<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT (NO. 2-57689) UNDER
THE SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO.
POST-EFFECTIVE AMENDMENT NO. 37
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
AMENDMENT NO. 41
VANGUARD MUNICIPAL BOND FUND, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
P.O. BOX 2600,
VALLEY FORGE, PA 19482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
RAYMOND J. KLAPINSKY, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
It is proposed that this filing become effective on December 30, 1997
pursuant to paragraph (b) of Rule 485.
Approximate Date of Proposed Public Offering: As soon as practicable after
this Registration Statement becomes effective.
We have elected to register an indefinite number of shares pursuant to Rule
24f-2 under the Investment Company Act of 1940. We filed our Rule 24f-2 Notice
for the year ended August 31, 1997 on November 28, 1997.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
VANGUARD MUNICIPAL BOND FUND, INC.
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
FORM N-1A
ITEM NUMBER LOCATION IN PROSPECTUS
<C> <C> <S>
Item 1. Cover Page............................ Cover Page
Item 2. Synopsis.............................. Highlights
Item 3. Condensed Financial Information....... Financial Highlights
Item 4. General Description of Registrant..... The Portfolios' Objective;
Investment Strategy;
Investment Limitations;
Investment Policies; A Word
About Risk; Investment
Performance; General
Information
Item 5. Management of the Fund................ The Portfolios and
Vanguard; Investment
Adviser
Item 5A. Management's Discussion of Fund
Performance........................... Herein incorporated by
reference from Registrant's
Annual Report to
Shareholders Dated August
31, 1997 filed with the
Securities & Exchange
Commission's EDGAR system
on October 29, 1997.
Item 6. Capital Stock and Other Securities.... Buying Shares; Redeeming
Shares; Share Price;
Dividends, Capital Gains
and Taxes; General
Information
Item 7. Purchase of Securities Being Offered.. Buying Shares; How to
Exchange Shares
Item 8. Redemption or Repurchase.............. Redeeming Shares
Item 9. Pending Legal Proceedings............. Not Applicable
<CAPTION>
FORM N-1A LOCATION IN STATEMENT
ITEM NUMBER OF ADDITIONAL INFORMATION
<C> <C> <S>
Item 10. Cover Page............................ Cover Page
Item 11. Table of Contents..................... Cover Page
Item 12. General Information and History....... Investment Policies;
Investment Management;
Description of Shares and
Voting Rights
Item 13. Investment Objective and Policies..... Investment Policies;
Investment Limitations
Item 14. Management of the Registrant.......... Management of the Fund;
Investment Management
Item 15. Control Persons and Principal Holders
of Securities......................... Management of the Fund
Item 16. Investment Advisory and Other
Services.............................. Management of the Fund;
Investment Management
Item 17. Brokerage Allocation.................. Not Applicable
Item 18. Capital Stock and Other Securities.... Description of Shares and
Voting Rights; Valuation of
Shares
Item 19. Purchase, Redemption and Pricing of
Securities Being Offered.............. Purchase of Shares;
Redemption of Shares
Item 20. Tax Status............................ Not Applicable
Item 21. Underwriters.......................... Not Applicable
Item 22. Calculations of Performance Data...... Calculation of Yield; Yield
and Total Return
Item 23. Financial Statements.................. Financial Statements
</TABLE>
<PAGE>
Vanguard
Municipal Bond Fund
Prospectus
December 30, 1997
Money Market
Portfolio
Short-Term Portfolio
Limited-Term
Portfolio
Intermediate-Term
Portfolio
Long-Term Portfolio
Insured Long-Term
Portfolio
High-Yield Portfolio
This prospectus
contains financial data
for the Fund through
the period ended
October 31, 1997.
A member of
[LOGO OF THE VANGUARD GROUP APPEARS HERE]
<PAGE>
Vanguard Municipal Bond Fund A Federal Income Tax-Exempt Mutual Fund
Contents
Portfolio Profile 1
Portfolio Expenses 3
Financial Highlights 5
A Word About Risk 9
The Portfolios' Objective 9
Who Should Invest 9
Investment Strategy 10
Investment Policies 14
Investment Limitations 15
Investment Performance 16
Share Price 16
Dividends, Capital
Gains, and Taxes 17
The Portfolios and
Vanguard 18
Investment Adviser 18
General Information 19
Investing with Vanguard 20
Services and Account
Features 20
Types of Accounts 21
Distribution Options 21
Buying Shares 22
Redeeming Shares 24
Transferring Registration 26
Fund and Account Updates 27
Prospectus Postscript 28
Glossary Inside Back Cover
Investment Objective
Vanguard Municipal Bond Fund (the Fund) is an open-end investment company that
includes seven separate, diversified mutual fund portfolios: Money Market,
Short-Term, Limited-Term, Intermediate-Term, Long-Term, Insured Long-Term, and
High-Yield.
Each Portfolio seeks to provide income that is exempt from federal income
taxes. One Portfolio emphasizes stability; three Portfolios seek varying
levels of stability and income; three Portfolios emphasize income over
stability.
You can buy shares in any of the seven Portfolios that meet your investment
needs; you do not have to buy shares in all seven.
It is important to note that none of the Portfolios' shares is guaranteed or
insured by the FDIC or any other agency of the U.S. government. Although the
interest and principal payments for at least 80% of the bonds in the Insured
Long-Term Portfolio are guaranteed, the value of the bonds themselves is not
guaranteed. As with any investment in bonds, which are sensitive to changes in
interest rates, you could lose money by investing in any of the Portfolios.
Fees and Expenses
The Portfolios are offered on a no-load basis, which means that you pay no
sales commissions or 12b-1 marketing fees. You will, however, incur expenses
for investment advisory, management, administrative, and distribution
services, which are included in each Portfolio's expense ratio.
Additional Information About the Portfolios
A Statement of Additional Information (dated December 30, 1997) containing
more information about the Portfolios is, by reference, part of this
prospectus and may be obtained without charge by writing to Vanguard, calling
our Investor Information Department at 1-800-662-7447, or visiting the
Securities and Exchange Commission's website (http://www.sec.gov).
Why Reading This Prospectus Is Important
This prospectus explains the objective, risks, and strategy of each Vanguard
Municipal Bond Portfolio. To highlight terms and concepts important to mutual
fund investors, we have provided "Plain Talk" explanations along the way.
Reading the prospectus will help you to decide which Portfolios, if any, are
the right investment for you. We suggest that you keep it for future
reference.
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
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.
<PAGE>
Portfolio Profile Vanguard Municipal Bond Fund
Who Should Invest (page 9)
. Investors seeking a municipal bond mutual fund as part of a balanced and
diversified investment program.
. Income-oriented investors in a high federal tax bracket.
Who Should Not Invest
. Investors seeking growth of their investment over time.
. Investors in a retirement account.
. Investors unwilling to accept significant fluctuations in share prices
(intermediate- and longer-term portfolios).
Risks of the Portfolios (pages 9-15)
The total returns of six Portfolios (the Money Market Portfolio, which seeks to
maintain a stable share price, is the exception) will fluctuate within a wide
range, so an investor could lose money over short or even extended periods; this
fluctuation is the result of interest rate risk (the chance that bond prices
will decline because of rising interest rates).
All seven Portfolios are subject to income risk (the chance that falling
interest rates will cause the Portfolios' income--and thus the Portfolios'
return--to decline) and objective risk (the chance that a specific segment of
the municipal bond market will trail returns from the overall bond market). More
detailed information about risk--including risks specific to each Portfolio--is
provided beginning on page 9.
Dividends and Capital Gains (page 17)
Dividends are declared daily and paid on the first business day of each month.
Capital gains, if any, are paid annually in December.
Investment Adviser (page 18)
Vanguard Fixed Income Group, Valley Forge, Pa., manages each of the seven
Portfolios.
Minimum Initial Investment for Each Portfolio: $3,000; $1,000 for custodial
accounts for minors.
Account Features (page 20)
. Telephone Redemption
. Checkwriting
. Vanguard Direct Deposit Service(SM)
. Vanguard Automatic Exchange Service(SM)
. Vanguard Fund Express(R)
. Vanguard Dividend Express(SM)
Average Annual Total Returns--Periods Ended October 31, 1997
<TABLE>
<CAPTION>
1 Year 5 Years 10 Years
-------------------------
<S> <C> <C> <C>
Money Market 3.5% 3.1% 4.1%
Lipper Tax-Exempt
Money Market Average 3.0 2.7 3.7
Short-Term 4.0% 3.9% 5.1%
Lipper Short-Term Municipal
Bond Average 4.2 3.9 4.8
Limited-Term 5.0% 4.9% 6.3%
Lipper Limited-Term Municipal
Bond Average 4.9 4.6 5.7
Intermediate-Term 6.6% 7.1% 8.4%
Lipper Intermediate-Term
Municipal Bond Average 6.6 6.2 7.1
Long-Term 8.2% 8.2% 9.4%
Lipper General Municipal
Bond Average 8.1 7.0 8.3
Insured Long-Term 7.6% 7.9% 9.1%
Lipper Insured Municipal
Bond Average 7.4 6.8 8.2
High-Yield 8.4% 8.1% 9.6%
Lipper High-Yield Municipal
Bond Average 9.3 7.4 8.3
- ------------------------------------------------------------------------------
</TABLE>
In evaluating past performance, remember that it is not indicative of future
performance. Performance figures include the reinvestment of any dividend and
capital gain distributions. The returns shown are net of expenses, but they do
not reflect income taxes an investor would have incurred. Note, too, that both
the return and (except for the Money Market Portfolio) principal value of an
investment will fluctuate so that investors' shares, when redeemed, may be worth
more or less than their original cost.
1
<PAGE>
Portfolio Profile (continued) Vanguard Municipal Bond Fund
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
Money Market Short-Term Limited-Term
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Inception Date: 6/10/1980 9/1/1977 8/31/1987
Net Assets as of 10/31/1997: $5.4 billion $1.5 billion $2.0 billion
Portfolio's Expense Ratio for the
Period Ended 10/31/1997: 0.18%** 0.18%** 0.18%**
Loads, 12b-1 Marketing Fees: None None None
Suitable for IRAs: No No No
Newspaper Abbreviation: VangMB* MuSht MuLtd
Vanguard Fund Number: 045 041 031
Cusip Number: 922907506 922907100 922907704
Quotron Symbol: VMSXX.Q VWSTX.Q VMLTX.Q
- ------------------------------------------------------------------------------------------------
</TABLE>
*Money market funds are listed separately from the daily mutual fund listings.
**Annualized.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------
Insured
Intermediate-Term Long-Term Long-Term
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Inception Date: 9/1/1977 9/1/1977 9/30/1984
Net Assets as of 10/31/1997: $6.8 billion $1.2 billion $2.0 billion
Portfolio's Expense Ratio for the
Period Ended 10/31/1997: 0.18%** 0.18%** 0.18%**
Loads, 12b-1 Marketing Fees: None None None
Suitable for IRAs: No No No
Newspaper Abbreviation: MuInt MuLong MuInLg
Vanguard Fund Number: 042 043 058
Cusip Number: 922907209 922907308 922907605
Quotron Symbol: VWITX.Q VWLTX.Q VILPX.Q
- -----------------------------------------------------------------------------------------------
</TABLE>
**Annualized.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------
High-Yield
- -----------------------------------------------------------------------------------------------
<S> <C>
Inception Date: 12/27/1978
Net Assets as of 10/31/1997: $2.3 billion
Portfolio's Expense Ratio for the
Period Ended 10/31/1997: 0.19%**
Loads, 12b-1 Marketing Fees: None
Suitable for IRAs: No
Newspaper Abbreviation: MuHY
Vanguard Fund Number: 044
Cusip Number: 922907407
Quotron Symbol: VWAHX.Q
- -----------------------------------------------------------------------------------------------
</TABLE>
**Annualized.
2
<PAGE>
Portfolio Expenses
The examples below are designed to help you understand the various costs
you would bear, directly or indirectly, as an investor in one of the
Portfolios.
As noted in this table, you do not pay fees of any kind when you buy,
sell, or exchange shares of any Portfolio:
Shareholder Transaction Expenses
<TABLE>
<S> <C>
Sales Load Imposed on Purchases: None
Sales Load Imposed on Reinvested Dividends: None
Redemption Fees: None
Exchange Fees: None
</TABLE>
The next table illustrates the operating expenses that you would incur as a
shareholder of each Portfolio. These expenses are deducted from the Portfolio's
income before it is paid to you. Expenses include investment advisory fees as
well as the costs of maintaining accounts, administering a Portfolio, providing
shareholder services, and other activities. The expenses shown in the tables are
for the period ended October 31, 1997.
Annual Portfolio Operating Expenses
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
Money
Market Short-Term Limited-Term
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Management and Administrative Expenses: 0.13% 0.12% 0.13%
Investment Advisory Expenses: 0.01% 0.01% 0.01%
12b-1 Marketing Fees: None None None
Other Expenses
Marketing and Distribution
Costs: 0.03% 0.03% 0.02%
Miscellaneous Expenses
(e.g., Taxes, Auditing): 0.01% 0.02% 0.02%
----- ----- -----
Total Other Expenses: 0.05% 0.05% 0.04%
----- ----- -----
Total Operating Expenses
(Expense Ratio): 0.18% 0.18% 0.18%
===== ===== =====
</TABLE>
----------------
PLAIN TALK ABOUT
----------------
The Costs of Investing
Costs are an important consideration in choosing a mutual fund. That's because
you, as a shareholder, pay the costs of operating a fund, plus any transaction
costs associated with buying, selling, or exchanging shares. These costs can
erode a substantial portion of the gross income or capital appreciation a fund
achieves. Even seemingly small differences in fund expenses can, over time, have
a dramatic impact on a fund's performance.
----------------
PLAIN TALK ABOUT
----------------
Fund Expenses
All mutual funds have operating expenses. These expenses, which are deducted
from a fund's gross income, are expressed as a percentage of the net assets of
the fund. For example, the Limited-Term Portfolio's annualized expense ratio in
the period ended October 31, 1997, was 0.18%, or $1.80 per $1,000 of average net
assets. The average federal tax-exempt bond mutual fund (excluding money market
funds) had expenses during this period of 1.02%, or $10.20 per $1,000 of average
net assets, according to Lipper Analytical Services, Inc., which reports on the
mutual fund industry.
