Money Market Portfolio
is calculated daily based on the return for a hypothetical
account having a beginning balance of one share for a partic-
ular period (usually seven days).
- --------------------------------------------------------------------------------
INVESTMENT The Fund is an open-end diversified investment company. The
OBJECTIVE objective of the Fund is to provide investors with the high-
est total return, with income that is exempt from federal in-
THE FUND SEEKS come tax, and overall management which is consistent with
TO PROVIDE preservation of capital.
TAX-EXEMPT
INCOME The Fund consists of seven Portfolios, each of which provides
tax-exempt income within prescribed maturity and credit qual-
ity standards. In addition, the Money Market Portfolio seeks
to maintain liquidity and a constant share price of $1.00.
The investment objective of the Fund is fundamental and so
cannot be changed without the approval of a majority of the
Fund's shareholders.
- --------------------------------------------------------------------------------
INVESTMENT Each Portfolio of the Fund will invest principally in tax-ex-
POLICIES empt municipal securities. Tax-exempt municipal securities
are debt obligations, issued by state and local governments
and regional governmental authorities, which provide interest
income that is exempt from federal income taxes. At least 65%
of the assets of each Portfolio will be invested in such tax-
exempt municipal securities. See "Implementation of Policies"
for a description of municipal securities.
The municipal securities held by each Portfolio are expected
to differ significantly in terms of credit quality and matu-
rity.
10
<PAGE>
THE MONEY The MONEY MARKET PORTFOLIO may invest in high quality short
MARKET term municipal securities and variable or floating rate in-
PORTFOLIO struments (including tender option bonds). The Portfolio's
INVESTS IN investments may include tax, revenue, and bond anticipation
SHORT-TERM notes; tax-exempt commercial paper; general obligation and
MUNICIPAL revenue bonds (including municipal lease obligations and re-
SECURITIES source recovery bonds). To be considered high quality, a se-
curity must be rated in one of the two highest rating catego-
ries for short term securities by at least two nationally
recognized rating services (or by one, if only one rating
service has rated the security), or, if unrated, determined
to be of equivalent quality by Vanguard.
In seeking to provide a stable share price of $1.00, the
Money Market Portfolio is expected to maintain an average
weighted maturity of 90 days or less, and will purchase secu-
rities with an effective maturity of 13 months or less.
FOUR The Short-Term, Limited-Term, Intermediate-Term and Long-Term
PORTFOLIOS Portfolios of the Fund will invest in high-quality municipal
DIFFER CHIEFLY securities of varying maturities:
BY MATURITY
THE SHORT-TERM PORTFOLIO is expected to maintain a dollar-
weighted average maturity between 1 and 2 years, and will
purchase securities with an effective maturity of 5 years or
less.
THE LIMITED-TERM PORTFOLIO is expected to maintain a dollar-
weighted average maturity between 2 and 5 years, and will
purchase securities with an effective maturity of 10 years or
less.
THE INTERMEDIATE-TERM PORTFOLIO is expected to maintain a
dollar-weighted average maturity between 7 and 12 years.
There is no limit on the maturity of any individual security
in the Portfolio.
THE LONG-TERM PORTFOLIO is expected to maintain a dollar-
weighted average maturity between 15 and 25 years. There is
no limit on the maturity of any individual security in the
Portfolio.
At least 75% of the municipal securities held by each of
these Portfolios will be rated in the top three ratings cate-
gories (Aaa, Aa, and A from Moody's or AAA, AA, and A from
Standard & Poor's). No more than 20% of net assets will be
invested in securities rated Baa (Moody's) or BBB (Standard &
Poor's). Not more than 5% of net assets may be lower rated or
unrated.
In addition, each of the four Portfolios may invest in the
following short-term municipal obligations:
. Short-term municipal notes rated MIG-1 or MIG-2 by Moody's
or SP-1+ or SP-1 by Standard & Poor's;
. Tax-exempt commercial paper rated P-1 by Moody's or A-1+ or
A-1 by Standard & Poor's;
. Municipal bonds with an effective maturity of one year or
less which are rated a minimum of A by Moody's or Standard
& Poor's; or
11
<PAGE>
. Unrated short-term obligations from an issuer whose out-
standing long-term municipal obligations are rated a mini-
mum of A by Moody's or Standard & Poor's.
THE INSURED In an effort to provide an additional level of credit protec-
LONG-TERM tion, the Insured Long-Term Portfolio will invest at least
PORTFOLIO 80% of its assets in insured tax-exempt municipal securities.
INVESTS IN The Portfolio may also invest up to 20% of its assets in un-
INSURED insured municipal securities rated a minimum of A by Moody's
MUNICIPAL or Standard & Poor's. The average credit rating of the munic-
SECURITIES ipal securities in the Insured Long-Term Portfolio is ex-
pected to be the equivalent of Aaa from Moody's or AAA from
Standard & Poor's.
The Insured Long-Term Portfolio is expected to maintain a
dollar-weighted average maturity between 15 and 25 years.
There is no limit on the maturity of any individual security
in the Portfolio. The Insured Long-Term Portfolio may also
invest in the same high quality short-term municipal obliga-
tions authorized for the Money Market Portfolio.
Insured municipal bonds are those in which scheduled payments
of interest and principal are guaranteed by a private (non-
governmental) insurance company. THE INSURANCE DOES NOT GUAR-
ANTEE THE MARKET VALUE OF THE MUNICIPAL BONDS OR THE VALUE OF
THE SHARES OF THE INSURED LONG-TERM PORTFOLIO. The insurance
refers to the face or par value of the securities in the
Portfolio, not the market values of those securities or the
share price of the Portfolio. See "Implementation of Poli-
cies" for a description of the insurance feature of the In-
sured Long-Term Portfolio.
THE HIGH-YIELD In an effort to provide higher yields, the High-Yield Portfo-
PORTFOLIO lio will invest in securities with an average credit quality
INVESTS IN lower than that of the Long-Term Portfolio. It will invest at
MEDIUM-GRADE least 80% of its assets in investment grade municipal securi-
MUNICIPAL ties--those securities rated a minimum of Baa by Moody's or
BONDS BBB by Standard & Poor's--and up to 20% of its assets in low-
er-rated or unrated municipal securities. Securities rated
less than Baa by Moody's or BBB by Standard & Poor's are
classified as non-investment grade securities. Such securi-
ties carry a high degree of risk and are considered specula-
tive by the major credit rating agencies. The Portfolio is
expected to maintain a dollar-weighted average maturity be-
tween 15 and 25 years. There is no limit on the maturity of
any individual security in the Portfolio. The High-Yield
Portfolio may also invest in the same short-term municipal
obligations authorized for the Short-Term, Limited-Term, In-
termediate-Term and Long-Term Portfolios.
AMT BONDS. The High-Yield Portfolio may also invest up to 20%
of its assets in AMT bonds--municipal securities that provide
interest income that is exempt from the regular federal in-
come tax but that is subject to the alternative minimum tax.
See "Implementation of Policies" for a description of AMT
bonds.
12
<PAGE>
THE FUND MAY Each Portfolio of the Fund except the Money Market Portfolio
INVEST IN is authorized to invest in bond futures contracts and options
FUTURES to a limited extent. Also, under unusual circumstances, each
CONTRACTS, Portfolio may invest temporarily in certain short-term tax-
OPTIONS AND able securities. See "Implementation of Policies" for a de-
TAXABLE scription of these and other investment practices of the
SECURITIES Fund.
The investment policies described above are not fundamental
and so may be changed by the Board of Directors without
shareholder approval. However, shareholders would be notified
before any material change is made in the Fund's policies.
- --------------------------------------------------------------------------------
INVESTMENT As mutual funds investing in fixed income securities, the
RISKS seven Portfolios of the Fund are subject primarily to inter-
est rate, credit, call, income, and manager, risk.
THE FUND IS INTEREST RATE RISK is the potential for fluctuations in bond
SUBJECT TO prices due to changing interest rates. In general, bond
INTEREST RATE, prices vary inversely with interest rates. If interest rates
CREDIT, CALL, rise, bond prices generally fall; if interest rates fall,
AND INCOME bond prices generally rise. In addition, for a given change
RISK in interest rates, longer-maturity bonds fluctuate more in
price (gaining or losing more in value) than shorter-maturity
bonds. To compensate investors for this risk, longer-maturity
bonds generally offer higher and more durable yields than
shorter-maturity bonds, all other factors, including credit
quality, being equal.
CREDIT RISK is the possibility that a bond issuer will fail
to make timely payments of interest or principal to a Portfo-
lio. The credit risk of a Portfolio depends on the credit
quality of its underlying securities. In general, the lower
the credit quality of a Portfolio's municipal securities, the
higher a Portfolio's yield, all other factors such as matu-
rity being equal.
CALL RISK is the possibility that, during periods of falling
interest rates, a municipal security with a high stated in-
terest rate will be prepaid (or "called") prior to its ex-
pected maturity date. As a result, a Portfolio will be re-
quired to invest the unanticipated proceeds at lower interest
rates, and the Portfolio's income may decline. Call provi-
sions are most common for intermediate- and long-term munici-
pal bonds.
INCOME RISK is the potential for a decline in a Portfolio's
income due to falling market interest rates. Because a Port-
folio's income is based on interest rates, which can fluctu-
ate substantially over short periods, income risk is expected
to vary from Portfolio to Portfolio.
THE FUND IS Finally, the investment adviser manages the Fund's Portfolios
SUBJECT TO according to the traditional methods of "active" investment
MANAGER RISK management, which involves the buying and selling of securi-
ties based upon economic, financial and market analysis and
investment judgment. MANAGER RISK refers to the possibility
that the Fund's investment adviser may fail to execute a
Portfolio's investment strategy effectively. As a result, a
Portfolio may fail to achieve its stated objective.
13
<PAGE>
EXCEPT FOR THE In terms of interest rate risk, you should anticipate that
MONEY MARKET the share prices of the Portfolios will fluctuate inversely
PORTFOLIO, with interest rates. The one exception is the Money Market
SHARE PRICES Portfolio, which is expected to maintain a stable share price
WILL FLUCTUATE of $1.00.
The following chart illustrates the relative interest rate
risk of the Short-Term, Limited-Term, Intermediate-Term and
Long-Term Portfolios. (The High-Yield and Insured Long-Term
Portfolios are expected to exhibit interest rate risk charac-
teristics similar to those of the Long-Term Portfolio.) The
chart depicts the effect on bond prices of a 2 percentage
point change in interest rates of a bond investment with ma-
turity characteristics similar to those of each Portfolio.
<TABLE>
<CAPTION>
2 PERCENTAGE POINT 2 PERCENTAGE POINT
INCREASE IN DECREASE IN
STATED MATURITY INTEREST RATES INTEREST RATES
--------------- ------------------ ------------------
<S> <C> <C>
Short-Term (1.5 years) (2.9%) 3.0%
Limited-Term (3 years) (5.5%) 5.8%
Intermediate-Term (10
years) (14.6%) 17.7%
Long-Term (20 years) (21.4%) 29.9%
</TABLE>
As illustrated, bond prices move inversely with interest
rates, and bonds with longer maturities are likely to exhibit
greater fluctuations in market value, all other things being
equal, than bonds with shorter maturities.
This chart is intended to provide you with general guidelines
for evaluating maturity differences among the Portfolios and
assist you with understanding the degree of interest rate
risk you may experience. It should not be considered a pre-
diction of the gain or loss expected in any Portfolio.
FIVE In terms of credit risk, five of the Fund's Portfolios--the
PORTFOLIOS Money Market, Short-Term, Limited-Term, Intermediate-Term and
MAINTAIN HIGH- Long-Term Portfolios--have almost identical credit quality
QUALITY CREDIT standards. Although the Money Market Portfolio's standards
STANDARDS are slightly higher, all five Portfolios attempt to maintain
a high level of credit quality. Credit risk is expected to be
low. The chief difference among these Portfolios is interest
rate risk, not credit risk.
TWO LONG-TERM The Insured Long-Term and High-Yield Portfolios, while simi-
PORTFOLIOS lar to the Long-Term Portfolio in terms of average maturity
OFFER and exposure to interest rate risk, differ somewhat in credit
DIFFERENT terms. The credit risk of the Insured Long-Term Portfolio is
CREDIT CHOICES expected to be minimal since at least 80% of the Portfolio's
assets must be insured. In contrast, the High-Yield Portfolio
is expected to incur a higher degree of credit risk since it
invests in securities of lower credit quality.
14
<PAGE>
The following chart summarizes credit, interest rate, and in-
come risks for the seven Portfolios of the Fund:
<TABLE>
<CAPTION>
CREDIT INTEREST INCOME
PORTFOLIO RISK RATE RISK RISK
--------------------------------------------------------------------------
<S> <C> <C> <C>
Money Market Low Low High
Short-Term Low Low High
Limited-Term Low Medium Medium
Intermediate-Term Low Medium Medium
Long-Term Low High Low
Insured Long-Term Very Low High Low
High-Yield Medium High Low
</TABLE>
- --------------------------------------------------------------------------------
WHO SHOULD The Fund is intended for investors seeking income that is ex-
INVEST empt from federal income taxes. As a rule, tax-free income is
attractive to investors in high federal income tax brackets.
INVESTORS You can determine whether tax-exempt or taxable income is
SEEKING TAX- more attractive in your own case by calculating the "taxable
FREE INCOME equivalent yield" of a Portfolio and comparing it with the
yield from a comparable taxable mutual fund investment. See
"How to Compare Tax-Free and Taxable Yields."
Assuming that tax-free income is attractive in your tax
bracket, you should base your selection of a Portfolio (or
Portfolios) on its expected price volatility, credit risk and
yield, and your own investment objectives, risk preferences
and time horizons.
The MONEY MARKET PORTFOLIO is intended for investors who are
seeking a stable share price and low credit risk. The yield
of the Portfolio is expected to fluctuate from day to day and
to be lower on average than yields from the Fund's other
Portfolios. The Portfolio is suitable as a short-term invest-
ment vehicle, emphasizing maximum protection of principal.
The SHORT-TERM, LIMITED-TERM, AND INTERMEDIATE-TERM PORTFO-
LIOS are intended for investors who are willing to accept
moderate share price fluctuations in exchange for potentially
higher and more durable yields. The choice between the three
is principally one of exposure to interest rate risk.
The LONG-TERM, HIGH-YIELD AND INSURED LONG-TERM PORTFOLIOS
are intended for investors who are seeking the highest, most
durable streams of income and who can tolerate sharp fluctua-
tions in share price in pursuit of their income objectives.
The Portfolios of the Fund, except for the Money Market Port-
folio, are intended to be long-term investment vehicles and
are not designed to provide investors with a means of specu-
lating on short-term market movements. Investors who engage
in excessive account activity generate additional costs which
are borne by all of the Fund's shareholders. In order to min-
imize such costs the Fund has adopted the following policies.
The Fund reserves the right to reject any purchase request
(including exchange purchases from other Vanguard portfolios)
that is reasonably deemed to be disruptive to efficient port-
folio management,
15
<PAGE>
either because of the timing of the investment or previous
excessive trading by the investor. Additionally, the Fund has
adopted exchange privilege limitations as described in the
section "Exchange Privilege Limitations." Finally, the Fund
reserves the right to suspend the offering of its shares.
- --------------------------------------------------------------------------------
HOW TO COMPARE Before choosing a specific tax-exempt investment, such as a
TAX-FREE AND Portfolio of the Fund, you should determine if you would be
TAXABLE YIELDS best served with taxable or tax-exempt income in your tax
bracket. To compare taxable and tax-exempt income, you should
calculate the "taxable equivalent yield" for the Portfolio
you are considering, and compare it with the yield of a tax-
able investment with similar credit and maturity standards.
