Rule 497(c)
Registration No. 2-82710
NEW YORK MUNI FUND(R)
90 Washington Street
New York, New York 10006
1-800-225-6864
New York Muni Fund, "New York's Oldest Triple Tax-Free Mutual Fund", (the
"Fund") is a series of Fundamental Funds, Inc. (the "Company"), a Maryland
corporation. The Fund seeks to provide a high level of income that is excluded
from gross income for Federal income tax purposes and exempt from New York State
and New York City personal income taxes and is consistent with the preservation
of capital. Under normal market conditions, at least 80% of the Fund's assets
will be invested in securities that are free from Federal, New York State and
New York City income taxes. Of course, there can be no assurance that the Fund's
investment objective will be achieved.
The Fund intends to achieve its objective by investing substantially all
(and at least 80%) of its total assets in municipal obligations of New York
State, its political subdivisions, and its other duly constituted authorities
and corporations, that are rated within the four highest quality grades for
bonds as determined by Moody's Investors Service, Inc. ("Moody's"), Standard &
Poor's Corporation ("S&P"), Fitch Investors Service, Inc. ("Fitch") or Duff &
Phelps, Inc. ("Duff") or within the three highest quality grades for municipal
notes as determined by Moody's, S&P, Fitch or Duff or, if unrated, are judged by
Fund management to be of comparable quality. While municipal obligations in
these categories are generally deemed to have adequate to very strong protection
of principal and interest, municipal obligations rated within the lowest of
these categories have speculative characteristics as well.
This Prospectus sets forth concisely the information you should know before
investing in the Fund. You should read it and keep it for future reference. A
Statement of Additional Information containing additional information about the
Fund has been filed with the Securities and Exchange Commission. You may obtain
a copy of the Statement without charge by writing to the Fund at the address
listed above, or by calling (800) 322-6864. Shareholder inquiries may also be
placed through this number.
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TABLE OF CONTENTS
Highlights 2
Fee Table 3
Financial Highlights 4
Investment Objective and Policies 5
Investment Strategies 8
Special Risks 13
Calculation of Yield and Performance Data 16
Purchase of Shares 17
Redemption of Shares 19
Determination of Net Asset Value 22
Distribution Expenses 22
Management 23
Dividends and Tax Status 25
General Information 28
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
THE STATEMENT OF ADDITIONAL INFORMATION DATED APRIL 30, 1997
IS HEREBY INCORPORATED BY REFERENCE INTO THIS PROSPECTUS.
PROSPECTUS DATED APRIL 30, 1997
<PAGE>
HIGHLIGHTS
What is New York Muni Fund?
New York Muni Fund is a non-diversified mutual fund which seeks to provide a
high level of income that is excluded from gross income for Federal income tax
purposes and exempt from New York State and New York City personal income taxes
and is consistent with the preservation of capital. There is no assurance,
however, that the Fund will achieve its stated objective. See "Investment
Objective and Policies".
Management
The Fund is a member of the Fundamental Family of Funds, a group of five
investment companies. Fundamental Portfolio Advisors, Inc. (the "Manager") is
the Fund's investment manager.
The Manager supervises and manages the Fund's investment portfolio and
directs the purchase and sales of its investment securities. The Manager
utilizes an investment committee to manage the assets of the Fund. See
"Management".
Investment Risks
To achieve its objective, the Fund invests primarily in municipal
obligations of New York issuers that are rated within the four highest quality
grades for bonds as determined by Moody's, S&P, Fitch or Duff or within the
three highest quality grades for municipal notes as determined by Moody's, S&P,
Fitch or Duff or, if unrated, are judged by Fund management to be of comparable
quality. While municipal obligations in these categories are generally deemed to
have adequate to very strong protection of principal and interest, municipal
obligations in the lowest of these categories have speculative characteristics
as well (see "Investment Objective and Policies" and "Special Risks").
In addition, the Fund may employ various investment strategies and
techniques which are designed to enhance income and liquidity or attempt to
hedge against market fluctuation and risk, such as buying and selling interest
rate futures contracts ("futures contracts"), using options to purchase or sell
such contracts, using options to purchase or sell debt securities, and writing
covered call options and cash-secured puts (see "Investment Strategies"). Such
strategies themselves involve certain additional risks (see "Special Risks").
Moreover, there are additional risk considerations associated with certain other
investment policies of, and strategies employed by, the Fund, such as those
relating to concentration of investments in New York issuers, investing in
variable and floating rate instruments, zero coupon bonds, pay-in-kind bonds,
lower quality municipal obligations, illiquid securities and borrowing for
investment (see "Investment Strategies" and "Special Risks").
Tax-Free Income
The interest earned by the Fund from municipal obligations that is paid as
exempt-interest dividends is not includable in your gross income for Federal
income tax purposes. Moreover, to the extent that dividends on shares of the
Fund are derived from interest received by the Fund on obligations of New York
and its political subdivisions, such dividends will also be exempt from a New
York shareholder's gross income for New York State and New York City personal
income tax purposes (see "Dividends and Tax Status"). You should recognize,
however, that the Fund's investment in municipal obligations of New York issuers
may involve inherent risks (see "Special Risks").
How to Buy and Sell Shares of the Fund?
Shares of the Fund may be purchased on a continuous basis without any sales
charge at the next determined net asset value per share (see "Purchase of
Shares" and "Determination of Net Asset Value"). Your purchase order becomes
effective immediately if it is received before 4:00 P.M. on any business day.
Shares are redeemable (may be sold) at your option without charge at the
next determined net asset value per share (see "Redemption of Shares"). The Fund
reserves the right, however, to liquidate an account with a value of less than
$100 on 60 days' notice.
Shareholder Services and Privileges
For your convenience, the Fund provides certain services and privileges
which we have suited to your particular needs, including the Automatic
Investment Program and the Exchange, Check Redemption, Telephone Redemption and
Expedited Redemption Privileges (see "Purchase of Shares" and "Redemption of
Shares").
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<PAGE>
Monthly Dividends
The Fund declares dividends daily and pays them on a monthly basis,
eliminating the need for you to hold your shares until quarter-end to receive
dividend income. Dividends are automatically reinvested at net asset value in
additional Fund shares without any charge. You may elect, however, to receive
them in cash (see "Dividends and Tax Status").
Management and The Fundamental Family of Funds
Fundamental Portfolio Advisors, Inc., 90 Washington Street, New York, New
York 10006, the Fund's investment manager (the "Manager") determines overall
investment strategy for the Fund and provides the Fund with all necessary office
facilities, equipment and personnel for managing the Fund's affairs and
investments (see "Management").
The Manager also acts as investment manager to several other mutual fund
portfolios in The Fundamental Family of Funds, including The California Muni
Fund, and the High-Yield Municipal Bond Series, the Tax-Free Money Market Series
and the Fundamental U.S. Government Strategic Income Fund Series of Fundamental
Fixed-Income Fund. Shares of such funds are exchangeable for shares of the Fund
(minimum $1,000 value) at the respective net asset values per share without any
charge and may be exchanged by telephone (see "Purchase of Shares").
FEE TABLE
Shareholder Transaction Expenses
------------------------------------------------------------
Sales Load Imposed on Purchases ..................... None
Sales Load Imposed on Reinvested Dividends .......... None
Redemption Fees ..................................... None
Exchange Fees ....................................... None
Annual Fund Expenses (as a percentage of average net assets)
------------------------------------------------------------
Management Fees ..................................... .49%
12b-1 Fees1 ......................................... .50%
Other Expenses:
Interest ........................................ 2.11%
Other ........................................... .67%
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Total Fund Expenses ................................. 3.77%
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Example: You would pay the following expenses on a $1,000 investment,
assuming (1) 5% annual return and (2) redemption at the end of each time period:
1 year 3 years 5 years 10 years
$38 $115 $194 $401
The purpose of the foregoing table is to assist you in understanding the
various costs and expenses that you will bear directly and indirectly. (For more
complete descriptions of the various costs and expenses, see "Management",
"Distribution Expenses" and the Financial Statements included at the end of the
Fund's Statement of Additional Information.) The expenses and example appearing
in the preceding table have been restated to reflect current fees and operating
expenses. The example shown in the table should not be considered a
representation of past or future expenses, and actual expenses may be greater or
less than those shown.
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1As a result of distribution fees of .50% per annum of the Fund's average daily
net assets, a long-term shareholder may pay more than the economic equivalent
of the maximum front-end sales charges permitted by the Rules of the
National Association of Securities Dealers, Inc.
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<PAGE>
FINANCIAL HIGHLIGHTS
The following selected per share data and ratios for each of the years in
the ten-year period ended December 31, 1996 has been audited by McGladrey &
Pullen, LLP, independent certified public accountants whose report on the
Financial Statements and the related notes appear at the end of the Fund's
Statement of Additional Information.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Year Ended December 31,
-------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the
period)
Net Asset Value, Beginning of year ...... $0.98 $0.88 $1.18 $1.21 $1.14 $1.04 $1.12 $1.09 $1.05 $1.25
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Income from investment operations:
Net investment income ................. .035 .035 .056 .065 .061 .059 .069 .072 .074 .078
Net realized and unrealized gain (loss)
on investments ...................... (.110) .101 (.290) .082 .070 .100 (.080) .031 .040 (.167)
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total from investment operations .. (.075) .136 (.234) .147 .131 .159 (.011) .103 .114 (.089)
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Less: Distributions:
Dividends from net investment income .. (.035) (.035) (.056) (.065) (.060) (.059) (.069) (.072) (.074) (.078)
Dividends from net realized gains ..... - (.001) (.010) (.112) (.001) - - - - (.030)
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total distributions ............... (.035) (.036) (.066) (.177) (.061) (.059) (.069) (.072) (.074) (.108)
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Net Asset Value, End of year ............ $0.87 $0.98 $0.88 $1.18 $1.21 $1.14 $1.04 $1.12 $1.09 $1.05
===== ===== ===== ====== ====== ===== ===== ===== ===== =====
Total Return ...................... (7.73%) 15.67% (20.47%) 12.58% 11.83% 15.73% (.99%) 9.60% 11.22% (7.44%)
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (000) ......... $196,746 $226,692 $212,665 $275,552 $196,516 $183,307 $182,282 $236,525 $230,356 $219,872
Ratios to Average Net Assets:
Interest expenses ..................... 2.11% 2.09% 1.59% .61% .19% .09% .17% .35% .55% .72%
Operating expenses .................... 1.66% 1.55% 1.62% 1.44% 1.50% 1.69% 1.48% 1.34% 1.19% 1.32%
----- ----- ----- ----- ----- ----- ----- ----- ----- -----
Total expenses .................... 3.77% 3.64% 3.21% 2.05% 1.69% 1.78% 1.65% 1.69% 1.74% 2.04%
===== ===== ===== ====== ====== ===== ===== ===== ===== =====
Net investment income ............. 3.89% 3.81% 5.34% 5.20% 5.16% 5.47% 6.43% 6.47% 6.94% 6.97%
Portfolio turnover rate ................. 347.44% 347.50% 289.69% 404.05% 460.58% 365.12% 482.58% 386.48% 462.73% 548.50%
BANK LOANS
Amount outstanding at end of period
(000 omitted) $1,200 $64,575 $20,000 $20,873 $725 - $248 $9,758 - $1,660
Average amount of bank loans
outstanding during the year
(000 omitted) $49,448 $49,603 $54,479 $24,100 $5,194 $1,483* $4,767* $9,581* $11,500*$24,000*
Average number of shares outstanding
during the year (000 omitted) 178,456 191,692 206,323 184,664 161,404 167,206* 209,484* 211,210* 212,394*228,740*
Average amount of debt per share during
the year $ .277 $ .259 $ .264 $ .131 $ .032 $ .009 $ .023 $ .045 $ .054 $ .105
<FN>
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**Based on monthly averages.
</FN>
</TABLE>
4
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INVESTMENT OBJECTIVE AND POLICIES
The Fund's fundamental investment objective is to provide you with a high
level of income that is excluded from gross income for Federal income tax
purposes and exempt from New York State and New York City personal income taxes
and is consistent with the preservation of capital. Under normal market
conditions, at least 80% of the Fund's assets will be invested in securities
that are free from Federal, New York State and New York City income taxes.
The Fund's investment objective and its investment policies and strategies
with respect to futures, options, lending portfolio securities and borrowing
(described below) are fundamental policies that cannot be changed without the
approval of the holders of a majority of the Fund's outstanding shares. A more
detailed explanation of certain investment policies and the Fund's fundamental
investment restrictions is contained in the Statement of Additional Information.
As used in this Prospectus, the phrase majority of the Fund's outstanding
shares means the vote of the lesser of (1) 67% of the Fund's shares present at a
meeting of shareholders if the holders of more than 50% of the outstanding
shares are present in person or by proxy at such a meeting or (2) more than 50%
of the Fund's outstanding shares.
The Fund attempts to achieve its objective by investing substantially all
(at least 80%) of its total assets in municipal obligations which are rated
within the four highest quality grades for bonds as determined by Moody's, S&P,
Fitch or Duff or within the three highest quality grades for municipal notes as
determined by Moody's, S&P, Fitch or Duff or, if unrated, are judged by Fund
management to be of comparable quality, and which are issued by the State of New
York, its political subdivisions, and its other duly constituted authorities and
corporations, the interest from which, in the opinion of counsel to the issuer,
is totally excluded from gross income for Federal income tax purposes, does not
constitute a preference item and, therefore, will not be subject to the Federal
alternative minimum tax on individuals and is exempt from New York State and New
York City personal income taxes. At least 65% of the value of the Fund's net
assets (except when maintaining a temporary defensive position) will be invested
in New York municipal obligations. There can be no assurance that the Fund's
objective will be achieved. The Fund's ability to achieve its objective is
subject to the continuing ability of the issuers of municipal obligations to
meet their principal and interest payments, and is further subject to
fluctuations in interest rates as well as other factors.
While the municipal obligations in which the Fund may invest are generally
deemed to have adequate to very strong protection of principal and interest,
those rated within the lowest of the quality grades described above are
considered medium-grade obligations which have speculative characteristics as
well. For example, obligations rated Baa by Moody's have been determined by
Moody's to be neither highly protected nor poorly secured, and although interest
payments and principal security appear adequate for the present, certain
protective elements may be lacking or may be characteristically unreliable over
any great length of time. Similarly, obligations rated BBB by S&P, Fitch or Duff
are regarded by S&P, Fitch and Duff as having adequate capacity to pay interest
and repay principal, and while such obligations normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for obligations in this category than in higher rated categories.
Although the Fund intends to invest primarily in higher quality municipal
obligations as described above, up to 10% of its total assets may be invested in
municipal obligations rated lower than Baa by Moody's or BBB by S&P, Fitch or
Duff and as low as Caa by Moody's or CC by S&P, Fitch or Duff, or if unrated,
are judged by Fund management to be of comparable quality. Investments rated Ba
or lower by Moody's and BB or lower by S&P, Fitch or Duff normally provide
higher yields, but involve greater risk because of their speculative
characteristics and are commonly referred to as "junk bonds." (See "Special
Risks-Special Risk Factors Relating to Lower Rated Securities.")
It should be noted that ratings are general and not absolute standards of
quality or guarantees of the creditworthiness of an issuer. The ratings of
Moody's, S&P, Fitch and Duff represent their opinions as to the quality of the
municipal obligations which they undertake to rate. It should be emphasized,
however, that ratings are relative and subjective and, although ratings may be
useful in
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<PAGE>
evaluating the safety of interest and principal payments, they do not evaluate
the market value risk of these bonds. Therefore, although these ratings may be
an initial criterion for selection of portfolio investments, the Manager also
will evaluate these securities and the ability of the issuers of such securities
to pay interest and principal. The Fund's ability to achieve its investment
objective may be more dependent on the Manager's credit analysis than might be
the case for a fund that invested in higher rated securities only. Once the
rating of a portfolio security or the quality determination ascribed by Fund
management to an unrated portfolio security has been downgraded, the Fund will
consider all circumstances deemed relevant in determining whether to continue to
hold the security, but in no event will the Fund retain such securities if it
would cause the Fund to have 20% of the value of its total assets invested in
securities rated lower than Baa by Moody's or BBB by S&P, Fitch or Duff, or if
unrated, are judged by Fund management to be of comparable quality. The purchase
of unrated securities is subject to guidelines that may be set for Fund
management from time to time by the Fund's Board of Directors. A description of
the ratings of municipal obligations as determined by Moody's, S&P, Fitch and
Duff is included in the Statement of Additional Information. (See the Appendix
to this Prospectus for a summary of the Fund's asset composition, based on the
monthly weighted average of credit ratings of its portfolio securities.)
The Fund invests in municipal obligations that have remaining maturities
ranging from short-term maturities (less than one year) to long-term maturities
(in excess of fifteen years). Depending on market conditions, the Fund attempts
to achieve a favorable tradeoff between longer maturities that have higher
income as opposed to shorter maturities with relatively less income. Because the
Fund may purchase bonds that mature in more than one year, invests in inverse
floating variable rate bonds, assumes some credit risk and does not have a
stable net asset value (the value of its shares fluctuates), it is not a money
market fund. The longer the maturity of a municipal obligation, the greater the
impact of fluctuating interest rates on the market value of the instrument. In
periods of rising interest rates, the market value of municipal obligations
generally declines in order to bring the current yield in line with prevailing
interest rates. Conversely, in periods of declining interest rates, the market
value of municipal obligations generally rises. Although fluctuating interest
rates affect the market value of all municipal obligations, short-term
obligations are generally less sensitive to such factors than long-term
obligations. During periods of rapidly rising interest rates, the Fund intends
to adopt various corrective measures (i.e., shortening the average length of
maturities of portfolio securities, raising the overall quality of portfolio
investments) in order to minimize the effect of such rates on per share net
asset value during such periods.
As a non-diversified investment company, the Fund could conceivably invest
all of its assets in one issuer. However, in order to qualify as a "regulated
investment company" for Federal income tax purposes, the Fund must comply with
the provisions of Subchapter M of the Internal Revenue Code of 1986, as amended
(the "Code"), which limit the aggregate value of all holdings (except U.S.
Government and cash items, as defined in the Code), each of which exceeds 5% of
the Fund's total assets, to an aggregate amount of 50% of such assets, and which
further limit the holdings of a single issuer (with the same exceptions) to 25%
of the Fund's total assets. Therefore, for our purposes, non-diversification
means that, with regard to the Fund's total assets, 50% of such assets may be
invested in as few as two single issuers. (These limits are measured at the end
of each quarter.) In the event of decline of creditworthiness or default on the
obligations of one or more such issuers exceeding 5%, an investment in the Fund
will involve greater risk than in a fund that has a policy of diversification.
Many of the Fund's portfolio securities will be obligations which are
related in such a way that an economic, business or political development or
change affecting one such security also would affect the other portfolio
securities (e.g., securities the interest on which is paid from revenues of
similar types of projects). As a result, the Fund's portfolio may be subject to
greater risk as compared to a portfolio composed of more varied obligations or
issuers. Furthermore, the relatively high degree of similarities among the
issuers of obligations in the Fund's portfolio may result in a greater degree of
fluctuation in the market value of the portfolio. To offset such fluctuations,
Fund management will attempt to adopt a temporary defensive posture during
periods of economic difficulty affecting either the economy as a whole or, more
specifically, individual issuers involved in the Fund's portfolio. Such practice
may include, among other modifications, reducing or eliminating holdings in
securities of issuers such as state and local governments which the Fund
believes may be adversely affected by changing economic conditions or political
events, shortening average maturity and/or upgrading the average quality of the
Fund's portfolio. These defensive measures may have the effect of reducing the
income to the
6
<PAGE>
Fund from the portfolio. Moreover, notwithstanding the imposition of such
measures, Fund management may not be able to foresee developments in the economy
sufficiently in advance to avoid significant declines in market value. To the
extent that the Fund is in a temporary defensive posture, the Fund's objective
may not be achieved.
Municipal Obligations
Municipal obligations include debt obligations of states, territories and
possessions of the United States and of any political subdivisions thereof, such
as counties, cities, towns, districts and authorities. Municipal obligations are
issued to raise funds for a variety of purposes, including construction of a
wide range of public facilities, refunding of outstanding obligations, obtaining
funds for general operating expenses, and lending to other public institutions
and facilities. In addition, certain types of qualified private activity bonds
are issued by, or on behalf of, public authorities to obtain funds for privately
operated facilities.
Also included within the definition of municipal obligations are short-term,
tax-exempt debt obligations, known as municipal notes, which are generally
issued in anticipation of receipt by the issuer of revenues from taxes, the
issuance of longer term bonds, or other sources. States, municipalities, and
other issuers of tax-exempt securities may also issue short-term debt, often for
general purposes, known as "municipal commercial paper." All of these
obligations (excluding those just referred to as "municipal commercial paper")
are included within the term "municipal obligations," as used in this
Prospectus, if their interest payments are excluded for Federal income tax
purposes.
Yields on municipal obligations depend on a variety of factors, including
the general condition of the money and municipal securities markets, the size of
a particular offering, the maturity of the obligation and the rating of the
issue. Unlike other types of securities, municipal obligations have
traditionally not been subject to regulation by, or registration with, the
Securities and Exchange Commission.
The two principal classifications of municipal obligations are general
obligation bonds and revenue bonds. General obligation bonds are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest. Revenue bonds are payable from only the revenues derived
from a particular facility or class of facilities or, in some cases, from the
proceeds of a special excise tax or other specific revenue source. Qualified
private activity bonds that are municipal obligations are, in most cases,
revenue bonds and do not generally constitute the pledge of the credit of the
issuer of such bonds. The credit quality of qualified private activity bonds is
usually related to the credit standing of the industrial user involved. The Fund
reserves the right to invest up to 20% of its total assets in qualified private
activity bonds, if such bonds meet the Fund's investment criteria.
There are also a variety of hybrid and special types of municipal
obligations, as well as numerous differences in the security of municipal
obligations, both within and between the two principal classifications described
above (see the Statement of Additional Information for more details).
Portfolio Transactions and Turnover
The Manager provides the Fund with investment advice and recommendations for
the purchase and sale of portfolio securities. All orders for the purchase and
sale of portfolio securities are placed by the Manager, subject to the general
control of the Fund's directors. The Manager may sell portfolio securities prior
to their maturity if market conditions and other considerations indicate, in the
opinion of the Manager, that such sale would be advisable. In addition, the
Manager may engage in short-term trading when it believes it is consistent with
the Fund's investment objective. Also, a security may be sold and another of
comparable quality may be simultaneously purchased to take advantage of what the
Manager believes to be a temporary disparity in the normal yield relationships
of two securities. The frequency of portfolio transactions-the Fund's turnover
rates-will vary from year to year depending upon market conditions. Because a
high turnover rate (over 100%) increases transaction costs and the possibility
of taxable short-term gains (see "Dividends and Tax Status"), the Manager weighs
the added costs of short-term investment against anticipated gains. The Fund's
portfolio turnover rate was approximately 347% for the year ended December 31,
1995, and was approximately 347% for the year ended December 31, 1996.
7
<PAGE>
INVESTMENT STRATEGIES
In seeking to achieve its investment objective, the Fund utilizes various
investment strategies, including borrowing to purchase additional securities,
investing in participation interests, variable and floating rate instruments,
purchasing municipal obligations that are offered on a "when-issued" or "delayed
delivery" basis and, when deemed necessary in the opinion of Fund management,
making temporary investments in certain taxable obligations, as described below.
The Fund's fundamental investment restrictions also permit buying and selling of
interest rate futures contracts ("futures contracts"), using options to purchase
or sell such contracts, using options to purchase or sell debt securities, and
writing covered call options and cash-secured puts. The use of options and
futures contracts may benefit the Fund and its shareholders by improving the
Fund's liquidity and by helping to stabilize the value of its net assets. In
addition, the Fund is permitted to enter into repurchase agreement and reverse
repurchase agreement transactions, to lend its portfolio securities and to
invest up to 15% of its net assets in illiquid securities.
Each investment strategy is briefly described below with a short example of
how it can be used by the Fund.
Futures Contracts
A futures contract is an agreement between two parties to buy and sell a
security for a set price on a future date. Futures contracts are traded on
designated "contract markets" which, through their clearing corporations,
guarantee performance of the contracts. Presently, there are futures contracts
based on such debt securities as long-term U.S. Treasury Bonds, Treasury Notes,
Government National Mortgage Association modified pass-through mortgage-backed
securities, three-month U.S. Treasury Bills, and bank certificates of deposit.
Although most futures contracts call for actual delivery or acceptance of debt
securities, the contracts usually are closed out before the settlement date
without the making or taking of delivery. A futures contract sale is closed out
by effecting a futures contract purchase for the same aggregate amount of the
specific type of debt security and the same delivery date. If the sale price
exceeds the offsetting purchase price, the seller would be paid the difference
and would realize a gain. If the offsetting purchase price exceeds the sale
price, the seller would pay the difference and would realize a loss. Similarly,
a futures contract purchase is closed out by effecting a futures contract sale
for the same aggregate amount of the specific type of debt security and the same
delivery date. If the offsetting sale price exceeds the purchase price, the
purchaser would realize a gain, whereas if the purchase price exceeds the
offsetting sale price, the purchaser would realize a loss. There is no assurance
that the Fund will be able to enter into a closing transaction. In the unlikely
event that the Fund was unable to enter into a closing transaction of an open
futures or options position, the Fund could be forced to perform certain actions
as specified by the futures or options contract. This would depend on the type
of outstanding contract involved. The two types of methods by which futures and
options contracts are closed in the absence of offsetting trades are by index
value and by delivery.
Futures and options contracts in financial instruments such as municipal
bonds and LIBOR rates, settle by index value. That means that on the last
trading day of the contract, all outstanding contracts are automatically closed
out at the value of the index that day. The effect on the Fund would be exactly
the same as if a closing transaction had been effected at that price.
Futures and options in financial instruments such as Treasury bonds and
notes, if not closed out, will result in actual delivery of the securities in
question. The holder of a long futures contract or an option contract that was
exercised could be forced to purchase (take delivery of) a specified amount of
securities at a specified price. Likewise the entity that was short a futures
contract or option that did not enter into a closing transaction prior to
expiration, could be forced to deliver a specific amount of securities at a
specified price according to the terms of the futures or option contract.
The inability of the Fund to enter into a closing contract could result in
the Fund being forced to deliver or take delivery of a specific amount of
securities at a specific price. Disposing of or obtaining the specified
securities could involve considerable expense to the Fund and could affect the
Fund's net asset value.
When the futures contract is entered into, each party deposits with a broker
or in a segregated custodial account approximately 5% of the contract amount,
called the "initial margin." The segregated custodial account will be in an
amount equal to the total market value of the futures contract, less the initial
margin deposited therefor. Subsequent payments to and from the broker or
account, called "variation margin," will be made on a daily basis as the price
of the underlying debt security fluctuates making the long and short positions
of the futures contract more or less valuable, a process known as "mark to the
market."
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The purpose of a futures contract, in the case of a portfolio holding
long-term municipal debt securities, is to gain the benefit of changes in
interest rates without actually buying or selling long-term debt securities.
Generally, if market interest rates increase, the value of outstanding debt
securities declines (and vice versa). Entering into a futures contract for the
sale of debt securities has an effect similar to the actual sale of such
securities, although the sale of the futures contract might be accomplished more
easily and quickly given the greater liquidity in the futures market. For
example, if the Fund holds long-term debt securities and it anticipates a rise
in long-term interest rates, it could, in lieu of disposing of its portfolio
securities, enter into futures contracts for the sale of similar long-term
securities. If rates increased and the value of the Fund's portfolio securities
declined, the value of the Fund's futures contracts would increase, thereby
protecting the Fund by preventing net asset value from declining as much as it
otherwise would have declined. Similarly, entering into futures contracts for
the purchase of debt securities has an effect similar to the actual purchase of
the underlying securities, but permits the continued holding of securities other
than the underlying securities. For example, if the Fund expects long-term
interest rates to decline, it might enter into futures contracts for the
purchase of long-term securities in order to gain rapid market exposure that may
offset anticipated increases in the cost of securities it intends to purchase,
while continuing to hold higher-yield, short-term securities or waiting for the
long-term market to stabilize. The Board of Directors has adopted a percentage
restriction limiting the aggregate market value of the futures contracts the
Fund holds to an amount not to exceed 20% of the market value of its total
assets.
Options
An option gives the holder a right to buy or sell futures contracts, or
securities, in the future. The Fund will only buy options listed on national
securities exchanges except for agreements, sometimes called cash puts, which
may accompany the purchase of a new issue of bonds from a dealer. Unlike a
futures contract, which requires the parties to the contract to buy and sell a
security on a set date, an option on a futures contract, for example, merely
entitles its holder to decide on or before a future date whether to enter into
such a contract. If the holder decides not to enter into the contract, all that
is lost is the price, called the "premium," paid for the option. Further,
because the value of the option is fixed at the point of sale, there are no
daily cash payments to reflect the change in the value of the underlying
contract. However, since an option gives the buyer the right to enter into a
contract at a set price for a fixed period of time, its value does change daily,
and the change is reflected in the net asset value of the Fund.
In addition to options on futures contracts, there are options that give the
buyer the right to buy or sell actual debt securities, such as tax-exempt bonds.