3
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
Intermediate- Insured
Term Long-Term Long-Term
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Management and Administrative Expenses: 0.13% 0.13% 0.13%
Investment Advisory Expenses: 0.01% 0.01% 0.01%
12b-1 Marketing Fees: None None None
Other Expenses
Marketing and Distribution
Costs: 0.02% 0.02% 0.02%
Miscellaneous Expenses
(e.g., Taxes, Auditing): 0.02% 0.02% 0.02%
----- ----- -----
Total Other Expenses: 0.04% 0.04% 0.04%
----- ----- -----
Total Operating Expenses
(Expense Ratio): 0.18% 0.18% 0.18%
===== ===== =====
<CAPTION>
- ------------------------------------------------------------------------------------------
High-Yield
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Management and Administrative Expenses: 0.13%
Investment Advisory Expenses: 0.01%
12b-1 Marketing Fees: None
Other Expenses
Marketing and Distribution Costs: 0.02%
Miscellaneous Expenses (e.g., Taxes, Auditing): 0.03%
-----
Total Other Expenses: 0.05%
-----
Total Operating Expenses (Expense Ratio): 0.19%
=====
</TABLE>
The following example is intended to help you compare the cost of investing in
the Portfolios to the cost of investing in other mutual funds. It illustrates
the hypothetical expenses that you would incur on a $1,000 investment over
various periods. The example assumes that (1) the Portfolio provides a return of
5% a year and (2) you redeem your investment at the end of each period.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
Portfolio 1 Year 3 Years 5 Years 10 Years
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Money Market $2 $6 $10 $23
Short-Term 2 6 10 23
Limited-Term 2 6 10 23
Intermediate-Term 2 6 10 23
Long-Term 2 6 10 23
Insured Long-Term 2 6 10 23
High-Yield 2 6 11 24
- ------------------------------------------------------------------------------------------
</TABLE>
This example should not be considered to represent actual expenses or
performance from the past or for the future, which may be higher or lower than
those shown.
4
<PAGE>
Financial Highlights
The following financial highlights tables show the results for a share
outstanding of each Portfolio for each of the last ten years ended August 31,
1997, and for the two-month period ended October 31, 1997. (Following August 31,
1997, the Fund changed its fiscal year-end to October 31.) The financial
statements that include these financial highlights were audited by Price
Waterhouse LLP, independent accountants. You should read this information in
conjunction with each Portfolio's financial statements and accompanying notes,
which appear, along with the audit report from Price Waterhouse, in the Fund's
most recent annual report to shareholders. The annual report is incorporated by
reference in the Statement of Additional Information and in this prospectus, and
contains a more complete discussion of each Portfolio's performance. You may
have the report sent to you without charge by writing to Vanguard or by calling
our Investor Information Department.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
MONEY MARKET PORTFOLIO
----------------------------------------------------------
Year Ended August 31,
Sep. 1 to ----------------------------------------------------------
Oct. 31, 1997 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period $1.00 $1.00 $1.00 $1.00 $1.00
--------------------------------------------------------------------------
Investment Operations
Net Investment Income .006 .034 .034 .036 .024
Net Realized and
Unrealized Gain (Loss)
on Investments -- -- -- -- --
--------------------------------------------------------------------------
Total from Investment
Operations .006 .034 .034 .036 .024
- ------------------------------------------------------------------------------------------------------------------------------------
Distributions
Dividends from
Net Investment Income (.006) (.034) (.034) (.036) (.024)
Distributions from
Realized Capital Gains -- -- -- -- --
--------------------------------------------------------------------------
Total Distributions (.006) (.034) (.034) (.036) (.024)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value,
End of Period $1.00 $1.00 $1.00 $1.00 $1.00
====================================================================================================================================
Total Return 0.59% 3.47% 3.48% 3.63% 2.43%
====================================================================================================================================
Ratios/Supplemental Data
Net Assets, End of
Period (Millions) $5,380 $5,345 $4,624 $4,166 $4,164
Ratio of Total Expenses to
Average Net Assets 0.18%* 0.19% 0.20% 0.22% 0.20%
Ratio of Net Investment
Income to Average
Net Assets 3.53%* 3.41% 3.42% 3.56% 2.41%
Portfolio Turnover Rate N/A N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
MONEY MARKET PORTFOLIO
--------------------------------------------------------------------------
Year Ended August 31,
--------------------------------------------------------------------------
1993 1992 1991 1990 1989 1988
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period $1.00 $1.00 $1.00 $1.00 $1.00 $1.00
--------------------------------------------------------------------------
Investment Operations
Net Investment Income .025 .035 .050 .057 .060 .048
Net Realized and
Unrealized Gain (Loss)
on Investments -- -- -- -- -- --
--------------------------------------------------------------------------
Total from Investment
Operations .025 .035 .050 .057 .060 .048
- ------------------------------------------------------------------------------------------------------------------------------------
Distributions
Dividends from
Net Investment Income (.025) (.035) (.050) (.057) (.060) (.048)
Distributions from
Realized Capital Gains -- -- -- -- -- --
--------------------------------------------------------------------------
Total Distributions (.025) (.035) (.050) (.057) (.060) (.048)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value,
End of Period $1.00 $1.00 $1.00 $1.00 $1.00 $1.00
====================================================================================================================================
Total Return 2.51% 3.54% 5.08% 5.90% 6.18% 4.91%
====================================================================================================================================
Ratios/Supplemental Data
Net Assets, End of
Period (Millions) $3,538 $3,165 $2,709 $2,488 $2,109 $2,150
Ratio of Total Expenses to
Average Net Assets 0.20% 0.23% 0.25% 0.25% 0.27% 0.29%
Ratio of Net Investment
Income to Average
Net Assets 2.48% 3.45% 4.94% 5.72% 5.99% 4.78%
Portfolio Turnover Rate N/A N/A N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
*Annualized
------------------
Plain Talk About
------------------
How to Read the Financial
Highlights Table
This explanation uses the Money Market Portfolio as an example. The Portfolio
began the period ended October 31, 1997, with a net asset value (price) of $1.00
per share. During the period, the Portfolio earned $.006 per share from
investment income (interest and dividends). All of these earnings were returned
to shareholders in the form of dividend distributions. The earnings ($.006 per
share) less distributions ($.006 per share) resulted in a share price of $1.00
at the end of the year. Assuming that the shareholder had reinvested the
distribution in purchasing more shares, total return from the Portfolio was
0.59% for the period. As of October 31, 1997, the Portfolio had $5.38 billion in
net assets; an annualized expense ratio of 0.18% ($1.80 per $1,000 of net
assets); and annualized net investment income amounting to 3.53% of its average
net assets.
5
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
SHORT-TERM PORTFOLIO
----------------------------------------------------------
Year Ended August 31,
Sep. 1 to ----------------------------------------------------------
Oct. 31, 1997 1997 1996 1995 1994 1993 1992
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $15.57 $15.54 $15.59 $15.46 $15.63 $15.64 $15.53
--------------------------------------------------------------------------
Investment Operations
Net Investment Income .103 .610 .609 .600 .534 .609 .720
Net Realized and Unrealized Gain (Loss) on Investments .010 .034 (.050) .131 (.150) .033 .171
--------------------------------------------------------------------------
Total from Investment Operations .113 .644 .559 .731 .384 .642 .891
- ------------------------------------------------------------------------------------------------------------------------------------
Distributions
Dividends from Net Investment Income (.103) (.610) (.609) (.600) (.534) (.609) (.720)
Distributions from Realized Capital Gains -- (.004) -- (.001) (.020) (.043) (.061)
--------------------------------------------------------------------------
Total Distributions (.103) (.614) (.609) (.601) (.554) (.652) (.781)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Period $15.58 $15.57 $15.54 $15.59 $15.46 $15.63 $15.64
====================================================================================================================================
Total Return 0.73% 4.22% 3.64% 4.83% 2.49% 4.18% 5.87%
====================================================================================================================================
Ratios/Supplemental Data
Net Assets, End of Period (Millions) $1,485 $1,464 $1,457 $1,442 $1,561 $1,329 $1,061
Ratio of Total Expenses to Average Net Assets 0.18%* 0.19% 0.20% 0.22% 0.20% 0.20% 0.23%
Ratio of Net Investment Income to Average Net Assets 3.96%* 3.91% 3.90% 3.88% 3.42% 3.88% 4.58%
Portfolio Turnover Rate 4% 34% 33% 32% 27% 46% 60%
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
SHORT-TERM PORTFOLIO
--------------------------------------
Year Ended August 31,
------------------------------------
1991 1990 1989 1988
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $15.35 $15.30 $15.21 $15.37
------------------------------------
Investment Operations
Net Investment Income .861 .906 .880 .785
Net Realized and Unrealized Gain (Loss) on Investments .180 .050 .090 (.056)
------------------------------------
Total from Investment Operations 1.041 .956 .970 .729
- --------------------------------------------------------------------------------------------------------------
Distributions
Dividends from Net Investment Income (.861) (.906) (.880) (.785)
Distributions from Realized Capital Gains -- -- -- (.104)
------------------------------------
Total Distributions (.861) (.906) (.880) (.889)
- --------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Period $15.53 $15.35 $15.30 $15.21
==============================================================================================================
Total Return 6.96% 6.42% 6.56% 4.89%
==============================================================================================================
Ratios/Supplemental Data
Net Assets, End of Period (Millions) $ 841 $ 751 $ 700 $ 841
Ratio of Total Expenses to Average Net Assets 0.25% 0.25% 0.27% 0.29%
Ratio of Net Investment Income to Average Net Assets 5.55% 5.90% 5.77% 5.13%
Portfolio Turnover Rate 104% 78% 54% 113%
- --------------------------------------------------------------------------------------------------------------
*Annualized
<CAPTION>
LIMITED-TERM PORTFOLIO
----------------------------------------------------------
Year Ended August 31,
Sep. 1 to ----------------------------------------------------------
Oct. 31, 1997 1997 1996 1995 1994 1993 1992
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $10.71 $10.62 $10.71 $10.57 $10.80 $10.64 $10.43
--------------------------------------------------------------------------
Investment Operations
Net Investment Income .078 .476 .483 .476 .454 .485 .541
Net Realized and Unrealized Gain (Loss) on Investments .030 .090 (.090) .140 (.208) .209 .271
--------------------------------------------------------------------------
Total from Investment Operations .108 .566 .393 .616 .246 .694 .812
- ------------------------------------------------------------------------------------------------------------------------------------
Distributions
Dividends from Net Investment Income (.078) (.476) (.483) (.476) (.454) (.485) (.541)
Distributions from Realized Capital Gains -- -- -- -- (.022) (.049) (.061)
--------------------------------------------------------------------------
Total Distributions (.078) (.476) (.483) (.476) (.476) (.534) (.602)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Period $10.74 $10.71 $10.62 $10.71 $10.57 $10.80 $10.64
====================================================================================================================================
Total Return 1.01% 5.44% 3.73% 5.99% 2.31% 6.68% 8.01%
====================================================================================================================================
Ratios/Supplemental Data
Net Assets, End of Period (Millions) $1,962 $1,929 $1,761 $1,669 $1,814 $1,625 $ 873
Ratio of Total Expenses to Average Net Assets 0.18%* 0.19% 0.21% 0.22% 0.20% 0.20% 0.23%
Ratio of Net Investment Income to Average Net Assets 4.34%* 4.46% 4.51% 4.51% 4.24% 4.50% 5.08%
Portfolio Turnover Rate 2% 28% 27% 35% 21% 20% 37%
- ------------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
LIMITED-TERM PORTFOLIO
--------------------------------------
Year Ended August 31,
--------------------------------------
1991 1990 1989 1988
- ----------------------------------------------------------------------------------------------------------------
<S> <S> <C> <C> <C>
Net Asset Value, Beginning of Period $10.17 $10.14 $10.10 $10.00
--------------------------------------
Investment Operations
Net Investment Income .614 .643 .638 .595
Net Realized and Unrealized Gain (Loss) on Investments .265 .041 .046 .100
--------------------------------------
Total from Investment Operations .879 .684 .684 .695
- ----------------------------------------------------------------------------------------------------------------
Distributions
Dividends from Net Investment Income (.614) (.643) (.638) (.595)
Distributions from Realized Capital Gains (.005) (.011) (.006) --
--------------------------------------
Total Distributions (.619) (.654) (.644) (.595)
- ----------------------------------------------------------------------------------------------------------------
Net Asset Value, End of Period $10.43 $10.17 $10.14 $10.10
================================================================================================================
Total Return 8.88% 6.93% 6.98% 7.11%
================================================================================================================
Ratios/Supplemental Data
Net Assets, End of Period (Millions) $ 420 $ 245 $ 166 $ 162
Ratio of Total Expenses to Average Net Assets 0.25% 0.25% 0.27% 0.29%
Ratio of Net Investment Income to Average Net Assets 5.91% 6.31% 6.33% 5.91%
Portfolio Turnover Rate 57% 55% 88% 122%
- ----------------------------------------------------------------------------------------------------------------
*Annualized
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
INTERMEDIATE-TERM PORTFOLIO
-------------------------------------------------------------------------------------
Year Ended August 31,
Sep. 1 to -------------------------------------------------------------------------------------
Oct. 31, 1997 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period $13.30 $13.04 $13.14 $13.02 $13.45 $12.85 $12.41 $11.90 $12.08 $11.71 $11.79
-------------------------------------------------------------------------------------------------
Investment Operations
Net Investment Income .111 .669 .671 .686 .683 .710 .747 .791 .822 .839 .800
Net Realized and
Unrealized Gain (Loss)
on Investments .050 .263 (.091) .278 (.354) .721 .516 .605 (.114) .370 .012
-------------------------------------------------------------------------------------------------
Total from Investment
Operations .161 .932 .580 .964 .329 1.431 1.263 1.396 .708 1.209 .812
- ------------------------------------------------------------------------------------------------------------------------------------
Distributions
Dividends from Net
Investment Income (.111) (.669) (.671) (.686) (.683) (.710) (.747) (.791) (.822) (.839) (.800)
Distributions from Realized
Capital Gains -- (.003) (.009) (.158) (.076) (.121) (.076) (.095) (.066) -- (.092)
-------------------------------------------------------------------------------------------------
Total Distributions (.111) (.672) (.680) (.844) (.759) (.831) (.823) (.886) (.888) (.839) (.892)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value,
End of Period $13.35 $13.30 $13.04 $13.14 $13.02 $13.45 $12.85 $12.41 $11.90 $12.08 $11.71
====================================================================================================================================
Total Return 1.21% 7.31% 4.47% 7.82% 2.49% 11.54% 10.52% 12.15% 6.05% 10.63% 7.22%
====================================================================================================================================
Ratios/Supplemental Data
Net Assets, End of
Period (Millions) $6,770 $6,658 $5,927 $5,448 $5,068 $4,945 $3,102 $2,006 $1,259 $1,005 $794
Ratio of Total Expenses to
Average Net Assets 0.18%* 0.19% 0.20% 0.22% 0.20% 0.20% 0.23% 0.25% 0.25% 0.27% 0.29%
Ratio of Net Investment
Income to Average
Net Assets 4.99%* 5.07% 5.09% 5.35% 5.15% 5.41% 5.91% 6.49% 6.83% 7.03% 6.88%
Portfolio Turnover Rate 1% 15% 14% 12% 18% 15% 32% 27% 54% 56% 89%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
*Annualized
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
LONG-TERM PORTFOLIO
-------------------------------------------------------------------------------------
Year Ended August 31,
Sep. 1 to -------------------------------------------------------------------------------------
Oct. 31, 1997 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period $11.11 $10.73 $10.68 $10.58 $11.38 $10.95 $10.58 $10.13 $10.53 $10.04 $10.38
-------------------------------------------------------------------------------------------------
Investment Operations
Net Investment Income .098 .588 .591 .608 .609 .640 .711 .722 .732 .760 .747
Net Realized and
Unrealized Gain (Loss)
on Investments .070 .403 .050 .256 (.595) .715 .561 .626 (.233) .490 (.022)
-------------------------------------------------------------------------------------------------
Total from Investment
Operations .168 .991 .641 .864 .014 1.355 1.272 1.348 .499 1.250 .725
- ------------------------------------------------------------------------------------------------------------------------------------
Distributions
Dividends from Net
Investment Income (.098) (.588) (.591) (.608) (.609) (.640) (.711) (.722) (.732) (.760) (.747)
Distributions from Realized
Capital Gains -- (.023) -- (.156) (.205) (.285) (.191) (.176) (.167) -- (.318)
-------------------------------------------------------------------------------------------------
Total Distributions (.098) (.611) (.591) (.764) (.814) (.925) (.902) (.898) (.899) (.760) (1.065)
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value,
End of Period $11.18 $11.11 $10.73 $10.68 $10.58 $11.38 $10.95 $10.58 $10.13 $10.53 $10.04
====================================================================================================================================
Total Return 1.52% 9.46% 6.08% 8.74% 0.08% 13.09% 12.60% 13.86% 4.88% 12.79% 7.57%
====================================================================================================================================
Ratios/Supplemental Data
Net Assets, End of
Period (Millions) $1,249 $1,222 $1,110 $1,054 $1,001 $1,131 $962 $798 $683 $626 $531
Ratio of Total Expenses to
Average Net Assets 0.18%* 0.19% 0.20% 0.23% 0.20% 0.20% 0.23% 0.25% 0.25% 0.27% 0.29%
Ratio of Net Investment
Income to Average
Net Assets 5.28%* 5.37% 5.45% 5.87% 5.56% 5.81% 6.52% 7.09% 7.04% 7.33% 7.48%
Portfolio Turnover Rate 1% 9% 26% 35% 45% 36% 63% 62% 110% 99% 34%
- ------------------------------------------------------------------------------------------------------------------------------------
*Annualized.