The taxable equivalent yield for a Portfolio is based upon
the Portfolio's current tax-exempt yield and your tax brack-
et. The formula is:
Portfolio's Tax-Exempt Yield = Your Taxable
----------------------------
100% - Your Tax Bracket Equivalent Yield
For example, if you are in the 28% federal tax bracket and can
earn a tax-exempt yield of 5.0%, the taxable equivalent yield
would be 6.94%:
5.0% = 6.94%
--------
100%-28%
In this example, you would choose the tax-free investment if
its taxable equivalent yield of 6.94% were greater than the
taxable yield from a comparable investment (e.g., a taxable
bond fund of comparable maturity and quality).
The following chart indicates the advantages of tax-exempt
investing based upon tax rates in effect during 1994. There
can be no guarantee, of course, that any Portfolio of the
Fund will achieve a specific yield. Also, although all of the
income of the Fund to date has been exempt from federal in-
come taxes, it is possible from time to time that small por-
tions of a Portfolio's dividends may be subject to such tax-
es. A substantial portion, if not all, of such dividends may
be subject to state and local tax. Finally, a portion of the
High-Yield Portfolio's dividends may be a tax preference item
for purposes of the alternative minimum tax.
TAXABLE EQUIVALENT YIELD TABLE
<TABLE>
<CAPTION>
FEDERAL TAXABLE EQUIVALENT RATES BASED ON TAX-
MARGINAL INCOME EXEMPT YIELD OF:
TAX BRACKET 2% 3% 4% 5% 6% 7%
--------------- ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
15% 2.35% 3.53% 4.71% 5.88% 7.06% 8.24%
28% 2.78 4.17 5.56 6.94 8.33 9.72
31% 2.90 4.35 5.80 7.25 8.70 10.14
36% 3.13 4.69 6.25 7.81 9.38 10.94
39.6% 3.31 4.97 6.62 8.28 9.93 11.59
</TABLE>
- --------------------------------------------------------------------------------
16
<PAGE>
IMPLEMENTATION The Fund's Adviser uses a variety of investment vehicles to
OF POLICIES achieve the objective of the Fund and the individual Portfo-
lios.
THE FUND Each Portfolio of the Fund invests principally in tax-exempt
INVESTS IN municipal securities. Tax-exempt municipal securities are
MUNICIPAL debt obligations, issued by state and local governments and
BONDS AND regional governmental authorities, which provide interest in-
NOTES come that is exempt from federal income taxes. Municipal se-
curities include both municipal bonds (those securities with
maturities of five years or more) and municipal notes (those
with maturities of less than five years).
Municipal bonds are issued for a wide variety of reasons: to
construct public facilities, such as airports, highways,
bridges, schools, hospitals, housing, mass transportation,
streets, water and sewer works; to obtain funds for operating
expenses; to refund outstanding municipal obligations; and to
loan funds to various public institutions and facilities.
Certain industrial development bonds are also considered mu-
nicipal bonds if their interest is exempt from federal income
tax. Industrial development bonds are issued on behalf of
public authorities to obtain funds for various privately-op-
erated manufacturing facilities, housing, sports arenas, con-
vention centers, airports, mass transportation systems and
water, gas or sewage works.
General obligation municipal bonds are secured by the is-
suer's pledge of full faith, credit and taxing power. Revenue
or special tax bonds are payable from the revenues derived
from a particular facility or, in some cases, from a special
excise or other tax, but not from general tax revenue. Indus-
trial development bonds are ordinarily dependent on the
credit quality of a private user, not the public issuer.
Municipal notes are issued to meet the short-term funding re-
quirements of local, regional and state governments. Munici-
pal notes include tax anticipation notes, bond anticipation
notes, revenue anticipation notes, tax and revenue anticipa-
tion notes, construction loan notes, short-term discount
notes, tax-exempt commercial paper, demand notes, and similar
instruments. Demand notes permit an investor (such as the
Fund) to demand from the issuer payment of principal plus ac-
crued interest upon a specified number of days' notice.
THE HIGH-YIELD The High-Yield Portfolio of the Fund is authorized to invest
PORTFOLIO MAY up to 20% of its assets in "AMT" bonds. AMT bonds are tax-ex-
INVEST IN AMT empt "private activity" bonds issued after August 7, 1986,
BONDS whose proceeds are directed at least in part to a private,
for-profit organization. While the income from AMT bonds is
exempt from regular federal income tax, it is a tax prefer-
ence item for purposes of the "alternative minimum tax." The
alternative minimum tax is a special tax that applies to a
limited number of taxpayers who have certain adjustments to
income or tax preference items.
EACH PORTFOLIO Each portfolio of the Fund may invest in "Market Discount"
MAY INVEST IN bonds when, in the opinion of the Fund's adviser, the invest-
MARKET ment will be advantageous to the Fund's shareholders. A Mar-
DISCOUNT BONDS ket Discount bond is a bond purchased with "Market Dis-
17
<PAGE>
count" after April 30, 1993 and with a maturity in excess of
one year from its issue date. In certain circumstances, a
Market Discount bond will result in taxable ordinary income
disposition of to the extent of any gain realized.
Although the objective of the Fund is to provide income free
of federal income tax, certain market conditions may make
Market Discount bonds desirable investments. The Fund will
purchase Market Discount bonds only if the Fund's adviser ex-
pects that the purchase of these investments on an after-tax
basis will enhance the Fund's total return.
A PORTFOLIO Each Portfolio of the Fund observes strict maturity guide-
MAY REPORT AN lines as set forth in detail under "Investment Policies."
EFFECTIVE These maturity standards are specified in terms of a Portfo-
DOLLAR- lio's dollar-weighted average maturity. From time to time,
WEIGHTED however, the Fund may also report a Portfolio's effective
AVERAGE dollar-weighted average maturity, which reflects, among other
MATURITY items, the likelihood that a municipal bond or note held by a
Portfolio may be redeemed or "called" prior to its stated ma-
turity date. For example, if a Portfolio consists entirely of
twenty-year bonds, some of which may be "called" prior to
their stated maturity in twenty years, the Portfolio's dol-
lar-weighted average maturity will be twenty years, while its
effective dollar-weighted average maturity will be shorter.
A Portfolio's effective dollar-weighted average maturity will
be influenced by bond market conditions, and so may vary from
day to day, even if no change has been made to the Portfo-
lio's underlying investment securities. For example, if in-
terest rates decline, a greater proportion of a Portfolio's
securities may be subject to call (redemption) prior to their
stated maturity. As a result, reflecting this increased call
risk, the effective dollar-weighted average maturity of the
Portfolio will shorten, independent of actual purchases or
sales of portfolio securities.
CERTAIN The Fund may utilize bond futures contracts and options to a
PORTFOLIOS MAY limited extent. Specifically, each Portfolio of the Fund (ex-
USE FUTURES cept the Money Market Portfolio) may enter into futures con-
CONTRACTS AND tracts provided that not more than 5% of its assets are re-
OPTIONS quired as a futures contract deposit; in addition, each Port-
folio (except the Money Market Portfolio) may enter into
futures contracts and options transactions only to the extent
that obligations under such contracts or transactions repre-
sent not more than 20% of the Portfolio's assets.
Futures contracts and options may be used for several rea-
sons: to maintain cash reserves while remaining fully invest-
ed, to facilitate trading, to reduce transactions costs, or
to seek higher investment returns when a futures contract is
priced more attractively than the underlying municipal secu-
rity, index or other interest rate futures contracts. A Port-
folio may not use futures contracts or options transactions
to leverage its assets.
For example, in order to remain fully invested in bonds,
while maintaining liquidity to meet potential shareholder re-
demptions, a Portfolio may invest a portion of its assets in
a bond futures contract. Because futures contracts only re-
quire a small initial margin deposit, the Portfolio would
then be able to main-
18
<PAGE>
tain a cash reserve to meet potential redemptions, while at
the same time remaining fully invested. Also, because the
transactions costs of futures contracts and options may be
lower than the costs of investing in bonds directly, it is
expected that the use of futures contracts and options may
reduce a Portfolio's total transactions costs.
FUTURES The primary risks associated with the use of futures con-
CONTRACTS AND tracts and options are: (i) imperfect correlation between the
OPTIONS POSE change in market value of the bonds held by a Portfolio and
CERTAIN RISKS the prices of futures contracts and options; and (ii) possi-
ble lack of a liquid secondary market for a futures contract
and the resulting inability to close a futures position prior
to its maturity date. The risk of imperfect correlation will
be minimized by investing only in those contracts whose price
fluctuations are expected to resemble those of a Portfolio's
underlying securities. The risk that a Portfolio will be un-
able to close out a futures position will be minimized by en-
tering into such transactions on a national exchange with an
active and liquid secondary market. In general, the futures
market is more liquid than the municipal bond market, and so
by investing in futures liquidity may be improved.
The risk of loss in trading futures contracts in some strate-
gies can be substantial, due both to the low margin deposits
required, and the extremely high degree of leverage involved
in futures pricing. As a result, a relatively small price
movement in a futures contract may result in immediate and
substantial loss (or gain) to the investor. When investing in
futures contracts, the Fund will segregate cash or cash
equivalents in the amount of the underlying obligation.
DERIVATIVE Derivative securities represent the purchaser's right to re-
SECURITIES ceive principal and interest payments from underlying bonds.
A Fund may purchase a derivative security from another port-
folio within the Vanguard Group, as permitted by the Invest-
ment Company Act of 1940 and applicable rules thereunder, or
from an outside financial institution. There are different
derivative structures. An example of the steps involved in
creating and using a derivative structure follows: 1) a de-
positor places the underlying bond into a trust supervised by
an independent party; 2) a financial institution provides the
purchasers the right, at periodic intervals, to tender the
derivative security; 3) the financial institution receives
the difference between the prevailing short-term interest
rate (which is paid to the Portfolio holding the derivative
security) and the coupon on the underlying bond in considera-
tion for providing the tender option; and 4) the tender op-
tion may be discontinued upon the occurrence of certain
events, in which case, the Fund which owns the derivative se-
curity should receive its proportional share of the under-
lying bond. The primary risks associated with the use of de-
rivative securities are the interest rate risks discussed un-
der "Investment Risks," the possible lack of a liquid second-
ary market, the risk that the other party in a contractual
derivative agreement cannot meet its obligations and the po-
tential for greater price volatility relative to the under-
lying security on which the derivative is based.
The Portfolios intend to limit the risk of derivative securi-
ties by purchasing only those derivative securities that are
consistent with a Portfolio's investment ob-
19
<PAGE>
jectives and policies. The Portfolios will not use such in-
struments to leverage assets. Hence, derivative securities'
contributions to the overall market risk characteristics of a
Portfolio will not materially alter its risk profile and will
be fully representative of the Portfolio's maturity guide-
lines.
IN UNUSUAL Although none of the Portfolios are expected to do so, except
CIRCUMSTANCES, in unusual circumstances, each Portfolio of the Fund may in-
THE FUND MAY vest up to 20% of its assets in the following non-tax-exempt
INVEST IN securities: notes issued by or on behalf of incorporated is-
TAXABLE suers; obligations of the United States Government and its
SECURITIES agencies or instrumentalities; commercial paper, bank certif-
icates of deposit, and bankers' acceptances; and repurchase
agreements collateralized by these securities, or taxable mu-
nicipal bonds.
REPURCHASE A repurchase agreement is a means of investing monies for a
AGREEMENTS short period. In a repurchase agreement, a seller--a U.S.
commercial bank or recognized U.S. securities dealer--sells
securities (either taxable or municipal securities) to a
Portfolio and agrees to repurchase the securities at the
Portfolio's cost plus interest within a specified period
(normally one day). In these transactions, the securities
purchased by the Portfolio will have a total value equal to
or in excess of the value of the repurchase agreement, and
will be held by the Fund's Custodian Bank until repurchased.
THREE TYPES OF The Insured Long-Term Portfolio may utilize new issue, mutual
INSURANCE MAY fund, or secondary market insurance. A new issue insurance
BE USED IN THE policy is purchased by a bond issuer who wishes to increase
INSURED LONG- the credit rating of a security. By paying a premium and
TERM meeting the insurer's underwriting standards, the bond issuer
PORTFOLIO: is able to obtain a high credit rating (usually, Aaa from
Moody's or AAA from Standard & Poor's) for the issued securi-
1. NEW ISSUE ty. Such insurance is likely to increase the purchase price
INSURANCE and resale value of the security. New issue insurance poli-
cies are non-cancellable and continue in force as long as the
bonds are outstanding.
2. MUTUAL FUND A mutual fund insurance policy is used to guarantee specific
INSURANCE bonds only while owned by a mutual fund. The Insured Long-
Term Portfolio of the Fund has obtained a mutual fund insur-
ance policy from Financial Guaranty Insurance Company ("Fi-
nancial Guaranty"). Based upon the expected composition of
the Portfolio, the annual premiums for the policy may range
from 0.20% to 0.40% of the principal value of the bonds in-
sured, thereby reducing the Portfolio's current yield.
3. SECONDARY A secondary market insurance policy is purchased by an in-
MARKET vestor (such as the Insured Long-Term Portfolio) subsequent
INSURANCE to a bond's original issuance and generally insures a partic-
ular bond for the remainder of its term. The Portfolio may
purchase bonds which have already been insured under a sec-
ondary market insurance policy by a prior investor, or the
Portfolio may itself purchase such a policy from Financial
Guaranty for bonds which are currently uninsured.
An insured municipal bond in the Portfolio will typically be
covered by only one of the three policies. For instance, if a
bond is already covered by a new issue insurance policy or a
secondary market insurance policy, then that security will
20
<PAGE>
not be insured under the Portfolio's mutual fund insurance
policy. All of the insurance policies used by the Portfolio
will be obtained only from insurance companies rated Aaa by
Moody's or AAA by Standard & Poor's.
THE FUND MAY Each Portfolio may purchase tax-exempt securities on a "when-
PURCHASE WHEN- issued" basis. In buying "when-issued" securities, a Portfo-
ISSUED lio commits to buy securities at a certain price even though
SECURITIES the securities may not be delivered for up to 45 days. The
Portfolio pays for the securities and begins earning interest
when the securities are actually delivered. As a consequence,
it is possible that the market price of the securities at the
time of delivery may be higher or lower than the purchase
price.
THE FUND MAY Each Portfolio may lend its investment securities on either a
LEND ITS short-term or long-term basis to qualified institutional in-
SECURITIES vestors for the purpose of realizing additional net invest-
ment income. Loans of securities by a Portfolio will be col-
lateralized by cash, letters of credit, or securities issued
or guaranteed by the U.S. Government or its agencies. The
collateral which will be held by the Fund's custodian bank,
will equal at least 100% of the current market value of the
loaned securities. Income derived from the lending of securi-
ties is not tax-exempt, and a portion of the tax-exempt in-
terest earned when a municipal security is on loan must be
characterized as taxable income. Therefore, each Portfolio
will limit such activity in accordance with its investment
objective.