Currently, the market for options on tax-exempt securities is very small. It is
anticipated that it will become substantially larger in the future. A put option
gives the buyer of the option the right to sell a designated security for a set
price, and a call option gives the buyer the right to buy a security for a set
price on or before a specified date. The "writer," or seller, of a call option,
for example, is required to sell the security described in the option to the
holder of the option, if the holder decides to buy such security. For
undertaking this obligation, the writer receives a premium, less the commission
charged by a broker, which the writer retains regardless of whether the option
is exercised. The Fund will only write call options on securities it holds in
its portfolio, (referred to as covered call writing) or will write "cash secured
puts," as defined below. The buyer of such a put pays the Fund a premium for the
option to sell to the Fund a specific bond at a specified price within a
specified period of time. The Fund will maintain adequate cash reserves to
purchase the underlying bond should the put option be exercised, by placing in a
segregated account, only liquid assets, such as cash, U.S. Government securities
or other appropriate high-grade debt obligations ("cash secured puts"). The Fund
retains the premium whether or not the option is exercised. However, the Fund
will be obligated to purchase the bond at the exercise price regardless of how
much the market value of the bond has declined below the exercise price. As a
covered call option writer, the Fund earns additional income from premiums, but
it risks losing any appreciation of the security covered by the option if
interest rates decline. Option writing can be used advantageously to generate
incremental income when the outlook is for relatively stable bond prices;
however, such income may be taxable. The aggregate market value of the options
on debt securities held or written by the Fund may not exceed 25% of the Fund's
total net assets. The risk involved in writing options (or selling futures) is
not limited to the value of the options, since the maximum potential loss to the
Fund is the cost of closing out the short options (or futures) positions which
theoretically has no limit. Participation in options transactions involves
certain risks (see "Special Risks").
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Investing in Other Investment Companies
The Fund may invest indirectly in municipal obligations by investing in
other investment companies. Such investments may involve the payment of premiums
above the net asset value of such issuers' portfolio securities, are subject to
limitations under the Investment Company Act of 1940 and are constrained by
market availability. As a shareholder in an investment company, the Fund would
bear its ratable share of that investment company's expenses, including its
advisory and administration fees. Fundamental Portfolio Advisors, Inc. has
agreed to waive its management (advisory) fees with respect to the portion of
the Fund's assets invested in shares of other open-end investment companies. The
Fund would continue to pay its own management fees and other expenses with
respect to its investments in shares of a closed-end investment company.
Repurchase Agreements
The Fund may enter into repurchase agreement transactions. Under a
repurchase agreement, the Fund acquires a debt instrument for a relatively short
period (usually not more than one week) subject to the obligation of the seller
to repurchase and the Fund to resell such debt instrument at a fixed price. The
resale price is in excess of the purchase price in that it reflects an
agreed-upon market interest rate effective for the period of time during which
the Fund's money is invested. The Fund's repurchase agreements will at all times
be fully collateralized in an amount at least equal to the purchase price
including accrued interest earned on the underlying securities. The instruments
held as collateral are valued daily, and as the value of instruments declines,
the Fund will require additional collateral. If the seller defaults and the
value of the collateral securing the repurchase agreement declines, the Fund may
incur a loss. Repurchase agreements are considered by the staff of the
Securities and Exchange Commission to be loans by the Fund.
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreement transactions only in
amounts such that the total of the reverse repurchase agreements and all other
borrowings combined will not exceed 33-1/3% of the Fund's total assets at the
time it enters into a reverse repurchase agreement. Such transactions involve
the sale of securities held by the Fund, with an agreement that the Fund will
repurchase such securities at an agreed upon price and date. The Fund will
employ reverse repurchase agreements when necessary to meet unanticipated net
redemptions so as to avoid liquidating other portfolio investments during
unfavorable market conditions, or as a technique to enhance income. At the time
it enters into a reverse repurchase agreement, the Fund will place in a
segregated custodial account high-quality liquid debt securities having a dollar
value equal to the repurchase price. The Fund will utilize reverse repurchase
agreements when the interest income to be earned from portfolio investments is
greater than the interest expense incurred as a result of the reverse repurchase
transactions. Any reverse repurchase agreement entered into by the Fund
constitutes a borrowing, has leveraging effects and makes the Fund's net asset
value more volatile.
Lending of Portfolio Securities
In order to generate income, the Fund may lend its portfolio securities in
an amount up to 33-1/3% of total assets to broker-dealers, major banks or other
recognized domestic institutional borrowers of securities not affiliated with
the Manager. The borrower at all times during the loan must maintain cash or
cash equivalent collateral or provide to the Fund an irrevocable letter of
credit equal in value to at least 100% of the value of the securities loaned.
During the time portfolio securities are on loan, the borrower pays the Fund any
dividends or interest paid on such securities, and the Fund may invest the cash
collateral in high-grade, short-term, tax-exempt instruments and earn income, or
it may receive an agreed-upon amount of interest income from the borrower who
has delivered equivalent collateral or a letter of credit.
Temporary Investments
The Fund may from time to time invest a small portion of its total assets,
on a temporary basis, in high-grade fixed-income obligations, the interest on
which is subject to Federal, New York State and/or New York City income tax.
Such high-grade quality
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investments include obligations issued or guaranteed by the U.S. Government, its
agencies or instrumentalities, and obligations of domestic branches of U.S.
banks, including certificates of deposit and bankers' acceptances. A description
of high-grade municipal obligations is included in the Statement of Additional
Information.
Investments of this kind may be obtained by the Fund pending investment or
reinvestment in municipal obligations of the proceeds from the sale of Fund
shares or the sale by the Fund of portfolio securities. In addition, the Fund
may invest in highly liquid taxable obligations to avoid the necessity of
liquidating portfolio securities to meet redemptions by investors. Although
there are no specific limitations other than those imposed under the Code (see
"Dividends and Tax Status") on the portion of Fund assets that may be invested
in taxable obligations, it is anticipated that on a 12-month average, taxable
obligations will constitute less than 10% of the value of the Fund's portfolio.
Fund management also anticipates that a cash reserve will be maintained for
purposes of meeting the day-to-day operating expenses of the Fund as well as
redemptions of Fund shares. Such cash reserve may be maintained in either
interest or non-interest bearing form, at the discretion of the Fund's
directors. Furthermore, if maintained in interest-bearing form, it is
anticipated that all or part of such interest will be subject to Federal, New
York State and/or New York City income tax. However, it is expected that, on a
12-month average, such reserve will constitute less than 5% of the Fund's total
assets.
Illiquid Securities
The Fund will not invest more than 15% of its net assets (taken at market
value) in illiquid securities, including repurchase agreements with maturities
in excess of seven days.
The Fund may invest in securities that are subject to restrictions on resale
because they have not been registered under the Securities Act of 1933 (the
"1933 Act"). These securities are sometimes referred to as private placements.
Although securities which may be resold only to "qualified institutional buyers"
in accordance with the provisions of Rule 144A under the 1933 Act are
technically considered "restricted securities", the Fund may purchase Rule 144A
securities without regard to the limitation on investments in illiquid
securities described above, provided that a determination is made that such
securities have a readily available trading market. Fund management will
determine the liquidity of Rule 144A securities under the supervision of the
Fund's Board of Directors. The liquidity of Rule 144A securities will be
monitored by Fund management and, if as a result of changed conditions, it is
determined that a Rule 144A security is no longer liquid, the Fund's holding of
illiquid securities will be reviewed to determine what, if any, action is
required to assure that the Fund does not exceed its applicable percentage
limitation for investments in illiquid securities.
Fund management anticipates that the market for certain restricted
securities such as inverse floaters that are created in the secondary market
will expand further as a result of this relatively new regulation and the
development of automated systems for the trading, clearing and settlement of
unregistered securities, as more institutions and dealers invest in and make
markets in these securities.
In reaching liquidity decisions, Fund management will consider, inter alia,
the following factors: (1) the frequency of trades and quotes for the security;
(2) the number of dealers wanting to purchase or sell the security and the
number of other potential purchasers; (3) dealer undertakings to make a market
in the security and (4) the nature of the security and the nature of the
marketplace trades (e.g., the time needed to dispose of the security, the method
of soliciting offers and the mechanics of the transfer).
When-lssued Purchases
Municipal securities are frequently offered on a "when-issued" basis. When
so offered, the price and coupon rate are fixed at the time the commitment to
purchase is made, but delivery and payment for the when-issued securities take
place at a later date. Normally, the settlement date occurs between 15-45 days
from the date of purchase. During the period between purchase and settlement, no
interest accrues to the purchase. The price that the Fund would be required to
pay may be in excess of the market value
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of the security on the settlement date. While securities may be sold prior to
the settlement date, the Fund intends to purchase such securities for the
purpose of actually acquiring them unless a sale becomes desirable for
investment reasons. At the time the Fund makes a commitment to purchase a
municipal security on a when-issued basis, it will record the transaction and
reflect the value of the security in determining its net asset value. That value
may fluctuate from day to day in the same manner as values of other municipal
securities held by the Fund. The Fund will establish a segregated account with
its custodian bank in which it will maintain cash or high-grade liquid debt
securities determined daily to be equal in value to its commitments for
when-issued securities. Generally, both the when-issued securities and the
securities held in the segregated account will tend to experience appreciation
when interest rates decline and depreciation when interest rates increase.
Accordingly, the purchase of when-issued securities may increase the volatility
of the Fund's net asset value. The Fund may invest in when-issued securities
without limitation.
At such time as the Fund is required to pay for when-issued securities, it
will meet its obligation from then-available cash flow, sale of the securities
held in the separate account, sale of other securities, or (although it would
not normally expect to do so) from the sale of the when-issued securities
themselves (which may have a market value greater or less than the Fund's
payment obligation). Sale of securities to meet such obligations carries with it
a greater potential for the realization of capital gains, which are not excluded
from gross income for Federal, state or local income tax purposes.
Delayed-Delivery Transactions
The Fund may buy and sell securities on a "delayed-delivery" basis, with
payment and delivery taking place at a future date. The market value of
securities purchased in this way may change before the delivery date, which
could affect the market value of the Fund's assets, and could increase
fluctuations in the Fund's yield and net asset value. Ordinarily, the Fund will
not earn interest on the securities purchased until they are delivered.
Participation Interests, Variable and Inverse Floating Rate Instruments
The Fund may purchase participation interests from financial institutions.
These participation interests give the purchaser an undivided interest in one or
more underlying municipal obligations.
The Fund may also invest in municipal obligations which have variable
interest rates that are readjusted periodically. Such readjustment may be based
either upon a predetermined standard, such as a bank prime rate or the U.S.
Treasury bill rate, or upon prevailing market conditions. Many variable rate
instruments are subject to redemption or repurchase at par on demand by the Fund
(usually upon no more than seven days' notice). All variable rate instruments
must meet the quality standards of the Fund. The Manager will monitor the
pricing, quality and liquidity of the variable rate municipal obligations held
by the Fund.
The Fund may purchase inverse floaters which are instruments whose interest
rates bear an inverse relationship to the interest rate on another security or
the value of an index. Changes in the interest rate on the other security or
index inversely affect the residual interest rate paid on the inverse floater,
with the result that the inverse floater's price will be considerably more
volatile than that of a fixed-rate bond. For example, a municipal issuer may
decide to issue two variable rate instruments instead of a single long-term,
fixed-rate bond. The interest rate on one instrument reflects short-term
interest rates. Typically, this component pays an interest rate that is reset
periodically through an auction process, while the interest rate on the other
instrument (the inverse floater) pays a current residual interest rate based on
the total difference between the total interest paid by the issuer on the
municipal obligation and the auction rate paid on the auction component. This
reflects the approximate rate the issuer would have paid on a fixed-rate bond,
multiplied by two, minus the interest rate paid on the short-term instrument.
Depending on market availability, the two portions may be recombined to form a
fixed-rate municipal bond. The Fund may purchase both the auction and the
residual components. (See "Special Risk Factors Relating to Inverse Floating
Rate Instruments").
The Fund may invest in municipal obligations that pay interest at a coupon
rate equal to a base rate, plus additional interest for a certain period of time
if short-term interest rates rise above a predetermined level or "cap". The
amount of such an additional interest payment typically is calculated under a
formula based on a short-term interest rate index multiplied by a designated
factor.
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The Fund may purchase various types of structured municipal bonds whose
interest rates fluctuate according to changes in other interest rates for some
period and then revert to a fixed rate. The relationship between the interest
rate on these bonds and the other interest rate or index may be direct or
inverse, or it may be based on the relationship between two other interest rates
such as the relationship between taxable and tax-exempt interest rates.
Borrowing For Investment and For Other Purposes
The Fund may borrow money from banks (including its custodian bank) or from
other lenders to the extent permitted under applicable law, for temporary or
emergency purposes, to meet redemptions or for purposes of leveraging and may
pledge its assets to secure such borrowings. Borrowing for investment increases
both investment opportunity and investment risk. Such borrowings in no way
affect the Federal or New York State tax status of the Fund or its dividends. If
the investment income on securities purchased with borrowed money exceeds the
interest paid on the borrowing, the net asset value of the Fund's shares will
rise faster than would otherwise be the case. On the other hand, if the
investment income fails to cover the Fund's costs, including the interest on
borrowings or if there are losses, the net asset value of the Fund's shares will
decrease faster than would otherwise be the case.
This is the speculative factor known as leverage.
The Investment Company Act of 1940 (the "1940 Act") requires the Fund to
maintain asset coverage of at least 300% for all such borrowings, and should
such asset coverage at any time fall below 300%, the Fund would be required to
reduce its borrowings within three days to the extent necessary to meet the
requirements of the 1940 Act. To reduce its borrowings, the Fund might be
required to sell securities at a time when it would be disadvantageous to do so.
In addition, because interest on money borrowed is a Fund expense that it
would not otherwise incur, the Fund may have less net investment income during
periods when its borrowings are substantial. The interest paid by the Fund on
borrowings may be more or less than the yield on the securities purchased with
borrowed funds, depending on prevailing market conditions.
SPECIAL RISKS
Special Risk Factors Relating to Non-Diversification
The Fund's portfolio is non-diversified (see "Investment Objective and
Policies") and may have greater risk than a diversified portfolio.
Special Risk Factors Relating to Futures and Options
There are certain risks in investing in options and interest rate futures
contracts. With respect to the use of futures contracts, although the Fund
intends to purchase or sell futures contracts only if there is an active market
for such contracts, no assurance can be given that a liquid market will exist
for any particular contract at any particular time. Many futures exchanges and
boards of trade limit the amount of fluctuation permitted in futures contract
prices during a single trading day. Once the daily limit has been reached in a
particular contract, no trades may be made that day at a price beyond that
limit. Futures contract prices could move to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of futures positions and potentially subjecting the Fund to
substantial losses. If it is not possible, or the Fund determines not to close a
futures position in anticipation of adverse price movements, the Fund will be
required to make daily cash payments of variation margin. In such circumstances,
an increase in the value of the portion of the portfolio being hedged, if any,
may offset partially or completely losses on the futures contract.
In addition, no assurance can be given that the price of the securities
being hedged will correlate with the price movements in a futures contract and
thus provide an offset to losses on the futures contract. However, the risk of
imperfect correlation generally tends to diminish as the maturity date of the
futures contract approaches.
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The Manager could also be incorrect in its expectations about the direction
or degree of various interest rate movements in the time span within which the
movements take place. Predicting interest rate direction involves skills and
techniques different from those used in most investment strategies, and there is
no guarantee that such predictions will be accurate.
The risk the Fund assumes when it buys an option is the loss of the premium
paid for the option. In order to benefit from buying an option, the price of the
underlying security must change sufficiently to cover the premium paid, the
commissions paid, both in the acquisition of the option and in a closing
transaction, or the exercise of the option and subsequent sale of the underlying
security. (The Fund could enter into a closing transaction by purchasing an
option if it had previously sold one, or by selling an option if it had
previously bought one, with the same terms as the option previously acquired.)
Nevertheless, the price change in the underlying security does not assume a
profit, because prices in the options market may not reflect such a change.
The risk involved in writing options on futures contracts the Fund owns, or
on securities held in its portfolio, is that there could be an increase in the
market value of such contracts or securities. In such case, the option would be
exercised and the asset would be sold at a lower price than the cash market
price. To some extent, the risk of not realizing a gain could be reduced by
entering into a closing transaction. However, the cost of closing the option and
terminating the Fund's obligation might be more or less than the premium
received when it originally wrote the option. Further, the Fund might not be
able to close the option because of insufficient activity in the options market.
The risk involved in writing options (or selling futures) is not limited to the
value of the options, since the maximun potential loss to the Fund is the cost
of closing out the short options (or futures) positions which theoretically has
no limit.
Finally, in deciding whether to use futures contracts or options,
consideration must be given to brokerage commission costs, which are normally
higher than those associated with general securities transactions.
Special Risk Factors Relating to Lower Rated Municipal Bonds
You should carefully consider the relative risks of investing in the higher
yielding (and, therefore, higher risk) securities in which the Fund may invest.
These are bonds such as those rated Ba to Caa by Moody's or BB to CC by S&P,
Fitch or Duff or, if unrated, are judged by Fund management to be of comparable
quality. They generally are not meant for short-term investing and may be
subject to certain risks with respect to the issuing entity and to greater
market fluctuations than certain lower yielding, higher rated fixed-income
securities. Bonds rated Ba by Moody's are judged to have speculative elements;
their future cannot be considered as well assured and often the protection of
interest and principal payments may be very moderate. Bonds rated BB by S&P,
Fitch or Duff are regarded as having predominantly speculative characteristics
and, while such obligations have less near-term vulnerability to default than
other speculative grade debt, they face major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. Bonds rated
CC by S&P, Fitch or Duff are regarded as having the highest degree of
speculation; while such bonds may have some small degree of quality and
protective characteristics, these are outweighed by large uncertainties or major
risk exposures to adverse conditions. Bonds rated as low as Caa by Moody's may
be in default or may present elements of danger with respect to principal or
interest. The Fund will not purchase bonds in default.
Investments in bonds rated Ba or lower by Moody's and BB or lower by S&P,
Fitch or Duff, while generally providing greater income and opportunity for gain
than investments in higher rated bonds, usually entail greater risk of principal
and income (including the possibility of default or bankruptcy of the issuers of
such bonds), and may involve greater volatility of price (especially during
periods of economic uncertainty or change) than investments in higher rated
bonds. However, since yields may vary over time, no specific level of income can
be assured. These lower rated, high yielding securities generally tend to
reflect economic changes and short-term corporate and industry developments to a
greater extent than higher rated securities which react primarily to
fluctuations in the general level of interest rates. Lower rated securities will
also be affected by the market's perception of their credit quality (especially
during times of adverse publicity) and the outlook for economic growth. In the
past, economic downturns or an increase in interest rates have, under certain
circumstances, caused a higher incidence of default by the issuers of these
securities and may do so in the
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future, especially in the case of highly leveraged issuers. The prices for these
securities may be affected by legislative and regulatory developments. For
example, new Federal rules require that savings and loan associations gradually
reduce their holdings of high-yield securities. An effect of such legislation
may be to significantly depress the prices of outstanding lower rated high
yielding fixed-income securities. Factors adversely affecting the market price
and yield of these securities will adversely affect the Fund's net asset value.
In addition, the retail secondary market for these securities may be less liquid
than that of higher rated bonds; adverse conditions could make it difficult at
times for the Fund to sell certain securities or could result in lower prices
than those used in calculating the Fund's net asset value. Therefore, judgment
may at times play a greater role in valuing these securities than in the case of
investment grade fixed-income securities, and it also may be more difficult
during certain adverse market conditions to sell these lower rated securities at
their fair value to meet redemption requests or to respond to changes in the
market.
Special Risk Factors Relating to Zero Coupon Bonds
The Fund may invest in zero coupon bonds and pay-in-kind bonds (bonds which
pay interest through the issuance of additional bonds), which involve special
considerations. These securities may be subject to greater fluctuations in value
due to changes in interest rates than interest-bearing securities and thus may
be considered more speculative than comparably rated interest-bearing
securities. In addition, current Federal income tax law requires the holder of a
zero coupon security or of certain pay-in-kind bonds to accrue income with
respect to these securities prior to the receipt of cash payments. To maintain
its qualification as a regulated investment company and avoid liability for
Federal income taxes, the Fund may be required to distribute income accrued with
respect to these securities and may have to dispose of portfolio securities
under disadvantageous circumstances in order to generate cash to satisfy these
distribution requirements. Fund management anticipates that investments in zero
coupon securities and pay-in-kind bonds will not ordinarily exceed 25% of the
value of the Fund's total assets. (See "Additional Information Relating to Lower
Rated Securities" in the Statement of Additional Information.)
Special Risk Factors Relating to Inverse Floating Rate Instruments
Changes in interest rates inversely affect the rate paid on inverse floating
rate instruments ("inverse floaters"). The inverse floaters' price will be more
volatile than that of a fixed rate bond. Additionally, some inverse floaters
contain a "leverage factor" whereby the interest rate moves inversely by a
"factor" to the benchmark. For example, the rates on the inverse floating rate
note may move inversely at three times the benchmark rate. Certain interest rate
movements and other market factors can substantially affect the liquidity of
inverse floaters. These instruments are designed to be highly sensitive to
interest rate changes and may subject the holders thereof to extreme reductions
of yield and possibly loss of principal.
Special Risk Factors Relating to New York Issuers
You should carefully consider the special risks inherent in the Fund's
investment in municipal obligations of New York issuers. These risks result from
the financial condition of New York State and certain of its public bodies and
municipalities, including New York City. Beginning in early 1975, New York State
(the "State"), New York City (the "City") and other entities faced serious
financial difficulties which jeopardized the credit standing and impaired the
borrowing abilities of such entities and contributed to high interest rates on,
and lower market prices for, debt obligations issued by them. A recurrence of
such financial difficulties, as may be currently developing, or a failure of
certain financial recovery programs related thereto could result in defaults or
declines in the market values of various municipal obligations in which the Fund
may invest. If there should be a default or other financial crisis relating to
the State, the City, a State or City agency, or other municipality, the market
value and marketability of outstanding municipal obligations of New York issuers
in the Fund's portfolio and the interest income to the Fund could be adversely
affected. In addition, the effects of actual and proposed changes in Federal and
State tax laws, as well as the significant slowdown in the New York and regional
economy, have added substantial uncertainty to estimates of the State's tax
revenues, which resulted in the State's overestimate of General Fund tax
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receipts in the 1992 fiscal year by $575 million. The 1992 fiscal year was the
fourth consecutive year in which the State incurred a cash-basis operating
deficit in the General Fund and issued deficit notes. The State's 1992-93 fiscal
year, however, was characterized by national and regional economies that
performed better than projected in April 1992. National gross domestic product,
State personal income, and employment and unemployment in the State were
estimated to have performed better than originally projected in April 1992.
After reflecting a 1992-93 year-end deposit to the refund reserve account of
$671 million, reported 1992-93 General Fund receipts were $45 million higher
than originally projected in April 1992. If not for that year-end transaction,
General Fund receipts would have been $716 million higher than originally
projected. The State completed the 1994 fiscal year with an operating surplus of
$914 million. The State reported a General Fund operating deficit of $1.426
billion for the 1995 fiscal year. The State ended its 1995-96 fiscal year with a
General Fund cash surplus. The General Fund closing fund balance was $287
million, an increase of $129 million from 1994-95 levels. There can be no
assurance that the State will not face substantial potential budget gaps in
future years. In 1990, Moody's and S&P lowered their ratings of the State's
general obligation debt from A-1 to A and AA- to A, respectively. In addition,
Moody's and S&P lowered their ratings of New York's short-term notes from MIG-1
to MIG-2 and from SP-1+ to SP-1, respectively. The rating changes reflected the
rating agencies' concerns about the State's financial condition, its heavy debt
load and economic uncertainties in the region. In February 1991, Moody's lowered
its rating on New York City's general obligation bonds from A to Baa1 and in
July 1995, S&P lowered its rating on such bonds from A\'96 to BBB+. On April 29,
1991, S&P downgraded the City's general obligation revenue anticipation notes
from SP-1 to SP-2, citing a budget impasse at the State level that would leave
the City at risk if the State was unable to forward promised State aid before
the end of the City's fiscal year June 30. On January 6, 1992, Moody's lowered
the ratings on certain appropriation-backed debt of New York State and its
agencies from A to Baa1. On January 13, 1992, S&P lowered from A to A\'96 the
ratings of New York State general obligation bonds. The ratings of various
agency debt, State moral obligations, contractual obligations, lease purchase
obligations and State guarantees also were lowered. A complete discussion of the
risks associated with investments in obligations of New York issuers is
contained in the Statement of Additional Information.
A number of pending court actions have been brought against or involve the
State, its agencies, or other municipal subdivisions of the State, which actions
relate to financing, the use of tax or other revenues for the payment of
obligations and claims that would require additional public expenditures.
Adverse decisions in such cases could require extraordinary appropriations or
expenditure reductions or both and might have a materially adverse effect on the
financial condition of the State and its agencies and municipal subdivisions.
Any such adverse effect could affect, to some extent, all municipal securities
issued by the State, its agencies, or municipal subdivisions.
To the extent that State agencies and local governments seek special State
assistance, the ability of the State to pay its obligations as they become due
or to obtain additional financing could be adversely affected, and the
marketability of notes and bonds issued by the State, its agencies, and other
governmental entities may be impaired.
CALCULATION OF YIELD AND PERFORMANCE DATA
The Fund may from time to time include yield information in advertisements
or information furnished to existing or proposed shareholders. The Fund's yield
is computed by dividing the Fund's net investment income per share during a base
period of 30 days, or one month, by the net asset value per share of the Fund on
the last day of such base period. The resulting 30-day yield is then annualized
pursuant to the bond equivalent annualization method described below. The Fund's
net investment income per share is determined by dividing the Fund's net
investment income during the base period by the average number of shares of the
Fund entitled to receive dividends during the base period. The Fund's 30-day
yield (computed as described above) is then annualized by a computation that
assumes the Fund's net investment income is earned and reinvested for a
six-month period at the same rate as during the 30-day base period and that the
resulting six-month income will again be generated over an additional period of
six months.
The Fund may also advertise from time to time its taxable equivalent yield.
The Fund's taxable equivalent yield is determined by dividing that portion of
the Fund's yield (calculated as described above) that is tax-exempt by one minus
the stated marginal Federal income tax rate and adding the product to that
portion, if any, of the Fund's yield that is not tax-exempt.
The Fund may also furnish to existing or prospective shareholders
information concerning the average annual total return on an investment in the
Fund for a designated period of time. The average annual total return quotation
for a given period is computed by
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determining the average annual compounded rate of return that would cause a
hypothetical investment made on the first day of the designated period (assuming
all dividends and distributions are reinvested) to equal the resulting net asset
value of such hypothetical investment on the last day of the designated period.
The yield and average annual total return quotations of the Fund do not take
into account any required payments for Federal or state income taxes.
The Fund's yield and average annual total return will vary from time to time
depending on market conditions, the composition of the Fund's portfolio, and the
Fund's operating expenses. These factors and possible differences in the methods
used in calculating yields and returns should be considered when comparing the
Fund's performance information to information published with respect to other
investment companies and other investment vehicles. Yields and return quotations
should also be considered relative to changes in the value of the Fund's shares
and the risks associated with the Fund's investment objective and policies. At
anytime in the future, yield and return quotations may be higher or lower than
past yields or return quotations, and there can be no assurance that any
historical yield or return quotation will continue in the future.
The Fund may also include comparative performance information in advertising
or marketing the Fund's shares. Such performance information may include data
from Lipper Analytical Services, Inc., and Morningstar, Inc., or other industry
publications.
For more information regarding the computation of yield or average annual
total return quotations, see the Statement of Additional Information.
PURCHASE OF SHARES
You may purchase shares directly from the Fund without a sales charge on any
day the New York Stock Exchange is open for business. The public offering price
for shares purchased is the net asset value per share of the Fund next
determined after a purchase order becomes effective. Orders for the purchase of
Fund shares become effective (i) immediately, if received prior to 4:00 P.M. New
York time on any business day. Shares being purchased will begin accruing
dividends on the day following the date of purchase and continue to earn
dividends until the date of redemption. Information regarding transmittal of
funds by bank wire and procurement of a Federal Reserve Draft may be obtained
from your bank. All payments (including checks from individual investors) must
be in U.S. dollars. If your check does not clear, Fundamental Shareholder
Services, Inc. will cancel your purchase and you could be liable for any losses
or fees incurred.
The minimum initial purchase is $1,000 and the minimum subsequent purchase
is $100. Subsequent investments are made in the same manner as an initial
purchase is made.
All shares purchased are confirmed to you and credited to your account at
the net asset value determined as described herein under the heading
"Determination of Net Asset Value." Share certificates are issued only on
written request by you to Fundamental Shareholder Services, Inc., Agent, Bowling
Green Station, P.O. Box 1013, New York, New York 10274-1013. There is no charge
for share certificates. Certificates are not issued for fractional shares.
Certificates will only be issued in amounts of 1,000 or more shares. The
issuance of certificates may be discontinued at any time without prior notice.
The Fund reserves the right to reject any purchase order. The Fund reserves the
right to limit the number of purchase order checks processed at any one time and
will notify investors prior to exercising this right. If this right is
exercised, the Fund will return checks immediately.
Although shares of the Fund may be purchased without a sales charge if you
purchase them directly from the Fund, you may be charged a fee for effecting
transactions in the Fund's shares through securities dealers, banks, or other
financial institutions.
The Fundamental Automatic Investment Program offers a simple way to maintain
a regular investment program. The Fund has waived the initial investment minimum
for you when you open a new account and invest $100 or more per month through
the Fundamental Automatic Investment Program. The Fundamental Automatic
Investment Program allows you to purchase shares
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(minimum of $50 per transaction) at regular intervals. Investments are made by
transferring funds directly from your checking, or bank money market account. At
your option investments can be made, once a month on either the fifth or the
twentieth day, or twice a month on both days.
To establish a Fundamental Automatic Investment Program, or to add this
option to your existing account simply complete an authorization form, which can
be obtained by calling 1-800-322-6864. You may cancel this privilege or change
the amount you invest at any time. Initial Program setup and any modifications
may take up to ten days to take effect. There is currently no charge for this
service, and the Fund may terminate or modify this privilege at any time.
Methods of Payment
Payment by Wire: An expeditious method of investing in the Fund is through the
transmittal of Federal funds by bank wire to The Chase Manhattan Bank, N.A. (the
"Bank"). Federal funds transmitted by bank wire to the Bank and received by it
prior to 4:00 P.M. New York time are priced at the net asset value determined on
such day. Federal funds received after 4:00 P.M. New York time will be available
on the next business day. Funds other than Federal funds transmitted by bank
wire may or may not be converted into Federal funds on the day received by the
Bank depending upon the time the funds are received and the bank wiring the
funds. We encourage you to make payment by wire in Federal funds. The Fund will
not be responsible for delays in the wiring system.