</TABLE>
7
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------------
INSURED LONG-TERM PORTFOLIO
-----------------------------------------------------------------------------------------
Year Ended August 31,
Sep. 1 to -----------------------------------------------------------------------------------------
Oct. 31, 1997 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period $12.45 $12.14 $12.12 $11.98 $12.89 $12.28 $11.74 $11.25 $11.67 $11.14 $11.24
--------------------------------------------------------------------------------------------------
Investment Operations
Net Investment Income .111 .674 .670 .684 .699 .718 .768 .775 .805 .833 .827
Net Realized and
Unrealized Gain (Loss)
on Investments .060 .382 .020 .313 (.734) .813 .616 .615 (.267) .530 --
--------------------------------------------------------------------------------------------------
Total from Investment
Operations .171 1.056 .690 .997 (.035) 1.531 1.384 1.390 .538 1.363 .827
- -------------------------------------------------------------------------------------------------------------------------------
Distributions
Dividends from Net
Investment Income (.111) (.674) (.670) (.684) (.699) (.718) (.768) (.775) (.805) (.833) (.827)
Distributions from Realized
Capital Gains -- (.072) -- (.173) (.176) (.203) (.076) (.125) (.153) -- (.100)
--------------------------------------------------------------------------------------------------
Total Distributions (.111) (.746) (.670) (.857) (.875) (.921) (.844) (.900) (.958) (.833) (.927)
- -------------------------------------------------------------------------------------------------------------------------------
Net Asset Value,
End of Period $12.51 $12.45 $12.14 $12.12 $11.98 $12.89 $12.28 $11.74 $11.25 $11.67 $11.14
===============================================================================================================================
Total Return 1.37% 8.93% 5.77% 8.88% -0.32% 13.06% 12.22% 12.79% 4.74% 12.57% 7.78%
===============================================================================================================================
Ratios/Supplemental Data
Net Assets, End of
Period (Millions) $2,043 $2,024 $1,936 $1,935 $1,938 $2,194 $1,947 $1,551 $1,122 $934 $735
Ratio of Total Expenses to
Average Net Assets 0.18%* 0.19% 0.20% 0.22% 0.20% 0.20% 0.23% 0.25% 0.25% 0.27% 0.29%
Ratio of Net Investment
Income to Average
Net Assets 5.32%* 5.47% 5.46% 5.82% 5.62% 5.77% 6.34% 6.77% 6.99% 7.24% 7.50%
Portfolio Turnover Rate 1% 18% 18% 7% 16% 30% 42% 33% 47% 36% 28%
- -------------------------------------------------------------------------------------------------------------------------------
*Annualized.
<CAPTION>
-----------------------------------------------------------------------------------------
HIGH-YIELD PORTFOLIO
-----------------------------------------------------------------------------------------
Year Ended August 31,
Sep. 1 to -----------------------------------------------------------------------------------------
Oct. 31, 1997 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value,
Beginning of Period $10.76 $10.39 $10.43 $10.39 $11.17 $10.76 $10.32 $9.90 $10.27 $9.73 $9.94
--------------------------------------------------------------------------------------------------
Investment Operations
Net Investment Income .106 .589 .594 .625 .626 .669 .723 .732 .739 .752 .745
Net Realized and
Unrealized Gain (Loss)
on Investments .070 .370 (.040) .213 (.566) .664 .546 .560 (.259) .540 (.006)
--------------------------------------------------------------------------------------------------
Total from Investment
Operations .176 .959 .554 .838 .060 1.333 1.269 1.292 .480 1.292 .739
- -------------------------------------------------------------------------------------------------------------------------------
Distributions
Dividends from Net
Investment Income (.106) (.589) (.594) (.625) (.626) (.669) (.723) (.732) (.739) (.752) (.745)
Distributions from Realized
Capital Gains -- -- -- (.173) (.214) (.254) (.106) (.140) (.111) -- (.204)
--------------------------------------------------------------------------------------------------
Total Distributions (.106) (.589) (.594) (.798) (.840) (.923) (.829) (.872) (.850) (.752) (.949)
- -------------------------------------------------------------------------------------------------------------------------------
Net Asset Value,
End of Period $10.83 $10.76 $10.39 $10.43 $10.39 $11.17 $10.76 $10.32 $ 9.90 $10.27 $9.73
===============================================================================================================================
Total Return 1.63% 9.45% 5.39% 8.69% 0.52% 13.08% 12.81% 13.66% 4.82% 13.64% 8.00%
===============================================================================================================================
Ratios/Supplemental Data
Net Assets, End of
Period (Millions) $2,256 $2,193 $1,985 $1,865 $1,781 $1,931 $1,505 $1,215 $962 $865 $690
Ratio of Total Expenses to
Average Net Assets 0.19%* 0.19% 0.20% 0.22% 0.20% 0.20% 0.23% 0.25% 0.25% 0.27% 0.29%
Ratio of Net Investment
Income to Average Net Assets 6.08%* 5.56% 5.66% 6.15% 5.83% 6.15% 6.83% 7.34% 7.30% 7.43% 7.74%
Portfolio Turnover Rate 3% 27% 19% 33% 50% 34% 64% 58% 82% 80% 40%
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
*Annualized.
8
<PAGE>
From time to time, the Vanguard Funds advertise yield and total return
figures. Yield is a historical measure of dividend income, and total return is a
measure of past dividend income (assuming that it has been reinvested) plus
realized and unrealized capital appreciation. Neither yield nor total return
should be used to predict the future performance of a fund.
================================================================================
A Word About Risk
This prospectus describes the risks you would face as an investor in the
Portfolios of Vanguard Municipal Bond Fund. It is important to keep in mind one
of the main axioms of investing: the higher the risk of losing money, the higher
the potential reward. The reverse, also is generally true: the lower the risk,
the lower the potential reward. As you consider an investment in one or more of
the Fund's Portfolios, you should weigh your need for tax-free income with your
personal tolerance for the daily fluctuations of the bond market.
Look for this "warning flag" symbol [FLAG APPEARS HERE] throughout the
prospectus. It is used to mark detailed information about each type of risk that
you, as a shareholder of any of the Portfolios, would confront.
================================================================================
The Portfolios' Objective
Each Portfolio seeks to provide varying amounts of income that is exempt from
federal income taxes. This objective is fundamental, which means that it cannot
be changed unless a majority of Portfolio shareholders vote to do so.
[FLAG Because of the several types of risks described on the following
APPEARS pages, your investment in one or more of the Portfolios, as with any
HERE] investment in bonds, could lose money.
Who Should Invest
Any of the Portfolios of Vanguard Municipal Bond Fund may be suitable for you
if:
. You wish to add a municipal bond income fund to your existing holdings,
which could include other tax-exempt--as well as stock, money market, and
taxable bond--investments.
. You are seeking income that is exempt from federal income taxes.
However, one Portfolio may more closely meet your personal investment
objectives than the others. For instance, the Money Market Portfolio may be
suitable for you if:
. You do not want fluctuation in the share price of your investment.
----------------
PLAIN TALK ABOUT
----------------
Municipal Bonds
Municipal bonds are securities issued by state and local governments and
regional government authorities as a way of raising money for public
construction projects (for example, highways, airports, housing); for operating
expenses; or for loans to public institutions and facilities. Generally,
investors can choose from thousands of municipal bond offerings.
9
<PAGE>
----------------
PLAIN TALK ABOUT
----------------
Taxable Versus
Tax-Exempt Investments
You may not always profit from a tax-exempt investment; some taxable investments
could serve you better. To determine which is more suitable, figure out the tax-
exempt portfolio's taxable equivalent yield. You do this by dividing the
portfolio's tax-exempt yield by the total of 100% minus your tax bracket. For
example, if you are in the 28% federal tax bracket, and can earn a tax-exempt
yield of 5%, the taxable equivalent yield would be 6.94% (5.0% / 72% [100% -
28%]). In this example, you would choose the tax-exempt portfolio if its taxable
equivalent yield of 6.94% were greater than the yield of a similar, though
taxable, investment.
----------------
PLAIN TALK ABOUT
----------------
Bonds and Interest Rates
When interest rates rise, bond prices fall. The opposite is also true: bond
prices go up when interest rates fall. Why do bond prices and interest rates
move in opposite directions? Let's assume that you hold a bond offering a 5%
yield. A year later, interest rates are on the rise and bonds are offered with a
6% yield. With higher-yielding bonds available, you would have trouble selling
your 5% bond for the price you paid--causing you to lower your asking price. On
the other hand, if interest rates were falling and 4% bonds were being offered,
you would be able to sell your 5% bond for more than you paid.
. You are seeking a short-term investment vehicle.
The Short-Term, Limited-Term, and Intermediate-Term Portfolios may be
suitable for you if:
. You are seeking a moderate level of tax-exempt income and a moderate amount
of share-price fluctuation.
The Long-Term, Insured Long-Term, and High-Yield Portfolios may be suitable
for you if:
. You are seeking a greater amount of tax-exempt income and are willing to
accept significant fluctuations in share price.
None of the Portfolios are appropriate investments if you are a
market-timer. Investors who engage in excessive in-and-out trading activity
generate additional costs that are borne by all of the shareholders in a
Portfolio. To minimize such costs, which reduce the ultimate returns achieved by
you and other shareholders, the Fund has adopted the following policies:
. Each Portfolio reserves the right to reject any purchase request--including
exchanges from other Vanguard funds--that it regards as disruptive to the
efficient management of the Portfolio. This could be because of the timing
of the investment or because of a history of excessive trading by the
investor.
. There is a limit on the number of times you can exchange into or out of a
Portfolio (see "Redeeming Shares" in the Investing with Vanguard section).
. The Fund reserves the right to stop offering shares at any time.
Investment Strategy
This section explains how the Portfolios' investment adviser seeks to provide
income that is exempt from federal income taxes. It also explains several
important risks--income risk, interest rate risk, call risk, objective risk,
credit risk, and manager risk--faced by Portfolio shareholders. The adviser's
investment strategy is not fundamental and can be changed by the Fund's Board of
Directors without shareholder approval. However, before making any important
change in its strategy, the Fund will give shareholders 30 days' notice, in
writing.
Market Exposure
Each of the Portfolios invests in municipal bonds that, depending on their
maturity and quality, provide varying amounts of tax-exempt income.
[FLAG Each Portfolio is subject to income risk, which is the possibility
APPEARS that a Portfolio's dividends (income) will fall due to falling
HERE] interest rates. Income risk is generally the greatest for short-term
bonds, and the least for long-term bonds.
Changes in interest rates will affect bond prices as well as bond income.