- --------------------------------------------------------------------------------
INVESTMENT The Fund has adopted certain limitations on its investment
LIMITATIONS practices, including the following:
THE FUND HAS (a) The Fund's Portfolios will generally not invest in secu-
ADOPTED rities other than municipal securities; however, each
CERTAIN Portfolio may invest up to 20% of its assets in certain
FUNDAMENTAL short-term taxable securities and (except for the Money
LIMITATIONS Market Portfolio) in bond futures contracts and options;
(b) A Portfolio will not borrow money except for temporary or
emergency purposes and then not in excess of 10% of total
assets; the Portfolio will repay all borrowings before
making additional investments; and interest paid on such
borrowings will reduce income;
(c) A Portfolio will not invest more than 5% of its assets in
securities of one issuer (except the United States Gov-
ernment, its agencies and instrumentalities, and any mu-
nicipal security guaranteed or collateralized by the U.S.
Government); for purposes of this limitation, identifica-
tion of the issuer will be based on a determination of
the source of assets and revenues committed to meeting
interest and principal payments of each security;
(d) A Portfolio will not purchase any securities which would
cause more than 25% of the value of that Portfolio's net
assets at the time of such purchase to be invested in the
securities of one or more issuers conducting their prin-
cipal activities in the same state; and
(e) A Portfolio will not pledge, mortgage or hypothecate more
than 10% of its assets.
21
<PAGE>
The above mentioned investment limitations are considered at
the time investment securities are purchased. The investment
limitations described here and in the Statement of Additional
Information may be changed only with the approval of a major-
ity of the Fund's shareholders.
- --------------------------------------------------------------------------------
MANAGEMENT OF The Fund is a member of The Vanguard Group of Investment Com-
THE FUND panies, a family of more than 30 investment companies with
more than 80 distinct investment portfolios and total assets
VANGUARD in excess of $130 billion. Through their jointly-owned sub-
ADMINISTERS sidiary, The Vanguard Group, Inc. ("Vanguard"), the Fund and
AND the other funds in the Group obtain at cost virtually all of
DISTRIBUTES their corporate management, administrative, shareholder ac-
THE FUND counting and distribution services. Vanguard also provides
investment advisory services on an at-cost basis to certain
Vanguard funds including Vanguard Municipal Bond Fund. As a
result of Vanguard's unique corporate structure, the Vanguard
funds have costs substantially lower than those of most com-
peting mutual funds. In 1993, the average expense ratio (an-
nual costs including advisory fees divided by total net as-
sets) for the Vanguard funds amounted to approximately .30%,
compared to an average of 1.02% for the mutual fund industry
(data provided by Lipper Analytical Services).
The Officers of the Fund manage its day to day operations and
are responsible to the Fund's Board of Directors. The Direc-
tors set broad policies for the Fund and choose its officers.
A list of the Directors and Officers of the Fund and a state-
ment of their present positions and principal occupations
during the past five years can be found in the Statement of
Additional Information.
Vanguard employs a supporting staff of management and admin-
istrative personnel needed to provide the requisite services
to the funds and also furnishes the funds with necessary of-
fice space, furnishings and equipment. Each fund pays its
share of Vanguard's total expenses, which are allocated among
the funds under methods approved by the Board of Directors
(Trustees) of each fund. In addition, each fund bears its own
direct expenses, such as legal, auditing and custodian fees.
Vanguard also provides distribution and marketing services to
the Vanguard funds. The funds are available on a no-load ba-
sis (i.e., there are no sales commissions or 12b-1 fees).
However, each fund bears its allocated share of the Group's
distribution costs.
- --------------------------------------------------------------------------------
INVESTMENT The Fund receives all investment advisory services on an at-
ADVISER cost basis from VANGUARD'S FIXED INCOME GROUP. The Group also
provides investment advisory services to more than 40 Van-
VANGUARD guard money market and bond portfolios, both taxable and tax-
MANAGES THE exempt. Total assets under management by Vanguard's Fixed In-
FUND'S come Group was $54 billion as of August 31, 1994. The Fixed
INVESTMENTS Income Group is supervised by the Officers of the Fund.
Ian A. MacKinnon, Senior Vice President of Vanguard, has been
in charge of the Group since its inception in 1981. Mr.
MacKinnon is responsible for setting the
22
<PAGE>
broad investment policies and strategies employed by the
Fund, and for overseeing the Portfolio managers who implement
those strategies on a day-to-day basis. The Fund's Portfolio
managers are as follows:
. Jerome J. Jacobs, Vice President, serves as portfolio man-
ager of the Long-Term and High-Yield Portfolios. Associated
with the Fixed Income Group since 1984, Mr. Jacobs has man-
aged the Portfolios since 1988. Previously he managed the
Short-Term, Limited-Term and Intermediate-Term Portfolios.
. Christopher M. Ryon, Assistant Vice President serves as
portfolio manager of the Short-Term, Limited-Term and In-
termediate-Term Portfolios. Associated with the Fixed In-
come Group since 1985, Mr. Ryon has managed the Short-Term
and Limited-Term Portfolio's since 1988, and the Intermedi-
ate-Term Portfolio since 1991. Previously he served as a
senior analyst.
. David E. Hamlin, Assistant Vice President serves as portfo-
lio manager of the Insured-Long Term Portfolio. Mr. Hamlin
has managed the Portfolio since joining the Fixed Income
Group in 1986. Previously he managed tax-exempt money mar-
ket funds for a major investment company.
The Fixed Income Group manages the investment and reinvest-
ment of the assets of the Portfolios of the Fund and continu-
ously reviews, supervises and administers each Portfolio's
investment program, subject to the maturity and quality stan-
dards specified in this Prospectus and supplemental guide-
lines approved by the Fund's Board of Directors. The Fixed
Income Group's selection of investments for the Portfolios is
based on: (a) continuing credit analysis of those instruments
held in the Portfolios and those being considered for inclu-
sion therein; (b) possible disparities in yield relationships
between different fixed income securities; and (c) actual or
anticipated movements in the general level of interest rates.
Vanguard's investment management staff places all orders for
purchases and sales of portfolio securities. Purchase of
portfolio securities are made either directly from the issuer
or from municipal securities dealers. The investment manage-
ment staff may sell portfolio securities prior to their matu-
rity if circumstances and considerations warrant and if it
believes such dispositions advisable. The Fund's policy of
investing in short-term instruments in the Short-Term Portfo-
lio will likely result in significant portfolio turnover. The
staff seeks to obtain the best available net price and most
favorable execution for all portfolio transactions. The full
range and quality of brokerage services are considered in
making these determinations.
- --------------------------------------------------------------------------------
DIVIDENDS, Dividends consisting of virtually all of the ordinary income
CAPITAL GAINS of each Portfolio are declared daily and are payable to
AND TAXES shareholders of record at the close of the previous business
day. Such dividends are paid on the first business day of
EACH PORTFOLIO each month. Capital gains distributions, if any, will be made
PAYS MONTHLY annually.
DIVIDENDS
In addition, in order to satisfy certain distribution re-
quirements of the Tax Reform Act of 1986, each Portfolio may
declare special year-end dividend and
23
<PAGE>
capital gains distributions during December. Such distribu-
tions, if received by shareholders by January 31, are deemed
to have been paid by the Portfolio and received by sharehold-
ers by December 31 of the prior year.
Dividend and capital gains distributions may be automatically
reinvested or received in cash. See "Choosing a Distribution
Option" for a description of these distributions methods.
EACH PORTFOLIO Each Portfolio intends to continue to qualify for taxation as
EXPECTS TO PAY a "regulated investment company" under the Internal Revenue
TAX-EXEMPT Code so that it will not be subject to federal income tax to
DIVIDENDS the extent its income is distributed to shareholders. In ad-
dition, each Portfolio intends to invest a sufficient portion
of its assets in municipal bonds and notes so that it will
qualify to pay "exempt-interest dividends" to shareholders.
Such exempt-interest dividends distributed to shareholders
are excluded from a shareholder's gross income for federal
tax purposes. The Revenue Reconciliation Act enacted during
1993 provides that market discount on tax-exempt bonds, pur-
chased after April 30, 1993 is taxable income to the extent
of any gain realized upon disposition. Accordingly, purchases
of such discounted securities may result in taxable income.
Distributions paid by the Portfolio from long-term capital
gains, whether received in cash or reinvested in additional
shares, are taxable, regardless of the length of time you
have owned shares in the Portfolio. Capital gains distribu-
tions are made when the Portfolio realizes net capital gains
on sales of portfolio securities during the year. For the
Portfolio, realized capital gains are not expected to be a
significant or predictable part of investment return.
Any short-term capital gains or any taxable interest income
will be distributed as a taxable ordinary dividend distribu-
tion. In general, such taxable income distributions from a
Portfolio are expected to be negligible in comparison with
tax-exempt dividends.
Also, a portion of the dividends from the High-Yield Portfo-
lio, while exempt from the regular federal income tax, may be
a tax preference item for purposes of the alternative minimum
tax.
The Fund will notify you annually as to the tax status of
dividend and capital gains distributions paid by the Fund.
A CAPITAL GAIN Although dividend income from the Fund is expected to be ex-
OR LOSS MAY BE empt from federal taxes, a sale of a Portfolio's shares is a
REALIZED UPON taxable event, and may result in a capital gain or loss. A
EXCHANGE OR capital gain or loss may be realized from an ordinary redemp-
REDEMPTION tion of shares, a check-writing redemption, or an exchange of
shares between two mutual funds (or two portfolios of a mu-
tual fund).
In addition, any capital loss realized from municipal securi-
ties held for six months or less is disallowed to the extent
of tax-exempt dividend income received. In other words, if
you held shares in a Portfolio for six months or less, and
sold those shares (or a portion of those shares) at a loss,
the capital loss you report is reduced by the tax-exempt div-
idends paid by these shares.
24
<PAGE>
Tax-exempt dividends from a Portfolio, capital gains distri-
butions from a Portfolio, and any capital gains or losses re-
alized from the sale or exchange of shares may be subject to
state and local taxes. However, some states allow sharehold-
ers to exclude from state income tax that portion of a Port-
folio's tax-exempt income that is attributable to municipal
securities issued within the shareholder's own state. To as-
sist shareholders of these states, the Fund will provide a
breakdown of each Portfolio's tax-exempt interest income on a
state-by-state basis subsequent to year-end.
The Fund is required to withhold 31% of taxable dividends,
capital gains distributions, and redemptions paid to share-
holders who have not complied with IRS taxpayer identifica-
tion regulations. You may avoid this withholding requirement
by indicating your proper Social Security or Taxpayer Identi-
fication Number on your Account Registration Form and by cer-
tifying that you are not subject to backup withholding.
Up to 85% of an individual's Social Security benefits may be
subject to federal income tax. Along with other factors, to-
tal tax-exempt income, including any tax-exempt dividend in-
come from Portfolios of the Fund, is used to calculate the
portion of Social Security benefits that is taxed.
The Fund has obtained a Certificate of Authority to do busi-
ness as a foreign corporation in Pennsylvania, and does busi-
ness and maintains an office in that state. In the opinion of
counsel, the shares of the Fund are exempt from Pennsylvania
personal property taxes.
The tax discussion set forth above is included for general
information only. Prospective investors should consult their
own tax advisers concerning the tax consequences of an in-
vestment in the Fund.
- --------------------------------------------------------------------------------
THE SHARE Each Portfolio's net asset value (or price per share) is com-
PRICE OF EACH puted daily by dividing the Portfolio's total value of in-
PORTFOLIO vestments and other assets, less any liabilities, by the num-
ber of outstanding shares of the Portfolio.
MONEY MARKET PORTFOLIO. The net asset value per share of the
Money Market Portfolio is determined as of the close of regu-
lar trading on the New York Stock Exchange (generally 4:00
p.m. Eastern time), on each day the Exchange is open. It is
the policy of the Money Market Portfolio to attempt to main-
tain a net asset value of $1.00 per share for purposes of
sales and redemptions. The instruments held by the Money Mar-
ket Portfolio are valued on the basis of amortized cost,
which does not take into account unrealized capital gains or
losses.
SHORT-TERM, LIMITED-TERM, INTERMEDIATE-TERM, LONG-TERM, IN-
SURED LONG-TERM AND HIGH-YIELD PORTFOLIOS. The net asset val-
ues per share of the Short-Term, Limited-Term, Intermediate-
Term, Long-Term, Insured Long-Term and High-Yield Portfolios
are determined as of the close of regular trading on the New
York Stock Exchange (generally 4:00 p.m. Eastern time), on
each day the Exchange is open. When approved by the Board of
Directors, bonds and other
25
<PAGE>
fixed income securities of each of the Portfolios may be val-
ued on the basis of prices provided by a pricing service when
such prices are believed to reflect the fair market value of
such securities. (Since the majority of municipal bond issues
do not trade each day, current prices are generally not
available for many securities. In estimating a security's
price, a pricing service takes into account institutional-
size trading in similar groups of securities and any develop-
ments related to specific securities.) The methods used by
the pricing service and the valuations so established are re-
viewed by the officers of the Fund under policies determined
by the Directors. There are a number of pricing services
available and the Directors, as part of an on-going evalua-
tion of these services, may authorize the use of other pric-
ing services or discontinue the use of any service in whole
or in part.
Securities not priced in this manner are priced at the most
recent quoted bid price provided by investment dealers.
Short-term instruments maturing within 60 days of the valua-
tion date may be valued at cost, plus or minus any amortized
discount or premium. Other assets and securities for which no
quotations are readily available will be valued in good faith
at their fair value using methods determined by the Direc-
tors.
- --------------------------------------------------------------------------------
GENERAL The Fund is a Maryland corporation. The Articles of Incorpo-
INFORMATION ration, as amended and restated, permit the Directors to is-
sue 7,250,000,000 shares of common stock with a $.001 par
value. The Board of Directors has the power to designate one
or more classes ("Portfolios") of shares of common stock.
Currently, the Fund is offering seven Portfolios.
Annual meetings of shareholders will not be held except as
required by the Investment Company Act of 1940 and other ap-
plicable law. An annual meeting will be held to vote on the
removal of a Director or Directors of the Fund if requested
in writing by the holders of not less than 10% of the out-
standing shares of the Fund.
The shares of each Portfolio are fully paid and non-assessa-
ble; have no preference as to conversion, exchange, divi-
dends, retirement or other features; and have no pre-emptive
rights. The shares of each Portfolio have non-cumulative vot-
ing rights, meaning that the holders of more than 50% of the
shares of the entire Fund (irrespective of the net asset
value of each Portfolio) voting for the election of Directors
can elect 100% of the Directors if they so choose.
CoreStates Bank, N.A., Philadelphia, Pennsylvania, has been
retained to act as custodian of the assets of the Fund. The
Bank takes no part in determining the investment policies of
the Fund or in deciding which securities are purchased or
sold by the Fund. The Vanguard Group, Inc. acts as Transfer
Agent and Dividend Disbursing Agent for the Fund. Price
Waterhouse LLP serves as independent accountants for the Fund
and audits its financial statements annually. The Fund is not
involved in any litigation.
- --------------------------------------------------------------------------------
26
<PAGE>
SHAREHOLDER GUIDE
OPENING AN To open a new account, either by mail or by wire, simply com-
ACCOUNT AND plete and return an Account Registration Form. Please indi-
PURCHASING cate the Portfolio you have chosen and the amount you wish to
SHARES invest. Your purchase must be equal to or greater than the
$3,000 minimum initial investment requirement for a Portfolio
($500 for Individual Retirement Accounts, other retirement
accounts or Uniform Gifts/Transfers to Minors Act accounts).
If you need assistance with the Account Registration Form or
have any questions about this Fund, please call our Investor
Information Department at 1-800-662-7447. NOTE: For other ac-
count registrations (e.g., corporations, associations, other
organizations, trust or powers of attorney, please call us to
determine which additional forms you may need.