To purchase shares by wiring funds, instruct a commercial bank to wire your
money to: The Chase Manhattan Bank, N.A., ABA#021000021, Credit to: United
States Trust Company of New York, A/C #920-1-073195, further credit to:
Fundamental Family of Funds, A/C #2073919. Instructions for new accounts should
specify the name, address, and social security number of each person in whose
name the shares are to be registered and the name of the Fund. If you are an
existing shareholder, you need only furnish your account number and the name of
the Fund. Failure to submit required information may delay investment.
Payment by Mail: Purchase orders for which remittance is to be made by check
may be submitted directly by mail to Fundamental Shareholder Services, Inc.,
Agent, P.O. Box 1013, Bowling Green Station, New York, New York 10274-1013.
Checks should be made payable to Fundamental Family of Funds.
When opening a new account, you must enclose a completed purchase
application. If you are an existing shareholder, you should enclose the
detachable stub from a monthly account statement you have received or otherwise
indicate your account number and the name of the Fund.
Personal Delivery: For personal delivery instructions, please call the Fund
at (800) 322-6864.
Exchange for Municipal Securities: If you own municipal obligations meeting
the criteria for investment by the Fund, you may exchange such securities for
shares of the Fund. All such exchanges are discretionary with the Fund. If you
desire to make such an exchange, you should contact the Fund prior to delivering
any securities in order to establish that the securities are acceptable for
exchange, to determine what transaction charges, if any, may be imposed and to
obtain delivery instructions for such securities. The value of the securities
being exchanged will be determined in the same manner that the value of the
Fund's portfolio securities is determined (see "Determination of Net Asset
Value"); the specific method of determining the value will be provided to you on
request. The Fund reserves the right to refuse any such exchange, even if the
securities offered by an investor meet the general investment criteria of the
Fund. A capital gain or loss for Federal income tax purposes may be realized by
the investor following the exchange. Maturing bonds or detached coupons
submitted within five (5) business days of the payment date are credited on the
payment date.
Exchange Privilege: For your convenience, the Exchange Privilege permits you
to purchase shares in any of the other funds for which Fundamental Portfolio
Advisors, Inc. acts as the investment manager in exchange for shares of the Fund
at respective net asset values per share. Exchange instructions must be given in
writing to Fundamental Shareholder Services, Inc., Agent, P.O. Box 1013, Bowling
Green Station, New York, New York 10274-1013, the Fund's transfer agent, and
must specify the number of shares of the Fund to be exchanged (such shares must
have a current value of at least $1,000) and the fund into which the exchange is
being made. If you
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have previously established a Telephone Exchange Privilege, you may telephone
exchange instructions by calling Fundamental Shareholder Services, Inc. However,
there are other considerations with respect to losses resulting from
unauthorized telephone transactions. For more detail, see "Redemption of
Shares-Telephone Redemption Privilege." Before any exchange, you must obtain,
and should review, a copy of the current prospectus of the fund into which your
exchange is being made. Prospectuses may be obtained by calling or writing the
Fund.
The Exchange Privilege is only available in those states where such
exchange can legally be made and exchanges may only be made between accounts
with identical account registration and account numbers. Prior to effecting an
exchange, you should consider the investment policies of the fund in which you
are seeking to invest. Any exchange of shares is, in effect, a redemption of
shares in one fund and a purchase of the other fund. You may recognize a capital
gain or loss for Federal income tax purposes in connection with an exchange. The
Exchange Privilege may be modified or terminated by the Fund at any time without
notice.
REDEMPTION OF SHARES
Shares of the Fund are redeemable at your option without charge at the next
determined net asset value following receipt by Fundamental Shareholder
Services, Inc. of a redemption request in proper order. To effect a redemption,
you may utilize the Check Redemption Privilege, the Telephone Redemption
Privilege, the Expedited Redemption Privilege, or the regular redemption
procedure. Due to the cost of maintaining an account, the Fund reserves the
right to redeem an account involuntarily, on not less than 60 days' written
notice, at any time an investor has reduced his or her account to less than
$100. During the 60-day period, a shareholder may increase his or her holdings
to $100 or more, and thereby avoid an involuntary redemption.
When redemption requests are received by Fundamental Shareholder Services,
Inc. by 4:00 P.M. New York time on any day during which the net asset value is
determined (see "Determination of Net Asset Value"), the redemption will be
effective on such day, and payment will be made on the next business day based
on the net asset value next determined after receipt of the redemption
instruction. If a redemption notice is received after 4:00 P.M. New York time,
the redemption will be effective on the next business day, and payment will be
made thereafter on the second business day. In the event you wish to liquidate
your holdings, you will be entitled to all dividends declared through the date
of redemption. At times, the Fund may be requested to redeem shares for which it
has not yet received good payment. The Fund may delay, or cause to be delayed,
the mailing of a redemption check until such time as it has assured itself that
good payment has been received from the purchase of such shares, which may take
up to 15 days from the purchase date. In the case of payment by check, the
determination of whether the check has been paid by the paying institution
generally takes up to seven days, but may take longer. You may avoid this delay
by purchasing shares by wire or by using a certified or official bank check
drawn on a U.S. bank. In the event of delays in payment of redemption proceeds,
the Fund will take all available steps to expedite collection of the investment
check. If shares were purchased by check, you may write checks against such
shares only after 15 days from the date the purchase was executed. Shareholders
who draw against shares purchased fewer than 15 days from the date of original
purchase, will be charged usual and customary bank fees. The Fund reserves the
right to suspend the right of redemption or postpone the day of payment (1)
during any period when the New York Stock Exchange is closed (other than
customary weekend and holiday closings), (2) when the trading markets normally
used by the Fund are restricted or an emergency exists as determined by the
Securities and Exchange Commission (the "Commission") as to make the disposal of
the Fund's investments or determination of its net asset value unreasonably
impracticable, or (3) for such other periods as the Commission by order may
permit to protect the Fund's shareholders.
You may realize a taxable capital gain or loss when shares are redeemed,
depending on their net asset value. On all redemption requests (including
redemption checks) for joint accounts, the signatures of all joint owners are
required unless shareholders have designated otherwise.
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Check Redemption Privilege
You may request that the Fund provide you with redemption checks ("Checks")
drawn on the Fund's account by either (i) completing the appropriate section of
the application order form or (ii) subsequent written request to the Fund. These
Checks will be sent only to the individuals in whose name the account is
registered and only to the address of record with the Fund. You may use the
Checks in any lawful manner and make them payable to the order of any person or
company in an amount of $100 or more. Dividends continue to be earned until the
Check clears the Fund account and is paid by Fundamental Shareholder Services,
Inc. The Fund may delay, or cause to be delayed, payment of redemption proceeds
until such time as it or Fundamental Shareholder Services, Inc. has assured
itself that good payment has been collected for the purchase of such shares. In
addition, the Fund reserves the right not to honor Check redemption requests
received by Fundamental Shareholder Services, Inc. within 15 days from the
purchase date if the shares to be redeemed have been purchased by check. You
will be subject to the same rules and regulations that the Bank applies to
checking accounts in general. There is currently no charge to you for the use of
the Checks, except that a fee may be imposed by Fundamental Shareholder
Services, Inc. if an investor requests that it stop payment of a Check or if it
cannot honor a Check due to insufficient funds or other valid reasons.
When a Check is presented for payment, Fundamental Shareholder Services,
Inc., as your agent, will cause the Fund to redeem a sufficient number of shares
in your account to cover the amount of the Check. Shares for which stock
certificates have been issued may not be redeemed by Check. Since the net asset
value of the Fund's shares changes daily, you should make certain that the total
value of your account is sufficient to cover the amount of your Check.
Otherwise, the Check will be returned marked insufficient funds. Checks may not
be used to close an account. The Check Redemption Privilege may be modified or
terminated by either the Fund or Fundamental Shareholder Services, Inc. upon 60
days' written notice to shareholders.
Telephone Redemption Privilege
You may direct redemptions of up to $150,000 worth of shares per day by
telephone either (i) by completing the appropriate section of the application
form or (ii) by later signature guaranteed* written request. Telephone calls may
be recorded. Fundamental Shareholder Services, Inc. will act on instructions
that it reasonably believes to be genuine. The proceeds of the redemption will
only be mailed to the address of record with the Fund, provided that your
account registration has not changed in the last 30 days. The Fund reserves the
right to refuse a telephone redemption and may limit the amount and frequency.
The Telephone Redemption Privilege may be modified or terminated at any time by
either the Fund or Fundamental Shareholder Services, Inc. Neither the Fund nor
its transfer agent will be liable for following instructions that they
reasonably believe to be genuine. It is the Fund's policy to provide that a
written confirmation statement of all telephone call transactions be mailed to
shareholders at their address of record within 3 business days after the
telephone call transaction. You should verify the accuracy of telephone call
transactions immediately upon receipt of your confirmation statement. As a
result of this policy, you will bear the risk of loss in the event of a
fraudulent telephone exchange or redemption transaction.
Expedited Redemption Privilege
Requests for expedited redemption may be made by letter or telephone for
amounts equal to or exceeding $5,000, if you have previously filed with
Fundamental Shareholder Services, Inc. a signed telephone authorization form
available from the Fund. If the request is for more than $5,000, proceeds of the
expedited redemption will be transferred by Federal Reserve wire to the
commercial bank specified in the authorization form or to a correspondent bank
if your bank is not a member of the Federal Reserve System. If the correspondent
bank fails to notify your bank immediately, there could be a delay in crediting
the funds to your bank account. Proceeds of less than $5,000 will be mailed to
your address. The Fund reserves the right to refuse an expedited redemption and
may limit the amount and frequency.
This privilege may be modified or terminated at any time without prior
notice by either the Fund or Fundamental Shareholder Services, Inc. Any time
funds are wired by the Bank, the proceeds of redemption may be subject to the
deduction of the Bank's usual and customary charges for wiring funds.
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Requests by letter should be addressed to Fundamental Shareholder Services,
Inc., Agent, P.O. Box 1013, Bowling Green Station, New York, New York
10274-1013.
In order to qualify to use the Expedited Redemption Privilege, you must
complete the appropriate portion of the new account application and your initial
payment for purchase of the Fund's shares must be drawn on, and redemption
proceeds paid to, the same bank and account as designated on the application.
In order to change the commercial bank or account designated to receive the
redemption proceeds, you must send a written request to Fundamental Shareholder
Services, Inc., Agent, P.O. Box 1013, Bowling Green Station, New York, New York
10274-1013. Such request must be signed by each shareholder with each signature
guaranteed by an eligible guarantor (see above).
- -----------
*A signature guarantee must be from an eligible guarantor institution approved
by Fundamental Shareholder Services, Inc. Signature guarantees in proper form
generally will be accepted from domestic banks, a member of a national
securities exchange, credit unions and savings associations, as well as from
participants in the Securities Transfer Agents Medallion Program ("STAMP"). If
you have any questions with respect to signature guarantees, please call the
transfer agent at (800) 322-6864.
Regular Redemption Procedure
You may redeem your shares by sending a written request, together with duly
endorsed stock certificates, if any, to Fundamental Shareholder Services, Inc.,
Agent, P.O. Box 1013, Bowling Green Station, New York, New York 10274-1013. All
certificates and all written requests for redemption must be endorsed by you.
For redemptions exceeding $50,000 (and for all written redemption requests,
regardless of amount, made within 30 days following any change in account
registration), your endorsement must be signature guaranteed, as described
above. Fundamental Shareholder Services, Inc. may, at its option, request
further documentation from corporations, executors, administrators, trustees or
guardians. If requested, redemption proceeds of more than $5,000 will be wired
into any member bank of the Federal Reserve System. However, such transaction
may be subject to a deduction of the Bank's usual and customary charges for
wiring funds. The Fund will accept other suitable verification arrangements for
foreign investors. Redemptions by mail will not become effective until all
documents in the form required have been received by Fundamental Shareholder
Services, Inc.
Requests for redemption subject to any special condition, or which specify
an effective date other than as provided herein, cannot be accepted and will be
returned to you.
How to Transfer Shares
Shares may be transferred from one person to another by sending to
Fundamental Shareholder Services, Inc. a written request for such transfer,
signed by the registered owner(s) exactly as the account is registered with each
signature guaranteed as described above, with (i) the name(s) of the new
registered owner(s), (ii) the social security number or taxpayer identification
number for the new registration, and (iii) the redemption option elected. If the
shares being transferred are represented by certificates in the possession of
the investor, such certificates, properly signed with signature guarantees, must
also be forwarded to Fundamental Shareholder Services, Inc. In addition,
Fundamental Shareholder Services, Inc. reserves the right to request any
additional documents that may be required for transfer by corporations,
executors, administrators, trustees, and guardians.
Reopening an Account
You may reopen an account with a minimum investment of $100 or more without
filing a new application form during the year in which your account was closed
or during the following calendar year, provided that the information on your
original form is still applicable. The Fund may require you to file a statement
that all information on the original account application form remains
applicable.
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DETERMINATION OF NET ASSET VALUE
The net asset value per share is determined as of the close of trading on
the New York Stock Exchange (currently 4:00 P.M., New York time) on each day
that both the New York Stock Exchange and the Fund's custodian bank are open for
business and on any other day during which there is a sufficient degree of
trading in the Fund's portfolio securities that the Fund's net asset value might
be materially affected by changes in the value of its portfolio securities,
unless there have been no shares tendered for redemption or orders to purchase
shares received. The net asset value per share is computed by taking the value
of all assets of the Fund, subtracting the liabilities of the Fund, and dividing
by the number of outstanding shares. For purposes of determining net asset
value, expenses of the Fund are accrued daily and taken into account.
The Fund's portfolio securities are valued on the basis of prices provided
by an independent pricing service when, in the opinion of persons designated by
the Fund's trustees, such prices are believed to reflect the fair market value
of such securities. Prices of non-exchange traded portfolio securities provided
by independent pricing services are generally determined without regard to bid
or last sale prices but take into account institutional size trading in similar
groups of securities, yield, quality, coupon rate, maturity, type of issue,
trading characteristics and other market data. Securities traded or dealt in
upon a securities exchange and not subject to restrictions against resale as
well as options and futures contracts listed for trading on a securities
exchange or board of trade are valued at the last quoted sales price, or, in the
absence of a sale, at the mean of the last bid and asked prices. Options not
listed for trading on a securities exchange or board of trade for which
over-the-counter market quotations are readily available are valued at the mean
of the current bid and asked prices. Money market and short-term debt
instruments with a remaining maturity of 60 days or less will be valued on an
amortized cost basis. Municipal daily or weekly variable rate demand instruments
will be priced at par value plus accrued interest. Securities not priced in a
manner described above and other assets are valued by persons designated by the
Fund's trustees using methods which the trustees believe accurately reflects
fair value. The prices realized from the sale of these securities could be less
than those originally paid by the Fund or less than what may be considered the
fair value of such securities.
Included in the portfolio of the Fund in determining net asset value is the
value of all when-issued securities that the Fund has committed itself to
purchase. However, the Fund's ability to purchase such securities remains
constant (see "Investment Objective and Policies").
The Fund's most recent asset value can be obtained by calling
1-800-322-6864 7 days a week, 24 hours a day. To obtain more detailed
information on the Fund's net asset value, yield, performance and portfolio
composition you can call 1-800-322-6864 weekdays 9:00 AM-5:30 PM Eastern Time.
DlSTRlBUTlON EXPENSES
The Board of Directors and shareholders of the Fund have approved a plan of
distribution under Rule 12b-1 of the 1940 Act (the "Plan"). Pursuant to the
Plan, the Fund may pay certain promotional and advertising expenses and may
compensate certain registered securities dealers and financial institutions for
services provided in connection with processing orders for the purchase or
redemption of Fund shares, and for furnishing other shareholder services.
Payments by the Fund shall not, in the aggregate, in any fiscal year of the
Fund, exceed one-half of 1% of daily net assets of the Fund for expenses
incurred in distributing and promoting the Fund's shares. The Plan will make
payments only for expenses actually incurred by such dealers and financial
institutions. Under the Plan, unreimbursed covered distribution expenses may be
carried forward for three consecutive fiscal years (without interest or any type
of finance or service charges) in the event such expenses exceed on an
annualized basis the amount that may be paid under the Plan in any one fiscal
year. If the Plan is terminated in accordance with its terms, the obligation of
the Fund to make payments pursuant to the Plan, including any prior expenses
carried forward, will cease and the Fund will not be required to make any
payments for expenses incurred after the date the Plan terminates. The Fund may
enter into shareholder processing and service agreements ("Shareholder Service
Agreements") with any securities dealer who is registered under the Securities
Exchange Act of 1934 and is a member in good standing of the National
Association of Securities Dealers, Inc., and with banks and other financial
institutions that may wish to establish accounts or sub-accounts on behalf of
their customers
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<PAGE>
("Shareholder Service Agents"). The Fund may pay such Shareholder Service Agents
for their services, and to cover expenses in connection with advertising, sales
literature and other promotional materials on behalf of the Fund, and the fees
payable therefor will be reviewed quarterly by the Fund's Board of Directors.
See "Distribution Plan" in the Statement of Additional Information for more
details.
The Board of Directors of the Fund, including a majority of the
disinterested directors who have no direct or indirect financial interest in the
operation of the Plan or any agreements relating thereto, authorized the Fund to
enter into an agreement with Fundamental Service Corporation, a Delaware
corporation, under the Plan. The agreement provides that the Fund may pay the
usual and customary agency's commission to Fundamental Service Corporation for
producing and placing Fund advertising in newspapers, magazines, or other
periodicals, on radio or television, or in direct marketing campaigns. In
addition to the foregoing, the Fund may pay Fundamental Service Corporation for
marketing research and promotional services specifically relating to the
distribution of Fund shares, including employment expenses and support services
of personnel primarily responsible for responding to inquiries from prospective
investors.
The Plan will continue from year to year if specifically approved annually
by the Board of Directors of the Fund and the affirmative vote of a majority of
the directors who are not interested persons of the Fund, and with no direct or
indirect financial interest in the Plan, by votes cast in person at a meeting
called for such purpose. The Plan may not be amended to increase the maximum
amount of payments by the Fund without shareholder approval, and all material
amendments to the provisions of the Plan must be approved by a vote of the Board
of Directors and the directors who have no direct or indirect interest in the
Plan, cast in person at a meeting called for the purpose of such vote.
The Plan provides that Fund management shall provide, and the independent
directors shall review, quarterly reports setting forth the amounts expended
pursuant to the Plan and the purpose for which the amounts were expended. It
further provides that while the Plan is in effect, the selection and nomination
of those directors of the Fund who are not interested persons of the Fund, is
committed to the discretion of the independent directors. During the year ended
December 31, 1996, the Fund paid $719,350 under the Plan, including $384,123
paid to Fundamental Service Corporation under the Plan.
The Glass-Steagall Act and other applicable laws, among other things,
generally prohibit Federally chartered or supervised banks from engaging in the
business of underwriting, selling, or distributing securities. Accordingly, the
Fund will engage banks as Shareholder Service Agents to perform only
administrative and shareholder servicing functions. While the matter is not free
from doubt, Fund management believes that such laws should not preclude a bank
from acting as a Shareholder Service Agent performing the above-referenced
administrative and shareholder servicing functions. However, judicial or
administrative decisions or interpretations of such laws, as well as changes in
either Federal or state statutes or regulations relating to the permissible
activities of banks or their subsidiaries or affiliates, could prevent a bank
from continuing to perform all or part of its servicing activities. If a bank
were prohibited from so acting, shareholder clients would be permitted to remain
as Fund shareholders and alternative means for continuing the servicing of such
shareholders would be sought. In such event, changes in the operation of the
Fund might occur, and shareholders serviced by such bank might no longer be able
to avail themselves of services then being provided by such a bank. It is not
expected that shareholders would suffer any adverse financial consequences as a
result of any of these occurrences.
MANAGEMENT
Under the laws of the State of Maryland, the Board of Directors is
responsible for managing the business and affairs of the Fund. Acting pursuant
to an investment management agreement adopted by the Board of Directors of the
Fund on October 3, 1990 and approved by shareholders on November 29, 1990,
Fundamental Portfolio Advisors, Inc. (the "Manager") serves as the investment
manager of the Fund. Its principal place of business is 90 Washington Street,
New York, NY 10006. The Manager has been providing investment advisory services
to the Fundamental Family of Funds since it was founded in 1986.
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The Manager manages and supervises the Fund's investment portfolio and
directs the purchase and sales of its investment securities. The Manager
utilizes an investment committee to manage the assets of the Fund. The committee
is currently composed of the following members: Christopher P. Culp, a portfolio
co-manager affiliated with Tocqueville Asset Management L.P., and Vincent J.
Malanga, a portfolio strategist affiliated with the manager and Jane Tubis, a
trading assistant affiliated with the Manager.
Christoper P. Culp is serving the Fund on an interim basis without
compenstation. He is the co-manager of Tocqueville Government Fund. He was a
Vice President with Belle Haven Investments L.P. from 1994 to 1995, before
joining Tocqueville Asset Management L.P., and was (i) an independent financial
consultant from 1993 to 1994 and (ii) a bond trader with Swiss Bank Corp. from
1991 to 1993 and with Carroll McEntee, a subsidiary of HSBC Corp., from 1990 to
1991.
Vincent J. Malanga is, and has been for more than the past five years,
Chairman of the Board, Chief Executive Officer, President and Treasurer of the
Fundamental Family of Funds. He is, and has been for more than the past five
years, President, Treasurer, and a Director of the Manager, Executive Vice
President, Secretary and a Director of Fundamental Service Corporation (the
Distributor for certain of the Fundamental Family of Funds) and President of
LaSalle Economics, Inc., an economic consulting firm, and a managing director of
LaSalle Portfolio Management, Inc., a commodity trading adviser.
Jane Tubis is, and has been for more than the past five years, a trading
assistant with the Manager.
The Agreement provides that the Manager shall, at its own expense, furnish
to the Fund office space in the offices of the Manager or in such other place as
may be agreed upon from time to time, and all necessary office facilities,
equipment and personnel for managing the affairs and investments and supervising
the keeping of the Fund's books and shall arrange, if desired by the Fund, for
all directors and executive officers of the Manager's organization to serve as
officers or directors of the Fund. Under the terms of the Agreement, the Manager
assumes and shall pay or reimburse the Fund for: (1) the compensation (if any)
of the directors of the Fund who are affiliated with, or "interested persons"
of, the Manager and all officers of the Fund as such; and (2) all expenses not
specifically assumed by the Fund where such expenses are incurred by the Manager
or by the Fund in connection with the management of the investment and
reinvestment of the assets of the Fund, and the management of the affairs of the
Fund.
Under the terms of the Agreement, the following expenses, among others,
incurred in the operation of the Fund, will be borne by the Fund (1) charges and
expenses for determining from time to time the value of the net assets of the
Fund and the keeping of its books and records; (2) charges and expenses of
auditors; (3) charges and expenses of any custodian, transfer agent, plan agent,
dividend-disbursing agent, and registrar appointed by the Fund; (4) brokers'
commissions, and issue and transfer taxes, chargeable to the Fund in connection
with securities transactions to which the Fund is a party; (5) insurance
premiums, interest charges, dues and fees for membership in trade associations,
and all taxes and fees payable by the Fund to Federal, state, or other
governmental agencies; (6) the cost of share certificates representing shares of
the Fund; (7) fees and expenses involved in registering and maintaining
registrations of the Fund and of its shares with the Commission, including the
preparation of prospectuses for filing with the Commission and any application
for exemption whether or not relating to, or directed toward, the sale of the
Fund's shares; (8) all expenses of shareholders and directors meetings and of
preparing, printing, and distributing notices, proxy statements, and all reports
to shareholders and to governmental agencies; (9) charges and expenses of legal
counsel to the Fund; (10) compensation of those directors of the Fund as such
who are not affiliated with or "interested persons" of the Manager or the Fund
(other than as directors); (11) fees and expenses incurred pursuant to a plan
adopted pursuant to Rule 12b-1 under the 1940 Act; and (12) such nonrecurring or
extraordinary expenses as may arise, including litigation affecting the Fund and
any indemnification by the Fund of its directors, officers, employees, or agents
with respect thereto.
Pursuant to the Agreement, the Manager will provide the Fund with advice
and recommendations in the choice of investments and will execute the Fund's
security transactions. These services will be under the supervision of Dr.
Vincent J. Malanga, as director, president-treasurer, and chief executive
officer of the Fund. The Agreement provides that the Manager shall, subject to
the supervision of the Board of Directors of the Fund, generally attend, direct,
and manage the affairs of the Fund. In consideration for such services,
24
<PAGE>
the Fund has agreed to pay the Manager an annual fee, accrued daily and paid
monthly, at the following rate on the average daily closing net asset value of
the Fund:
Net Asset Value Annual Rate
- --------------------------------------------------------------------------------
For assets up to $100,000,000 50/100 of 1%
For assets in excess of S100,000,000 up to S200,000,000 48/100 ot 1%
For assets in excess of $200,000,000 up to $300,000,000 46/100 of 1%
For assets in excess of $300,000,000 up to $400,000,000 44/100 of 1%
For assets in excess of $400,000,000 up to $5OO,OOO,OOO 42/100 of 1%
For assets in excess of $500,000,000 40/100 of 1%
Under the Agreement, the Manager is required to reimburse the Fund an amount
not exceeding the amount of fees payable to the Manager under the Agreement for
any fiscal year, if, and to the extent that the aggregate operating expenses of
the Fund for any fiscal year (including the fees payable to the Manager, but
excluding interest expenses, taxes, brokerage fees and commissions, expenses
paid pursuant to the Plan, and extraordinary expenses beyond the control of the
Manager) exceed, on an annual basis, 1.5% of the average daily net assets of the
Fund. During the year ended December 31, 1996, the Manager received fees from
the Fund in the amount of $787,962, which represented .49% of the Fund's average
net assets.
The Agreement terminates upon assignment and may be terminated without
penalty on 60 days' written notice by a vote of the majority of the Fund's Board
of Directors or by the holders of a majority of the Fund's outstanding shares.
Unless earlier terminated as described above, the Agreement will continue in
effect from year to year if its continuance is approved at least annually (1) by
the Board of Directors of the Fund or the vote of the holders of a majority of
the outstanding shares of the Fund and (2) in either event, by a majority of the
directors of the Fund who are not parties to the Agreement or "interested
persons" of any such party, by votes cast in person at a meeting called for the
purpose of voting on such approval.
The Fund's independent directors have retained an investment banking firm to
consider fund organizations willing to manage the Fundamental Funds and to
submit requests for proposals. In addition, the Manager is pursuing an
investment management firm's interest in purchasing certain of the Manager's
assets relating to the Fundamental Funds. Any proposed transaction must be
approved by the Fund's Board of Directors, including a majority of the
independent directors, and is subject to approval by the Fund's shareholders.
The Fund, its Manager and Fundamental Service Corporation have agreed, in an
assurance of discontinuance (the "assurance") entered into with the Department
of Law of the State of New York, to refrain from making certain statements about
the Fund's investment objectives in advertisements and sales materials and to
disclose more about the risks involved in certain of the Fund's investment
strategies, particularly with respect to certain investment strategies employed
by the Fund that may differ from or may result in an increased level of risk not
present in some other tax-exempt mutual funds.
In addition, the Fund has agreed to establish a portfolio review committee,
consisting of no less than three independent directors of the Fund, to oversee
the Fund's investment performance and strategies, internal controls and
procedures, Prospectus review and compliance with the investment policies stated
therein, and review of annual and semi-annual reports to shareholders (See
"Management of the Fund-Portfolio Review Committee" in the Statement of
Additional Information). The Fund has also agreed to submit new sales material
for certain specified time periods to the staff of the Department of Law (the
"staff") for prior review and to submit to the staff, copies of any shareholder
complaints and Fund filings with, or submissions to, the Commission or the
National Association of Securities Dealers, Inc.
The assurance also requires (i) that a portfolio composition report
portraying the Fund's (a) principal asset categories, (b) use of leverage, (c)
effective portfolio duration or sensitivity to interest rate risk and (d) credit
ratings of portfolio securities be included in the Fund's annual and semi-annual
reports to shareholders and that a portfolio composition report be delivered to
potential investors along with the Fund's Prospectus.
25
<PAGE>
For further information concerning the management of the Fund, see the
Fund's Statement of Additional Information under the caption "Management of the
Fund."
Portfolio Brokerage
It is the Fund's policy to seek execution of its purchases and sales at the
most favorable prices through responsible broker-dealers and in agency
transactions, at competitive commission rates. The Fund's brokerage allocation
policy may permit the Fund to pay a broker-dealer which furnishes research
services a higher commission than that which might be charged by another
broker-dealer which does not furnish research services, provided that such
commission is deemed reasonable in relation to the value of the services
provided by such broker-dealer (see the Statement of Additional Information for
a complete discussion of the Fund's brokerage allocation policy). It is not the
Fund's practice to allocate principal business on the basis of sales of Fund
shares which may be made through brokers or dealers, although broker-dealers
effecting purchases of Fund shares for their customers may participate in
principal transactions or brokerage allocation. The Fund may, however, allocate
principal business or brokerage to obtain for the benefit of the Fund services
that the Fund would otherwise have to pay for directly.
The Fund's directors have authorized the Manager to effect portfolio
transactions on an agency basis with affiliated broker-dealers, subject to
quarterly determination of compliance by the board, including a majority of the
independent directors and have adopted certain procedures incorporating the
standards of Rule 17e-1 of the 1940 Act, which requires, among other things,
that the commissions paid to any affiliated broker-dealer must be "reasonable
and fair compared to the commission, fee, or other remuneration received, or to
be received, by other brokers in connection with comparable transactions
involving similar securities during a comparable period of time."