10
<PAGE>
[FLAG Six of the seven Portfolios (the Money Market Portfolio is the
APPEARS exception) are subject to interest rate risk, which is the possibility
HERE] that bond prices overall will decline over short or even extended
periods due to rising interest rates. Interest rate risk should be
modest for shorter-term bonds, moderate for intermediate-term bonds,
and high for longer-term bonds.
In the past, bond investors have seen the value of their investment rise and
fall--sometimes significantly--with changes in interest rates. Between December
1976 and September 1981, for instance, rising interest rates caused long-term
bond prices to fall by almost 48%.
Because each Portfolio (except the Money Market Portfolio) invests mainly in
bonds, changes in interest rates will impact, to varying degrees, the value of
each Portfolio's assets. To illustrate how much of an impact, the following
table shows the effect of a 2% change (both up and down) in interest rates on
three bonds with a face value of $1,000; each has a different maturity.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
How Interest Rate Changes Affect Bonds*
- --------------------------------------------------------------------------------
Value of a $1,000 Bond Value of a $1,000 Bond
After a 2% Increase After a 2% Decrease
Maturity in Interest Rates in Interest Rates
- --------------------------------------------------------------------------------
<S> <C> <C>
Short-Term (2.5 years) $956 $1,046
Intermediate-Term (10 years) 870 1,156
Long-Term (20 years) 816 1,251
- --------------------------------------------------------------------------------
</TABLE>
*Assuming a 7% yield.
These figures are for illustration only and should not be regarded as an
indication of future returns from the municipal bond market as a whole, or any
Portfolio in particular.
Falling interest rates can cause other problems for bond portfolio
shareholders.
[FLAG Six of the seven Portfolios (the Money Market Portfolio is the
APPEARS exception) are subject to call risk, which is the possibility that
HERE] during periods of falling interest rates, a bond issuer will
"call"--or repay--its high-yielding bond before the bond's maturity
date. Forced to invest the unanticipated proceeds at lower interest
rates, the Portfolio would experience a decline in income--and the
potential for taxable capital gains.
Security Selection
Vanguard Fixed Income Group, adviser to the Portfolios, selects bonds issued by
different state and local governments and government authorities. The municipal
bonds held by each Portfolio differ significantly in terms of maturity and
quality. Up to 20% of each Portfolio may be invested in securities that are
subject to the
----------------
PLAIN TALK ABOUT
----------------
Bond Maturities
A bond is issued with a specific maturity date--the date when the bond's issuer,
or seller, must pay back the bond's initial value (known as its "face value").
Bond maturities generally range from less than one year (short term) to 30 years
(long term). The longer a bond's maturity, the more risk you, as a bond
investor, face as interest rates rise--but also the more interest you could
receive. Long-term bonds are more suitable for investors willing to take greater
risks in hopes of higher yields; short-term bond investors should be willing to
accept lower yields in return for less fluctuation in the value of their
investment.
----------------
PLAIN TALK ABOUT
----------------
Callable Bonds
Although bonds are issued with clearly defined maturities, a bond issuer may be
able to redeem, or call, a bond earlier than its maturity date. The bondholder
must now replace the called bond with a bond that may have a lower yield than
the original. One way for bond investors to protect themselves against call risk
is to purchase a bond early in its lifetime, when it is less likely to be
called. Another way is to buy bonds with call protection--that is, assurance
that a bond will not be called for a specific time period, such as ten years.
11
<PAGE>
----------------
PLAIN TALK ABOUT
----------------
Credit Quality
A bond's credit quality depends on the issuer's ability to pay interest on the
bond and, ultimately, to repay the debt. The lower the rating by one of the
independent bond-rating agencies (for example, Moody's or Standard & Poor's),
the greater the chance (in the rating agency's opinion) the bond issuer will
default, or fail to meet its payment obligations. Most bond-rating agencies use
a descending alphabet scale to rate bonds (for example, Aaa is the highest
rating, C among the poorest quality). All things being equal, the lower a bond's
credit rating, the higher the yield the bond seeks to pay (as compensation for
the risks an investor must take).
Alternative Minimum Tax (AMT). A "Plain Talk" about the AMT appears on page 13.
[FLAG The Portfolios are subject to objective risk, which is the possibility
APPEARS that returns from a particular bond market segment (for example, bonds
HERE] of a specific quality or with a specific maturity) will trail returns
from the overall bond market.
The Money Market Portfolio invests in a variety of high-quality, short-term
municipal securities. The Portfolio seeks to provide a stable net asset value of
$1 per share by investing in securities with a maturity of 397 days or less and
by maintaining a dollar-weighted average maturity of 90 days or less. An
investment in a money market fund is neither insured nor guaranteed by the U.S.
government, and there can be no assurance that the fund will be able to maintain
a stable net asset value of $1 per share.
At least 75% of the securities held by the Short-Term, Limited-Term,
Intermediate-Term, and Long-Term Portfolios are invested in municipal bonds in
the top three ratings categories (Aaa, Aa, and A for Moody's Investors Service,
Inc., or AAA, AA, and A for Standard & Poor's Corporation). No more than 20% of
each Portfolio's assets may be invested in bonds rated Baa (by Moody's) or BBB
(by Standard & Poor's). The remaining 5% may be invested in securities with
lower ratings or that are unrated.
The Short-Term Portfolio holds securities with maturities of not greater than
five years and is expected to maintain a dollar-weighted average maturity of one
to two years.
The Limited-Term Portfolio holds securities with maturities of not greater
than ten years and is expected to maintain a dollar-weighted average maturity of
two to five years.
While the Intermediate-Term Portfolio and the Long-Term Portfolio have no
limitations about the maturity of individual securities, the Intermediate-Term
Portfolio is expected to maintain a dollar-weighted average maturity of 7 to 12
years and the Long-Term Portfolio is expected to maintain a dollar-weighted
average maturity of between 15 and 25 years.
At least 80% of the assets of the Insured Long-Term Portfolio is invested in
municipal bonds whose principal and interest payments are guaranteed by a top-
rated private insurance company at the time of purchase. This insurance coverage
may take one of several forms:
. A new issue insurance policy, which is purchased by a bond issuer at the
time the security is issued. This insurance is likely to increase the
credit rating of the security, as well as its purchase price and resale
value.
. A mutual fund insurance policy, which is used to guarantee specific bonds
only while held by a mutual fund. For the Insured Long-Term Portfolio
(which has obtained a policy from Financial Guaranty Insurance Company),
the annual premiums for the policy may reduce the Portfolio's current
yield.
12
<PAGE>
. A secondary market insurance policy, which is purchased by an investor (such
as the Insured Long-Term Portfolio) after a bond has been issued and insures
the bond until its maturity date.
Typically, an insured municipal bond in the Portfolio will be covered by only
one of the three policies. For instance, if a bond is covered by a new issue
insurance policy or a secondary market insurance policy, the security will
probably not be insured under the Portfolio's mutual fund insurance policy.
The remaining 20% of the Insured Long-Term Portfolio's assets may be invested
in municipal securities with a minimum quality rating of A by a Nationally
Recognized Statistical Rating Organization (NRSRO) or equivalent rating firm.
Although the Portfolio has no limitations as to maturity, its dollar-weighted
average maturity is expected to be between 15 and 25 years.
The High-Yield Portfolio invests at least 80% of its assets in investment-
grade municipal securities (that is, securities with ratings of Baa or higher)
and up to 20% in bonds that are rated less than Baa or are unrated.
[PICTURE OF FLAG Each Portfolio is subject to credit risk, which is the
APPEARS HERE] possibility that a bond issuer will fail to repay interest
and principal in a timely manner.
Credit risk should be very low for the Insured Long-Term Portfolio, low for
the Money Market, Short-Term, Limited-Term, Intermediate-Term, and Long-Term
Portfolios, and moderate for the High-Yield Portfolio. The average qualities of
each Portfolio, as rated by Moody's Investors Service, as of October 31, 1997,
follow.
<TABLE>
<CAPTION>
--------------------------------------------
Average
Portfolio Quality
--------------------------------------------
<S> <C>
Money Market MIG-1
Short-Term Aa1
Limited-Term Aa1
Intermediate-Term Aa1
Long-Term Aa1
Insured Long-Term Aaa
High-Yield Aa3
--------------------------------------------
</TABLE>
The Portfolios try to minimize credit risk by purchasing a wide selection of
municipal securities issued by many different state and local governments. As a
result, there is less chance that a Portfolio will be hurt by a particular bond
issuer's failure to repay either principal or interest.
[PICTURE OF FLAG The Portfolios are subject to manager risk, which is the
APPEARS HERE] possibility that Vanguard Fixed Income Group will do a
poor job of selecting securities.
------------------
PLAIN TALK ABOUT
------------------
Alternative Minimum Tax
Certain tax-exempt bonds whose proceeds are used to fund private, for-profit
organizations are subject to the Alternative Minimum Tax (AMT)--a special tax
system that ensures that individuals pay at least some federal taxes. Although
AMT bond income is exempt from federal regular income tax, a very limited number
of taxpayers who have many tax deductions may have to pay Alternative Minimum
Tax on the income from bonds considered "tax-preference items."
13
<PAGE>
------------------
PLAIN TALK ABOUT
------------------
Portfolio Turnover
Before investing in a mutual fund, you should review its portfolio turnover rate
for an indication of the potential effect of transaction costs on the fund's
future returns. In general, the greater the volume of buying and selling by the
fund, the greater the impact that brokerage commissions and other transaction
costs will have on its return. Also, funds with high portfolio turnover rates
may be more likely than low-turnover funds to generate capital gains that must
be distributed to shareholders as taxable income. The average turnover rate for
actively managed tax-exempt bond funds (excluding money market funds) is 57%.
------------------
PLAIN TALK ABOUT
------------------
Derivatives
A derivative is a financial contract whose value is based on (or "derived" from)
a traditional security (such as a stock or a bond), an asset (such as a
commodity like gold), or a market index (such as the S&P 500 Index). Futures and
options are derivatives that have been trading on regulated exchanges for more
than two decades. These "traditional" derivatives are standardized contracts
that can easily be bought and sold, and whose market values are determined and
published daily. It is these characteristics that differentiate futures and
options from the relatively new types of derivatives--such as swap agreements
and partnerships or grantor trust-type derivatives. If used for speculation or
as leveraged investments, derivatives can carry considerable risks.
To help you distinguish between the Portfolios and their various risks, a
summary table is provided below.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Risks of the Portfolios
- --------------------------------------------------------------------------------
Income Interest Call Credit
Portfolio Risk Rate Risk Risk Risk
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Money Market High Low Negligible Low
Short-Term High Low Low Low
Limited-Term Moderate Moderate Low Low
Intermediate-Term Moderate Moderate Moderate Low
Long-Term Low High High Low
Insured Long-Term Low High High Very Low
High-Yield Low High High Moderate
- --------------------------------------------------------------------------------
</TABLE>
Portfolio Turnover
Although the Portfolios generally seek to invest for the long term, they retain
the right to sell securities regardless of how long they have been held.
Shorter-term bonds will mature, and need to be replaced, more frequently than
longer-term bonds. As a result, shorter-term bond portfolios may tend to have
higher portfolio turnover rates than longer-term bond portfolios.
Investment Policies
Besides investing in high-quality municipal bonds, each Portfolio may follow a
number of investment policies to achieve its objective.
[PICTURE OF FLAG The Portfolios may invest, to a limited extent, in
APPEARS HERE] derivatives.
The Money Market Portfolio may invest in partnership and grantor trust-type
derivatives. Ownership of derivative securities allows the purchaser to receive
principal and interest payments on underlying municipal bonds or municipal
notes. There are many types of derivatives, including derivatives in which the
tax-exempt interest rate is determined by an index, a swap agreement, or some
other formula.
The Money Market Portfolio intends to use derivatives to increase the
diversification and maintain the quality of securities held by the Portfolio.
Derivative securities are subject to certain structural risks that, in
unexpected circumstances, could cause the Portfolio's shareholders to lose money
or receive taxable income. However, the Portfolio will invest in derivatives
only when these securities are judged consistent with the Portfolio's objective
of maintaining a stable $1 share price and producing tax-exempt income.
The Short-Term, Limited-Term, Intermediate-Term, Long-Term, Insured Long-Term,
and High-Yield Portfolios may invest in bond (interest rate) futures and options
contracts and other types of derivatives. Losses (or gains) involving futures
can sometimes
14
<PAGE>
be substantial--in part because a relatively small price movement in a futures
contract may result in an immediate and substantial loss (or gain) for a
portfolio. The Portfolios will keep separate cash reserves or other liquid
portfolio securities in the amount of the obligation underlying the futures
contract. Only a limited percentage of a Portfolio's assets--5%--may be applied
toward the deposits required on futures contracts, and the value of all futures
contracts in which a Portfolio acquires an interest cannot exceed 20% of the
Portfolio's total assets. The reasons for which a Portfolio may use futures and
options are:
. To keep cash on hand to meet shareholder redemptions or other needs while
simulating full investment in bonds.
. To make it easier to trade.
. To reduce the Portfolio's transaction costs by buying futures instead of
actual bonds when futures are cheaper.
The Portfolios will not use futures and options for speculative purposes or as
leveraged investments that magnify the gains or losses of an investment. The
Statement of Additional Information offers a detailed explanation of the types
of derivatives in which the Portfolios may invest.
The Portfolios will usually hold only a small percentage of their assets in
cash reserves, although if the investment adviser believes that market
conditions warrant a temporary defensive measure, the Portfolios may hold cash
reserves without limit.
Each Portfolio may purchase tax-exempt securities on a "when-issued" basis.
With "when-issued" securities, a Portfolio agrees to buy the securities at a
certain price, even if the market price of the securities at the time of
delivery is higher or lower than the agreed-upon purchase price.
Investment Limitations
To reduce risk, the Portfolios have adopted certain fundamental limitations on
some of their investment policies. Some of these limitations are that each
Portfolio may not:
. Invest more than 5% of its assets in the securities of any single issuer,
except the U.S. government.
. Invest more than 25% of its assets in any one state.
. Borrow money, except for temporary or emergency purposes, such as meeting
shareholder requests to redeem shares, and then not in amounts that exceed
10% of a Portfolio's net assets. A Portfolio will repay all money borrowed
before making additional investments.