Because of the risks associated with bond investments, the
Fund is intended to be a long-term investment vehicle and is
not designed to provide investors with a means of speculating
on short-term market movements. Consequently, the Fund re-
serves the right to reject any specific purchase (and ex-
change purchase) request. The Fund also reserves the right to
suspend the offering of shares for a period of time.
Each Portfolio's shares are purchased at the next-determined
net asset value after your investment has been received in
the form of Federal Funds. See "When Your Account Will Be
Credited." The Fund is offered on a no-load basis (i.e.,
there are no sales commissions or 12b-1 fees).
ADDITIONAL Subsequent investments may be made by mail ($100 minimum per
INVESTMENTS Portfolio), wire ($1,000 minimum per Portfolio), exchange
from another Vanguard Fund account, or Vanguard Fund Express.
--------------------------------------------------------------
ADDITIONAL INVESTMENTS
NEW ACCOUNT TO EXISTING ACCOUNTS
PURCHASING BY Please include the Additional investments should
MAIL amount of your initial include the Invest-by-Mail re-
Complete and investment and the mittance form attached to your
sign the name of the Portfo- Fund confirmation statements.
enclosed lio(s) you have se- Please make your check payable
Account lected on the regis- to The Vanguard Group-(Portfo-
Registration tration form, make lio number), see page 28 for
Form your check payable to appropriate Portfolio number,
The Vanguard Group- write your account number on
(Portfolio number), your check and, using the re-
see page 28 for appro- turn envelope provided, mail to
priate Portfolio num- the address indicated on the
ber and mail to: Invest-by-Mail Form.
VANGUARD FINANCIAL
CENTER
P.O. BOX 2600
VALLEY FORGE, PA 19482
27
<PAGE>
For express or VANGUARD FINANCIAL All written requests should be
registered CENTER 455 DEVON PARK mailed to one of the addresses
mail, send to: DRIVE WAYNE, PA 19087 indicated for new accounts. Do
not send registered or express
mail to the post office box ad-
dress.
VANGUARD MUNICIPAL BOND FUND PORTFOLIO NUMBERS
Money Market Portfolio-45 Long-Term Portfolio-43
Short-Term Portfolio-41 Insured Long-Term Portfolio-58
Limited-Term Portfolio-31 High-Yield Portfolio-44
Intermediate-Term Portfolio-42
--------------------------------------------------------------
PURCHASING BY CORESTATES BANK, N.A.
WIRE ABA 031000011
Money should be CORESTATES NO 0141 1274
wired to: ATTN VANGUARD
VANGUARD MUNICIPAL BOND FUND
BEFORE WIRING NAME OF PORTFOLIO
Please contact ACCOUNT NUMBER
Client Services ACCOUNT REGISTRATION
(1-800-662-2739)
To assure proper receipt, please be sure your bank includes
the Portfolio name, the account number Vanguard has assigned
to you and the eight digit Corestates number. If you are
opening a new account, please complete the Account Registra-
tion Form and mail it to the "New Account" address after com-
pleting your wire arrangement. NOTE: Federal Funds wire pur-
chase orders will be accepted only when the Fund and Custo-
dian Bank are open for business.
--------------------------------------------------------------
PURCHASING BY You may open an account or purchase additional shares by mak-
EXCHANGE (from ing an exchange from an existing Vanguard Fund account. Call
a Vanguard Vanguard's Client Services Department at 1-800-662-2739. The
account) new account will have the same registration as the existing
account. However, the Fund reserves the right to refuse any
exchange purchase request.
--------------------------------------------------------------
PURCHASING BY The Fund Express Special Purchase option lets you move money
FUND EXPRESS from your bank account to your Vanguard account at your re-
quest. Or if you choose the Automatic Investment option,
Special money will be moved from your bank account to your Vanguard
Purchase and account on the schedule (monthly, bimonthly [every other
Automatic month], quarterly or yearly) you select. To establish these
Investment Fund Express options, please provide the appropriate informa-
tion on the Account Registration Form. We will send you a
confirmation of your Fund Express service; please wait three
weeks before using the service.
- --------------------------------------------------------------------------------
28
<PAGE>
CHOOSING A You must select one of three distribution options:
DISTRIBUTION
OPTION 1. AUTOMATIC REINVESTMENT OPTION--Both dividends and capital
gains distributions will be reinvested in additional Fund
shares. This option will be selected for you automatically
unless you specify one of the other options.
2. CASH DIVIDEND OPTION--Your dividends will be paid in cash
and your capital gains will be reinvested in additional
Fund shares.
3. ALL CASH OPTION--Dividend and capital gains distributions
will be paid in cash.
You may change your option by calling our Client Services De-
partment (1-800-662-2739).
In addition, an option to invest your cash dividends and/or
capital gains distributions in another Vanguard Fund Account
is available. Please call our Client Services Department (1-
800-662-2739) for information. You may also elect Vanguard
Dividend Express which allows you to transfer your cash divi-
dends and/or capital gains distributions automatically to
your bank account. Please see "Other Vanguard Services" for
more information.
- --------------------------------------------------------------------------------
TAX CAUTION Under Federal tax laws, the Fund is required to distribute
net capital gains and dividend income to Fund shareholders.
INVESTORS These distributions are made to all shareholders who own Fund
SHOULD ASK shares as of the distribution's record date, regardless of
ABOUT THE how long the shares have been owned. Purchasing shares just
TIMING OF prior to the record date could have a significant impact on
CAPITAL GAINS your tax liability for the year. For example, if you purchase
AND DIVIDEND shares immediately prior to the record date of a sizable cap-
DISTRIBUTIONS ital gain, you will be assessed taxes on the amount of the
BEFORE capital gain distribution later paid even though you owned
INVESTING the Fund shares for just a short period of time. (Taxes are
due on the distributions even if the dividend or gain is re-
invested in additional Fund shares.) While the total value of
your investment will be the same after the capital gain dis-
tribution--the amount of the capital gain distribution will
offset the drop in the net asset value of the shares--you
should be aware of the tax implications the timing of your
purchase may have.
Prospective investors should, therefore, inquire about poten-
tial distributions before investing. The Fund's annual capi-
tal gains distribution normally occurs in December while in-
come dividends are generally paid on the first business day
of each month. For additional information on distributions
and taxes, see the section titled "Dividends, Capital Gains,
and Taxes."
- --------------------------------------------------------------------------------
IMPORTANT The easiest way to establish optional Vanguard services on
INFORMATION your account is to select the options you desire when you
complete your Account Registration Form. IF YOU WISH TO ADD
ESTABLISHING SHAREHOLDER OPTIONS LATER, YOU MAY NEED TO PROVIDE VANGUARD
OPTIONAL WITH ADDITIONAL INFORMATION AND A SIGNATURE GUARANTEE. PLEASE
SERVICES CALL OUR CLIENT SERVICES DEPARTMENT (1-800-662-2739) FOR FUR-
THER ASSISTANCE.
29
<PAGE>
SIGNATURE For our mutual protection, we may require a signature guaran-
GUARANTEES tee on certain written transaction requests. A signature
guarantee verifies the authenticity of your signature, and
may be obtained from banks, brokers and any other guarantor
that Vanguard deems acceptable. A SIGNATURE GUARANTEE CANNOT
BE PROVIDED BY A NOTARY PUBLIC.
CERTIFICATES With the exception of the Money Market Portfolio, share cer-
tificates will be issued upon request. If a certificate is
lost, you may incur an expense to replace it.
BROKER-DEALER If you purchase shares in Vanguard Funds through a registered
PURCHASES broker-dealer or investment adviser, the broker-dealer or ad-
viser may charge a service fee.
CANCELLING The Fund will not cancel any trade (e.g., a purchase, ex-
TRADES change or redemption) believed to be authentic, received in
writing or by telephone, once the trade request has been re-
ceived.
- --------------------------------------------------------------------------------
WHEN YOUR The trade date is the date on which your account is credited.
ACCOUNT WILL It is generally the day on which the Fund receives your in-
BE CREDITED vestment in the form of Federal Funds (monies credited to the
Fund's Custodian Bank by a Federal Reserve Bank). Your trade
date varies according to your method of payment for your
shares.
Purchases of Fund shares by check (except the Money Market
Portfolio) will receive a trade date the day the funds are
received in good order by Vanguard. Thus, if your purchase by
check is received by the close of regular trading on the New
York Stock Exchange (generally 4:00 p.m. Eastern time), your
trade date is the business day your check is received in good
order. If your purchase is received after the close of the
Exchange, your trade date is the business day following re-
ceipt of your check. Vanguard will not accept third-party
checks to open an account. Please be sure your purchase check
is made payable to the Vanguard Group.
For purchases by check for the Money Market Portfolio, the
Fund is ordinarily credited with Federal Funds within one
business day. Thus, if your purchase by check is received by
the close of regular trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time), your trade date is the
business day following receipt of your check. If your pur-
chase is received after the close of the Exchange your trade
date is the second business day following receipt of your
check.
For purchases by Federal Funds wire or exchange, all portfo-
lios of the Fund (including the money market portfolio) are
credited immediately with Federal Funds. Thus, if your pur-
chase by Federal Funds wire or exchange is received by the
close of regular trading on the Exchange your trade date is
the day of receipt. If your purchase is received after the
close of regular trading on the Exchange your trade date is
the business day following receipt of your wire or exchange.
Your shares are purchased at the next-determined net asset
value after your investment has been received in the form of
Federal Funds. You will begin to earn dividends on the calen-
dar day following the trade date. (For a Friday trade
30
<PAGE>
date, you will begin earning dividends on Saturday.) For a
purchase of shares of the Money Market Portfolio by Federal
Funds wire, you may qualify for a dividend on the date of
purchase if you have notified the Fund of your intention to
make the purchase by 10:45 a.m. (Eastern time) on the busi-
ness day of the wire.
In order to prevent lengthy processing delays caused by the
clearing of foreign checks, Vanguard will only accept a for-
eign check which has been drawn in U.S. dollars and has been
issued by a foreign bank with a U.S. correspondent bank. The
name of the U.S. correspondent bank must be printed on the
face of the foreign check.
Each Portfolio reserves the right to suspend the offering of
shares for a period of time. Each Portfolio also reserves the
right to reject any specific purchase request.
- --------------------------------------------------------------------------------
SELLING YOUR You may withdraw any portion of the funds in your account by
SHARES redeeming shares at any time. Please see "Important Redemp-
tion Information". You may initiate a request by writing or
by telephoning. Your redemption proceeds are normally mailed,
credited or wired--depending upon the method of withdrawal
you have PREVIOUSLY chosen--within two business days after
the receipt of the request in Good Order.
SELLING BY You may withdraw funds from your account by writing a check
WRITING A payable in the amount of $250 or more. When a check is pre-
CHECK sented for payment to the Fund's agent, CoreStates Bank,
N.A., the Fund will redeem sufficient shares in your account
at the next determined net asset value to cover the amount of
the check.
In order to establish the checkwriting option on your ac-
count, all registered shareholders must sign a signature
card. After your completed signature card is received by the
Fund, an initial supply of checks will be mailed within 10
business days. There is no charge for checks or for their
clearance. CORPORATIONS, TRUSTS AND OTHER ORGANIZATIONS
SHOULD CALL VANGUARD'S CLIENT SERVICES DEPARTMENT (1-800-662-
2739) BEFORE SUBMITTING SIGNATURE CARDS, AS ADDITIONAL DOCU-
MENTS MAY BE REQUIRED TO ESTABLISH THE CHECKWRITING SERVICE.
Before establishing the checkwriting option, you should be
aware that:
1. Writing a check (a redemption of shares) is a taxable
event.
2. The Fund does not allow an account to be closed through
the checkwriting option.
3. Vanguard cannot guarantee a stop payment on the
checkwriting option. If you wish to reverse a stop payment
order, you must do so in writing.
4. Shares held in certificate form cannot be redeemed using
the checkwriting option.
5. The Fund reserves the right to terminate or alter this
service at any time.
--------------------------------------------------------------
SELLING BY Requests should be mailed to VANGUARD FINANCIAL CENTER, VAN-
MAIL GUARD MUNICIPAL BOND FUND, P.O. BOX 1120, VALLEY FORGE, PA
19482. (For express or registered mail, please send your re-
quest to Vanguard Municipal Bond Fund, 455 Devon Park Drive,
Wayne, PA 19087.)
31
<PAGE>
The redemption price of shares will be the Portfolio's net
asset value next determined after Vanguard has received all
required documents in Good Order.
--------------------------------------------------------------
DEFINITION OF GOOD ORDER means that the request includes the following:
GOOD ORDER
1. The account number and Portfolio name.
2. The amount of the transaction (specified in dollars or
shares).
3. Signatures of all owners EXACTLY as they are registered on
the account.
4. Any required signature guarantees.
5. Other supporting legal documentation that might be re-
quired in the case of estates, corporations, trusts and cer-
tain other accounts.
6. Any certificates you are holding for the account.
If you have questions about this definition as it pertains to
your request, please call our Client Services Department at
1-800-662-2739.
--------------------------------------------------------------
SELLING BY To sell by telephone, you or your preauthorized representa-
TELEPHONE tive may call our Client Services Department at 1-800-662-
2739. For telephone redemptions, you may have the proceeds
sent to you either by mail or by wire. In addition to the de-
tails below, please see "Important Information About Tele-
phone Transactions."
BY MAIL: Telephone mail redemption is automatically estab-
lished on your account unless you indicate otherwise on your
Account Registration Form. The Registered Shareowner may re-
deem any amount by calling Vanguard. The proceeds will be
paid to the registered shareholders and mailed to the address
of record.
BY WIRE: Telephone wire redemption must be specifically
elected for your account. The best time to elect telephone
wire redemption is at the time you complete your Account Reg-
istration Form. If you do not presently have telephone wire
redemption and wish to establish it, please contact our Cli-
ent Services Department.
With the wire redemption option, you may withdraw a minimum
of $1,000 and have the amount wired directly to your bank ac-
count. Wire redemptions less than $5,000 are subject to a $5
charge deducted by Vanguard. There is no Vanguard charge for
wire redemptions of $5,000 or more. However, your bank may
assess a separate fee for incoming wires.
A request to change the bank associated with your wire re-
demption option must be received in writing, signed by each
registered shareholder, and accompanied by a voided check or
preprinted deposit slip. A signature guarantee is required if
your bank registration is not identical to your Vanguard Fund
account registration.
--------------------------------------------------------------
32
<PAGE>
If you select the Fund Express Automatic Withdrawal option,
SELLING BY money will be automatically moved from your Vanguard Fund ac-
FUND EXPRESS count to your bank account according to the schedule you have
selected. The Special Redemption option lets you move money
Automatic from your Vanguard account to your bank account upon your re-
Withdrawal & quest. You may elect Fund Express on the Account Registration
Special Form or call our Investor Information Department at 1-800-
Redemption 662-7447 for a Fund Express application.
--------------------------------------------------------------
SELLING BY You may sell shares of the Fund by making an exchange into
EXCHANGE another Vanguard Fund account. Please see "Exchanging Your
Shares" for details.
--------------------------------------------------------------
IMPORTANT Shares purchased by check or Fund Express may be redeemed at
REDEMPTION any time. However, your redemption proceeds will not be paid
INFORMATION until payment for the purchase is collected, which will take
ten calendar days. Your money is invested and earns dividends
during the holding period.
--------------------------------------------------------------
DELIVERY OF Redemption requests received by telephone prior to the close
REDEMPTION of regular trading on the New York Stock Exchange (generally
PROCEEDS 4:00 p.m. Eastern time) are processed on the day of receipt
and the redemption proceeds are normally sent on the follow-
ing business day.