DIVIDENDS AND TAX STATUS
Dividends and Distributions
The Fund declares all of its net investment income as a dividend, on a daily
basis, prior to calculating net asset value, on shares of record at the close of
business on the preceding day. Dividends are distributed monthly. Capital gains,
if any, will normally be distributed in December of each fiscal year of the
Fund. The amounts paid, and distribution dates thereof, are subject to
determination by the Fund's Board of Directors. All dividends paid and capital
gains distributed are paid in additional shares of the Fund's common stock,
which are credited to the shareholder's account. If you desire to receive such
distribution in cash, you must file an election with Fundamental Shareholder
Services, Inc., which election will remain in effect until Fundamental
Shareholder Services, Inc. is notified by you in writing to change the election,
at least ten (10) days prior to payment date. Distributions declared in the
months of October, November or December will be treated as received by
shareholders of record in such months as of December 31 even if they are not
paid until the following January. Certificates will not be issued for dividend
distributions.
Taxes
The Fund intends to qualify as a "regulated investment company" for
Federal income tax purposes under Subchapter M of the Code. If the Fund so
qualifies, it will not pay any Federal corporate income taxes on net investment
taxable income or net realized capital gains which are distributed to investors
in a timely manner. If the Fund fails to meet certain distribution requirements
at the end of the calendar year, the Fund will be subject to a 4% excise tax on
a portion of its undistributed taxable income. The Fund intends to make
distributions in a timely manner and, accordingly, does not expect to be subject
to Federal income taxes or the 4% excise tax.
Distributions by the Fund of its tax-exempt interest income (net of
expenses) are designated as exempt-interest dividends and shareholders should
exclude the interest from their gross income for Federal income tax purposes. It
is a policy of the Fund to maximize the percentage of distributions to
shareholders that are not subject to Federal income taxes. However, a small
portion of the Fund's net
26
<PAGE>
investment income may under certain circumstances be taxable, and distributions
thereof, as well as distributions of any capital gains, will be taxable to
shareholders. Distributions by the Fund of any taxable net investment income and
of any net short-term capital gain over net long-term capital loss are taxable
to shareholders as ordinary income. Such distributions constitute dividends for
Federal income tax purposes but do not qualify for the 70% dividends-received
deduction for corporations. Distributions of any net capital gain are designated
as capital gain dividends and are taxable as long-term capital gains without
regard to the length of time the shareholder has held shares of the Fund. If a
shareholder sells shares held for six months or less at a loss, the loss will be
disallowed to the extent of the exempt-interest dividends received on the shares
and (to the extent not disallowed) will be treated as a long-term capital loss
to the extent of any capital gain dividends received on the shares.
Tax-exempt interest on specified private activity bonds issued after August
7, 1986 is treated as a tax preference item for purposes of the Federal
alternative minimum tax ("AMT"). Thus, corporate and individual shareholders may
incur an AMT liability as a result of receiving exempt-interest dividends from
the Fund to the extent such dividends are attributable to interest from such
private activity bonds. In addition, because all exempt-interest dividends are
included in a corporate shareholder's adjusted current earnings (which are used
in computing a separate preference item for corporations), corporate
shareholders may incur an AMT liability as a result of receiving any
exempt-interest dividends from the Fund. For a description of the AMT, see the
Fund's Statement of Additional Information under the caption "Tax Matters."
Although exempt-interest dividends are excludable from gross income for
Federal income tax purposes, shareholders are required to report the receipt of
exempt-interest dividends, together with other tax-exempt interest, on their
Federal income tax returns. In addition, exempt-interest dividends must be taken
into account in computing the portion, if any, of social security or railroad
retirement benefits that must be included in an individual shareholder's gross
income and subject to Federal income tax. Further, shareholders are denied a
deduction for interest on indebtedness incurred or continued to purchase or
carry shares of the Fund. Moreover, a shareholder who is (or is related to) a
"substantial user" of a facility financed by industrial development bonds held
by the Fund will likely be subject to tax on dividends paid by the Fund that are
derived from interest on such bonds.
Distributions to shareholders will be treated in the manner described above
regardless of whether received in cash or reinvested in additional shares of the
Fund. In general, distributions by the Fund are taken into account by the
shareholders in the year in which they are made. However, certain distributions
made during January will be treated as having been paid by the Fund and received
by the shareholders on December 31 of the preceding year.
Under the backup withholding rules of the Code, certain shareholders may be
subject to 31% withholding of Federal income tax on ordinary income dividends,
capital gain dividends and redemption payments made by the Fund. To avoid this
backup withholding, a shareholder must provide the Fund with a correct taxpayer
indentification number (which for an individual is usually his or her social
security number) and/or certify that it is a corporation or otherwise exempt
from or not subject to backup withholding.
The exclusion from gross income for Federal income tax purposes of
exempt-interest dividends does not necessarily result in exclusion under the
income or other tax laws of any state or local taxing authority. However, to the
extent that exempt-interest dividends are derived from interest received by the
Fund on obligations of New York State, its political subdivisions or its duly
constituted authorities, they will be exempt from New York State and City
personal income taxes for a New York resident individual shareholder.
Exempt-interest dividends will not be excluded in determining New York State or
City franchise taxes applicable to corporations or financial institutions. You
are advised to consult with your tax advisors concerning the application of
state and local taxes to an investment in the Fund, which may differ from the
Federal income tax consequences heretofore described.
Statements regarding the tax status of distributions by the Fund will be
mailed annually by Fundamental Shareholder Services, Inc. In the event that a
distribution may not be wholly excludable from gross income for Federal income
tax purposes or exempt from New York State and City personal income taxes, the
statement will provide information about the tax-exempt percentage, which may
vary from distribution to distribution.
27
<PAGE>
The foregoing discussion is for general information only. A prospective
shareholder should also review the more detailed discussion of Federal income
tax considerations in the Fund's Statement of Additional Information under the
caption "Tax Matters." In addition, each prospective shareholder should consult
with his or her own tax advisor as to the tax consequences of an investment in
the Fund.
GENERAL INFORMATION
The Company, which was incorporated under the laws of the State of New York
on January 30, 1980, and which was reorganized as a Maryland corporation on
December 31, 1990, is an open-end, non-diversified management investment
company. The Fund's fiscal year begins January 1 and ends December 31. On April
24, 1996, the Company changed its name from New York Muni Fund, Inc. to
Fundamental Funds, Inc.
Annual and semi-annual reports of the Fund, together with the list of
securities held by the Fund in its portfolio, are mailed to each shareholder.
The Company is authorized to issue 1,000,000,000 shares of common stock, par
value $.001 per share, of which 500,000,000 shares are designated "New York Muni
Fund Series" and the balance of which are unclassified. All shares of the Fund
are entitled to equal participation in dividends and distributions declared by
the Fund and in its net assets on liquidation remaining after satisfaction of
all outstanding liabilities. The Fund's shares are fully paid and non-assessable
when issued and have no preemptive rights. Holders of common stock are entitled
to one vote for each full share and to such fraction of a vote that corresponds
to any fractional shares. The Fund will not normally hold annual shareholders'
meetings. Shareholders may remove directors from office by a majority of votes
entitled to be cast at a meeting of shareholders. Shareholders holding 10% or
more of the Fund's outstanding stock may call a special meeting of shareholders.
The Code of Ethics of Fundamental Portfolio Advisors, Inc. and the Fund
prohibits all affiliated personnel from engaging in personal investment
activities which compete with or attempt to take advantage of the Fund's planned
portfolio transactions. The objective of the Code of Ethics of both the Fund and
Fundamental Portfolio Advisors, Inc. is that their operations be carried out for
the exclusive benefit of the Fund's shareholders. Both organizations maintain
careful monitoring of compliance with the Code of Ethics.
The Manager and the Fund's Directors have cooperated in an investigation
being conducted by the Securities and Exchange Commisssion concerning an
affiliated fund. The Commission's staff is considering recommending to the
Commission the commencement of certain proceedings (but not against the
affiliated fund).
The custodian for the assets of the Fund is The Chase Manhattan Bank, N.A.
("Chase"). Fundamental Shareholder Services, Inc. performs all services in
connection with the transfer of the shares of the Fund. Shareholder inquiries
concerning the status of an account should be directed to Fundamental
Shareholder Services, Inc. by calling (800) 322-6864.
This Prospectus omits certain information contained in the Fund's
Registration Statement, filed with the Securities and Exchange Commission.
Copies of the Registration Statement, including items omitted herein, may be
obtained from the Commission by paying the charges prescribed under its rules
and regulations. The Statement of Additional Information included in such
Registration Statement may be obtained without charge from the Fund.
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<PAGE>
APPENDIX
For the fiscal year ended December 31, 1996, the Fund's asset composition,
based on the monthly weighted average of credit ratings of portfolio securities,
was as follows:
S&P or Percentage of Percentage of assets
Moody's assets rated by unrated but determined to
Rating rating agency be of comparable quality*
- ------- --------------- -------------------------
AAA or Aaa 33.70% 0%
AA or Aa 10.23% 0%
A 30.55% 0%
BBB or Baa 19.95% 0%
BB or Ba 0% 0%
B 0% 0%
Below B 0% 0%
- ---------
*5.56% of the Fund's assets was invested in unrated securities during the fiscal
year ended December 31, 1996. Unrated securities are not necessarily
lower-quality securities. Issuers of municipal securities frequently choose not
to incur the expense of obtaining a rating. Please refer to the Fund's
Statement of Additional Information for a more complete discussion of these
ratings.
29
<PAGE>
(LEFT SIDE)
NEW YORK MUNI FUND(R)
90 Washington Street
New York NY 10006
1-800-225-6864
Transfer Agent
Fundamental Shareholder Services, Inc.
P.O. Box 1013
New York, NY 10274
1-800-322-6864
Counsel to the Fund
Kramer, Levin, Naftalis & Frankel
New York, New York
Independent Accountants
McGladrey & Pullen, LLP
New York, New York
No person has been authorized to give any information or to make any
representations other than those contained in this Prospectus and in the Fund's
official sales literature in connection with the offer of the Fund's shares,
and, if given or made, such other information or representations must not be
relied upon as having been authorized by the Fund. This Prospectus does not
constitute an offer in any State in which, or to any person to whom, such
offering may not lawfully be made.
(RIGHT SIDE)
NEW YORK MUNI FUND(R)
Prospectus
April 30, 1997
NEW YORK MUNI FUND
F U N D A M E N T A L
F a m i l y o f F u n d s
<PAGE>
Rule 497(c)
Registration no. 2-82710
STATEMENT OF ADDITIONAL INFORMATION
NEW YORK MUNI FUND
P.O. Box 1013
Bowling Green Station
New York, New York 10274-1013
(800) 322-6864
NEW YORK MUNI FUND (the "Fund") is a series of Fundamental Funds, Inc.(the
"Company"), a Maryland corporation. The Fund seeks to provide a high level of
income that is excluded from gross income for federal income tax purposes and
exempt from New York State and New York City personal income taxes and is
consistent with the preservation of capital. Of course, there can be no
assurance that this investment objective will be achieved. The Fund intends to
achieve its objective through investing primarily in municipal obligations of
New York State, its political subdivisions, and its other duly constituted
authorities and corporations, that are rated within the four highest quality
grades for bonds as determined by Moody's Investors Service, Inc.("Moody's"),
Standard & Poor's Corporation ("S&P"), Fitch Investors Service, Inc.("Fitch") or
Duff & Phelps, Inc.("Duff") or within the three highest quality grades for
municipal notes as determined by Moody's, S&P, Fitch or Duff or, if unrated, are
judged by Fund management to be of comparable quality. While municipal
obligations in these categories are generally deemed to have adequate to very
strong protection of principal and interest, municipal obligations rated within
the lowest of these categories may have speculative characteristics as well.
This Statement of Additional Information provides certain detailed
information concerning the Fund. It is not a Prospectus and should be read in
conjunction with the Fund's current Prospectus, a copy of which may be obtained
by writing to Fundamental Service Corporation at the address listed above, or by
calling (800) 322-6864. Shareholder inquiries may also be placed through this
number.
THIS STATEMENT IS DATED APRIL 30, 1997 AND
SUPPLEMENTS THE FUND'S PROSPECTUS OF THE SAME DATE.
<PAGE>
TABLE OF CONTENTS
PAGE
INVESTMENT OBJECTIVE, POLICIES AND RESTRICTIONS............................. 3
ADDITIONAL INFORMATION RELATING TO MUNICIPAL OBLIGATIONS.................... 6
ADDITIONAL INFORMATION RELATING TO LOWER RATED SECURITIES................... 9
ADDITIONAL INFORMATION CONCERNING NEW YORK ISSUERS..........................11
MANAGEMENT OF THE FUND......................................................26
DISTRIBUTION PLAN...........................................................30
CALCULATION OF YIELD........................................................32
CUSTODIAN AND INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS......................35
TAX MATTERS.................................................................35
PORTFOLIO TRANSACTIONS......................................................44
OTHER INFORMATION...........................................................47
FINANCIAL STATEMENTS........................................................46
APPENDIX....................................................................A-1
- 2 -
<PAGE>
INVESTMENT OBJECTIVE, POLICIES AND RESTRICTIONS
As stated in the Fund's Prospectus, the objective of the Fund is to
provide investors with a high level of income that is excluded from gross income
for federal income tax purposes and exempt from New York State and New York City
personal income taxes and is consistent with the preservation of capital. Of
course, there can be no assurance that this objective will be achieved. The Fund
intends to attempt to achieve its objective by investing substantially all, and
at least 80%, of its total assets in debt obligations which are rated within the
four highest quality grades for bonds as determined by Moody's, S&P, Fitch or
Duff or within the three highest quality grades for municipal notes as
determined by Moody's, S&P, Fitch or Duff or, if unrated, are judged by Fund
management to be of comparable quality, and which are issued by the State of New
York, its political subdivisions, and its other duly constituted authorities and
corporations, the interest from which is, in the opinion of counsel to the
issuer, totally excluded from gross income for federal income tax purposes and
exempt from New York State and New York City personal income taxes.
The investment restrictions described below have been adopted by the
Fund as fundamental policies which cannot be changed without approval of a
majority of the outstanding shares of the Fund.
1. The Fund will not issue any senior security (as defined in the 1940
Act), except that (a) the Fund may enter into commitments to purchase securities
in accordance with the Fund's investment program, including reverse repurchase
agreements, delayed delivery and when-issued securities, which may be considered
the issuance of senior securities; (b) the Fund may engage in transactions that
may result in the issuance of a senior security to the extent permitted under
applicable regulations, interpretations of the 1940 Act or an exemptive order;
(c) the Fund may engage in short sales of securities to the extent permitted in
its investment program and other restrictions; (d) the purchase or sale of
futures contracts and related options shall not be considered to involve the
issuance of senior securities; and (e) subject to fundamental restrictions, the
Fund may borrow money as authorized by the 1940 Act.
2. The Fund will not underwrite any issue of securities, except to the
extent that the purchase of municipal obligations directly from the issuer, in
accordance with the Fund's investment objective, policies and restrictions, may
be deemed to be an underwriting.
3. The Fund will not purchase or sell real estate. This restriction
shall not prevent the Fund from investing in municipal obligations secured by
real estate or interests therein.
- 3 -
<PAGE>
4. The Fund will not invest in commodity contracts, except that the
Fund may, to the extent appropriate under its investment program, purchase
securities of companies engaged in whole or in part in such activities, may
enter into transactions in financial and index futures contracts and related
options and may engage in transactions on a when-issued or forward commitment
basis.
5. The Fund will not invest in oil, gas or thermal mineral exploration,
or development programs.
6. The Fund will not make loans, except that, to the extent appropriate
under its investment program, the Fund may (a) purchase debt instruments,
including bonds, debentures, notes and municipal commercial paper; (b) enter
into repurchase transactions; and (c) lend portfolio securities provided that
the value of such loaned securities does not exceed one-third of the Fund's
total assets.
7. The Fund may borrow money from banks (including its custodian bank)
or from other lenders to the extent permitted under applicable law, for
temporary or emergency purposes, to meet redemptions or for purposes of
leveraging, but only if, immediately after such borrowing, the value of the
Fund's assets, including the amount borrowed, less its liabilities, is equal to
at least 300% of the amount borrowed, plus all outstanding borrowings. If at any
time the value of the Fund's assets fails to meet the 300% asset coverage
requirement, the Fund will, within three days (not including Sundays and
holidays), reduce its borrowings to the extent necessary to meet the 300% test.
The Fund may enter into certain futures contracts and options related thereto
and the Fund may enter into commitments to purchase securities in accordance
with the Fund's investment program, including delayed delivery and when-issued
securities and reverse repurchase agreements.
8. The Fund will not invest 25% or more of its total assets in
securities of issuers in any one industry; provided, however, that such
limitation shall not be applicable to municipal obligations other than those
municipal obligations backed only by the assets and revenues of non-governmental
users, nor shall it apply to municipal obligations issued or guaranteed by the
U.S. Government, its agencies or instrumentalities.
In addition to the foregoing, the Fund is subject to the following
non-fundamental restrictions:
1. The Fund will not purchase a qualified private activity bond if as a
result of such purchase more than 20% of the Fund's total assets, determined at
market value at the time of the proposed investment, would be invested in
qualified private activity bonds.
- 4 -
<PAGE>
2. The Fund may purchase and sell futures contracts and related options
under the following conditions: (a) the then-current aggregate futures market
prices of financial instruments required to be delivered and purchased under
open futures contracts shall not exceed 20% of the fund's total assets, at
market value; and (b) no more than 5% of the assets, at market value at the time
of entering into a contract, shall be committed to margin deposits in relation
to futures contracts.
3. The Fund will not invest more than 15% of its net assets in illiquid
investments, including repurchase agreements maturing in more than seven days,
securities that are not readily marketable and restricted securities not
eligible for resale pursuant to Rule 144A under the Securities Act of 1933.
4. The Fund will not make short sales of securities, other than short
sales "against the box", or purchase securities on margin except for short-term
credits necessary for clearance of portfolio transactions, provided that this
restriction will not be applied to limit the use of options, futures contracts
and related options, in the manner otherwise permitted by the investment
restrictions, policies and investment program of the Fund.
Since the Fund may invest in qualified private activity bonds, its
shares may not be an appropriate investment for "substantial users" of
facilities financed by industrial development bonds (as defined in Treasury
regulation section 1.103-11), or "related persons" to such users (within the
meaning of Internal Revenue Code section 147(a)).
The Fund, together with any of its "affiliated persons" (as described
in the 1940 Act), may only purchase up to 3% of the total outstanding securities
of any underlying investment company. Accordingly, when the Fund or such
"affiliated persons" hold shares of any of the underlying investment companies,
the Fund's ability to invest fully in shares of those investment companies is
restricted, and Fundamental Portfolio Advisors, Inc.must then, in some
instances, select alternative investments that would not have been its first
preference.
The 1940 Act also provides that an underlying investment company whose
shares are purchased by the Fund will be obligated to redeem shares held by the
Fund and its affiliates only in an amount up to 1% of the underlying investment
company's outstanding securities during any period of less than 30 days. Shares
held by the Fund and its affiliates in excess of 1% of an underlying investment
company's outstanding securities therefore will be considered not readily
marketable securities, which together with other such illiquid securities may
not exceed 15% of the Fund's net assets.
- 5 -
<PAGE>
In certain circumstances, an underlying investment company may
determine to make payment of a redemption by the Fund wholly or partly by a
distribution in kind of securities from its portfolio, in lieu of cash, in
conformity with rules of the Securities and Exchange Commission. In such cases,
the Fund may hold securities distributed by an underlying investment company
until Fundamental Portfolio Advisors, Inc.determines that it is appropriate to
dispose of such securities.
There can be no assurance that funds for investing in municipal
obligations will be available for investment. The Fund does not intend to invest
in such funds unless, in the judgment of Fundamental Portfolio Advisors, Inc.,
the potential benefits of such investment justify the payment of any applicable
premium or sales charge.
Where relevant in this Statement of Additional Information, the term
"issuer" is defined as the entity which has either actually issued the security
or which is ultimately responsible for payment of the obligation. For purposes
of diversification of the Fund's investments, separate issues by the same issuer
will be considered as distinct or diverse investments provided that such issues
differ either with respect to collateral (i.e., the pledge of specific revenue
or taxes standing as security for the payment of the obligation) or guarantor of
ultimate payment.
ADDITIONAL INFORMATION RELATING TO MUNICIPAL OBLIGATIONS
MUNICIPAL BONDS
Municipal bonds are long-term debt obligations, generally with a
maturity at the time of issuance of greater than three years, of states and
their political subdivisions issued to obtain funds for various public purposes,
including construction of a wide range of public facilities, such as airports,
bridges, highways, housing, hospital, mass transportation, schools, streets and
water and sewer works. Other purposes for which municipal bonds may be issued
include refunding outstanding obligations; obtaining funds for general operating
expenses; or obtaining funds to lend to public or private institutions for
construction of such facilities as educational, hospital and housing facilities.
In addition, certain types of bonds may be issued by public authorities to
finance privately operated housing facilities, sports facilities, convention or
trade show facilities, and certain local facilities for water supply, gas,
electricity, or sewage or solid waste disposal. Other types of qualified private
activity bonds, the proceeds of which are used for the construction, equipment,
repair or improvement of privately operated industrial or commercial facilities,
may constitute municipal bonds, although current
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federal tax laws place substantial limitations on the size of such issues.
The two principal classifications of municipal bonds are general
obligation and revenue bonds. General obligation bonds are secured by the
issuer's pledge of faith, credit and taxing power for the payment of principal
and interest. Revenue bonds are payable from only revenues derived from a
particular facility or class of facilities or, in some cases, from the proceeds
of a special excise tax or other specific revenue sources such as from the user
of the facility being financed. Qualified private activity bonds are, in most
cases, revenue bonds and do not generally constitute the pledge of the credit or
taxing power of the issuer of such bonds. The payment of the principal and
interest on such bonds depends solely on the ability 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.
MUNICIPAL NOTES
Municipal notes are short-term obligations, generally with a maturity
at the time of issuance of six months to three years. The principal types of
municipal notes include tax anticipation notes, bond anticipation notes, revenue
anticipation notes, and project notes. Tax anticipation notes are sold to
provide working capital to states and municipalities in anticipation of
collection of taxes. Bond anticipation notes are issued to provide funds
temporarily in anticipation of a bond sale. Revenue anticipation notes are sold
in expectation of receipt of other revenues, such as funds under the Federal
Revenue Sharing Program. Project notes are issued by local agencies in
connection with such programs as construction of low-income housing in order to
provide construction financing prior to permanent financing. Project notes are
guaranteed by the U.S. Department of Housing and Urban Development and
consequently are secured by the full faith and credit of the United States.
VARIABLE RATE INSTRUMENTS
Municipal bonds and notes are sometimes issued with a variable interest
rate ("variable rate instruments"). The interest rate on variable rate
instruments is usually tied to an objective standard, such as the 90-day
Treasury Bill rate or the prime rate of a bank involved in the financing. Prime
rates can change daily; the auction for 90-day Treasury Bill rates is held
weekly. In addition to having a variable interest rate, any such instruments are
subject to repayment of principal on demand by the Fund, usually in not more
than five business days. Both the variable rate feature and the principal
repayment on demand feature tend to reduce fluctuations in the price of variable
rate instruments;
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these instruments are generally of interest and sold to institutional investors.
Also available are participation interests in loans to municipal issuers, which
are similar except that these loan participations are made available through a
commercial bank that arranges the tax-exempt loan. Participation interests are
frequently backed by an irrevocable bank letter of credit or a guarantee by a
financial institution and give the Fund the right to demand, on short notice
(usually not more than seven days), payment of all or any part of the principal
amount and accrued interest. The Board of Directors will determine that the
participation interest in the municipal securities meets the Fund's prescribed
quality standards. The Fund's management has been instructed by the Board of
Directors to monitor the pricing, quality and liquidity of any variable rate
demand instruments held, including participation interests supported by letters
of credit or guarantee, on the basis of published financial information and
reports of the rating agencies and other analytical sources. The Fund's
management will also monitor the creditworthiness of the guarantor. Banks retain
fees for their role in an amount equal to the excess of the interest paid on the
municipal securities over the negotiated yield at which the participation
interests were purchased. In the event that the participation interest that the
Fund acquires includes the right to demand payment of principal and accrued
interest from the issuer of the participation interest pursuant to a letter of
credit or other commitment, the maturity will be deemed to be equal to the time
remaining until the principal amount can be recovered from the issuer through
demand, although the stated maturity may be in excess of one year. To the extent
that variable rate instruments and loan participations may lack liquidity
(unless payable on demand or within seven days), they are subject to the
restriction on illiquid securities, described herein under the caption
"Investment Objective, Policies and Restrictions".
OTHER INFORMATION
A portion of the Fund's assets may be invested in qualified hospital
bonds. Such bonds are rated on the basis of feasibility studies that project
occupancy levels, revenues and expenses. The gross receipts and income of
hospitals are affected by many future events and conditions (including among
other things, demand for hospital services, the ability of the hospital to
provide such services, competition, actions by insurers and governmental
agencies, the cost and possible unavailability of malpractice insurance, and the
funding of medicare and medicaid programs), whose effects are often difficult to
predict. Changes or future developments in all of the foregoing areas may have
an adverse effect on the price or marketability of such bonds.
A part of the Fund's assets may be invested in obligations of state and
local housing authorities. Such
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obligations are not part of the general obligations of the state or the
municipality in question. To a large extent, such obligations are generally
supported by Federal housing subsidy programs. Any weakness in such programs or
their administration, or the failure by a state or local housing authority to
meet the qualifications required for coverage under such programs, may result in
a decrease or the elimination of such Federal subsidies and could adversely
affect payment of principal and interest on housing authority bonds. These
factors as well as general economic factors affecting housing in general could
cause a decrease in the value or marketability of such bonds.
A portion of the Fund's assets may be invested in municipal obligations
that are moral obligation bonds issued by agencies and authorities of the State
of New York (i.e., issued pursuant to the municipality's good faith and credit
to pay principal and interest). Under the statutes applicable to such bonds, the
State may be called on to restore any deficits in capital reserve funds of such
agencies or authorities created with respect to the bonds. Any such restoration
requires appropriation by the state legislature for such purposes, and
accordingly, the statutes do not constitute legally enforceable obligations or
debt of the State. The agencies or authorities in question have no taxing power,
and on a default by such agencies or authorities, there are no guarantees that
payments of principal and interest will be met.
ADDITIONAL INFORMATION RELATING TO LOWER RATED SECURITIES
The lower quality securities in which the Fund may invest (i.e., those
rated lower than Baa by Moody's or BBB by S&P, Fitch or Duff or determined by
Fund management to be a comparable quality if unrated) generally produce a
higher current yield than do securities of higher ratings. However, these
obligations are considered speculative because they involve greater price
volatility and risk than do higher rated securities and the yields on these
securities will tend to fluctuate over time. Although the market value of all
fixed-income securities varies as a result of changes in prevailing interest
rates (e.g., when interest rates rise, the market value of fixed-income
securities can be expected to decline), values of lower rated securities tend to
react differently than the values of higher rated securities. The prices of
lower rated securities are less sensitive to changes in interest rates than
higher rated securities. Conversely, lower rated securities also involve a
greater risk of default by the issuer in the payment of principal and income and
are more sensitive to economic downturns and recessions than higher rated
securities. The financial stress resulting from an economic downturn could have
a greater negative effect on the ability of issuers of lower rated securities to
service their principal and interest payments, to
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meet projected business goals and to obtain additional financing than on more
creditworthy issuers. In the event of an issuer's default in payment of
principal or interest on such securities, or any other securities in the Fund's
portfolio, the net asset value of the Fund will be negatively affected.
Moreover, as the market for lower rated securities is a relatively new one which
has not yet been tested through a recession, a severe economic downturn might
increase the number of defaults, thereby adversely affecting the value of all
outstanding lower rated municipal bonds and disrupting the market for such
securities. Securities purchased by the Fund as part of an initial underwriting
present an additional risk due to their lack of market history. These risks are
exacerbated with respect to securities rated CCC or lower by S&P, Fitch or Duff
or Caa or lower by Moody's. Unrated securities generally carry the same risks as
do lower rated securities.
The Fund may invest in lower rated securities that are structured as
zero coupon or pay-in-kind bonds. Such securities may be more speculative and
subject to greater fluctuation in value due to changes in interest rates than
lower rated, income- bearing securities. In addition, zero coupon and
pay-in-kind securities are also subject to the risk that in the event of a
default, a fund may realize no return on its investment, because these
securities do not pay cash interest. Zero coupon, or deferred interest,
securities are debt obligations that do not entitle the holder to any periodic
payment of interest prior to maturity or a specified date when the securities
begin paying current interest (the "cash payment date") and therefore are issued
and traded at a discount from their face amounts or par value. Pay-in-kind
securities are securities that pay interest through the issuance of additional
securities. Holders of zero coupon securities are considered to receive each
year the portion of the original issue discount on such securities that accrues
that year and must include such amount in gross income, even though the holders
receive no cash payments during the year. Consequently, as a fund is accruing
original issue discount on these securities prior to the receipt of cash
payment, it is still subject to the requirement that it distribute substantially
all of its income to its shareholders in order to qualify as a "regulated
investment company" under applicable tax law. Therefore, such fund may have to
dispose of its portfolio securities under disadvantageous circumstances or
leverage itself by borrowing to generate the cash necessary to satisfy its
distribution requirements.
Lower rated securities are typically traded among a smaller number of
broker-dealers rather than in a broad secondary market. Purchasers of lower
rated securities tend to be institutions, rather than individuals, a factor that
further limits the secondary market. To the extent that no established retail
secondary market exists, many lower rated securities may not be as liquid as
Treasury and investment grade securities. The ability of
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the Fund to sell lower rated securities will be adversely affected to the extent
that such securities are thinly traded or illiquid. Moreover, the ability of the
Fund to value lower rated securities becomes more difficult, and judgment plays
a greater role in valuation, as there is less reliable, objective data available
with respect to such securities that are thinly traded or illiquid.