A complete list of applicable investment limitations can be found in the
Statement of Additional Information; these are fundamental and may be changed
only by approval of a majority of Portfolio shareholders.
----------------
PLAIN TALK ABOUT
----------------
Cash Reserves
With mutual funds, holding cash reserves--"cash"--does not mean literally that
the fund holds a stack of currency. Rather, cash refers to short-term, interest-
bearing securities that can easily and quickly be converted to cash. (Most
mutual funds keep at least a small percentage of assets in cash to accommodate
shareholder redemptions.) While some funds strive to keep cash levels at a
minimum and to always remain fully invested in bonds, other bond funds allow
investment advisers to hold up to 20% or more of a fund's assets in cash
reserves.
15
<PAGE>
----------------
PLAIN TALK ABOUT
----------------
Past Performance
Whenever you see information on a fund's performance, do not consider the
figures to be an indication of the performance you could expect by making an
investment in the fund today. The past is an imperfect guide to the future;
history does not repeat itself in neat, predictable patterns.
Investment Performance
The Portfolios of Vanguard Municipal Bond Fund invest in bonds with a variety of
maturities from a variety of issuers, so their performance will differ depending
upon the performance of specific bond market segments. Historically, changes in
interest rates have been--and remain--the strongest influence on bond market
performance.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Average Annual Total Returns
For Periods Ended 10/31/1997
- --------------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Money Market 3.5% 3.6% 3.1% 4.1%
Lipper Tax-Exempt Money
Market Average 3.0 3.1 2.7 3.7
- --------------------------------------------------------------------------------
Short-Term 4.0% 4.4% 3.9% 5.1%
Lipper Short-Term Municipal
Bond Average 4.2 4.4 3.9 4.8
- --------------------------------------------------------------------------------
Limited-Term 5.0% 5.5% 4.9% 6.3%
Lipper Limited-Term Municipal
Bond Average 4.9 5.0 4.6 5.7
- --------------------------------------------------------------------------------
Intermediate-Term 6.6% 7.8% 7.1% 8.4%
Lipper Intermediate-Term
Municipal Bond Average 6.6 7.3 6.2 7.1
- --------------------------------------------------------------------------------
Long-Term 8.2% 10.2% 8.2% 9.4%
Lipper General Municipal
Bond Average 8.1 8.9 7.0 8.3
- --------------------------------------------------------------------------------
Insured Long-Term 7.6% 9.8% 7.9% 9.1%
Lipper Insured Municipal
Bond Average 7.4 8.9 6.8 8.2
- --------------------------------------------------------------------------------
High-Yield 8.4% 10.0% 8.1% 9.6%
Lipper High-Yield Municipal
Bond Average 9.3 9.2 7.4 8.3
- --------------------------------------------------------------------------------
</TABLE>
The results shown above represent the Portfolios' "average annual total
return" performance, which assumes that any distributions of capital gains and
dividends were reinvested for the indicated periods. Also included is
comparative information for each Portfolio's unmanaged benchmark index. The
chart does not make any allowance for state or local income taxes that
shareholders must pay on a current basis.
Share Price
Each Portfolio's share price, called its net asset value, is calculated each
business day after the close of regular trading (generally 4 p.m. Eastern time)
on the New York Stock Exchange. Net asset
16
<PAGE>
value per share is computed by adding up the total value of the Portfolio's
investments and other assets, subtracting any of its liabilities, or debts, and
then dividing by the number of Portfolio shares outstanding:
Total Portfolio Assets - Liabilities
Net Asset Value = ----------------------------------------
Number of Portfolio Shares Outstanding
Daily net asset value, or NAV, is useful to you as a shareholder because the
NAV, multiplied by the number of Portfolio shares you own, gives you the dollar
amount you would have received had you sold all of your shares back to the
Portfolio that day.
With the exception of the Money Market Portfolio (which seeks to maintain a
stable net asset value of $1 per share), each Portfolio's share price can be
found daily in the mutual fund listings of most major newspapers under the
heading Vanguard Group. Different newspapers use different abbreviations of the
Portfolios' names, but the most common are MuSht, MuLtd, MuInt, MuLong, MuInLg,
and MuHY. The Money Market Portfolio is listed, along with other money market
funds, separately from other mutual funds; its abbreviation is VangMB.
Dividends, Capital Gains, and Taxes
The Portfolios' dividends accrue daily. On the first business day of every
month, the Portfolios distribute to shareholders virtually all of their income
from interest and dividends as dividend distributions. Any capital gains
realized from the sale of securities are distributed annually in December. In
addition, the Portfolios may occasionally be required to make supplemental
dividend or capital gain distributions at some other time during the year. Your
distributions of income or capital gains are automatically reinvested in more
shares of a Portfolio, unless you elect to receive the distributions in cash. In
either case, distributions of capital gains (but not dividends) that are
declared in December--if paid to you by the end of January--are taxed as if they
had been paid to you in December. Vanguard will send you a statement each year
showing the tax status of all your distributions.
. The short-term capital gains that you receive are taxable to you as
ordinary dividend income for federal income tax purposes. Any distributions
of net long-term capital gains by a Portfolio are taxable to you as
long-term capital gains, no matter how long you've owned shares in the
Portfolio. Long-term gains may be taxed at different rates depending on how
long the Portfolios held the securities. Capital gain distributions are
taxable to you whether received in cash or reinvested in additional shares.
Although the Portfolios do not seek to realize any particular amount of
capital gains during a year, such gains are realized from time to time as
by-products of the ordinary investment activities of the Portfolios. Keep
in mind, however, that capital
----------------
PLAIN TALK ABOUT
----------------
Distributions
As a shareholder, you are entitled to your share of a Portfolio's income from
interest and dividends, and gains from the sale of investments. You receive such
earnings as either an income dividend or capital gain distribution. Income
dividends come from interest and dividends the Portfolio earns from its money
market and bond investments. Capital gains are realized whenever the Portfolio
sells securities for higher prices than it paid for them. These capital gains
are either short-term or long-term, depending on whether a Portfolio held the
securities for less than or more than one year.
----------------
PLAIN TALK ABOUT
----------------
"Buying a Capital Gain"
It is not to your advantage to buy shares of a Portfolio shortly before it makes
a capital gains distribution, because part of your investment will come back to
you as a taxable distribution. This is known as "buying a capital gain." For
example: on December 15, you invest $5,000, buying 250 shares for $20 each. If
the Portfolio pays a capital gain distribution of $1 per share on December 16,
its share price would drop to $19 (not counting market change). You would still
have only $5,000 (250 shares x $19 = $4,750 in share value, plus 250 shares x
$1 = $250 in capital gains distributions), but you would owe tax on the $250
capital gain you received, even if you had reinvested it in more shares. To
avoid "buying a capital gain," check a Portfolio's distribution schedule before
you invest.
17
<PAGE>
------------------
PLAIN TALK ABOUT
------------------
Vanguard's Unique
Corporate Structure
The Vanguard Group, Inc. is the only mutual mutual fund company. It is owned
jointly by the funds it oversees and by the shareholders in those funds. Other
mutual funds are operated by for-profit management companies that may be owned
by one person, by a group of individuals, or by investors who bought the
management company's publicly traded stock. Vanguard operates its funds at cost.
Instead of distributing profits to a separate management company, Vanguard
returns profits to fund shareholders in the form of lower operating expenses.
------------------
PLAIN TALK ABOUT
------------------
The Fund's Adviser
The managers responsible for the Fund are:
Ian A. MacKinnon, Managing Director; has worked in investment management since
1974; primary responsibility for Vanguard's internal fixed-income policy and
strategy since 1981; B.A., Lafayette College, M.B.A., Pennsylvania State
University.
Christopher M. Ryon, CFA, Principal, and (since 1988) Portfolio Manager of the
Intermediate-Term and Long-Term Portfolios; has worked in investment management
since 1985; B.S., Villanova University, M.B.A., Drexel University.
Reid O. Smith, CFA, Principal, and (since June 1996) Portfolio Manager of the
Insured Long-Term and High-Yield Portfolios; has worked in investment management
since 1984; B.A. and M.B.A., University of Hawaii.
Pamela Wisehaupt Tynan, Principal, and (since 1988) Portfolio Manager of the
Money Market, Short-Term and Limited-Term Portfolios; has worked in investment
management since 1982; B.S., Temple University.
gains are not expected to be a significant part of any Portfolio's investment
return.
. If you sell or exchange shares of a Portfolio, any gain or loss you have is a
taxable event, which means that you may have a capital gain to report as
income, or a capital loss to report as a deduction, when you complete your
federal income tax return.
. Distributions of dividends or capital gains, and capital gains or losses from
your sale or exchange of Portfolio shares, may be subject to state and local
income taxes as well.
The tax information in this prospectus is provided as general information. You
should consult your own tax adviser about the tax consequences of an investment
in one of the Portfolios.
The Portfolios and Vanguard
The Portfolios are part of Vanguard Municipal Bond Fund. The Fund is a member of
The Vanguard Group, a family of more than 30 investment companies with more than
95 distinct investment portfolios and total net assets of more than $310
billion. All of the Vanguard funds share in the expenses associated with
business operations, such as personnel, office space, equipment, and
advertising.
Vanguard also provides marketing services to the funds. Although shareholders
do not pay sales commissions or 12b-1 marketing fees, each fund pays its
allocated share of The Vanguard Group's costs.
A list of the Fund's Directors and officers, and their present positions and
principal occupations during the past five years, can be found in the Statement
of Additional Information.
Investment Adviser
Vanguard Fixed Income Group, P.O. Box 2600, Valley Forge, PA 19482, provides
investment advisory service to the Portfolios of Vanguard Municipal Bond Fund on
an at-cost basis, subject to the control of the officers and Directors of the
Fund.
The Group currently manages more than $92 billion invested in some 40 Vanguard
Portfolios.
Vanguard Fixed Income Group chooses brokers or dealers to handle the purchase
and sale of the Portfolios' securities, and is directed to get the best
available price and most favorable execution from these brokers or dealers with
respect to all transactions.
18
<PAGE>
General Information
Vanguard Municipal Bond Fund is a corporation organized under the laws of the
state of Maryland. Shareholders of the Fund's Portfolios have rights and
privileges similar to those enjoyed by other corporate shareholders. For
example, shareholders will not be responsible for any liabilities of a
Portfolio. If any matters are to be voted on by shareholders (such as a change
in a fundamental investment objective or the election of directors), each
Portfolio share outstanding at that point would be entitled to one vote. Annual
meetings will not be held except as required by the Investment Company Act of
1940. A meeting will be scheduled to vote on the removal of a Director if the
holders of at least 10% of the Fund's shares request a meeting in writing.
19
<PAGE>
- --------------------------------------------------------------------------------
Investor Information 1-800-662-7447 Tele-Account 1-800-662-6273
Client Services 1-800-662-2739
- --------------------------------------------------------------------------------
Investing with Vanguard
Are you looking for the most convenient way to open or add money to a Vanguard
account? Obtain instant access to fund information? Establish an account for a
minor child or for your retirement savings?
Vanguard can help. Our goal is to make it easy and pleasant for you to do
business with us.
The following sections of the prospectus briefly explain the many services we
offer you as a shareholder in a Vanguard Municipal Bond Fund. Booklets providing
detailed information are available on the services marked with a [PICTURE OF
BOOK APPEARS HERE]. Please call us to request copies.
Services and Account Features
Vanguard offers many services that make it convenient to buy, sell, or exchange
shares.
<TABLE>
- ----------------------------------------------------------------------------------------------------------------
<S> <C>
Telephone Redemptions Automatically set up for each Portfolio unless you notify us otherwise.
(Sales and Exchanges)
- ----------------------------------------------------------------------------------------------------------------
Checkwriting Method for drawing money from your account by writing a check for $250 or
more.
- ----------------------------------------------------------------------------------------------------------------
Vanguard Direct Deposit Automatic method for depositing your paycheck or U.S. government payment
Service (including Social Security and government pension checks) into your
[PICTURE OF BOOK APPEARS HERE] account.
- ----------------------------------------------------------------------------------------------------------------
Vanguard Automatic Exchange Automatic method for moving a fixed amount of money from one Vanguard fund
Service account to another.*
[PICTURE OF BOOK APPEARS HERE]
- ----------------------------------------------------------------------------------------------------------------
Vanguard Fund Express Electronic method for buying or selling shares. You can transfer money
[PICTURE OF BOOK APPEARS HERE] between your Vanguard fund account and an account at your bank, savings and
loan, or credit union on a systematic schedule or whenever you wish.*
- ----------------------------------------------------------------------------------------------------------------
Vanguard Dividend Express Electronic method for transferring dividend and/or capital gain
[PICTURE OF BOOK APPEARS HERE] distributions directly from your Vanguard fund account to your bank,
savings and loan, or credit union account.
- ----------------------------------------------------------------------------------------------------------------
Vanguard Brokerage Services A cost-effective way to trade stocks, bonds, and options on major
(VBS) exchanges, Nasdaq, and other domestic over-the-counter markets at reduced
[PICTURE OF BOOK APPEARS HERE] rates, and to buy and sell shares of non-Vanguard mutual funds. Call VBS
(1-800-992-8327) for additional information and the appropriate forms.
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
*Can be used to "dollar-cost average" [PICTURE OF BOOK APPEARS HERE].
20
<PAGE>
- --------------------------------------------------------------------------------
Investor Information 1-800-662-7447 Tele-Account 1-800-662-6273
Client Services 1-800-662-2739
- --------------------------------------------------------------------------------
Types of Accounts
Individual or Other Entity
Vanguard's account registration form can be used to establish a variety of
accounts.
<TABLE>
- -----------------------------------------------------------------------------------------------------------
<S> <C>
For One or More People To open an account in the name of one (individual) or more (joint
tenants) people. $3,000 minimum initial investment.
- -----------------------------------------------------------------------------------------------------------
For a Minor Child To open an account as an UGMA/UTMA (Uniform Gifts/Transfers to
[PICTURE OF BOOK Minors Act). Age of majority and other requirements are set by
APPEARS HERE] state law. $1,000 minimum initial investment.
- -----------------------------------------------------------------------------------------------------------
For Holding Trust Assets To invest assets held in an existing trust. $3,000 minimum
[PICTURE OF BOOK APPEARS HERE] initial investment.