Redemption requests received by telephone after the close of
regular trading on the Exchange are processed on the business
day following receipt and the proceeds are normally sent on
the second business day following receipt.
All unpaid dividends credited to your account up to the date
of redemption will be included in the redemption check. Re-
demption proceeds must be sent to you within seven days of
receipt of your request in Good Order.
If you experience difficulty in making a telephone redemption
during periods of drastic economic or market changes, your
redemption request may be made by regular or express mail. It
will be implemented at the net asset value next determined
after your request has been received by Vanguard in Good Or-
der. The Fund reserves the right to revise or terminate the
telephone redemption privilege at any time.
The Fund may suspend the redemption right or postpone payment
at times when the New York Stock Exchange is closed, or under
any emergency circumstances as determined by the United
States Securities and Exchange Commission.
--------------------------------------------------------------
VANGUARD'S If you make a redemption from a qualifying account, Vanguard
AVERAGE COST will send you an Average Cost Statement which provides you
STATEMENT with the tax basis of the shares you redeemed. Please see
"Other Vanguard Services" for additional information.
--------------------------------------------------------------
MINIMUM Due to the relatively high cost of maintaining smaller ac-
ACCOUNT counts, the Fund reserves the right to redeem shares in any
BALANCE account that is below the minimum initial investment amount
REQUIREMENT of $3,000. In addition, if at any time the total investment
does not have a value of at least $1,000, you may be notified
that the value of your account is below the Fund's minimum
account balance requirement. You
33
<PAGE>
would then be allowed 60 days to make an additional invest-
ment before the account is liquidated. Proceeds would be
promptly paid to the shareholder. This minimum does not apply
to IRAs, other retirement accounts and Uniform
Gifts/Transfers to Minors Act accounts.
- --------------------------------------------------------------------------------
EXCHANGING Should your investment goals change, you may exchange your
YOUR SHARES shares of Vanguard Municipal Bond Fund for those of other
available Vanguard Funds.
EXCHANGING BY When exchanging shares by telephone, please have ready the
TELEPHONE Portfolio name, account number, Social Security number or Em-
ployer Identification number listed on the account and exact
Call Client name and address in which the account is registered. Only the
Services registered shareholder may complete such an exchange. Re-
(1-800-662- quests for telephone exchanges received prior to the close of
2739) regular trading on the New York Stock Exchange (generally
4:00 p.m. Eastern time) are processed at the close of busi-
ness that same day. Requests received after the close of reg-
ular trading on the Exchange are processed the next business
day. TELEPHONE EXCHANGES ARE NOT ACCEPTED INTO OR FROM VAN-
GUARD BALANCED INDEX FUND, VANGUARD INDEX TRUST, VANGUARD IN-
TERNATIONAL EQUITY INDEX FUND AND VANGUARD QUANTITATIVE PORT-
FOLIOS. If you experience difficulty in making a telephone
exchange, your exchange request may be made by regular or ex-
press mail, and it will be implemented at the closing net as-
set value on the date received by Vanguard provided the re-
quest is received in Good Order.
Neither the Fund nor Vanguard is responsible for the authen-
ticity of exchange instructions received by telephone. In-
vestors bear the full risk of any loss arising from unautho-
rized telephone exchanges. To prohibit telephone exchanges on
your account, please notify the Fund in writing. Otherwise,
the telephone exchange privilege will be automatically estab-
lished for your account.
--------------------------------------------------------------
EXCHANGING BY Please be sure to include on your exchange request the name
MAIL and account number of your current Portfolio, the name of the
Fund you wish to exchange into, the amount you wish to ex-
change, and the signatures of all registered account holders.
Send your request to VANGUARD FINANCIAL CENTER, VANGUARD MU-
NICIPAL BOND FUND, P.O. BOX 1120, VALLEY FORGE, PA 19482.
(For express or registered mail, please send your request to
Vanguard Municipal Bond Fund, 455 Devon Park Drive, Wayne, PA
19087.)
--------------------------------------------------------------
IMPORTANT Before you make an exchange, you should consider the follow-
EXCHANGE ing:
INFORMATION
. Please read the Fund's prospectus before making an ex-
change. For a copy and for answers to any questions you may
have, call our Investor Information Department (1-800-662-
7447).
. An exchange is treated as a redemption and a purchase.
Therefore, you could realize a taxable gain or loss on the
transaction.
. Exchanges are accepted only if the registrations and the
Taxpayer Identification numbers of the two accounts are
identical.
34
<PAGE>
. The shares to be exchanged must be on deposit and not held
in certificate form.
. New accounts are not currently accepted in Vanguard/Windsor
Fund.
. The redemption price of shares redeemed by exchange is the
net asset value next determined after Vanguard has received
the required documents in Good Order.
. When opening a new account by exchange, you must meet the
minimum investment requirement of the new Fund.
Every effort will be made to maintain the exchange privilege.
However, the Fund reserves the right to revise or terminate
its provisions, limit the amount of or reject any exchange,
as deemed necessary, at any time.
The exchange privilege is only available in states in which
the shares of the Fund are registered for sale. The Fund's
shares are currently registered for sale in all 50 states and
the Fund intends to maintain such registration.
- --------------------------------------------------------------------------------
EXCHANGE The Fund's exchange privilege is not intended to afford
PRIVILEGE shareholders a way to speculate on short-term movements in
LIMITATIONS the market. Accordingly, in order to prevent excessive use of
the exchange privilege that may potentially disrupt the man-
agement of a Portfolio and increase transactions costs, the
Fund has established a policy of limiting excessive exchange
activity.
Exchange activity generally will not be deemed excessive if
limited to TWO SUBSTANTIVE EXCHANGE REDEMPTIONS (AT LEAST 30
DAYS APART) from a Portfolio during any twelve month period.
These limitations do not apply to exchanges from Vanguard's
money market portfolios. Notwithstanding these limitations,
the Fund reserves the right to reject any purchase request
(including exchange purchases from other Vanguard portfolios)
that is reasonably deemed to be disruptive to efficient port-
folio management.
- --------------------------------------------------------------------------------
IMPORTANT The ability to initiate redemptions (except wire redemptions)
INFORMATION and exchanges by telephone is automatically established on
ABOUT your account unless you request in writing that telephone
TELEPHONE transactions on your account not be permitted. The ability to
TRANSACTIONS initiate wire redemptions by telephone will be established on
your account only if you specifically elect this option in
writing.
To protect your account from losses resulting from unautho-
rized or fraudulent telephone instructions, Vanguard adheres
to the following security procedures:
1. SECURITY CHECK. To request a transaction by telephone, the
caller must know (i) the name of the Portfolio; (ii) the
10-digit account number; (iii) the exact name and address
used in the registration; and (iv) the Social Security or
Employer Identification number listed on the account.
2. PAYMENT POLICY. The proceeds of any telephone redemption
by mail will be made payable to the registered shareowner
and mailed to the address of record, only. In the case of
a telephone redemption by wire, the wire transfer will be
made only in accordance with the shareowner's prior writ-
ten instructions.
35
<PAGE>
Neither the Fund nor Vanguard will be responsible for the au-
thenticity of transaction instructions received by telephone,
provided that reasonable security procedures have been fol-
lowed. Vanguard believes that the security procedures de-
scribed above are reasonable and that if such procedures are
followed, you will bear the risk of any losses resulting from
unauthorized or fraudulent telephone transactions on your ac-
count. If Vanguard fails to follow reasonable security proce-
dures, it may be liable for any losses resulting from unau-
thorized or fraudulent telephone transactions on your ac-
count.
- --------------------------------------------------------------------------------
TRANSFERRING You may transfer the registration of any of your Fund shares
REGISTRATION to another person by completing a transfer form and sending
it to: VANGUARD FINANCIAL CENTER, P.O. BOX 1110, VALLEY
FORGE, PA 19482. The request must be in Good Order. BEFORE
MAILING YOUR REQUEST, PLEASE CALL OUR CLIENT SERVICES DEPART-
MENT (1-800-662-2739) FOR FULL INSTRUCTIONS.
- --------------------------------------------------------------------------------
OTHER VANGUARD For more information about any of these services, please call
SERVICES our Investor Information Department at 1-800-662-7447.
STATEMENTS AND Vanguard will send you a confirmation statement each time you
REPORTS initiate a transaction in your account except for
checkwriting redemptions from Vanguard money market accounts.
You will also receive a comprehensive account statement at
the end of each calendar quarter. The fourth-quarter state-
ment will be a year-end statement, listing all transaction
activity for the entire calendar year.
Vanguard's Average Cost Statement provides you with the aver-
age cost of shares redeemed from your account, using the av-
erage cost single category method. This service is available
for most taxable accounts opened since January 1, 1986. In
general, investors who redeemed shares from a qualifying Van-
guard account may expect to receive their Average Cost State-
ment in February of the following year. Please call our Cli-
ent Services Department (1-800-662-2739) for information.
Financial reports on the Fund will be mailed to you semi-an-
nually, according to the Fund's fiscal year-end.
VANGUARD With Vanguard's Direct Deposit Service, most U.S. Government
DIRECT DEPOSIT checks (including Social Security and military pension
SERVICE checks) and private payroll checks may be automatically de-
posited into your Vanguard Fund account. Separate brochures
and forms are available for direct deposit of U.S. Government
and private payroll checks.
VANGUARD Vanguard's Automatic Exchange Service allows you to move
AUTOMATIC money automatically among your Vanguard Fund accounts. For
EXCHANGE instance, the service can be used to "dollar cost average"
SERVICE from a money market portfolio into a stock or bond fund or to
contribute to an IRA or other retirement plan.
VANGUARD FUND Vanguard's Fund Express allows to you transfer money between
EXPRESS your Fund account and your account at a bank, savings and
loan association, or a credit
36
<PAGE>
union that is a member of the Automated Clearing House (ACH)
system. You may elect this service on the Account Registra-
tion Form or call the Investor Information Department (1-800-
662-7447) for a Fund Express application.
The minimum amount that can be transferred by telephone is
$100. However, if you have established one of the automatic
options, the minimum amount is $50. The maximum amount that
can be transferred using any of the options is $100,000.
Special rules govern how your Fund Express purchases or re-
demptions are credited to your account. In addition, some
services of Fund Express cannot be used with specific Van-
guard Funds. For more information, please refer to the Van-
guard Fund Express brochure.
VANGUARD Vanguard's Dividend Express allows you to transfer your divi-
DIVIDEND dends and/or capital gains distributions automatically from
EXPRESS your Fund account, one business day after the Fund's payable
date, to your account at a bank, savings and loan associa-
tion, or a credit union that is a member of the Automated
Clearing House (ACH) network. You may elect this service on
the Account Registration Form or call our Investor Informa-
tion Department (1-800-662-7447) for a Vanguard Dividend Ex-
press application.
VANGUARD Vanguard's Tele-Account is a convenient, automated service
TELE-ACCOUNT that provides share price, price change and yield quotations
on Vanguard Funds through any TouchTone TM telephone. This
service also lets you obtain information about your account
balance, your last transaction, and your most recent dividend
or capital gains payment. To contact Vanguard's Tele-Account
service, dial 1-800-ON-BOARD (1-800-662-6273). A brochure of-
fering detailed operating instructions is available from our
Investor Information Department (1-800- 662-7447).
- --------------------------------------------------------------------------------
37
<PAGE>
[LOGO OF VANGUARD MUNICIPAL BOND FUND APPEARS HERE]
- ---------------
THE VANGUARD GROUP
OF INVESTMENT
COMPANIES
Vanguard Financial Center
P.O. Box 2600
Valley Forge, PA 19482
INVESTOR INFORMATION
DEPARTMENT:
1-800-662-7447 (SHIP)
CLIENT SERVICES
DEPARTMENT:
1-800-662-2739 (CREW)
TELE-ACCOUNT FOR
24-HOUR ACCESS:
1-800-662-6273 (ON-BOARD)
TELECOMMUNICATIONS SERVICE
FOR THE HEARING-IMPAIRED:
1-800-662-2738
TRANSFER AGENT:
The Vanguard Group Inc.
Vanguard Financial Center
Valley Forge, PA 19482
[LOGO OF VANGUARD MUNICIPAL
BOND FUND APPEARS HERE]
P R O S P E C T U S
DECEMBER 14, 1994
[LOGO OF THE VANGUARD GROUP APPEARS HERE]
P095
<PAGE>
PART B
VANGUARD MUNICIPAL BOND FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
DECEMBER 14, 1994
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectus relating to all of the Fund's Portfolios (dated
December 14, 1994). To obtain the Fund's Prospectus, please call:
INVESTOR INFORMATION DEPARTMENT
1-800-662-7447
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Policies........................................................ 1
Calculation of Yield (Money Market Portfolio).............................. 6
Yield and Total Return..................................................... 7
Investment Management...................................................... 7
Purchase of Shares......................................................... 8
Redemption of Shares....................................................... 8
Valuation of Shares........................................................ 9
Management of the Fund..................................................... 10
Portfolio Transactions..................................................... 12
Description of Shares and Voting Rights.................................... 13
Financial Statements....................................................... 13
</TABLE>
INVESTMENT POLICIES
INVESTMENT LIMITATIONS
The following limitations cannot be changed without the consent of the hold-
ers of a majority of the Fund's outstanding shares (as defined in the Invest-
ment Company Act of 1940), including a majority of the shares of each Portfo-
lio. Each Portfolio of the Fund may not:
1. Invest in securities other than Municipal Bonds, except that it may
make temporary investments (up to 20% of its assets under normal circum-
stances) in notes issued by or on behalf of municipal or corporate issuers,
obligations of the United States Government and its agencies or instrumen-
talities, commercial paper, bank certificates of deposit, and any such
items or Municipal Bonds subject to short-term repurchase agreements;
2. Purchase securities of any issuer (except the United States Govern-
ment, its agencies and instrumentalities and any Municipal Bond guaranteed
by the U.S. Government) if as a result more than 5% of the total assets of
that Portfolio would be invested in the securities of such issuer; for pur-
poses of this limitation, identification of the "issuer" will be based on a
determination of the source of assets and revenues committed to meeting in-
terest and principal payments of each security;
3. Invest in companies for the purpose of exercising control;
4. Borrow money except for temporary or emergency purposes and then only
in an amount not exceeding 10% of the value of the total assets of the
Portfolio. The Portfolio will repay all borrowings before making additional
investments and interest paid on such borrowings will reduce income;
B-1
<PAGE>
5. Pledge, mortgage or hypothecate its assets to any extent greater than
10% of the value of its total assets;
6. Issue senior securities as defined in the Investment Company Act of
1940;
7. Engage in the business of underwriting securities issued by other per-
sons, except to the extent that the Portfolio may technically be deemed to
be an underwriter under the Securities Act of 1933, as amended, in dispos-
ing of investment securities;
8. Purchase or otherwise acquire any security if, as a result, more than
15% (10% for the Money Market Portfolio) of its net assets (including any
investment in The Vanguard Group, Inc.) would be invested in securities
that are illiquid;
9. Purchase or sell real estate, but this shall not prevent investments
in Municipal Bonds secured by real estate or interests therein;
10. Make loans to other persons, except by the purchase of bonds, deben-
tures or similar obligations which are publicly distributed and as provided
under "Lending of Securities";
11. Purchase on margin or sell short, except as specified below in
"(13)";
12. Purchase or retain securities of an issuer if an officer or director
of such issuer is an officer or director of the Fund or its investment ad-
viser and one or more of such officers or directors (trustees) of the Fund
or its investment adviser owns beneficially more than 1/2% of the shares or
securities of such issuer and all such directors and officers owning more
than 1/2% of such shares or securities together own more than 5% of such
shares or securities;
13. Purchase or sell commodities or commodities contracts, except that
each Portfolio (except the Money Market Portfolio) may invest in bond
futures contracts and bond options to the extent that not more than 5% of
the Portfolio's assets are required as initial margin deposit for such con-
tract and each portfolio may invest in bond futures contracts and bond op-
tions to the extent that not more than 20% of the Portfolio's assets are
invested in such instruments at any time;
14. Invest in securities of other investment companies, except as may be
acquired as a part of a merger, consolidation of acquisition of assets or
otherwise to the extent permitted by Section 12 of the 1940 Act. Each Port-
folio will invest only in investment companies which have investment objec-
tives and investment policies consistent with those of the Portfolio;
15. Invest in put, call, straddle or spread options except to the extent
set forth above, or interests in oil, gas or other mineral exploration or
development programs except as specified above in "(13)"; and
16. Purchase any securities which would cause more than 25% of the value
of the Portfolio's total net assets at the time of such purchase to be in-
vested in the securities of one or more issuers conducting their principal
activities in the same state, provided that there is no limitation with re-
spect to investments by the Money Market and Short Term Portfolio in U.S.