Because investors may perceive that there are greater risks associated
with the medium to lower rated securities of the type in which the Fund may
invest, the yields and prices of such securities may tend to fluctuate more than
those for securities with a higher rating. Changes in perception of issuers'
creditworthiness tend to occur more frequently and in a more pronounced manner
in the lower quality segments of the fixed-income securities market than do
changes in higher quality segments of such market, resulting in greater yield
and price volatility.
The general legislative environment has included discussions and
legislative proposals relating to the tax treatment of high-yield securities.
Any or a combination of such proposals, if enacted into law, could negatively
affect the value of the high-yield securities in the Fund's portfolio. The
likelihood of any such legislation is uncertain.
Fund management believes that the risks of investing in such
high-yielding securities may be minimized through careful analysis of
prospective issuers. Although the opinion or ratings services such as Moody's,
S&P, Fitch and Duff is considered in selecting portfolio securities, they relate
to credit risk and evaluate the safety of the principal and the interest
payments of the security, not their market value risk. Additionally, credit
rating agencies may experience slight delays in updating ratings to reflect
current events. The Fund relies, primarily, on its own credit analysis, which
includes a study of the existing debt, capital structure, ability to service
debts and to pay dividends, and the current trend of earnings for any issuer
under consideration for the Fund's investment portfolio. This may suggest,
however, that the achievement of the Fund's investment objective is more
dependent on its proprietary credit analysis, than is otherwise the case for a
fund that invests in higher quality securities.
ADDITIONAL INFORMATION CONCERNING NEW YORK ISSUERS
The financial condition of New York State (the "State") and certain of
its public bodies (the "Agencies") and municipalities, particularly New York
City (the "City"), could affect the market values and marketability of New York
Municipal Obligations which may be held by the Fund. The following information
constitutes only a brief summary, does not purport to be a complete description,
and is based on information drawn from
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official statements relating to securities offerings of the State, the City and
the Municipal Assistance Corporation for the City of New York ("MAC") available
as of the date of this Statement of Additional Information. While the Fund has
not independently verified such information, it has no reason to believe that
such information is not correct in all material respects.
A national recession commenced in mid-1990. The downturn continued
through the remainder of the 1990-91 fiscal year, and was followed by a period
of weak economic growth during the remainder of the 1991 calendar year. For the
calendar year 1992, the national economy continued to recover, although at a
rate below all post-war recoveries. The recession was more severe in the State
than in other parts of the nation, owing to a significant retrenchment in the
financial services industry, cutbacks in defense spending, and an overbuilt real
estate market. The State economy remained in recession until 1993, when
employment growth resumed. Since early 1993, the State has gained approximately
100,000 jobs. The State's economy expanded modestly during 1995. Although
industries that export goods and services abroad are expected to benefit from
the lower dollar, growth will be slowed by government cutbacks at all levels. On
an average annual basis, employment growth in 1995 was estimated to be about the
same as 1994. Both personal income and wages were estimated to have recorded
moderate gains in 1995. Employment growth is expected to slow significantly in
1996 as the pace of national economic growth slackens, entire industries
experience consolidations, and governmental employment continues to shrink.
Personal income is estimated to increase by approximately 5.0% in 1996.
The State's budget for the 1996-97 fiscal year was enacted by the
Legislature on July 13, 1996, more than three months after the start of the
fiscal year. Prior to adoption of the budget, the Legislature enacted
appropriations for disbursements considered to be necessary for State operations
and other purposes, including all necessary appropriations for debt service. The
State Financial Plan for the 1996-97 fiscal year was formulated on July 25, 1996
and is based on the State's budget as enacted by the Legislature and signed into
law by the Governor, as well as actual results for the first quarter of the
1996-97 fiscal year.
After adjustments for comparability between fiscal years, the adopted
1996-97 budget projects a year-over-year increase in General Fund disbursements
of 0.2%. Adjusted State Funds (excluding federal grants) disbursements are
projected to increase by 1.6% from the prior fiscal year. All Governmental Funds
projected disbursements increase by 4.1% over the prior fiscal year, after
adjustments for comparability.
The 1996-97 State Financial Plan is projected to be balanced on a cash
basis. As compared to the Governor's proposed
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budget as revised on March 20, 1996, the State's adopted budget for 1996-97
increases General Fund spending by $842 million, primarily from increases for
education, special education and higher education ($563 million). The balance
represents funding increases to a variety of other programs, including community
projects and increased assistance to fiscally distressed cities. Resources used
to fund these additional expenditures include $540 million in increased revenues
projected for 1996-97 based on higher-than-projected tax collections during the
first half of calendar 1996, $110 million in projected receipts from a new State
tax amnesty program, and other resources including certain non-recurring
resources. The total amount of non-recurring resources included in the 1996-97
State budget is projected to be $1.3 billion, or 3.9% of total General Fund
receipts.
The State Financial Plan was based upon forecasts of national and State
economic activity. Economic forecasts have frequently failed to predict
accurately the timing and magnitude of changes in the national and the State
economies. Many uncertainties exist in forecasts of both the national and State
economies, including consumer attitudes toward spending, Federal financial and
monetary policies, the availability of credit and the condition of the world
economy, which could have an adverse effect on the State. There can be no
assurance that the State economy will not experience worse-than-predicted
results, with corresponding material and adverse effects on the State's
projections of receipts and disbursements.
There can be no assurance that the State will not face substantial
potential budget gaps in future years resulting from a significant disparity
between tax revenues projected from a lower recurring receipts base and the
spending required to maintain State programs at current levels. To address any
potential budgetary imbalance, the State may need to take significant actions to
align recurring receipts and disbursements in future fiscal years.
On June 6, 1990, Moody's changed its ratings on all the State's
outstanding general obligation bonds from A1 to A. On March 26, 1990 and January
13, 1992, S&P changed its ratings on all of the State's outstanding general
obligation bonds from AA- to A and from A to A-, respectively. In February 1991,
Moody's lowered its rating on the City's general obligation bonds from A to Baa1
and in July 1995, S&P lowered its rating on such bonds from A- to BBB+. Ratings
reflect only the respective views of such organizations, and their concerns
about the financial condition of New York State and City, the debt load of the
State and City and any economic uncertainties about the region. There is no
assurance that a particular rating will continue for any given period of time or
that any such rating will not be revised downward or withdrawn entirely if, in
the judgment of the agency originally establishing the rating, circumstances so
warrant.
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(1) The State, Agencies and Other Municipalities. During the mid
- -1970s, some of the Agencies and municipalities (in particular, the City) faced
extraordinary financial difficulties, which affected the State's own financial
condition. These events, including a default on short-term notes issued by the
New York State Urban Development Corporation ("UDC") in February 1975, which
default was cured shortly thereafter, and a continuation of the financial
difficulties of the City, created substantial investor resistance to securities
issued by the State and by some of its municipalities and Agencies. For a time,
in late 1975 and early 1976, these difficulties resulted in a virtual closing of
public credit markets for State and many State related securities.
In response to the financial problems confronting it, the State
developed and implemented programs for its 1977 fiscal year that included the
adoption of a balanced budget on a cash basis (a deficit of $92 million that
actually resulted was financed by issuing notes that were paid during the first
quarter of the State's 1978 fiscal year). In addition, legislation was enacted
limiting the occurrence of additional so-called "moral obligation" and certain
other Agency debt, which legislation does not, however, apply to MAC debt.
GAAP-Basis Results--1995-96 Fiscal Year. The State completed its
1995-96 fiscal year with a combined Governmental Funds operating surplus of $432
million, which included an operating surplus in the General Fund of $380
million, in the Capital Projects Funds of $276 million and in the Debt Service
Funds of $185 million. There was an operating deficit of $409 million in the
Special Revenue Funds. The State's Combined Balance Sheet as of March 31, 1996
showed an accumulated deficit in its combined Governmental Funds of $1.23
billion, reflecting liabilities of $14.59 billion and assets of $13.35 billion.
This accumulated Governmental Funds deficit includes a $2.93 billion accumulated
deficit in the General Fund and an accumulated deficit of $712 million in the
Capital Projects Fund type as partially offset by accumulated surpluses of $468
million and $1.94 billion in the Special Revenue and Debt Service fund types,
respectively.
GAAP-Basis Results--1994-95 Fiscal Year. The State's Combined Balance
Sheet as of March 31, 1995 showed an accumulated deficit in its combined
governmental funds of $1.666 billion reflecting liabilities of $14.778 billion
and assets of $13.112 billion. This accumulated governmental funds deficit
includes a $3.308 billion accumulated deficit in the General Fund, as well as
accumulated surpluses in the special Revenue and Debt Service fund types of $877
million and $1.753 billion, respectively, and a $988 million accumulated deficit
in the Capital Projects fund type.
The State completed its 1994-95 fiscal year with a combined
Governmental Funds operating deficit of $1.791 billion,
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which included operating deficits in the General Fund of $1.426 billion, in the
Capital Projects Funds of $366 million, and in the Debt Service Funds of $38
million. There was an operating surplus in the Special Revenue Funds of $39
million.
GAAP-Basis Results--1993-94 Fiscal Year. The State reported a General
Fund operating surplus of $914 million for the 1993-94 fiscal year, as compared
to an operating surplus of $2.065 billion for the prior fiscal year. The 1993-94
fiscal year surplus reflects several major factors, including the cash basis
surplus recorded in 1993-94, the use of $671 million of the 1992-93 surplus to
fund operating expenses in 1993-94, net proceeds of $575 million in bonds issued
by the New York Local Government Assistance Corporation ("LGAC") and the
accumulation of a $265 million balance in the Contingency Reserve Fund ("CRF").
Revenues increased $543 million (1.7%) over prior fiscal year revenues with the
largest increase occurring in personal income taxes. Expenditures increased
$1.659 billion (5.6%) over the prior fiscal year, with the largest increase
occurring in State aid for social services programs.
The Special Revenue fund and Debt Service fund ended 1993-94 with
operating surpluses of $149 million and $23 million, respectively. The Capital
Projects fund ended with an operating deficit of $35 million. GAAP-Basis
Results--1992- 93 Fiscal Year. The State completed its 1992-93 fiscal year with
a GAAP-basis operating surplus of $2.065 billion in the General Fund and an
accumulated deficit of $2.551 billion. The Combined Statement of Revenues,
Expenditures and Changes in Fund Balances reported total revenues of $31.085
billion, total expenditures of $29.337 billion, and net other financing sources
and uses of $317 million. The surplus primarily reflects the 1992-93 cash-basis
surplus and the net proceeds of $881 million in bonds issued by LGAC.
The Special Revenue, Debt Service and Capital Projects fund types ended
the 1992-93 fiscal year with GAAP-basis operating surpluses of $131 million,
$381 million, and $57 million, respectively.
State Financial Plan--Cash-Basis Results--General Fund. The General
Fund is the principal operating fund of the State and is used to account for all
financial transactions, except those required to be accounted for in another
fund. It is the State's largest fund and receives almost all State taxes and
other resources not dedicated to particular purposes. General Fund moneys are
also transferred to other funds, primarily to support certain capital projects
and debt service payments in other fund types.
In the State's 1996-97 fiscal year, the General Fund is expected to
account for approximately 47% of total Governmental Funds disbursements and 71%
of total State Funds disbursements.
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The General Fund is projected to be balanced on a cash basis for the 1996-97
fiscal year. Total receipts and transfers from other funds are projected to be
$33.17 billion, an increase of $365 million from the prior fiscal year. Total
General Fund disbursements and transfers to other funds are projected to be
$33.12 billion, an increase of $444 million from the total in the prior fiscal
year.
New York State's financial operations have improved during recent
fiscal years. During the period 1989-90 through 1991-92, the State incurred
General Fund operating deficits that were closed with receipts from the issuance
of tax and revenue anticipation notes ("TRANs"). First, the national recession,
and then the lingering economic slowdown in the New York and regional economy,
resulted in repeated shortfalls in receipts and three budget deficits. During
its last four fiscal years, however, the State recorded balanced budgets on a
cash basis, with positive fund balances as described below.
The State ended its 1995-96 fiscal year on March 31, 1996 with a
General Fund cash surplus. The Division of the Budget reported that revenues
exceeded projections by $270 million, while spending for social service programs
was lower than forecast by $120 million and all other spending was lower by $55
million. From the resulting benefit of $445 million, a $65 million voluntary
deposit was made into the Tax Stabilization Reserve Fund ("TSRF"), and $380
million was used to reduce 1996-97 Financial Plan liabilities by accelerating
1996-97 payments, deferring 1995-96 revenues, and making a deposit to the tax
refund reserve account.
The General Fund closing fund balance was $287 million, an increase of
$129 million from 1994-95 levels. The $129 million change in fund balance is
attributable to the $65 million voluntary deposit to the TSRF, a $15 million
required deposit to the TSRF, a $40 million deposit to the Contingency Reserve
Fund ("CRF"), and a $9 million deposit to the Revenue Accumulation Fund. The
closing fund balance includes $237 million on deposit in the TSRF, to be used in
the event of any future General Fund deficit as provided under the State
Constitution and State Finance Law. In addition, $41 million is on deposit in
the CRF. The CRF was established in State fiscal year 1993-94 to assist the
State in financing the costs of extraordinary litigation . The remaining $9
million reflects amounts on deposit in the Revenue Accumulation Fund. This fund
was created to hold certain tax receipts temporarily before their deposit to
other accounts. In addition, $678 million was on deposit in the tax refund
reserve account, of which $521 million was necessary to complete the
restructuring of the State's cash flow under the New York Local Government
Assistance Corporation ("LGAC") program.
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General Fund receipts totaled $32.81 billion, a decrease of 1.1% from
1994-95 levels. This decrease reflects the impact of tax reductions enacted and
effective in both 1994 and 1995. General Fund disbursements totaled $32.68
billion for the 1995-96 fiscal year, a decrease of 2.2% from 1994-95 levels.
The State ended its 1994-95 fiscal year with the General Fund in
balance. The $241 million decline in the fund balance reflects the planned use
of $264 million from the CRF , partially offset by the required deposit of $23
million to the TSRF. In addition, $278 million was on deposit in the tax refund
reserve account, $250 million of which was deposited to continue the process of
restructuring the State's cash flow as part of the LGAC program. The closing
fund balance of $158 million reflects $157 million in the TSRF and $1 million in
the CRF.
General Fund receipts totaled $33.16 billion, an increase of 2.9% from
1993-94 levels. General Fund disbursements totaled $33.40 billion for the
1994-95 fiscal year, an increase of 4.7% from the previous fiscal year. The
increase in disbursements was primarily the result of one-time litigation costs
for the State, funded by the use of the CRF, offset by $188 million in spending
reductions initiated in January 1995 to avert a potential gap in the 1994-95
State Financial Plan. These actions included savings from a hiring freeze,
halting the development of certain services, and the suspension of non-
essential capital projects. The State ended its 1993-94 fiscal year with a
General Fund cash surplus, primarily the result of an improving national
economy, State employment growth, tax collections that exceeded earlier
projections and disbursements that were below expectations. A deposit of $268
million was made to the CRF, with a withdrawal during the year of $3 million,
and a deposit of $67 million was made to the TSRF. These three transactions
resulted in the change in fund balance of $332 million. In addition, a deposit
of $1.14 billion was made to the tax refund reserve account, of which $1.03
billion was available for budgetary purposes in the 1994-95 fiscal year. The
remaining $114 million was redeposited in the tax refund reserve account at the
end of the State's 1994-95 fiscal year to continue the process of restructuring
the State's cash flow as part of the LGAC program. The General Fund closing
balance was $399 million, of which $265 million was on deposit in the CRF and
$134 million in the TSRF . The CRF was initially funded with a transfer of $100
million attributable to a positive margin recorded in the 1992-93 fiscal year.
General Fund receipts totaled $32.23 billion, an increase of 2.6% from 1992-93
levels. General Fund disbursements totaled $31.90 billion for the 1993-94 fiscal
year, 3.5% higher than the previous fiscal year. Receipts were higher in part
due to improved tax collections from renewed State economic growth, although the
State continued to lag behind the national economic recovery. Disbursements were
higher due in part to increased local assistance costs for school aid and social
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services, accelerated payment of certain Medicaid expenses, and the cost of an
additional payroll for State employees.
Cash-Basis Results--Other Governmental Funds. Activity in the three other
governmental funds has remained relatively stable over the last three fiscal
years, with Federally-funded programs comprising approximately two- thirds of
these funds. The most significant change in the structure of these funds has
been the redirection, beginning in the 1993-94 fiscal year, of a portion of
transportation-related revenues from the General Fund to two new dedicated funds
in the Special Revenue and Capital Projects Fund types. These revenues are used
to support the capital programs of the Department of Transportation and the
Metropolitan Transportation Authority ("MTA").
The Special Revenue Funds account for State receipts from specific
sources that are legally restricted in use to specified purposes and include all
moneys received from the Federal government. Revenues in Special Revenue Funds
in the State's 1995-96 fiscal year increased $1.45 billion over the prior fiscal
year as a result of increases in federal grants and lottery revenues.
Disbursements from Special Revenue Funds in the State's 1995-96 fiscal year
increased $1.21 billion over the prior fiscal year as a result of increased
costs for social services programs and an increase in the distribution of
lottery proceeds to school districts.
The Capital Projects Funds are used to finance the acquisition and
construction of major capital facilities and to aid local government units and
Agencies in financing capital constructions. Revenues in the Capital Projects
Funds in the State's 1995-96 fiscal year increased $260 million primarily
because a larger share of the petroleum business tax was shifted from the
General Fund to the Dedicated Highway and Bridge Trust Fund and by an increase
in federal grant revenues. Expenditures increased $194 million because of
increased expenditures for education and health and environmental projects.
The Debt Service Funds serve to fulfill State debt service on long-
term general obligation State debt and other State lease/purchase and
contractual obligation financing commitments. Revenues in the Debt Service Funds
in the State's 1995-96 fiscal year increased $10 million because of increases in
both dedicated taxes and mental hygiene patient fees. Expenditures increased
$201 million.
State Borrowing Plan. The State anticipates that its capital programs
will be financed, in part, through borrowings by the State and public
authorities in the 1996-97 fiscal year. The State expects to issue $411 million
in general obligation bonds (including $153.6 million for purposes of redeeming
outstanding
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<PAGE>
BANs) and $154 million in general obligation commercial paper. The Legislature
has also authorized the issuance of up to $101 million in COPs during the
State's 1996-97 fiscal year for equipment purchases . The projection of the
State regarding its borrowings for the 1996-97 fiscal year may change if
circumstances require.
State Agencies. The fiscal stability of the State is related, at least
in part, to the fiscal stability of its localities and various of its Agencies.
Various Agencies have issued bonds secured, in part, by non-binding statutory
provisions for State appropriations to maintain various debt service reserve
funds established for such bonds (commonly referred to as "moral obligation"
provisions).
At September 30, 1995, there were 17 Agencies that had outstanding debt
of $100 million or more. The aggregate outstanding debt, including refunding
bonds, of these 17 Agencies was $73.45 billion as of September 30, 1995. As of
March 31, 1995, aggregate Agency debt outstanding as State- supported debt was
$27.9 billion and as State-related was $36.1 billion. Debt service on the
outstanding Agency obligations normally is paid out of revenues generated by the
Agencies' projects or programs, but in recent years the State has provided
special financial assistance, in some cases on a recurring basis, to certain
Agencies for operating and other expenses and for debt service pursuant to moral
obligation indebtedness provisions or otherwise. Additional assistance is
expected to continue to be required in future years.
Several Agencies have experienced financial difficulties in the past.
Certain Agencies continue to experience financial difficulties requiring
financial assistance from the State. Failure of the State to appropriate
necessary amounts or to take other action to permit certain Agencies to meet
their obligations could result in a default by one or more of such Agencies. If
a default were to occur, it would likely have a significant effect on the
marketability of obligations of the State and the Agencies. These Agencies are
discussed below.
The New York State Housing Finance Agency ("HFA") provides financing
for multifamily housing, State University construction, hospital and nursing
home development, and other programs. In general, HFA depends upon mortgagors in
the housing programs it finances to generate sufficient funds from rental
income, subsidies and other payments to meet their respective mortgage repayment
obligations to HFA, which provide the principal source of funds for the payment
of debt service on HFA bonds, as well as to meet operating and maintenance costs
of the projects financed. From January 1, 1976 through March 31, 1987, the State
was called upon to appropriate a total of $162.8 million to make up deficiencies
in the debt service reserve funds of HFA pursuant
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<PAGE>
to moral obligation provisions. The State has not been called upon to make such
payments since the 1986-87 fiscal year.
UDC has experienced, and expects to continue to experience, financial
difficulties with the housing programs it had undertaken prior to 1975, because
a substantial number of these housing program mortgagors are unable to make full
payments on their mortgage loans. Through a subsidiary, UDC is currently
attempting to increase its rate of collection by accelerating its program of
foreclosures and by entering into settlement agreements. UDC has been, and will
remain, dependent upon the State for appropriations to meet its operating
expenses. The State also has appropriated money to assist in the curing of a
default by UDC on notes which did not contain the State's moral obligation
provision.
The MTA oversees New York City's subway and bus lines by its
affiliates, the New York City Transit Authority and the Manhattan and Bronx
Surface Transit Operating Authority (collectively, the "TA"). Through MTA's
subsidiaries, the Long Island Rail Road Company, the Metro-North Commuter
Railroad Company and the Metropolitan Suburban Bus Authority, the MTA operates
certain commuter rail and bus lines in the New York metropolitan area. In
addition, the Staten Island Rapid Transit Authority, an MTA subsidiary, operates
a rapid transit line on Staten Island. Through its affiliated agency, the
Triborough Bridge and Tunnel Authority (the "TBTA"), the MTA operates certain
toll bridges and tunnels. Because fare revenues are not sufficient to finance
the mass transit portion of these operations, the MTA has depended and will
continue to depend for operating support upon a system of State, local
government and TBTA support and, to the extent available, Federal operating
assistance, including loans, grants and subsidies. If current revenue
projections are not realized and/or operating expenses exceed current
projections, the TA or commuter railroads may be required to seek additional
State assistance, raise fares or take other actions.
Over the past several years the State has enacted several
taxes--including a surcharge on the profits of banks, insurance corporations and
general business corporations doing business in the 12-county region (the
"Metropolitan Transportation Region") served by the MTA and a special .25%
regional sales and use tax--that provide additional revenues for mass transit
purposes, including assistance to the MTA. In addition, since 1987, State law
has required that the proceeds of .25% mortgage recording tax paid on certain
mortgages in the Metropolitan Transportation Region be deposited in a special
MTA fund for operating or capital expenses. Further, in 1993, the State
dedicated a portion of certain additional State petroleum business tax receipts
to fund operating or capital assistance to the MTA. For the 1996-97 State fiscal
year, total State assistance to the MTA is estimated at approximately $1.09
billion.
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<PAGE>
In 1981, the State Legislature authorized procedures for the adoption,
approval and amendment of a five-year plan for the capital program designed to
upgrade the performance of the MTA's transportation systems and to supplement,
replace and rehabilitate facilities and equipment, and also granted certain
additional bonding authorization therefor.
State legislation accompanying the 1996-97 adopted State budget
authorized the MTA, TBTA and TA to issue an aggregate of $6.5 billion in bonds
to finance a portion of a new $11.98 billion MTA capital plan for the 1995
through 1999 calendar years (the "1995-99 Capital Program"), and authorized the
MTA to submit the 1995-99 Capital Program to the Capital Program Review Board
for approval. This plan will supersede the overlapping portion of the MTA's
1992-96 Capital Program. This is the fourth capital plan since the Legislature
authorized procedures for the adoption, approval and amendment of MTA capital
programs and is designed to upgrade the performance of the MTA's transportation
systems by investing in new rolling stock, maintaining replacement schedules for
existing assets and bringing the MTA system into a state of good repair. The
1995-99 Capital Program assumes the issuance of an estimated $5.1 billion in
bonds under this $6.5 billion aggregate bonding authority. The remainder of the
plan is projected to be financed through assistance from the State, the federal
government, and the City of New York, and from various other revenues generated
from actions taken by the MTA.
There can be no assurance that such governmental actions will be taken,
that sources currently identified will not be decreased or eliminated, or that
the 1995-1999 Capital Program will not be delayed or reduced. If the MTA capital
program is delayed or reduced because of funding shortfalls or other factors,
ridership and fare revenues may decline, which could, among other things, impair
the MTA's ability to meet its operating expenses without additional State
assistance.
The cities, towns, villages and school districts of the State are
political subdivisions of the State with the powers granted by the State
Constitution and statutes. As the sovereign, the State retains broad powers and
responsibilities with respect to the government, finances and welfare of these
political subdivisions, especially in education and social services. In recent
years the State has been called upon to provide added financial assistance to
certain localities.
Other Localities. Certain localities in addition to the City could have
financial problems leading to requests for additional State assistance during
the last several State fiscal years. The potential impact on the State of such
actions by localities is not included in the projections of the State receipts
and disbursements in the State's 1996-97 fiscal year.
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<PAGE>
Fiscal difficulties experienced by the City of Yonkers resulted in the
re-establishment of the Financial Control Board for the City of Yonkers by the
State in 1984. That Board is charged with oversight of the fiscal affairs of
Yonkers. Future actions taken by the State to assist Yonkers could result in
increased State expenditures for extraordinary local assistance.
Beginning in 1990, the City of Troy experienced a series of budgetary
deficits that resulted in the establishment of a Supervisory Board for the City
of Troy in 1994. The Supervisory Board's powers were increased in 1995, when
Troy MAC was created to help Troy avoid default on certain obligations. The
legislation creating Troy MAC prohibits the City of Troy from seeking federal
bankruptcy protection while Troy MAC bonds are outstanding.
Seventeen municipalities received extraordinary assist ance during the
1996 legislative session through $50 million in special appropriations targeted
for distressed cities.
Municipalities and school districts have engaged in substantial
short-term and long-term borrowings. In 1994, the total indebtedness of all
localities in the State, other than the City, was approximately $17.7 billion. A
small portion (approximately $82.9 million) of this indebtedness represented
borrowing to finance budgetary deficits and was issued pursuant to enabling
State legislation. State law requires the Comptroller to review and make
recommendations concerning the budgets of those local government units other
than the City authorized by State law to issue debt to finance deficits during
the period that such deficit financing is outstanding. Seventeen localities had
outstanding indebtedness for deficit financing at the close of their fiscal year
ending in 1994.
From time to time, Federal expenditure reductions could reduce, or in
some cases eliminate, Federal funding of some local programs and accordingly
might impose substantial increased expenditure requirements on affected
localities to increase local revenues to sustain those expenditures. If the
State, the City or any of the Agencies were to suffer serious financial
difficulties jeopardizing their respective access to the public credit markets,
the marketability of notes and bonds issued by localities within the State could
be adversely affected. Localities also face anticipated and potential problems
resulting from certain pending litigation, judicial decisions and long- range
economic trends. The longer-range, potential problems of declining city
population, increasing expenditures and other economic trends could adversely
affect localities and require increasing State assistance in the future.
Certain litigation pending against the State or its
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<PAGE>
officers or employees could have a substantial or long-term adverse
effect on State finances. Among the more significant of these litigations are
those that involve: (i) the validity and fairness of agreements and treaties by
which various Indian tribes transferred title to the State of approximately six
million acres of land in central New York; (ii) certain aspects of the State's
Medicaid rates and regulations, including reimbursements to providers of
mandatory and optional Medicaid services; (iii) contamination in the Love Canal
area of Niagara Falls; (iv) a challenge to the State's practice of reimbursing
certain Office of Mental Health patient-care expenses with clients' Social
Security benefits; (v) a challenge to the methods by which the State reimburses
localities for the administrative costs of food stamp programs; (vi) a challenge
to the State's possession of certain funds taken pursuant to the State's
Abandoned Property law; (vii) alleged responsibility of State officials to
assist in remedying racial segregation in the City of Yonkers; (viii) an action,
in which the State is a third party defendant, for injunctive or other
appropriate relief, concerning liability for the maintenance of stone groins
constructed along certain areas of Long Island's shoreline; (ix) actions
challenging the constitutionality of legislation enacted during the 1990
legislative session which changed the actuarial funding methods for determining
contributions to State employee retirement systems; (x) an action against State
and City officials alleging that the present level of shelter allowance for
public assistance recipients is inadequate under statutory standards to maintain
proper housing; (xi) an action challenging legislation enacted in 1990 which had
the effect of deferring certain employer contributions to the State Teachers'
Retirement System and reducing State aid to school districts by a like amount;
(xii) a challenge to the constitutionality of financing programs of the Thruway
Authority authorized by Chapters 166 and 410 of the Laws of 1991 (described
below in this Part); (xiii) a challenge to the constitutionality of financing
programs of the Metropolitan Transportation Authority and the Thruway Authority
authorized by Chapter 56 of the Laws of 1993 (described below in this Part);
(xiv) challenges to the delay by the State Department of Social Services in
making two one-week Medicaid payments to the service providers; (xv) challenges
by commercial insurers, employee welfare benefit plans, and health maintenance
organizations to provisions of Section 2807-c of the Public Health Law which
impose 13%, 11% and 9% surcharges on inpatient hospital bills and a bad debt and
charity care allowance on all hospital bills paid by such entities; (xvi)
challenges to the promulgation of the State's proposed procedure to determine
the eligibility for and nature of home care services for Medicaid recipients;
(xvii) a challenge to State implementation of a program which reduces Medicaid
benefits to certain home-relief recipients; and (xviii) challenges to the
rationality and retroactive
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<PAGE>
application of State regulations recelebrating nursing home Medicaid rates.
(2) New York City. In the mid-1970s, the City had large accumulated
past deficits and until recently was not able to generate sufficient tax and
other ongoing revenues to cover expenses in each fiscal year. However, the City
has achieved balanced operating results for each of its fiscal years since 1981
as reported in accordance with the then-applicable GAAP standards. The City's
ability to maintain balanced operating results in future years is subject to
numerous contingencies and future developments.