- -----------------------------------------------------------------------------------------------------------
For an Organization To open an account as a corporation, partnership, or other
entity. These accounts may require a corporate resolution or
other documents to name the individuals authorized to act. $3,000
minimum initial investment.
- -----------------------------------------------------------------------------------------------------------
</TABLE>
Distribution Options
You can receive distributions of dividends and/or capital gains in a number
of ways:
<TABLE>
- -----------------------------------------------------------------------------------------------------------
<S> <C>
Reinvestment Dividends and capital gains are automatically reinvested in
additional shares of the Portfolio, unless you request a
different distribution method.
- -----------------------------------------------------------------------------------------------------------
Dividends in Cash Dividends are paid by check and mailed to your account's address
of record, and capital gains are reinvested in additional shares
of the Portfolio.
- -----------------------------------------------------------------------------------------------------------
Dividends and Capital Gains Both dividends and capital gains are paid by check and mailed to
in Cash your account's address of record.
- -----------------------------------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
To electronically transfer cash dividends and/or capital gains to your bank,
savings and loan, or credit union account, see Vanguard Dividend Express under
"Services and Account Features."
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
If you have elected to receive dividend and/or capital gain distributions in
cash and the postal service is unable to make delivery to your address of
record, your distribution option will be changed to reinvestment. No interest
will accrue on amounts represented by uncashed distribution checks.
- --------------------------------------------------------------------------------
21
<PAGE>
- --------------------------------------------------------------------------------
Investor Information 1-800-662-7447 Tele-Account 1-800-662-6273
Client Services 1-800-662-2739
- --------------------------------------------------------------------------------
Buying Shares
If Vanguard receives your check (or electronic transfer) before the close of
trading on the New York Stock Exchange (generally 4 p.m. Eastern time) on a
regular business day, your investment in all Vanguard Municipal Bond Fund
Portfolios (except the Money Market Portfolio) will be converted to federal
funds and credited to your account at that day's closing price, the next-
determined net asset value. You will begin earning dividends on your investment
the following calendar day. (Federal funds are Federal Reserve deposits that
banks and other financial institutions "borrow" from one another to meet short-
term cash needs; portfolio advisers must use federal funds to pay for the
securities they buy.)
Your investment in the Money Market Portfolio will also be converted to federal
funds and credited to your account; however, the conversion to federal funds for
Money Market Portfolio investments takes one business day. Because of this
conversion period, your Money Market Portfolio account will be credited on the
business day following the day we receive your check. You will begin earning
dividends on your investment on the next following calendar day. For example, if
we receive your check before the close of trading on the New York Stock Exchange
(generally 4 p.m. Eastern time) on a Thursday, your account will be credited the
next business day (Friday) and you will begin earning dividends on Saturday.
Each of the Fund's Portfolios are offered on a no-load basis, meaning that you
do not pay sales commissions or 12b-1 marketing fees.
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------
Open A New Account Add To An Existing Account
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Minimum Investment $3,000 (regular account); $1,000 $100 by mail or exchange; $1,000
(custodial accounts for minors). by wire.
- ------------------------------------------------------------------------------------------------------------------------
By Mail Complete and sign the application form. Mail your check with an Invest-
[PICTURE OF ENVELOPE APPEARS HERE] By-Mail form detached from
First-class mail to: your confirmation statement to
The Vanguard Group the address listed on the form.
P.O. Box 2600
Valley Forge, PA 19482-2600 Make your check payable to: Make your check payable to:
The Vanguard Group-(insert appro- The Vanguard Group-(insert appro-
Express or Registered mail to: priate Portfolio number; see below) priate Portfolio number; see below)
The Vanguard Group Money Market 45 Money Market 45
455 Devon Park Drive Short-Term 41 Short-Term 41
Wayne, PA 19087-1815 Limited-Term 31 Limited-Term 31
Intermediate-Term 42 Intermediate-Term 42
Long-Term 43 Long-Term 43
Insured Long-Term 58 Insured Long-Term 58
High-Yield 44 High-Yield 44
All purchases must be made in All purchases must be made in
U.S. dollars, and checks must be U.S. dollars, and checks must be
drawn on U.S. banks. drawn on U.S. banks.
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
Important Note: To prevent check fraud, Vanguard will not accept checks made
payable to third parties.
- --------------------------------------------------------------------------------
22
<PAGE>
- --------------------------------------------------------------------------------
Investor Information 1-800-662-7447 Tele-Account 1-800-662-6273
Client Services 1-800-662-2739
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Open A New Account Add To An Existing Account
<S> <C> <C>
By Telephone Call Vanguard Tele-Account* 24 Call Vanguard Tele-Account* 24
[ARTWORK APPEARS HERE] hours a day--or Client Services hours a day--or Client Services
during business hours--to ex- during business hours--to ex-
1-800-662-6273 change from another Vanguard change from another Vanguard
Vanguard Tele-Account(R) fund account with the same reg- fund account with the same reg-
istration (name, address, taxpayer istration (name, address, taxpayer
1-800-662-2739 I.D., and account type). I.D., and account type).
Client Services
Use Vanguard Fund Express (see
"Services and Account Features")
to transfer assets from your bank
account. Call Client Services be-
fore your first use to verify that
this option is in place.
</TABLE>
*You must obtain a Personal Identification Number through Tele-Account at least
seven days before you request your first exchange.
For the Money Market Portfolio only: If you buy Portfolio shares through an
exchange from another Vanguard fund by the close of trading on the New York
Stock Exchange (generally 4 p.m. Eastern time), your investment does not have to
be converted to federal funds; you begin earning dividends the next calendar
day.
Important Note: Once a telephone transaction has been approved by you and a
confirmation number assigned, it cannot be revoked. We reserve the right to
refuse any purchase.
<TABLE>
<S> <C> <C>
By Wire Call Client Services to arrange Call Client Services to arrange
[ARTWORK APPEARS HERE] your wire transaction. your wire transaction.
Wire to:
CoreStates Bank, N.A.
ABA 031000011
CoreStates No. 0141-1274
[Temporary Account Number]
Vanguard Municipal Bond Fund
[Portfolio Name]
[Account Registration]
Attention: Vanguard
</TABLE>
For the Money Market Portfolio only: If you buy Portfolio shares through a
federal funds wire, your investment begins earning dividends the next calendar
day. You can begin earning dividends immediately if you notify Vanguard by 10:45
a.m. Eastern time that you intend to make a wire purchase that day.
<TABLE>
<S> <C> <C>
Automatically -- Vanguard offers a variety of ways
[ARTWORK APPEARS HERE] that you can add to your account
automatically. See "Services and
Account Features."
</TABLE>
You can redeem (that is, sell or exchange) shares purchased by check or Vanguard
Fund Express at any time. However, while your redemption request will be
processed at the next-determined net asset value after it is received, your
redemption proceeds will not be available until payment for your purchase is
collected, which may take up to ten calendar days.
Important Note: If you buy Portfolio shares through a registered broker-dealer
or investment adviser, the broker-dealer or adviser may charge you a service
fee.
23
<PAGE>
- --------------------------------------------------------------------------------
Investor Information 1-800-662-7447 Tele-Account 1-800-662-6273
Client Services 1-800-662-2739
- --------------------------------------------------------------------------------
Buying Shares (continued)
It is important that you call Vanguard before you invest a large dollar
amount by wire or check. We must consider the interests of all Portfolio
shareholders and so reserve the right to delay or refuse any purchase that will
disrupt the Portfolio's operation or performance.
Redeeming Shares
- --------------------------------------------------------------------------------
Important Tax Note: Any sale or exchange of Portfolio shares could result in a
taxable gain or a loss. However, because the Money Market Portfolio seeks to
maintain a stable net asset value of $1 per share, you will not incur a taxable
gain or a loss when you sell or exchange shares of this Portfolio.
- --------------------------------------------------------------------------------
The ability to redeem (that is, sell or exchange) Portfolio shares by telephone
is automatically established for your account unless you tell us in writing that
you do not want this option.
To protect your account from unauthorized or fraudulent telephone
instructions, Vanguard follows specific security procedures. When we receive a
call requesting an account transaction, we require the caller to provide:
[X] Portfolio name.
[X] 10-digit account number.
[X] Name and address exactly as registered on that account.
[X] Social Security or employer identification number as registered on that
account.
If you call to sell shares, the sale proceeds will be made payable to you,
as the registered shareholder, and mailed to your account's address of record.
If we follow reasonable security procedures, neither the Fund nor Vanguard
will be responsible for the authenticity of transaction instructions received by
telephone. We believe that these procedures are reasonable and that, if we
follow them, you bear the risk of any losses resulting from unauthorized or
fraudulent telephone transactions on your account.
How to Sell Shares
You may withdraw any part of your account, at any time, by selling shares.
One way to sell shares is the checkwriting option (established when you set up
your account or by calling Client Services).Your personalized Vanguard checks
work in much the same way as bank checks, except that Vanguard checks are
considered drafts and cannot be cashed immediately like a bank check. You cannot
write a Vanguard check to redeem shares that you purchased by check within the
previous ten days.
When you sell shares by telephone or mail, sale proceeds are normally mailed
within two business days after Vanguard receives your request. The sale price of
your shares will be the Portfolio's next-determined net asset value after
Vanguard receives your request in good order. Good order means that the request
includes:
[X] Portfolio name and account number.
[X] Amount of the transaction (in dollars or shares).
[X] Signatures of all owners exactly as registered on the account.
[X] Signature guarantees (if required).
[X] Any supporting legal documentation that may be required.
[X] Any certificates you are holding for the account.
Sales or exchange requests received after the close of trading on the New York
Stock Exchange (generally 4 p.m. Eastern time) are processed the next business
day. No interest will accrue on amounts represented by uncashed redemption
checks.
24
<PAGE>
- --------------------------------------------------------------------------------
Investor Information 1-800-662-7447 Tele-Account 1-800-662-6273
Client Services 1-800-662-2739
- --------------------------------------------------------------------------------
The Portfolios reserve the right to close any account whose balance falls
below the minimum initial investment. The Portfolios will deduct a $10 annual
fee in either June or December if your account balance falls below $2,500 or if
your UGMA/UTMA account balance falls below $500. The fee is waived if your total
Vanguard account assets are $50,000 or more.
- --------------------------------------------------------------------------------
Some written requests require a signature guarantee from a bank, broker, or
other acceptable financial institution. A notary public cannot provide a
signature guarantee.
- --------------------------------------------------------------------------------
How to Exchange Shares
An exchange is the selling of shares of one Vanguard fund to purchase shares
of another.
Although we make every effort to maintain the exchange privilege, Vanguard
reserves the right to revise or terminate the exchange privilege, limit the
amount of an exchange, or reject any exchange, at any time, without notice.
Because excessive exchanges can potentially disrupt the management of the
Portfolios and increase transaction costs, Vanguard limits exchange activity to
two substantive exchange redemptions (at least 30 days apart) from each
Portfolio (except the Money Market Portfolio) during any 12-month period.
"Substantive" means either a dollar amount large enough to have a negative
impact on a Portfolio or a series of movements between Vanguard funds.
Before you exchange into a new Vanguard fund, be sure to read its prospectus.
For a copy and for answers to questions you might have, call Investor
Information.
<TABLE>
<CAPTION>
Selling or Exchanging Shares Instructions
<S> <C>
By Telephone Call Vanguard Tele-Account* 24 hours a day--or Client Services dur-
[ARTWORK APPEARS HERE] ing business hours--to sell or exchange shares. You can exchange shares
from any of these Portfolios to open an account in another
1-800-662-6273 Vanguard fund or to add to an existing Vanguard fund account with an
Vanguard Tele-Account identical registration.
1-800-662-2739 *You must obtain a Personal Identification Number through Tele-Account at
Client Services least seven days before you request your first redemption.
By Mail Send a letter of instruction signed by all registered account holders.
[ARTWORK APPEARS HERE] Include the Portfolio name and account number and (if you are sell-
First-class mail to: ing) a dollar amount or number of shares OR (if you are exchanging)
The Vanguard Group the name of the fund you want to exchange into and a dollar amount
Vanguard Municipal Bond Fund or number of shares.
P.O. Box 1120
Valley Forge, PA 19482-1120
Express or Registered mail to:
The Vanguard Group
Vanguard Municipal Bond Fund
455 Devon Park Drive
Wayne, PA 19087-1815
</TABLE>
25
<PAGE>
- --------------------------------------------------------------------------------
Investor Information 1-800-662-7447 Tele-Account 1-800-662-6273
Client Services 1-800-662-2739
- --------------------------------------------------------------------------------
Redeeming Shares (continued)
<TABLE>
<CAPTION>
Selling or Exchanging Shares Instructions
<S> <C>
Exchanging Shares Online You may use your personal computer to exchange shares of most
[ARTWORK APPEARS HERE] Vanguard funds by accessing Vanguard's website
(http://www.vanguard.com). To establish this service for your account,
you must first register through our website. We will then send to you,
by mail, an account access password that will enable you to make on-
line exchanges.
The Vanguard funds that you cannot purchase or sell through online
exchange are Vanguard Index Trust, Vanguard Balanced Index Fund,
Vanguard International Equity Index Fund, Vanguard REIT Index
Portfolio, Vanguard Total International Portfolio, and Vanguard
Growth and Income Portfolio (formerly known as Vanguard Quan-
titative Portfolios). These funds do permit online exchanges within IRAs
and other retirement accounts.
By Check You can sell shares by writing a checkwriting draft for $250 or more.
[ARTWORK APPEARS HERE]
Automatically Vanguard offers several ways to sell or exchange shares automatically
[ARTWORK APPEARS HERE] (see "Services and Account Features"). Call Investor Information for
the appropriate booklet and application if you did not elect a feature
when you opened your account.
</TABLE>
It is important that you call Vanguard before you redeem a large dollar
amount. We must consider the interests of all Portfolio shareholders and so
reserve the right to delay your redemption proceeds--up to seven days--if the
amount will disrupt a Portfolio's operation or performance.
- --------------------------------------------------------------------------------
A Note on Unusual Circumstances
Vanguard reserves the right to revise or terminate the telephone redemption
privilege at any time, without notice. In addition, Vanguard can stop selling
shares 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. If you experience difficulty making a
telephone redemption during periods of drastic economic or market change, you
can send us your request by regular or express mail. Follow the instructions on
selling or exchanging shares by mail in the "Redeeming Shares" section.