Treasury Bills, other obligations issued or guaranteed by the Federal Gov-
ernment, its agencies and instrumentalities and certificates of deposit.
Notwithstanding these limitations, the Fund may own all or any portion of
the securities of, or make loans to, or contribute to the costs or other fi-
nancial requirements of, any company which will be (1) wholly-owned by the
Fund and one or more other investment companies and (2) primarily engaged in
the business of providing, at cost, management, administrative, distribution
and/or related services to the Fund and such other investment companies. See
"Management of the Fund." Additionally, the Fund may invest without limit in
when issued securities. Please see the prospectus for a description of such
securities.
The above mentioned investment limitations are considered at the time in-
vestment securities are purchased.
B-2
<PAGE>
LENDING OF SECURITIES. Each Portfolio may lend its investment securities to
qualified institutions who need to borrow securities in order to complete cer-
tain transactions, such as covering short sales, avoiding failures to deliver
securities or completing arbitrage operations. By lending its investment secu-
rities, the Portfolio attempts to increase its income through the receipt of
interest on the loan. Any gain or loss in the market price of the securities
loaned that might occur during the term of the loan would be for the account
of the Portfolio. The Portfolio may lend its investment securities to quali-
fied brokers, dealers, banks or other financial institutions, so long as the
terms and the structure of such loans are not inconsistent with the Investment
Company Act of 1940, or the Rules and Regulations or interpretations of the
Securities and Exchange Commission (the "Commission") thereunder, which cur-
rently require that (a) the borrower pledge and maintain with the Portfolio
collateral having a value at all times not less than 100% of the value of the
securities loaned, (b) the borrower add to such collateral whenever the price
of the securities loaned rises (i.e., the borrower "marks to the market" on a
daily basis), (c) the loan be made subject to termination by the Portfolio at
any time and (d) the Portfolio receive reasonable interest on the loan (which
may include the Portfolio investing any cash collateral in interest bearing
short-term investments), any distribution on the loaned securities and any in-
crease in their market value. A Portfolio will not lend its investment securi-
ties, if as a result, the aggregate of such loans exceeds 10% of the value of
its total assets. Currently, each Portfolio of the Fund does not intend for
its securities lending activities to approach this limit. Loan arrangements
made by the Portfolio will comply with all other applicable regulatory re-
quirements, including the rules of the New York Stock Exchange, which rules
presently require the borrower, after notice, to redeliver the securities
within the normal settlement time of five business days. All relevant facts
and circumstances, including the creditworthiness of the broker, dealer or in-
stitution, will be considered in making decisions with respect to the lending
of securities, subject to review by the Fund's Board of Directors. Income de-
rived from lending of securities is not tax-exempt, and, thus, a Portfolio
will limit such activity in accordance with its investment objective.
FUTURES CONTRACTS
Each Portfolio of the Fund (except the Money Market Portfolio) may enter
into futures contracts, options, and options on futures contracts for several
reasons: to simulate full investment in the underlying securities while re-
taining a cash balance for Fund management purposes, to facilitate trading, to
reduce transaction costs, or to seek higher investment returns when a futures
contract is priced more attractively than the underlying equity security or
index. Futures contracts provide for the future sale by one party and purchase
by another party of a specified amount of a specific amount of a specific se-
curity at a specified future time and at a specified price. Futures contracts
which are standardized as to maturity date and underlying financial instrument
are traded on national futures exchanges. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission ("CFTC"), a U.S. Government Agency.
Although futures contracts by their terms call for actual delivery or ac-
ceptance of the underlying securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Clos-
ing out an open futures position is done by taking an opposite position ("buy-
ing" a contract which has previously been "sold," or "selling" a contract pre-
viously purchased) in an identical contract to terminate the position. Broker-
age commissions are incurred when a futures contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure comple-
tion of the contract (delivery or acceptance of the underlying security) if it
is not terminated prior to the specified delivery date. Minimal initial margin
requirements are established by the futures exchange and may be changed. Bro-
kers may establish deposit requirements which are higher than the exchange
minimums.
B-3
<PAGE>
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent
that the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the con-
tract value may reduce the required margin, resulting in a repayment of excess
margin to the contract holder. Variation margin payments are made to and from
the futures broker for as long as the contract remains open. The Fund expects
to earn interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset unfavor-
able changes in the value of securities otherwise held for investment purposes
or expected to be acquired by them. Speculators are less inclined to own the
securities underlying the futures contracts which they trade, and use futures
contracts with the expectation of realizing profits from fluctuations in the
prices of underlying securities. Regulations of the CFTC applicable to the
Fund require that all of its futures transactions constitute bona fide hedging
transactions.
Although techniques other than the sale and purchase of futures contracts
could be used to control a Portfolio's exposure to market fluctuations, the
use of futures contracts may be a more effective means of hedging this expo-
sure. While a Portfolio will incur commission expenses in both opening and
closing out futures positions, these costs are lower than transaction costs
incurred in the purchase and sale of the underlying securities.
Regulations of the CFTC applicable to the Fund require that all of its
futures transactions constitute bonafide hedging transactions. A Portfolio
will only sell futures contracts to protect securities it owns against price
declines or purchase contracts to protect against an increase in the price of
securities it intends to purchase.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS
A Portfolio of the Fund will not enter into futures contract transactions to
the extent that, immediately thereafter, the sum of its initial margin depos-
its on open contracts exceeds 5% of the market value of the Fund's total as-
sets. In addition, a Portfolio will not enter into futures contracts to the
extent that its outstanding obligations to purchase securities under these
contracts would exceed 20% of its total assets.
RISK FACTORS IN FUTURES TRANSACTIONS
Positions in futures contracts may be closed out only on an Exchange which
provides a secondary market for such futures. However, there can be no assur-
ance that a liquid secondary market will exist for any particular futures con-
tract at any specific time. Thus, it may not be possible to close a futures
position. In the event of adverse price movements, a Portfolio would continue
to be required to make daily cash payments to maintain its required margin. In
such situations, if the Portfolio has insufficient cash, it may have to sell
portfolio securities to meet daily margin requirements at a time when it may
be disadvantageous to do so. In addition, a Portfolio may be required to make
delivery of the instruments underlying futures contracts it holds. The inabil-
ity to close options and futures positions also could have an adverse impact
on the ability to effectively hedge it.
A Portfolio will minimize the risk that it will be unable to close out a
futures contract by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary market.
The risk of loss in trading resulting from futures contracts in some strate-
gies can be substantial, due both to the low margin deposits required, and the
extremely high degree of leverage involved. As a result, a relatively small
price movement in a futures contract may result in immediate and sub-
B-4
<PAGE>
stantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin,
a subsequent 10% decrease in the value of the futures contract would result in
a total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the initial margin requirement for the contract. However, because
the futures strategies of a Portfolio are engaged in only for hedging purposes
and will not be leveraged, the Adviser does not believe that the Portfolio is
subject to the risks of loss frequently associated with futures transactions.
A Portfolio would presumably have sustained comparable losses if, instead of
the futures contract, it had invested in the underlying financial instrument
and sold it after the decline.
Utilization of futures transactions by a Portfolio does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is
also possible that a Portfolio could both lose money on futures contracts and
also experience a decline in value of its portfolio securities. There is also
the risk of loss by the fund of margin deposits in the event of bankruptcy of
a broker with whom a Portfolio has an open position in a futures contract or
related option.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades
may be made on that day at a price beyond that limit. The daily limit governs
only price movement during a particular trading day and therefore does not
limit potential losses, because the limit may prevent the liquidation of unfa-
vorable positions. Futures contract prices have occasionally moved to the
daily limit for several consecutive trading days with little or no trading,
thereby preventing prompt liquidation of future positions and subjecting some
futures traders to substantial losses.
FEDERAL TAX TREATMENT OF FUTURES CONTACTS AND OTHER FEDERAL TAX MATTERS
Except for transactions a Portfolio has identified as hedging transactions,
the Portfolio is required for federal income tax purposes to recognize as in-
come for each taxable year its net unrealized gains and losses on certain
futures contracts as of the end of the year as well as those actually realized
during the year. In most cases, any gain or loss recognized with respect to a
futures contract is considered to be 60% long-term capital gain or loss and
40% short-term capital gain or loss, without regard to the holding period of
the contract. Furthermore, sales of futures contracts which are intended to
hedge against a change in the value of securities held by the Portfolio may
affect the holding period of such securities and, consequently, the nature of
the gain or loss on such securities upon disposition.
A Portfolio will distribute to shareholders annually any net capital gains
which have been recognized for federal income tax purposes (including
unrealized gains at the end of the Portfolio's fiscal year) on futures trans-
actions. Such distributions will be combined with distributions of capital
gains realized on the Portfolio's other investments and shareholders will be
advised on the nature of the transactions.
In order for the Portfolio to continue to qualify for federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest, income derived from loans of securities, gains from the sale of se-
curities or of foreign currencies or other income derived with respect to the
Portfolio's business of investing in securities. In addition, gains realized
on the sale or other disposition of securities held
B-5
<PAGE>
for less than three months must be limited to less than 30% of the Portfolio's
annual gross income. It is anticipated that any net gain realized from the
closing out of futures contracts will be considered gain from the sale of se-
curities and therefore be qualifying income for purposes of the 90% require-
ment. In order to avoid realizing excessive gains on securities held less than
three months, the Portfolio may be required to defer the closing out of
futures contracts beyond the time when it would otherwise be advantageous to
do so. It is anticipated that unrealized gains on futures contracts, which
have been open for less than three months as of the end of the Portfolio's
fiscal year and which are recognized for tax purposes, will not be considered
gains on sales of securities held less than three months for the purpose of
the 30% test.
CALCULATION OF YIELD (MONEY MARKET PORTFOLIO)
The current yield of the Money Market Portfolio is calculated daily on a
base period return of a hypothetical account having a beginning balance of one
share for a particular period of time (generally 7 days). The return is deter-
mined by dividing the net change (exclusive of any capital changes) in such
account by its average net asset value for the period, and then multiplying it
by 365/7 to get the annualized current yield. The calculation of net change
reflects the value of additional shares purchased with the dividends by the
Portfolio, including dividends on both the original share and on such addi-
tional shares. An effective yield, which reflects the effects of compounding
and represents an annualization of the current yield with all dividends rein-
vested, may also be calculated for the Portfolio by dividing the base period
return by 7, adding 1 to the quotient, raising the sum to the 365th power, and
subtracting 1 from the result.
Set forth below is an example, for purposes of illustration only, of the
current and effective yield calculations for the Money Market Portfolio for
the 7 day base period ending August 31, 1994.
<TABLE>
<CAPTION>
MONEY MARKET PORTFOLIO
----------------------
8/31/94
----------------------
<S> <C>
Value of account at beginning of period............... $1.00000
Value of same account at end of period*............... 1.00057
--------
Net Change in account value........................... $ .00057
========
Annualized Current Net Yield
(Net Change X 365/7) / average net asset value........ 2.97%
========
Effective Yield
365/7
[(Net Change) + 1] -1.......................... 3.01%
========
Average Weighted Maturity of investments.............. 51 days
========
</TABLE>
* Exclusive of any capital changes.
The net asset value of the Money Market Portfolio is $1.00 and has remained
at that amount since the initial offering of the Portfolio. The yield of the
Portfolio will fluctuate. The annualization of a week's dividend is not a rep-
resentation by the Portfolio as to what an investment in the Portfolio will
actually yield in the future. Actual yields will depend on such variables as
investment quality, average maturity, the type of instruments the Portfolio
invests in, changes in interest rates on instruments, changes in the expenses
of the Fund and other factors. Yields are one basis investors may use to ana-
lyze the Portfolios of the Fund, and other investment vehicles; however yields
of other investment vehicles may not be comparable because of the factors set
forth in the preceding sentence, differences in the time periods compared, and
differences in the methods used in valuing portfolio instruments computing net
asset value and calculating yield.
B-6
<PAGE>
YIELD AND TOTAL RETURN
The yield of each Portfolio of the Fund for the 30-day period ended August
31, 1994 is set forth below. Yields are calculated daily for each Portfolio.
<TABLE>
<S> <C>
Short-Term Portfolio................................................... 3.84%
Limited-Term Portfolio................................................. 4.18%
Intermediate-Term Portfolio............................................ 5.07%
Long-Term Portfolio.................................................... 5.73%
Insured Long-Term Portfolio............................................ 5.66%
High-Yield Portfolio................................................... 6.08%
</TABLE>
The average annual total return of each Portfolio of the Fund for the one,
five and ten year periods ended August 31, 1994 is set forth below:
<TABLE>
<CAPTION>
1 YEAR ENDED 5 YEARS ENDED 10 YEARS ENDED
8/31/94 8/31/94 8/31/94
------------ ------------- --------------
<S> <C> <C> <C>
Short-Term Portfolio............... 2.49% 5.17% 5.73%
Limited-Term Portfolio............. 2.31% 6.54% 6.68%*
Intermediate-Term Portfolio........ 2.49% 8.49% 9.76%
Long-Term Portfolio................ 0.08% 8.76% 10.50%
Insured Long-Term Portfolio........ -0.32% 8.36% 10.16%*
High-Yield Portfolio............... 0.52% 8.85% 10.76%
</TABLE>
* Since inception:
Insured Long-Term Portfolio--September 30, 1984.
Limited Term Portfolio--August 31, 1987.
Total return is computed by finding the average compounded rates of return
over the periods set forth above that would equate an initial amount invested
at the beginning of the periods to the ending redeemable value of the invest-
ment.
INVESTMENT MANAGEMENT
The Fund receives all investment advisory services on an "internalized," at-
cost, basis from an experienced investment management staff employed directly
by The Vanguard Group, Inc. ("Vanguard"), a subsidiary jointly-owned by the
Fund and the other Funds in The Vanguard Group of Investment Companies. The
investment management staff is supervised by the senior officers of the Fund.
In substance, the Fund can be viewed as a series of seven broadly diversi-
fied Portfolios of Municipal Bonds, with the investment management staff re-
sponsible for: maintaining the specified standards; making changes in specific
issues in light of changes in the fundamental basis for purchasing such secu-
rities; and adjusting the seven Portfolios to meet cash inflow (or outflow),
which reflects net purchases and exchanges of shares by investors (or net re-
demptions of shares) and reinvestment of a Portfolio's income.