The City's economy, whose rate of growth slowed substantially over the
past three years, is currently in recession. During the 1990 and 1991 fiscal
years, as a result of the slowing economy, the City has experienced significant
shortfalls in almost all of its major tax sources and increases in social
services costs, and has been required to take actions to close substantial
budget gaps in order to maintain balanced budgets in accordance with the
Financial Plan.
In 1975, the City became unable to market its securities and entered a
period of extraordinary financial difficulties. In response to this crisis, the
State created MAC to provide financing assistance to the City and also enacted
the New York State Financial Emergency Act for the City of New York (the
"Emergency Act") which, among other things, created the Financial Control Board
(the "Control Board") to oversee the City's financial affairs and facilitate its
return to the public credit markets. The State also established the Office of
the State Deputy Comptroller ("OSDC") to assist the Control Board in exercising
its powers and responsibilities. On June 30, 1986, the Control Board's powers of
approval over the City Financial Plan were suspended pursuant to the Emergency
Act. However, the Control Board, MAC and OSDC continue to exercise various
monitoring functions relating to the City's financial condition. The City
prepares and operates under a four-year financial plan which is submitted
annually to the Control Board for review and which the City periodically
updates.
The City's independently audited operating results for each of its
fiscal years from 1981 through 1995 show a General Fund surplus reported in
accordance with GAAP. The City has eliminated the cumulative deficit in its net
General Fund position.
According to a recent OSDC economic report, the City's economy was slow
to recover from the recession and is expected to experience a weak employment
situation, and moderate wage and income growth, during the 1995-96 period. Also,
Financial Plan reports of OSDC, the Control Board, and the City Comptroller have
variously indicated that many of the City's balanced budgets have been
accomplished, in part, through the use of non-recurring
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<PAGE>
resource, tax and fee increases, personnel reductions and additional State
assistance; that the City has not yet brought its long-term expenditures in line
with recurring revenues; that the City's proposed gap-closing programs, if
implemented, would narrow future budget gaps; that these programs tend to rely
heavily on actions outside the direct control of the City; and that the City is
therefore likely to continue to face futures projected budget gaps requiring the
City to reduce expenditures and/or increase revenues. According to the most
recent staff reports of OSDC, the Control Board and the City Comptroller during
the four-year period covered by the current Financial Plan, the City is relying
on obtaining substantial resources from initiatives needing approval and
cooperation of its municipal labor unions, Covered Organizations, and City
Council, as well as the State and Federal governments, among others, and there
can be no assurance that such approval can be obtained.
The City requires certain amounts of financing for seasonal and capital
spending purposes. The City has issued $1.75 billion of notes for seasonal
financing purposes during the 1994 fiscal year. The City's capital financing
program projects long-term financing requirements of approximately $17 billion
for the City's fiscal years 1995 through 1998 for the construction and
rehabilitation of the City's infrastructure and other fixed assets. The major
capital requirement include expenditures for the City's water supply system, and
waste disposal systems, roads, bridges, mass transit, schools and housing. In
addition, the City and the Municipal Water Finance Authority issued about $1.8
billion in refunding bonds in the 1994 fiscal year.
State Economic Trends. The State historically has been one of the
wealthiest states in the nation. For decades, however, the State has grown more
slowly than the nation as a whole, gradually eroding its relative economic
position. Statewide, urban centers have experienced significant changes
involving migration of the more affluent to the suburbs and an influx of
generally less affluent residents. Regionally, the older Northeast cities have
suffered because of the relative success that the South and the West have had in
attracting people and business. The City has also had to face greater
competition as other major cities have developed financial and business
capabilities which make them less dependent on the specialized services
traditionally available almost exclusively in the City.
During the 1982-83 recession, overall economic activity in the State
declined less than that of the nation as a whole. However, in the calendar years
1984 through 1991, the State's rate of economic expansion was somewhat slower
than that of the nation. In the 1990-91 recession, the economy of the State, and
that of the rest of the Northeast, was more heavily damaged than that of the
nation as a whole and has been slower to recover. The total
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<PAGE>
employment growth rate in the State has been below the national average since
1984. The unemployment rate in the State dipped below the national rate in the
second half of 1981 and remained lower until 1991; since then, it has been
higher. According to data published by the U.S. Bureau of Economic Analysis,
during the past ten years, total personal income in the State rose slightly
faster than the national average only from 1986 through 1988.
MANAGEMENT OF THE FUND
DIRECTORS AND OFFICERS
Directors and officers of the Fund, together with information as to
their principal business occupations during the last five years, are shown
below. Each director who is considered to be an "interested person" of the Fund,
as defined in the 1940 Act, is indicated by as asterisk (*).
James C. Armstrong: Director of the Fund. Mr. Armstrong is a partner in
Armstrong/Seltzer Communications Inc., a New York management, consulting and
public relations firm. He was formerly Executive Director, Global Public Affairs
Institute at New York University and Professor, Bell of Pennsylvania Chair in
Telecommunications, Temple University, and is a management consultant. He was
with American Telephone and Telegraph Company for 15 years. His last position
with AT&T was Director, Corporate Policy Analysis. Mr. Armstrong previously held
positions at the Institute for Defense Analysis, the Office of the Postmaster
General, and on the faculty of the University of Maryland. He has been a
consultant to government, academic and business organizations, and has served on
various government- industry task forces and committees. Mr. Armstrong was an
Officer in the United States Navy and holds a Ph.D. in nuclear physics. Mr.
Armstrong's address is 51 Mt. Pleasant Road, Morristown, New Jersey 07960.
James A. Bowers: Director of the Fund. Mr. Bowers is a consultant for
CAMBA, Inc., Prototypes (formerly, Director of Finance and Administration), The
American Telephone and Telegraph Company (AT&T) and the RAND Corporation. He was
employed at AT&T for 23 years. His latest position with AT&T was in the Treasury
Department as District Manager-Securities and Exchange Commission Reporting. Mr.
Bowers holds Bachelor of Science and Master of Arts degrees in Economics from
Florida Atlantic University. Mr. Bowers' address is 60 East Eighth Street, New
York, N.Y. 10003.
Clark L. Bullock: Director of the Fund. Mr. Bullock is Chairman of the
Board of Shelter Rock Investors Services Corp., a privately-held, New York-based
investment company. Mr. Bullock received a Masters of Science degree in
Mathematical Economics from Purdue University in 1972 and a Bachelor of Arts
degree
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<PAGE>
in International Relations from the University of Arizona. Mr. Bullock's address
is c/o Shelter Rock Investors, 150 Hopper Avenue, Waldwick, NJ 07463.
L. Greg Ferrone: Director of the Fund. Mr. Ferrone is a consultant with
IntraNet, Inc., a provider of computer systems to the domestic and international
banking industry. Previously he was the Director of Sales & Marketing for RAV
Communications Inc., Vice President/Regional Manager with National Westminster
Bank USA and an officer at Security Pacific Bank. Mr. Ferrone received a
Bachelor of Science degree from Rensselaer Polytechnic Institute in 1972 and
studied at the Stonier Graduate School of Banking. Mr. Ferrone's address is 83
Ronald Court, Ramsey, New Jersey 07446.
*Vincent J. Malanga: Chairman of the Board, Chief Executive Officer,
President and Treasurer of the Fund, The California Muni Fund and Fundamental
Fixed Income Fund. Mr. Malanga is President, Treasurer and a Director of
Fundamental Portfolio Advisors, Inc., Executive Vice President, Secretary and a
Director of Fundamental Service Corporation, and President, LaSalle Economics
Inc., an economic consulting firm. Mr. Malanga is a managing director and a 50%
shareholder of LaSalle Portfolio Management, Inc., a commodity trading adviser.
Prior thereto, he was a Vice President and Senior Economist at A. Gary Shilling
& Company, Inc., an economic consulting and brokerage firm. He previously served
as an Economist at White, Weld & Co. (an investment banking and brokerage firm)
and so served from 1976 to 1978. Prior thereto, Mr. Malanga, who holds a Ph.D.
in Economics from Fordham University, was an Economist at the Federal Reserve
Bank of New York. Mr. Malanga's address is 90 Washington Street, 19th Floor, New
York, New York 10006.
David P. Wieder: Vice President of the Fund, Secretary of Fundamental
Portfolio Advisors, Inc., and President and a Director of Fundamental
Shareholder Services, Inc.Mr. Wieder holds a Bachelor of Science degree in
Economics from Cornell University. Mr. Wieder's address is 90 Washington Street,
19th Floor, New York, New York 10006.
Carole M. Laible: Secretary of the Fund. Treasurer and Secretary of
Fundamental Shareholder Services, Inc.She was formerly a General Service Manager
for McGladrey & Pullen. Ms. Laible received a Bachelor of Science degree in
Accounting from St. John's University in 1985. Ms. Laible's address is 90
Washington Street, 19th Floor, New York, New York 10006.
All of the Directors of the Fund are also Trustees of The California
Muni Fund and Fundamental Fixed-Income Fund. All of the officers of the Fund
hold similar offices with The California Muni Fund and Fundamental Fixed-Income
Fund.
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<PAGE>
For services and attendance at board meetings and meetings of
committees which are common to the Fund, Fundamental Fixed-Income Fund and The
California Muni Fund (other affiliated mutual funds for which the Fund's
investment manager acts as the investment adviser), each Director of the Fund
who is not affiliated with the Fund's investment manager is compensated at the
rate of $6,500 per quarter prorated among the three funds based on their
respective net assets at the end of each quarter. Each such Director is also
reimbursed by the three funds, on the same basis, for actual out-of-pocket
expenses relating to his attendance at meetings. Some Directors received
additional compensation at a rate of $125 per hour for services related to
servicing on the Portfolio Review Committee. For the fiscal year ended December
31, 1996, Directors' fees totalling $56,296 were paid by the Fund to the
Directors as a group. As of the date of this Statement of Additional
Information, Directors and officers of the Fund as a group owned beneficially
less than 1% of the Fund's outstanding shares.
COMPENSATION TABLE
(FOR EACH CURRENT BOARD MEMBER
RECEIVING COMPENSATION FROM
A FUNDAMENTAL FUND FOR THE
MOST RECENTLY COMPLETED FISCAL YEAR)
AGGREGATE COMPENSATION FROM FUND
<TABLE>
<CAPTION>
AGGREGATE
COMPENSATION
PAID BY ALL
FUNDS MANAGED
BY
HIGH-YIELD TAX-FREE U.S. GOV'T FUNDAMENTAL
CALIFORNIA MUNICIPAL MONEY STRATEGIC PORTFOLIO
NAME NY MUNI MUNI BOND MARKET INCOME ADVISERS, INC.
<S> <C> <C> <C> <C> <C> <C>
JAMES C. ARMSTRONG $15,950 $5,394 $151 $10,804 $1,700 $34,000
JAMES A. BOWERS 15,950 5,394 151 10,804 1,700 34,000
CLARK L. BULLOCK 12,198 4,125 116 8,262 1,300 26,000
L. GREG FERRONE 12,198 4,125 116 8,262 1,300 26,000
</TABLE>
Pursuant to the terms of an assurance of discontinuance (the
"assurance") entered into with the Department of Law of the State of New York,
the Fund has established and will maintain for a period of at least five years
from April 15, 1994, a Portfolio
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<PAGE>
PORTFOLIO REVIEW COMMITTEE
Review Committee of its Board of Directors, consisting of no fewer than three
independent directors. All of the Independent Directors currently serve on the
Portfolio Review Committee.
The Portfolio Review Committee oversees the Fund's (i) investment
performance and strategies; (ii) the adequacy of internal controls and
procedures applicable to portfolio personnel and activity; (iii) the amendment,
as they may deem necessary in the exercise of their duties, of the Fund's
Prospectus; and (iv) compliance with investment policies stated in the Fund's
Prospectus, with such other policies as the Board of Directors may from time to
time establish, and with all applicable laws, rules and regulations. The
Portfolio Review Committee also reviews all annual and semi-annual reports prior
to their dissemination to shareholders.
The Portfolio Review Committee is required to keep a record of its
meetings and has the authority to retain such expert (legal, financial or
accounting) assistance as the Committee in its sole discretion deems necessary
in the exercise of their duties. Fundamental Service Corporation has designated
a Compliance Officer who has day-to-day responsibility for the Fund's compliance
with applicable Federal and state laws, rules and regulations, the assurance
entered into with the Department of Law of the State of New York, and the rules,
policies and by- laws of the National Association of Securities Dealers, Inc.,
particularly as they pertain to sales materials. The Compliance Officer also
assists the work of the Portfolio Review Committee.
INVESTMENT MANAGEMENT
As discussed in the Fund's Prospectus, a Management Agreement (the
"Agreement") between the Company, on behalf of the Fund, and Fundamental
Portfolio Advisors, Inc.(the "Manager"), was adopted by the Board of Directors
of the Fund on October 3, 1990, and was approved by shareholders on November 29,
1990. Vincent J. Malanga, Chairman of the Board, Chief Executive Officer,
President and Treasurer of the Fund, and Dr. Lance M. Brofman, each own
approximately 48.5% of the outstanding shares of the voting capital stock of the
Manager.
The Manager has agreed that it will notify the Fund's Board of
Directors before engaging any new clients of material significance; that, if
requested, each Director will receive a weekly portfolio transaction statement
from the Manager in order to review all trades made by the Manager; and that if
at any time three or more Directors who are "non-interested persons" of the Fund
desire to purchase or sell any security for or of the Fund, the Manager, at the
direction of the "non-interested" Directors, will immediately purchase or sell
such security, as the case may be, at the expense and risk of the Fund.
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<PAGE>
TRANSFER AGENT
Fundamental Shareholder Services, Inc., P.O. Box 1013, Bowling Green
Station, New York, New York 10274-1013, an affiliate of Fundamental Portfolio
Advisors, Inc.and Fundamental Service Corporation, performs all services in
connection with the transfer of shares of the Fund, acts as its dividend
disbursing agent, and as administrator of the exchange, check redemption,
telephone redemption and expedited redemption privileges of the Fund pursuant to
a Transfer Agency and Service Agreement dated as of February 1, 1990. During the
fiscal year ended December 31, 1996, fees paid to the Transfer Agent by the Fund
amounted to $360,306.
DISTRIBUTION PLAN
The Board of Directors and shareholders of the Fund have approved a
plan of distribution under Rule 12b-1 of the 1940 Act (the "Plan"). Pursuant to
the Plan, the Fund may pay certain promotional and advertising expenses and may
compensate certain registered securities dealers and financial institutions for
services provided in connection with the processing of orders for purchase or
redemption of the shares of the Fund and furnishing other shareholder services.
Payments by the Fund shall not in the aggregate in any fiscal year of the Fund
exceed 1/2 of 1% of daily net assets of the Fund. The Fund may enter into
shareholder processing and service agreements (the "Shareholder Service
Agreements") with any securities dealer who is registered under the Securities
Exchange Act of 1934 and a member in good standing of the National Association
of Securities Dealers, Inc., and with banks and other financial institutions,
who may wish to establish accounts or sub-accounts on behalf of their customers
("Shareholder Service Agents"). For processing investor purchase and redemption
orders, responding to inquiries from Fund shareholders concerning the status of
their accounts and operations of the Fund and communicating with the Fund, the
Fund may pay each such Shareholder Service Agent to cover expenditures for
advertising, sales literature and other promotional materials on behalf of the
Fund.
The fees payable to Shareholder Service Agents under Shareholder
Service Agreements will be negotiated by the Fund's management. The Fund's
management will report quarterly to the Board of Directors on the rate to be
paid under each such agreement and the amounts paid or payable under such
agreements. It will be based upon the management's analysis of (1) the
contribution that the Shareholder Service Agent makes to the Fund by increasing
Fund assets and reducing expense ratios; (2) the nature, quality and scope of
services being provided by the Shareholder Service Agent; (3) the cost to the
Fund if shareholder services were provided directly by the Fund or other
authorized persons; (4) the costs incurred by the Shareholder Servicing Agent in
connection with
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providing services to shareholders; and (5) the need to respond to competitive
offers of others which could result in assets being withdrawn from the Fund and
an increase in the expense ratio for the Fund.
The Board of Directors of the Fund, including a majority of the
"disinterested" Directors who have no direct or indirect financial interest in
the operation of the Plan or any agreements relating thereto, authorized the
Fund to enter into an agreement with Fundamental Service Corporation, a Delaware
corporation, under the Plan. The agreement provides that the Fund may pay the
usual and customary agency's commission to Fundamental Service Corporation for
producing and placing Fund advertising in newspapers, magazines or other
periodicals, on radio or television, or in direct marketing campaigns. In
addition to the foregoing, the Fund may pay Fundamental Service Corporation for
marketing research and promotional services specifically relating to the
distribution of Fund shares, including office space, facilities and equipment,
salaries, training and administrative expenses, computer systems and software,
communications, supplies, photocopying and similar types of expenses. The
following persons own of record 5% or more of the outstanding shares of voting
stock of Fundamental Service Corporation: Mr. Vincent J. Malanga (43.71%); Mr.
Thomas W. Buckingham (43.71%); and Dr. Lance M. Brofman (9.90%).
The Plan will continue in effect until December 31, 1996. The Plan will
continue in effect from year to year if specifically approved at least annually
by the Board of Directors and the affirmative vote of a majority of the
Directors who are not parties to any Shareholder Service Agreement or
"interested persons" of any such party by votes cast in person at a meeting
called for such purpose. In approving the Plan, the Directors determined, in the
exercise of their business judgment and in light of their fiduciary duties as
Directors of the Fund, that there was a reasonable likelihood that the Plan
would benefit the Fund and its shareholders. The Plan may only be renewed if the
Directors make a similar determination for each subsequent year. The Plan may
not be amended to increase the maximum amount of payments by the Fund to its
Shareholder Service Agents without shareholder approval, and all material
amendments to the provisions of the Plan must be approved by a vote of the Board
of Directors and of the Directors who have no direct or indirect interest in the
Plan, cast in person at a meeting called for the purpose of such vote.
The Plan provides that the Fund's management shall provide, and that
the independent Directors shall review, quarterly reports setting forth the
amounts expended pursuant to the Plan and the purpose for which the amounts were
expended. It further provides that while the Plan is in effect, the selection
and nomination of those Directors of the Fund who are not "interested persons"
of the Fund is committed to the discretion of the
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independent Directors.
During the year ended December 31, 1996, the Fund paid $719,350 for
expenses incurred pursuant to the Plan, which amount was spent in the
distribution of the Fund's shares, including expenses for: advertising --
$169,974; printing and mailing of Prospectuses to other than current
shareholders -- $23,467; and sales, and shareholder servicing support services
and other distribution services, -- $525,909. Of the amount paid by the Fund
during last year, $384,123 was paid to Fundamental Service Corporation for
expenses incurred and services rendered by it pursuant to the Plan.
CALCULATION OF YIELD
The Fund's yield quotations and average annual total return quotations
as they may appear in the Prospectus, this Statement of Additional Information
or in advertising and sales material, are calculated by standard methods
prescribed by the Securities and Exchange Commission.
The Fund's yield is computed by dividing the Fund's net investment
income per share during a base period of 30 days, or one month, by the net asset
value per share of the Fund on the last day of such base period in accordance
with the following formula:
a-b
Yield = 2[(----+1)^6 -1]
cd
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of
reimbursements)
c = the average daily number of shares outstanding
during the period that were entitled to receive
dividends.
d = the maximum offering price per share on the last
day of the period.
For purposes of calculating interest earned on debt obligations as provided in
item "a" above:
1. The yield to maturity of each obligation held by the Fund is
computed based on the market value of the obligation (including actual accrued
interest, if any) at the close of business on the last day of each month, or,
with respect to obligations purchased during the month, the purchase price (plus
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actual accrued interest, if any).
2. The yield to maturity of each obligation is then divided by 360 and
the resulting quotient is multiplied by the market value of the obligation
(including actual accrued interest, if any) to determine the interest income on
the obligation for each day of the subsequent month that the obligation is in
the portfolio. For these purposes, it is assumed that each month has 30 days.
3. Interest earned on all debt obligations during the 30-day or
one-month period is then totaled.
4. The maturity of an obligation with a call provision(s) is the next
call date on which the obligation reasonably may be expected to be called or, if
none, the maturity date.
5. In the case of a tax-exempt obligation issued without original issue
discount and having a current market discount, the coupon rate of interest of
the obligation is used in lieu of yield to maturity to determine interest income
earned on the obligation.
In the case of a tax-exempt obligation with original issue discount where the
discount based on the current market value of the obligation exceeds the then
remaining portion of original issue discount (i.e. market discount), the yield
to maturity used to determine interest income earned on the obligation is the
imputed rate based on the original issue discount calculation. In the case of a
tax-exempt obligation with original issue discount where the discount based on
the current market value of the obligation is less than the then remaining
portion of the original issue discount (market premium), the yield to maturity
used to determine interest income earned on the obligation is based on the
market value of the obligation.
With respect to the treatment of discount and premium on mortgage or
other receivables-backed obligations which are expected to be subject to monthly
payments of principal and interest ("pay downs"), the Fund accounts for gain or
loss attributable to actual monthly pay downs as an increase or decrease to
interest income during the period. In addition, the Fund may elect (1) to
amortize the discount or premium on a remaining security, based on the cost of
the security, to the weighted average maturity date, if such information is
available, or to the remaining term of the security, if the weighted average
maturity date is not available, or (2) not to amortize the discount or premium
on a remaining security.
For the purposes of computing yield, dividend income is recognized by
accruing 1/360 of the stated dividend rate of each
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obligation in the Fund's portfolio each day that the obligation is in the
portfolio. The Fund does not use equalization accounting in the calculation of
yield. Expenses accrued during any base period, if any, pursuant to the Plan are
included among the expenses accrued during the base period. Any reimbursement
accrued pursuant to the Plan during a base period, if any, will reduce expenses
accrued pursuant to such plan, but only to the extent the reimbursement does not
exceed the accrued expenses for the base period.
The Fund's yield for the one-month period ended December 31, 1996
determined in accordance with the above formula was 3.51%.
Average annual total return quotations are computed by finding the
average annual compounded rates of return that would cause a hypothetical
investment made on the first day of a designated period (assuming all dividends
and distributions are reinvested) to equal the ending redeemable value of such
hypothetical investment on the last day of the designated period in accordance
with the following formula:
^n
P(1+T) = ERV
Where: P = a hypothetical initial payment of $1000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical
$1000 payment made at the end of a designated
period (or fractional portion thereof)
For purposes of the above computation, it is assumed that all dividends and
distributions made by the Fund are reinvested at net asset value during the
designated period. The average annual total return quotation is determined to
the nearest 1/100 of 1%. The average annual total return for the year ended
December 31, 1996 was - 7.73%. For the five-year period ended December 31, 1996,
the average annual total return was 1.34% and for the ten year period ended
December 31, 1995, the average annual total return was 3.29%.
In determining the average annual total return (calculated as provided
above), recurring fees, if any, that are charged to all shareholder accounts are
taken into consideration. For any account fees that vary with the size of the
account, the account fee used for purposes of the above computation is assumed
to be the fee that would be charged to the Fund's mean account size.
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The Fund may also from time to time advertise its taxable equivalent
yield. The Fund's taxable equivalent yield is determined by dividing that
portion of the Fund's yield (calculated as described above) that is tax-exempt
by one minus the stated marginal Federal income tax rate and adding the product
to that portion, if any, of the yield of the Fund that is not tax-exempt. The
taxable equivalent yield of the Fund for the one-month period ended December 31,
1996 was 6.57% for a taxpayer whose income was subject to the then highest
combined Federal, New York State and New York City income tax rate of 46.60%.
The Fund's yield and average annual total return will vary from time to
time depending on market conditions, the composition of the Fund's portfolio and
operating expenses of the Fund. These factors and possible differences in the
methods used in calculating yields and returns should be considered when
comparing performance information regarding the Fund to information published
for other investment companies and other investment vehicles. Yields and return
quotations should also be considered relative to changes in the value of the
Fund's shares and the risks associated with the Fund's investment objectives and
policies. At any time in the future, yields and return quotations may be higher
or lower than past yields or return quotations and there can be no assurance
that any historical yield or return quotation will continue in the future.
CUSTODIAN AND INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS
The Chase Manhattan Bank, N.A. (the "Bank"), 114 West 47th Street, New
York, New York, acts as Custodian of the Fund's cash and securities. The Bank
also acts as bookkeeping agent for the Fund, and in that capacity, monitors the
Fund's accounting records and calculates its net asset value.
McGladrey & Pullen, LLP, 555 Fifth Avenue, New York, New York, acts as
independent certified public accountants for the Fund, performing an annual
audit of the Fund's financial statements and preparing its tax returns.
TAX MATTERS
The following is only a summary of certain additional tax
considerations generally affecting the Fund and its shareholders that are not
described in the Prospectus. No attempt is made to present a detailed
explanation of the tax treatment of the Fund or its shareholders, and the
discussions here and in the Prospectus are not intended as substitutes for
careful tax planning.
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Qualification as a Regulated Investment Company
The Fund has elected to be taxed as a regulated investment company for
federal income tax purposes under Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code"). As a regulated investment company, the Fund is
not subject to federal income tax on the portion of its net investment income
(i.e., taxable interest, dividends and other taxable ordinary income, net of
expenses) and capital gain net income (i.e., the excess of capital gains over
capital losses) that it distributes to shareholders, provided that it
distributes at least 90% of its investment company taxable income (i.e., net
investment income and the excess of net short-term capital gain over net
long-term capital loss) and at least 90% of its tax-exempt income (net of
expenses allocable thereto) for the taxable year (the "Distribution
Requirement"), and satisfies certain other requirements of the Code that are
described below. Distributions by the Fund made during the taxable year or,
under specified circumstances, within twelve months after the close of the
taxable year, will be considered distributions of income and gains of the
taxable year and will therefore satisfy the Distribution Requirement.
If the Fund has a net capital loss (i.e., the excess of capital losses
over capital gains) for any year, the amount thereof may be carried forward up
to eight years and treated as a short-term capital loss which can be used to
offset capital gains in such years. As of December 31, 1996, the Fund has
capital loss carryforwards of $20,655,000 expiring through December 31, 2004.
Under Code Section 382, if the Fund has an "ownership change," ten the Fund's
use of its capital loss carryforwards in any year following the ownership change
will be limited to an amount equal to the net asset value of the Fund
immediately prior to the ownership change multiplied by the highest adjusted
long- term tax-exempt rate (which is published monthly by the Internal Revenue
Service (the "IRS"))in effect for any month in the 3- calendar-month period
ending with the calendar month in which the ownership change occurs (the highest
rate for the 3-month period ending in April, 1997 is 5.50%). The Fund will use
its best efforts to avoid having an ownership change. However, because of
circumstances which may be beyond the control of the Fund, there can be no
assurance that the Fund will not have, or has not already had, an ownership
change. If the Fund has or has had an ownership change, any capital gain net
income for any year following the ownership change in excess of the annual
limitation on the capital loss carryforwards will have to be distributed by the
Fund and will be taxable to shareholders as described under "Fund Distributions"
below.
In addition to satisfying the Distribution Requirement, a regulated
investment company must: (1) derive at least 90% of its gross income from
dividends, interest, certain payments with
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respect to securities loans, gains from the sale or other disposition of stock
or securities or foreign currencies (to the extent such currency gains are
directly related to the regulated investment company's principal business of
investing in stock or securities) and other income (including but not limited to
gains from options, futures or forward contracts) derived with respect to its
business of investing in such stock, securities or currencies (the "Income
Requirement"); and (2) derive less than 30% of its gross income (exclusive of
certain gains on designated hedging transactions that are offset by realized or
unrealized losses on offsetting positions) from the sale or other disposition of
stock, securities or foreign currencies (or options, futures or forward
contracts thereon) held for less than three months (the "Short Short Gain
Test"). For purposes of these calculations, gross income includes tax-exempt
income. However, foreign currency gains, including those derived from options,
futures and forwards, will not in any event be characterized as Short-Short Gain
if they are directly related to the regulated investment company's investments
in stock or securities (or options or futures thereon). Because of the
Short-Short Gain Test, the Fund may have to limit the sale of appreciated
securities that it has held for less than three months. However, the Short-Short
Gain Test will not prevent the Fund from disposing of investments at a loss,
since the recognition of a loss before the expiration of the three-month holding
period is disregarded for this purpose. Interest (including original issue
discount) received by the Fund at maturity or upon the disposition of a security
held for less than three months will not be treated as gross income derived from
the sale or other disposition of such security within the meaning of the
Short-Short Gain Test. However, income that is attributable to realized market
appreciation will be treated as gross income from such sale or other disposition
of securities for this purpose.
In general, gain or loss recognized by the Fund on the disposition of
an asset will be a capital gain or loss. However, gain recognized on the
disposition of a debt obligation (including municipal obligations) purchased by
the Fund at a market discount (generally, at a price less than its principal
amount) will be treated as ordinary income to the extent of the portion of the
market discount which accrued during the period of time the Fund held the debt
obligation.
In general, for purposes of determining whether capital gain or loss
recognized by the Fund on the disposition of an asset is long-term or
short-term, the holding period of the asset may be affected if (1) the asset is
used to close a "short sale" (which includes for certain purposes the
acquisition of a put option) or is substantially identical to another asset so
used or, (2) the asset is otherwise held by the Fund as part of a "straddle"
(which term generally excludes a situation where the asset is stock and the Fund
grants a qualified covered call option (which, among other things,
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<PAGE>
must not be deep-in-the- money) with respect thereto. However, for purposes of
the Short-Short Gain Test, the holding period of the asset disposed of may be
reduced only in the case of clause (1) above. In addition, the Fund may be
required to defer the recognition of a loss on the disposition of an asset held
as part of a straddle to the extent of any unrecognized gain on the offsetting
position.