- --------------------------------------------------------------------------------
Transferring Registration
How To Transfer Shares
You may transfer the registration of any of your Fund shares to another owner by
completing a transfer form and sending it to: Vanguard Financial Center, P.O.
Box 1110, Valley Forge, PA 19482-1110, Attention: Transfer Department.
26
<PAGE>
- --------------------------------------------------------------------------------
Investor Information 1-800-662-7447 Tele-Account 1-800-662-6273
Client Services 1-800-662-2739
- --------------------------------------------------------------------------------
Fund and Account Updates
Statements and Reports
We will send you clear, concise account and tax statements to help you keep
track of your Portfolio account throughout the year as well as when you are
preparing your income tax returns.
In addition, you will receive financial reports about each Portfolio
twice a year. These comprehensive reports include an assessment of the
Portfolio's performance (and a comparison to its industry benchmark), an
overview of the markets, a report from the adviser, as well as a listing of
its holdings and other financial statements.
Confirmation Statement Sent each time you buy, sell, or exchange
shares; confirms the trade date and the
amount of your transaction.
Portfolio Summary Mailed quarterly; shows the market value of
[PICTURE OF BOOK your account at the close of the statement
APPEARS HERE] period, as well as distributions,
purchases, sales, and exchanges for the
current calendar year.
Fund Financial Reports Mailed in April and October for all seven
Fund Portfolios.
Tax Statements Generally mailed in January; report
previous year's taxable distributions and
proceeds from the sale of shares.
Average Cost Statement Issued quarterly for most taxable accounts
[PICTURE OF BOOK (accompanies your Portfolio Summary);
APPEARS HERE] shows the average cost of shares that you
redeemed during the calendar year, using
the average cost single category method.
Checkwriting Statement Sent monthly to shareholders using
Vanguard's Checkwriting Option. Our clear,
easy-to-use statement provides images of
the front and back of each checkwriting
draft paid in the previous month. This
consolidated statement is sent instead of
the original canceled drafts, which will
not be returned.
Automated Telephone Access
Vanguard Tele-Account Toll-free access to Vanguard fund and
1-800-662-6273 account information--as well as some
Any time, seven day a transactions--through any Touch-Tone
week, from anywhere in the telephone. Tele-Account provides total
continental United States return, share price, price change, and
and Canada. yield quotations for all Vanguard funds;
[PICURE OF BOOK gives your account balances and history
APPEARS HERE] (e.g., last transaction, latest dividend
distribution, redemptions by check during
the last three months); and allows you to
sell or exchange fund shares.
Computer Access
Vanguard Online Use your personal computer to learn more
http://www.vanguard.com about Vanguard funds and services; keep in
touch with your Vanguard accounts; map out
a long-term investment strategy; initiate
certain transactions; and ask questions,
make suggestions, and send messages to
Vanguard.
Our education-oriented website provides
timely news and information about Vanguard
funds and services; an online "university"
that offers a variety of mutual fund
classes; and easy-to-use, interactive tools
to help you create your own investment and
retirement strategies.
27
<PAGE>
----------------
PLAIN TALK ABOUT
----------------
Keeping Your Prospectus
Reading this prospectus will help you to decide whether one or more of the
Portfolios is suitable for your investment goals. If you decide to invest, don't
throw the prospectus out; you will no doubt need it for future reference.
Prospectus Postscript
This prospectus is designed to provide you with pertinent information about the
seven Portfolios of Vanguard Municipal Bond Fund, including their investment
objective, risks, strategy, and expenses, as well as services available to you
as a shareholder.
It is important that you understand these facts so that you can decide
whether an investment in any of the Portfolios is right for you. The following
questions offer a quick review of some of the subjects covered by this
prospectus.
In Reading The Prospectus, Did You Learn:
[_] Each Portfolio's objective? (page 9)
[_] Each Portfolio's investment strategy? (page 10)
[_] Who should invest in each Portfolio? (pages 9-10)
[_] The risks associated with each Portfolio? (pages 9-15)
[_] Whether each Portfolio is federally insured?
(inside front cover)
[_] Each Portfolio's expenses? (pages 3-4)
[_] The background of the Portfolios' investment managers?
(page 18)
[_] How to open an account? (pages 22-24)
[_] How to sell or exchange shares? (pages 24-26)
[_] How often you'll receive statements and financial reports?
(page 27)
28
<PAGE>
[LOGO OF THE VANGUARD
GROUP APPEARS HERE]
Post Office Box 2600
Valley Forge, PA 19482
Investor Information
Department
1-800-662-7447 (SHIP)
Text Telephone:
1-800-952-3335
For information on our funds,
fund services, and retirement
accounts; requests for
literature
Client Services Department
1-800-662-2739 (CREW)
Text Telephone:
1-800-662-2738
For information on your
account, account transactions,
account statements
Vanguard Brokerage
Services
1-800-992-8327
For information on trading
stocks, bonds, and options
at reduced commissions
Vanguard Tele-Account/(R)/
1-800-662-6273 (ON-BOARD)
For 24-hour automated access
to price and yield, information
on your account, certain
transactions
Electronic Access to the
Vanguard Mutual Fund
Education and Information
Center
World Wide Web
http://www.vanguard.com
E-mail
[email protected]
(C) 1997 Vanguard Marketing
Corporation, Distributor
P095N
<PAGE>
PART B
VANGUARD MUNICIPAL BOND FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
DECEMBER 30, 1997
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 30, 1997). 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........................................................ B-1
Calculation of Yield (Money Market Portfolio).............................. B-6
Yield and Total Return..................................................... B-7
Investment Management...................................................... B-8
Portfolio Transactions..................................................... B-8
Purchase of Shares......................................................... B-8
Redemption of Shares....................................................... B-8
Valuation of Shares........................................................ B-9
Management of the Fund..................................................... B-11
Description of Shares and Voting Rights.................................... B-14
Financial Statements....................................................... B-14
</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 (the "1940 Act")), including a majority of the shares
of each Portfolio. Each Portfolio of the Fund may not:
1. Invest in securities other than Municipal Securities, except that it
may make temporary investments (up to 20% of its assets under normal cir-
cumstances) in certain short-term taxable securities issued by or on behalf
of municipal or corporate issuers, obligations of the United States Govern-
ment and its agencies or instrumentalities, commercial paper, bank certifi-
cates of deposit, and any such items subject to short-term repurchase
agreements;
2. Purchase securities of any issuer (except the United States
Government, 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 purposes of this limitation, identification 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;
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 1940 Act;
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 Limi-
tation 13;
12. Purchase or retain securities of an issuer if an officer or director
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 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 or 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 in Limitation 13;
16. Invest in interests in oil, gas or other mineral exploration or de-
velopment programs except as specified above in Limitation 13; and
17. 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."
* For purposes of Limitation 14, an investment company will be considered to
have investment objectives and investment policies consistent with those of a
Portfolio if such investment company invests primarily in securities that are
permissible investments for the Portfolio.
The investment limitations set forth above are considered at the time that
investment securities are purchased. If a percentage restriction is adhered to
at the time of purchase, a later increase in percentage resulting from a
change in the market value of assets will not constitute a violation of such
restriction.
B-2
<PAGE>
FUTURES CONTRACTS AND OPTIONS
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 from
intermarket arbitrage opportunities when a futures contract is mispriced rela-
tive to the underlying 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 security 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 ex-
changes and trading are regulated under the Commodity Exchange Act by the Com-
modity Futures Trading Commission ("CFTC"), a U.S. Government Agency. Assets
committed to Futures contracts will be segregated at the Fund's custodian bank
to the extent required by law.
Most futures contracts are closed out before the settlement date without the
making or taking of delivery. Closing out an open futures position is done by
taking an opposite position ("buying" a contract which has previously been
"sold," or "selling" a contract previously purchased) in an identical contract
to terminate the position. Brokerage 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.
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 initial margin deposit.
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. Under CFTC regulations, the Portfolios may
use futures transactions for bona fide hedging purposes only, except that a
Portfolio may establish non-hedging futures positions if the aggregate initial
margin and premiums for such positions do not exceed five percent of the value
of the Portfolio's assets.
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.
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.
B-3
<PAGE>
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.
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 substantial
loss (as well as gain) to the investor. For example, if at the time of pur-
chase, 10% of the value of the futures contract is deposited as margin, a sub-
sequent 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.
OTHER TYPES OF DERIVATIVES
In addition to futures and options, each Portfolio may invest in other types
of derivatives, including warrants, swap agreements and partnerships or
grantor trust derivative products. Derivatives are instruments whose value is
linked to or derived from an underlying security. Derivatives may be traded
separately on exchanges or in the over-the-counter market, or they may be im-
bedded in securities. The most common imbedded derivative is the call option
attached to, or imbedded in, a callable bond. The owner of a traditional call-
able bond holds a combination of a long position in a non-callable bond and a
short position in a call option on that bond.
B-4
<PAGE>
Derivative instruments may be used individually or in combination to hedge
against unfavorable changes in interest rates, or to take advantage of antici-
pated changes in interest rates. Derivatives may be structured with no or a
high degree of leverage. When derivatives are used as hedges, the risk in-
curred is that the derivative instrument's value may change differently than
the value of the security being hedged. This "basis risk" is generally lower
than the risk associated with an unhedged position in the security being
hedged. Some derivatives may entail liquidity risk, i.e., the risk that the
instrument cannot be sold at a reasonable price in highly volatile markets.
Leveraged derivatives used for speculation are very volatile, and therefore,
very risky. However, the Portfolios will only utilize derivatives for hedging
or arbitrage purposes, and not for speculative purposes. Over-the-counter de-
rivatives involve a counterparty risk, i.e., the risk that the individual or
institution on the other side of the agreement will not or cannot meet their
obligations under the derivative agreement.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS 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 may be re-
quired to defer the recognition of losses on futures contracts to the extent
of any unrecognized gains on related positions held by the Portfolio.
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. It is anticipated that any
net gain realized from the closing out of futures contracts will be considered
gain from the sale of securities and therefore be qualifying income for pur-
poses of the 90% requirement.
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 transac-
tions. 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.
MUNICIPAL LEASE OBLIGATIONS
Each Portfolio of the Fund may invest in municipal lease obligations. These
securities are sometimes considered illiquid because of the inefficiency and
thinness of the market in which they are traded. Under the supervision of the
Fund's Board of Directors, the Fixed Income Group may determine to treat cer-
tain municipal lease obligations as liquid, and therefore not subject to the
Fund's 15% limit on illiquid securities (10% for the Money Market Portfolio).
The factors that the Fixed Income Group may consider in making these liquidity
determinations include: (1) the frequency of trades and quotations for the se-
curity; (2) the number of dealers willing to purchase or sell the security and
the number of other potential buyers; (3) the willingness of dealers to under-
write and make a market in the security; (4) the nature of the marketplace
trades, including the time needed to dispose of the security, the method of
soliciting offers, and the mechanics of transfer; and (5) factors unique to a
particular security, including general credit worthiness of the issuer, the
importance to the issuer of the property covered by the lease and the likeli-
hood that the marketability of the securities will be maintained throughout
the time the security is held by the Portfolio.
B-5
<PAGE>
In the case of any unrated municipal lease obligations, a Fixed Income Group
analyst will assign a credit rating based upon criteria that include an analy-
sis of factors similar to those considered by nationally recognized statisti-
cal rating organizations. In addition, the Fixed Income Group's liquidity de-
terminations will incorporate those factors mentioned in (5) above.
WHEN-ISSUED SECURITIES
Each Portfolio of the Fund may purchase tax-exempt securities on a "when-is-
sued" basis. In buying "when-issued" securities, a Portfolio commits to buy
securities at a certain price even though the securities may not normally 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. It is also possible that the
securities will never be issued and the commitment canceled.
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 October 31, 1997.
<TABLE>
<CAPTION>
MONEY MARKET
PORTFOLIO
10/31/97
------------
<S> <C>
Value of account at beginning of period........................ $1.00000
Value of same account at end of period*........................ 1.00071
--------
Net Change in account value.................................... $ .00071
Annualized Current Net Yield (Net Change X 365/7)/average net
asset value................................................... 3.69%
Effective Yield [(Net Change) + 1](365/7) -1................... 3.75%
Average Weighted Maturity of investments....................... 60 days
</TABLE>
--------
*Exclusive of any capital changes.
The net asset value of a share of the Money Market Portfolio is $1.00 and it
is not expected to fluctuate. However, the yield of the Portfolio will fluctu-
ate. The Fund has obtained private insurance that partially protects the Money
Market Portfolio against default of principal or interest payments on the in-
struments it holds, and against bankruptcy by issuers and credit enhancers of
these instruments. Treasury and other U.S. Government securities held by the
Portfolio are excluded from this coverage. The annualization of a week's divi-
dend is not a representation 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 analyze the Portfolios of the Fund, and other investment vehicles; however
yields of other investment vehicles may not be comparable because of the fac-
tors set forth in the preceding sentence, differences in the time periods com-
pared, 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 October
31, 1997 is set forth below. Yields are calculated daily for each Portfolio.
<TABLE>
<S> <C>
Money Market Portfolio................................................. 3.53%
Short-Term Portfolio................................................... 3.75%
Limited-Term Portfolio................................................. 4.05%
Intermediate-Term Portfolio............................................ 4.40%
Long-Term Portfolio.................................................... 4.81%
Insured Long-Term Portfolio............................................ 4.86%
High-Yield Portfolio................................................... 4.97%
</TABLE>
The average annual total return of each Portfolio of the Fund for the one-,
five- and ten-year periods ended October 31, 1997 is set forth below:
<TABLE>
<CAPTION>
1 YEAR 5 YEARS 10 YEARS
ENDED ENDED ENDED
10/31/97 10/31/97 10/31/97
-------- -------- --------
<S> <C> <C> <C>
Money Market Portfolio.......................... 3.50% 3.13% 4.09%
Short-Term Portfolio............................ 4.04% 3.91% 5.15%
Limited-Term Portfolio.......................... 5.03% 4.92% 6.26%
Intermediate-Term Portfolio..................... 6.56% 7.12% 8.39%
Long-Term Portfolio............................. 8.23% 8.16% 9.44%
Insured Long-Term Portfolio..................... 7.57% 7.94% 9.06%
High-Yield Portfolio............................ 8.35% 8.10% 9.60%
</TABLE>
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>
PORTFOLIO TRANSACTIONS
HOW TRANSACTIONS ARE EFFECTED
The types of securities in which the Portfolios invest are generally pur-
chased and sold through principal transactions, meaning that the Portfolios
normally purchase securities directly from the issuer or a primary market-
maker acting as principal for the securities on a net basis. Brokerage commis-
sions are not paid on these transactions, although the purchase price for se-
curities usually includes an undisclosed compensation. Purchases from under-
writers of securities typically include a commission or concession paid by the
issuer to the underwriter, and purchases from dealers serving as market-makers
typically include a dealer's mark-up (i.e., a spread between the bid and the
asked prices). During the fiscal years ended August 31, 1996 and 1997, and the
two-month fiscal period ended October 31, 1997, the Portfolios did not pay any
brokerage commissions.