The investment policies of each of the Portfolios may lead to frequent
changes in investments, particularly in periods of rapidly fluctuating inter-
est rates. A change in securities held by a Portfolio is known as "portfolio
turnover" and may involve the payment by the Portfolio of dealer mark-ups, un-
derwriting commissions and other transaction costs on the sales of securities
as well as on the reinvestment of the proceeds in other securities. The annual
portfolio turnover rate for the Portfolios is set forth under the heading "Fi-
nancial Highlights" in the Vanguard Municipal Bond Fund Prospectus. The port-
folio turnover rate is not a limiting factor when management deems it desir-
able to sell or purchase securities. It is impossible to predict whether or
not the portfolio turnover rates in future years will vary significantly from
the rates in recent years.
B-7
<PAGE>
PURCHASE OF SHARES
The Fund reserves the right in its sole discretion (i) to suspend the offer-
ing of its shares, (ii) to reject purchase orders when in the judgment of man-
agement such rejection is in the best interest of the Fund, and (iii) to re-
duce or waive the minimum for initial and subsequent investments for certain
fiduciary accounts or under circumstances where certain economies can be
achieved in sales of the Fund's shares.
STOCK CERTIFICATES. Your purchase will be made in full and fractional shares
of the Portfolio calculated to three decimal places. Shares are normally held
on deposit for shareholders by the Fund, which will send to shareholders a
statement of shares owned at the time of each transaction. This saves the
shareholders the trouble of safekeeping the certificates, and saves the Fund
the cost of issuing certificates. Share certificates are, of course, available
at any time upon written request at no additional cost to shareholders. No
certificates will be issued for fractional shares.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment
(i) during any period that the New York Stock Exchange is closed, or trading
on the Exchange is restricted as determined by the Securities and Exchange
Commission (the "Commission"), (ii) during any period when an emergency exists
as defined by the rules of the Commission as a result of which it is not rea-
sonably practicable for the Fund to dispose of securities owned by it, or
fairly to determine the value of its assets, and (iii) for such other periods
as the Commission may permit.
The Fund has made an election with the Commission to pay in cash all redemp-
tions requested by any shareholder of record limited in amount during any 90-
day period to the lesser of $250,000 or 1% of the net assets of the Fund at
the beginning of such period. Such commitment is irrevocable without the prior
approval of the Commission. Redemptions in excess of the above limits may be
paid in whole or in part, in investment securities or in cash, as the Direc-
tors may deem advisable; however, payment will be made wholly in cash unless
the Directors believe that economic or market conditions exist which would
make such a practice detrimental to the best interests of the Fund. If redemp-
tions are paid in investment securities, such securities will be valued as set
forth in the Prospectus under "How Is the Share Price of Each Portfolio Deter-
mined?" and a redeeming shareholder would normally incur brokerage expenses if
he converted these securities to cash.
No charge is made by the Fund for redemptions, except for wire withdrawals
under $5,000 which are subject to a $5.00 charge. Any redemption may be more
or less than the shareholder's cost depending on the market value of the secu-
rities held by each Portfolio.
SIGNATURE GUARANTEES. To protect your account, the Fund and Vanguard from
fraud, signature guarantees are required for certain redemptions. Signature
guarantees enable the Fund to verify the identity of the person who has autho-
rized a redemption from your account. SIGNATURE GUARANTEES ARE REQUIRED IN
CONNECTION WITH: (1) REDEMPTIONS INVOLVING MORE THAN $25,000 ON THE DATE OF
RECEIPT BY VANGUARD OF ALL NECESSARY DOCUMENTS; (2) ALL REDEMPTIONS, REGARD-
LESS OF THE AMOUNT INVOLVED, WHEN THE PROCEEDS ARE TO BE PAID TO SOMEONE OTHER
THAN THE REGISTERED OWNER(S) AND/OR ARE GOING TO AN ADDRESS OTHER THAN THE ONE
ON RECORD; AND (3) SHARE TRANSFER REQUESTS.
A signature guarantee may be obtained from banks, brokers and any other
guarantor institution that Vanguard deems acceptable. NOTARIES PUBLIC ARE NOT
ACCEPTABLE GUARANTORS.
The signature guarantee must appear either: (1) on the written request for
redemption; (2) on a separate instrument for assignment ("stock power") which
should specify the total number of shares
B-8
<PAGE>
to be redeemed; or (3) on all stock certificates tendered for redemption and,
if shares held by the Fund are also being redeemed, on the letter or stock
power.
VALUATION OF SHARES
The valuation of shares of the Fund's Short-Term, Limited-Term, Intermedi-
ate-Term, Long-Term, High Yield and Insured Long-Term Portfolios is described
in detail in the Prospectus.
MONEY MARKET PORTFOLIO. The net asset value per share of the Money Market
Portfolio is determined on each day that the New York Stock Exchange is open.
It is the policy of the Money Market Portfolio to attempt to maintain a net
asset value of $1.00 per share for purposes of sales and redemptions. The in-
struments held by the Money Market Portfolio are valued on the basis of amor-
tized cost which does not take into account unrealized capital gains or loss-
es. This involves valuing an instrument at-cost and thereafter assuming a con-
tinuous amortization for as long as the security is held of any discount or
premium, regardless of the impact of fluctuating interest rates on the market
value of the instrument. While this method provides certainty in valuation, it
may result in periods during which value, as determined by amortized cost, is
higher or lower than the price the Portfolio would receive if it sold the in-
strument. During periods of declining interest rates, the daily yield on
shares of the Portfolio computed as described above may tend to be higher than
a like computation made by a fund with identical investments utilizing a
method of valuation based upon market prices and estimates of market prices
for all of its portfolio instruments. Thus, if the use of amortized cost by
the Portfolio resulted in a lower aggregate portfolio value on a particular
day, a prospective investor in the Portfolio would be able to obtain a some-
what higher yield than would result from investment in a fund utilizing solely
market values, and existing investors in the Portfolio would receive less in-
vestment income. The converse would apply in a period of rising interest
rates.
The valuation of the Money Market Portfolio's instruments based upon their
amortized cost and the commitment to maintain the Portfolio's per share net
asset value of $1.00 is permitted by an exemptive order granted to the Fund by
the Securities and Exchange Commission, pursuant to which the Fund has agreed
to adhere to certain conditions. Accordingly, the Fund has agreed to maintain
a dollar-weighted average portfolio maturity for the Money Market Portfolio of
90 days or less, to purchase instruments having remaining maturities of 13
months or less only, and to invest only in securities determined by the Board
of Directors to be of good quality with minimal credit risks.
It is a fundamental objective of management to maintain the Portfolio's
price per share as computed for the purpose of sales and redemptions at $1.00.
The Directors have established procedures designed to achieve this objective.
Such procedures will include a review of the Portfolio's holdings by the Di-
rectors, at such intervals as they may deem appropriate, to determine whether
the Portfolio's net asset value calculated by using available market quota-
tions deviates from $1.00 per share based on amortized cost. The extent of any
deviation will be examined by the Directors. If such deviation exceeds 1/2 of
1%, the Directors will promptly consider what action, if any, will be initiat-
ed. In the event the Directors determine that a deviation exists which may re-
sult in material dilution or other unfair results to investors or existing
shareholders, they have agreed to take such corrective action as they regard
as necessary and appropriate, including the sale of portfolio instruments
prior to maturity to realize capital gains or losses or to shorten average
portfolio maturity; withholding dividends; making a special capital distribu-
tion; redemptions of shares in kind; or establishing a net asset value per
share by using available market quotations.
B-9
<PAGE>
MANAGEMENT OF THE FUND
OFFICERS AND DIRECTORS
The Fund's officers, under the supervision of the Board of Directors, manage
the day-to-day operations of the Fund. The Directors, which are elected annu-
ally by shareholders, set broad policies for the Fund and choose its officers.
A list of the Directors and officers of the Fund and a brief statement of
their present positions and principal occupations during the past 5 years is
set forth below. The mailing address of the Directors and officers is Post Of-
fice Box 876, Valley Forge, PA 19482.
JOHN C. BOGLE, Chairman, Chief Executive Officer and Director*
Chairman, Chief Executive Officer, and Director of The Vanguard Group, Inc.
and each of the investment companies in The Vanguard Group; Director of The
Mead Corporation and General Accident Insurance.
JOHN J. BRENNAN, President & Director*
President of The Vanguard Group, Inc. and each of the investment companies in
The Vanguard Group.
ROBERT E. CAWTHORN, Director
Chairman and Chief Executive Officer, Rhone-Poulenc Rorer, Inc.; Director of
Sun Company, Inc.
BARBARA BARNES HAUPTFUHRER, Director
Director of The Great Atlantic and Pacific Tea Company, ALCO Standard Corp.,
Raytheon Company, Knight-Ridder, Inc., Massachusetts Mutual Life Insurance
Co., and Trustee Emerita of Wellesley College.
BURTON G. MALKIEL, Director
Chemical Bank Chairman's Professor of Economics, Princeton University; Direc-
tor of Prudential Insurance Co. of America, Amdahl Corporation, Baker
Fentress & Co., The Jeffrey Co., and Southern New England Communications Com-
pany.
ALFRED M. RANKIN, JR., Director
President, Chief Executive Officer and Director of NACCO Industries, Inc.;
Director of The BFGoodrich Company, The Standard Products Company and The Re-
liance Electric Company.
JOHN C. SAWHILL, Director
President and Chief Executive Officer, The Nature Conservancy; formerly, Di-
rector and Senior Partner, McKinsey & Co.; Director of Pacific Gas and Elec-
tric Company and NACCO Industries.
JAMES O. WELCH, JR., Director
Retired Chairman of Nabisco Brands Inc. and retired Vice Chairman and Direc-
tor of RJR Nabisco; Director of TECO Energy, Inc.
J. LAWRENCE WILSON, Director
Chairman and Chief Executive Officer, Rohm & Haas Company; Director of
Cummins Engine Company; Trustee of Vanderbilt University and the Culver Edu-
cational Foundation.
RAYMOND J. KLAPINSKY, Secretary*
Senior Vice President and Secretary of The Vanguard Group, Inc.; Secretary of
each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND, Treasurer*
Treasurer of The Vanguard Group, Inc. and of each of the investment companies
in The Vanguard Group.
KAREN E. WEST, Controller*
Vice President of The Vanguard Group, Inc.; Controller of each of the invest-
ment companies in The Vanguard Group.
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* Officers of the Fund are "interested persons" as defined in the Investment
Company Act of 1940.
- -------------------------------------------------------------------------------
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<PAGE>
THE VANGUARD GROUP
Vanguard Municipal Bond Fund is a member of The Vanguard Group of Investment
Companies. Through their jointly-owned subsidiary, The Vanguard Group, Inc.
("Vanguard"), the Fund and the other Funds in the Group obtain at-cost virtu-
ally all of their corporate management, administrative and distribution serv-
ices. Vanguard also provides investment advisory services on an at-cost basis
to certain Vanguard Funds, including Vanguard Municipal Bond Fund.
Vanguard employs a supporting staff of management and administrative person-
nel needed to provide the requisite services to the Funds and also furnishes
the Funds with necessary office space, furnishings and equipment. Each Fund
pays its share of Vanguard's total expenses which are allocated among the
Funds under methods approved by the Board of Directors (Trustees) of each
Fund. In addition, each Fund bears its own direct expenses, such as legal, au-
diting and custodian fees.
The Fund's officers are also officers and employees of Vanguard. No officer
or employee owns, or is permitted to own, any securities of any external ad-
viser for the Funds.
The Vanguard Group, Inc. ("Vanguard") was established and operates under a
Funds' Service Agreement which was approved by the shareholders of each of the
Funds. The amounts which each of the Funds have invested are adjusted from
time to time in order to maintain the proportionate relationship between each
Fund's relative net assets and its contribution to Vanguard's capital. At Au-
gust 31, 1994, the Fund had contributed capital of $2,701,000 Vanguard, repre-
senting 13.5% of Vanguard's capitalization. The Fund's Service Agreement was
amended on about May 10, 1993, to provide as follows: (a) each Vanguard Fund
may invest up to 0.40% of its current net assets in Vanguard and (b) there is
no other limitation on the amount that each Vanguard Fund may contribute to
Vanguard's Capitalization.
MANAGEMENT. Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian rela-
tionships; (6) shareholder reporting; and (7) review and evaluation of serv-
ices provided to the Funds by third parties. During the fiscal year ended Au-
gust 31, 1994, the Fund's allocated share of Vanguard's actual net costs of
operation relating to management and administrative services (including trans-
fer agency) totaled approximately $27,050,000.
DISTRIBUTION. Vanguard provides all distribution and marketing activities
for the Funds in the Group. Vanguard Marketing Corporation, a wholly-owned
subsidiary of The Vanguard Group, Inc., acts as Sales Agent for shares of the
Funds, in connection with any sales made directly to investors in the states
of Florida, Missouri, New York, Ohio, Texas and such other states as it may be
required.
The principal distribution expenses are for advertising, promotional materi-
als and marketing personnel. Distribution services may also include organizing
and offering to the public, from time to time, one or more new investment com-
panies which will become members of the Group. The Directors and officers of
Vanguard determine the amount to be spent annually on distribution activities,
the manner and amount to be spent on each Fund, and whether to organize new
investment companies.
One half of the distribution expenses of a marketing and promotional nature
is allocated among the Funds based upon their relative net assets. The remain-
ing one half of these expenses is allocated among the Funds based upon each
Fund's sales for the preceding 24 months relative to the total sales of the
Funds as a Group, provided, however, that no Fund's aggregate quarterly rate
of contribution for distribution expenses of a marketing and promotional na-
ture shall exceed 125% of the average distribution expense rate for the Group,
and that no Fund shall incur annual distribution expenses in excess of 20/100
of 1% of its average month-end net assets. During the fiscal year ended August
31, 1994, the Fund paid approximately $3,993,000 of the group's distribution
and marketing expenses, which represented an effective annual rate of .02 of
1% of the Fund's average net assets.
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<PAGE>
INVESTMENT ADVISORY SERVICES. Vanguard also provides the Fund, Vanguard
Money Market Reserves, Vanguard Institutional Money Market Portfolio, Vanguard
New York Insured Tax-Free Fund, Vanguard New Jersey Tax-Free Fund, Vanguard
Pennsylvania Tax-Free Fund, Vanguard Ohio Tax-Free Fund, Vanguard California
Tax-Free Fund, Vanguard Florida Insured Tax-Free Fund, Vanguard Tax-Managed
Fund, several Portfolios of Vanguard Fixed Income Securities Fund, Vanguard
Index Trust, Vanguard Admiral Funds, Vanguard International Equity Index Fund,
Vanguard Balanced Index Fund, Vanguard Institutional Index Fund, several Port-
folios of Vanguard Variable Insurance Fund, Vanguard Bond Index Fund, a por-
tion of Vanguard/Windsor II, a portion of Vanguard/Morgan Growth Fund as well
as several indexed separate accounts with investment advisory services. These
services are provided on an at-cost basis from a money management staff em-
ployed directly by Vanguard. The compensation and other expenses of this staff
are paid by the Funds utilizing these services. During the fiscal years ended
August 31, 1992, 1993 and 1994, the Fund paid approximately $1,158,000,
$1,314,000 and $1,844,000 respectively, of Vanguard's expenses relating to in-
vestment advisory services.