Any gain recognized by the Fund on the lapse of, or any gain or loss
recognized by the Fund from a closing transaction with respect to, an option
written by the Fund will be treated as a short-term capital gain or loss. For
purposes of the Short- Short Gain Test, the holding period of an option written
by the Fund will commence on the date it is written and end on the date it
lapses or the date a closing transaction is entered into. Accordingly, the Fund
may be limited in its ability to write
options which expire within three months and to enter into closing transactions
at a gain within three months of the writing of options.
Certain transactions that may be engaged in by the Fund (such as
regulated futures contracts and options on futures contracts) will be subject to
special tax treatment as "Section 1256 contracts." Section 1256 contracts are
treated as if they are sold for their fair market value on the last business day
of the taxable year, even though a taxpayer's obligations (or rights) under such
contracts have not terminated (by delivery, exercise, entering into a closing
transaction or otherwise) as of such date. Any gain or loss recognized as a
consequence of the year- end deemed disposition of Section 1256 contracts is
taken into account for the taxable year together with any other gain or loss
that was previously recognized upon the termination of Section 1256 contracts
during that taxable year. Any capital gain or loss for the taxable year with
respect to Section 1256 contracts (including any capital gain or loss arising as
a consequence of the year-end deemed sale of such contracts) is generally
treated as 60% long-term capital gain or loss and 40% short-term capital gain or
loss. The Fund, however, may elect not to have this special tax treatment apply
to Section 1256 contracts that are part of a "mixed straddle" with other
investments of the Fund that are not Section 1256 contracts. Under Treasury
Regulations, deemed gains arising from Section 1256 contracts will be treated
for purposes of the Short-Short Gain Test as being derived from securities held
for not less than three months.
Treasury Regulations permit a regulated investment company, in
determining its investment company taxable income and net capital gain (i.e.,
the excess of net long-term capital gain over net short-term capital loss) for
any taxable year, to elect (unless it has made a taxable year election for
excise tax purposes as discussed below) to treat all or any part of any net
capital loss, any net long-term capital loss or any net foreign currency
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<PAGE>
loss incurred after October 31 as if it had been incurred in the succeeding
year.
In addition to satisfying the requirements described above, the Fund
must satisfy an asset diversification test in order to qualify as a regulated
investment company. Under this test, at the close of each quarter of the Fund's
taxable year, at least 50% of the value of the Fund's assets must consist of
cash and cash items, U.S. Government securities, securities of other regulated
investment companies, and securities of other issuers (as to each of which the
Fund has not invested more than 5% of the value of the Fund's total assets in
securities of such issuer and does not hold more than 10% of the outstanding
voting securities of
such issuer), and no more than 25% of the value of its total assets may be
invested in the securities of any one issuer (other than U.S. Government
securities and securities of other regulated investment companies), or in two or
more issuers which the Fund controls and which are engaged in the same or
similar trades or businesses. Generally, an option (call or put) with respect to
a security is treated as issued by the issuer of the security, not the issuer of
the option.
If for any taxable year the Fund does not qualify as a regulated
investment company, all of its taxable income (including its net capital gain)
will be subject to tax at regular corporate rates without any deduction for
distributions to shareholders, and such distributions will be taxable to the
shareholders as ordinary dividends to the extent of the Fund's current and
accumulated earnings and profits. Such distributions generally will be eligible
for the dividends-received deduction in the case of corporate shareholders.
Excise Tax on Regulated Investment Companies
A 4% non-deductible excise tax is imposed on a regulated investment
company that fails to distribute in each calendar year an amount equal to 98% of
ordinary taxable income for the calendar year and 98% of capital gain net income
for the one-year period ended on October 31 of such calendar year (or, at the
election of a regulated investment company having a taxable year ending November
30 or December 31, for its taxable year (a "taxable year election")).
(Tax-exempt interest on municipal obligations is not subject to the excise tax.)
The balance of such income must be distributed during the next calendar year.
For the foregoing purposes, a regulated investment company is treated as having
distributed any amount on which it is subject to income tax for any taxable year
ending in such calendar year.
For purposes of the excise tax, a regulated investment company shall:
(1) reduce its capital gain net income (but not below its net capital gain) by
the amount of any net ordinary loss
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for the calendar year; and (2) exclude foreign currency gains and losses
incurred after October 31 of any year (or after the end of its taxable year if
it has made a taxable year election) in determining the amount of ordinary
taxable income for the current calendar year (and, instead, include such gains
and losses in determining ordinary taxable income for the succeeding calendar
year).
The Fund intends to make sufficient distributions or deemed
distributions of its ordinary taxable income and capital gain net income prior
to the end of each calendar year to avoid liability for the excise tax. However,
investors should note that the Fund may in certain circumstances be required to
liquidate portfolio investments to make sufficient distributions to avoid excise
tax liability.
Fund Distributions
The Fund anticipates distributing substantially all of its investment
company taxable income for each taxable year. Such distributions will be taxable
to shareholders as ordinary income and treated as dividends for federal income
tax purposes, but will not qualify for the 70% dividends-received deduction for
corporate shareholders.
The Fund may either retain or distribute to shareholders its net
capital gain for each taxable year. The Fund currently intends to distribute any
such amounts. Net capital gain that is distributed and designated as a capital
gain dividend, will be taxable to shareholders as long-term capital gain,
regardless of the length of time the shareholder has held his shares or whether
such gain was recognized by the Fund prior to the date on which the shareholder
acquired his shares.
The Fund intends to qualify to pay exempt-interest dividends by
satisfying the requirement that at the close of each quarter of the Fund's
taxable year at least 50% of the Fund's total assets consists of tax-exempt
municipal obligations. Distributions from the Fund will constitute
exempt-interest dividends to the extent of the Fund's tax-exempt interest income
(net of expenses and amortized bond premium). Exempt-interest dividends
distributed to shareholders of the Fund are excluded by them from gross income
for federal income tax purposes. However, shareholders required to file federal
income tax returns will be required to report the receipt of exempt-interest
dividends on their returns. Moreover, while exempt-interest dividends are
excluded from gross income for federal income tax purposes, they may be subject
to alternative minimum tax ("AMT") in certain circumstances and may have other
collateral tax consequences discussed below. Distributions by the Fund of any
investment company taxable income or of any net capital gain will be taxable to
shareholders as discussed above.
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<PAGE>
AMT is imposed in addition to, but only to the extent it exceeds, the
regular tax and is -- computed at a maximum marginal rate of 28% for
noncorporate taxpayers and 20% for corporate taxpayers -- on the excess of the
taxpayer's alternative minimum taxable income ("AMTI") over an exemption amount.
Exempt interest dividends derived from certain "private activity"
municipal obligations issued after August 7, 1986 will generally constitute an
item of tax preference includable in AMTI for both corporate and noncorporate
taxpayers. In addition, exempt-interest dividends derived from all municipal
obligations, regardless of the date of issue, must be included in adjusted
current earnings, which are used in computing an additional corporate preference
item (i.e., 75% of the excess of a corporate taxpayer's adjusted current
earnings over its AMTI (determined without regard to this item and the AMT net
operating loss deduction)) includable in AMTI.
Exempt-interest dividends must be taken into account in computing the
portion, if any, of social security or railroad retirement benefits that must be
included in an individual shareholder's gross income and subject to federal
income tax. Further, a shareholder of the Fund is denied a deduction for
interest on indebtedness incurred or continued to purchase or carry shares of
the Fund. Moreover, a shareholder who is (or is related to) a "substantial user"
of a facility financed by industrial development bonds held by the Fund will
likely be subject to tax on dividends paid by the Fund which are derived from
interest on such bonds. Receipt of exempt-interest dividends may result in other
collateral federal income tax consequences to certain taxpayers, including
financial institutions, property and casualty insurance companies and foreign
corporations engaged in a trade or business in the United States. Prospective
investors should consult their own tax advisers as to such consequences.
Distributions by the Fund that do not constitute ordinary income
dividends, exempt-interest dividends or capital gain dividends will be treated
as a return of capital to the extent of (and in reduction of) the shareholder's
tax basis in his shares; any excess will be treated as gain from a sale of the
shares, as discussed below.
Distributions by the Fund will be treated in the manner described above
regardless of whether such distributions are paid in cash or reinvested in
additional shares of the Fund (or of another fund). Shareholders receiving a
distribution in the form of additional shares will be treated as receiving a
distribution in an amount equal to the fair market value of the shares received,
determined as of the reinvestment date. In addition, if the net asset value at
the time a shareholder purchases shares of the Fund reflects undistributed
income or gain, or unrealized appreciation in the value of assets held by the
Fund, a subsequent distribution of such amounts will be taxable to the
shareholder in the manner
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described above, although it economically constitutes a return of capital.
Ordinarily, shareholders are required to take distributions by the Fund
into account in the year in which they are made. However, dividends declared in
October, November or December of any year and payable to shareholders of record
on a specified date in such a month will be deemed to have been received by the
shareholders (and made by the Fund) on December 31 of such calendar year if such
dividends are actually paid in January of the following year. Shareholders will
be advised annually as to the U.S. federal income tax consequences of
distributions made (or deemed made) to them during the year.
The Fund will be required in certain cases to withhold and remit to the
U.S. Treasury 31% of ordinary income and capital gain dividends, and the
proceeds of redemption of shares, paid to any shareholder who (1) has provided
either an incorrect tax identification number or no number at all, (2) is
subject to backup withholding for failure to report the receipt of interest or
dividend income properly, or (3) has failed to certify to the Fund that it is
not subject to backup withholding or that it is an "exempt recipient" (such as a
corporation).
Sale or Redemption of Shares
A shareholder will recognize gain or loss on the sale or redemption of
shares of the Fund in an amount equal to the difference between the proceeds of
the sale or redemption and the shareholder's adjusted tax basis in the shares.
All or a portion of any loss so recognized may be disallowed if the shareholder
purchases other shares of the Fund within 30 days before or after the sale or
redemption. In general, any gain or loss arising from (or treated as arising
from) the sale or redemption of shares of the Fund will be considered capital
gain or loss and will be long-term capital gain or loss if the shares were held
for longer than one year. However, any capital loss arising from the sale or
redemption of shares held for six months or less will be disallowed to the
extent of the amount of exempt-interest dividends received on such shares and
(to the extent not disallowed) will be treated as a long-term capital loss to
the extent of the amount of capital gain dividends received on such shares. For
this purpose, the special holding period rules of Code Section 246(c)(3) and (4)
generally will apply in determining the holding period of shares. Long-term
capital gains of noncorporate taxpayers are currently taxed at a maximum rate
11.6% lower than the maximum rate applicable to ordinary income. Capital losses
in any year are deductible only to the extent of capital gains plus, in the case
of a noncorporate taxpayer, $3,000 of ordinary income.
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Foreign Shareholders
Taxation of a shareholder who, as to the United States, is a
nonresident alien individual, foreign trust or estate, foreign corporation, or
foreign partnership ("foreign shareholder"), depends on whether the income from
the Fund is "effectively connected" with a U.S. trade or business carried on by
such shareholder.
If the income from the Fund is not effectively connected with a U.S.
trade or business of a foreign shareholder, ordinary income paid to the
shareholder will be subject to U.S. withholding tax at the rate of 30% (or lower
applicable treaty rate) on the gross amount of the dividend. Such a foreign
shareholder would generally be exempt from U.S. federal income tax on gains
realized on the sale of shares of the Fund, capital gain dividends and
exempt-interest dividends, and amounts retained by the Fund that are designated
as undistributed capital gains.
If the income from the Fund is effectively connected with a U.S. trade
or business of a foreign shareholder, then ordinary income and capital gain
dividends received in respect of, and any gains realized on, the sale of shares
of the Fund will be subject to U.S. federal income tax at the rates applicable
to U.S. citizens or domestic corporations.
In the case of a foreign noncorporate shareholder, the Fund may be
required to withhold U.S. federal income tax at a rate of 31% on distributions
that are otherwise exempt from withholding (or taxable at a reduced treaty
rate), unless the shareholder furnishes the Fund with proper notification of its
foreign status.
The tax consequences to a foreign shareholder entitled to claim the
benefits of an applicable tax treaty may be different from those described
herein. Foreign shareholders are urged to consult their own tax advisers with
respect to the particular tax consequences to them of an investment in the Fund,
including the applicability of foreign taxes.
Effect of Future Legislation; Local Tax Considerations
The foregoing general discussion of U.S. federal income tax
consequences is based on the Code and Treasury Regulations issued thereunder as
in effect on the date of this Statement. Future legislative or administrative
changes or court decisions may significantly change the conclusions expressed
herein, perhaps with retroactive effect.
Rules of state and local taxation of ordinary income dividends,
exempt-interest dividends and capital gain dividends
- 43 -
<PAGE>
from regulated investment companies often differ from the rules for U.S. federal
income taxation described above. Shareholders are urged to consult their tax
advisers as to the consequences of these and other state and local tax rules
affecting investment in the Fund.
PORTFOLIO TRANSACTIONS
The Fund's management provides the Fund with investment advice and
recommendations for the purchase and sale of portfolio securities. Newly issued
securities are usually purchased from the issuer or an underwriter, at prices
including underwriting fees; other purchases and sales are usually placed with
those dealers from whom it appears that the best price or execution will be
obtained. All orders for the purchase and sale of portfolio securities are
placed by the Fund's management, subject to the general control of the Fund's
Directors. The Fund's management may sell portfolio securities prior to their
maturity if market conditions and other considerations indicate, in the opinion
of the Fund's management, that such sale would be advisable. In addition, the
Fund's management may engage in short-term trading when it believes it is
consistent with the Fund's investment objective. Also, a security may be sold
and another of comparable quality may be simultaneously purchased to take
advantage of what the Fund's management believes to be a temporary disparity in
the normal yield relationships of two securities. The frequency of portfolio
transactions -- the Fund's turnover rates -- will vary from year to year
depending upon market conditions. For the years ended December 31, 1995 and
1996, the Fund's annual rate of portfolio turnover was approximately 348% and
347%, respectively. Because a high turnover rate increases transaction costs and
the possibility of taxable short-term gains (see "Dividends and Tax Status" in
the Fund's Prospectus), the Fund's management weighs the added costs of
short-term investment against anticipated gains. The Fund's management is
generally responsible for the implementation, or supervision of the
implementation, of investment decisions, including the allocation of principal
business and portfolio brokerage, and the negotiation of commissions.
It is the Fund's policy to seek execution of its purchases and sales at
the most favorable prices through responsible broker-dealers and in agency
transactions, at competitive commission rates. When considering broker-dealers,
the Fund will take into account such factors as the price of the security, the
size and difficulty of the order, the rate of commission, if any, the
reliability, financial condition, integrity and general execution and
operational capabilities of competing broker-dealers, and the brokerage and
research services which they provide to the Fund's management.
The Board of Directors of the Fund is authorized to adopt
- 44 -
<PAGE>
a brokerage allocation policy pursuant to the Securities Exchange Act of 1934
which would permit the Fund to pay a broker-dealer which furnishes research
services a higher commission than that which might be charged by another
broker-dealer which does not furnish research services, or which furnishes
research services deemed to be of a lesser value, provided that such commission
is deemed reasonable in relation to the value of the brokerage and research
services provided by the broker-dealer.
Section 28(e)(3) of the Securities Exchange Act of 1934 defines
"Brokerage and Research Services" as including, among other things, advice as to
the value of securities, the advisability of investing in, purchasing or selling
securities, the availability of securities or purchasers or sellers of
securities, furnishing analyses and reports concerning issuers, industries,
securities, economic factors and trends, portfolio strategy and performance of
accounts, and offering securities transactions and performing functions
incidental thereto (such as clearance and settlement).
It is not the Fund's practice to allocate principal business or
brokerage on the basis of sales of Fund shares which may be made through brokers
or dealers, although broker-dealers effecting purchases of Fund shares for their
customers may participate in principal transactions of brokerage allocation as
described above.
The Fund pays LAS Investments, Inc.("LAS") commissions or fees for
effecting, or participating in the effectuation of (but not executing),
transactions in futures contracts and options thereon on behalf of the Fund
("Fund Futures and Options Transactions"). LAS is located at 190 South LaSalle
Street, Chicago, Illinois. Mr. Donald E. Newell is the chief executive officer
of LAS and the owner of all of its outstanding shares. Messrs. Malanga and
Newell are each executive officers and 50% shareholders of LaSalle Portfolio
Management, Inc. As a result of Mr. Newell's business relationship with Mr.
Malanga, certain procedures incorporating the standards of Rule 17e-1 of the
1940 Act govern the computation and review of all commissions paid and payable
to LAS. The procedures limit the commissions or fees received, or to be
received, by LAS for Fund Futures and Options Transactions to an amount which is
reasonable and fair compared to the commissions, fees or other remuneration
received by other introducing brokers in connection with comparable transactions
involving similar futures contracts or options on futures contracts, as the case
may be, being purchased or sold on a commodities exchange during a comparable
period of time. The Fund's independent Board Members determine no less
frequently than quarterly that all transactions with LAS during the quarter were
effected in compliance with such procedures.
Beginning in July 1990, all of the Fund's transactions
- 45 -
<PAGE>
in futures contracts and related options were effected through Sierra
Securities, Inc., a broker-dealer located at 190 South LaSalle Street, Chicago,
Illinois ("Sierra"). The total amount of commissions paid to Sierra as
introducing broker on such transactions for the Fund's account during the years
1990 through 1995 and during January of 1996 was $11,298. The Manager has
represented that during such period, it believes that Mr. Donald Newell was a
minority shareholder of Sierra. As a result of Mr. Newell's business
relationship with Mr. Malanga (see discussion above), all of the futures and
options transactions Sierra performed on behalf of the Fund may have been
subject to certain standards comparable to those set forth in Rule 17e-1 of the
1940 Act (the "Rule"). On February 1, 1996, the Manager commenced using LAS as
its introducing broker for Fund transactions in futures contracts and related
options in place of Sierra. At a meeting held on May 2, 1996, the Fund's Board
of Directors, including a majority of the independent Directors, adopted new
standards and procedures for the Fund comparable to those set forth in the Rule
for transactions in futures contracts and related options through LAS, an
affiliated broker-dealer. See above discussion pertaining to LAS.
From January 1, 1990 to January 31, 1996, the Manager directed
syndicate designations in the aggregate dollar amount of $858,094 to Capital
Institutional Services, Inc. ("CIS") in connection with the Fundamental Funds'
bond purchases through underwriting syndicates. The Manager has represented that
CIS, a third-party research provider, at the Manager's direction, paid portions
of such syndicate designations to approximately 30 different firms that provided
research services used by the Manager in managing the Fundamental Funds,
including Capital Market Services, Inc. ("CMS"). Further, that CMS was paid by
CIS $115,000 for research provided to the Manager. The $115,000 dollar amount
paid by CIS to CMS for the following fiscal years of the Fund was: $35,000 in
1995; $55,000 in 1994; and $25,000 in 1993. The Manager has also represented
that it learned in 1996 that at all times during the years 1993, 1994 and 1995,
CMS was 100% owned by Mr. Donald E. Newell's wife. Mr. Vincent J. Malanga and
Mr. Donald E. Newell are each executive officers and 50% shareholders of LaSalle
Portfolio Management, Inc. In order to remove any appearance of impropriety
concerning all of the payments made by CIS to CMS in return for research the
Manager obtained from CMS, the Manager reimbursed Fundamental U. S. Government
Strategic Income Fund (the beneficiary of the research) $115,000 out of its own
resources.
OTHER INFORMATION
As of March 31, 1997, the Directors and Officers of the Fund as a group
beneficially owned less than 1% of the outstanding shares of the Fund. As of
such date, no persons were known by Fund management to have owned beneficially,
directly or indirectly, 5%
- 46 -
<PAGE>
or more of the outstanding shares of the Fund.
FINANCIAL STATEMENTS
Audited financial statements of the Fund for the year ended December
31, 1996 are attached hereto.
- 47 -
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1996
- --------------------------------------------------------------------------------
ASSETS
Investment in securities at value
(Note 4) (cost $215,662,677) ...................... $205,380,685
Receivables:
Interest .......................................... 3,808,422
Investment securities sold ........................ 16,494,369
-------------
Total assets .......................... 225,683,476
-------------
LIABILITIES
Notes payable (Note 6) ............................... 1,200,000
Payables:
Investment securities purchased ................... 26,425,838
Bank overdraft payable ............................ 131,343
Dividend declared ................................. 396,856
Accrued expenses .................................. 783,646
-------------
Total liabilities ..................... 28,937,683
-------------
NET ASSETS consisting of:
Accumulated net realized loss ............ $(21,892,882)
Unrealized depreciation of
securities ............................ (10,281,992)
Paid-in-capital applicable to
225,957,736 shares of $.01
par value capital stock ............... 228,920,667
-------------
$196,745,793
=============
NET ASSET VALUE PER SHARE ............................... $.87
====
STATEMENT OF OPERATIONS
Year ended December 31, 1996
- --------------------------------------------------------------------------------
INVESTMENT INCOME
Interest income ...................................... $12,274,611
EXPENSES (Notes 2 and 3)
Management fee ........................... $787,962
Custodian and accounting fees ............ 119,035
Transfer agent fees ...................... 360,306
Professional fees ........................ 299,015
Directors' fees .......................... 52,370
Printing and postage ..................... 11,194
Interest ................................. 3,366,228
Distribution expenses .................... 719,350
Operating expenses on
defaulted bonds ........................ 240,629
Other .................................... 89,055
------------
Total expenses ................................. 6,045,144
------------
Net investment income .......................... 6,229,467
------------
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized loss on:
Investments ............................. (2,404,362)
Net unrealized depreciation of
investments ............................ (4,292,643)
------------
Net loss on investments .............................. (6,697,005)
------------
NET DECREASE IN NET ASSETS
FROM OPERATIONS ....................................... $(467,538)
============
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, December 31,
1996 1995
------------ ------------
INCREASE (DECREASE) IN NET ASSETS FROM
OPERATIONS
<S> <C> <C>
Net investment income .................................................... $6,229,467 $6,873,684
-------------
Net realized (loss) gain on investments and futures contracts ......... (2,404,362) 2,451,958
Net realized (loss) on option contracts written ....................... -- (73,794)
Unrealized (depreciation) appreciation on investments ................. (4,292,643) 25,287,298
------------- -------------
Net (decrease) increase in net assets from operations .......... (467,538) 34,539,146
DIVIDENDS PAID TO SHAREHOLDERS FROM:
Investment income ..................................................... (6,229,467) (6,873,684)
Net realized gain from investments .................................... -- (112,509)
CAPITAL SHARE TRANSACTIONS (Note 5) ................................... (23,248,833) (13,526,231)
------------- -------------
Total (decrease) increase ...................................... (29,945,838) 14,026,722
NET ASSETS:
Beginning of year ..................................................... 226,691,631 212,664,909
------------- -------------
End of year ........................................................... $196,745,793 $226,691,631
============= =============
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF CASH FLOWS
Year Ended December 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Increase (Decrease) in Cash
Cash Flows From Operating Activities
Net decrease to net assets from operations ........................ $(467,538)
Adjustments to reconcile net increase in net assets from operations
to net cash provided by operating activities:
Purchase of investment securities .............................. (957,246,583)
Proceeds on sale of securities ................................. 963,017,568
Decrease in interest receivable ................................ 200,589
Decrease in accrued expenses ................................... (38,111)
Net accretion of discount on securities ........................ (174,768)
Net realized gain:
Investments ................................................. 2,404,362
Unrealized depreciation on securities .......................... 4,292,643
---------------
Net cash provided by operating activities ................... 11,988,162
---------------
Cash Flows From Financing Activities:*
Net payments on notes payable .................................. (63,375,000)
Net borrowings of note payable ................................. 131,343
Proceeds on shares sold ........................................ 3,394,647,202
Payment on shares repurchased .................................. (3,342,817,867)
Cash dividends paid ............................................ (982,880)
---------------
Net cash used in financing activities ....................... (12,397,202)
---------------
Net decrease in cash ........................................ (409,040)
Cash at beginning of year ............................................ 409,040
---------------
Cash at end of year .................................................. $0
===============
</TABLE>
- --------------
*Non-cash financing activities not included herein consist of reinvestment of
dividends of $4,939,206.
Cash payments for interest expense totaled $3,394,366.
See Notes to Financial Statements.
5
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF INVESTMENTS
December 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Principal
Amount Issue ooo Type o Rating oo Value
------ --------- ------ --------- -----
<S> <C> <C> <C> <C>
$ 1,980,000++ Cayuga County, HIC, COP, Auburn Memorial Hospital, Asset Guaranty Insured,
6.00%, 1/1/21 ................................................................... FCLT AAA $ 2,008,849
2,050,000++ Franklin County, SWMA, Solid Waste System Project, RB, 6.25%, 6/1/15 .............. FCLT BBB- 2,057,831
1,080,000++ Glen Cove, IDA, CFR, The Regency at Glen Cove Project, AMBAC Insured, ETM,
CAB, 10/15/19 ................................................................... FCLT AAA 280,757
1,880,000++ Lyons, MCF, Initiatives Corporation Project, RB, 6.80%, 9/1/24 .................... FCLT BAA+ 1,997,406
2,000,000 Municipal Assistance Corporation for the City of Troy, General Resolution Bonds,
MBIA Insured, CAB, 1/15/21 ...................................................... FCLT AAA 517,940
11,870,000++x New York City, GO, IFRN*, 7.50%, 8/15/10 .......................................... INLT A 11,870,000
18,330,000++x New York City, GO, IFRN*, 5.21%, 8/1/12 ........................................... INLT A- 17,124,253
13,640,000++ New York City, GO, IFRN*, 5.21%, 8/1/14 ........................................... INLT A- 13,640,000
14,600,000++x New York City, GO, IFRN*, 4.15%, 8/15/17 .......................................... INLT A- 14,618,250
5,290,000++x New York City, ECF, MBIA Insured, STEP** 5.50%, 4/1/08 ............................ FCSI AAA 5,304,706
5,925,000++x New York City, ECF, MBIA Insured, STEP** 5.50%, 10/1/08 ........................... FCSI AAA 5,941,471
9,520,000++ New York City, Health & Hospital Corp, RB, Series A, 6.30%, 2/15/20 ............... FCLT BBB 9,542,182
2,975,000++ New York City, Health & Hospital Corp, RB, Series A, AMBAC Insured,
5.75%, 2/15/22 .................................................................. FCLT AAA 2,978,600
2,200,000++x New York City, IDA, Imclone Systems Inc Project, AMT, 11.25%, 5/1/04 .............. FCSI NR 2,345,112
6,025,000++ New York City, Transportation Authority, RB, Livingston Plaza Project,
FSA Insured, 5.25%, 1/1/20 ...................................................... FCLT AAA 5,716,881
2,113,000++x New York City, IDA, Imclone Systems Inc Project, AMT, 10.75%, 2/15/97 ............. FCSI NR 2,113,824
7,000,000++ New York State, DAR, NHRB, LOC Chemical Bank, 5.75%, 7/1/17 ....................... FCLT AA- 7,049,350
1,125,000 New York State, DAR, German Masonic Home Corporation, FHA Insured,
6.00%, 8/1/36 ................................................................... FCLT AA 1,128,330
1,050,000 New York State, DAR, Amsterdam Memorial Hospital, FHA Insured,
Mortgage RB, 6.00%, 8/1/25 ...................................................... FCLT AAA 1,070,139
2,770,000 New York State, DAR, WK Nursing Home Corporation, FHA Insured,
Mortgage RB, 6.05%, 2/1/26 ...................................................... FCLT AAA 2,827,671
3,600,000 New York State, DAR, WK Nursing Home Corporation, FHA Insured,
Mortgage RB, 6.13%, 2/1/36 ...................................................... FCLT AA 3,674,664
1,000,000 New York State, DAR, Hospital for Special Surgery, FHA Insured, Mortgage RB,
Series 1996, 6.00%, 8/1/26 ...................................................... FCLT AA 1,017,480
425,000++ New York State, DAR, Hospital for Special Surgery, FHA Insured, Mortgage RB,
Series 1996, 6.05%, 8/1/36 ...................................................... FCLT AA 432,412
200,000++ New York State, DAR, City University System, Third General Resolution Bond,
6.20%, 7/1/22 ................................................................... FCLT A- 204,624
7,230,000++ New York State, DAR, Methodist Hospital, AMBAC Insured, FHA Insured,
Mortgage RB, 6.05%, 2/1/34 ...................................................... FCLT AAA 7,392,747
2,250,000++ New York State, DAR, Department of Health Veterans Home, 5.50%, 7/1/21 ............ FCLT A 2,134,170
6,000,000 New York State, DAR, Montefiore Medical Center, AMBAC Insured,
FHA Insured, 5.25%, 2/1/15 ...................................................... FCLT AAA 5,802,540
3,950,000 New York State, DAR, State University, Trust Custodial Receipts Connie Lee Insured,
5.40%, 5/15/23 .................................................................. FCLT AAA 3,753,013
4,755,000 New York State, DAR, Mental Health Services, Series 96-E, AMBAC Insured,
5.37%, 2/15/12 .................................................................. FCSI AAA 4,711,016
280,000++ New York State, EFC, State Water Pollution Control, RB, Pooled Loan Issue,
5.20%, 6/15/17 .................................................................. FCLT AAA 271,760
360,000++ New York State, EFC, State Water Pollution Control, RB, Pooled Loan Issue,
5.20%, 12/15/17 ................................................................. FCLT AAA 349,265
1,975,000++ New York State, HFA, RB, Fulton Manor, FHA Insured, 6.10%, 11/15/25 ............... FCLT AAA 1,999,806
2,500,000++ New York State, HFA, RB, Service Contract Obligation, Series 93-C, 5.88%, 9/15/14 . FCLT BBB 2,467,275
2,250,000++ New York State, HFA, RB, Service Contract Obligation, Series 93-D, 5.38%, 3/15/23 . FCLT BBB 2,052,675
650,000++ New York State, HFA, RB, Service Contract Obligation, Series 96-A, 6.00%, 3/15/26 . FCLT BBB 647,263
1,000,000++ New York State, MCFFA, Mental Health Services Facilities, 5.25%, 2/15/07 .......... FCSI BBB+ 989,890
1,000,000++ New York State, MCFFA, Mercy Medical Center, LOC Natwest Bank,
5.88%, 11/11/15 ................................................................. FCLT AA- 1,018,520
4,785,000 New York State, MCFFA, Mental Health Services Facilities, Trust Custodial Receipts
Connie Lee Insured, 5.25%, 8/15/23 .............................................. FCLT AAA 4,429,953
25,000,000++/x/ New York State Thruway Authority, FGIC Insured, IFRN*, 4.62%, 1/1/24 .............. LRIB AAA 25,000,000
</TABLE>
6
<PAGE>
NEW YORK MUNI FUND
STATEMENT OF INVESTMENTS (continued)
December 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Principal
Amount Issue ooo Type o Rating oo Value
------ --------- ------ --------- -----
<S> <C> <C> <C> <C>
4,000,000 New York State, UDC, RB, Correctional Capital Facilities, 5.70%, 1/1/27 ........... FCLT A $ 3,839,320
19,695,000+++x Niagara County IDA Bonds and Niagara Falls URABond; Falls Street Faire Project,
Falls Street Station Project, AMT10.00% 9/1/06, Old Falls Street Improvement
Project, 11.00% 5/1/09 (See Note 4 to financial statements) ..................... FCSI NR 8,397,267
3,400,000++ Onondaga County, IDA, Series A, Crouse Irving Project, LOC Fleet Bank,
7.90%, 1/1/17 ................................................................... FCLT A 3,851,826
4,170,000++ Onondaga County, IDA, Community General Hospital Project, 6.63%, 1/1/18 ........... FCLT BBB 4,289,721
325,000 Puerto Rico, Public Buildings Authority Guaranteed, Public Education & Health
Facilities, Step Coupon, 3.75%, 7/1/16 .......................................... FCLT A 300,349
1,595,000++ Puerto Rico, ITEMECF Financing Authority, Polytechnic University of Puerto Rico
Project, 5.70%, 8/1/13 .......................................................... FCLT BBB- 1,535,363
5,145,000++ Puerto Rico, ITEMCF Financing Authority, Polytechnic University of Puerto Rico
Project, 5.50%, 8/1/24 .......................................................... FCLT BBB- 4,684,214
------------
Total Investments (Cost $215,662,677@) ................................ $205,380,685
============
</TABLE>
* Inverse Floating Rate Notes (IFRN) are instruments whose interest rates bear
an inverse relationship to the interest rate on another security or the
value of an index. Rates shown are at December 31, 1996.