HOW BROKERS AND DEALERS ARE SELECTED
Vanguard's Fixed Income Group chooses brokers or dealers to handle the pur-
chase and sale of the Portfolios' securities, and is responsible for getting
the best available price and most favorable execution for all transactions.
When the Portfolios purchase a newly-issued security at a fixed price, the
Group may designate certain members of the underwriting syndicate to receive
compensation associated with that transaction. Certain dealers have agreed to
rebate a portion of such compensation directly to the Portfolios to offset
their management expenses. The Group is required to seek best execution of all
transactions and is not authorized to pay a brokerage commission in excess of
that which another broker might have charged for effecting the same transac-
tion solely on account of the receipt of research or other services.
HOW THE REASONABLENESS OF BROKERAGE COMMISSIONS IS EVALUATED
As previously explained, the types of securities that the Portfolios pur-
chase do not normally involve the payment of brokerage commissions. If any
brokerage commissions are paid, however, the Fixed Income Group will evaluate
their reasonableness by considering: (a) historical commission rates; (b)
rates which other institutional investors are paying, based upon publicly
available information; (c) rates quoted by brokers and dealers; (d) the size
of a particular transaction, in terms of the number of shares, dollar amount,
and number of clients involved; (e) the complexity of a particular transaction
in terms of both execution and settlement; (f) the level and type of business
done with a particular firm over a period of time; and (g) the extent to which
the broker or dealer has capital at risk in the transaction.
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 investment for or any other restrictions on initial
and subsequent investments for certain fiduciary accounts or under circum-
stances 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 practi-
B-8
<PAGE>
cable for the Fund to dispose of securities owned by it, or fairly to deter-
mine the value of its assets, and (iii) for such other periods as the Commis-
sion 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 below under "Valuation of Shares" and a redeeming shareholder would nor-
mally 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) ALL REDEMPTIONS, REGARDLESS 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 (2) 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 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
SHORT-TERM, LIMITED-TERM, INTERMEDIATE-TERM, LONG-TERM, INSURED LONG-TERM
AND HIGH-YIELD PORTFOLIOS. The net asset values per share of the Short-Term,
Limited-Term, Intermediate-Term, Long-Term, Insured Long-Term and High-Yield
Portfolios are determined on each day that the New York Stock Exchange is
open. For purposes of calculating net asset values, the Board of Directors has
approved the use of pricing services to value bonds and other fixed income se-
curities held by the Portfolios, so long as the prices provided 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 se-
curities and any developments related to specific securities.) The methods
used by the pricing services and the valuations so established are reviewed 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-go-
ing evaluation of these services, may authorize the use of other pricing serv-
ices 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
valuation 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 de-
termined by the Directors.
B-9
<PAGE>
MONET 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.
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-10
<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 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 occupa-
tions during the past 5 years is set forth below. The mailing address of the
Directors and officers is Post Office Box 876, Valley Forge, PA 19482. As a
group, the Fund's Directors and Officers own less than one percent of the out-
standing shares of each Portfolio of the Fund.
JOHN C. BOGLE, Chairman and JOHN C. SAWHILL, Director
Director* President and Chief Executive
Chairman and Director of The Officer of The Nature Conservancy;
Vanguard Group, Inc. and each of formerly, Director and Senior
the investment companies in The Partner of McKinsey & Co., and
Vanguard Group; Director of The President of New York University;
Mead Corporation, General Accident Director of Pacific Gas and
Insurance, and Chris-Craft Electric Company, Procter & Gamble
Industries, Inc. Company, and NACCO Industries.
JOHN J. BRENNAN, President, Chief JAMES O. WELCH, JR., Director
Executive Officer & Director* Retired Chairman of Nabisco Brands
President, Chief Executive Officer, Inc.; retired Vice Chairman and
and Director of The Vanguard Group, Director of RJR Nabisco; Director
Inc. and each of the investment of TECO Energy, Inc., and Kmart
companies in The Vanguard Group. Corporation.
ROBERT E. CAWTHORN, Director J. LAWRENCE WILSON, Director
Chairman Emeritus and Director of Chairman and Chief Executive
Rhone-Poulenc Rorer, Inc.; Managing Officer of Rohm & Haas Company;
Director of Global Health Care Director of Cummins Engine Company,
Partners/DLJ Merchant Banking and The Mead Corporation; and
Partners; Director of Sun Company, Trustee of Vanderbilt University.
Inc., and Westinghouse Electric
Corporation. RAYMOND J. KLAPINSKY, Secretary*
Managing Director and Secretary of
BARBARA BARNES HAUPTFUHRER, Director The Vanguard Group, Inc.; Secretary
Director of The Great Atlantic and of each of the investment companies
Pacific Tea Company, IKON Office in The Vanguard Group.
Solutions, Inc., Raytheon Company,
Knight-Ridder, Inc., Massachusetts RICHARD F. HYLAND, Treasurer*
Mutual Life Insurance Co., and Treasurer of The Vanguard Group,
Ladies Professional Golf Inc. and of each of the investment
Association; and Trustee Emerita of companies in The Vanguard Group.
Wellesley College.
KAREN E. WEST, Controller*
BURTON G. MALKIEL, Director Principal of The Vanguard Group,
Chemical Bank Chairman's Professor Inc.; Controller of each of the
of Economics, Princeton University; investment companies in The
Director of Prudential Insurance Vanguard Group.
Co. of America, Amdahl Corporation, --------
Baker Fentress & Co., The Jeffrey *Officers of the Fund are "inter-
Co., and Southern New England ested persons" as defined in the
Telecommunications Company. Investment Company Act of 1940.
ALFRED M. RANKIN, JR., Director
Chairman, President, Chief
Executive Officer, and Director of
NACCO Industries, Inc.; Director of
The BFGoodrich Company, and The
Standard Products Company.
B-11
<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 adheres to a Code of Ethics established pursuant to Rule
17j-1 under the Investment Company Act of 1940. The Code is designed to pre-
vent unlawful practices in connection with the purchase or sale of securities
by persons associated with Vanguard. Under Vanguard's Code of Ethics, certain
Officers and employees of Vanguard who are considered access persons are per-
mitted to engage in personal securities transactions. However, such transac-
tions are subject to procedures and guidelines substantially similar to those
recommended by the mutual fund industry and approved by the U.S. Securities
and Exchange Commission.
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 Oc-
tober 31, 1997, the Fund had contributed capital of $1,422,000 to Vanguard,
representing 7.1% of Vanguard's capitalization. The Fund's Service Agreement
provides for the following arrangement: (a) each Vanguard fund may invest up
to 0.40% of its current net assets in Vanguard and (b) there is no other limi-
tation on the amount that each Vanguard fund may contribute to Vanguard's cap-
italization.
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, 1997, 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 $27,779,000. (The Fund's share of such costs
for the two-month fiscal period ended October 31, 1997 is not representative.)
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.
B-12
<PAGE>
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, 1997, the Fund paid approximately $5,040,000 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. (The Fund's share of such costs for the
two-month fiscal period ended October 31, 1997 is not representative.)
INVESTMENT ADVISORY SERVICES. Vanguard also provides the Fund, Vanguard
Money Market Reserves, 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, Vanguard Treasury Fund, Aggressive
Growth Portfolio of Vanguard Horizon Fund, REIT Index Portfolio of the Van-
guard Specialized Portfolios, The Total International Portfolio of Vanguard
STAR Fund, several Portfolios of Vanguard Fixed Income Securities Fund, Van-
guard Index Trust, Vanguard Admiral Funds, Vanguard International Equity Index
Fund, Vanguard Balanced Index Fund, Vanguard Institutional Index Fund, several
Portfolios of Vanguard Variable Insurance Fund, Vanguard Bond Index Fund, a
portion 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
employed 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, 1995, 1996 and 1997, the Fund paid approximately $2,210,000,
$2,254,000, and $2,917,000 respectively, of Vanguard's expenses relating to
investment advisory services. (The Fund's share of such costs for the two-
month fiscal period ended October 31, 1997 is not representative.)
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 Fund's proportionate share of remunera-
tion paid to Officers for the year ended August 31, 1997 was $492,334. (The
Fund's share of such costs for the two-month fiscal period ended October 31,
1997 is not representative.)
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 under its Retirement and Thrift Plans on behalf of all eligi-
ble officers of the Fund, as a group, during the 1997 fiscal year ended August
31, 1997 was approximately $10,800. (The Fund's share of such costs for the
two-month fiscal period ended October 31, 1997 is not representative.)
B-13
<PAGE>
The following table provides detailed information with respect to the amounts
paid or accrued for the Directors for the fiscal year ended August 31, 1997.
(The Fund's share of such costs for the two-month fiscal period ended October
31, 1997 is not representative.)
VANGUARD MUNICIPAL BOND FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
PENSION OR TOTAL
RETIREMENT ESTIMATED COMPENSATION
BENEFITS ANNUAL FROM ALL
AGGREGATE ACCRUED AS BENEFITS VANGUARD
COMPENSATION PART OF FUND UPON FUNDS PAID TO
NAMES OF DIRECTORS FROM FUND EXPENSES RETIREMENT DIRECTORS(2)
- ------------------ ------------ ------------ ---------- -------------
<S> <C> <C> <C> <C>
John C. Bogle(1)............. $251,264 $2,130 -- --
John J. Brennan(1)........... $156,762 $2,130 -- --
Barbara Barnes Hauptfuhrer... $5,890 $879 $15,000 $70,000
Robert E. Cawthorn........... $5,890 $733 $13,000 $70,000
Burton G. Malkiel............ $5,929 $590 $15,000 $70,000
Alfred M. Rankin, Jr. ....... $5,890 $463 $15,000 $70,000
John C. Sawhill.............. $5,890 $550 $15,000 $70,000
James O. Welch, Jr. ......... $5,890 $676 $15,000 $70,000
J. Lawrence Wilson........... $5,890 $489 $15,000 $70,000
</TABLE>
- --------
(1) As an "Interested Directors" Messrs. Bogle and Brennan receive no
compensation for their service as Directors.
(2) The amounts reported in this column reflect the total compensation paid to
each Director for their service as Director or Trustee of 35 Vanguard Funds
(34 in the case of Mr. Malkiel).
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Fund was organized as a Maryland corporation on October 15, 1976. On Jan-
uary 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 10,800,000,000
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 nonassessable 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 hold-
ers of more than 50% of the shares voting for the election of Directors can
elect 100% of the Directors if they choose to do so. 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 required by the Investment Com-
pany Act of 1940, shares shall be voted by individual class; and (ii) when the
matter does not affect any interest of a particular class, then only sharehold-
ers of the affected class or classes shall be entitled to vote thereon.
FINANCIAL STATEMENTS
The Fund's Financial Statements for the period ended October 31, 1997, in-
cluding the financial highlights for each of the five fiscal years in the pe-
riod ended August 31, 1997 and the two-month
B-14
<PAGE>
period ended October 31, 1997, appearing in the 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 in-
corporated by reference in this Statement of Additional Information. The
Fund's Annual Report to Shareholders and the insert thereto are enclosed with
this Statement of Additional Information.
GENERAL INFORMATION
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 pur-
chased 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 in-
dependent accountants for the Fund and audits its financial statements annual-
ly. The Fund is not involved in any litigation.
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APPENDIX A--DESCRIPTION OF MUNICIPAL BONDS AND THEIR RATINGS
Vanguard may use reprinted material discussing the Vanguard Group, Inc. or
any of the member funds of The Vanguard Group of Investment Companies.
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, demand notes
and tax-exempt commercial paper.
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 397 days' 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.
The Portfolios may purchase municipal bonds subject to so-called "demand
features." In such cases the Portfolio may purchase a security that is nomi-
nally long-term, but has many of the features of
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shorter-term securities. By virtue of this demand feature, the security will
be deemed to have a maturity date that is earlier than its stated maturity
rate.
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 Investors Service, Inc.'s Municipal Bond rat-
ings: 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 sta-
ble 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 generally known as "high grade bonds";
A--possess many favorable investment attributes and are considered "upper me-
dium 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 impairment sometime in the future; Baa--con-
sidered 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 char-
acteristically unreliable over any great length of time; Ba--protection of
principal and interest payments may be very moderate; judged to have specula-
tive elements; their future cannot be considered as well-assured; B--lack
characteristics of a desirable investment; assurance 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 princi-
pal and interest; Ca--speculative in a high degree; often in default; C--low-
est rated class of bonds; issues so rated can be regarded as having extremely
poor prospects for ever attaining any real investment 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 an adequate capacity to pay principal and interest;
normally exhibit adequate protection parameters but adverse economic condi-
tions or changing circumstances are more likely to lead to a weakened capacity
to pay prin-
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cipal and interest than for bonds in A category; BB--B--CCC--CC--predominantly
speculative with respect to capacity to pay interest and repay principal in
accordance 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, with the exception of the Money Market and Insured Long-Term Portfolios,
must be rated a minimum of Baa (or BBB) by Moody's or Standard & Poor's. The
Money Market Portfolio cannot hold bonds rated BBB or below investment grade.
The Insured Long-Term Portfolio will be at least 80% insured with the remain-
ing 20% having a minimum rating of A. Of the remaining Portfolios, 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 creditworthiness of the obligation to determine whether it contin-
ues to meet the policies and objectives of the Portfolio.
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