REMUNERATION OF DIRECTORS (TRUSTEES) AND OFFICERS. The Fund pays each Direc-
tor (Trustee), who is not also an officer, an annual fee plus travel and other
expenses incurred in attending Board meetings. The Fund's officers and employ-
ees are paid by Vanguard which, in turn, is reimbursed by the Fund, and each
other Fund in the Group, for its allocated share of officers' and employees'
salaries and retirement benefits.
The following information is furnished with respect to the Directors and of-
ficers of the Fund for whom the Fund's proportionate share of remuneration ex-
ceeded $60,000 for the fiscal year ended August 31, 1994, and for all Direc-
tors and officers as a group:
<TABLE>
<CAPTION>
NAMES AND CAPACITIES IN WHICH DIRECT
REMUNERATION WAS RECEIVED REMUNERATION(1)
----------------------------- ---------------
<S> <C>
John C. Bogle, Chairman and Chief Executive Officer.......... $398,869
John J. Brennan, President................................... $178,977
All Directors and Officers as a Group........................ $694,970
</TABLE>
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(1) Includes, in the aggregate, $85,000 of fees and expenses paid by the Fund
to its "non-interested" Directors, and the Fund's proportionate share of
remuneration paid by Vanguard to all officers of the Fund, as a group.
Under its retirement plan, Vanguard contributes annually an amount equal to
10% of each officer's annual compensation plus 5.7% of that part of the offi-
cer's compensation during the year, if any, that exceed the Social Security
Taxable Wage Base then in effect. Under Vanguard's thrift plan, all employees
are permitted to make pre-tax contributions in a maximum amount equal to 4% of
total compensation. Vanguard matches the basic contribution on a 100% basis.
Directors who are not Officers are paid an annual fee based on the number of
years of service on the board, up to fifteen years of service, upon retire-
ment. The fee is equal to $1,000 for each year of service and each investment
company member of The Vanguard Group contributes a proportionate amount to
this fee based on its relative net assets. This fee is paid, subsequent to a
Director's retirement, for a period of ten years or until the death of a re-
tired Director. The Fund's proportionate share of retirement contributions
made by Vanguard on behalf of all eligible officers of the Fund was approxi-
mately $81,343.
PORTFOLIO TRANSACTIONS
The Fund expects that purchases and sales of securities for its seven Port-
folios usually will be principal transactions. Securities will normally be
purchased directly from the issuer or from an underwriter or market maker for
the securities. There usually will be no brokerage commissions paid by the
Portfolios for such purchases. Purchases from underwriters of securities will
include a
B-12
<PAGE>
commission or concession paid by the issuer to the underwriter, and purchases
from dealers serving as market makers will include a dealer's mark-up. Van-
guard's investment management staff may sell securities prior to their matu-
rity if circumstances and considerations warrant and if it believes such dis-
positions desirable.
Decisions with respect to the purchase and sale of securities on behalf of
the Fund's Portfolios are made by Vanguard's investment management staff under
the supervision of the officers of the Fund. The staff is also generally re-
sponsible for implementing these decisions, including the allocation of prin-
cipal business and portfolio brokerage, and the negotiation of commissions.
In purchasing and selling securities for each of the Fund's Portfolios, it
is the Fund's policy to seek to obtain quality execution at the most favorable
prices, through responsible broker-dealers. In selecting broker-dealers to ex-
ecute the Fund's securities transactions, consideration will be given to such
factors as the price of the security, the rate of the commission, the size and
difficulty of the order, the reliability, integrity, financial condition, gen-
eral execution and operational capabilities of competing broker-dealers, and
the brokerage and research services which they provide to the Fund.
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be through such firms.
However, the Fund may place portfolio orders with qualified brokers or dealers
who recommend shares of the Fund to clients, or who act as agent in the pur-
chase of shares of any of the Fund's Portfolios for their clients and may,
when a number of brokers and dealers can provide comparable best price and ex-
ecution on a particular transaction, consider the sale of shares by a broker
or dealer in selecting among qualified brokers or dealers.
The Fund paid no brokerage commissions during the fiscal years ended August
31, 1992, August 31, 1993 and August 31, 1994.
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Fund was organized as a Maryland corporation on October 15, 1976. On
January 3, 1984, the Fund was reorganized into a Pennsylvania business trust
which was organized solely for that purpose. The Fund was reorganized as a
Maryland corporation on December 31, 1985.
The Articles of Incorporation permit the Directors to issue 7,250,000,000
shares of Common Stock, $.001 par value from an unlimited number of separate
classes ("Portfolio") of shares. Currently the Fund is offering shares of
seven Portfolios. The shares of each Portfolio are fully paid and nonassess-
able and have no preference as to conversion, exchange, dividends, retirement
or other features. The shares of each Portfolio have no pre-emptive rights.
The shares of each Portfolio have non-cumulative voting rights, which means
that the holders of more than 50% of the shares voting for the election of Di-
rectors can elect 100% of the Directors if they choose to do so. A shareholder
is entitled to one vote for each full share held (and a fractional vote for
each fractional share held), then standing in his name on the books of the
Fund. On any matter submitted to a vote of shareholders, all shares of the
Fund then issued and outstanding and entitled to vote, irrespective of the
class, shall be voted in the aggregate and not by class: except (i) when re-
quired by the Investment Company Act of 1940, shares shall be voted by indi-
vidual class; and (ii) when the matter does not affect any interest of a par-
ticular class, then only shareholders of the affected class or classes shall
be entitled to vote thereon.
FINANCIAL STATEMENTS
The Fund's Financial Statements for the year ended August 31, 1994, includ-
ing the financial highlights for each of the five fiscal years in the period
ended August 31, 1994, appearing in the
B-13
<PAGE>
Vanguard Municipal Bond Fund Annual Report to Shareholders and insert thereto,
and the report thereon of Price Waterhouse LLP, independent accountants, also
appearing therein, are incorporated by reference in this Statement of Addi-
tional Information. The Fund's Annual Report to Shareholders and the insert
thereto are enclosed with this Statement of Additional Information.
APPENDIX A--DESCRIPTION OF MUNICIPAL BONDS AND THEIR RATINGS
MUNICIPAL BONDS--GENERAL. Municipal Bonds generally include debt obligations
issued by states and their political subdivisions, and duly constituted au-
thorities and corporations, to obtain funds to construct, repair or improve
various public facilities such as airports, bridges, highways, hospitals,
housing, schools, streets and water and sewer works. Municipal Bonds may also
be issued to refinance outstanding obligations as well as to obtain funds for
general operating expenses and for loan to other public institutions and fa-
cilities.
The two principal classifications of Municipal Bonds are "general obliga-
tion" and "revenue" or "special tax" bonds. General obligation bonds are se-
cured by the issuer's pledge of its full faith, credit and taxing power for
the payment of principal and interest. Revenue or special tax bonds are pay-
able only from the revenues derived from a particular facility or class of fa-
cilities or, in some cases, from the proceeds of a special excise or other
tax, but not from general tax revenues. The Fund may also invest in tax-exempt
industrial development bonds, short-term municipal obligations (rated SP-1+ or
SP-1 by Standard & Poor's Corporation or MIG. by Moody's Investors Service),
project notes, demand notes and tax-exempt commercial papers (rated A-1 by
Standard & Poor's Corporation or P-1 by Moody's Investors Service).
Industrial revenue bonds in most cases are revenue bonds and generally do
not have the pledge of the credit of the issuer. The payment of the principal
and interest on such industrial revenue bonds is dependent solely on the abil-
ity of the user of the facilities financed by the bonds to meet its financial
obligations and the pledge, if any, of real and personal property so financed
as security for such payment. Short-term municipal obligations issued by
states, cities, municipalities or municipal agencies, include Tax Anticipation
Notes, Revenue Anticipation Notes, Bond Anticipation Notes, Construction Loan
Notes and Short-Term Discount Notes.
Note obligations with demand or put options may have a stated maturity in
excess of one year, but permit any holder to demand payment of principal plus
accrued interest upon a specified number of days' notice. Frequently, such ob-
ligations are secured by letters of credit or other credit support arrange-
ments provided by banks. The issuer of such notes normally has a corresponding
right, after a given period, to repay in its discretion the outstanding prin-
cipal of the note plus accrued interest upon a specific number of days' notice
to the bondholders. The interest rate on a demand note may be based upon a
known lending rate, such as a bank's prime rate, and be adjusted when such
rate changes, or the interest rate on a demand note may be a market rate that
is adjusted at specified intervals. The demand notes in which the Fund will
invest are payable on not more than one year's notice. Each note purchased by
the Fund will meet the quality criteria set out above for the Fund.
The yields of Municipal Bonds depend on, among other things, general money
market conditions, conditions in the Municipal Bond market, the size of a par-
ticular offering, the maturity of the obligation, and the rating of the issue.
The ratings of Moody's Investors Service, Inc. and Standard & Poor's Corpora-
tion represent their opinions of the quality of the Municipal Bonds rated by
them. It should be emphasized that such ratings are general and are not abso-
lute standards of quality. Consequently, Municipal Bonds with the same maturi-
ty, coupon and rating may have different yields, while Municipal Bonds of the
same maturity and coupon, but with different ratings may have the same yield.
It will be the responsibility of the investment management staff to appraise
independently the fundamental quality of the bonds held by the Fund.
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<PAGE>
Municipal Bonds are sometimes purchased on a "when issued" basis meaning the
Fund has committed to purchasing certain specified securities at an agreed
upon price when they are issued. The period between commitment date and issu-
ance date can be a month or more. It is possible that the securities will
never be issued and the commitment canceled.
From time to time proposals have been introduced before Congress to restrict
or eliminate the Federal income tax exemption for interest on Municipal Bonds.
Similar proposals may be introduced in the future. If any such proposal were
enacted, it might restrict or eliminate the ability of the Fund to achieve its
investment objective. In that event, the Fund's Trustees and officers would
reevaluate its investment objective and policies and consider recommending to
its shareholders changes in such objective and policies.
Similarly, from time to time proposals have been introduced before State and
local legislatures to restrict or eliminate the State and local income tax ex-
emption for interest on Municipal Bonds. Similar proposals may be introduced
in the future. If any such proposal were enacted, it might restrict or elimi-
nate the ability of each Portfolio to achieve its respective investment objec-
tive. In that event, the fund's trustees and officers would reevaluate its in-
vestment objective and policies and consider recommending to its shareholders
changes in such objective and policies. Ratings. Excerpts from Moody's Invest-
ors Service, Inc.'s Municipal Bond ratings: Aaa--judged to be of the "best
quality" and are referred to as "gilt edge"; interest payments are protected
by a large or by an exceptionally stable margin and principal is secure; Aa--
judged to be of "high quality by all standards" but as to which margins of
protection or other elements make long-term risks appear somewhat larger than
Aaa-rated Municipal Bonds; together with Aaa group they comprise what are gen-
erally known as "high grade bonds"; A--possess many favorable investment at-
tributes and are considered "upper medium grade obligations." Factors giving
security to principal and interest of A-rated Municipal Bonds are considered
adequate, but elements may be present which suggest a susceptibility to im-
pairment sometime in the future; Baa--considered as medium grade obligations;
i.e., they are neither highly protected nor poorly secured; interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time; Ba-- protection of principal and interest payments may be very
moderate; judged to have speculative elements; their future cannot be consid-
ered as well-assured; B--lack characteristics of a desirable investment; as-
surance of interest and principal payments over any long period of time may be
small; Caa--poor standing; may be in default or there may be present elements
of danger with respect to principal and interest; Ca--speculative in a high
degree; often in default; C--lowest rated class of bonds; issues so rated can
be regarded as having extremely poor prospects for ever attaining any real in-
vestment standing.
Description of Moody's ratings of state and municipal notes: Moody's ratings
for state and municipal notes and other short-term obligations are designated
Moody's Investment Grade ("MIG"). Symbols used will be as follows: MIG-1--Best
quality, enjoying strong protection from established cash flows of funds for
their servicing or from established and broad-based access to the market for
refinancing, or both: MIG-2--High quality with margins of protection ample al-
though not so large as in the preceding group.
Description of Moody's highest commercial paper rating; Prime-1 ("P-1")--
judged to be of the best quality. Their short-term debt obligations carry the
smallest degree of investment risk.
Excerpts from Standard & Poor's Corporation's Municipal Bond ratings: AAA--
has the highest rating assigned by S&P; extremely strong capacity to pay prin-
cipal and interest; AA--has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in a small degree; A--
has a strong capacity to pay principal and interest, although somewhat more
susceptible to the adverse changes in circumstances and economic conditions;
BBB--regarded as having
B-15
<PAGE>
an adequate capacity to pay principal and interest; normally exhibit adequate
protection parameters but adverse economic conditions or changing circum-
stances are more likely to lead to a weakened capacity to pay principal and
interest than for bonds in A category; BB--B--CCC--CC--predominantly specula-
tive with respect to capacity to pay interest and repay principal in accor-
dance with terms of obligations; BB is being paid; D--in default, and payment
of principal and/or interest is in arrears.
The ratings from "AA" to "B" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
Excerpt from Standard & Poor's Corporation's rating of municipal note is-
sues: SP-1+--very strong capacity to pay principal and interest; SP-1--strong
capacity to pay principal and interest.
Description of S&P's highest commercial papers ratings: A-1+--This designa-
tion indicates the degree of safety regarding timely payment is overwhelming.
A-1--This designation indicates the degree of safety regarding timely payment
is very strong.
At least 95% of the municipal securities held by each of the Fund's Portfo-
lios must be rated a minimum of Baa (or BBB) by Moody's or Standard & Poor's.
No more than 20% of the Portfolio will be held in the lowest investment grade
rating. Not more than 5% of the municipal securities of each Portfolio may be
lower-rated or unrated.
In the event that a particular obligation held by a Portfolio of the Fund is
downgraded below the minimum investment level permitted the investment poli-
cies of such Portfolio, the directors and officers of the Fund will carefully
assess the credit worthiness of the obligation to determine whether it contin-
ues to meet the policies and objectives of the Portfolio.
APPENDIX B--MUNICIPAL LEASE OBLIGATIONS
Each Portfolio may invest in municipal lease obligations. Such securities
will be treated as liquid under the following guidelines have been established
by the Board of Directors:
1. The obligation has been rated "investment grade" by at least one NRSRO
and is considered to be investment grade by the investment adviser.
2. The obligation is secured by payments from a governmental lessee which
is generally recognized and has debt obligations which are actively traded
by a minimum of five broker/dealers.
3. At least $25 million of the lessee debt is outstanding either in a
single transaction or on parity, and owned by a minimum of five institu-
tional investors.
4. The investment adviser has determined that the obligation, or a compa-
rable lessee security, trades in the institutional marketplace at least pe-
riodically, with a bid/offer spread of 20 basis points or less.
5. The governmental lessee has a full faith and credit general obligation
rating of at least "A-" as published by at least one NRSRO or as determined
by the investment adviser. If the lessee is a state government, the general
obligation rating must be at least BAA1, BBB+, or equivalent, as determined
above.
6. The projects to be financed by the obligation are determined to be
critical to the lessee's ability to deliver essential services.
7. Specific legal features such as covenants to maintain the tax-exempt
status of the obligation, covenants to make lease payments without the
right of offset or counterclaim, covenants to return leased property to the
lessor in the event of non-appropriation, insurance policies, debt service
reserve fund, are present.
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<PAGE>
8. The lease must be "triple net" (i.e.-lease payments are net of prop-
erty maintenance, taxes and insurance).
9. If the lessor is a private entity, there must be a sale and absolute
assignment of rental payments to the trustee, accompanied by a legal opin-
ion from recognized bond counsel that lease payments would not be consid-
ered property of the lessor's estate in the event of lessor's bankruptcy.
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