** Step Bonds (STEP) are instruments whose interest rate is fixed at an initial
rate and then increases ("steps up") to another fixed rate until maturity.
@ Cost for Federal income tax purposes is $215,671,028.
+ The value of these non-income producing securities has been estimated by
persons designated by the Fund's Board of Directors using methods the
Director's believe reflect fair value. See Note 4 to the financial
statements.
/x/The value of this security has been estimated by persons designated by the
Fund's Board of Directors using methods the Director's believe reflect
fair value. See Note 4 to the financial statements.
++ Approximately $172,308,270 market value of securities are segregated in
whole or in part as collateral securing a line of credit
x The Fund owns 100% of the security and therefore there is no trading in the
security. See Note 4 to the financial statements.
LEGEND
o Type FCLT --Fixed Coupon Long Term
FCSI --Fixed Coupon Short or Intermediate Term
LRIB --Residual Interest Bond Long Term
INLT --Indexed Inverse Floating Rate Bond Long Term
oo Ratings If a security has a split rating the highest applicable rating is
used, including published ratings on identical credits for
individual securities not individually rated.
NR--Not Rated
ooo Issue AMBAC American Municipal Bond Assurance Corporation
AMT Alternative Minimum Tax
CAB Capital Appreciation Bond
CFR Civic Facility Revenue
COP Certificates of Participation
DAR Dormitory Authority Revenue
ECF Educational Construction Fund
EFC Environmental Facilities Corp.
ETM Escrowed to Maturity
FGIC Financial Guaranty Insurance Corporation
FHA Federal Housing Administration
FSA Financial Security Association
GO General Obligation
HFA Housing Financing Agency
HIC Hospital Improvement Corporation
IDA Industrial Development Authority
ITEMECF Industrial, Tourist, Education, Medical and
Environmental Control Facilities
LOC Letter of Credit
MBIA Municipal Bond Insurance Assurance Corporation
MCF Medical Care Facilities
MCFFA Medical Care Facilities Finance Agency
MWFA Municipal Water Finance Authority
NHRB Nursing Home Revenue Bond
RB Revenue Bond
RDA Research and Development Authority
SWMA Solid Waste Management Authority
URA Urban Renewal Authority
See Notes to Financial Statements.
7
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS
December 31, 1996
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
New York Muni Fund (the Fund) is a series of Fundamental Funds, Inc. (the
"Company"). The Company is an open-end management investment company registered
under the Investment Company Act of 1940. The Fund seeks to provide a high level
of income that is excluded from gross income for Federal income tax purposes and
exempt from New York State and New York City personal income taxes. The Fund
intends to achieve its objective by investing substantially all of its total
assets in municipal obligations of New York State, its political subdivisions
and its duly constituted authorities and corporations. The Fund employs leverage
in attempting to achieve this objective. The following is a summary of
significant accounting policies followed in the preparation of its financial
statements:
Valuation of Securities--The Fund's portfolio securities are valued on
the basis of prices provided by an independent pricing service when, in the
opinion of persons designated by the Fund's directors, such prices are
believed to reflect the fair market value of such securities. Prices of
non-exchange traded portfolio securities provided by independent pricing
services are generally determined without regard to bid or last sale prices
but take into account institutional size trading in similar groups of
securities, yield, quality, coupon rate, maturity, type of issue, trading
characteristics and other market data. Securities traded or dealt in upon a
securities exchange and not subject to restrictions against resale as well
as options and futures contracts listed for trading on a securities
exchange or board of trade are valued at the last quoted sales price, or,
in the absence of a sale, at the mean of the last bid and asked prices.
Options not listed for trading on a securities exchange or board of trade
for which over-the-counter market quotations are readily available are
valued at the mean of the current bid and asked prices. Money market and
short-term debt instruments with a remaining maturity of 60 days or less
will be valued on an amortized cost basis. Municipal daily or weekly
variable rate demand instruments will be priced at par value plus accrued
interest. Securities not priced in a manner described above and other
assets are valued by persons designated by the Fund's directors using
methods which the directors believe reflect fair value.
Futures Contracts and Options Written on Future Contracts--Initial
margin deposits with respect to these contracts are maintained by the
Fund's custodian in segregated asset accounts. Subsequent changes in the
daily valuation of open contracts are recognized as unrealized gains or
losses. Variation margin payments are made or received as daily
appreciation or depreciation in the value of these contracts occurs.
Realized gains or losses are recorded when a contract is closed.
Options Written on Municipal Bonds--The Fund may write options on
municipal bonds. Premiums received for options written are recorded as a
liability and subsequently marked to market daily to reflect the current
value of the options written. If the written option expires unexercised,
the premium received is treated as realized gain. If the option is
exercised, the premium received is used to reduce the cost of the security
purchased or sold.
Federal Income Taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to "regulated
investment companies" and to distribute all of its taxable and tax exempt
income to its shareholders. Therefore, no provision for federal income tax
is required.
Distributions--The Fund declares dividends daily from its net
investment income and pays such dividends on the last business day of each
month. Distributions of net capital gains, if any, realized on sales of
investments are made annually, as declared by the Fund's Board of
Directors. Distributions are determined in accordance with income tax
regulations. Dividends are reinvested at the net asset value unless
shareholders request payment in cash.
General--Securities transactions are accounted for on a trade date
basis. Interest income is accrued as earned. Premiums and original issue
discount on securities purchased are amortized over the life of the
respective securities. Realized gains and losses from the sale of
securities are recorded on an identified cost basis. Net operating expenses
incurred on properties collateralizing defaulted bonds are charged to
operating expenses as incurred. Costs incurred to restructure defaulted
bonds are charged to realized losses as incurred.
Accounting Estimates--The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of increases and decreases in net assets from operations during the
reporting period. Actual results could differ from those estimates.
8
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1996
- --------------------------------------------------------------------------------
2. INVESTMENT ADVISORY FEES AND OTHER TRANSACTIONS WITH AFFILIATES
Under a Management Agreement, the Fund pays an investment management fee to
Fundamental Portfolio Advisors, Inc. (the Manager) equal to 0.5% of the Fund's
average daily net asset value up to $100 million and decreasing by .02% of each
$100 million increase in net assets down to 0.4% of net assets in excess of $500
million. The Manager is required to reimburse the Fund an amount not exceeding
the amount of fees payable to the Manager under the agreement for any fiscal
year, if, and to the extent that the aggregate operating expenses of the Fund
for any fiscal year including the fees payable to the Manager, but excluding
interest expenses, taxes, brokerage fees and commissions, expenses paid pursuant
to the Distribution Plan, and extraordinary expenses exceeds, on an annual
basis, 1.5% of the average daily net assets of the Fund. No such reimbursement
was required for the year ended December 31, 1996.
The Manager and the Fund's Directors are cooperating in an investigation
being conducted by the Securities and Exchange Commission concerning an
affiliated fund. The Commission's staff indicated an intention to recommend to
the Commission the commencement of certain proceedings.
Pursuant to a Distribution Plan (the Plan) adopted pursuant to Rule 12b-1
promulgated under the Investment Company Act of 1940, the Fund may pay certain
promotional and advertising expenses and may compensate certain registered
securities dealers and financial institutions for services provided in
connection with the processing of orders for purchase or redemption of the
Fund's shares and furnishing other shareholder services. Payments by the Fund
shall not in the aggregate, in any fiscal year, exceed 0.5% of the average daily
net assets of the Fund.
Under a distribution agreement with Fundamental Service Corporation (FSC),
an affiliate of the Manager, amounts are paid under the Plan to compensate FSC
for the services it provides and the expenses it bears in distributing the
Fund's shares to investors. Any cumulative distribution expenses related to the
Fund incurred by FSC in excess of the annual maximum amount payable by the Fund
under the Plan may be carried forward for three years in anticipation of
reimbursement by the Fund on a "first in-first out" basis. If the Plan is
terminated or discontinued in accordance with its terms, the obligation of the
Fund to make payments to FSC will cease and the Fund will not be required to
make payments past the termination date. Amounts paid to FSC pursuant to the
agreement totaled $384,123 for the year ended December 31, 1996.
The Fund compensates Fundamental Shareholder Services, Inc., an affiliate
of the manager, for the services it provides under a Transfer Agent and Service
Agreement. Transfer agent fees for the year ended December 31, 1996 are set
forth in the statement of operations.
3. DIRECTORS' FEES
All of the Directors of the Fund are also directors or trustees of two
other affiliated mutual funds for which the Manager acts as investment adviser.
For services and attendance at board meetings and meetings of committees which
are common to each Fund, each Director who is not affiliated with the Manager is
compensated at the rate of $6,500 per quarter pro rated among the funds based on
their respective average net assets.
4. COMPLEX SECURITIES, CONCENTRATIONS OF CREDIT RISK, AND INVESTMENT
TRANSACTIONS
INVERSE FLOATING RATE NOTES (IFRN):
The Fund invests in variable rate securities commonly called "inverse
floaters". The interest rates on these securities have an inverse relationship
to the interest rate of other securities or the value of an index. Changes in
interest rate on the other security or index inversely affect the rate paid on
the inverse floater, and the inverse floater's price will be more volatile than
that of a fixed-rate bond. Additionally, some of these securities contain a
"leverage factor"whereby the interest rate moves inversely by a "factor" to the
benchmark rate. For example, the rates on the inverse floating rate note may
move inversely at three times the benchmark rate. Certain interest rate
movements and other market factors can substantially affect the liquidity of
IFRN's.
CONCENTRATION OF CREDIT RISK AND TRANSACTIONS IN DEFAULTED BONDS:
The Fund owned 100% of two Niagara Falls Industrial Development Agency
bonds ("IDA Bonds") due to mature on September 1, 2006, and 98.3% of a Niagara
Falls New York Urban Renewal Agency 11% bond ("URA Bond") due to mature on May
1, 2009 which are in default. The IDA Bonds are secured by commercial retail and
office buildings known as the Falls Street Faire and Falls Street Station
Projects ("Projects"). The URA Bond is secured by certain rental payments from
the Projects.
9
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1996
- --------------------------------------------------------------------------------
The Fund, through its investment banker and manager, negotiated agreements
whereby the Fund received cash of $3,000,000 subsequent to December 31, 1996 and
executed an assumption agreement with the purchasers of the Falls Street Faire
and Station Projects. Under the assumption agreement the purchaser has agreed to
assume debt of $8,000,000 bearing interest at 10% per annum in exchange for the
Fall Street Faire Project. The assumption agreement provides for certain
interest and forbearance payments in accordance with the agreement's payment
schedule.
These securities are being valued under methods approved by the Board of
Directors. The aggregate value of these securities is $8,397,267 (42.64% to
their aggregate face value of $19,695,000). There is uncertainty as to the
timing of events and the subsequent ability of the Projects to generate cash
flows sufficient to provide repayment of the bonds. No interest income was
accrued on these bonds during the year ended December 31, 1996. Legal investment
banking, and other restructuring costs charged to realized loss totaled
approximately $294,000 for the year ended December 31, 1996 ($1,487,000
cumulatively from October 6, 1992 to December 31, 1996). The Fund through its
investment banker, engaged a manager to maintain the Projects on its behalf, and
the Fund is paying the net operating expenses of the Projects. Net operating
expenses related to the Projects for the year ended December 31, 1996 are
disclosed in the statement of operations, and cumulatively from October 6, 1992
to December 31, 1996 totaled approximately $612,629
Additionally, the Fund owns 100% of several securities as indicated in the
Statement of Investments. As a result of its ownership position there is no
active trading in these securities. Valuations of these securities are provided
by a pricing service and are believed by the Manager to reflect fair value. The
market value of securities owned 100% by the Fund was approximately $92,714,000
(47% of net assets) including the securities described in the previous paragraph
at December 31, 1996. With respect to securities owned 100% by the Fund, the
$25,000,000 New York State Thruway FGIC Insured, IFRN Bonds, in addition to the
$8,397,267 bonds described in the preceding paragraph, have been valued using
methods approved by the Board of Directos.
OTHER INVESTMENT TRANSACTIONS:
During the year ended December 31, 1996, purchases and sales of investment
securities, other than short-term obligations, were $735,241,325 and
$795,122,155 respectively.
As of December 31, 1996 net unrealized depreciation of portfolio securities
on a federal income tax basis amounted to $10,290,342 composed of unrealized
appreciation of $3,794,391 and unrealized depreciation of $14,084,733.
The Fund has capital loss carryforwards available to offset future capital
gains as follows:
Amount Expiration
------- ---------
$18,503,000 December 31, 2002
2,152,000 December 31, 2004
-----------
$20,655,000
===========
5. CAPITAL STOCK
As of December 31, 1996 there were 500,000,000 shares of $.01 par value
capital stock authorized. Transactions in capital stock were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1996 December 31, 1995
-------------------------- --------------------------
Shares Amount Shares Amount
------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Shares sold .................... 3,704,110,578 $3,314,430,819 3,269,945,429 $3,074,627,178
Shares issued on reinvestment
of dividends ................. 5,501,544 4,939,206 6,772,089 6,361,886
Shares redeemed ................ (3,714,943,217) (3,342,618,858) (3,287,552,791) (3,094,515,295)
------------ ------------ ------------- -------------
Net (decrease) ................. (5,331,095) $ (23,248,833) (10,835,273) $(13,526,231)
============ ============ ============= =============
</TABLE>
6. LINE OF CREDIT
The Fund has line of credit agreements with banks collateralized by cash
and portfolio securities. Borrowings under these agreements bear interest linked
to the banks' prime rate. Pursuant to these agreements $1,200,000 was
outstanding at December 31, 1996.
The maximum month end and the average borrowings outstanding during the
year ended December 31, 1996 were $90,000,000 and $49,448,000, respectively.
10
<PAGE>
NEW YORK MUNI FUND
NOTES TO FINANCIAL STATEMENTS (continued)
December 31, 1996
- --------------------------------------------------------------------------------
7. SELECTED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Year .................. $0.98 $0.88 $1.18 $1.21 $1.14
------ ------ ------ ------ ------
Income from investment operations:
Net investment income ............................... .035 .035 .056 .065 .061
Net realized and unrealized gains (losses)
on investments .................................... (.110) .101 (.290) .082 .070
------ ------ ------ ------ ------
Total from investment operations ........... (.075) .136 (.234) .147 .131
------ ------ ------ ------ ------
Less Distributions:
Dividends from net investment income ................ (.035) (.035) (.056) (.065) (.060)
Dividends from net realized gains ................... -- (.001) (.010) (.112) (.001)
------ ------ ------ ------ ------
Total distributions ........................ (.035) (.036) (.066) (.177) (.061)
------ ------ ------ ------ ------
Net Asset Value, End of Year ........................ $0.87 $0.98 $0.88 $1.18 $1.21
====== ====== ====== ====== ======
Total Return ............................... (7.73%) 15.67% (20.47%) 12.58% 11.83%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (000) ....................... $196,746 $226,692 $212,665 $275,552 $196,516
Ratios to Average Net Assets:
Interest expense .................................. 2.11% 2.09% 1.59% .61% .19%
Operating expenses ................................ 1.66% 1.55% 1.62% 1.44% 1.50%
------ ------ ------ ------ ------
Total expenses ............................. 3.77% 3.64% 3.21% 2.05% 1.69%
====== ====== ====== ====== ======
Net investment income ...................... 3.89% 3.81% 5.34% 5.20% 5.16%
Portfolio turnover rate ............................. 347.44% 347.50% 289.69% 404.05% 460.58%
BANK LOANS
Amount outstanding at end of year (000 omitted) ..... $1,200 $64,575 $20,000 $20,873 $725
Average amount of bank loans outstanding during the year
(000 omitted) ..................................... $49,448 $49,603 $54,479 $24,100 $5,194
Average number of shares outstanding during the year
(000 omitted) ..................................... 178,456 191,692 206,323 184,664 161,404
Average amount of debt per share during the year $.277 $.259 $.264 $.131 $.032
</TABLE>
11
<PAGE>
INDEPENDENT AUDITOR'S REPORT
- --------------------------------------------------------------------------------
The Board of Directors and Shareholders
New York Muni Fund, Inc.
We have audited the accompanying statement of assets and liabilities, including
the statement of investments, of New York Muni Fund, Inc. as of December 31,
1996, and the related statements of operations and cash flows for the year then
ended, the statements of changes in net assets for each of the two years in the
period then ended, and selected financial information for each of the five years
in the period then ended. These financial statements and selected financial
information are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and selected financial
information based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and selected
financial information are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. Our procedures included confirmation of securities
owned as of December 31, 1996 by correspondence with the custodian and brokers.
An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements and selected financial information
referred to above present fairly, in all material respects, the financial
position of New York Muni Fund, Inc. as of December 31, 1996 and the results of
its operations, cash flows, changes in net assets, and selected financial
information for the periods indicated, in conformity with generally accepted
accounting principles.
As discussed in Note 4 the Fund owns 100% of certain securities as of December
31, 1996. These securities include $33,397,267 of bonds (16.9% of net assets),
whose values have been estimated by the Board of Directors in the absence of
readily ascertainable market values. We have reviewed the procedures used by the
Board of Directors in arriving at its estimate of value of such securities and
have inspected underlying documentation, and in the circumstances, we believe
the procedures are reasonable and the documentation appropriate. However because
of the inherent uncertainty of valuation, those estimated values may differ
significantly from the values that would have been used had a ready market for
the securities existed, and the differences could be material.
S I G N A T U R E
New York, New York
February 21, 1997
except for the last paragraph in Note 4 as to which
the date is March 6, 1997
12
<PAGE>
APPENDIX
RATINGS OF MUNICIPAL BONDS
MOODY'S INVESTORS SERVICE, INC.
A brief description of the applicable Moody's Investors Services, Inc.
rating symbols and their meanings is as follows:
Aaa-Bonds which are Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Aa-Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in the Aaa securities or fluctuation of
protective elements may be of a greater amplitude or there may be other elements
present which make the long-term risk appear somewhat larger than Aaa
securities.
A-Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper-medium grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa-Bonds which are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba-Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B-Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
A-1
<PAGE>
Caa-Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest.
Ca-Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C-Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers 1, 2 and 3 to show relative
standing within the major rating categories, except in the Aaa category. The
modifier 1 indicates a ranking for the security in the higher end of a rating
category; the modifier 2 indicates a mid-range ranking; and the modifier 3
indicates a ranking in the lower end of a rating category.
I. Con. (---)--Bonds for which the security depends upon the completion of some
act or the fulfillment of some condition are rated conditionally. These are
bonds secured by 1. earnings of projects under construction, 2. earnings of
projects unseasoned in operation experience, 3. rentals which begin when
facilities are completed, or 4. payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of condition.
STANDARD & POOR'S CORPORATION
A brief description of the applicable S&P Corporation rating symbols
and their meanings is as follows:
AAA-This is the highest rating assigned by S&P to a debt obligation and
indicates an extremely strong capacity to pay principal and interest.
AA-Bonds rated AA also qualify as high-quality debt obligations.
Capacity to repay principal and interest is very strong, and in the majority of
instances they differ from AAA issues in only small degrees.
A-Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.
BBB-Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened
A-2
<PAGE>
capacity to pay principal and interest for bonds in this category than for bonds
in the A category.
BB, B, CCC, CC-Bonds rated BB, B, CCC and CC are regarded, on balance,
as predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and CC the highest degree of speculation. While
such bonds will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
C-The rating C is reserved for income bonds on which no interest is
being paid.
D-Bonds rated D are in default, and payment of interest and/or
repayment of principal is in arrears.
Plus (+) or minus (-): The ratings from AA to BBB may be modified by
the addition of a plus or minus sign to show relative standing within the major
ratings categories.
Provisional Ratings: the letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of the
project being financed by the issuance of the bonds being rated and indicates
that payment of debt service requirements is largely or entirely dependent upon
the successful and timely completion of the project. This rating, however, while
addressing credit quality subsequent to completion of the project, makes no
comment on the likelihood of, or the risk of default upon failure of, such
completion. Accordingly, the investor should exercise his own judgment with
respect to such likelihood and risk.
FITCH
Ratings
A brief description of the applicable Fitch Investors Service, Inc.
rating symbols and their meanings is as follows:
AAA
Bonds rated AAA are considered to be investment grade and of the
highest credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
AA
Bonds rated AA are considered to be investment grade and of the very
high credit quality. The obligor's ability to pay
A-3
<PAGE>
interest and repay principal is very strong, although not quite as strong as
bonds rated AAA. Because bonds rated in the AAA and AA categories are not
significantly vulnerable to foreseeable future developments, short-term debt of
these issuers is generally rated F-1+.
A
Bonds rated A are considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is considered
to be strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
BBB
Bonds rated BBB are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have an adverse impact on these
bonds and, therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
BB
Bonds rated BB are considered speculative. The obligor's ability to pay
interest and repay principal may be affected over time by adverse economic
changes. However, business and financial alternatives can be identified which
could assist the obligor in satisfying its debt service requirements.
B
Bonds rated B are considered highly speculative. While bonds in this
class are currently meeting debt service requirements, the probability of
continued timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and economic
activity throughout the life of the issue.
CCC
Bonds rated CCC have certain identifiable charac teristics, which, if
not remedied, may lead to default. The ability to meet obligations requires an
advantageous business and economic environment.
A-4
<PAGE>
CC
Bonds rated CC are minimally protected. Default in payment of interest
and/or principal seems probable over time.
C
Bonds rated C are in imminent default in payment of interest or
principal.
DDD, DD AND D
Bonds rated DDD, DD and D are in actual or imminent default of interest
and/or principal payments. Such bonds are extremely speculative and should be
valued on the basis of their ultimate recovery value in liquidation or
reorganization of the obligor. DDD represents the highest potential for recovery
on these bonds and D represents the lowest potential for recovery.
Plus (+) and minus (-) signs are used with a rating symbol to indicate
the relative position of a credit within the rating category. Plus and minus
signs, however, are not used in the AAA Category covering 12-36 months or the
DDD, DD or D categories.
DUFF & PHELPS, INC.
RATING DEFINITION
SCALE
AAA Highest credit quality. The risk factors are negligible, being only
slightly more than for risk- free U.S.
Treasury debt.
AA+ High credit quality. Protection factors are strong.
AA- Risk is AA modest but may vary slightly from time to time
AA- because of economic conditions.
A+ Protection factors are average but adequate. However,
A risk factors are more variable and greater in periods of
A- economic stress.
BBB+ Below average protection factors but still considered BBB sufficient
for prudent investment. Considerable BBB- variability in risk during
economic cycles.
BB+ Below investment grade but deemed likely to meet
BB obligations when due. Present or prospective financial
BB- protection factors fluctuate according to industry conditions or
company fortunes. Overall quality may move up or down frequently within
this category.
A-5
<PAGE>
B+ Below investment grade and possessing risk that obligations
B will not be met when due. Financial protection factors will
B- fluctuate widely according to economic cycles, industry
conditions and/or company fortunes. Potential exists for
frequent changes in the rating within this category or into a
higher or lower rating grade.
CCC Well below investment grade securities. Considerable
uncertainty exists as to timely payment of principal, interest
or preferred dividends. Protection factors are narrow and risk
can be substantial with unfavorable economic/industry
conditions, and/or with unfavorable company developments.
DD Defaulted debt obligations. Issuer failed to meet scheduled
principal and/or interest payments.
DP Preferred stock with dividend arrearages.
RATING DEFINITION
SCALE
HIGH GRADE
Duff 1+ Highest certainty of timely payment. Short-term liquidity, including
internal operating factors and/or access to alternative sources of
funds, is outstanding, and safety is just below risk-free U.S. Treasury
short-term obligations.
Duff 1 Very high certainty of timely payment. Liquidity factors are excellent
and supported by good fundamental protection factors. Risk factors are
minor.
Duff 1- High certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are very
small.
GOOD GRADE
Duff 2 Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge
total financing requirements, access to capital markets is good. Risk
factors are small.
SATISFACTORY GRADE
Duff 3 Satisfactory liquidity and other protection factors qualify issues as
to investment grade. Risk factors are larger and subject to more
variation. Nevertheless, timely payment is expected.
A-6
<PAGE>
NON-INVESTMENT GRADE
Duff 4 Speculative investment characteristics. Liquidity is not sufficient to
insure against disruption in debt service. Operating factors and market
access may be subject to a high degree of variation.
DEFAULT
Issuer failed to meet scheduled principal and/or interest payments.
RATINGS OF MUNICIPAL NOTES
MOODY'S INVESTORS SERVICE, INC.
A brief description of the applicable Moody's Investors Service, Inc.
rating symbols for municipal notes and their meanings is as follows:
MIG-1 - This is the highest rating assigned by Moody's to municipal
notes and designates noted judged to be of the best quality.
MIG-2 - This rating designates notes of a high quality by all
standards. However, the margins of protection, although ample, are not as large
as in the preceding group.
MIG-3 - This rating designates notes which are of a favorable quality,
with all security elements accounted for. However, such notes are lacking the
undeniable strength of notes in the preceding two groups. Market access for
refinancing, in particular, is likely to be less well established.
SHORT-TERM RATINGS
FITCH
Fitch's short-term ratings apply to debt obligations that are payable
on demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
Although the credit analysis is similar to Fitch's bond rating
analysis, the short-term rating places greater emphasis than bond ratings on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
F-1+
Exceptionally Strong Credit Quality. Issues assigned
A-7
<PAGE>
this rating are regarded as having the strongest degree of assurance for timely
payment.
Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated F-1+.
F-1
Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated F-1+.
F-2
Good Credit Quality. Issues carrying this rating have a satisfactory
degree of assurance for timely payments, but the margin of safety is not as
great as the F-1+ and F-1 categories.
SHORT-TERM MUNICIPAL LOANS
Moody's highest rating for short-term municipal loans is MIG-1/VMIG-1.
Moody's states that short-term municipal securities rated MIG-1/VMIG-1 are of
the 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. Loans bearing the MIG-2/VMIG- 2 designation are
of high quality, with margins of protection ample although not so large as in
the MIG-1/VMIG-1 group.
S&P's highest rating for short-term municipal loans is SP-1. S&P states
that short-term municipal securities bearing the SP-1 designation have very
strong or strong capacity to pay principal and interest. Those issues rated SP-1
which are determined to possess overwhelming safety characteristics will be
given a plus (+) designation. Issues rated SP-2 have satisfactory capacity to
pay principal and interest.
OTHER MUNICIPAL SECURITIES AND COMMERCIAL PAPER
"Prime-1" is the highest rating assigned by Moody's for other
short-term municipal securities and commercial paper, and "A-1+" and "A-1" are
the two highest ratings for commercial paper assigned by S&P (S&P does not rate
short-term tax-free obligations). Moody's uses the numbers 1, 2 and 3 to denote
relative strength within its highest classification of "Prime", while S&P uses
the number 1+, 1, 2 and 3 to denote relative strength within its highest
classification of "A". Issuers rated "Prime" by Moody's have the following
characteristics: their short-term debt obligations carry the smallest degree of
investment risk, margins of support for current indebtedness are large or stable
with cash flow and asset protection well assured, current liquidity provides
ample coverage of near-term liabilities
A-8
<PAGE>
and unused alternative financing arrangements are generally available. While
protective elements may change over the intermediate or longer term, such
changes are most unlikely to impair the fundamentally strong position of
short-term obligations. Commercial paper issuers rated "A" by S&P have the
following characteristics: liquidity ratios are better than industry average,
long-term debt rating is A or better, the issuer has access to at least two
additional channels of borrowing, and basic earnings and cash flow are in an
upward trend. Typically, the issuer is a strong company in a well- established
industry and has superior management.
A-9
